Horsemeat Economics

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The British (and now Europe-wide) scandal of corporations selling horse meat as beef is emblematic of many of the problems with big, unwieldy systems.

The similarity between horse meat and subprime has already been noted in a Financial Times editorial:

The food industry has long known that processed meat is susceptible to fraud. While it is relatively easy to verify whole cuts of meat taken from a carcass, this is not the case for the bits left behind. These are gathered up and shipped out to thousands of outlets for processing into lower-value products. In Britain, monitoring this industry is left to local authorities and the retailers themselves.

Yet this surveillance has become virtually impossible in the modern world of food production. Consumers want ever lower prices. But food margins are already wafer thin. The drive to cut costs has sent retailers scouting for cheaper suppliers in far-flung parts of the world. Supply chains have become vast and unwieldy. And internet tenders drive prices down even further.

This has brought big benefits to consumers who until recently enjoyed consistently falling prices. But in a disturbing parallel to the financial sector’s subprime crisis, the growing distance between supermarkets and their suppliers has also opened the door to fraud on a scale that as yet can only be guessed at. The meat used in these products now travels across multiple borders and through myriad companies. Regulators do not have the resources to keep up. Only those who buy the processed products and sell them under their own brands can apply the pressure that will limit chances for fraud.

Just as with subprime, complicated, impersonal systems have bred fraud. Once upon a time, banks were impelled to lend responsibly, because if they did not their balance sheets would become filled with trash, and they would face bankruptcy. Then they discovered that they could pull a ruse — lend irresponsibly, and pass off the risk to someone else. Purchasers of subprime mortgage-backed securities thought they were buying a AAA grade product, as that is what ratings agencies passed them off as being. But it turns out they were just buying unsustainable trash. It is, of course, possible that the subprime crisis could have been avoided had the price of oil and other commodities not risen so steeply and precipitously, squeezing consumers’ budgets.

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But sooner or later, the banks’ irresponsibility would have come home to roost, and the ruse would have collapsed. If it hadn’t been ballooning commodities prices, it would have been something else.

Similarly, in an equally sprawling and disconnected system — the global food supply chain — anonymity has bred irresponsibility once again. Retailers claim to have been misled. Meat processors and food manufacturers claim to have been misled too. But somewhere along the line, someone is lying. Someone, at some point decided that horse was a cheaper alternative to beef, someone tested it for taste, to affirm that it would be taken as an acceptable substitute. And someone decided that horse would enter the food chain, and that consumers could be fooled into thinking that it was beef. Would that be possible with a local butcher? Would it be possible for unwanted substances to penetrate the food chain if the supply chain was much shorter?

Maybe, but there are strong disincentives. With a shorter supply chain, it is not so easy to pass off the blame to someone else. If a local British butcher decides to substitute horse for beef, it would be more easily discoverable than if a sprawling multinational — whose abattoirs are located in Romania or Cyprus, but its customers in Britain, Spain, France and Italy — decided to do so. British abattoir workers would know, and might dissent. Butchers would be able to tell the difference, and most would have a serious problem with deceiving customers who they see face to face. A supermarket that sells meals packaged in plastic containers by other companies, has no such problem with deception. Customers don’t ever get to meet the person who butchered or cooked or shipped their ready meal. This provides a barrier of anonymity. There is no immediate embarrassment in deception carried out at distance. Simply, anonymity makes deception easier, and big, complex systems create anonymity.

In 2010, The Telegraph reported on some empirical research supporting this idea:

There is a growing body of research to support the logically obvious idea that humans become increasingly dishonest as cheating becomes easier:

From finding a £50 note on the floor to being accidentally given the answers to test questions, even normally honest people can suddenly become dishonest, it found.

But they will only cheat if it does not involve any work, said the academic study for the journal Psychological and Personality Science.

In an experiment on 84 students, researchers set up a trial involving a maths test on a computer, without telling them the reasons why they were doing it.

Half the students were warned the system was not working properly. If they pressed the space bar on the keyboard the answers would come up.

The other half were told that if they did not press the enter key immediately after seeing the question, then the answer would come up.

Overall, few cheated at all. But those who did not have to press a key to cheat were almost TEN times as likely to do so, said the researchers from the University of Toronto.

They said it was because pressing a key was like ‘intentionally’ trying to cheat while those who didn’t acted as if they were cheating by accident, so they did not feel they were making an immoral choice.

In a second test, the volunteers were tested on their willingness to help a fellow student with a disability complete an exam paper.

Half were told the way to volunteer was to follow an online link, the other half simply had to click ‘yes’ or ‘no’ on the screen.

Those who had to follow the link were five times less likely to volunteer to help, because it was easier for them to get out of it than the others who had a clear choice to make.

Study author Rimma Teper said: “People are more likely to cheat and make immoral decisions when their transgressions don’t involve an explicit action.”

I am coming to believe very strongly that as this century continues, and as systemic interconnectivity and complexity increases, we will see many more horse meat and subprime style scandals exploiting the anonymity of big systems.

Meanwhile, those who do not wish to be exposed to such counterparty risk will avoid such complexity like the plague.

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The Origin of Money

Markets are true democracies. The allocation of resources, capital and labour is achieved through the mechanism of spending, and so based on spending preferences. As money flows through the economy the popular grows and the unpopular shrinks.  Producers receive a signal to produce more or less based on spending preferences. Markets distribute power according to demand and productivity; the more you earn, the more power you accumulate to allocate resources, capital and labour. As the power to allocate resources (i.e. money) is widely desired, markets encourage the development of skills, talents and ideas.

Planned economies have a track record of failure, in my view because they do not have this democratic dimension. The state may claim to be “scientific”, but as Hayek conclusively illustrated, the lack of any real feedback mechanism has always led planned economies into hideous misallocations of resources, the most egregious example being the collectivisation of agriculture in both Maoist China and Soviet Russia that led to mass starvation and millions of deaths. The market’s resource allocation system is a complex, multi-dimensional process that blends together the skills, knowledge, and ideas of society, and for which there is no substitute. Socialism might claim to represent the wider interests of society, but in adopting a system based on economic planning, the wider interests and desires of society and the democratic market process are ignored.

This complex process begins with the designation of money, which is why the choice of the monetary medium is critical.

Like all democracies, markets can be corrupted.

Whoever creates the money holds a position of great power — the choice of how to allocate resources is in their hands. They choose who gets the money, and for what, and when. And they do this again and again and again.

Who should create the monetary medium? Today, money is designated by a central bank and allocated through the financial system via credit creation. Historically, in the days of commodity-money, money was initially allocated by digging it up out of the ground. Anyone with a shovel or a gold pan could create money. In the days of barter, a monetary medium was created even more simply, through producing things others were happy to swap or credit.

While central banks might claim that they have the nation’s best democratic interests at heart, evidence shows that since the world exited the gold exchange standard in 1971 (thus giving banks a monopoly over the allocation of money and credit), bank assets as a percentage of GDP have exploded (this data is from the United Kingdom, but there is a similar pattern around the world).

Clearly, some pigs are more equal than others:

Giving banks a monopoly over the allocation of capital has dramatically enriched banking interests. It is also correlated with a dramatic fall in total factor productivity, and a dramatic increase in income inequality.

Very simply, I believe that the present system is inherently undemocratic. Giving banks a monopoly over the initial allocation of credit and money enriches the banks at the expense of society. Banks and bankers — who produce nothing — allocate resources to their interests. The rest of society — including all the productive sectors — get crumbs from the table. The market mechanism is perverted, and bent in favour of the financial system. The financial system can subsidise incompetence and ineptitude through bailouts and helicopter drops.

Such a system is unsustainable. The subsidisation of incompetence breeds more incompetence, and weakens the system, whether it is government handing off corporate welfare to inept corporations, or whether it is the central bank bailing out inept financial institutions. The financial system never learned the lessons of 2008; MF Global and the London Whale illustrate that. Printing money to save broken systems just makes these systems more fragile and prone to collapse. Ignoring the market mechanism, and the interests of the wider society to subsidise the financial sector and well-connected corporations just makes society angry and disaffected.

Our monopoly will eventually discredit itself through the subsidisation of graft and incompetence. It is just a matter of time.