In India, Child Labor Ban Leads to More Child Labor

Just one of the many examples of how noble-sounding statutes backfire when faced with economic reality. 

From the Wall Street Journal Real Times Economic Blog

A ban on child labor sounds like a policy move that would yield nothing but favorable results. But a new paper on the fallout from such a measure in India finds that isn’t the case.

The title — “Perverse Consequences of Well Intentioned Regulation: Evidence from India’s Child Labor Ban” — captures the conclusion that families’ welfare diminished rather than improved after India’s 1986 prohibition against labor by children under age 14.

The authors focused on particular jobs that the ban prohibited children from doing, such as working in mines, handling toxic substances, making cigarettes or providing food at rail stations. The ban didn’t extend to agriculture or family businesses, but the legislation set forth limits on how many and which hours children could work. Penalties for flouting the law included fines or prison time.

After the ban, the authors found, child labor actually increased — while wages for children, relative to those of adults, decreased. In addition, since fewer children were being paid, families became poorer, consumed and spent less and all told, found themselves struggling more financially than they had before the ban.

The abstract of the NBER paper by Prashant Bharadwaj, Leah K. Lakdawala and Nicholas Li (bold mine)

While bans against child labor are a common policy tool, there is very little empirical evidence validating their effectiveness. In this paper, we examine the consequences of India’s landmark legislation against child labor, the Child Labor (Prohibition and Regulation) Act of 1986. Using data from employment surveys conducted before and after the ban, and using age restrictions that determined who the ban applied to, we show that child wages decrease and child labor increases after the ban. These results are consistent with a theoretical model building on the seminal work of Basu and Van (1998) and Basu (2005), where families use child labor to reach subsistence constraints and where child wages decrease in response to bans, leading poor families to utilize more child labor. The increase in child labor comes at the expense of reduced school enrollment. We also examine the effects of the ban at the household level. Using linked consumption and expenditure data, we find that along various margins of household expenditure, consumption, calorie intake and asset holdings, households are worse off after the ban

At the end of the day, arbitrary edicts intended to safeguard certain constituents end up going on the opposite direction. Such is the law of unintended consequences

In Beijing, Property Curbs Fail to Stop Bubbles

When authorities say that regulations would do the wonders of effecting price controls, they are mostly propagandizing. That's because markets will prove them utterly wrong. 

One great example, the stiff property curbs in Beijing has failed to stem the locality’s ballooning property bubble.

From Bloomberg: (bold mine)

Beijing, which already has China’s strictest real estate curbs, is being forced to take additional steps to contain surging home prices as demands for record-high down payments fail to deter buyers.

The city has enforced citywide price caps since March by withholding presale permits for any new project asking selling prices authorities deem too high, according to developer Sunac China Holdings Ltd. (1918) and realtor Centaline Group. Local officials will need further tightening as they struggle to meet this year’s target of keeping prices unchanged from last year, said Bacic & 5i5j Group, the city’s second-biggest property broker.

The failure of official curbs to stem price increases in the nation’s capital highlights the government’s struggle to keep housing affordable as urbanization sends waves of rural workers into China’s largest cities. New-home prices in Beijing rose by 3.1 percent in April from the previous month, the biggest gain among the nation’s four so-called first-tier cities, and climbed by the most after Guangzhou in May, according to SouFun Holdings Ltd. (SFUN) They rose in each of the first five months of this year…

Beijing, the nation’s third-most populous city, is the only city that enforces price caps in earnest, according to Bacic & 5i5j. Guangzhou and Shenzhen in the southern province of Guangdong are rejecting presale permits for some projects seen as too expensive, CEBM’s Luo said. The three cities, along with Shanghai, are considered first-tier.

In one of his last policies, Wen, replaced by Li Keqiang less than a month later, on Feb. 20 called on city governments to “decisively” curb real estate speculation after home prices surged the most in two years in January.

Beijing followed with the toughest curbs among the 35 provincial-level cities that responded with price-control targets, becoming the only region to raise the minimum down payment on second homes from 60 percent and to enforce a 20 percent capital-gains tax on existing homes, according to Centaline Property Agency Ltd., China’s biggest property agency.

Still, new-home prices in the city of 19.6 million, jumped 10.3 percent in April from a year earlier, the biggest rise after Guangzhou and Shenzhen, the National Bureau of Statistics said May 18. Prices of existing homes jumped 10.9 percent, the most since they reversed declines in December, and the greatest gain among all the 70 cities tracked by the government.

Given China’s underdeveloped capital markets, the ongoing consolidation of their stock markets, the artificially low rates designed to attain negative real rates or via the "inflation tax" (I doubt the accuracy of official statistics suggesting otherwise) and the massive credit expansion channeled mostly through State Owned Enterprises, where do you think the average Chinese will put their savings?

Bubble policies motivates people to go into wild (yield chasing) speculative activities. Thus, property bubbles and property sector backed shadow banking system are merely symptoms of bubble policies. 

For as long as the Chinese government promotes credit inflation, bubbles will be the economic and financial order.

The failure of property curbs only exhibits of the flagrant myopia of politics—where authorities see their constituents as unthinking subjects or automatons who will merely surrender to their whims.

In reality, many Chinese look for loopholes such as resorting to “divorce” in order to circumvent property regulations.

Moreover, additional regulations only complicates a fragmented and diverse system which only encourages corruption and other unethical behavior.

Yet aside from property bubbles and the shadow banking system, the more cautious Chinese protect their savings through accumulations of gold. 

The recent flash crash has only prompted many of the the Chinese to a gold buying spree. Premiums on physical gold in China has “jumped four-fold in the last six weeks” according to the the Zero Hedge.

In the illusory world of the fiat based monetary political economy, people have been incentivized to either indulge in wanton speculation or to hedge on real assets rather than to engage in productive activities. Thus bubbles everywhere.

And price controls only worsens such imbalances.

World Competitiveness: Philippines Jumps to 65th Place

The World Economic Forum (WEF) recently released, The Global Competitiveness Report for 2012-2013 which attempts to measure relative competitiveness among 144 nations that provides “insight into the drivers of their productivity and prosperity”

It is important to highlight that the competitive ranking have been defined by the WEF as

as the set of institutions, policies, and factors that determine the level of productivity of a country. The level of productivity, in turn, sets the level of prosperity that can be earned by an economy. The productivity level also determines the rates of return obtained by investments in an economy, which in turn are the fundamental drivers of its growth rates. In other words, a more competitive economy is one that is likely to sustain growth.

Here is the roster of the top 30 most competitive nations.

Notice that the WEF says the ranking is about productivity, and not about “cheap labor”.

If competitiveness is about the “cheap labor” then the Philippines and Africa will be on top of the list. Unfortunately mainstream demagoguery has obstinately been focused on this, so as to justify the inflationist-interventionists doctrines.

Also notice that the most competitive nations have been developed economies. The GCI rankings have been closely aligned with the list of most economically free nations (Heritage Foundation: 2012 Index of Economic Freedom).

It is important to note that the above rankings are comparative or relatively based. This implies that changes in standings may not necessarily translate to advancement or deterioration in domestic policies but about quantified comparative measures.

First the good news.

According to the report, the Philippines leapt from 75^th to 65^th

Yet despite the huge gains, which obviously will be construed and used by the mainstream and political forces to grab credit as “achievement” for the administration, the Philippines trails vastly behind the ASEAN peers.

Curiously Africa’s Rwanda has even been ahead.

The bad news is that despite the remarkable gains, the gap in the per capita GDP figures has been widening relative to our developing Asian peers.

This means that yes the Philippines has shown material progress but such gains has not been enough to cope up with the scale of advancement in the region.

Lastly, the reason for the lag in productivity has been about over politicization of the domestic economy which has been manifested through a bloated bureaucracy, lack of infrastructure (which has been politically determined—see below), tax and labor regulations and high tax rates.

Of course corruption has still been the biggest deterrent to business. But, in truth, corruption signifies as symptoms of interventionism expressed through arbitrary policies and regulations, the bureaucracy, welfare-warfare state and state determined allocation of resources.

The informal economy, which is also a symptom of interventionism, takes up a huge chunk of economic activities. This is a clear manifestation of the failures of interventionism and of the incumbent political institutions.

Ironically the salutary conditions of the shadow economy could be suggestive of the alternative positive aspects of corruption, where people pay bribe money to authorities in order to do productive endeavors. This in spite of the major negative attribution on the survey.

The burgeoning informal gold mining sector, which comes mostly in response to recently imposed higher taxes should serve as a wonderful anecdotal example.

Yet the media and the social desirability bias afflicted pop culture cheers about the Php 407 billion proposed infrastructure or so-called “investment” spending without the realization that productive money will be diverted to the pockets of cronies (who will get the contracts), bureaucrats (who will pick the winners) and politicians (which most likely will be the source of electoral finance for the upcoming 2013 national elections).

chart from US Global Investors

All these supposed stimulus will only translate to greater inequality (enrichment of the political class and of the politically connected enterprises), more debts, higher taxes (for the middle class and the politically unconnected), more PRICE inflation (which will be blamed on the private sector) and importantly adds to the ballooning bubble dynamics driven by current easy money policies.

These so-called public work policies are a chimera, as the great Professor Ludwig von Mises explained.

The fundamental error of the interventionists consists in the fact that they ignore the shortage of capital goods. In their eyes the depression is merely caused by a mysterious lack of the people's propensity both to consume and to invest. While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment. They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill wants the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, the shortage of capital goods.

For media and the dumb downed (“madlang people”) electorate which sees this as good news hardly understands that effects of so-called government stimulus would be based on the illusions of statistics [mainstream economic statistics are based on Keynesian formula constructs] and not from real growth.

Thus, temporary good news will eventually become long term bad news.

However, despite such realities, the relatively better competitive standings today will likely continue to improve. Again, this is hardly because of internal ‘business friendly’ improvements but because of positional standings which will mostly be determined by the political responses to the unfolding crisis abroad.

Again the WEF’s GCI

The global economy faces a number of significant and interrelated challenges that could hamper a genuine upturn after an economic crisis half a decade long in much of the world, especially in the most advanced economies. The persisting financial difficulties in the periphery of the euro zone have led to a long-lasting and unresolved sovereign debt crisis that has now reached the boiling point. The possibility of Greece and perhaps other countries leaving the euro is now a distinct prospect, with potentially devastating consequences for the region and beyond. This development is coupled with the risk of a weak recovery in several other advanced economies outside of Europe—notably in the United States, where political gridlock on fiscal tightening could dampen the growth outlook. Furthermore, given the expected slowdown in economic growth in China, India, and other emerging markets, reinforced by a potential decline in global trade and volatile capital flows, it is not clear which regions can drive growth and employment creation in the short to medium term

The big picture gives us an objective dimension of the real developments rather than fall for trap to political demagoguery

Updated to add:

I was unaware when I wrote a few hours back that the competitiveness issue accounts for today's main headline story.

How Government Policies Contributed to JP Morgan’s Blunder

Author and derivatives manager Satyajit Das, ironically a neoliberal, has a superb article at the Minyanville, which elaborates on how regulations and government policies, which I earlier posted, has shaped the incentives of Too Big to Fail institutions to take excessive risks and the failure of regulators to prevent them (all bold emphasis mine)

The large investment portfolio is the result of banks needing to maintain high levels of liquidity, dictated by both volatile market conditions and also regulatory pressures to maintain larger cash buffers against contingencies. Broader monetary policies, such as quantitative easing, have also increased cash held by banks, which must be deployed profitably. Regulatory moves to prevent banks from trading on their own account -- the Volcker Rule -- have encouraged the migration of trading to other areas of the bank, such as liquidity management and portfolio risk management hedging.

Faced with weak revenues in its core operations and low interest rates on cash or secure short term investment, JPMorgan may have been under pressure to increase returns on this portfolio. The bank appears to have invested in a variety of securities, including mortgage backed securities and corporate debt, to generate returns above the firm’s cost of capital.

Again, the failure of models…

Given JPMorgan vaunted risk management credentials and boasts of a “fortress like” balance sheet, it is surprising that the problems of the hedge were not identified earlier. In general, most banks stress test hedges to ensure their efficacy prior to implementation and monitor them closely.

While the $2 billion loss is grievous, the bank’s restatement of its VaR risk from $67 million to $129 million (an increase of 93%) and reinstatement of an older risk model is also significant, suggesting a failure of risk modeling.

The knowledge problem…

Banks are now obliged to report positions and trades, especially certain credit derivatives. This information is available to regulators in considerable detail. Given that the hedge appears to have been large in size (estimates range from ten to hundreds of billions), regulators should have been aware of the positions. It is not clear whether they knew and what discussions if any ensued with the bank.

External auditors and equity analysts who cover the bank also did not pick up the potential problems. Like regulators, they perhaps relied on assurances from the bank’s management, without performing the required independent analysis.

Hayek’s “Fatal Conceit” or the pretentions of knowledge by regulators to apply controls over society or the marketplace…

Legislators and regulators now argue that the rules for portfolio hedging are too wide and impossible to police effectively. In addition, the statutory basis may not support the rule. The legislative intent was intended only to exempt risk-mitigating hedging activity, specifically hedging positions that reduce a bank’s risk. Interestingly, drafters of the portfolio hedging exemption recognized the potential problems, seeking comment on whether portfolio hedging created “the potential for abuse of the hedging exemption” or made it difficult to distinguish between hedging or prohibited trading.

In a recent Congressional hearing, Former Fed Chairman Paul Volcker, who helped shape the eponymous provision, questioned whether the volume of derivatives traded was “all directed toward some explicit protection against some explicit risk.”

The pundits have been quick to suggest that the losses point to the need for more stringent regulations. But it is not clear that a prohibition on proprietary trading would have prevented the losses.

In practice, without deep and intimate knowledge of the institution and its activities, it is difficult to differentiate between legitimate investment and trading of a firm’s surplus cash resources or investment capital.

It is also difficult sometimes to distinguish between hedging and speculation. The JPMorgan positions that caused the problems were predicated on certain market movements -- a flattening of the credit margin term structure -- which did not occur.

Hedging individual positions is impractical and would be expensive. It would push up the cost of credit to borrowers significantly. All hedging also entails risk. At a minimum, it assumes that the counterparty performs on its hedge. But inability to legitimately hedge also escalates risk of financial institutions. Ultimately no hedging is perfect. or as author Frank Partnoy told Bloomberg: “The only perfect hedge is in a Japanese garden.”

Additional regulation assumes that the appropriate rules can be drafted and policed. Experience suggests that it will not prevent future problems.

Bankers and regulators have always been seduced by an elegant vision of a scientific and mathematically precise vision of risk. As the English author G.K. Chesterton wrote: “The real trouble with this world [is that]…. It looks just a little more mathematical and regular than it is; its exactitude is obvious but its inexactitude is hidden; its wildness lies in wait.”

In reality it is not just “without deep and intimate knowledge of the institution and its activities” but about having the prior knowledge of the choices of the individuals behind these institutions. This is virtually unknowable.

Finally, the monumental government failure…

How do regulatory initiatives and monetary policy action affect bank risk taking? Central bank policies are adding to the problem of banks in terms of large cash balances which must be then invested at a profit. The implementation of the Volcker Rule may have had unintended consequences. It encouraged moving risk-taking activities from trading desks where the apparatus of risk management may be marginally better established to other parts of banks where there is less scrutiny.

The most important question remains whether any specific action short of banning specific instruments and activities can prevent such episodes in the future. It seems as Lord Voldemort observed in Harry Potter and the Deathly Hallows Part 2: “They never learn. Such a pity.”

People who are blinded by power and or the thought of power never really learn.

A Map Of The World’s Drinking Habits

Interesting article from the Economist

THE world drank the equivalent of 6.1 litres of pure alcohol per person in 2005, according to a report from the World Health Organisation published on February 11th. The biggest boozers are found in Europe and in the former Soviet states. Moldovans are the most bibulous, getting through 18.2 litres each, nearly 2 litres more than the Czechs in second place. Over 10 litres of a Moldovan's annual intake is reckoned to be 'unrecorded' home-brewed liquor, making it particularly harmful to health. Such moonshine accounts for almost 30% of the world's drinking. The WHO estimates that alcohol results in 2.5m deaths a year, more than AIDS or tuberculosis. In Russia and its former satellite states one in five male deaths is caused by drink.

I’d like to add that institutions like the WHO, whom has called for stronger “alcohol control policies” appears to have forgotten about the epic regulatory failure in the “Volstead Act” or the US alcohol prohibition law of the 1920s.

Such prohibition, also known as ‘the Noble experiment’, according to wikipedia.org, “stimulated the proliferation of rampant underground, organized and widespread criminal activity” which eventually led to its repeal.

Noble intentions will never rescind the laws of demand and supply.

Doug Casey On Corruption: Laws Create Corruption And Corruption Engenders Laws

Investment guru Doug Casey in this conversation gives a trenchant insight of the mechanics of corruption

On his definition of corruption: (all bold highlights mine)

a betrayal of a trust for personal gain

On the difference between private and public corruption

One can find corruption within corporations, as when directors betray their duty to the shareholders for personal gain. Or churches, as when priests, for pleasure, betray the trust of the young people under their guidance. Even a parent can be corrupt, if he fritters away on high living money intended to be left to his kid. But those types of corruption stem from personal weakness and personal vices. They're horrible – but corruption in government is much worse.

Only government can impose its will on you by law, and back it up with a gun. And with other sources of corruption you can – theoretically at least – go to the government for redress. But when the government is corrupt, it's hard to get the state's right hand to cut off its left. Not only that, but government – partly because its essence is force – concentrates corruption, and incubates it. If a company or church is corrupt, one can quit them. But citizens are stuck with their government – and they'll probably keep paying taxes to it regardless of their feelings toward it. A discussion about corruption is necessarily a discussion about government as an institution.

On the roots of public corruption:

As Tacitus said in the second century A.D., "The more corrupt the state, the more numerous the laws." It's absolutely predictable that as all these governments around the world – and I mean all of them – respond to the ongoing crisis with an ever-accelerating onslaught of new laws, there will be more and more corruption – and frustration with that corruption.

Tacitus was right. But he could just as accurately have said, "The more numerous the laws, the more corrupt the state," because lots of laws engender lots of corruption. In other words, corruption isn't the problem. The state and its laws are the problem, to which corruption is an unsavory and unaesthetic – but necessary – solution. Laws create corruption, and corruption engenders laws.

Every time a legislature convenes, they pass more and more laws. That's all they do, all day long. So the body of laws and the accompanying volumes of administrative regulations and procedures to implement them is constantly growing – the whole world over. Legislatures are horrible and dangerous things that bring out the absolute worst in the people who inhabit them.

Laws and regulations are like barnacles on a ship. They keep growing and growing, weighing the ship down, slowing it down. If they aren't scraped off from time to time, they will threaten the ship's structural integrity.

On the efficacy of anti-corruption laws:

Those laws necessarily have the opposite effect of what's intended. By raising the stakes, they just raise the level of bribery required, resulting in even more severe corruption. Like everything governments do, it' not just the wrong thing to do, but the exact opposite of the right thing to do....

The only way to fight official corruption is to reduce the amount of legal control of officials, particularly their regulatory power over the economy. If there were no government regulators, inspectors, assessors, auditors, and so forth ad nauseam, there'd be no reason for businesses and consumers to bribe them to get the hell out of the way.

On how free markets are self regulated:

There are many market forces that regulate business activity – and more broadly, cultural forces that regulate interactions between people. In the marketplace, reputation is a very powerful force. So is competition. And so is liability – it's a powerful negative incentive. More broadly, culture is a very powerful regulatory force, which is to say, peer pressure, moral opprobrium, and social approbation restrain people from being naughty far more than fear of police does. And there are also private institutions that have powerful regulatory influences, such as churches, Rotary, Lions Clubs, and the like.

On the public’s wrong impression on the significance of government:

People somehow imagine that because government regulations are backed with the iron fist of the law, they work better, especially when the matter is considered vital. This is simply incorrect. It shows an ignorance of both history and of the state of the world today. Regulation usually becomes so corrupt that it ends up doing the opposite of its intended effect. A business that pays officials to look the other way can do even worse things than they would do if there were no officials, because the official seal of approval falsely tells the people that all is well. That's why the SEC should be called the "Swindler's Encouragement Commission" – because it lulls investors, especially the novices, into feeling they're protected.

On the roots of regulatory corruption:

Strict regulation leads naïve people to think, "Everything is under control." That has two important effects. One, it makes them irresponsible – a belief that they don't have to concern themselves. That general attitude then permeates the society. Two, regulation always creates distortions in the market. It's like a lid on a pressure cooker. Everything looks under control until the whole thing blows up.

That's what lies at the root of the concept of "black swan" type unexpected events. The black swan lands when the amount of corruption necessary to evade laws becomes as onerous as the laws themselves.

On why corruption is a good thing:

There's good news and bad news in this.

In itself, corruption is a bad thing – it shouldn't have to be necessary. As I touched on earlier, insofar as it's necessary, it's also a good thing. If we can't eliminate the laws that give rise to corruption, it's a good thing that it's possible to circumvent these laws. The worst of all situations is to have a mass of strict, stultifying, economically suicidal laws – and also have strict, effective enforcement of those laws. If a culture doesn't allow people to work around stupid laws, that culture's doom is further sealed with every stupid law passed – which is pretty much all of them.

Read the rest here

More Regulations Equals More Politics

In an egroup message, several former schoolmates decried on the pervading corrupting influence of politics in the state of the Philippine educational system as seen through this plea or manifesto.

However, the expressed dissatisfaction had not been complete as this did not deal with the cause-and-effect, where regulations and politics basically go hand in hand.

To extrapolate: the greater the role of regulations in the economy, the deeper the involvement of politics as means to distribute resources.

Perhaps the state of Greece as described by Michael Lewis at the Vanity Fair could be emblematic of the corrupting influence of a collectivist and highly politicized society (hat tip Russ Roberts). [all bold emphasis mine]

The Greek state was not just corrupt but also corrupting. Once you saw how it worked you could understand a phenomenon which otherwise made no sense at all: the difficulty Greek people have saying a kind word about one another. Individual Greeks are delightful: funny, warm, smart, and good company. I left two dozen interviews saying to myself, “What great people!” They do not share the sentiment about one another: the hardest thing to do in Greece is to get one Greek to compliment another behind his back. No success of any kind is regarded without suspicion. Everyone is pretty sure everyone is cheating on his taxes, or bribing politicians, or taking bribes, or lying about the value of his real estate. And this total absence of faith in one another is self-reinforcing. The epidemic of lying and cheating and stealing makes any sort of civic life impossible; the collapse of civic life only encourages more lying, cheating, and stealing. Lacking faith in one another, they fall back on themselves and their families.

The structure of the Greek economy is collectivist, but the country, in spirit, is the opposite of a collective. Its real structure is every man for himself.

Will A Ban on ‘Texting While Driving’ Reduce Accidents?

In examining accidents, the intuitive response by policymakers is to look at the immediate cause and subsequently apply restrictions on it.

And this applies to “texting while driving”, where the underlying belief is--just ban ‘texting while driving’ and accidents will go away.

Simple antidote right?

Well, a study demonstrates that this socialist “feel-good-to-do-something-about-it” policy is nothing but nonsensical fairy tale, with even more vicious consequences (other than restricting one’s liberty).

From the Cleveland Leader, (bold highlights mine) [Hat tip: Professor Don Boudreaux]

Laws that ban the practice of texting while driving are designed to keep drivers' attention on the road and avoid accidents, but new research published Tuesday by the Highway Loss Data Institute suggest otherwise. Laws banning texting while driving may actually increase the risk of road crashes, according to the study.

The HLDI research showed that crash rates rose in three out of four states after texting bans were implemented

Adrian Lund, president of HLDI and the Insurance Institute for Highway Safety says:

"Texting bans haven't reduced crashes at all. In a perverse twist, crashes increased in three of the four states we studied after bans were enacted.

It's an indication that texting bans might even increase the risk of texting for drivers who continue to do so despite the laws."

Lund added that the findings "call into question the way policymakers are trying to address the problem of distracted driving crashes", and said that the increased crash rates were due to drivers responding to the regulations by moving their phones lower down and out of sight when sending a text. This increases the risk of a crash because the driver's eyes are diverted further from the road and for a longer time.

So, the unintended consequences appear to be worse than the desired the goal of reducing accidents or that the costs of the policy seems greater than the intended benefit.

So what’s wrong with the policy?

It basically overlooks human response to circumvent or go around regulations.

Of course, there are other possible ramifications: this law could be used to harass the public, increase the incidence of extortion and corruption, increase taxpayer costs of applying the law (bureaucracy), selective implementation of the law, curtail personal liberty and etc…

In short, the end does NOT justify the means.

Hernando De Soto: Unclear Property Rights And Complex Rules Led To Market Crashes

In a recent interview, the illustrious economist Hernando De Soto, author of The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, suggests that complicated and opaque laws, which muddles up the property rights issue, has prompted for the latest market crashes.

On the rule of law...

"when it comes to property rights: most of the world is still in the 19th century. During that time period, the US put all their property information on paper. These "rule of law" standards identified who owned what property - this system is still viable today...

"when independence, solidarity and individuality function under the "Rule of Law, all players are on the same playing field; that is the rules apply the same to all [but note, this concept is non-existent in many parts of the world]. South American and African nations borrowed their laws from their colonizers. In contrast, anarchy has many laws within the same territory.

my comment: In an earlier post Are People Inherently Nihilistic?, we said that the term "anarchy" comes with different references. Here, Mr. De Soto appears to imply that anarchy (or perhaps defined as market turmoil) was caused by the many intricate laws within the same territory, which brings us to the next topic...

De Soto's view on property rights and rule of law's role in today's market crash...

``The basic problem with the financial meltdown today is that with all the convoluted derivatives, trades, bundling, etc. the US does not know where its financial paper is. Thus, the US cannot define who is solvent and who is not. The "Rule of Law" comes into play because property ownership is based on a paper trail. Since the paper trail is incomplete regarding detailed ownership of the property underlying the complex derivatives that were sold in the financial industry, no one knows who owns exactly what and what it is worth. As a result, trust plummets."

my comment: so the questionable application of the "rules" which has led to the ambiguous stance on ownership rights has prompted for a lost of trust or "anarchy".

Besides, excess and poorly defined regulations have prompted for regulatory arbitrage, regulatory capture, administrative lapses by regulators (because of sheer volume of laws, enforceability issues and possible confusion) and amplifies conflict of interest among participants or agency problems. And all these get to be reflected on distorted price signals. I'd like to add that inflation, as a hidden tax, is a major contributor to De Soto's property rights-rule of law dilemma.

In Greg Ransom's Hayek Center (where I sourced this, thanks Greg...) adds that... (bold highlight mine)

``My ancestors recorded property right claims with a central registrar in the no-mans land of Oregon when the region had no legitimately recognized government. The people of the region followed customs of law and governance share among the English and Americans, with the anticipation that their property rights claims would later be recognized by the U. S. government when the region became part of the United States. The story is recounted in Nimrod: Courts, Claims and Killing on the Oregon Frontier by Ronald Lansing of the Lewis & Clark School of Law. Yes, remarkably enough, the story is a murder mystery."

my comment: more evidence that property rights had been observed outside of the realm of government.

Graphic: 7 (+1) Ingredients That Led To Today's Financial Crisis

Interesting graphic on the anatomy of today's crisis [hat tip: Barry Ritholtz/wallstats.com]

I'd like to add an 8th variable; policies and regulations that has skewed the public's incentives towards the bubble.

As Tyler Cowen wrote in the New York Times, ``And legislation that has been on the books for years — like the Home Mortgage Disclosure Act and the Community Reinvestment Act — helped to encourage the proliferation of high-risk mortgage loans. Perhaps the biggest long-term distortion in the housing market came from the tax code: the longstanding deduction for mortgage interest, which encouraged overinvestment in real estate.

``In short, there was plenty of regulation — yet much of it made the problem worse. These laws and institutions should have reined in bank risk while encouraging financial transparency, but did not. This deficiency — not a conscientious laissez-faire policy — is where the Bush administration went wrong."

To add, this from Arnold Kling of Econlib, ``Our high corporate tax rate, along with the deductibility of interest for corporations, encourages corporations to look for ways to minimize equity financing. For individuals, government-subsidized mortgages and the tax deductibility of mortgage interest help to encourage over-leveraging."

Nicolas Kristof: Why The War On Drugs Is A Failure

The war on drugs seems to have turned out like the US prohibition of alcohol or the "Volstead Act" in the 1920s.

The consequence of which was not only a failure of regulation to achieve its goal, but that it had created more problems than what it was meant to achieve, particularly black market for bootleg liquors, gangsters, mass violence, mass murder and etc.

Obviously the end result was that the Act was lifted in 1933.

Now, New York Times' high profile columnist Nicolas Kristof makes a pitch on why the same legal efforts to purge drug use seems to achieve parallel unintended consequences akin to the defunct Volstead Act.

This excerpt from his excellent article "Drugs Won The War" (all bold emphasis mine)

``This year marks the 40th anniversary of President Richard Nixon’s start of the war on drugs, and it now appears that drugs have won.

``“We’ve spent a trillion dollars prosecuting the war on drugs,” Norm Stamper, a former police chief of Seattle, told me. “What do we have to show for it? Drugs are more readily available, at lower prices and higher levels of potency. It’s a dismal failure.”

``For that reason, he favors legalization of drugs, perhaps by the equivalent of state liquor stores or registered pharmacists. Other experts favor keeping drug production and sales illegal but decriminalizing possession, as some foreign countries have done.

``Here in the United States, four decades of drug war have had three consequences:

``First, we have vastly increased the proportion of our population in prisons. The United States now incarcerates people at a rate nearly five times the world average. In part, that’s because the number of people in prison for drug offenses rose roughly from 41,000 in 1980 to 500,000 today. Until the war on drugs, our incarceration rate was roughly the same as that of other countries.

Second, we have empowered criminals at home and terrorists abroad. One reason many prominent economists have favored easing drug laws is that interdiction raises prices, which increases profit margins for everyone, from the Latin drug cartels to the Taliban. Former presidents of Mexico, Brazil and Colombia this year jointly implored the United States to adopt a new approach to narcotics, based on the public health campaign against tobacco. [see below-BTe]

``Third, we have squandered resources. Jeffrey Miron, a Harvard economist, found that federal, state and local governments spend $44.1 billion annually enforcing drug prohibitions. We spend seven times as much on drug interdiction, policing and imprisonment as on treatment. (Of people with drug problems in state prisons, only 14 percent get treatment.)...

``It’s now broadly acknowledged that the drug war approach has failed. President Obama’s new drug czar, Gil Kerlikowske, told the Wall Street Journal that he wants to banish the war on drugs phraseology, while shifting more toward treatment over imprisonment.

``The stakes are huge, the uncertainties great, and there’s a genuine risk that liberalizing drug laws might lead to an increase in use and in addiction. But the evidence suggests that such a risk is small. After all, cocaine was used at only one-fifth of current levels when it was legal in the United States before 1914. And those states that have decriminalized marijuana possession have not seen surging consumption."

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The 3 former presidents of Latin American Nations mentioned above by Mr. Kristoff are Mr. Fernando Cardoso the former president of Brazil, Mr. Cesar Gaviria former president of Colombia and Mr. Ernesto Zedillo former president of Mexico, whom also made the same argument early this year at the Wall Street Journal.

``The war on drugs has failed. And it's high time to replace an ineffective strategy with more humane and efficient drug policies. This is the central message of the report by the Latin American Commission on Drugs and Democracy we presented to the public recently in Rio de Janeiro.

``Prohibitionist policies based on eradication, interdiction and criminalization of consumption simply haven't worked. Violence and the organized crime associated with the narcotics trade remain critical problems in our countries. Latin America remains the world's largest exporter of cocaine and cannabis, and is fast becoming a major supplier of opium and heroin. Today, we are further than ever from the goal of eradicating drugs.

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Be reminded that laws or regulations no matter how noble its goal, can have unintended or long term "unseen" consequences.

And at the end of the day, regulations fall into the taxonomy of economics. The success of which would be determined by the tradeoffs between long term costs and benefits.