Cronyism and the global city (again)

by John Quiggin on August 22, 2013

Alex Pareene at Salon points to a bunch of evidence showing, in essence, that the rich look out for themselves and their kids, and no one else, then to a piece by Andrew Ross Sorkin defending nepotism in the US, and by extension in China. There was a time, not so long ago, when Asia’s reliance on guanxi and similar networking practices was denounced as ‘crony capitalism’, to be contrasted with the pure and hard-edged version to be found in the US. This was supposed to explain the vulnerability of Asian economies to the crisis of 1997, and the stability of the US, then well into the Great Moderation.

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.

I turned that into a magazine article at Next American City (now Next City, whose web site seems to have lost it). Then I wrote a longer and more academic version and submitted it a lot of journals in economic geography, urban geography and so on, none of whom were interested. I think it stands up well in retrospect (much more so than most of the ‘global city’ literature, at any rate), but of course I’m biased.

At any rate, at least now everyone, and not least a defender and beneficiary of the system like Sorkin, is comfortable with the notion that capitalism is a rigged game, in which the ability to fix the next round is part of the prize for winning this one.

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. It’s possible to take the view that the financial sector does things that are inconsistent with EMH, but nevertheless socially beneficial. An obvious example is the kind of opaque, over-the-counter derivatives that Dodd-Frank has tried to ban, and that the finance sector is lobbying hard to protect: it seems clear that doing these kinds of deals would benefit from face-to-face contact. So, if such deals are, in aggregate, socially beneficial, my argument fails – the converse also holds.

{ 147 comments }

1

Tim Worstall 08.22.13 at 7:47 am

“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.

2

Barry 08.22.13 at 8:30 am

“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.”

Jesus Christ, man – at least try to come up with some logic.

3

MapMaker 08.22.13 at 9:15 am

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….

4

John Quiggin 08.22.13 at 9:40 am

@3 If you had bothered following the link, you would have seen that comparable problems in academia are discussed, though the primary issue is personal connections rather than family relationships.

5

ajay 08.22.13 at 9:54 am

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…

6

John Quiggin 08.22.13 at 9:57 am

Indeed, I noticed that too.

7

John Quiggin 08.22.13 at 9:59 am

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.

8

SusanC 08.22.13 at 10:16 am

One advantage of being in the same city as other similar businesses is that many of your employees are in long-term relationships (married, civil partnerships, whatever), typically both partners work, so both partners need to find jobs in the same city, and so it makes it much easier to hire people if you’re in a location where the partners of prospective employees will be able to find work.

In high-tech industries (don’t know about finance) I’ve seen this being a serious factor in choice of location.

9

Metatone 08.22.13 at 10:23 am

@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…

10

Metatone 08.22.13 at 10:26 am

@SusanC – that seems to suggest that “tech” has more “in discipline” long-term relationships. (No idea if that’s true.)

At a more general level, that’s a major advantage of a big city. Both people might be able to find work that they are happy with.

11

SusanC 08.22.13 at 10:28 am

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.

12

MapMaker 08.22.13 at 10:29 am

Read the links, thanks. Was referring to Sorkin’s article. Having your children’s names splashed across the NYTimes as Sorkin did is embarrassing, even if he did think were “deserving”. In academia, I know the children of the towering legends in my field, a large number of whom ended up in great academic positions. I’d seriously like to know if that is as common across all academic fields and whether people view that as cronyism, merit or what…

13

reason 08.22.13 at 10:36 am

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.

14

Alex 08.22.13 at 10:36 am

But why would you expect the productivity benefits to come from being co-located with your counterparty, rather than being co-located with your colleague or your client? That seems a weird thing to expect.

Also, being co-located with your suppliers would surely help. For example, the ring around the City of London is rammed with data centres, dark fibre, LINX interconnection nodes and the like. You could move the company to Sheffield, or Paris, but re-creating all this infrastructure would be extremely expensive.

You might object that this stuff is there because its customers are there, but now that it is there, it’s a kickable fact you have to deal with. (And in part, the customers were there because some of that stuff was *already* there.)

15

Alex 08.22.13 at 10:38 am

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.

16

John Quiggin 08.22.13 at 10:42 am

@12 There’s a natural tendency of children to do the same kind of work as their parents, and to acquire a bunch of relevant skills by osmosis. But unless you’re in the same discipline (not unknown, but uncommon), the fact that your parents are professors is almost entirely irrelevant when it comes to the job market. Having parents in the same field is a mixed blessing, I’d say.

Academic genealogy (that’s literally what we call it) runs from dissertation adviser to student, not from parent to child. But with that change, there is plenty of nepotism going in, particularly in the inner circles.

17

Steve Williams 08.22.13 at 10:55 am

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

18

John Quiggin 08.22.13 at 10:59 am

@17 D’oh! Fixed now.

19

PlutoniumKun 08.22.13 at 11:53 am

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.

20

Zamfir 08.22.13 at 12:30 pm

Plutonium, as someone who does regular business with small-town German industry, I can assure you that it is deeply drenched in connections. Everybody knows everybody who is everybody, from their golf clubs and from boozing. Especially bankers, who have a different and closer relation to industry than London City-style bankers. Foreigners and women have a tough job getting into the circles, and ‘foreigner’ often includes Germans from too far away.

21

Cian 08.22.13 at 12:30 pm

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).

22

hix 08.22.13 at 1:03 pm

How do you define guanxi in this context? To me it is a very specific term describing only the Chinese model, which cannot be used as a synonym for broader asia specific difference to the anglo saxon model.

23

The Raven 08.22.13 at 1:09 pm

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

24

P O'Neill 08.22.13 at 1:14 pm

A couple of things that seem to support the hypothesis.

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. This suggests a combination of managerial preference and cronyism … there is no way the suits were going to head out to Nebraska where backup systems for a New York bank should be when they could seem edgy by taking their pals to dinner in Jersey City after a a business continuity inspection visit and then come back to Manhattan by boat.

Then there’s Washington DC. In the last couple of years there have been numerous articles about the city’s boom, which is interpreted to mean the arrival of “professionals” and other supposedly high value service sector works. It’s almost certainly a lot more to do with consulting firms and others who thrive in the broader federal government contracting ecosystem — for which connections are critical.

25

JW Mason 08.22.13 at 1:21 pm

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.

26

Barry 08.22.13 at 1:28 pm

P O’Neill “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. This suggests a combination of managerial preference and cronyism … there is no way the suits were going to head out to Nebraska where backup systems for a New York bank should be when they could seem edgy by taking their pals to dinner in Jersey City after a a business continuity inspection visit and then come back to Manhattan by boat. “

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.

27

Barry 08.22.13 at 1:32 pm

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.

28

JW Mason 08.22.13 at 1:47 pm

There are three possibilities here.

1. “Knowledge-sector” firms are concentrated in big cities because various external economies make them the profit-maximizing location, despite higher costs.

2. Knowledge-sector firms are concentrated in big cities because their employees prefer them, and have the social power to make this preference effective even when it is less efficient from the point of view of profit maximization.

3. Knowledge-sector firms are concentrated in big cities because of cronyism and corruption.

As Barry says, more empirical work would be needed to distinguish 1 from 2. But I think just as important, more conceptual work is needed to distinguish 2 from 3. It is true that since the 1980s, there has been a widespread view that a corporate decision made on any bass except maximally enriching shareholders is inherently unethical. But I wouldn’t imagine John Q. shares this view.

29

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?

30

Omega Centauri 08.22.13 at 1:56 pm

I’ll certainly second what Cian said. Its hard to communicate (or recieve) a subtle point via emails. But, in person one can usually just cutto the relevant intellectual issue. certainly where skills and the development of the foundations upon which deeper understanding of intellectual issues are involved, having parent (or role models) in the house growing up is a great advantage. I rememebr my kids making remarks like “I wish our teachers could explain stuff (math) like you do”. Their co-students with equal genetics, just didn’t recieve that those crucial adavantages early on.

Even, if it isn’t formal nepotism. If I were interviewing someone I have some social acquaintence with, I’d be more confident in my ability to correctly judge his ability to do the job, than I would of a total stranger. I also suspect the candidate will natually be a bit less prone to nervousness during the process.

31

ajay 08.22.13 at 2:06 pm

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.

32

Mao Cheng Ji 08.22.13 at 2:17 pm

Cronyism has many, many forms. From the straight father-son nepotism in the movie industry, to ethnic preferences in business (and the mob), to nationality (regardless of ethnicity) in international organizations. Haven’t had a chance to read the link, but the emphasis on geographic location seems to be a way to miss the point of it.

33

chris 08.22.13 at 2:27 pm

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.

34

Jerry Vinokurov 08.22.13 at 2:29 pm

It’s funny that in a thread a few weeks ago we had folks telling us all about how in-person education was totally obsolete, and here we are discussing the various benefits of agglomeration to being able to work together in close proximity. Just a funny kind of coincidence, I guess!

35

JW Mason 08.22.13 at 2:31 pm

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?

36

JW Mason 08.22.13 at 2:34 pm

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.

This is a really perfect example of the liberal position. Genes and money may legitimately be passed from parents to children. Any other connection between family members is, by definition, nepotism.

37

peter 08.22.13 at 2:35 pm

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.

38

Bob 08.22.13 at 2:47 pm

What Barry said

Showing my age here, but jane jacobs and urban economists used to (still do?) claim that cities were the fount of all economic activity and especially innovation The claim was based on a host of reasons, not simply social or family connections.

39

Ragweed 08.22.13 at 2:55 pm

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.

40

bob mcmanus 08.22.13 at 3:25 pm

35: we need to abandon equality of opportunity as a mirage, and just worry about equality of outcome?

Pretty much as the starting position.

Certainly not full Harrison Bergeron or Stalinist state capitalism, but an initial position that the lucky will find their satisfactions or rewards (which need not be monetary or political power) and the less lucky need all the help we can give them, and that this is the just society is the likely moral decision.

Maybe I should worry more about freedom or efficiency. But they don’t seem urgent.

41

ktward 08.22.13 at 3:54 pm

@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.

42

mud man 08.22.13 at 4:01 pm

Zamfir #20: Foreigners and women have a tough job getting into the circles, and ‘foreigner’ often includes Germans from too far away.

Is localism the same thing as agglomeration? There’s certainly a lot of nepotism/cronyism (sexism) out here in our small city, but I don’t think there’s the room for the NYC-type inequality. Maybe it’s just the same thing writ small, but it does seem that distributed localism is a defense against the radical instability that JQ mentions. Not driving as fast as you absolutely can is safer, in general.

… and if you have to go to your backup systems, that’s going to cost, indeed it is. “Drive over the bridge”, yuk yuk yuk.

43

ajay 08.22.13 at 4:03 pm

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.

44

ajay 08.22.13 at 4:07 pm

if you have to go to your backup systems, that’s going to cost, indeed it is. “Drive over the bridge”, yuk yuk yuk.

Yes, drive them over the bridge. That’s what Morgan Stanley did when it got flooded out – “I wasn’t expecting to have to go into the bus business”, their head of disaster recovery said, but the bank spent the next month or so operating a sizeable fleet of buses to get employees around between DR sites and from home to work.

45

Cian 08.22.13 at 4:41 pm

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.

46

Cian 08.22.13 at 4:46 pm

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.

My kids at 6 already have basic experience of programming. Not because they’re particularly smart, but because I work in the industry, am interested and had the cultural capital to access the resources necessary to make that happen. I’m guessing this will give them a considerable advantage if they ever want to work in the industry. Where does that fit on the genetic/nepotism scale?

47

Barry 08.22.13 at 5:35 pm

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?

48

Anon 08.22.13 at 5:42 pm

The generalization of the point that Ajay is making is in the Glaeser inspired literature on scity specialization. The latest is a working paper by Rebecca Diamond, that emphasizes agglomeration effects on worker productivity. So businesses go to global cities because of the high productivity relative to the wage. I am not saying that that is right, but that you haven’t dealt with the key points of the mainstream literature. I think there is a very interesting paper if you extend it to deal with that literature, but until then I can see why it was not published.

49

mpowell 08.22.13 at 5:47 pm

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.

50

js. 08.22.13 at 5:55 pm

the demonstrably impossible “equality of outcome”

Except that the much-loved “equality of opportunity” is equally impossible. Or at the very least, thinking through what it would really mean to have equality of opportunity shows it to be a much weirder idea than it’s normally taken to be. For a non-economist’s treatment of this thought, it’s well worth checking out Bernard Williams’ “The Idea of Equality”.

51

William Timberman 08.22.13 at 6:09 pm

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….

52

Watson Ladd 08.22.13 at 6:10 pm

JQ, I lived in a town where people worked in finance. The reason is because the market is for finance jobs and people would prefer not to move when they change jobs, ergo employers will want to locate nearby. See the literature on flexibility in the labor market having to do with housing supply type: home ownership reduces ability to move with the job.

53

ktward 08.22.13 at 6:19 pm

@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.

54

Random Lurker 08.22.13 at 7:30 pm

@ktward
My certainly superficial view of the history of the 20th century says that “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.

55

Bruce Wilder 08.22.13 at 7:30 pm

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.

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Ronan(rf) 08.22.13 at 7:54 pm

Dont these kind of exclusionary social/employment networks work ‘all the way down’ though, and not just by osmosis but by design? How do you get into university if you come from a family with no history of third level education? How do you get a trade if you come from a family with no connections/history of having a trade? What are your possibilities of being succesful in an SME (profession, trade etc) if you havent inherited a ‘name’/social network etc? Hiring practices are always tied up in this, and your abilities to prosper in a field is generally tied up in it as well
I agree with Sorkin, although I might be missing the point and havent read all the comments, what happens at the top doesnt really matter, if social mobility is the aim

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Ragweed 08.22.13 at 8:13 pm

“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].

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Lance 08.22.13 at 8:14 pm

“..Depressions occur after investment bubbles burst. In free-market capitalism, capital generates income for the owners of the capital which in turn is used to create additional capital. This is very good. Sometimes, it can be actually too good. As capital continues to accumulate, its owners find it more and more difficult to deploy it efficiently. The business sector generally must interact with the household sector by selling goods and services or lending to them. When capital accumulates too rapidly, the productive capacity of the business sector can outpace the ability of the household sector to absorb the increasing production.
The capitalists, or if you prefer, job creators use their increasing wealth and income to reinvest, thus increasing the productive capacity of the business they own. They also lend their accumulated wealth to other businesses as well as other entities after they have exhausted opportunities within the business they own. As they seek to deploy ever more capital, excess factories, housing and shopping centers are built and more and more dubious loans are made. This is overinvestment. As one banker described the events leading up to 2008 – First the banks lent all they could to those who could pay them back and then they started to lend to those could not pay them back. As cash poured into banks in ever increasing amounts, caution was thrown to the wind. For a while consumers can use credit to buy more goods and services than their incomes can sustain. Ultimately, the overinvestment results in a financial crisis that causes unemployment, reductions in factory utilization and bankruptcies all of which reduce the value of investments.
If the economy was suffering from accumulated chronic underinvestment, shifting income from the non-rich to the rich would make sense. Underinvestment would mean there was a shortage of shopping centers, hotels, housing and factories were operating at 100% of capacity but still not able to produce as many cars and other goods as people needed. It might not seem fair, but the quickest way to build up capital is to take income away from the middle class who have a high propensity to consume and give to the rich who have a propensity to save (and invest). Except for periods in the 1950s and 1960s and possibly the 1990s when tax rates on the rich just happened to be high enough to prevent overinvestment, the economy has generally suffered from periodic overinvestment cycles.
It is not just a coincidence that tax cuts for the rich have preceded both the 1929 and 2007 depressions. The Revenue acts of 1926 and 1928 worked exactly as the Republican Congresses that pushed them through promised. The dramatic reductions in taxes on the upper income brackets and estates of the wealthy did indeed result in increased savings and investment. However, overinvestment (by 1929 there were over 600 automobile manufacturing companies in the USA) caused the depression that made the rich, and most everyone else, ultimately much poorer.
Since 1969 there has been a tremendous shift in the tax burdens away from the rich and onto the middle class. Corporate income tax receipts, whose incidence falls entirely on the owners of corporations, were 4% of GDP then and are now less than 1%. During that same period, payroll tax rates as percent of GDP have increased dramatically. The overinvestment problem caused by the reduction in taxes on the wealthy is exacerbated by the increased tax burden on the middle class. While overinvestment creates more factories, housing and shopping centers; higher payroll taxes reduces the purchasing power of middle-class consumers…”
http://seekingalpha.com/article/1543642

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Alison P 08.22.13 at 8:19 pm

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.

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NR 08.22.13 at 8:26 pm

I heard from a former Vice President of the Graduate School of Arts and Sciences at Columbia University that they believed being in New York gave them an edge in faculty recruitment and retention that helped make up for the fact that they couldn’t always compete in salaries. And I know a lot of faculty in my field (anthropology) and some related fields do indeed consider New York a huge draw. I am sure the same would go for other charismatic cities, and that cities in general probably have a big advantage over the middle of nowhere. On the other hand, I am sure some people really do like the quiet life.

But is the excitement that many people feel about living in a city like New York really reducible to the sheer thrill of career networking or to the cultural capital that growing up in a cultural capital confers upon your their offspring (assuming they any)? I somehow doubt it.

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ktward 08.22.13 at 8:29 pm

@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.

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Alison P 08.22.13 at 8:49 pm

clearly you believe Equal Opportunity is a “stupid thing”,

A person who says we need equal outcomes to enable equal opportunities is not saying giving opportunities is stupid. They are saying that aiming at one without the other is futile.

A feature of liberal (I mean in the European sense, non-left) , political parties is to identify equality of opportunity as a sufficient goal, and to dismantle programs which sustain equality of outcomes, labeling them (as you did) ‘not doable’, ‘not sustainable’, not realistic. In the UK this is the program of the Lib Dems, which is why I feel so strongly about this issue.

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ktward 08.22.13 at 8:57 pm

@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.

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Paul 08.22.13 at 9:00 pm

Tim Worstall…where have I heard that name? If it’s the fellow I am thinking of, he’s far too modest. Someone by that name has figured out that the way to beat the rigged market is to own a corner of it, like the global supply of needed exotic metals.

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. I thought the NHS was about equality of access, with more equitable outcomes as a goal. Outcomes aren’t something that can be legislated (why do I think of Lysenko or “the rain follows the plow” when I hear that argument?). But access to opportunity can. If access to opportunity is more evenly distributed, the market should take care of the outcomes.

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Alison P 08.22.13 at 9:00 pm

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

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ktward 08.22.13 at 9:02 pm

@Alison P

Ah. Yes. We’re on completely different playing fields. My comments are specific to the US.

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Alison P 08.22.13 at 9:09 pm

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.

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chris 08.22.13 at 9:10 pm

[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].

Uterine replicators would be simpler, if we’re going to throw realism out the window.

What is public library except equality of outcome.

A public library isn’t equality of outcome (even within that specific narrow area) unless private ownership of books is strictly forbidden. Even then, it’s only equality of outcome if the ban is effective and can’t be circumvented by people with the right money or connections.

Raising the minimum possible level of access to resources is a worthy goal, but it isn’t equality of anything.

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Substance McGravitas 08.22.13 at 9:11 pm

Medicare’s an equality of outcome program.

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GiT 08.22.13 at 9:13 pm

“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.”

You don’t seem to be following the causal connection being asserted, which is not that equality of opportunity decreases inequality of outcomes, but that equal provision of baseline amounts of some goods (education, health care, food) is needed in order to actually have equality of opportunity.

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chris 08.22.13 at 9:16 pm

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.

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ktward 08.22.13 at 9:16 pm

Paul:

Two students in the same class with the same textbook don’t automatically get the same grade. I thought the NHS was about equality of access, with more equitable outcomes as a goal. Outcomes aren’t something that can be legislated (why do I think of Lysenko or “the rain follows the plow” when I hear that argument?). But access to opportunity can.

More or less my point.

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Random Lurker 08.22.13 at 10:30 pm

@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.

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John Quiggin 08.22.13 at 10:34 pm

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

Looking at an Australian example, anyone who wants to work in finance has to move from Brisbane to Sydney (or, at a pinch, Melbourne). But the general direction of population movement is in the opposite direction, reflecting the fact that Brisbane is a more pleasant place to live.

It’s arguable that the concentration of high-income financial workers calls forth a supply of luxury goods and services, which then becomes an attraction more specific to this group. But I don’t think there are big economies of scale here. Wealthy people will be able to buy luxuries wherever they live.

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Substance McGravitas 08.22.13 at 10:46 pm

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.

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SamChevre 08.22.13 at 10:50 pm

In my observation, the big economy of scale with finance in NY, tech in SF, and so on is that people can change jobs without needing to move.

That isn’t a luxury that you can buy in a “one employer for your profession” town (like the one I currently live in is for my profession.)

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Jake 08.22.13 at 11:14 pm

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?

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john c. halasz 08.22.13 at 11:31 pm

Actually, I thought Alfred Marshall explained the several reasons for the tendency for specific industries to cluster geographically, (economies of agglomeration, in the jargon), in wonderfully pellucid prose, (no “econo-math”), a long time ago. The more interesting question nowadays would be why finance has tended toward ever-increasing degrees of oligopolistic concentration, despite little or no evidence of economies of scale in that “industry”, (rather the contrary).

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John Quiggin 08.22.13 at 11:38 pm

@Substance Sure, a small town, or even Omaha, Nebraska limits you. But there are plenty of US cities with fancy restaurants, opera, theatre, luxury stores like Marcus Neiman & Tiffany’s and so on.

Finding decent coffee is more of a stretch, but from my observation finance sector workers tend to go for takeaway from Starbucks

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adam.smith 08.23.13 at 12:02 am

@JQ #78 – Opera?
I mean, I won’t argue that opera is necessary for a luxury life (though it is for me), but since you bring it up – plenty of US cities with opera??? I count six serious opera houses in the US (LA, SF, Houston, Chicago, NYC, Washington DC – defined as reasonably large companies with 5 or more productions per year). So that’s a really weird example.
I’m also inclined to agree with Substance otherwise. 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.

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PatrickinIowa 08.23.13 at 12:02 am

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

Well, yeah it should. But it doesn’t.

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John Quiggin 08.23.13 at 12:52 am

@Adam.Smith Six is enough for my argument. The point is that NYC isn’t so special that any wealthy person would want to live there rather than in the other places you mention.

And the reason for choosing opera is precisely that it’s a luxury service that’s more restricted than most in terms of geographical access.

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Main Street Muse 08.23.13 at 1:01 am

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?

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js. 08.23.13 at 1:03 am

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.

Also, as adam.smith mentions, it’s orders of magnitude easier to get good coffee in smaller US cities than it is to have access to opera, good theater, or even a steady supply of art-house films (tho this is a relatively recent development).

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Matt 08.23.13 at 1:20 am

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.)

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Matt 08.23.13 at 1:22 am

Well, that 2nd paragraph was supposed to be italicized, too. The first is said by one person, the 2nd is a reply to that, and the 3rd is my comment. Didn’t someone here once say it would be nice to have a preview function? I think I remember that being mentioned once or twice.

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krippendorf 08.23.13 at 1:37 am

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.

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Mao Cheng Ji 08.23.13 at 1:37 am

They actually broadcast that opera, live, all over the world. Not the same thing of course, but close enough.

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John Quiggin 08.23.13 at 4:24 am

My last comment on this side isse: (Lack of) big city amenities explain why the finance sector doesn’t locate in Cleveland, or maybe Denver. They don’t explain why (much more than, say, the tech sector) it is concentrated in NYC and a handful of other cities around the world, while being virtually non-existent in other places that are equally or more appealing.

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David 08.23.13 at 5:10 am

Disclaimer: I only just started this thread, but surely this sets a record for the dumbest comment out of the box with Tim at #1. And probably for the whole thread, which I will now peruse.

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David 08.23.13 at 5:14 am

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.

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js. 08.23.13 at 5:16 am

It’s possible to take the view that the financial sector does things that are inconsistent with EMH, but nevertheless socially beneficial.

It seems to me that there’s a kind of false dilemma in the “Update/clarification”. Because surely, it’s possible to take the view that the “global city” clusterings of financial sector institutions are (1) inconsistent with EMH, (2) not a result of cronysim, and (3) still quite the opposite of socially beneficial.

What would be the problem with this? After all lots of things work like this. Just for example, the transmission of certain kinds of tacit knowledge (rather different kind of example, yes), is quite likely inexplicable according to market mechanisms, is not cronyism in any obvious sense, and could very well end up not being socially beneficial in the aggregate. I think you could keep multiplying examples like this.

(Just to be clear: you, JQ, are opposed to the EMH, yes? Because the “but nevertheless” in the quoted bit is throwing me off somewhat.)

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js. 08.23.13 at 5:18 am

A false trilemma, actually.

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Mike Otsuka 08.23.13 at 5:25 am

I think the “simple version of the managerial interest hypothesis” that John offers in his linked pdf is a more plausible explanation of the concentration of the financial sector in global cities than his “network-based explanations of managerial preferences.”

According to the latter, “such location facilitates the creation and maintenance of personal networks of trust and obligation”.

With their constant travelling, not just to other cities, but also to places like Davos, Tuscany, and Martha’s Vineyard, for deals, conferences, holidays, and the like, it doesn’t seem that having headquarters in a global city is all that essential to networking.

Academics have pretty tight personal networks, with people who live far away, that are sustained pretty much entirely through the conferences where they keep bumping into each other. I would guess that something similar is true of finance.

So I go with the “simple version”:

“managers choose to locate corporate headquarters in global cities because these are pleasant places to live, at least for high income earners. As has already been noted, global cities are characterised by the availability of a wide range of luxury retail services and of high-prestige cultural activities (opera, Broadway and West End theatre and so on). Global city office locations are prestigious in themselves and are typically more luxurious than those found elsewhere.”

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John Holbo 08.23.13 at 5:26 am

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.

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Meredith 08.23.13 at 5:26 am

I’ve learned a lot from the post, links, and comments, but I guess I’m mostly puzzled by the OP. There are just so many reasons for the finance sector to be concentrated in a handful of major cities, many reasons already mentioned in the comments, to which I would add: inertia (these centers are well established); proximity to other sectors on which the financial relies (e.g., major law firms, major journalistic media); a large pool of well-educated support staff (e.g., secretaries, IT folks); most people really do find these cities amazing places to live, especially when you’re wealthy; plenty of opportunities exist for finding a partner, for partner found to pursue her or his career and interests; opportunities, too, for children you might have (e.g., excellent schools, public as well as private).

Btw, what level of wealth are we talking here? Sorkin talks about Chelsea Clinton and Jamie Rubin. Okay, that’s 1% wealth (maybe even .01% wealth). But most people in the finance sector aren’t THAT wealthy, especially when they’re young. And many smart and talented college graduates (they need not be connected via their families to anyone important — their college connections can make up for that) seek jobs in the finance sector not because they expect to want to stay there but because those jobs (like jobs with consulting firms) can give them both an education in what the big wide world of “business” might include and opportunities to explore new career paths. Bethany McLean is a good example of such a person. From Hibbing, Minnesota and an English and Math major at an “elite” northeastern college, she was hired right out of college by Goldman Sachs, whence after several years she moved to WSJ (first as a copy editor or something pretty lowly, later on to the Enron expose), and after that on to other interesting journalistic things. A Goldman Sachs wouldn’t attract many a Bethany McLean without being itself located in some place like NYC. (And however much a Goldman Sachs will hire cronies’ children, it knows better than to overlook the truly best talent for most of its hiring, even if not all that talent stays on.)

Maybe the following undermines the arguments I have just offered! But a very interesting piece just today or yesterday on the way art fairs for the super rich are changing the ways galleries in cities like NY have to work, and are driving smaller galleries out of business. It really is relevant to the OP, I think.
http://www.nytimes.com/2013/08/22/arts/for-art-dealers-a-new-life-on-the-fair-circuit.html?src=me&_r=0

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js. 08.23.13 at 5:30 am

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.

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Jake 08.23.13 at 6:13 am

js./#92 the EMH bit gives it away; he’s just trolling his blog again.

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John Quiggin 08.23.13 at 6:59 am

@js Maybe this is just the way I use the word, but I’d say “socially harmful exchanges of tacit (or explicit) information” is a pretty good definition of cronyism, particularly relevant to the financial sector. 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.

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TM 08.23.13 at 8:08 am

There are good reasons on why a finance firm would want to keep its employees together on the workplace instead of, say, from home or wherever (economies of scale, security of the transactions, etc.). With firms still tied to locations, then the dynamics of the labor market are enough to explain clustering of firms.

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JW Mason 08.23.13 at 10:39 am

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?

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ajay 08.23.13 at 10:44 am

(Lack of) big city amenities explain why the finance sector doesn’t locate in Cleveland, or maybe Denver. They don’t explain why (much more than, say, the tech sector) it is concentrated in NYC and a handful of other cities around the world, while being virtually non-existent in other places that are equally or more appealing.

No, but it’s been explained at length in the comments that, while it might be more appealling to live in Brisbane than in Sydney (which is a highly debatable statement for a start), industry clusters tend to develop for all sorts of very well-known and well-studied reasons that don’t have anything to do with nepotism or corruption or cronyism, or even that the managers want to live in nice places for rich people (though it’s worth noting that pretty much anywhere where a lot of rich people end up living will probably turn into a nice place for rich people to live, because rich people have lots of money and like living in nice places).

And if you want an example of an industry that is inexplicably concentrated in complete dumps and neglects all the really nice places, then finance probably isn’t the best one to pick. London and New York and Paris and Milan are pretty great cities to live in. Singapore and Hong Kong and even Chicago, I understand (never been) are pretty good.

As for the degree of concentration, I’d need to see some figures on that. Is finance really more concentrated than, say, aerospace? Shipbuilding? Semiconductors?

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JW Mason 08.23.13 at 10:44 am

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

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ajay 08.23.13 at 11:02 am

An obvious example is the kind of opaque, over-the-counter derivatives that Dodd-Frank has tried to ban, and that the finance sector is lobbying hard to protect: it seems clear that doing these kinds of deals would benefit from face-to-face contact.

I am reminded of the dictum that you should always look particularly closely at the bits of an argument that start with “clearly”, “obviously” or “it is trivial that”, because that’s the bit that the author is rather hoping you will skate over quickly.

105

Trader Joe 08.23.13 at 11:50 am

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.

106

Chris Williams 08.23.13 at 12:07 pm

ajay “Is finance really more concentrated than, say, aerospace?” I’m not sure, but I note that if we want to measure the effect of amenity verses that of a regional skills base, then Warton and Brough are in a really useful corner of the graph.

107

Mike Otsuka 08.23.13 at 12:08 pm

“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.

108

Tim Worstall 08.23.13 at 12:08 pm

“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.”

There’s a reason the latest pottery to open in the UK opened in Stoke on Trent. That’s where all the people who know how to make pottery are. Similarly, a company commercialising some Cambridge University work on the fabrication of metals from their oxides set up in Rotherham. Because that’s where all the people who know how to deal with weird metals are along with the support services. Remarkably, it wasn’t for the opera.

“Tim Worstall…where have I heard that name? If it’s the fellow I am thinking of, he’s far too modest. Someone by that name has figured out that the way to beat the rigged market is to own a corner of it, like the global supply of needed exotic metals. “

And the way to beat me cornering a market is to have free entry into that market. Which is rather my point above. 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.

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Trader Joe 08.23.13 at 1:03 pm

@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.

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ajay 08.23.13 at 1:05 pm

I note that if we want to measure the effect of amenity verses that of a regional skills base, then Warton and Brough are in a really useful corner of the graph.

As are the Potteries. I refuse to believe that the west midlands became the hub of Britain’s ceramics industry because lots of rich entrepreneurs really, really wanted to live in Stoke.

111

John Quiggin 08.23.13 at 1:10 pm

@104 As you say, ajay, I’ve led with my chin here. So point out where I’m wrong.

112

ajay 08.23.13 at 1:15 pm

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.

Because the major banks are much more dependent on the infrastructure at the existing clusters than the money managers are? (And most of those major money managers will have trading offices in the cluster cities anyway, even if their headquarters are elsewhere.)

You can’t possibly argue that all the major banks are in New York because of cronyism and guanxi (and I think JQ is arguing this still, though it’s become difficult to tell), unless you also explain why the major money managers seem to be immune from all these malign forces.

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ajay 08.23.13 at 1:25 pm

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.

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Alex 08.23.13 at 1:35 pm

Dunno about Brough, but within a hour’s driving from Warton there’s also Samlesbury, Woodford, and R-R in Barnoldswick. There’s a fairly obvious regional labour market story there.

115

Barry 08.23.13 at 2:02 pm

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.

116

parse 08.23.13 at 2:10 pm

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.

This doesn’t address the major topic, but I seen this knock on New York’s Mexican food in so many different places that I’m going to indulge myself and respond here. I think people who say this believe that Manhattan is New York. Living in a Brooklyn neighborhood where most of the residents speak Spanish as their first language (and 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.

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Tim Wilkinson 08.23.13 at 2:32 pm

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>

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?

Trader Joe’s angle sounds promising – if the aim is to take this rather indirect route of drawing inferences from geographical observations, rather than simply observing the widespread practice of conspiratorial market rigging, as, e.g., observed (rather than deduced) by Adam Smith, per the well-known quote. If two industries appear to materially differ only in the degree of geographical clustering, one may then start looking for hidden causes – I don’t know how far the need for secret discussion would appear to be a good candidate for an explanatory variable in this case.

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’.

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Tim Wilkinson 08.23.13 at 2:36 pm

Me: I don’t know how far the need for secret discussion would appear to be a good candidate for an explanatory variable in this case.

And ajay @112 suggests it wouldn’t, in the specific case mentioned. The approach in general would, though, be a methodologically good one, if it could be made to work,.

119

Matt 08.23.13 at 2:48 pm

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.

120

ajay 08.23.13 at 3:11 pm

If two industries appear to materially differ only in the degree of geographical clustering, one may then start looking for hidden causes – I don’t know how far the need for secret discussion would appear to be a good candidate for an explanatory variable in this case.

Theoretically yes, but I think you’d have a hard time finding truly comparable pairs of industries, to be frank.

121

Trader Joe 08.23.13 at 4:00 pm

@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.

122

ajay 08.23.13 at 4:27 pm

Yes, I’d agree with all of that. My gut feeling would be that infrastructure issues are massive – it would be prohibitively difficult to move a major bank completely out of a cluster city. (Even the ones that are headquartered elsewhere, like HBOS, had big offices in London).

123

Barry 08.23.13 at 7:10 pm

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.

124

Sebastian H 08.23.13 at 7:21 pm

“Medicare’s an equality of outcome program.”

No, it is a good start at an equality of opportunity program. If you have access to good surgeons and treatment you have an equal chance to beat your cancer or whatever. That doesn’t mean you’ll actually beat the cancer.

125

Chatham 08.23.13 at 7:45 pm

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.

126

John Quiggin 08.23.13 at 8:31 pm

@ajay “Dodd-Frank isn’t banning OTC derivatives, it’s just mandating that they be CCP cleared where appropriate and exchange traded where possible” “

I’m obviously misunderstanding something here. AFAIK, the defining feature of OTC derivatives is that they are not exchange traded.

127

Tim Worstall 08.24.13 at 9:02 am

“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.

128

Tim Wilkinson 08.24.13 at 9:37 am

So that programme in full:

1. ‘Regulate’ (not nationalise, of course), in some unspecified way, privatised natural monopolies.

2. Rail against monopoly and oligopoly, as a general theme.

3. Er,

4. That’s it.

You’re doing a pretty good job at monopolising sewage provision yourself.

129

Agog 08.24.13 at 10:16 am

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.

130

Agog 08.24.13 at 10:31 am

131

Tim Worstall 08.24.13 at 12:52 pm

“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.

132

Tim Wilkinson 08.24.13 at 2:42 pm

Of course you’re supposed to have something ready to back up your sweeping claims. Don’t pretend this is some kind of ambush – you’re the one who is always touting this stuff. I’m entitled to ask you to justify it.

After all, you had your carefully-worded and -selected anecdote ready, didn’t you. (BTW, ‘sewage provision’ is about right, if the example of Southern Water’s ‘rationalisation’ of operations on the south coast is anything to go by.)

But even at this late stage, I’d rather avoid a derail and don’t want to go into the iterated game where you produce one of your handful of carefully-prepared anecdotal factoids and I spend half an hour unpicking it (like with the railways, remember? And I’m pretty sure we had the water and sewerage one a few years back – obviously the refutation in that case wasn’t quite embarrassingly comprehensive enough for that one to be shelved.)

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.

133

NR 08.24.13 at 6:36 pm

@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.)

134

Random Lurker 08.24.13 at 7:24 pm

@Agog 129
Thanks, however I should point out that I was just expanding on JW Mason 35, who explains the point in a better way imho:

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?

135

Tim Worstall 08.24.13 at 8:15 pm

“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?

136

Tim Wilkinson 08.24.13 at 8:56 pm

I’ve offered a direct and personal example of how the market prevents me from exploiting my previous oligopolistic position well actually you didn’t. But, in any case, again, your ungeneralisable anecdotal factoids are of no interest, and dealing in scandium doesn’t give you any special authority to pronounce on matters of political economy.

I mean, what is your point? That despite the evidence of our lying eyes there are no monopolies, no oligipolies, no collusion, no plutocratic ruling class, because the very same ‘market forces’ that gave rise to them, will, once reality comes to its senses and learns to conform to your ridiculous dogma, turn out to have eliminated them all?

137

Watson Ladd 08.25.13 at 4:50 pm

@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

ajay 08.27.13 at 8:52 am

126: “I’m obviously misunderstanding something here. AFAIK, the defining feature of OTC derivatives is that they are not exchange traded.”

Let me rephrase that. Dodd-Frank didn’t say “it is illegal to trade derivatives OTC”. It said “Where possible, you should trade on exchanges. If there aren’t any exchanges that list your preferred derivative, you should clear them through a CCP. If there aren’t any CCPs that clear your preferred derivative either, you can continue to trade OTC and clear bilaterally.”

139

dsquared 08.27.13 at 10:21 am

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.

140

Sancho 08.27.13 at 10:23 am

None of this is my field and I don’t have the lay-knowledge to fully understand the arguments being made, but it seems that several participants in the thread are genuinely surprised, if not offended, by the suggestion that wealthy capitalists simply behave like hereditary aristocrats.

I wonder how that can be in any way surprising to anyone.

141

dsquared 08.27.13 at 10:31 am

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.

142

dsquared 08.27.13 at 10:33 am

FWIW, by the way, Deutsche Bank is in the process of moving quite a lot of its operations to Birmingham, including a proportion of front office trading that surprised everyone when it was announced. So we’ve got an experiment here to see if it works.

143

ajay 08.27.13 at 12:20 pm

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.

144

dsquared 08.27.13 at 4:24 pm

also the definition of ‘a standardised product suitable for clearing’ is, as you know Bob, ‘a product which is accepted for clearing by at least one clearing house’. Thus meaning a) that any clearing house which decides to deem a product suitable for clearing has an immediate and regulator-guaranteed stream of business (possibly an intended consequence), and b) that this regulator-guaranteed stream of business will show up whether or not the product is actually liquid enough to be clearable (not, I hope, an intended consequence) and c) there is basically no oversight of the clearing houses’ decisions with respect to a), despite the obvious conflict of interest created by b). (I would have thought not an intended consequence, but they wrote it down in the regulations and presumably knew what they were doing).

145

PGD 08.27.13 at 6:10 pm

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.

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PGD 08.27.13 at 6:43 pm

Also, although a major clearinghouse would clearly be TBTF, I think a crisis caused by a clearinghouse failure would look quite different from a crisis caused by the failure of other kinds of major financial institutions. It would be much simpler for the government to simply step in and perform the clearinghouse functions to prevent the crisis spreading. Yes, this creates moral hazard problems going forward, but the actual immediate economic impact should be lessened, probably significantly. Also, the moral hazard impacts could be lessened and perhaps negated entirely by hanging the clearinghouse management on live TV.

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dsquared 08.28.13 at 12:09 pm

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.

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