Monday, August 03, 2009

On private information and social uselessness

The Nobel prize-winning economist Paul Krugman has a useful article looking at things such as high-frequency trading. As he says, "If you aren’t outraged, you haven’t been paying attention" (we've noted a more colourful version of this here.)

Krugman points to two important studies. The first is a 1971 study by Jack Hirshleifer, which finds that

"Private information that remains private was shown to be of no social value - in the sense of being purely redistributive, not leading to any improvement in productive arrangements. There is an incentive for individuals to expend resources in a socially wasteful way."

Krugman explains it like this:

"Just to be clear: financial speculation can serve a useful purpose. It’s good, for example, that futures markets provide an incentive to stockpile heating oil before the weather gets cold and stockpile gasoline ahead of the summer driving season. But speculation based on information not available to the public at large is a very different matter. As the U.C.L.A. economist Jack Hirshleifer showed back in 1971, such speculation often combines “private profitability” with “social uselessness.”"

What are the keys to private profitability? Well, using bigger and faster computers is one way to get an edge over the competition (as Krugman puts it, it’s a kind of tax on investors who lack access to those superfast computers.) But by far the most important methods of getting access to private information are: a) insider information and insider trading, b) generating and mastering complexity that others can't penetrade and c) outright secrecy. Now all three of these are quintessential "offshore" specialities.

Just think of all the wasted money and talent when lawyers and accountants dream up schemes to pull a fast one over the taxpayer by generating complexity, secrecy and, in many cases, insider information.

This is not all. Krugman notes, too, a 1975 study by Kenneth Arrow, another Nobel prizewinner,

"speculation based on private information imposes a “double social loss”: it uses up resources and undermines markets."

Private information is, in this case, information not available to the public at large. Krugman concludes that

"neither the administration, nor our political system in general, is ready to face up to the fact that we’ve become a society in which the big bucks go to bad actors, a society that lavishly rewards those who make us poorer."

The point to make here is that there is a solid, and veteran, academic basis for TJN's concerns about offshore.

Yet this does not include the inequality-expanding role of offshore, through providing tax and regulatory subsidies to the wealthiest actors via the offshore system. And there lies another whole story.


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