American Culture

The remarkable power of remarkable people

Oh, the brutality...

Periander, however, understood Thrasybulus’ actions. He realised that he had been advising him to kill outstanding citizens, and from then on he treated his people with unremitting brutality.

Herodotus, Histories

What Herodotus knew in 440BC, some 2,500 years ago, was this: opportunity is set on the margin. It is the historical power to choose either astonishing innovation, or “unremitting brutality”.

Consider the power of the margin. Say the average inter-city passenger airplane can carry a maximum of 150 passengers. Now, they may fly full at peak times, but they don’t at others, so the airline will set themselves a target of 85% occupancy. Plus, they’ll want a 15% profit (at least) on their capital.

This means that the airline doesn’t begin to make a profit until the 109th person gets on board. Everyone is important, but a plane that flies with only 108 people on board runs at a loss.

These subtle marginal effects can rock markets, bankrupt companies, and destroy nations.

The inequality of nations

Governments have fixed costs for fulfilling their obligations for all the things they promise to do. Unlike businesses, they don’t charge directly for their services. You don’t pay a road surcharge to drive in your area, any more than you pay a monthly subscription to the local police.

The reason for this is one of “fairness”; everyone benefits from these services, but not everyone can afford to pay for them. So governments have introduced a system of charges known as regressive taxation. This means that the wealthiest are charged more, and the poorest are charged less.

The balance of where to place taxes, and how to weight the different groups’ obligations, is the source of much debate and political intrigue.

Consider: rich people spend a smaller proportion of their money on food and clothing, but more of their money on big houses, flashy cars and other obvious markers of wealth. You could tax everyone the same proportion of their incomes and then charge targeted consumption taxes on specific products.

But consumption taxes are unpopular, difficult to enforce and can result in peculiar avoidance behaviour.

In 1662 Charles II, king of England, imposed a hearth tax on his island nation. Henceforth every household would have to pay two shillings per year, per chimney. It was designed to be fair, in that the wealthy had more chimneys and should, therefore, pay more.

It was an extremely unpopular tax, not least because tax inspectors had to come into people’s homes to inspect. Almost immediately people began to avoid the tax by bricking up their chimneys. In 1684 a fire broke out, destroying 20 houses and killing four people in Oxfordshire, after a baker broke through from her stove into a neighbour’s chimney in order to avoid the tax.

In 1689 the tax was repealed and replaced with one that was even sillier; a window tax. People avoided it by, as expected, bricking up their windows. It was even more unpopular being seen as a tax on “light and air”. It may, or may not, have been the origin of the phrase “daylight robbery”.

The point is that people are not mindless automatons. They will react to protect themselves from silly and victimising pieces of legislation.

A careful politician may consider it an equitable tax, but, if it is at all targeted, then those within the target zone will try to avoid it.

Tax one, tax all

When you select against a particular group, then the most ambitious and creative people within that group move. Sometimes they hide out within society by simply quashing the thing that makes them a target. Sometimes they go somewhere else where they feel more accepted.

So, we punish murderers, not to redress the harm they have done, but to frighten other potential murderers into thinking a bit more deeply before committing a murder. And Gary Glitter, a paedophile convicted in the UK, goes to Vietnam in the hopes that he won’t be prosecuted there.

But say you started punishing people for things that are not necessarily harmful, perhaps even beneficial? Racial, religious, gender or sexual orientation laws also act to select for, or against particular groups.

You can only ride so longSouth Africa’s Apartheid laws denied dark-skinned citizens not only the right to vote, but also to work. This allowed the minority of light-skinned South Africans to dominate and control a majority of dark-skinned fellow citizens. Following Thrasybulus’ instructions, the minority leadership sought out and punished outstanding individuals from amongst the dark-skinned citizens. But this also meant that talented doctors, engineers and scientists – who just happened to be dark-skinned – either didn’t work at all, or emigrated and made their skills available to other nations.

Promoting people based on their skin-colour also meant that those in the most responsible positions frequently lacked the ability to perform their jobs. Inadequacy became the expected performance level.

When South Africa eventually discarded Apartheid, the economy was shattered and dominated by idiots.

Any type of bias levied against a particular segment of the population goes on to affect the entire population. In the case of preventing murderers and rapists from being able to operate, this is a bias that society is probably very happy with. In the case of preventing talented surgeons from pursuing their craft because they happen to be female, then the whole of society may not be so happy with the arrangement.

A bias is a form of tax. Some taxes we’re happy to pay; other taxes may please a particular subgroup, but leave the whole of society worse off.

Now consider how much excluding outstanding individuals can hurt a society when marginal effects come into play.

Marginal bias, general effect

Say that a country is able to manage its health needs if it has more than 1.40 doctors per 1,000 people in its population. Turkey has 1.37, about 116,000 doctors. Many of these are women, and many of these women are devout Muslims. At present, wearing a head-scarf, a traditional sign of piety amongst Muslim women, is illegal. So, some women who are pious and doctors made a choice to remove their scarves in order to continue working, some stopped working altogether, and some emigrated to countries where they can be doctors and wear a scarf.

It is the same situation as the airline. All the doctors are equally important, but only a small number need to stop working for all the rest to be unable to meet the demand. In other words, a discriminatory law punishes a small number of people for their beliefs but denies an entire nation good healthcare.

This can work the other way round as well. The Cuban dictator, Fidel Castro, was determined that his small island nation would excel at something. He chose public health and subsidised the training of a vast number of doctors. There are now almost six doctors per 1,000 people in Cuba.

This may sound like a good thing but, if you’re a doctor, it’s a bit of a disaster. A society may suffer if it has too few doctors but, once it hits the appropriate level, any extra doctors merely increase supply without adding to demand. The only way doctors can get sufficient business is to discount their prices. In Cuba, doctors are plentiful but poorly paid.

Cuba, poor in so much, has resolved this conflict by becoming probably the only nation to deliberately export doctors on work contracts to other nations in order to purchase foreign currency.

Perverse, too, is promoting individuals based on characteristics that have nothing to do with their performance. You lower the standard for everyone, as in South Africa under Apartheid where people were hired on the basis of being light-skinned and male.

Sometimes the desire to extend a product or service beyond reason results in harm to all. Sub-prime lending is just such an example. It seemed like a reasonable set of assumptions. Most people don’t default on their loans, no matter how onerous they may be. Insurance works on a similar principle; I don’t know which person is going to have their car stolen, but most people manage to get through a year without incident. Work out the base probability of disaster and charge everyone sufficient to cover the disaster, plus a bit extra for your trouble. Hence, insurance.

Very smart people built mathematical models to calculate the cost of sub-prime default, given certain assumptions. Loans were bundled together, discounted for the expected defaults, and sold to hedge funds who would carry the risk of failure if the assumptions were wrong.

This was quite a bit of money and so the hedge funds borrowed the money they used to buy the sub-prime bundles. They borrowed this from banks who, themselves, were selling sub-prime bundles. Everything relied on those assumptions.

It didn’t need everyone to bail on paying their mortgages back, it just needed to happen on the margin. And then all hell broke loose.

The balancing act and the perversity of incentives

So, here we are, trying to design an equitable society that gives those who lack ostensible advantages a shot at improving themselves, while tapping those who got a lot more advantages to pay for it.

Marginal effects mean that, if we don’t allow the most disadvantaged a shot at success, they may take their potential talents elsewhere as economic migrants. Or, some may decide that, since society has failed them, society owes them, and steal what they want.

On the other end, though, if we tax the wealthy too much, they could simply take their cash and go elsewhere, as tax exiles. Or, they may decide not to produce any more wealth than they have to for themselves.

The balance is critical. Get the balance wrong and you introduce asymmetries.

For instance, when the US Forest Service manages an area of environmental value purely for recreational purposes, they have to send that money directly to the Treasury. When they licence an area for logging, they get to keep a portion of that revenue, plus they get cash from Congress to manage the land afterwards.

If the US Forest Service wants to make enough money to carry out its functions, it can only do so by logging the forests it is supposed to be looking after.

This is a perverse incentive. There are lots of them in the average economy.

Consider autoworkers. The rise of manufacturing in Eastern Europe and Asia Pacific has resulted in a falling cost of motor vehicles as companies locate their factories in low-cost production centres. The prices of cars are falling and old manufacturing hubs in the US, Germany and the UK are feeling the pressure.

Both workers and investors stand to lose what they have, their livelihoods. Arguably, it is the owners of these businesses fault. They should have invested in more efficient, lean manufacturing systems, designed more interesting vehicles, or come up with a better strategy.

That shareholders should lose their investments is just-desserts and a powerful part of the capitalist system which ensures that cash should follow value. However, it’s pretty unfair on the workers, who were just doing what they were told.

There are many ways you could help these workers. The most common is to raise tariffs on imports and to pass a subsidy to the manufacturer to allow them to improve their profits without raising their prices too much.

However, this is a distortion. There are plenty of people who work in the auto industry who don’t actually make cars. There are people who import them, have showrooms, service and repair them, or simply write about them. None of these people are affected in any way by the collapse of local manufacturing. However, all of them and every car buyer, is affected by higher prices.

Plus, a company that is protected from competition is also protected from innovation. Forget fuel efficiency or environmental compliance.

Get the leverage right...In exchange for protecting a handful of jobs, the entire nation has to suffer.

Worse, the benefit doesn’t even go to the workers, who merely get to keep their jobs. Tax money is channelled directly to shareholders who no longer have to work for their money.

A far better response is to admit that the industry is no longer competitive, tell the shareholders to get shafted, and bail out the employees through income support and reskilling.

The marginal effects also come into play. The protection of a small number of businesses deprives the state of using that revenue to pay for other things that may have a significant return on investment. It deprives investors in other industries of a level competitive environment and so denies citizens of their opportunity to benefit from innovation and price drops.

Protecting a few hurts a lot of people and also chases the other few innovators out of the market, since there is no place for them.

The leverage of innovators

Ever wondered what would have happened if Bill Gates had decided to set up in Canada instead of the US? Or if Russia had tried informed capitalism instead of Communism?

When the Berlin Wall came down, the real cost of “from each according to his ability, to each according to his needs” became apparent. Those with the most ability left, leaving everyone getting only as they could produce. The society balanced. You really can only consume as much as you can produce. Any extra comes from the margins.

As with all marginal effects, any society needs a certain number of innovators just to break even. The variance triggers booms or busts.

Innovators have no more votes than does anyone else in their nations, yet they have disproportionate impacts on their societies. Countries that can attract the best and the brightest do better than those who chase them away.

Subsidies and tariffs aimed at the few distort markets in outlandish ways. Subsidies to oil producers push entire economies to rely on cheap oil at the expense of, seemingly, more expensive alternatives. Not costing in the impact of pollution leads to more pollution.

The next time a politician promises you a benefit that you don’t have to pay for, ask yourself who it is costing and how they may react. And not just now, but into the future. No matter how much benefit you may feel that you will derive, you have to remember that the others who must pay for it are not slaves. They may shut-down or go elsewhere.

In the case of murderers, that may make you quite happy. But it if it results in services denied, jobs not created, opportunities foregone, or a future that never happens, then that sounds like a costly bargain.

2 replies »

  1. Any margin is a double edged sword. If one is correct when using a great deal of leverage, unimaginable wealth can be the result. A single mistake while highly leveraged can put a huge dent in one’s bank roll. I personally use about 5X margin, and hedge all of my trades with options. The funds and banks that use 100X margin are courting disaster, and are the reason of the financial melt down. The economic system can’t handle all of this leverage, and that’s why we’re experiencing such volatility. The necessary unwinding of all of the leverage and carry trade is causing the market fits, but is nevertheless presenting excellent trading opportunities.