Cronyism and the global city (again)

“capitalism is a rigged game, in which the ability to fix the next round is part of the prize for winning this one.”

Has anyone ever thought different? The important question though is how to beat the rigging. One answer to which (and not the only one) is those free markets things.

I’d love to see the same article about academics. Children who have parents who are tenured professors at top universities either must have a huge genetic advantage when it comes to applying for academic positions or … nepotism. If you reduce choices to that view of looking at the world, then the financial and academic systems in the world are merely rigged systems for benefit of the wealthy / tenured….

A few years later, in the very early days of blogging, I wrote a post pointing out that the eagerness of financial sector workers to congregate in the same physical location, even though their work was supposed to be based on objective evaluation of data transmitted by computer, was pretty good evidence that the “global city” phenomenon, much in vogue at the time, was just guanxi writ large.

“But this just isn’t true. See ch. 3 of Brown and Duguid’s _The Social Life of Information_ for some discussion of the downsides of people doing their work isolated from one another at the end of an telephone or computer terminal.
Management of people, at least good management of people, requires face to face contact (at least sometimes). And those aspects of the day-to-day running of, say, an academic department, that get achieved over lunch or in the corridor aren’t best represented as “conspiracy” (!).” – Chris Bertram, 2004

I notice that the rejoinder to this was that stock prices always go up when a company moves headquarters to save money, and therefore that proves that it’s the right thing to do. 2004 really was a long, long time ago if arguments like that could be used without anyone laughing…

@JQ

I like that paper – did you try any sociology/anthropology journals?

On the original blog post, Postrel didn’t seem to know that the “guanxi” of Western bank lending had simply moved from local banks (using computerised systems) to brokers. I was reminded of this recently with the resurgence of Buy To Let in the UK. Bank algorithms in the UK have been tightened up a lot, but if you’re known to any of the successful brokers you’ll find your options are much more open.

(That’s all of course before you consider the notion that an automated system embeds particular “guanxi” assumptions in the code. But that’s a bigger topic for another day.)

I’d probably argue that “guanxi” is a ritualised/reified form of “trust heuristics.” As such, like all ritual/reified forms, it presents problems in the strong form, but at the same time, it’s not actually something you can (in the weak form) eradicate…

Also, I’m told that for some types of financial actitivity, network latency is a serious issue. Some of those people care about an additional 10 milliseconds in the time it takes to get a message between their computers and the computers of other organizations. (e.g. High Frequency Trading). So it makes sense if they all locate in the same city, to minimise the number of Internet routers their data is going through.

Tim Worstall @1 – rather depends on what you mean by “free” doesn’t it. “Free” as currently defined, doesn’t seem to stop it happening.

There’s probably something clever to say here about “a rigged game”, “path dependence”, and even “growth” describing the same thing from different points of view.

An interesting discussion! One small point – the writer at Salon is Alex Pareene, not David Sirota.

As someone long interested in urban economics I find this a very interesting perspective. While the benefits of productivity agglomeration have long been recognised, I’ve yet to read many convincing explanations for why agglomeration benefits are so pronounced even in a networked world. Having said that, having been the victim of ‘decentralisation’ policies by employers in the past, I would never underestimate the benefits of having lots of people under one roof.

I also appreciate it been pointed out that ‘guangxi’ and other Asian practices are really just another name for common worldwide practices – I’m reminded of a businessman who was carefully briefed to ensure that his new Asian colleagues ‘didn’t lose face’ in meetings asking if anyone could name an American or European who liked to ‘lose face’.

Just one counter – argument – if agglomeration benefits are largely down to corruption, surely we would see a positive relationship between the levels of corruption in a society and the creation of large cities? I’m not really sure there is such such a relationship, although I suppose you could argue that northern European countries like Germany have a more even urban spread than Southern or Anglo-Saxon states.

I wrote a post pointing out that the eagerness of financial sector workers to congregate in the same physical location, even though their work was supposed to be based on objective evaluation of data transmitted by computer,

I think this actually demonstrated that the supposed benefits of teleworking were massively oversold. In all the CSCW literature, the thing that emerges is that tacit and informal communication doesn’t really work.

In my own work (IT/UX), if I’m working with someone in an office things like requirements need to be well defined, but they don’t have to be perfect. We can work these things out in person, or if a developer isn’t sure about something we can have a quick 5 minute conversation. If work is being outsourced, the requirements have to be absolutely rock solid and perfect, which in practice is impossible. Consequently this results in bugs, or delays if they decide to contact me. Working together in an office is way more efficient.

One reason you tend to get IT clusters as people want to be where there will be other jobs (people move), where they can meet other people and learn, or just do neat stuff (hacker labs/meetups).

John, I think it needs fieldwork or research to back it up. Right now—I have so far only skimmed the paper—, it looks to me like it started as a good blog post, but badly needs some data to back it up. Now, I recognize how difficult it is to get that data, but still, I think that is what would make it work.

Chris Bertram, #16: o/~ I hate to wake up sober in Nebraska ~/o

It’s certainly true that the clustering of various kinds of white-collar jobs in big cities is a big problem for a liberal ideal in which the only ties between people are market exchanges. I am not sure, however, that “cronyism” is a good generic term for all the various ways that nonmarket social ties shape people’s professional lives.

John, I think that this is a rather weak thesis, for the simple reason that cities offer so many benefits for concentrated industries (I can’t find the quote about ‘knowledge in the air’, but you’ve probably heard it). To support this thesis, one has to disentangle honest agglomeration benefits from corruption.

So Barry, having the same water surge knock out the main systems in Manhattan and the business continuity system 10 miles away was a good thing?

But Chris’s reference only shows that co-workers in the same company benefit from co-location, which is entirely plausible. I can’t see a comparable explanation for both parties in a trade of financial assets living in the same city.

Really? Because I can see lots, very easily.

First of all, the relationship between two investment banks (say) isn’t always just that of being counterparties on a trade. They might, for example, work together on a placement or an IPO. In that scenario, they’re co-workers, with all the benefits that being co-located brings.

Second, there’ s more to the financial sector than just banks. Asset managers, hedge funds, law firms, auditors, accountants, consultants, analysts and so on – it’s an entire industry, and they work together – they don’t just do trades with each other. Your lawyer can’t do his job as well for you over a phone line. And once the rest of the industry is there in London, why would you move to Sheffield just to save a bit on lease costs?

SusanC’s point about latency times is also a good one – and becoming more important by the month. It’s not so much that it pays bank A to be in the same place as bank B, as that it pays all of them to be in the same place as the exchange’s server racks.

Alex’s point about hard infrastructure – not the lawyers and auditors, but the cables and data centres – is also good. Why would you give that up? To save a few grand a month on office space?

The basic message here seems to be that the financial industry is actually an industry, and subject to all the same clustering effects as any other industry. You really don’t have to propose any guanxi effects; just economics.

Tell you what – I’ll take on the task of setting those up in NJ, and you the task of doing the same in Nebraska. On the same budget, which you will probably be laughing at (Nebraska is cheap, right?) until you try to assemble the physical and software support.

Not only that, Barry, but P O’Neill can also take on the task of flying all the staff out to your DR centre in Nebraska to resume operations when the office gets flooded; you can drive yours over the bridge to New Jersey or up the road to Midtown. Let’s see who gets up and running again first.
Oh, and by the way, if this is Hurricane Sandy we’re talking about, your New York office is going to be unusable again until the end of March (like Citi’s was) so you’re going to have to fly all your employees out to Omaha, once the airport reopens. No, you can’t have an entire duplicate set of staff sitting in Omaha waiting to be activated; that’s not how DR works. And then you’ll have to keep them there for five months. Living in motels! Without their families! Unable to meet any clients or customers without flying for five hours! They’ll love that! But, hey, you’re saving money on office space.

In the aftermath of Hurricane Sandy, we found out that brilliant investment banks had located their business continuity (i.e. backup systems) in, er, New Jersey.

Probably comes from fighting the last war — it would be much harder for a 9/11 like event to hit Manhattan and Jersey at the same time.

I should add:

Market relationships are always embedded, they always depend on some degree of trust, on shared norms, on the shared (in the broad sense) that makes communication reliable. The idea that transactions — in finance or anywhere else — can be conducted solely on the basis of numbers on a screen strikes me as an economists’ fantasy.

So once you accept that people will always prefer to do business with someone they have other social connections to — for entirely rational reasons — what do you do? Do you try to sever all these connections, destroy the social substrate the market rests on in order to make human labor a fungible commodity like any other? Or do you accept that on some level “guanxi” just means society, and that — to reverse the liberal slogan — we need to abandon equality of opportunity as a mirage, and just worry about equality of outcome?

John, you’ve read Polanyi, right? When he talks about the fiction of the labor market, was your takeaway that we need to work harder to make reality conform to that fiction?

No one has mentioned the key advantage of nepotism in a world full of self-interested individuals: relatives are infinitely more reliable and malleable than are strangers. As Joseph Kennedy was supposed to have said : If you want something done properly, have your son do it.

Has anyone ever thought different? The important question though is how to beat the rigging. One answer to which (and not the only one) is those free markets things.

True – or at least, it was true in Adam Smith’s day, when the rigging was about a titled aristocracy. Not so true today, when the wealthy rig the system by buying it on the “free” market.

@35

Or do you accept that on some level “guanxi” just means society, and that — to reverse the liberal slogan — we need to abandon equality of opportunity as a mirage, and just worry about equality of outcome?

There exists no such thing as utopia. The ultimate mirage, that. I generally assume that we’re all largely agreed on at least that singular point, political/ideological bent notwithstanding.

That said, it seems to me that only a utopian-minded point of view could conceive that worrying about the demonstrably impossible “equality of outcome” is somehow a more constructive use of time and energy than worrying about the admittedly f**king hard yet demonstrably doable “equality of opportunity.”

Surely I’m misunderstanding your point.

Probably comes from fighting the last war — it would be much harder for a 9/11 like event to hit Manhattan and Jersey at the same time.

Spot on there. The thing about BCM is that you have to take a view on what you’re preparing for. If the scenario is “fire in the office” or “someone digs through the fibre line” – by far the most likely scenario, incidentally – then a DR site ten blocks away is fine. If the scenario is “airliner hits building” then you want to be a bit further away, but Jersey is fine. If it’s “storm closes airports and offices” then you need to plan to set up somewhere that’s far enough away not to be affected, but close enough that you can actually get your staff there overland, or you need a plan to get your London office and your NY office to pick up the slack. If it’s “SARS 2: The Sneezening” then you need a different plan again.

One company was very proud of the way it had prepared for a flu epidemic by having two completely separate data centres – so even if staff at one got flu and passed it on to each other, the staff at the other one would be fine. Of course they didn’t reckon on the fact that all the techies at both sites knew each other and used to meet up at a bar midway between the two data centres for beer and contagion after work.

Disaster Recovery isn’t about solving every possible problem. It’s about having a good solution, to likely problems, for a sustainable cost. If your DR solution is so expensive that you lose money in day to day trading, it’s probably not going to work…

Of course most banks have data recovery centers in other countries. They’re called ‘the other offices’. And London is probably more accessible than Nebraska – plus it has better connectivity.

P O’Neill 08.22.13 at 1:48 pm

” So Barry, having the same water surge knock out the main systems in Manhattan and the business continuity system 10 miles away was a good thing?”

P O’Neill, when did you stop beating your wife?

I agree with JW Mason and some others here. Non market social relations are a big deal. This is a significant part of the whole critique of the belief in the existence of ‘efficient’ markets. But to just equate that with all forms of nepotism is ridiculous. I guess you could try to make some ‘difference in degree but not in kind arguments’, but you haven’t even scratched the surface with anything I see here. You’ll be preaching to the choir and no one else with arguments of this quality.

Whenever I hear the term global city, I’m reminded either of the Los Angeles of Blade Runner, or the Manila or Lima of Mike Davis’ Planet of Slums. I’ve no doubt that the City in the sense described in the OP is still a machine for living, but in the broader sense, one still wonders about the machine’s real purpose, or its ultimate destiny….

@49

Equality of Opportunity is crazy hard and laborious, no question.
But history — specifically 19th, 20th, and 21st century history — proves it is both doable and sustainable. Albeit imperfectly. (Winning Ugly, as it were.)

Equality of Outcome, otoh, has NEVER proven doable, much less sustainable. Not. Ever.

M: “Cronyism has many, many forms.”

Indeed. And, in any form, it may be an aid to performance, or a hinderance, or both in succession.

In the ethnically segregated corporate ghettoes of the 1950’s, observing sociologists could cite homogeneity as a organizational strength and source of economies of communication. 40 years later, corporate organizations could discover the advantages of diversity.

The fictions with which we create tension and exceptions are key. The liberal fiction of anonymity in cities and “markets” works to maintain useful normative structures, precisely by departing from reality and creating tension, while benefitting from the check that social reality can provide.

Meritocracy, if pure, is depressing, because it leaves no excuse for failure. Hereditary aristocracy, without competition, leaves no scope for ambition or credit.

We cannot have pure anything social. We cannot have markets in everything. We have to have the fictions of duty, etc. and, the hypocrisy, too, i suppose.

It’s not familial nurturance i would fear; its the familial amoralism. In the OP, not that the rich look out for their own families, but the “and no one else”. That’s the mark of a sick society.

“equality of opportunity” strongly correlates with “equality of outcomes”. In fact the really stupid thing about equality of opportunity is that its proponents believe they can have it instead of equality of outcomes, whereas the first usually presupposes the second.

You can have equality of opportunity, w/out equality of outcomes. But it does require that children are immediately removed from their birth families and raised in a homogenous institutional setting.

Some Kibbutz tried this at one point – I am not sure the outcome of that experience, but a modern understanding of the neurobiology of attachment formation would predict some issues.

[and even then you still have issues of maternal environment, so I guess maternal healthcare and intrusive oversight of pregnant women’s diet and behavior would also be required].

Equality of Outcome, otoh, has NEVER proven doable, much less sustainable. Not. Ever.

What is the NHS except equality of outcome? What is public library except equality of outcome. Basic nutrition for all. This manifestly can and does exist.

In the world of ‘equality of opportunity’ I have the chance to succeed on the same basis as everyone else and if I ‘win’ I will be able to afford books and medicine and food. In a world of ‘equality of outcome’ I get the books and medicine and food even if I don’t win, even before I start to compete. And so does everyone else.

Furthermore, as Random Lurker says, it is hard to image how a child who is not given access to books and medicine (and public transport and basic nutrition etc.) can even begin to have equality of opportunity.

@54

My certainly superficial view of the history of the 20th century says that “equality of opportunity” strongly correlates with “equality of outcomes”.

I agree.

In fact the really stupid thing about equality of opportunity is that its proponents believe they can have it instead of equality of outcomes, whereas the first usually presupposes the second.

Huh? To my knowledge, there are no Equal Opportunity proponents who see Opportunity and Outcome as an either/or thing. Not at all. In fact, you’re totally correct in that equalized outcomes, to whatever extent possible, can only happen in an environment of equal opportunity.

So, clearly you believe Equal Opportunity is a “stupid thing”, but I’m left totally confused as to why you believe it’s a stupid thing.

@58

I don’t disagree with any of your points- I suspect we’re simply miscommunicating. Sounds like you and I hail from different countries. (NHS? That’s UK, no?) The OP and links are specific to the US, which is me.

Equal Opportunity, as a governance concept in the US, is about Federal Law. I’m not saying that state and local laws can’t help a person out, but EO doesn’t happen in this country unless it is under the auspices of Federal Law.

That something has not been done in the USA hardly proves that it can not be done.

It’s disappointing to see downthread the argument that equality of opportunity = equality of outcome. Two students in the same class with the same textbook don’t automatically get the same grade.

That’s really turning the argument on its head. The argument is that equality of outcome (everyone gets a book) = equality of opportunity.

Medicare’s an equality of outcome program.

It’s disappointing to see downthread the argument that equality of opportunity = equality of outcome. Two students in the same class with the same textbook don’t automatically get the same grade.

But if one of them doesn’t even have a textbook, or didn’t have anything to eat on test day, they’re even less likely to get the same grade. As long as children are dependent for most of their resources on *their parents specifically* and not on society generally, any inequality of outcomes in the parental generation will crop up as inequality of opportunity in their children.

@ktward & Paul
The “Lysenko argument” only holds if you think of total equality of outcomes.
As a matter of fact, societies have different degrees of quality: suppose that we have 3 societies A, B and C.
– In society A, everybody has the same income of 100 whatever they do;
– In B, the average guy has income of 70 and the very rich guy income of 700;
– In C, average guy has income of 40 and very rich guy income of 4000.

While only A can be described as “complete equality of outcomes”, society B is certainly more equal than society C. I think nobody (or almost nobody) disputes that we can reach societies that are more equal than the society we live in presently, not as a pie in the sky dream but as a material possibility. Maybe we can reach society B for real (though even C is more equal than the world we live in presently).

However, the idea of “equality” in general was apparently abandoned somewhere in the last quarter of century, replaced with “equality of opportunities”. This, apparently, happened because the more general concept of “equality” was tainted by the experience of soviet communism. As a consequence, the more limited concept of “equality of opportunity” was developed, as more doable in a free market society.
“Equality of outcome” is just the residual of equaity – equality of opportunity.
As a consequence, I assume that when someone speaks of “equality of opportunity”, he/she uses that concept in opposition o “equality of outcomes”.

But in pratical reality, it is impossible to have “equality of opportunity” alone, if society is extremely unequal: “equality” (in general) is a prerequisite of “equality of opportunity”, as other commenters pointed out. So speaking of “equality of opportunity” alone is quite misleading IMHO.

Wealthy people will be able to buy luxuries wherever they live.

They can’t buy a decent city in which there are things to do; there aren’t too many good restaurants in small towns.

Maybe academics are so used to having to move to wherever the institution that happens to hire them is that they have a hard time imagining how it can be otherwise?

“If access to opportunity is more evenly distributed, the market should take care of the outcomes.”

Well, yeah it should. But it doesn’t.

Find myself wondering when “the pure and hard-edged version” of capitalism was ever found in the US. And when in history have the rich failed to look out for themselves?

The drop in the quality of food & entertainment from a great city like NYC or Chicago to a good city like, say, Denver is quite significant even if you’re not rich. If you’re rich it’s even bigger.

I’d put this much more strongly. In NYC, Toronto, LA, etc., you can get amazing non-expensive food—esp. good ethnic food, also groceries—access to art-house films, and lots of other cultural amenities that don’t cost a ton and that are simply not available in a city like, oh I don’t know, Cleveland.

There is, of course, something to this, but it’s also very easy to over-put. Since Denver was mentioned, and I just moved from there, I can say that it had a lot of food options that were as good or better than New York (where I also lived for a few years.) It was certainly much easier to get good (and often inexpensive) Mexican food in Denver. Denver has one of the best sushi restaurants in the US (Sushi Den.) The average local beer in Denver is much better than the average local beer in NY City. The street food trucks in Denver were better, more varied, and at least no more expensive than in NYC. The Korean food in Denver was very good, and compared nicely with that in NYC. If you want to take hamburgers, fries, and beer as a combo, I’d match Park Burger in Denver with pretty much any place in NY City. There are a lot of reasons to like NY more than Denver- in fact, I’d rather live in NY than Denver- but the idea that NY is just head and shoulders above more mid-sized places for many things is just not true. And, of course, if you like to do outside activities at all, (anything except go to the beach, really) Denver is just massively, massively better.
(I can’t say anything about Cleveland, having never been there.)

On cross-generational transmission of occupation (e.g., the professors discussion upthread), there’s some systematic work on the topic in sociology. For those with institutional subscriptions to JSTOR, see Jonsson et al. 2009. “Micro-Class Mobility: Social Reproduction in Four Countries.” American Journal of Sociology 114: 977-1036.

Or, for a shorter version, Jonsson et al. 2011. “It’s a Decent Bet that our Children Will be Professors Too.” Pp. 499-516 in The Inequality Reader: Contemporary and Foundational Readings in Race, Class, and Gender, 2nd Edition, edited by David B. Grusky and Szonja Szelényi. Boulder: Westview.

The punchline is, as I recall, that about 10% of men and 3% of women have the same occupation as adults as their fathers. Most of what sociologists think of as social class inheritance is driven by occupational inheritance. The exception is among professionals, where there’s some general classwide inheritance: e.g., the sons of doctors are more likely to become lawyers than they are to become, say, carpenters.

These patterns could be generated by a lot of different mechanisms, including the transmission of occupational skills, socialization into occupational tastes and cultures, direct transmission of occupation-specific financial resources (e.g., the family practice), and, yes, the benefits of social networks.

At ajay, #5: indeed. Entire careers and a whole sub-discipline in geography are centered on the agglomeration of regions of knowledge/expertise. Tacit knowledge is best shared by the gold standard of person to person. That has yet to change in the networked world.

A false trilemma, actually.

Sorkin’s piece is especially ironic in light of this sort of thing:

http://dealbook.nytimes.com/2013/07/15/on-wall-st-a-culture-of-greed-wont-let-go/

If it’s fine for the market to be a self-perpetuating oligarchy – so long as this arrangement makes self-interested sense for the firms that employ these rings of cronies – it’s a bit hard to see why we should be bothered about a spot of undetected insider trading. It’s not going to hurt your firm if you engage in undetected insider trading, after all.

And to clarify further, it’s not that I think there isn’t cronyism in the financial sector. There surely is—Pareene’s article makes this very clear I think. It’s just that the argument in the post—about clustering—would prove too much if it were right. Because there’re all kinds of reasons why you might see that kind of geographical clustering of some industry that need have nothing to do with cronyism.

Given that explicit exchanges of non-public information are tightly constrained by insider trading laws, I’d say it’s the exchange of tacit information that matters.

What fraction of total financial transactions, do you think, are sales of corporate stock where one party is an insider? 0.1%? 0.001%? Less?

Ah, just read the update. You are a funny man, John.

The concentration of finance in exchange centers (NY, London etc.) was essentially mandated by early securities laws. While it’s hard to imagine today, back in the day of paper shares it was a legal requirement that physical securities were delivered within 3 days between custodial agents of buyers and sellers. As one can imagine, in the ‘pre-flight’ pre-computer era this effectively mandated co-location within a fairly tight physical proximity as it usually took 24 of the 72 available hours to see a transaction recorded, shares were then delivered on day two and recorded to the receiver on day three satisfying the requirement.

Fed-ex didn’t exist and regular mail was no where near efficient or quick enough. As late as the 1960s the industry employed thousands of runners to move ‘papers’ between trading houses. Large firms would do this hourly because of the sheer volumes involved and being located across the street from each other in lower Manhattan or within the 1 square mile of the city in London was a physical necessity.

Electronic trading has created some dispersion, but realistically the biggest of the big were already established in their locations so moves were to Jersey City from Lower Manhattan or Connecticut, not to the middle of nowhere. There are countless good reasons already given above ranging from critical mass, to access to talent to quality of life that perpetuates the status quo.

I’d note however that while the location of exchanges and clearing banks remains clustered, the location of “buy side” houses and money managers disperses more and more all the time. One of the biggest – Blackrock – is primarily located in Princeton, NJ which is well away from the information sharing/cronyism implied by the OP and yet they do just fine.

“One of the biggest – Blackrock – is primarily located in Princeton, NJ which is well away from the information sharing/cronyism implied by the OP…”

You must be joking. Eating Clubs. Nassau Inn. Reunions. Etc.

@106
Congratulations on missing the point. Allow me to spell it out.

The point is there used to be a reason for phyical co-location. With modern communication tools that’s no longer necessary for cronyism to persist in its various flavors. If the processing/exchange banks have chosen not to relocate to East-Overshoe Nebraska, there must be some other reason for that since the money managers have and continue to do so….Baltimore, Ardmore PA, Princeton, Kansas City, Cleveland….all have hundreds of billions of assets under management.

111: you’re wrong because Dodd-Frank isn’t banning OTC derivatives, it’s just mandating that they be CCP cleared where appropriate and exchange traded where possible. And both of those moves are going to increase, not decrease, the advantage of physical co-location.
Nor do I think it’s clear why an OTC derivative trade would benefit more from face-to-face contact than any other sort of trade. Unless you’re thinking of the kind of customised derivative that, say, an insurer might draw up – if you’re providing pensions to a lot of ex-IBM workers, you might draw up a contract where the underlying is “life expectancy of a cohort of retired engineers aged between 75 and 85 in California”. That’s not a standardised contract, so you’ll need to do a lot of work with your bankers to get it done and sell it – but that kind of bespoke contract is exactly the kind that will be left unaffected by Dodd-Frank.

John: “Update/clarification I’ve implicitly taken the efficient markets hypothesis as a benchmark, and assumed that features of the financial sector (for example, physical colocation) that can’t be explained by EMH are likely indicators of cronyism. ”

I think that you’re not invoking EMH, but rather an idea of frictionless markets.

I can try playing capitalist to my heart’s content and attempt to rig the market: whether I fail or succeed will depend upon the number of people competing with me. Free markets curtail the capitalist desire to rig the market.,/i>

I’d prefer to see a more direct approach to investigating collusive practices, or at least one which triangulates via a number of approaches. In the paper, JQ says that some aspects of regulation of the financial sector encourage physical dispersion.
Financial sector enterprises are supposed to maintain ‘Chinese walls’ between different groups of workers, such as securities analysts and investment bankers, in order to ensure that advice given to one group of clients is not compromised by the business interests of other groups within the firms. Similarly, partners in law and accounting firms may be subject to conflicts of interests, precluding them from giving advice to one party in a transaction or dispute, if close colleagues represent other parties. The likelihood that conflicts will be judged material is enhanced if the relevant partners are located in close physical proximity.

This is surely an important point – but because of the trajectory of the paper, is approached from a slightly eccentric angle, eventuating in a counter-intuitive conclusion. I’ve gone on about the degradation of the concept of conflict of interest – in favour of something much like ‘material’ conflict of interest (conflict of interest that actually matters, because it is so blatantly operative as to be impossible to ignore) – on two Larry Summers threads. But here it’s treated not as a target of analysis but as a lemma in the ‘argument from clustering’. The conclusion, tailored to that argument, is that businesses should be expected (pro tanto, prima facie, cet. par, or what-have-you) to try and strengthen chinese walls through geographical distance, so as to remain above suspicion. But since it’s perfectly obvious that chineses walls, e.g. between auditors of and providers of lucrative consultancy services to a given client, are often mere fictions, surely the point is actually that by maintaining physical proximity and thus the opportunity for covert communication, firms can avoid being found to have ‘material’, i.e. provably operative, conflict of interest.

I’d like to hear a lot more detail about the operation of what JQ refers to as ‘relationship capitalism’ or, more pejoratively, as ‘crony capitalism’, of which he continues: In general, it is viewed favourably during booms, when the disregard of process tends to facilitate rapid generation of wealth, and less favourably during recessions when the exchange of personal favours and the evasion of formal controls tends to be reclassified (often retrospectively) as corrupt.
—

Also, just to note that Rajan and Zingales are clearly Worstall-style free market fundamentalists, and have a rather different focus. They discuss ‘relationship financing’ as an exotic, old-fashioned, state-backed failure of ‘free markets’, rather than as (collusive) business as usual. Rational-actor, profit-seeking models are best (or least poorly) exemplified by sophisticated financial operators with good info, high intelligence and adequate time, staff and processing power at their disposal (cf. the various EMHs).

It’s therefore rather absurd to suppose that these people wouldn’t be engaged in, and rather good at, ‘rent-seeking’ via collusion as well as ordinary ‘market power’. The benefots of ‘bounded competition’ are obvious, and the ability to organise it via collusion is a trivial matter when heads of hierarchical organisatiosn are able to communicate in secrecy. Even more absurd to suppose that it is the notoriously inefficient and malcoordinated state that is the primary – and indeed only – source of the ‘rents’ sought via behind-the-scenes manoeuvring. I really don’t think the point is stressed enough that free-market types really do talk as though ‘markets’ were actually perfectly competitive (as well as lacking sharp practice except via lobbying teh State), and thus utterly ignore the reality of oligopolistic corporate capitalism with all its confidentiality and unaccountability. It’s as if economies of scale, and the concomitant tendency to centralisation, didn’t exist – whereas in fact of all the concepts of classical and neoclassical etc. economics, this is surely one (of rather few, I think) that has undeniable reality. But I suppose focussing on it would tend to create a certain tension when one’s main approach is the ‘know-nothing’ or ‘Nothing Succeeds as Planned’ model.

—

JWM; What fraction of total financial transactions, do you think, are sales of corporate stock where one party is an insider? 0.1%? 0.001%? Less? Well how are you proposing to settle this issue? Direct confirmable evidence will indicate only a lower – and one would suppose a very low – bound on the true vlaue. It also very much depends on how you are going to define ‘insider’ – it’s the transfer of ‘insider’ knowledge that’s important, not the status of one party (or both: collusive practices based on illicitly aquired non-public info may benefit both parties as against the general public). And there are plenty of ways that a class of colluders can obtain benefits to the public detriment besides standard cases of ‘insider dealing’.

most of the Spanish-speaking residents are Mexicans and Central Americans rather than Puerto Rican or Dominican) I find it harder to avoid good and inexpensive Mexican food that it is to find it.

Unless Denver has places with multiple quality taquerias on the same block, I don’t think it beats Sunset Park.

First, Mexican food and food from other Central American countries is often quite different. (The food from each Central American country differs, too, though less starkly, in my experience, from Mexican food.) Secondly, there are several places in Denver itself, and several more in the surrounding suburbs, with multiple taquerias on the same block. Is it surprising that there would be better Mexican food in places with large, long established Mexican populations? You can find some pretty okay Chinese food in Denver, but not like going out to Flushing. It’s similar in the other direction for Mexican food.

@112
My argument would be that the major banks are clustered for valid historical reasons associated with the physical processing and delivery of share certificates. The money managers were much more similarly co-located when physical delivery was the norm. Ever since electronic delivery and custodianship money management has dispersed – while the banks have remained where they always had been.

If access to cronyism and insider information was a meaningful part of money management, they wouldn’t have dispersed, which suggests to me that location isn’t a key driver to informational access. I’d agree with JQ that there is some presumption that information has a value if we accept a reasonable degree of EMH….it has to be that distance is no longer an impediment to access.

Equally, the fact that banks have remained clustered and close to the exchanges suggests that there is some reason for doing. While cronyism and guanxi may play a role – as others suggested infrastructure, access to talent and other factors are likely at play. I wouldn’t discount the simple fact of inertia – which is to say, what’s the case FOR moving, the strand has collectively listed dozens of reasons against. Cost doesn’t long stand as a good reason if you lose talent or market presence.

Trader Joe 08.23.13 at 4:00 pm

” My argument would be that the major banks are clustered for valid historical reasons associated with the physical processing and delivery of share certificates. The money managers were much more similarly co-located when physical delivery was the norm. Ever since electronic delivery and custodianship money management has dispersed – while the banks have remained where they always had been.”

As in all things, Krugman has written on this – he mentioned in a column that Manhattan has seen a ‘hollowing out’ of the mid-level financial work, compared to the 70’s and before[1]; work which could be conducted off-site has frequently been sent to New Jersey. High-level work, which would involve lots of personal touch, is still strongly in Manhattan, as well as the low-level work (e.g., janitors).

[1] Note – *relative* to what it was before, when not being in the same building was a much bigger problem for communications.

It should be noted that there is a certain amount of image that comes with being in certain locations. There are certainly cheaper areas of the respective cities that these firms could set themselves up in; areas where they would still have access to the infrastructure they need, would still allow for networking and cronyism, would still have access to the same labor supply, etc. Yet in my experience these firms tend to stick to expensive offices in prestigious locations. Whether this is because they think it’s necessary to attract clients and recruits or they simply have access to too much money to waste is another question.

“Presumably, then, Tim Worstall’s programme for implementing ‘free markets’ involves government intervention to stamp out all monopoly, oligopoly, and imperfect competition, as well as outright collusion and other admittedly ‘sharp practice’. And if not, why not?”

Pretty much. Some monopolies can’t be stamped out (say, sewage provision) and thus need to be regulated instead. Slightly depends upon the definition of imperfect competition: there was definitely a period when I was making excess profits (in the formal definition) in my little corner of the metals world. On the grounds that I had more information than anyone else, no other advantages. Should the government then insist that all other metals traders should be issued with that information? Not sure I would so argue, no. And not just because we’re talking about me and my profits.

But as a general theme, yes, I rail against monopoly and oligopoly.

On equality of opportunity, Random Lurker is very much correct, as so often.

It’s always worth pointing out that the neoliberal conception of this differs from the norm. When they talk about equality of opportunity, they are always talking about equality of opportunity for capital, not for people. That’s taken for granted for them. Witness Mr Worstall up there, saying

…whether I fail or succeed will depend upon the number of people competing with me. Free markets curtail the capitalist desire to rig the market.

Which is of course not necessarily correct because it assumes that those other people possess enough credit to compete with the capitalist in question (as well as all the non-market relationships that can be so useful).

I commend href=”http://delong.typepad.com/sdj/2010/11/neoliberal-economists-agonistes.html”>this post from Prof. DeLong which lays out a thought-process justifying the ‘let markets do their thing’ approach while being fully aware of the power disparities:

He (and I) never were believers in the efficient markets hypothesis. How could we be? Look around: there are idiots! The market’s prices are the results of a wealth-weighted voting mechanism: the more money you have, the bigger is your weight in the market’s average. People who have done well in the recent past thus have more weight than people who have done badly.

[ . . . ]

The financial rich are overwhelmingly the patient risk-bearers. The financial poor are those who sought safety, or who were unwilling or unable to hold their positions and wait for fundamentals to reassert themselves. Leverage then becomes a way of taking the money of the risk-averse of whom the market has too many–for that is what low long-term returns on “safe” portfolios tell us–and putting it too work in the hands of the too-few who will use it to take the long-term risks that the market, historically, has always handsomely rewarded. And financial sophistication becomes a way of concentrating and amplifying the rewards of risk-bearing to call forth additional risk-bearing capital to bolster the numbers of the too-few.

The ‘He’ mentioned at the beginning being Lawrence Summers.

“So that programme in full:”

Eh? I’m supposed, just as some bloke writing on the internet, to have a full and entire economic policy ready to drop into a blog comments box? On the off chance that I’m asked for one?

“‘Regulate’ (not nationalise, of course),”

Seems like a good idea. When the UK privatised water and sewage provision England got those regulated private monopolies. Wales got a mutually owned one (200 of the Great and Good of that nation own it), Scotland got a government owned company and Northern Ireland stayed with local council run provision. When OfWat looked at the results a decade later they checked on various things. Prices (lower is good), quality of water (higher is good) leaks, (fewer is good), river and environmental quality (cleaner is better). And England was the most improved, Wales second, Scotland third and NI fourth.

So yes, it would seem that nationalisation is a bad idea as at least in this instance the more the government is involved the worse the performance.

“Which is of course not necessarily correct because it assumes that those other people possess enough credit to compete with the capitalist in question (as well as all the non-market relationships that can be so useful). ”

I can assure you that there are very few capitalists with insufficient credit to be able to compete with me. It’s likely that there are cats with sufficient credit to be able to compete with me.

@John Quiggin “@NR Do you think Columbia/NY would get this kind of benefit wrt Berkeley/SF?”

No. Definitely not. But I imagine Berkeley/SF would probably have the same sort of advantage as NYC with respect to most other places in North America.

(Interestingly, the former Columbia VP who told me this is now the Chancellor of UC Berkeley.)

“You’ve made it quite clear you don’t have any idea how anything resembling ‘the free market’ is supposed to magically unrig the capitalist game, so that’s good enough for me.”

A slightly strange statement given that I’ve offered a direct and personal example of how the market prevents me from exploiting my previous oligopolistic position in the scandium market. But if that’s what you want to believe then so be it.

Pfft. Why should actual evidence change prejudices?

@Tim Wilkinson: Unless you have some experience in the markets, it is a bit hard to believe how easy it is to get people to give you money to play with. Convince them you have a good idea, put some of your own money to work and show that it works, and they will open the gates and write big checks. If you want to compete with the other Tim, you just need some scandium, and put it out that you will buy and sell scandium.

138: also “But we are going to increase the capital requirement and regulatory scrutiny of the remaining OTC derivatives [1] in order to provide an ongoing incentive for the industry to get its act together in terms of setting up clearing facilities, and because the rump of genuinely unclearable OTC contracts are probably an adverse selection of the whole universe”.

[1] and, perhaps controversially, set a very low weighting indeed on exposures to clearing houses, which we presume will have no unintended consequences at all hem hem.

also, I think the point that might have banjaxed JQ is that central clearing isn’t the same thing as exchange trading, although the fact that people don’t generally understand this is entirely the industry’s own fault for conflating the two during the usual period of hysterical Chicken-Littleism that forms its reaction to any regulatory change ever.

Nor do I think it’s clear why an OTC derivative trade would benefit more from face-to-face contact than any other sort of trade.

I think on this point, though, that it’s definitionally true. An OTC trade[1] is not a standardised commodity, so there are always details to be agreed. And where there are details to be agreed, there’s a need for people to trust each other, which is a lot easier to achieve if they’ve met each other.

[1] unless we’re talking about a trade that is classified as OTC because it’s done on an ICAP screen or similar “I Can’t Believe It’s Not A Securities Exchange” trading facility. In which case, you still benefit from knowing the market, in the sense of having met a lot of the players, because you get a much better sense of whether the quote is likely to be firm or not, and whether your order flow information is going to be used to trade against you. Mind you, I do agree that it’s not really a case of OTC = face to face and exchange = disembodied robots. There’s a reason why, even for stocks quoted on a number of exchanges, all the liquidity and trading is in their home country.

set a very low weighting indeed on exposures to clearing houses, which we presume will have no unintended consequences at all

Indeed. I might as well save time and start writing “How the CCP Crisis Of 2017 Happened” stuff now.

A clearinghouse should really be a non-profit public utility. Nevertheless, even the competitive private clearinghouse model (which is not optimal because competition can lead to reductions in margin and cutting corners in other ways) should have big systemic risk benefits over the OTC markets. It is worth looking at the historic record of clearinghouses — in over 150 years of use, a clearing house has never failed in the U.S. (although there have been near misses). This is quite different from the record of banks. Clearinghouses have very large impacts in shortening financial intermediation chains and greatly reducing the complexity of the web of counterparty exposures. Clearinghouses are also purely in the business of risk management, period, they are far better at it than banks.

Yes, a large clearinghouse would be TBTF. But it’s a cheap debaters point to say this and then be all YOU HAVEN”T GOTTEN RID OF FINANCIAL RISK HAR HAR HAR. Particularly since the central role of clearinghouses was in the first place a compromise with the financial industry that didn’t want to see more radical change. For a good background and what the regulators are thinking the issue, I recommend this speech by Ben Bernanke.

b) that this regulator-guaranteed stream of business will show up whether or not the product is actually liquid enough to be clearable

A decidedly mixed blessing for the clearinghouse, unless its time horizon is extremely short.

c) there is basically no oversight of the clearing houses’ decisions with respect to a

This is simply not true, at least in the U.S. I don’t understand the European rules as well.

Fair points all, although some of those near misses have been very near indeed, and “consider the 150 year track record” is surely exactly what the crisis should have taught us we shouldn’t do. Getting interest rate swaps (and currency swaps and swaptions) onto a centrally cleared basis is the right thing to do for all the reasons that you suggest, and frankly should have been done years ago, except that nobody in the industry trusts each other.

But setting up central clearing as the gold standard, and giving the clearing houses effectively guaranteed funding reinforced by a zero risk weight creates the sort of moral hazard that you really can’t deal with, and I don’t think the regulators seem to understand at all that there really are some products that can’t be cleared (and most specifically, that nearly all single-name CDS fall into this category). Added to which, there’s a finite supply of clearing house eligible collateral, and parking more of it at clearing houses means that you have more uncollateralised or inadequately capitalised exposures somewhere else. It seems to me that people have got all fired up about a part of the system that actually worked pretty well during Lehmans (bilateral OTC exposures).

The Great Clearing House Crisis of 2017 that Ajay is planning to write about actually nearly happened in 2009, when the LCH raised haircuts on Italian government bond collateral in Repoclear. The problem created by clearinghouses is not that one of them might collapse, it’s that the measures they take to ensure that they don’t collapse have horrible knock-on effects elsewhere in the system.