Occupy Wall Street

Russ Roberts

I have recently read a report on the banking crisis (“gambling with other people’s money” henceforth referred to as GWOPM) written by Russ Roberts of George Mason University. The report clearly was not aimed at the academic community. However I still found the report lacking in precision of formulation of arguments. I also found that there was not enough evidence provided to back up the arguments made.

I am sympathetic to Russ Roberts’ motivation. Russ Roberts is a classical liberal and I share many political views with him. I think Russ and I would agree that in order to promote classical liberalism we must have good arguments for it. I think that this entails that any argument we make for classical liberalism must pass the most stringent tests available. Russ Roberts has a PhD and is a professor of economics so some may say that I am out of my league to argument with him. But this is not about a conflict between me and Russ Roberts, but rather a conflict of ideas (ideas of how to best express an understanding of the banking crisis). Because this is a battle of ideas it makes no difference who is presenting them. Ideas fight in an intellectual dimension and we are all just observers.

I think that GWOPM has many flaws. I think that overall GWOPM thus does not serve the classical liberal cause very well. Firstly I will outline on what basis I made this judgement. Then I will show some evidence to support my judgement.

Any theory is either disproved or reinforced with close scrutiny. Scrutinising of a theory is done in two ways.

Firstly the theory must be checked to be logically valid and verifiable. A theory is valid if the theory’s conclusion logically follows from the theory’s premises. A theory is verifiability only if it can be falsified. This means that the premises or the conclusion of the theory is measurable or quantifiable. This implies that theory must be formulated in a very precise way so as to be able to quantify varies effects and their causes. Otherwise it would be impossible to judge its logical validity or its verifiability.

The second way a theory can be scrutinised is to actually measure the premises and the conclusion in the real world. A theory can be logically valid and verifiable but disproved by real life data.

A theory can never be positively said to have been proven by real life observation (see David Hume’s problem of induction and Karl Popper’s Conjectures and Refutations). It may be only falsified or not falsified. However once a theory has withstood many tests against real world observations it is deemed to be the closest to truth that there is, unless a later theory or observation disproves it.

The basic hypothesis of GWOPM is that the banking crisis was caused by:

1) Moral hazard hypothesis: a long history of the US government bailing out financial firms. This lead to banks being more relaxed about risk taking. This made the banks sure that if their risky actions caused loss the government will bail them out.

2) Market distortions hypothesis: US government’s push to make poor people buy houses which they could not afford.

Russ Roberts provides a very journalistic formulation of the moral hazard hypothesis in the context of the banking crisis. Not a single mathematical model from information economics is mentioned. Only a superficial description of the link between government bailing out financial firms and banks becoming greater risk takers is given. This means that the moral hazard hypothesis is not testable against data because there is nothing to test. Whatever data which is then provided cannot falsify the hypothesis.

For example, Russ Roberts goes on to describe bail outs in 1980s and 1990s, again in a journalistic way. But how much influence, if at all, did this have on the behaviours of the banks? Russ Roberts thinks that it played a great influence. It may have, but it may not have. Maybe the bankers of 2000s paid no attention to what happened in 1980s because the whole of the executive branch had changed from Ronald Reagan to George W Bush and George W Bush had no incentive to follow the example of Ronald Reagan’s administration.

The market distortion hypothesis on the surface seems to be better presented. However it still suffers from the same problems as the moral hazard hypothesis. Although the links between varies financial institutions like the banks, the home buyers, mortgage companies and Freddie and Fanny are described more fully the links are still not quantified. Thus the very complicated interactions between all of these economic agents are not obvious and not testable. For example, I think that in the last 30 years there has been a cultural change from high saving and low consumption to low saving and high consumption. I think that this cultural change was not brought about by government action but rather by change in technology. Technology has created cheap consumer goods which are constantly improving in performance but are cheap . So consumers now buy a good for only a year or two before disposing of that good and getting a newer version. I think that this fundamental change in culture has played just as bigger role in the economic crisis as did government action. However without a precise formulation and defining how to test this hypothesis I face the same problem as Russ Roberts. My hypothesis may be true, after all electronics nowadays do become obsolete in 24 months, but someone could just as easy say that I am not right, and no one can determine the who is right.

Economists use methods of econometrics to test their models. Econometrics is still a very young sub-field and thus a lot of econometric findings could be argued to be false. However econometrics is the best method we have of testing our conjectures (outside of game theory which can be easily tested in a lab with real people playing games). Russ Roberts did not do any econometric testing. what this means is that GWOPM is at best only a guess.

The economy is a complex system. Most interactions are non-linear. One event causes many effects which in turn have other effects and feedback loops. This complexity is very hard to model and impossible to understand fully unless it is expressed in a very rigorous way, i.e. mathematically. Although Russ Roberts highlighted a few possible causes of the banking crisis he certainly has not proved his hypothesis. GWOPM is an interesting journalistic piece. It may serve as a starting point for a proper study of the banking crisis. However GWOPM is not a definitive account of the banking crisis. I think a much more precise and thus more compelling argument could have been made but was not.

We are still left with the question "do markets , especially capital markets, naturally spin out of control and crash, or are they naturally stable and any instability is caused by government interventions?". Russ Roberts and I think that markets work others do no, but the question is still to answered.

Illogical but Reasonable Limits to Freedom

Classical liberals, like me, always say that fundamentally one is free to do anything one wishes as long as one does not coerce others against their will. This very simple approach leads to everyone being better off through mutually beneficial trade (I sell you an apple for £1 because I value £1 more than the apple, and you buy the apple because you value the apple more than £1, hence both of us gain in value).

However this kind of freedom could result in situations which most people would regard as unreasonable. An example is production and sale of nuclear weapons. But banning production and sale of nuclear weapons results in breaking the classical liberal fundamental principle which undermines the coherence of classical liberalism.

Firstly let me outline different but related ideas: Sorites paradox and slippery slope fallacy. I will then use to show exactly how the classical liberal thinking may be faulty in terms of informal logic.

In Sorites paradox, one begins with a heap of sand and one continuously removes grains of sand until one is left with just one particle of sand. The paradox: at what time did the heap stop being a heap?

The slippery slope fallacy can be illustrated with the following scenario: a tree in a forest falls. The probability it makes another tree fall is 0.9. The probability that 3 trees end up falling is 0.9*0.9*0.9=0.729. The probability of more trees falling approaches 0 as one calculates the probability of more and more trees fall.

Now here is the puzzle:
In a liberal and open society law is such that one is free to do whatever one wishes as long as it does not impose on others. Clearly this means that one may make and sell firearms (single particle of sand). What about other weapons? Can one make and sell large nuclear weapons (the heap of sand)? Clearly any reasonable social order would curtail the freedom of individuals to produce and sell such weapons because the risk of use of such weapons is just too devastating. This reasonable step has just broken our liberal principle of freedom to allow anyone to do anything one wishes as long as it does not harm others. What about small nuclear weapons? These ought to be reasonably banned too. What about biological or chemical weapons? As we move down the scale of lethality at some point society must stop banning weapons in order to allow the freedom of the individual of having and trading a firearm, which reasonably ought to be allowed for self-defence. But this sudden break in what is considered too lethal and ok is arbitrary, just like when a heap of sand stops being a heap and becomes just a number of particles of sand. For me it is unreasonable for people own fully automatic assault rifles but pump action shotguns are ok, while for others it is very unreasonable for people to own pump action shotguns while very reasonable for people to own assault rifles. An open liberal society thus must either ban all weapons or not ban any weapons to stick to the coherence of the principle that law is not arbitrary.

Some problems arise from such a scenario. Firstly, if an open and liberal society wishes to avoid arbitrary power of the administrator, it must allow all weapons to be made and freely traded or none at all. Clearly both of these are undesirable to the classical liberal. What is the objective test the society use to define weapons which cannot be made and traded?

Secondly we assumed that there is a slippery slope which inevitably will lead to all forms of weapons being banned if society bans just nuclear weapons. However as we have seen with the trees in a forest example, this could be a fallacy in itself as the individual events in the chain are discrete and may break the chain that leads to the supposedly inevitable event of all weapons being banned. The slippery slope argument which is often used by classical liberals may be a fallacy if the events in the chain are not clearly illustrated and proved to be likely. Although history often demonstrates that slippery slope to an illiberal outcome often occurs, we cannot place our faith fully into the idea that it will occur again if a piece of legislation which is illiberal, is passed. By arguing that since other slippery slopes have occurred in the past, they will happen again we are also hitting upon the David Hume’s problem of induction (just because something often happened in the past does not guarantee it will occur again in the future). So by using the slippery slope argument the classical liberal runs the risk of two logical fallacies: the fallacy of slippery slope and the problem of induction.

Clearly there is some thinking to be done by classical liberals. Specifically there appears to be some very reasonable but nonetheless arbitrary limits to freedom and classical liberal argument against certain legislation may be unfounded in logic (but not in history).

Writing and Speaking

There exists a difference between spoken and written forms of a language. Everyone knows that there is a difference but no one can pinpoint what the exact difference is. Experts of language are even more confused and divided on this topic than a layman. This is because in truth, the differences are not clear cut. Both mediums share the same underlying grammar of the language and can be used to fulfil the same functions. In a modern society, speaking and writing have been used to do different things. This is where the difference comes from. That is why writing is not speech and speech not writing. Thus, one cannot say that writing is more than speech or judge one medium by its closeness to the other.

One should note that both mediums can be used interchangeably. Hansel and Gretel can be read out loud and a linguistics lecture can be written down. The difference between the two mediums thus lies in style, function and appropriateness to the context rather than the fact that speech is spoken and writing involves putting pen to paper.

It is important to note that both mediums have great variety within themselves as well as between each other. For example, the language in a copy of Hansel and Gretel is about as different from a note on a fridge door as a conversation at a train station. Hence, one cannot think of the differences between written and spoken language as being static. The differences ought to be thought of as a continuum. This leads implies that some written texts may resemble some spoken texts.

The most common type of speech is an everyday conversation, be it on the telephone, over lunch or on the bus. Speech is used in these situations because of its inherent strengths. Speech can be produced very quickly with rapid adjustments and corrections being made. Most importantly, in conversations, timely response is needed and thus speech is the ideal medium. This responsiveness includes adding new points, restating or exemplifying the previous point, adding qualifications and incorporation of others’ ideas into one’s own discourse. Speech is usually, if not always, accompanied by other forms of communication. These include hand gestures, intonation, pausing, loudness and facial expressions and body gestures. This allows speech to carry more information than if only words were used. Writing typically does not contain these features due to the limitations of writing technology as well as to the very use of writing. Writing tends to be detached from its immediate context as it does not need to be linked to the surroundings of the reader. For example, writing does not require an equivalent of hand gestures, or intonation or any other particular link to the immediate environment of the reader.

That is not to say that writing cannot record these features of language. An example of this is the use of punctuation. Western languages use exclamation marks, question marks and quotation marks as well as other punctuation marks to achieve a sense of intonation and possibly an indication of the writer’s emotions. Still, a usual written texts’ detachment from the context enables the meaning to be conveyed without punctuation. The style of an actual written text makes it so that the reader able to understand the meaning without needing other clues, like and gestures, for meaning.

As human society evolved over the years, writing has become a way of recording ever increasing abstract ideas, notions. Writing gained the ability to pass information to people across both physical distances and time. This has pushed writing further away from speech. Transformation of human society from nomadic hunter-gather to a settled, agricultural society brought the need for recording of information about trade, law and religious rituals. Over time the subject matter of writing has become more abstract. People began to use written text for education and discussion. It became a convention to think of written text as something to be criticised and evaluated.

Today when people think of writing they tend to think of school essays and journalistic articles. These uses of language have a different requirement from speech. These examples of writing require abstraction and generalisation of ideas and events. More precisely, because more time is afforded to the writer than the speaker, by the reader or listener respectively, written text tends to be more packed with information per clause. More nouns, adjectives and relative clauses tend to be used in order to achieve higher rate of information transfer through written text. The written text will usually be read over and over again thus clarity is a requirement. Although speech can be just as clear if not more than writing, because written text can be redrafted, they tend to be clearer and easier to understand. Of course it is common to find incomprehensible written texts (e.g. tax laws). This may be due to the individual writer than the nature of the written text. For example, a very well read university professor may write a text which to him seems perfectly clear while an uneducated youth may look upon the text as if it was written in another language. Indeed to him, the vocabulary, as well as complexity of the issue will be a foreign language even if the fundamental grammar is familiar.

Writing has rarely been speech written down. In the past writing has been used primarily for valued information like religious texts, contracts, treaties and scientific research. The meaning conveyed in written form thus tends to differ from the meaning conveyed through speech.

Although the very nature of the written versus spoken language may be different, the differences may also arise from the fact that each person is different. Socio-economic status, age, life experiences and sex all will affect both the written texts and speech produced. As mentioned before, the differences, being a continuum rather than discrete and clearly defined, means that there will be a great amount of overlapping of written text and spoken text. A written theatrical play may be very close to an everyday conversation while a university lecture may be very close to a textbook. This implies that differences between the two mediums are inherently dependent on circumstances. To put it simply “it all depends”.

In recent years, with the advent of the telephone, radio, television and most importantly digital telecommunication such as mobile phone text messaging and internet based instant messaging (IM), the distinction between writing and speaking is blurring more and more. A typical IM conversation would actually be just like a spoken conversation. The written IM conversation is speeded up with the dropping of double letters and vowels, shortening of words, use of emoticons and, in the latest IM software, even sound and pictures.

There has always been a feedback effect between writing and speaking. In the past the direction of influence was usually the written to the spoken medium because writing has higher social status and thus people want to be as eloquent in their speech as they are, ideally, in the written medium. Today this effect is getting reversed with writing becoming more like speaking since text is becoming more contextualised. It is now more important to interact with the immediate environment and the reader of the text. Of course written and spoken forms of a language will never fully merge because there will always be a need for written accounts, for example, scientific exploration and journalistic prose.

In conclusion writing is more than speech written down; it is something different. That something tends to be abstract and detached because the function of writing is different from that of speech. In the same way speech is not something read out loud. Speech is used for a different function. It is used to interact with the environment and the audience. As Aristotle said “ach kind of rhetoric has its own appropriate style. The style of written prose is not that of spoken oratory”. Time and progress of course has a way of debunking even the smartest of philosophers, and it seems that the very functions of spoken and written language are changing to make the distinction between writing and speaking blurred if not nonexistent.

Natural Law

Many would say that there is no natural law. I think this is the wrong way of thinking about the topic.

Man’s nature is constant: he has unlimited needs and wants. Man’s environment on the other hand presents him with limited resources to fulfil his needs and wants. This reality is the basis of principles of natural law. The constant reality of unlimited wants, limited resources necessarily leads to evolution of certain principles which govern behaviour of men and how they interact with others. The evolution of these principles is lead by emotion, logic, and trial and error. These principles are natural because they arise from the very nature of man and the reality of man’s environment.

What would these principles be? To answer this question we need to look at man’s nature. These natural principles facilitate fulfilling as many wants and needs in the environment of limited resources. But what are these wants and needs? Man has certain qualities which were shaped by biological evolution. These natural qualities are fundamentally: emotions, ways of thinking and physical abilities to change the environment. All of mankind shares these qualities. It is undeniable that a man would feel violated when these natural qualities are denied to him by others. This is the natural basis of protection of the individual from others.

The beginning of the individual is his body. But with his body he can labour and produce things for himself. He can interact with others. Through these actions the individual can end up violating other individuals. Only time can define where one individual ends and another begins. The definition of what an individual is cannot be done all at once. People learn, invent and change their environment. The rules governing man’s behaviour and interactions with others will thus necessarily change over time. However, the fundamental principle of protecting the individual from violation will not change because the fundamentals of man will not change.

Nature exists. From nature arises the need for protection of individual. The principles of this protection forms what is sometimes called natural law.

Hayek vs. Keynes Rap

A great rap video from Russ Roberts at Cafe Hayek. The song explores the differences between Hayek and Keynes. Of course I am with Hayek.

Charitable Giving in a Classical Liberal State

In a free and open society one cannot escape profiting from others’ misfortunes when one gives to charity. This may be thought to be immoral especially if the charitable act is obviously motivated by self advancement. Yet others may say that charity is immoral because it somehow denies self-interest, which they deem to be the foundation of a free and open society. Both opinions may have grim implications.

By a free and open society I mean a liberal society with a liberal state. A liberal state is where the community recognised the natural trait of man that he does not like to be told what to do by others. Man is left alone to be guided by his own wit and feelings as long as this does not interfere with others’ freedom to do the same. This means that in this state one is reasonably protected from coercion of others. There is a place for a central government but its major functions are limited to protecting the personal private sphere of individuals from coercion and reducing transaction costs. Reducing transaction costs means reducing cost of trade. This may mean reducing cost of risk of trade by enforcing contracts, or creating standards like a measurement system. The society in such a state still looks after the needy by mandatory contributions from the rest. So there is some coercion and personal private sphere of individuals do overlap. But such provisions are only the minimum which ensures that coercion is minimised. This prevents extreme hardship of fellow man and also protects the general society from acts of desperation (e.g. food riots etc.).

In such liberal state one may not be forced to contribute to help the needy beyond stopping starvation. This means that if one does contribute to charity it is more likely to be a show of genuine, and more importantly voluntary, compassion.

At this point it may be said that because the individual is left to be guided by his own wit and feelings he most logically is actually guided by self-interest. This is because this is most likely to ensure the individual’s survival. However such thinking forgets that the individual is still a human. He is not just interested in his material well being. It is natural for men to derive pleasure from helping fellow man. Denying people from giving charity for the reason that it is against their own interest is thus contradictory. In a free and open society people will always do what is in their self interest, but that may also be interest of others. But charitable contributions may also benefit individuals in a more direct way.

A voluntary contribution to charity in a liberal state will obviously improve one's standing in the community. This is because the gift to the needy will be more likely to be a genuine show of compassion and mercy if one does not obviously boast about it. Naturally man values those who are willing to help him and ask for nothing back in return. However the receiver of charity may be less impressed by the gift if he found out that the charitable contribution was made for selfish reasons, like trying to improve his standing in a community which values selflessness. At the very least if one gives to charity only to improve his standing it is no longer compassion. At worst one may say that one is in fact is profiting from someone else’s misfortune. Profiting from someone else’s misfortune is in fact deemed unethical for selfish reasons. People generally would like to be treated by others as they would reasonably treat others. Thus a person in need would expect help instead of someone profiting by others by his position. This is why people think profiting from other’s misfortune is so unfavourable. Not because it hurts anyone but because if they themselves were in a position of need they would like to have had help instead of no particular gain for themselves while someone else was gaining something. One may characterise it as envy of someone else’s profit.

It must be noted that this is all somewhat of an oversimplification. People would be able to, to a large degree, judge when charity is genuine and when not. Certainly people would be able to tell if someone was boastful of his actions. Cultural norms will also have influence on when someone ought to help someone and when not.

Thus profiting from someone’s misfortune is not necessarily ‘bad’, at least from a materialistic point of view. It does not hurt the giver or the receiver but benefits both. The giver profits from his increased standing in the community. The receiver’s position is obviously helped out because of the hand out. This kind of an improvement where both parties benefit while no one is made worse off is called Pareto-improvement. However there is still the question of ethics. If one does not realise that demanding the stopping of profiting from someone else’s misfortune is in fact selfish one may still feel obligated to try to stop it. One may then argue that the state should concern itself to make the situation more ethical.

One possibility is banning all charitable giving. This would be impossible to enforce. People would still find a way to give to others. More importantly a ban on charity would be unnatural as it interferes with a basic natural trait of man to show compassion and mercy, whether for selfish reasons or not. This solution seems to be even more unethical (whatever that means) than the unethical situation it is trying to resolve.

A more reasonable solution may lie in making all charitable giving secret. This would mean that the giver no longer has the incentive of raising his own standing in the community. This would make it appear that some of the selfishness has been gotten rid of. Of course the giver may will still profit because he is fulfilling his own desires to give. So he is still ripping some profit. However if the incentive of raising one’s of standing is lost many people would stop contributing to charity and many needy would be worse off. It is also somewhat questionable if forcing people to make their contributions secret is in itself all that ethical. This is because this measure restricts people’s freedom (of basically boasting) while it does not stop any imposition on others’ personal private sphere which is the only excuse for restrictions of individuals in a liberal state and society. This solution may end up hurting the poor and the needy for the benefit of allowing a few moralists to sleep easier which seems a poor trade off.

Another possibility may be to allow the state to take from the well off and give to the poor like Robin Hood did. But forcing people to give in such a way is hardly ethical and constitutes robbery. This solution looses all traits of compassion and mercy and imposes on the natural freedom to choose not to give. This solution seems to be most unethical. From a materialistic point of view it does benefit the poor the most because the state can rob the rich to a very large extent and make the poor as rich as it pleases.

A theoretical solution may be to stop people from thinking selfishly or to make people stop regarding mercy and compassion as a virtue. This would require a vast social engineering project which of course would impose on individuals’ natural make up. This would be tyranny.

It seems that there are no ethical solutions to the unethical situation where one profits from another’s misfortune but falsely calls it compassion. All the solutions seem to be even more unethical. It seems that the best thing to do is simply let people be people and let them make their own judgment what is ethical and unethical, what they should do and not do.