68% of the Great British Public support a Tobin tax. This is a paradox - because the argument for a Tobin tax is also an argument for not giving a stuff about what the public want.
The case for such a tax is that traders trade too much, which causes prices to be excessively volatile*. This can happen because people over-react to signals, in (at least) three different possible ways:
1. They mistake noise for news. They fail to see that some things just don’t mean anything. One way in which they make this error is to fail to see that correlated signals are redundant, with the result that they trade on stale news.
For example, there’s lots of talk now that the economy is recovering. But the tenth or eleventh story along these lines adds nothing to this picture. If, however, people think they do, they might become over-confident about the recovery, thus driving prices too high.
2. Information cascades. People believe things because others do, or seem to. As a result, they might respond to a rise in prices by thinking “hey, this is a good investment” rather than by “expected returns have gone down.” As a result, rising prices can lead to further rises in prices.
3. The confirmation bias. We tend to look for evidence that corroborates our prior beliefs, and downgrade or explain away contradictory evidence. So, if a stock rises after we’ve bought it, we think “I knew it was a good stock; I’ll buy some more.” But if it falls, we think; “it’s just a blip. It’ll come good.” The result, again, is that rises lead to rises.
However, these arguments all have analogues in political thinking, for example:
1. People might over-react to a series of anti-immigrant stories by failing to see that they are highly correlated. Or they construct narratives around the Edlington case, whilst under-rating the fact that such stories come from the far end of the bell curve and so might not be informative about the general shape of that curve; such narratives, of course, almost always consist of stories we already knew.
2. Our beliefs are shaped by those around us. So, for example, Richard Murphy doesn’t think he’s an extremist because none of his friends do (oblivious to selection bias). Or we think that support for immigration controls is a mainstream view merely because it is so widespread.
3. We read newspapers and blogs that support our prejudices, and discuss politics with friends who think like us, and so emerge with our prejudices confirmed.
This raises the question. If these sort of mechanisms are so powerful as to drive financial markets awry, aren’t they even more likely to drive the public’s political beliefs awry too? After all, participants in financial markets have an incentive to think rationally because some of them at least are staking their own money. But as we don’t stake our money on our political views, we have less incentive to purge ourselves of stupidity.
So, if you support a Tobin tax, shouldn't you also be sceptical about giving the public what it wants?
The counter-argument here is that, in financial markets, people’s errors are correlated, so rising prices lead to rises and falls to fall, whereas in politics the errors cancel out: for everyone who regurgitates Richard Littlecock’s crypto-fascist fantasies, someone else parrots Polly’s platitudes.
But even if this is true - is it? - there’s a still a cost involved. My three mechanisms all cause people to be over-confident about their beliefs. The upshot is that political debate becomes a mere empty exchange of prejudices.
* Note that a Tobin tax would have not have prevented the current crisis. This has its origins in the fact that mortgage derivatives became illiquid - they were traded too little, not too much. A Tobin tax would have exacerbated this problem.
The case for such a tax is that traders trade too much, which causes prices to be excessively volatile*. This can happen because people over-react to signals, in (at least) three different possible ways:
1. They mistake noise for news. They fail to see that some things just don’t mean anything. One way in which they make this error is to fail to see that correlated signals are redundant, with the result that they trade on stale news.
For example, there’s lots of talk now that the economy is recovering. But the tenth or eleventh story along these lines adds nothing to this picture. If, however, people think they do, they might become over-confident about the recovery, thus driving prices too high.
2. Information cascades. People believe things because others do, or seem to. As a result, they might respond to a rise in prices by thinking “hey, this is a good investment” rather than by “expected returns have gone down.” As a result, rising prices can lead to further rises in prices.
3. The confirmation bias. We tend to look for evidence that corroborates our prior beliefs, and downgrade or explain away contradictory evidence. So, if a stock rises after we’ve bought it, we think “I knew it was a good stock; I’ll buy some more.” But if it falls, we think; “it’s just a blip. It’ll come good.” The result, again, is that rises lead to rises.
However, these arguments all have analogues in political thinking, for example:
1. People might over-react to a series of anti-immigrant stories by failing to see that they are highly correlated. Or they construct narratives around the Edlington case, whilst under-rating the fact that such stories come from the far end of the bell curve and so might not be informative about the general shape of that curve; such narratives, of course, almost always consist of stories we already knew.
2. Our beliefs are shaped by those around us. So, for example, Richard Murphy doesn’t think he’s an extremist because none of his friends do (oblivious to selection bias). Or we think that support for immigration controls is a mainstream view merely because it is so widespread.
3. We read newspapers and blogs that support our prejudices, and discuss politics with friends who think like us, and so emerge with our prejudices confirmed.
This raises the question. If these sort of mechanisms are so powerful as to drive financial markets awry, aren’t they even more likely to drive the public’s political beliefs awry too? After all, participants in financial markets have an incentive to think rationally because some of them at least are staking their own money. But as we don’t stake our money on our political views, we have less incentive to purge ourselves of stupidity.
So, if you support a Tobin tax, shouldn't you also be sceptical about giving the public what it wants?
The counter-argument here is that, in financial markets, people’s errors are correlated, so rising prices lead to rises and falls to fall, whereas in politics the errors cancel out: for everyone who regurgitates Richard Littlecock’s crypto-fascist fantasies, someone else parrots Polly’s platitudes.
But even if this is true - is it? - there’s a still a cost involved. My three mechanisms all cause people to be over-confident about their beliefs. The upshot is that political debate becomes a mere empty exchange of prejudices.
* Note that a Tobin tax would have not have prevented the current crisis. This has its origins in the fact that mortgage derivatives became illiquid - they were traded too little, not too much. A Tobin tax would have exacerbated this problem.
"A Tobin tax would have exacerbated this problem."
So the popular response to the crisis is something that would have made it worse?
In the words of Kent Brockman "Democracy just doesn't work".
Posted by: ad | September 10, 2009 at 05:59 PM
I think you possibly accord too much rationalisation to Turner's prescription for a Tobin tax: he just thought "City profits are proportional to transaction volumes - so tax the latter".
Where the idea really falls down is the idea that more transaction costs would lower volatility. Wider spreads don't really suit anyone except insiders. Whatever wealth redistribution he might have achieved would be unlikely to have been socially useful.
Most of the too-frequent transactions Turner is taking aim at are perhaps owned for fractions of a minute; they don't produce lasting out-of-equilibrium markets. It's storing and hoarding a position which can do that - take, for example, the housing market, where the ability of people to monopolise land is far more important than the number of transactions.
Leverage was the problem - that is where
the solutions lie.
Posted by: Giles | September 10, 2009 at 08:48 PM
@ Giles - silly me, thinking that the government's technocrat of first choice might do something as vulgar as think.
Couldn't we develop your point? Mightn't a Tobin tax drive the rational arbitrage-type traders out of the market more than it drives noise traders out?
I mean, if traders are over-confident about the profits they expect, they are more likely to regard the tax as worth paying. It's the rational traders who, at the margin, will duck out - but are these really the source of momentum?
Posted by: chris | September 11, 2009 at 09:25 AM
Bulk traders are the major cause behind many of the price rise for many goods .. hence this kind of tax may be necessary to control unwanted price rise.
Posted by: Steve | September 11, 2009 at 11:39 AM
Hi Chris: because I'm a bit new at all this typekey/pingback stuff, I'm putting my comment here as well:
While it pains me to defend the people who want Tobin taxes, but I am not sure that the extrapolation between the two kinds of irrationality holds.
I think you can have a fairly straightforward model of how bubbles happen in which every individual agent is rational, but because they are rewarded for short-term over long-term movements (think 90% chance up 1, 10% down 10, sorts of random walks). You might want to curtail the disequilibriating, bubble-forming proclivities of agents that are each acting in a way that accords with individual, rational economic man – because as a system, their operations are destabilising.
The voting analogy fails for me because individual votes do not have the same systemic links as trades – whereas momentum traders, for example, affect each others ‘vote’ on the market by their actions. So, in brief, you can think people are rational, and still be in favour of Tobin taxes to deal with momentum effects – but still want people to vote
BTW, I think Martin Wolf took the exact opposite view to you today: that the Tobin Tax would take out the irrational 0.01bps traders, leaving in the ones that have LTBH positions that are 'rational'. Now, how can we prove who is right?
I appreciate Turner is thoughtful, but his comments seemed a bit off the cuff
Posted by: Giles | September 11, 2009 at 05:57 PM
You seem to think that our political beliefs are unconstrained, however is it not true that we may only 'cash them in' on the market place of ideas every 4 years?
Could this not be seen an equivalent form of market restriction to the Tobin tax?
In any case your conclusion is a false dilemma.
The fact that,in the heat of the moment, we sometimes behave irrationally, doesn't mean we can't also have a reasoned public discussion about this irrationality and attempt to correct it.
There is a difference between normative and descriptive rationality. Now perhaps you are questioning our ability to 'know' normative rationality, given that we are in fact irrational. If so, I agree, Savage's axioms are still very much a worthy subject of debate.
Posted by: Ben | September 12, 2009 at 10:48 AM
This is just one idea, and perhaps displays no more than my limited imagination. If there are better ideas out there, that amount to more than "implement something called "market socialism" and then - alacazam! - full employment!" then I'd love to hear them. http://www.watchgy.com/ mostly bank deposits, fell by £143.2bn in Q1. And of course there’s no guarantee such buying will continue.
http://www.watchgy.com/tag-heuer-c-24.html
http://www.watchgy.com/rolex-submariner-c-8.html
Posted by: omega watches | December 27, 2009 at 05:17 PM