The UNwisdom Of The Crowd

``What I must do is all that concerns me, not what the people think. This rule, equally arduous in actual and in intellectual life, may serve for the whole distinction between greatness and meanness. It is the harder because you will always find those who think they know what is your duty better than you know it. It is easy in the world to live after the world's opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude.” Ralph Waldo Emerson, Self Reliance

The Follies of Groupthink

Groupthink is when people substitute the opinion of the consensus or the group for their own. It is a product of group cohesion, which leads to a deterioration of “mental efficiency, reality testing, and moral judgment”[1] or particularly the erosion of critical thinking.

This thought process also sacrifices independence, uniqueness, toleration of alternative perspectives and independent thinking in pursuit of group cohesiveness, mostly with the aim to reduce group conflict or maintain balance.

By casting off critical thinking, groupthink leads to hasty, irrational decisions and actions that could be harmful. Think fraternity violence.

If based on social psychologist Irving Janis’ 1970s study on groupthink, the eight symptoms are[2]: (bold emphasis and italics mine)

1. Illusion of invulnerability –Creates excessive optimism that encourages taking extreme risks.

2. Collective rationalization – Members discount warnings and do not reconsider their assumptions.

3. Belief in inherent morality – Members believe in the rightness of their cause and therefore ignore the ethical or moral consequences of their decisions.

4. Stereotyped views of out-groups – Negative views of “enemy” make effective responses to conflict seem unnecessary.

5. Direct pressure on dissenters – Members are under pressure not to express arguments against any of the group’s views.

6. Self-censorship – Doubts and deviations from the perceived group consensus are not expressed.

7. Illusion of unanimity – The majority view and judgments are assumed to be unanimous.

8. Self-appointed ‘mindguards’ – Members protect the group and the leader from information that is problematic or contradictory to the group’s cohesiveness, view, and/or decisions.

In other words, Groupthink embodies the psychological properties that characterize most religious, political and economic forms of social zealotry.

Applied to investing, groupthink represents as the wisdom of the crowd at the extreme levels or near the inflection point of any major trend.

The Wisdom Of The Crowds

In analysing social aspects of life, crowd psychology always operate as very critical factors in determining the sentiment and the possible path of people’s action. This means that crowd psychology does not represent random walk, but as collective sentiment brought about by the crowd’s reaction to the fluid circumstances they are faced with.

Whether vetting on the outcome of national elections, observing the behaviour of horse racing enthusiasts or examining the behaviour the financial markets or the real economy, we run a common ground of crowd psychology in different stages.

The crowd psychology comprises as form of social signalling.

Since people are intrinsically social animals, we always have the frequent sublime need to commune as group, and such is the reason why society has ultimately flourished over the centuries, even amidst the destructive impulses likewise inherent in men to dominate and to plunder (that has led to wars).

Ever since the eons of our prehistoric ancestors, as hunters, our progenitors operated on groups (tribes) to seek protection from among each other, to have a greater chance of attaining the goal of a successful hunt, and importantly, to achieve posterity via gene reproduction purposes.

Conforming to these social patterns is how man’s actions have mostly been directed.

As example “Keeping up with the Jones’” is a common catchphrase that signifies attempts by the individual to emulate an elevated social status in terms material possessions.

The crowd psychology also represents a form of tradition.

For instance the perpetuation of various forms of superstitions, such as in politics, are part of the tradition based crowd psychology.

As English philosopher and liberal political theorist Herbert Spencer once wrote[3],

“The great political superstition of the past was the divine right of kings. The great political superstition of the present is the divine right of parliaments. The oil of anointing seems unawares to have dripped from the head of the one on to the heads of the many, and given sacredness to them also and to their decrees.” (emphasis added)

Applied to politics, the crowd psychology hardly distinguishes between functioning reality and the romanticized expectations of government as supermen.

Traditionalism also finds its way deeply rooted into culture, economics, religion and others aspects of social life.

Of course traditionalism via the crowd psychology can also be used as an escape mechanism.

In Henry Kaufman’s Memoirs, he writes[4],

``Most predictions fall within a rather narrow range that does not deviate from consensus views in the financial community. In large measure, this reflects an all-too-human propensity to minimize risk and avoid isolation. There is, after all, comfort in running with the crowd. Doing so makes it impossible to be singled out for being wrong, and allows one to avoid envy or resentment that often inflicts those who are right more often than not.” (emphasis added)

In other words, traditionalism, or applied conventionally, could be used as an advantage to secure social acceptance.

As in the case above, it can be used to as pretext to elude responsibility. And conversely, as ploy to generate ‘networking’ effects.

A good example of this is from Prof Angelo Codevilla[5], who aptly he describes how the American ruling class have used traditionalism (conventionalism) to secure their current position.

``Today's ruling class, from Boston to San Diego, was formed by an educational system that exposed them to the same ideas and gave them remarkably uniform guidance, as well as tastes and habits. These amount to a social canon of judgments about good and evil, complete with secular sacred history, sins (against minorities and the environment), and saints. Using the right words and avoiding the wrong ones when referring to such matters -- speaking the "in" language -- serves as a badge of identity. Regardless of what business or profession they are in, their road up included government channels and government money because, as government has grown, its boundary with the rest of American life has become indistinct.” (emphasis added)

In short, to be sociologically “IN” means to assimilate conventional ‘uniform’ behavior, de facto ethics and morality as normative.

Importantly, crowd psychology is a form of social expression.

Political elections are the strongest demonstrations of crowd expression.

And so with market bubbles, as James Surowiecki writes[6],

``Bubbles and crashes are textbook examples of collective decision making gone wrong. In a bubble, all of the conditions that make groups intelligent -- independence, diversity, private judgement--disappear.” (emphasis added)

Crowd psychology isn’t always wrong though.

In financial markets crowd psychology can be depicted by trends. Major trends, for instance, are emblematic of the direction of the dominance of crowd behaviour.

As Shawn Andrew of Ricercar Fund observed[7],

“The CROWD is always wrong at market turning points but often times right once a trend sets in. The reason many market fighters go broke is they believe the CROWD is always wrong. There is nothing further from the truth. Unless volatility is extremely low or very high one should think twice before betting against the CROWD.” (all caps original)

The fact of the matter is that it is groupthink or the excessiveness of the crowd to impetuously gravitate towards the collective opinion as the assumed gospel of truth that creates such instability.

Of course, this can only happen when underlying incentives are set to condition people’s mind. Such conditions, in terms of financial markets, include government policies as interest rate manipulation, inflationism, tax policies, the picking winners or losers and etc...

Lessons From The Crowd

So what are the lessons we should learn?

Crowd psychology is a very essential variable in determining social trends (political, economic, and financial trends)

In financial markets, the flow with the crowd is useful for as long as they reflect on the general trend, and for as long as conditions are yet distant from reaching groupthink status.

Groupthink fallacy is the surrender of one’s opinion for the collective. This accounts for as a loss of critical thinking and is reflective of emotional impulses in the decision making of the crowd. When groupthink becomes the dominant mindset of the crowd, an ensuing volatile episode can be expected to occur applied to both markets and politics (bubble implosion or political upheaval).

Though crowd-following is useful, doing what the crowd does isn’t. This prominent quote from a movie character Alan Ashley-Pitt in Quigley Down Under, says it all[8]

"The man who follows the crowd will usually get no further than the crowd. The man who walks alone is likely to find himself in places no one has ever been."

That’s because thinking with the crowd exposes one to deep vulnerability, since crowd psychology hardly represents what the reality is. This is especially pertinent to the markets or even to politics.

Gustave Le Bon[9] spared no sympathy on the crowd’s unintelligence, he wrote,

``This very fact that crowds possess in common ordinary qualities explains why they can never accomplish acts demanding a high degree of intelligence. The decisions affecting matters of general interest come to by an assembly of men of distinction, but specialists in different walks of life, are not sensibly superior to the decisions that would be adopted by a gathering of imbeciles. The truth is, they can only bring to bear in common on the work in hand those mediocre qualities which are the birthright of every average individual. In crowds it is stupidity and not mother-wit that is accumulated.” (emphasis added)

And it’s not just Mr. Le Bon, but likewise one of the world’s richest and most successful investor, Mr. Warren Buffett, the sage of Omaha, subtlety admonishes people from using crowd psychology as justification to trade or invest[10],

"A great IQ is not needed to do well as an investor, what is needed is the ability to detach yourself from the crowd."

Why? Because what matters is independent ‘critical’ thinking! This ability, in my opinion, is to get within the ambit of what is consistently effective or what works and what doesn’t.

Author James Surowiecki sees non-correlation and diversity of knowledge as important variables to independent thinking, he writes[11]

``Independence is important to intelligent decision making for two reasons. First, it keeps the mistakes that people make from becoming correlated. Errors in individual judgement won't wreck the group's collective judgement as long as those errors aren't systematically pointing in the same direction. One of the quickest ways to make people's judgements systematically biased is to make them dependent on each other for information. Second, independent individuals are more likely to have a new information rather than the same old data everyone is already familiar with. The smartest groups, then, are made up of people with diverse perspectives who are able to stay independent of each other. Independence doesn't imply rationality or impartiality though. You can be biased and irrational, but as long as you're independent, you won't make the group any dumber.”

Since groupthink extinguishes personal opinion for the collective then the variability of information becomes eroded and homogenized and thus expanding the potential errors of the consensus in their assessment and their succeeding courses of action. Thus, independent thinking not only maintains the diversity of opinion and information, but should likewise be representative of more “efficient” markets.

Nevertheless, the groupthink phases of crowd psychology should be taken advantage of by people in the know.

THUS, people who think for themselves, who are not afraid to get socially ostracized and or lose ‘temporal’ acceptance via conformity or signalling, or are prepared to go against conventionalism/traditionalism are the people who are likely to work through with right actions derived from pertinent independent analysis.

If there is one single market today which resonates actions of a bubble matched by groupthink psychology it is the US treasury markets.

The 10 year treasury whose bond yields are near the 3 decade long lows (left window), which I flipped to demonstrate the degree of the bubble action (red upside trend at the right window) is currently matched by the humdrum of daily fervid incantations of mainstream opinion makers and their followers, pumped up by from the insights of policymakers, of the mythical “deflation”.

As a caveat, let me repeat “mythical”, in the world of central banking, deflation would only exist once policymakers abandon to use of the printing press and accept the dominance of market forces.

This isn’t happening.

---

[1] Psysr.org, What is Group Think

[2] Ibid

[3] Spencer, Herbert, The Great Political Superstition (1884)

[4] Random Roving Blogspot, Running With The Crowd

[5] Codevilla Angelo M. Codevilla America's Ruling Class -- And the Perils of Revolution, Spectator.org

[6] Surowiecki, James The Wisdom of The Crowd (p 244) bloggiaim.com

[7] Andrew, Shawn; Jeffrey Hirsch Stock Trader’s Almanac 2010

[8] Iwise.com, Alan Ashley-Pitt

[9] Le Bon, Gustave Le Bon The Crowd p. 17

[10] MoneyCentral MSN.com 12 steps to being a 'Zen millionaire'

[11] Surowiecki, James loc sit

Why Deflationists Are Most Likely Wrong Again

“After the crisis arrives and the depression begins, various secondary developments often occur. In particular, for reasons that will be discussed further below, the crisis is often marked not only by a halt to credit expansion, but by an actual deflation — a contraction in the supply of money. The deflation causes a further decline in prices. Any increase in the demand for money will speed up adjustment to the lower prices. Furthermore, when deflation takes place first on the loan market, i.e., as credit contraction by the banks — and this is almost always the case — this will have the beneficial effect of speeding up the depression-adjustment process.” Murray N. Rothbard

I find it bizarre for many mainstream experts, if not nearly all, would try to interpret government’s policy actions as means to support the economy (read: property markets) and NOT the politics (read: the banking system).

And these are the same set of people who appear to impassionedly invoke the reprehensible deities of deflation in order for the government to apply more inflationism.

Figure 1: Mark Perry[1]: Relative Bank Failures/St. Louis Fred: M2 annual change

It doesn’t really matter whether the US government put in line an estimated $23.7 billion in bailouts[2], and the countless alphabet soup of stop-gap measures or programs in terms guarantees, swaps, and the various functionality of last resorts, all of which had been applied to ensure the untrammelled flow of liquidity into the financial system.

What seem to only matter to them is that “deleveraging” and the attendant alleged price contraction on every level will be due to loss of “aggregate demand” which ensures a deflationary outcome. As if these “deleveraging” is straightforwardly corollary with “price decline” regardless of the validity and strength of causation linkages.

Yet it’s been nearly two years since deflationists have brandished charts similar to the M2 in figure 1 (right window) to call for the unsustainability of the current economic recovery, and now, since the deflationary spiral hasn’t still happen, they invoke new references such as low interest rates to try to argue their case based on a preconceived bias.

Equally, they now junk this piece of evidence since it has now gone against their argument. So selective perception dominate the mainstream’s reasoning to argue for their rabid fear of deflation.

It doesn’t really matter too, that today’s banking failure hardly matches EVEN the savings and loans meltdown during the 90s and remains a fraction to the domino effect of bank collapses during the GREAT Depression of the 1930s (left window). Yes this includes the 110^th bank in Illinois[3], which failed August 13^th.

Gustave Le Bon appear to be correct[4] anew when dealing with crowd perception, “A crowd thinks in images, and the image itself immediately calls up a series of other images, having no logical connection with the first.”

These people fail to acknowledge that the deflation mess of 1930s wasn’t only due to banking collapses which paved way for the monetary contraction but importantly had also been due to the massive waves of regulations imposed that inhibited trade (Smoot-Hawley Act) and the necessary adjustments in the price levels within the system (New Deal Programs)[5].

Blindness Stems From Political and Economic Religion

The difference why many pundits can’t seem to see is because the monetary contraction they’ve hoped for, out of their predetermined bias, had been offset by an expansion of free trade worldwide.

Thus whatever contraction in US based credit from the banking system had clearly been offset by a surge in globalization[6]and the attendant boom of credit elsewhere. And this is why despite the incremental improvement in the traditional credit system, there has been a boom ongoing in US corporate bonds[7].

Some have argued that corporate bond market are meant to fall, due to the possibility of a double dip, but which is chicken and which is the egg? Given their logic, bonds markets should have never rebounded on the first place.

Besides, there is also the uneven impact from convergent rescue policies applied by respective governments. Given the idiosyncratic nature of each economy, the impact has clearly been asymmetric. And German’s stunning 2^nd quarter outperformance in economic growth seems to be an example[8].

So far, this has been what the Fed has accomplished: By preventing the collapse in the US banking system, which incidentally still remains as the de facto reserve currency of the world, it has managed to keep afloat the payments and settlements function that has allowed the trade mechanism to flourish in spite of signs of credit contraction at home.

This represents as Pyrrhic ‘battle’ (meaning short term) victory at astounding cost to the US taxpayers to sustain the her stature as the world’s currency reserve standard, with the big possibility of a huge unintended payback in the future. That payback, from our perspective will be in the form of higher inflation, bear market in US treasuries or an overall stagflationary environment.

The point is by preventing a collapse in the banking system the Fed has effectively staved off deflation in the 1930 context.

In addition, I don’t see Japan’s lost decade[9] as the path for America in the way the mainstream bears paints her to be. So it’s hardly a paradigm for adequate comparison.

The second and most important point is, the reason why monetary contraction hasn’t impacted the US the way mainstream foresees it is because they ignore that trade by itself, is first and foremost the liquidity provider.

How?

As Murray N. Rothbard explained[10],

“We come to the startling truth that it doesn’t matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of the gold-unit. There is no need to tamper with the market in order to alter the money supply that it determines.” (italics original)

Since money’s purchasing power will naturally adjust to the level of existing stock, then there won’t be any required money level in a free market regime. Thus, the persistence of trade is enough to assure the continuity of liquidity and the avoidance of deflation. This applies even if the Fed would remain non-activist.

Even the popular Harvard duo Carmen Reinhart and Kenneth Rogoff whom has made extensive reviews of the historical relationship of debt, inflation and economic growth during every banking and property crisis worldwide, can’t pinpoint out the definite critical offsetting threshold on how debt and economic growth balance.

Figure 2: VoxEu.org: Reinhart-Rogoff: 90% Debt As Threshold?

This comes with the exception when debt levels have reached or exceeded 90% of GDP (see figure 1), they write, “relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90% of GDP” and “no apparent contemporaneous link between inflation and public debt levels for the advanced countries as a group (some countries, such as the US, have experienced higher inflation when debt/GDP is high)”.

It’s truly difficult to try and compare with past episodes because there is simply NO two similar situations, one can only make estimates and hope that the performances will fall within the ambit of models. However, their implicit point is, this addiction to debt has got to stop. And this is what truly plagues the mainstream mindset.

The third important point is that we have been validated anew.

US authorities on fear of a slowdown that may transform into a double-dip at a time nearing national elections, where the ruling incumbents seem at the risks of being politically dethroned, has called on our poker bluff.

Here is what I wrote at the start of the year[11],

``Many have used the strong showing of 2009 to advert that 2010 would be the year of “exits”. I don't buy it.

``As in the game of poker, I’d call this equivalent to a policymaker’s Poker bluff.”

The FOMC has changed tunes about adapting an exit strategy and will maintain their bloated balance sheets.

Here is the Danske Research team[12], (emphasis added)

``The FOMC revised downward the near-term growth outlook and decided to reinvest the principal payments from the Fed’s portfolio of Agency and MBS holdings in longer-term Treasuries. This implies that the balance sheet will be held constant and effectively puts the exit strategy on hold. While the amount of treasuries to be bought is insignificant, the decision sends a strong signal to markets. It provides a clear indication that rate hikes remain in the indefinite future and that the central bank is prepared for another round of quantitative easing if necessary.”

In short, the Fed’s action is a direct communication to the market that the policy spigot towards Quantitative Easing 2 is being recalibrated as insurance for any material economic growth slowdown.

So there you go—path dependency, economic ideology and the morbid fear emanating from wrong perspectives and analytics will drive the Fed to pump the next wave of liquidity into the system.

For the mainstream, anything that goes down is DEFLATION. There never seems to be within the context of their vocabulary the terms as moderation, slowdown and reprieve. Everything has got to go like Superman, up up up and away!

I’m quite sure, even if statistics would prove to be a false alarm the Fed, would be quick-handed to initiate the trigger.

Let me guess, politics will dictate such action. The Democrats don’t want go without a fight and the Fed will supposedly provide the backdrop for a benign outlook with the slowdown as pretext. It has never really been about economics but the politics of control. Yet the mainstream obstinately refuses to see this.

Of course, there are many other aspects that could debunk the deflation outlook, such actions in commodities markets, the yield curve, exploding emerging bonds and some EM equity markets.

But it really doesn’t matter, because for the mainstream these markets are out of the ambit of “aggregates”. Unfortunately, as F. A. Hayek[13], “aggregates conceal the most fundamental mechanisms of change”.

Phisix: No Decoupling, Only Outperformance

Also this is just a reminder to our Filipino colleagues and audiences where today’s market action is seen or interpreted by some as in some semblance of decoupling.

I’m glad that the ASEAN markets have been showing a steady outperformance, but the case for a decoupling hasn’t clearly been established (see figure 3).

Thus, it would be a darned big mistake to be presumptive of a “decoupling” in the event of another turbulent episode such as US recession which I don’t think will leave the Philippines or ASEAN markets unscathed.

One must be reminded that decoupling and outperformance are two different dynamics.

Figure 3: Tradingeconomics.com[14]: US and Philippine GDP

What ASEAN markets seem to imply is that the US isn’t headed for a double dip as the US mainstream bears suggests.

By the way, the definition of a Double dip recession[15] is a backslide to a recession (negative growth) following one or two quarters of positive growth. Based on semantics, the window for a double dip is fast closing—the end of third quarter of 2010 as per definition (if January of 2010 is the starting point of the recovery based on chart).

For me, if there would any immediate real risk worth monitoring this would possibly emanate from China[16] (yes she is slowing down).

That’s because she has engaged in massive credit expansion to immunize herself from a global growth slowdown in 2008 and many of these loans have channelled via shell companies[17] and lent to government projects that likewise got involved in real estate speculation which is hardly part of their core businesses. And such expansion usually creates alot of malinvestments and would likely result to capital consumption, when the imbalances are forced by the natural laws of economics to reveal themselves.

One thing going for China is that she is replete still with savings. There is as much as 9.3 trillion yuan ($1.4 trillion) of hidden assets or undeclared assets according to Yahoo News[18].

Nevertheless, I think signs are pointing to a soft landing more than a hard landing.

The problem anew for the bears is that following a slowdown and prospective stabilization, a renewed reacceleration will likely spur another episode of serious lift-off for ASEAN and many emerging markets, whom depend on China for trade and investments. And this should also help boost the US and the Eurozone too.

And another thing, for as long as the US won’t fall into a recession, the expressed policy by the Fed to indefinitely postpone the ‘exit strategy’, and reemergent possibility to engage in QE version 2 is also likely to serve as another tremendous boost for Asia.

For instance, Hong Kong is already having a difficult time fighting her internal bubbles recently having to impose a “60% limit on the loan to value for property purchases worth more than $1.55 million”[19], given her peg to the US dollar which basically makes her import Fed policies. The transmission mechanism will just get magnified by the ensuing policy divergences.

So bears will continue to fumble from one mistake after another, until the broken clock finally strikes twice a day and claim victory. How bizarre.

---

[1] Perry, Mark 106 Bank Failures in Perspective, Enterprise Blog

[2] See $23.7 Trillion Worth Of Bailouts?

[3] Thestreet.com Another Illinois Bank Fail, August 14, 2010

[4] Le Bon Gustave, ibid p. 23

[5] See Financial Reform Bill And Regime Uncertainty

[6] See How Free Trade Saved The World From Depression

[7] See US and Global Economy: Pieces Of The Jigsaw Puzzles All Falling In Place

[8] Marketwatch.com German GDP grows 2.2% in second quarter, August 13, 2010

[9] See Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionis

[10] Rothbard Murray N. What Government Has Done To Our Money p.29

[11] See Poker Bluff: The Exit Strategy Theme For 2010

[12] Danske Weekly, Fear of a slump August 13, 2010

[13] Hayek, Friedrich August von Reflections on the Pure Theory of Money of Mr. J.M. Keynes, Mises.org

[14] Tradingeconomics.com

[15] Investopedia.com, Double-dip recession

[16] See China’s State Driven Bubble

[17] FinanceAsia.com, China's endless moral hazard, May 6, 2010

[18] Yahoonews.com Hidden trillions widen China's wealth gap: study, August 11, 2010

[19] Wall Street Journal Blog, Hong Kong Forced to Fight Fed Again, August 13, 2010

Quote of the Day on Self Learning And Death of Credentials

Says Richard Kaalgard at Forbes Magazine (Hat tip: Professor Arnold Kling)

“Self-learning rules. We are at the beginning of the Death of Credentials. The ROI for 95% of college educations will be negative.”

That’s just one of the insightful “10 cheap revolution” or “creative destruction” rules cited by Mr. Kaalgard in today's transition to the information age.

This has been one of my themes wherein I noted that online learning has the potential to pop the inflating bubble at the Philippine Education System.

And also, if self learning and death of credentialism determines the jobs or career of tomorrow, then what good is it to extend the domestic education cycle?

Do Roads Without Traffic Lights Translate To Chaos?

A small town in Britain took out traffic lights and got a pleasant surprise-a smoother flow of traffic!


As Professor Alex Tabarrok writes,

``The experiments are interesting in their own right but they are also very good illustrations of spontaneous order; how order is possible without orders."

Of course, for the mainstream, this is just another form of sacrilege.

Do iPhone Users Have More Sex Appeal?

Many interesting stuff from the web as this

iPhone users draw in more sexual partners than BlackBerry and Android users.

According to Professor Landsburg,

Data from 9,785 users of the dating site OKCupid reveal that iPhone users have 50% to 100% more sex partners than Android users, at every age.

This graph combines men and women, but the same pattern holds for each gender separately.

Correlation isn’t causation, i.e. doesn’t mean that you buy and use an iPhone you automatically get a surge of admirers from the opposite sex, but what gives?

Beware the Leviathan!

Great words of admonition from the Economist

LISTEN carefully, and you may detect a giant sucking sound across the rich world. In the 1990s this was the sound protectionists in the United States thought (wrongly) would accompany jobs disappearing to Mexico as a result of a free-trade deal. This time, too, there are big worries about jobs and growth, but the source of the noise is different, and real enough: it comes from the tentacles of the state, reaching into more and more areas of business in an effort to get the economy moving. It is the sound of Leviathan Inc. (emphasis added)

Here’s the kicker....

In the rich world, meanwhile, the record shows, again and again, that industrial policy doesn’t work. The hall of infamy is filled with costly failures like Minitel (a dead-end French national communications network long since overtaken by the internet) and British Leyland (a nationalised car company). However many new justifications are invented for the government to pick winners, and coddle losers, it will remain a bad old idea. Thanks to globalisation and the rise of the information economy, new ideas move to market faster than ever before. No bureaucrat could have predicted the success of Nestlé’s Nespresso coffee-capsule system—just as none foresaw that utility vehicles, vacuum cleaners and tufted carpets (to cite examples noted by Charles Schultze, an American opponent of state planning) would have been some of America’s fastest-growing industries in the 1970s. Officials ignore the potential for innovation in consumer products or services and get seduced by the hype of voguish high-tech sectors. (bold emphasis mine)

Is There A Brewing Bubble In The Philippine Education System?

The Philippine educational system seems to be in a bubble. By bubble, this means that the current setup is unsustainable. As famed economist Herb Stein once puts it, if something cannot go on forever it will stop.

The cost of private education has been exploding, as exemplified by the estimated 7 year annual fee increases by PIDS on architecture and engineering courses from 1994-2001 (left window). This has been way beyond the rate of inflation (tradingeconomics.com-right window).

Yet it would be misleading to claim that competition among private schools doesn’t exist.

Most school participants of the major sports tournaments as the UAAP and NCAA demonstrate not only competition for sports superiority, but likewise “competition” for privately funded education.

And competition ought to have brought down tuition fees to market (affordable) levels. But this hasn’t been happening. So what’s wrong? Is this a case of market failure?

Competition Is In The Real Resources

Table from the Department of Education

Even as public schools dominate the education market in the primary/elementary (37,607 for school years 2008-2009) and secondary/high school (5,359) relative to the private sector (primary/elementary 7,084 and secondary/high school 4,707) based on the DepEd report, the relationship between the private sector and the public sector is incomparable or can’t be discerned as either “monopoly” or “market based competition” in the traditional sense, because both cater to distinct constituents, particularly to the underprivileged for public schools and to privately funded education.

However, where factual competition is going on is in the real resources department. Both the private sector and the public sector basically compete to consume the same materials, such as pencils, papers, food and etc... And this includes manpower (e.g. teachers).

Yet the fundamental difference will be on how the consumption patterns are being carried out, i.e. the private sector is sensitive to price mechanism via profit and loss discipline, whereas the public sector is politically determined.

A good example of how this competition for resources is being waged is in the subsidies provided by the Philippine government to private school students.

This from the Inquirer.net, (bold highlights mine)

Monsignor Gerardo Santos, national president of the Catholic Educational Association of the Philippines (CEAP), said private schools needed more subsidies from the government because their lowly-paid teachers were transferring to the public schools.

“That’s not just okay with us. We are advocating it [subsidies]. We are fighting for it,” Santos said in a recent media briefing.

“We want it increased. I hope the government hears us. We really need more,” he said.

The Department of Education estimated that almost half of the country’s 1.3-million private high school students are subsidized by public funds though the Government Assistance to Students and Teachers in Private Education (GASTPE). The program provides a P10,000-subsidy to first- and second-year high school beneficiaries in Metro Manila.

Junior and senior high school beneficiaries in the metropolis get P5,000 while all the beneficiaries in the provinces also receive the same amount.

The government allotted P3.59 billion for the GASTPE program this year.

We learn of several things from the article;

1. There is a mandate for private schools to accept or accommodate welfare constituents via tax funded subsidies.

2. Since government subsidies are considered as deficient, then the private schools shoulders the additional load of expenses (resource consumption) incurred by the welfare students.

3. Operating similar to the mechanics of the senior citizen’s discount cards, the subsidy gap contracted will have to borne, not by the school owners (through profit or earnings), but by passing these costs to the paying consumers, in this case, the paying students.

The last thing that anyone would do is to apply the onus of the cost of government compliance to their own income or earnings. Instead, it would be intuitive for them to just pass it to consumers. This means that any subsidy that comes out of the pocket of the owners suggests that market pricing limits have been reached and that consumers can bear no more. Alternatively, this means lots of marginal providers will go kaput upon reaching this level.

Hence, the exploding costs of private education partly reflect on the subsidies covered by private students on welfare recipients.

And perchance, the high cost of education has significantly diminished the rate of college enrolment from 2001-2005 (tradingeconomics.com).

4. Since government has extensive controls over private schools at almost every aspects, from welfare accommodation to curriculum mandates, enough to designate private schools as extensions of the public school system, then the operating ‘competitive’ environment may not be seen as genuine market based competition but a semblance of cartel-like pseudo-competition.

Thus the first pin to the bubble is when these indirect costs of private sector subsidies become too onerous to bear.

Of course, this resource competition represents only a symptom to a much a larger disease-the education welfare state.

The Original Sin-Welfare Education

For the public ingrained with state paternalism, it would seem like blasphemy to talk about the ills of welfarist education. The deeply entrenched popular opinion is that the state is the only dutiful and rightful provider of education and thus must supply, and if not regulate, almost every activity associated educational development.

Hardly anyone ever realizes that throughout world history, schools or the educational system have been frequently used as the primary conduit by the state to inculcate or impress upon political or religious agendas to commandeer society’s acceptance or what is known as theory of passive obedience.

Murray N. Rothbard in Education: Free and Compulsory wrote,

``It is inevitable that the State would impose uniformity on the teaching of charges. Not only is uniformity more congenial to the bureaucratic temper and easier to enforce; this would be almost inevitable where collectivism has supplanted individualism. With collective State ownership of the children replacing individual ownership and rights, it is clear that the collective principle would be enforced in teaching as well. Above all, what would be taught is the doctrine of obedience to the State itself. For tyranny is not really congenial to the spirit of man, who requires freedom for his full development. Therefore, techniques of inculcating reverence for despotism and other types of "thought control" are bound to emerge. Instead of spontaneity, diversity, and independent men, there would emerge a race of passive, sheep-like followers of the State. Since they would be only incompletely developed, they would be only half-alive.” (emphasis added)

And all these ‘romance with the state’ through education has clearly been visible on budgetary allotment of Philippine government as shown from the above table from National Statistics Coordination Board.

Budgetary allocation for education has ballooned to Php 185.5 billion (Philstar) out of the Php 1.541 trillion or accounting for about 12% of the national budget for the year 2010 (Sunstar).

Yet for the many who embrace Sta. Claus economics, nothing is ever enough. There are many who still clamor for more spending as if government is a fountain of endless wealth.

Never has it occurred to them that government’s primary source of revenue is mainly through taxation which means government redistributes rather than creates wealth. And government can only redistribute what is available, or that there are effective limits to redistribution.

The worst part is that by depending on government, welfare recipients have been relieved of their major personal responsibilities such as family planning, by which the ensuing dependency mindset could have contributed to the above world average population growth for the Philippines (Google Public Data). “Why not have more children”, welfare beneficiaries might think, “since government pays for their education anyway”.

The dependency mindset via the welfare state is the most obvious way to manipulate society to create a political constituency that could ensure the preservation or the expansion of power by the political class.

Yet what we aren’t told about is that resources consumed by the public sector, in this case Php 185.5 billion worth from the education department, represents as lost productive opportunity or money that could have been used by the private sector to get invested into productive ventures that could have increased the per capita of the Filipinos, from which would allow them to finance out of their own pockets, a quality education of their choice for their own children.

Besides, private sector charity or philanthropic activities would surely get amplified once the burden of taxation will have been mitigated from the diminished pressures of government expenditures. But all these aren’t likely to happen until the unsustainability of the system will forced upon by economic laws.

The crux of the bubble in welfare state is that the bubble can only last for as long as the taxpaying population is willing to tolerate the costs or comply with government’s redistribution program or the market is open to funding fiscal spending requirements.

For now, this would seem to be the case, as per capita GDP of the Philippines appears to be picking up.

Three Pins To Pop The Bubble

Nevertheless, I see three possible proverbial pins that could implode the education welfare bubble.

One, An Overdose of Welfarism.

As mentioned above, disharmony in the economic system caused by too much subsidies and other interventions could drive up the cost of education to highly restrictive levels. And as consequence, there will be increases in the political demand for more free (lunch policies) education. And instituting more of these welfare policies will push the country’s fiscal conditions into a boiling point where funding from taxation or from market based debt financing won’t be sufficient.

Two, Contagion Effect From Boom Bust Cycles

Since the world operates on boom bust cycles, I don’t see it as a distant possibility for a crisis to happen in Asia or within the Southeast Asian region. And any crisis of this nature is likely to have a severe contagion effect on the Philippines, similar to the Asian crisis of 1997.

Like all cycles, during good times, social programs like education are alluringly on path for expansion. That’s because as the economy expands, political leaders are likely to exhibit more generosity—in order to buy votes or preserve or enhance their popularity ratings—in the expectations that the growth in tax revenue collections will be sustained.

However, once a financial or economic bust should emerge, all these programs will suddenly suffer from a withdrawal or a dearth of funding. It’s not hard to picture a recent noteworthy example of government prodigiousness penalized—Greece.

Three, there is always the transition to the information age to consider.

Acceptability of “affordable” online education seems to be picking up momentum and may displace the overrated industrial age educational system in place.

This from SFGate.com

``Evidence nationwide suggests students could be warm to the idea of online learning.

``The number of college students taking online courses nearly tripled between 2002 and 2008, according to the Sloan Consortium, a nonprofit that encourages online education. Nearly 5 million students took at least one online course in 2008, up from 1.6 million in 2002, Sloan found.

``UC wouldn't be the first university to offer undergraduate degrees online. Among the most successful is the University of Massachusetts' "UMassOnline," which includes graduate degrees. It reported revenue growth of 20 percent since last year, to $56 million, and 14 percent enrollment growth, to 45,815 students.”

And here is how Mises Academy fared with its introductory online course, according to Jeff Tucker at the Mises Blog,

``From our own experience, the success of the Mises Academy has far exceeded anything we imagined. It grows and grows. The venue is super compelling, highly effective, economically rational, and it connects students and professors together again as they were before the rise of the overfunded, unresponsive, heavily bureaucratized brick-and-mortar U. There is no doubt about the future; the only question is who will be making it happen vs. who will be left in the dust.

The major problem for online courses, for now, is that the current business environment has been oriented towards the recognition of credentials via government accreditation procedures or mechanisms. This is actually part of how the state controls our actions.

As Murray Rothbard once wrote,

By enforcing certification for minimum standards, the State effectively, though subtly, dominates the private schools and makes them, in effect, extensions of the public school system. Only removal of compulsory schooling and enforced standards will free the private schools and permit them to function in independence.

But the continued permeation of online education could reach a tipping point where the current credential-accreditation system risks being deconstructed.

And this obviously will pose as another threat to mainstream’s educational platforms, be it on the private sector or on the public schools.

As online education grows expect fireworks (resistance to change) from here.

Matt Ridley: When Ideas Have Sex

Great stuff from Matt Ridley, watch it....

US Unemployment: It’s Partly About Skills-Jobs Mismatch

It isn’t true that unemployment in the US is all about the lack of opportunities.

Instead a big part of this, aside from regulatory uncertainties, is the mismatch of required skills relative to the available jobs.

According to the Wall Street Journal,(all bold emphasis mine)

Employers and economists point to several explanations. Extending jobless benefits to 99 weeks gives the unemployed less incentive to search out new work. Millions of homeowners are unable to move for a job because the real-estate collapse leaves them owing more on their homes than they are worth.

The job market itself also has changed. During the crisis, companies slashed millions of middle-skill, middle-wage jobs. That has created a glut of people who can't qualify for highly skilled jobs but have a hard time adjusting to low-pay, unskilled work like the food servers that Pilot Flying J seeks for its truck stops....

Matching people with available jobs is always difficult after a recession as the economy remakes itself. But Labor Department data suggest the disconnect is particularly acute this time around. Since the economy bottomed out in mid-2009, the number of job openings has risen more than twice as fast as actual hires, a gap that didn't appear until much later in the last recovery. The disparity is most notable in manufacturing, which has had among the biggest increases in openings. But it is also appearing in other areas, such as business services, education and health care....

Longer-term trends are at play. For one, the U.S. education system hasn't been producing enough people with the highly specialized skills that many companies, particularly in manufacturing, require to keep driving productivity gains. "There are a lot of people who are unemployed, but those aren't necessarily the people employers are looking for," says David Autor, an economist at the Massachusetts Institute of Technology.

In the transition to the information age, the shape of investment and hiring would pronouncedly be different as it will involve more specialized “local knowledge” skills and deepened division of labor.

Government intervention (stimulus, unemployment benefits, bailouts, obamacare) has kept the labor market from the adjustment process that should have met these “new” realities. Thus, additional government interventions won’t help.

And the recent resignation of the head of the Council of Economic Advisers to President Obama, Mrs. Christina Romer, appear to be a revelation of the failed Keynesian policies of the Obama regime.

How Bro. Armin Luisitro’s 12 Year Basic Education Cycle Will Benefit The Big League Schools

The proposal of De La Salle Bro Armin Luistro, the incumbent education secretary, to extend the basic education cycle into 12 year cycle isn’t likely achieve the purported goals. [Sorry, but I have to part ways with my alma mater, assuming DLSU adheres to Bro. Luistro’s stand].

According to the Inquirer.net,

“The current thinking is if you don’t finish with a college degree, there is something missing. But in basic education, the operative term is basic, and what is basic is that they should be able to live a meaningful life, be prepared to start a family, be productively employed,” Luistro said.”

Will an additional 2 years of education guarantee that students will become productively employed? The answer is NO. Instead, what such policy will guarantee is that schools, particularly the elite schools, will be assured of additional revenues.

Yet, isn’t 10 years enough to instill basics?

Table From Alabama Cooperative Extension: What Are Employability Skills?

Many of the employable skills are actually self-learned from actual occupational experiences than from a classroom setting. This includes high-order thinking skills and personal qualities in that come in relation with people relations management.

Adding practical skills to the curriculum will not likely enhance for the simple reason that the students won’t get the desired experience of real work pressures until they get formally employed. Employers will unlikely put pressure on people whom are not committed to them. For instance, at On the Job Training (OJT) with companies, students will merely be given the least sensitive job, and thus, will hardly imbue so-called required skills.

This would be analogous to teaching people how to swim in the swimming pool (controlled setting) when what is needed is how to survive the open seas (variable conditions).

Another example would be competition, you can’t exhaustively teach competitive skills in the classroom or practical class, but from the rigors of the real world.

In addition, Bro. Luisito isn’t dealing with reality but dabbles instead with statistics.

Again from the Inquirer,

``While a large percentage of families could not afford to send their children to college, the current basic education cycle is inadequate in giving students employable skills, Luistro noted.

``Only 16 percent of the student population finish college while 84 percent leave school at different stages, Luistro noted.

Yet, despite this, the Philippines has one of highest educational attainment in Asia that’s according to the ADB’s 2007 Education and structural change in four Asian countries

“Of the four countries studied in this chapter, India is the least educated. Thais are slightly less educated than Indonesians, and Filipinos are the most highly educated. Three of the four countries have aggressively pursued increases in education levels, especially at the secondary level, during the period under consideration. Around 90% of Thai secondary education is privately provided. The corresponding figure is 20% for the Philippines, down from 32% in the mid-1990s, and roughly 40% for India and Indonesia”

You see, the problem isn’t much about employable skills, but about that the lack of investments that spurs the job creation. In short, it’s the lack of jobs.

Let say Bro Luisito can produce many employable skilled workers alright, but absent jobs these employable skilled workers will remain unemployed.

Importantly, I see Bro Luisito protecting the interests of the elites by introducing anti-competitive provisions,

Again from the same inquirer article,

“While not everyone will end up with a degree that is very, very academic, we recognize now more than ever that for nation-building, our high school program should look at [offering] different tracks to be able to address the many needs and gifts of students,” Luistro said, describing this as a “multi-intelligence” approach.

“For instance, certain high schools could specialize in the arts, partner with the Technical Education and Skills Development Authority for technical-vocational courses, or the Philippine Sports Commission to develop a more sports-oriented curriculum.

The new provisions would effectively mandate affiliations with “specialty partners”, thus schools that don’t meet the criteria would be forced out of the playing field. This means that the school big leaguers would be the major beneficiaries from the new law.

Besides where he claims that the new law will “address the many needs and gifts of students” is in contrary to his earlier statement saying that the law will “conform with global standards”. How does uniformity (global standards) harmonize with individuality (many needs and gifts) [unless our children will get transformed into automatons]?

Finally, Bro. Luisito claims that there won’t be added financial burdens.

Of course, he saying this, because he isn’t paying for it. To paraphrase Warren Buffett, this would be like asking a barber if you need a haircut.

Again from the inquirer,

“Luistro dismissed fears that the expanded elementary and high school period in the only country with a 10-year basic education cycle would be a financial burden to parents.”

I have NO direct figures to make a comparison of the inflation of the private primary and secondary school levels.

Table From PIDS: College Fee Structure and Fee Inflation

Nevertheless, the table above from PIDS, gives us some insights on why there have been huge college drop-out rate, as well as, the rate of inflation that encompass private college courses.

Bottom line: in contrast to Bro. Luisitro’s claim, there will be material financial burden to families, be it directly (as above) or indirectly (as below). This will particularly onerous to low income levels.

Graph From The ADB’s Hyun Son Has Inflation Hurt the Poor?

In other words, this would mean additional load for families to sustain the burden of carrying children through additional 2 years of the 12 year basic cycle, which doesn’t guarantee anything but huge revenues for the big league schools.

The other way to say it, is that expect more tuition fee increases for schools to meet such mandates!

Is this the change we’ve been looking for-more politicization of education for the benefit of a few?

Why Capital Is Never Homogeneous

What is Capital?

1. It is a function of savings.

Capital goods come into existence by saving. A part of the goods produced is withheld from immediate consumption and employed for processes the fruits of which will only mature at a later date. All material civilization is based upon this "capitalistic" approach to the problems of production. "Roundabout methods of production," as Böhm-Bawerk called them, are chosen because they generate a higher output per unit of input. (Mises)

2. It is the “fundamental concept of economic calculation” (Mises)

Capital is an applicable concept only for market economies.

3. Capital is everything that goes into the entrepreneurial process that produces a final output.

Capital is the sum of the money equivalent of all assets minus the sum of the money equivalent of all liabilities as dedicated at a definite date to the conduct of the operations of a definite business unit. It does not matter in what these assets may consist, whether they are pieces of land, buildings, equipment, tools, goods of any kind and order, claims, receivables, cash, or whatever. (Mises)

4. It is specific and limited usage.

For instance, materials that go into a pencil production won’t be the same as those in car or semi-conductor production.

5. It is complimentary.

Example, a semi-conductor chip fits into the motherboard. A carburetor enhances the engine.

6. It has opportunity costs.

A doctor may know how to do the work of the secretary but opts not to. That’s because he is more efficient in being a doctor and instead hires a secretary. The opportunity cost here is the division of labor.

So is capital homogeneous? Never!

Therefore, any models predicated from the assumption that capital is homogeneous should automatically be thrown to the garbage bin and should not be wasted a second of precious time.

Graphic: Recalculation Theory

Jessica Hagy calls her splendid and evocative piece of graphic as “Somebody has to do something!”

Whereas my interpretation of this is Professor Arnold Kling’s Recalculation Theory.

This excerpt From Professor Kling,

``if the old patterns of specialization and trade are not sustainable, the economy faces the Recalculation Problem. New patterns of specialization and trade need to be created. While the economy is creating new patterns even in good times, when it faces a Recalculation Problem it cannot create new patterns rapidly enough to prevent widespread unemployment.” (emphasis original)

In the transition to the information age, the new pattern of specialization and trade is the discovery process called as the “seed of the start up”!