“As investigators comb through the wreckage of the financial meltdown, one fact remains clear and startling: Credit default swaps and collateralized debt obligations, as well as debt and equity from large financial firms were useless as indicators of fiscal health. One of the biggest revelations has been the utter failure of markets to capture the relevant information required to set accurate prices on securities.” (emphasis mine)

And this is from Fortune magazine, not some leftist socialist newspaper.

The price is not always right.

http://money.cnn.com/2010/04/01/markets/hedge_fund_manager_pay/index.htm

“the 25 top-earning hedge fund managers made a record $25.3 billion last year … [this] marked a dramatic comeback from the beating managers took during the financial crisis … Income for top hedge fund bosses plummeted nearly 50% in 2008 to $11.6 billion” (emphasis mine)

Oh, those poor guys. Only 11.6 billion. They really took a beating.

It’s hard to take seriously claims that financial superstars need to be paid obscene amounts to make them perform well when they make only slightly less obscene amounts when they do terribly.

“A tourist stops at a motel and gives the manager a $100 cash deposit while he looks at the rooms. The manger runs and pays off his $100 debt to the butcher. The butcher runs and pays off his $100 debt to the farmer. The farmer pays off his debt to the feed store, and then the feed store owner pays off his debt to the motel owner. The motel owner then gives the $100 depost back to the tourist.”

That’s called a liquidity crisis. Everyone’s net worth is above zero. Everyone has debts and credits, but no one can pay their debts because they can’t collect their credits. All you need to solve this problem is a little liquidity. Temporary use of some money that can be later returned. Low interest small business loans would work nicely.

But there’s a different kind of financial problem called a solvency crisis. Imagine instead that a restaurant owner takes out a small business loan to stock his wine cellar. The next day Bernie Madoff comes in and drinks $1000 of wine, paying with cash. The restaurant owner turns around and invests that cash in Madoff’s hedge fund. The next day Madoff comes back and drinks another $1000 of wine, paying with cash (the same $1000 bill he used yesterday), and the restaurant owner turns around and invests that money with Madoff too. This continues ten times. Madoff has drunk $10,000 of wine, and has a $10,000 debt (the investment he is supposed to eventually return to the restaurant owner), but he only has $1000 of cash to repay that debt. Madoff has a solvency problem. His net worth is less than zero. Temporary use of some cash, to be paid back later, would not solve this problem. This situation is different because value was actually destroyed. The $1000 of cash still exists, but $10,000 of wine disappeared into Madoff’s stomach, and Madoff didn’t produce anything of equal value he could use to pay for the wine.

If the restaurant owner was counting on his Madoff investment to pay off his small business loan he’s got a problem too. He may think he has a liquidity problem (as soon as Madoff pays me I can pay my debts), but really Madoff is never going to pay. Madoff’s solvency problem creates a solvency problem for the restaurant owner too.

Our current financial situation is a giant artificial solvency crisis. Lots of people can’t make their mortgage payments because they lost their jobs, and they can’t sell their houses because they are underwater because of recent steep price declines. It appears they have a net worth less than zero. This solvency crisis is somewhat artificial because it has been created by a liquidity crisis which is causing all the job losses and the lack of house buyers causing the price declines. But the liquidity crisis was caused by a real underlying solvency crisis. People funded unaffordable consumption with either deficit spending (home equity loans and credit cards) or fictitious investment profits (selling stocks or real-estate at bubble prices). Whoever made those loans or bought at bubble prices now has a solvency problem, and that solvency problem can propagate to whoever they owe money to.

It’s important to think about this in terms of stability. Airplane manufacturers think a lot about stability. When a gust of wind tips an airplane a little to the side does it naturally come back to center, or spin out of control? Having stability is a good thing, but stability can be sacrificed for performance. Acrobatic airplanes can do those amazing flips and spins because they are much less stable than a jumbo jet. But there’s a reason airlines don’t fly passengers from New York to LA every day in high performance acrobatic airplanes.

One of the fundamental root causes of our current financial crisis is that our financial system was unstable. A small solvency crisis created a bigger liquidity crisis, which created an even bigger solvency crisis. A small gust of wind tipped our wing a little and we spun out of control.

During the bubble, financial firms thought that exotic financial instruments and high leverage were great because they increased financial performance. But they were ignoring stability. We managed to build our economy into a high performance acrobatic plane instead of a reliable jumbo jet. Individuals should be held responsible for a personal solvency crisis caused by unaffordable consumption, but society should design the financial system to be stable so that those individual solvency problems don’t propagate and amplify. That is achieved with boring financial regulations like margin requirements on banks, and loan-to-value requirements on mortgages.

That’s the tagline for Karrass negotiation training. You may have seen the ad on the back cover of an airline in-flight magazine. There’s a distinguished looking gentleman letting you know that:

“You don’t get what you deserve, you get what you negotiate.”

It’s supposed to make you think you need to take his class to become a really good negotiator. When I saw that my first thought was, capitalism is broken.

I mean, shouldn’t people get what they deserve? If there were one socioeconomic system that gives people what they deserve and another that doesn’t, wouldn’t we prefer the one that does?

Instead, if someone said, “You don’t get what you deserve, you get what you can steal.” We would think this person had their values screwed up. This would be someone whom good people should be protected from. It wouldn’t make you want to take a class to become a really good thief.

1) Force people to fulfill their moral obligations when they might not do so under the honor system. People have moral obligations, whether these are negative obligations like not committing crimes or positive obligations like doing what you agreed to in a contract. Society should make sure these obligations are fulfilled. If we can do so without government that’s great, but if not it is legitamate to use coercive, statist government to make sure these things get done.

One refrain I have heard from libertarians is, “Government cannot give anything to anybody that it doesn’t first take from somebody else.” The idea being that government is nothing more than a common theif. I have a more expansive idea than libertarians of what positive moral obligations people have. When people work just as hard and take the same risks but get different results due to forces outside their control they have a duty to even out those effects of undeserved luck. Government taking money from someone to give it to someone else can be a legitimate act of forcing someone to fulfil their obligations. Libertarians complain that this doesn’t create wealth, but creating wealth isn’t the purpose of it. The purpose is ensuring fairness by making people live up to their obligations.

Not every case of government transferring money from one person to another falls under this legitamate purpose. There are a lot of instances where government programs are just unfair boondoggles for some special interest.

2) The second purpose of government is to create value in a small number of cases where the private sector has trouble. For this I’m thinking of things like the interstate highway system, a local water utility, or fundamental science research. There are goods where fundamental features of the good make it hard for the market to supply it efficiently. These cases are rare, but they exist. Libertarians are right that society could get along without the government doing this, but less value would be created. We need to carefully consider cases when the inefficiency of government is better than the inefficiency of a non-governmental solution or not having the good at all.

First, I feel like some people are still going to say, “What you propose is theoretically impossible, human wants are infinite.” For basic necessities I don’t think so. All you can eat restaurants are an example of that. Also, the hierarchy of needs theory says that once you have your lower levels of the hierarchy satisfied you move on to higher levels. For emotionally healthy people who don’t try to satisfy love and esteem needs by accumulating material goods, their desire for the basic necessities is finite.

But there is is the danger that the co-op will turn into something like a college dorm. Everyone is forced to accept an identical apartment with low quality furnishings that get trashed all the time because nobody cares about taking care of anything because there’s no individual ownership. That could happen, but a lot of the problems of college dorms are due to the emotional maturity level of the residents. It’s ridiculous to think that in a community of a few hundred people they wouldn’t be able to work things out and agree not to act that way knowing if everyone acted that way they’d all be worse off. Game theory might say people will always be selfish and short-sighted, but people often don’t behave how game theory says they should.

And their are other ways to deal with the problem. You could have free housing, but still make people individually liable for damage. You could have “housing” be an empty apartment and people have to provide their own furnishings.

As far as forcing everyone to have the same you could have different size apartments. The basic level is free and you pay for upgrades. If there are several different communities to choose from and members of a community have a say in the community design then the available choice shouldn’t be any worse that the current system where you have to pick from what’s available in your price range.

There’s also a problem where certain community members may contribute less or create more costs than average. For the most part I don’t think this will be a widespread problem. People in these kinds of communities won’t be the type to count pennies and get upset if someone else gets 3% more benefit than them for the same cost. The whole point of the community is to avoid the cost and hassle of keeping track of those kind of details. Everyone pays a non-onerous price, and everyone gets their needs met. If you get upset if the cake isn’t sliced exactly equally then you won’t want to live there.

But there will still be the possibility of a few problem residents who are just irresponsible an uncooperative. I do think the community will need a way to kick people out after reasonable attempts to solve the problems. There may even come a time when the community is torn by issues that can’t be resolved, and there should be a previously agreed upon process for dissolving the community.

Even if some communities don’t work out it doesn’t mean the surplus co-op model isn’t useful. Every year many small businesses go broke and go out of business. Libertarians would never accept that as evidence that small businesses are an infeasible form of organization because many small businesses do succeed, and even when a business fails the participants often try again with a different business and succeed. So it will be with surplus co-ops.

There’s a final problem that a co-op could turn into a cult. I get a sense from libertarians that they feel it is inevitable that any system based on cooperation will always become a totalitarianism where a leader or ruling class oppresses everyone else. I don’t think it is inevitable, but it is a possibility. Awareness and openness are probably the best defense against this problem.

A surplus co-op would probably only work for a self-selected group of people who want to live in that sort of community. It would need procedures for kicking out bad apples, or even dissolving the community entirely. The process of planning economic production would require time and effort and probably some social norms. But I think it’s entirely feasible.

Such a community could provide a welcome alternative for those who don’t want to live in an every-man-for-himself libertarian world while removing moral objections for a more libertarian system outside those communities for those who want that.

http://en.wikipedia.org/wiki/Principal-agent_problem

It’s one of the oft heard mantras of capitalist apologists that in capitalism you are spending your own money on something for yourself so you are motivated to spend your money wisely, while the government is spending someone else’s money on someone else so there’s no motivation to spend it wisely.

But most of the time you aren’t actually directly doing something for yourself, instead you are paying someone else to do something for you. This gives rise to the agent problem where the person you are paying is not really motivated to do what’s best for you.

If you remember my post from a long time ago about a problem I had with an electrician doing a bad job. The electrician wasn’t motivated to do a good job. He was just motivated to get paid. He was perfectly happy to do a quick and sloppy job and still get paid because I didn’t have the knowledge to tell whether he did a good job. I spent my money on something for myself and didn’t get what was best for me because of the agent problem.

In fact, the agent problem is the reason behind the corporate capitalist structure itself. When a company gets too big for the owners to personally supervise all employees they have to add layers of managers, and more layers to supervise the managers. You wind up with a bloated organization where many people are there just to look over other people’s shoulders.

The agency problem is a big efficiency problem for corporate capitalism. The reason Dilbert is so funny is because it rings so true. You really do find all kinds of crazy behavior in a corporate bureaucracy because the people there do not have a strong motivation to accomplish the organizations goals.

Incidentally, that’s why I’m not scared of government health care. Any government health care system will be a giant bloated inefficient bureaucracy. But so what, our health care system is already run by a giant bloated inefficient bureaucracy. It just happens to be a corporate bureaucracy, but that doesn’t give me any warm fuzzies. The agent problem is fundamental to any bureaucracy whether government or corporate.

1. Food
2. Clothing
3. Shelter
4. Utilities (plumbing, heating, etc.)
5. Health Care
6. Child Care
7. Elder Care

I put “pays” in quotes above because it doesn’t have to be just money.  Members could contribute work instead, young children and the elderly could be exempt from paying, etc.

Sounds idealistic.  How would it work?  One objection could be that if you allow people to have as much as they want then demand would be infinite and thus unsatisfiable.  My earlier post about surplus economics talks about this.  The short answer is that for some commodities demand is not infinite, and all-you-can-eat restaurants are proof of that fact.

But even if it’s theoretically possible, how would it really work?  You still have to decide how much stuff to produce or buy and that has to be at least equal to desired consumption or there will be shortages.

Here is my vision of how it would work.  An intentional community of a few hundred people owns enough housing for all its members.  This could be an apartment building or separate houses, there are many possibilities.  Each member must contribute a certain number of hours of work each year.  Members of the community would do construction and maintenence.  The community would staff it’s own medical clinic and child care center, etc.  There are enough people to achieve economic benefits from division of labor.

It’s not necessary that the community be self-sufficient, but I think a certain amount of the community producing its own goods would provide benefits.  It would lower transaction costs and marginal costs, which would make it easier to provide goods in surplus.  It would also improve stability in the face of external economic shocks by having internal customers for internal jobs.  But it’s unlikely, and probably not desirable, that a community would be entirely self-sufficient so some members would buy down their work hours with dollars from jobs outside the community.  These dollars would be available to buy things that the community doesn’t produce.

Aggregate production would be planned by direct democracy.  The community would come together and figure out how much food will be needed, how many person-hours of maintainence work to expect, etc.  Planning could be done annually, or quarterly, or more often if it proves beneficial.  These plans would be based on past data, requests from members, and problems with previous plans.

What I am suggesting is a centrally planned economy.  Centrally planned economies have gotten a bad reputation due to certain totalitarian states that had a centrally planned economy.  Some would even suggest that centrally planned economies are doomed to fail.  But those people fail to notice that there are plenty of successful centrally planned micro-economies all around us.  Every corporation in America is internally centrally planned.  And so is every family budget.  The important thing to consider is who does the planning for whom and what checks and balances exist to make sure everyone’s interests are taken into account.  I think it would be difficult for a controlling elite or special interests to co-opt a process of direct democracy involving only a few hundred people.

The specific work assignments could be allocated in the plan as well, or a market based system could be used.  The plan lists how much stuff needs to be produced and what service jobs need to be done, and members bid for the work.  I might offer to vacuum the common area in exchange for a credit of 1.2 hours, and someone else who offers to do it for 1.1 gets the job.  But just like the planning process the market system would have to be well designed to prevent abuse like someone with a unique skill weilding monopoly power, or someone low-balling a bid and then doing a bad job.

Consumption would not need to be planned, regulated, or tracked in accounting ledgers in any way.  Eliminating the work involved in tracking consumption is one of the benefits of this sytem.  Consumption could be handled in many ways.  There could be a community supermarket where you go and pick up the food you want, or there could be a community restaurant where you order what you want and it’s prepared for you with the cooking staff being part of the production plan.  The members of a community have flexibility in deciding exactly what they want to provide themselves, and thus how much work will be required of each member.

I know your head is probably brimming with potential problems this community might have, and I will eventually talk about that.  But first, let me talk about benefits.  Why would someone want to live in such a community?

First of all, let me say that not everyone would want to live in such a community.  But that’s the beauty of an intentional community.  A self-selected group can create the environment in which they want to live, even if it’s not for everyone.  The kind of person that would want to live in a surplus co-op is someone for whom money is not the primary motivation in their life.  It may be someone who wants a comfortable middle-class lifestyle, but not someone who fantasizes about being rich.  It would be someone who would take more free time over a larger paycheck.  This person would be annoyed at the antagonistic nature of a buyer beware system.  Even if they could defend themself they would ask, “Why do I have to defend myself?  Why don’t people just treat each other fairly as a matter of course?”  This person would have strong values about helping others in need and feel ashamed to live in a rich country where some people are homeless.  For such a person it would be a great benefit to live in an environment where economics is seen as a group effort to provide prosperity and fairness to everyone instead of the war of all against all.

In addition to those kinds of benefits, I think this system could be economically more efficient than our current system for several reasons:

1) Lower transaction costs

We won’t need people to stand behind a checkout counter, or stand in line to check out.  There won’t be any billing or collections.  Paperwork will be drastically reduced.  Also, transaction costs can prevent the most efficient transaction from occurring.  For example, small quantities of small items can’t be sold very easily.  If you go into a hardware store you can buy a box of a thousand screws for maybe a penny per screw, but you can’t buy one screw for a penny.  Transaction costs would overwhelm any profit.  So you have to buy a pack of at least 10, and it costs a lot more per screw than if you bought 1000, and there’s extra packaging waste to keep the small package from getting shoplifted.  But if you really only need one screw the other nine are left unused in a junk drawer in your garage.  That’s wasted production that could be avoided if there was just a bin of screws and you took only what you were going to use for free.

2) Higher capital utilization

On an average suburban street with 20 houses there are 20 washing machines that are each used maybe 5% of the time.  That street could get by with just one washing machine.  The same is true for lawnmowers, microwave ovens, etc.  A surplus co-op could achieve the same benefit with less production by getting higher utilization of the goods that are produced.  I’m not saying it could get 100% utilization.  Maybe no one wants to do their laundry at 2am.  But it could certainly improve on the current utilization of household appliances.

3) Design to eliminate need

Currently, most people have a car that they use to drive to work.  You could say that having those cars is an economic benefit, but most people consider their daily commute an annoying chore.  If you could reorganize things so that people are within walking distance of their work, that would be an even better economic benefit than having those cars even though it means less consumption of material goods.  You won’t be able to eliminate every need in this way, but I think it’s fertile soil for a significant reduction in the production required to provide a good standard of living.

4) Full employment

A surplus co-op won’t need to keep a certain percentage of people unemployed to provide liquidity in an every-man-for-himself labor market.  Instead, everyone will be required to contribute and labor allocation will be a collaborative effort to ensure that everyone is doing productive work.

I said I would address potential problems, and I will, but this post is already getting too long, so I will do it in another post.  Feel free to offer problems in the comments.

“To my progressive friends, I would remind you that for decades, the driving idea behind reform has been to end insurance company abuses and make coverage affordable for those without it”

“Ends discrimination against people with pre-existing conditions”

This relates to the philosophy I’ve talked about before that if people take the same risk and get different results for reasons outside their control they have a moral responsibility to even out those results.  That’s what progressives believe.  Just by living we are all taking the risk of getting sick.  When Republicans try to scare people about having to subsidize health care for others they only talk about overweight smokers, people who they can point their finger at and say “It’s their own fault.”  They don’t talk about a 6 year old with Lukemia.  I have no problem paying the average cost of treating both healthy and sick people, even though I’m healthy and could pay less if we left those sick people to fend for themselves.

Traditional economic theory says demand is fundamentally insatiable.  People always want more of everything.  Even with the law of diminishing returns, economists still assume that getting a little more of any good will always make you a little bit happier.  This idea has even been codified into the law of scarcity – the problem of infinite human needs and wants, in a world of finite resources.

And yet, all-you-can-eat restaurants make money.  Why doesn’t the first person through the door eat everything?  Clearly, for some goods, demand is not insatiable.

According to the law of scarcity, it is an iron rule that demand will always be greater than supply, and therefore consumption must be restricted in some way.  Whether through prices or rationing, people cannot be allowed to consume as much as they want because there can never possibly be enough.

But what if scarcity doesn’t apply to some things?  The demand for food isn’t infinite.  And our current technological society is very productive.  It’s rediculous to think that we couldn’t produce enough food to make everyone in America say “No thanks, I’m stuffed.”  We could do that if our society decided to use it’s economic resources in that way.

Economics already has a concept called free goods for things like air where everyone can have as much as they want without anyone having to lift a finger to produce it.  What I’m suggesting is a different catagory.  A surplus good is something that would be scarce if we didn’t produce it, or didn’t produce enough of it, but that we have the ability to produce enough to entirely satiate a finite demand.  Whether something is a free good, a surplus good, or a scarce good may change in different times and places.  And any society will most certainly have instances of all three types.

This could lead to a new paradigm of surplus economics instead of scarcity economics.  There would still be problems to solve of how to gather information to know how much production is required to satiate demand, how to motivate productive behavior, and how to share the costs of production fairly, but gone would be the problem of how to restrict consumption.

This may sound like kind of a weird idea, and you may be wondering where am I going with this.  I didn’t want to throw too much into a single post so I’m going to elaborate on this idea in another post later.  Stay tuned.