A small challenge to a Nobel prize winner in Economics!
In a recent New York Times op-ed, Paul Krugman continues his boundless quest to become the “it” guy in the world of economics. I have taken issue with his command of basic economic facts in the past — a gutsy, if not insane thing to do given the man was awarded a Nobel Prize in Economics.
This post is more about ego than economics, however.
In this op-ed, Mr. Krugman says (and I kid you not),
…But after the debacle of the past two years, there’s broad agreement — I’m tempted to say, agreement on the part of almost everyone not on the financial industry’s payroll — with Mr. Turner’s assertion that a lot of what Wall Street and the City do is “socially useless.” And a transactions tax could generate substantial revenue, helping alleviate fears about government deficits. What’s not to like?
Well, I disagree with the idea that what Wall Street does is socially useless. And I am not on the financial industry’s payroll.
Nope, I’m just a simple economist, using my head, training, and experience to consider this idea, map out the pros and cons, and analyze the logical end-game of such a tax. I conclude that it is a really bad idea.
Why? There are lots of reasons, but I will mention only two.
- One, raising taxes reduces private economic activity, which will curtail growth, reduce tax revenues and increase the deficit.
- Two, taxes distort the price signal between suppliers and demanders of goods and services, including financial capital, reducing economic efficiency.
His reasons? Other than citing one academic study (while ignoring the many others that reach a different conclusion), he gives no economic reasons for his views. Instead, he make claims. He claims, for example, that “socially damaging behavior … caused our current crisis.” He says that the financial services industry is “bloated” and needs to be cut down to size. He says that the new tax is okay because it raises revenues for the government which, he claims, should make us all feel better about the deficit and, apparently, the size and nature of government spending under Obama. And, the lamest of all, for no other reason than to hide behind their skirt, he claims the existence of some phantom majority, apparently to create the impression that anyone with a different view is clearly in the minority. A tactic that should be beneath a Noble Prize winner, but one that runs through his work with increasing frequency over time.
But, Mr. Krugman, I so disagree with you. And even in an op-ed piece — perhaps especially in an op-ed piece – I believe that one needs to reign in an ego that would parade claims as facts, especially when each of those claims is disputed by your fellow economists, none of whom stooped so low as to imply that you were paid for your views.
By Sherry Jarrell
Learning from Dogs 
Dear Sherry:
No offense meant or contained, but I will resonate thus:
Banks are not pastry shops. Just as airlines, or aircraft makers, they are crucial institutions in society. They create money. For everybody. Not just Mr. Bankster.
Just as aircraft makers, when they fly a new product, there should be rule. Airbus and Boeing cannot fly (and a fortiori sell!) anything they want. Even the first flight is regulated. later the test programs are rigorous, and closely supervised by government regulators, with all sorts of milestones and tests well in excess of foreseeable circumstances (wings are bent 150% beyond maximal operating loads, for example). Why different for financials? Not everybody flies, but everybody uses money, and money, or lack thereof, kills just as well.
A Financial Transaction Tax is a necessity. It will not just be considerably income generating, it will force the banks to feed again the real economy. As a tax on cigarette or alcohol, it would be a sin tax, the last step before outright outlawing exaggerated transaction which are “socially useless” as the British finance minister pointed out.
A well known dogma: “raising taxes reduces private economic activity, which will curtail growth, reduce tax revenues and increase the deficit.” So let’s not raise taxes; taxes, as they are are obviously perfect. Especially the one about the hyper rich paying no more than 15% in taxes.
An even funnier one: “taxes distort the price signal between suppliers and demanders of goods and services, including financial capital, reducing economic efficiency.”
Hmm… Maybe we should just not do taxes anymore, there would be no more distortions. The solution to that problem had been found in the European Middle Ages, where taxes were roughly zero. Peasants shared the land, they paid their Lord in kind. The Church, being the richest, did charity. The department of defense would send troops about the land, to get necessities, rest and relaxation among the populations. No doubt the USA will be back to this state pretty soon.
I have advocated a Financial Transaction Tax for years, and was the first to do so as far as I know (Tobin’s was about currencies).
Some reasons for the Financial Transaction Tax go conceptually deeper than what usual economists are used to. In physics, the speed of light is finite, so as to maintain causality. the FTT is needed in economics to reestablish causality, and allow to make sense of the economical universe.
Finance is not a primary economic system, it’s just a trick used by sophisticated economies. It’s a bit like ABS (Assisted Braking System): you need brakes first. Then you can tinker with them. No brakes, no ABS.
Enormous economies have worked splendidly without finance. Constantinople and the high and middle Middle Ages being splendid examples. During the Second World War, the main Western economies switched to command and control, and it completely crushed the capitalistic free market Nazi system.
There is plenty of evidence that the existing financial system is not just too big relative to the existing economy, but has actually transited to another universe, the universe of derivatives. The geniuses who created that contraption were careful to connect it to the normal universe only through imaginary revenues and real bonuses. To energize the parallel universe, they use all the capital they can find, correspondingly starving the real economy of capital.
Now the real economy is in the physical world, where projects take time. In a given duration, very few real world economic projects can occur, while, in the fake world of derivatives, an ever increasing arbitrary high number of derivative cycles can generate an arbitrarily high “revenue” and thus “profit”. These activities are not in the real universe, so are not just “socially useless” as the British finance minister put it, but they actually have no impact on our universe whatsoever, except to generate bonuses and fake added values for the richest of the rich.
This has got to stop, because the speed of derivative cycles could go to infinity (indeed it is in what is called in physics a phase space, so it’s not even limited by the speed of light!), and in the process of feeding that infernal device, it would suck up absolutely all capital.
As the velocity of derivative trade keeps on going up, causality itself fails, and one can argue that this has already been observed (say in oil futures, which went up from 25 to 150 and then back down to 40 without obvious causality).
Hence a speed limit has to be introduced. One can do this in several ways. A proportionally tiny Financial Transaction Tax is a way to do this. Another interest is that the Financial Transaction Tax will limit how much fake revenues could be made in the fake universe of derivatives.
So, some will naturally observe, why not to outlaw derivatives all together? Because they can be useful for commercial operators insurance purposes, as set up initially for farmers in the Middle West. So if an airline wants to go long oil future with dazzling leverage (properly regulated), fine. But if it’s Goldman Sachs, not fine: leverage should be severely limited, because it is a bank, in trust of public money, and in trust of money creation. Then the FTT will come into play, handicapping further those ways that caused the crash of 2008 and the general perversion of the economy of the West. The airline, would not be handicapped by the FTT, since airlines rarely trade, as they use futures for insurance.
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I agree that there are some issues that need to be explored regarding the separation of commercial banks and investment banks. But banks could not create money without the fractional reserve system of the Federal Reserve. So the root source of money creation is the Federal Reserve and the policy and regulation of the federal government.
The financial crisis was caused by the social engineering activities of Congress, and by its lack of understanding and appreciation of the fairness of the free market.
There is a large and meaningful gulf between the so-called laws of physics as they currently exist and the pricing activities of an economic system. Try as you may, physics does not inform economic transactions, including derivatives. The two fields happen to share some mathematical expressions, but that is where the similarities end.
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An article about the fractional reserve system would be welcomed by this reader!
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Dear Sherry:
We seem to start to agree that banks are a function of the State (through the Fed, sure, and the fractional reserve system, sure, but precisely my point).
Now as far as physics and economics are concerned, I precisely claim information ought to flood from the former to the later.
I know perfectly well that I am the only one with that opinion, but I have lots of new reasonings to back it up with. I put out the idea of the relationship between a finite speed of transaction and causality on the Baseline Scenario, where people were not as dismissive of it.
My implicit argument about the speed of light and causality is even new, in physics. There is a well known connection between speed of light,relativity and causality, but it’s different; my argument is much more general: in a world with an infinite interaction speed, any butterfly’s flutter would instaneously move the entire universe, making the butterfly into God.
Thus, if one does not believe in God, but in locality, thus in hte fact that butterflies are small, one needs a finite interaction speed. The same reasoning carries over to derivatives, and is at the heart of the instability they created (the way they are presently set-up).
I claim that many reasonings used in physics are general enough to apply to economics. Economics is not just about pricing things.
My general view of the situation is actually that the Lagrangians in economics are more genral than in physics, so I expect economics to become somewhat more general than physics.
Eco-nomy is house-management. “House” is a physical concept. “Management” is a meta concept applied on… physics. And what is manage, ultimately? Not just money, not just people and infrastructure, but ENERGY.
Energy is THE fundamental concept of contemporary physics. So it is in economics. just economists don’t know it yet.
Very respectfully yours,
PA
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Paul:
I was thinking about an appropriate link to “fractional reserve system”, and could think of none. then I got the amazingly self serving idea to search my own site, and, to my amazement, it worked splendidly.
Here is one article I extracted: http://patriceayme.wordpress.com/2009/10/20/the-principle-of-plausible-public-utility/
But there are dozens of others, and some are actually pedagogical, and do the basic math.
meanwhile, to inject some humor:
Banking is not private industry, it’s state industry. In the hands of the privates.
When such a thing was done on the seas, a few centuries ago, the floating equivalent of banks, were called privateers. It was roughly the same idea as with fractional reserve private banking. The European states had invented such a method to insure their influence. Ships called privateers belonged to and were run by individuals or private companies but were authorized by their governments to engage in battle during war, and keep the profits. This is what is happening now, and the banks are apparently making war on the people (who else?)
PA
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