Tag Archives: political economy

Repeal regulation requiring ratings

The credit rating agencies (Moody’s, Fitch etc) have been accused of inflating the ratings of companies after their ratings underestimated the default risk during the 2008 financial crisis. First, it is strange to accept ratings expressed as letters (AAA, AAB etc) when the market participants care about the default risk and the letter codes are based (or so the rating agencies say) on the default risk. Remove the coarse letter codes and require the rating to equal the estimated probability of default over the next n years. The probability should have enough significant digits and should report standard errors. It should not vaguely claim that the default probability is somewhere between x and y. The potential for rating inflation and later justification of wrong ratings is reduced by transparency.
A good punishment for the rating agencies that also increases transparency is to repeal any regulation requiring the use of their ratings. Currently, banks are only allowed to invest in “investment grade” bonds, where the grade is determined by the credit rating (agencies). The purpose of the regulation should be to prevent banks from taking too much risk, so the variable of interest is the default probability, not the rating. Replace the requirement of “investment grade” rating with a requirement that the predicted default probability over the next n years must be below x. The obvious question is who predicts this probability.
The restriction to investing only in bonds predicted to be unlikely to default is similar to the vague requirement of due diligence. The investing bank must be able to justify its decision later if the investment turns out badly. The bank must use all available sources of info (maybe even rating agencies) and state of the art methods to predict default probabilities for bonds it intends to invest in. To prevent the bank from manufacturing a justification ex post to excuse its bad decision, the methodology it uses to predict must be provably unchanged from the time of investing. This can be achieved by sharing the methodology with the regulator.
There is a concern that business secrets leak from the regulator to competitors. This can be eliminated by encrypting the info that the bank gives the regulator, with the bank keeping the key. The encrypted info can even be publicly posted on the web. If concerns arise, the bank can later be ordered to give the key to the regulator (or even to the public), who can then verify the info received in the past. If the bank claims to have lost the key, the punishment should be the same as for the lawbreaking that the key is intended to verify.

Lobbying for free insurance

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In many countries, farmers have managed to obtain free insurance from the government – if there is a bad harvest (due to drought, flood or anything else), the government compensates the farmers using tax revenue. On the other hand, if the harvest is unusually bountiful, the farmers do not pay a windfall tax to the government (which would reduce the tax bill of other people or provide more public services). There is thus no premium for the insurance that the rest of society provides to agribusiness.
A thought experiment: the insurance for the agricultural industry is bought from some insurance company who has to pay the farmers if the harvest is bad. The premiums paid to the insurer are taken from the general tax revenues each year. If the insurance company just breaks even (perhaps due to enough competition between insurers, profits are driven to zero), then the movement of money is the same as in the case of “free” insurance by the government.
Agribusiness has managed to pump some money out of other taxpayers with the free insurance. Their success is explained by the classic lobbying theory: if the benefits of lobbying go to a small group, each member of which gets a large sum, then each member of that group has an incentive to put in the effort and money for influencing politicians. If the cost of lobbying is borne by a large group (say the taxpayers), each member of which only pays a small amount, then members of the paying group do not find it worthwhile to make the effort to counterlobby. The savings are too small to be worth the time and money.
If some politician tries to reduce the subsidy to farmers, they are targeted with intense negative publicity. The agricultural industry claims itself to be necessary for “food security” or “feeding the people”. Nevermind that large amounts of food are currently shipped worldwide. Only the import barriers to foreign-produced food are keeping it out of the domestic market. And food security – who takes a country by blockading it into submission these days? A force large enough to surround the country and cut off food import is large enough to take it by storm, which is considerably quicker. Food security really means preventing the rise of food prices. But this is a financial problem and has a financial solution – insurance against a price rise.
If reducing the farming subsidy does not work, a similar effect can be achieved by providing the same subsidy to everyone and raising taxes. Only the administrative costs are higher than in the case of reducing the subsidy. Other industries could argue that they are affected by the weather or other “national emergencies” and deserve compensation from the government. For example, rainy weather reduces ice cream sales and tourism revenues, so the ice cream sellers and the tourism industry could lobby for the same free insurance as the farmers get. If the world price of some natural resource falls, the miners of that could claim an event beyond their control is threatening them with bankruptcy and ask the government for help. If the tastes of the public change so that some form of entertainment is no longer profitable (theatre, opera, classical music), the providers of that can claim to be important for preserving the national culture and the very civilization itself and ask for taxpayer support… wait, that already happens. It is described in the Yes, Minister and Yes, Prime Minister books.
Of course in reality, the subsidies differ across industries, depending on their lobbying prowess. But if the subsidies were proportional to the tax payments of their receivers, they would neatly cancel with the extra taxes levied to finance them. So the government could abolish subsidies by enlarging the set of receivers to include everyone.
By providing free or subsidized insurance, the government is crowding out private insurance – why insure and pay premiums if the government compensates the loss without premiums? This is especially a problem for risks that are common to many voters. For example, a flood is likely to affect the whole neighbourhood, not just one house. In case of flood damage, the people in the neighbourhood can jointly lobby for the declaration of a disaster zone and a public subsidy for rebuilding. So no need to buy flood insurance. With very few buyers, insurance companies stop offering the product.

Why politics is as it is and how to change it

Proposed method of change

Trying to get enough honest politicians elected to change the system just won’t work because honesty limits their tools of making people elect them. Politicians use dishonesty because it works and gets them power.

In a democracy the power ultimately rests with the people. If all people or even just a bare majority were rational and perfectly informed, there would be no room for manipulation and dishonesty. The present political situation is only possible because people are stupid enough to be manipulated into electing the people who create such a political situation. Every nation deserves its leaders.

The way to lessen dishonesty in politics is to make people recognize and dislike it. Most people are not clever enough to see through the manipulation themselves, so the media and perhaps scientists should help them.

When televising speeches of politicians the news agencies could place a running commentary on the speech in the subtitles, pointing out logically or factually wrong statements, demagogy and meaningless phrases, giving examples of the politician’s possible motives for saying certain things, pointing out the interest group to whom a promise is aimed.

The news agencies could keep a file on every politician of sufficient influence. The file should contain their earlier promises, statements, voting record and press releases. Every time the news agency runs a story containing that politician the online version of the story should have a link to that politician’s file. If the politician contradicts his or her earlier talk, it should be pointed out by the news agency and a link to the appropriate place in that politician’s file placed next to the reference.

People could be educated in basic mathematical logic so they could notice some logically false statements (one can never teach most people enough to make them recognize factually wrong claims, that is what the politician’s file would be for).

In countries where a certain number of citizens can initiate laws, those interested in honest politics could campaign for a law recalling a politician who has lied. Then a referendum can be organized to pass that law because politicians themselves certainly would not do it. Lying would need to be clearly defined in the law so that uncertain statements and slips of the tongue would not empty all government institutions. In some cases, however, it can certainly be proved that what the politician said contradicts the facts or is logically false.