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Nobel Prize Winning Economist: Core Problem Is Too Much Centralization ... In Both Government AND the Private Sector
Nobel prize winning economist Ed Prescott has previously said that we have to break up the big banks.
Prescott notes in a new interview that centralization – of either government or banking – is a core problem:
[Question] Brussels is using this crisis to grab more powers from governments. How does that make things even worse?
[Prescott] Dangerous centralization.
China … From 1,000 to 1,300[A.D.] was the richest country, the most advanced. They had done much better than Europe, and they were by far the leader.
But then – under the Ming Dynasty – they got centralized, and they started preserving the status quo. The provinces lost their power.
[The Ming Dynasty got rid of the "press".]
And technological regression set in there. People from the other end of the Euro-Asia land mass came and humbled that great empire.
[Question] Why is the U.S. economy doomed to fail and what will happen?
[Prescott] They haven’t gotten rid of the too big to fail problem.
They get real big … people know who led to these financial institutes, know that they will be bailed out, will expect it, and therefore the institutes can borrow at a lower rate. So they gamble…
Government likes to get favors out to certain people and then big contributions ….
Dr. Prescott is right …
Numerous studies show that big banks are less efficient than smaller banks.
The New York Times notes:
The economics suggest that big banks are less efficient at credit creation than smaller ones. And there is no evidence that the simpler financial system we had from the 1940s through the 1970s restrained growth. In fact, for all its innovation, the financial industry of today is less efficient than it was in the age of the railway, according to research by Thomas Philippon at New York University. That is, it charges the rest of society more for financial intermediation than it did 130 years ago.
Indeed, it is well known that – while larger organizations can be more efficient than small ones – when any organization gets too big, “diseconomies of scale” may make them less efficient (and see this).
Below, we’ll discuss some of the reasons this is true. But an analogy will easily make the point.
Giraffes have huge hearts, because they have to pump the blood all the way up to their heads.
Similarly, humans can’t be 100 feet tall and weigh 10,000 pounds. Our bodies would be too inefficient to survive.
Why Centralization Can Be Bad
As Prescott notes, organizations which become too big tend to spend an inordinate amount of time in preserving the status quo, and thus have less room to innovate. Inertia often takes over, and the organizations lose their vitality and success. This is especially true since larger organizations are more subject to bureaucratic insularity, which causes stagnation.
Organizations in the public or private sector which become too big also spend huge amounts of time, money and energy on communications between their various parts:
They also spend more time and money duplicating efforts, political in-fighting, and other wasted efforts:
Moreover, the larger an organization, the more centralization and less diversity. True, numerous business books have touted more of a decentralized “team” attitude in the last decade or so. But many large organizations are still very hierarchical, allowing little diversity of viewpoint. Groupthink also commonly occurs.
More importantly, when you have a couple of giant organizations in a given market, it means that there are less competitors. In the banking space, for example, we have extensively documented that breaking up the giant banks would allow small banks to thrive.
So – by definition – organizations that are too big decrease diversity in competition.
And the less diversity, the more vulnerable we become to “black swans”:
It has been accepted science for decades that when all the farmers in a certain region grow the same strain of the same crop – called “monoculture” – the crops become much more susceptible.
Why?
Because any bug (insect or germ) which happens to like that particular strain could take out the whole crop on pretty much all of the region’s farms.
For example, one type of grasshopper – called “differential grasshoppers” – loves corn. If everyone grows the same strain of corn in a town in the midwest, and differential grasshoppers are anywhere nearby, they may come and wipe out the entire town’s crops (that’s why monoculture crops require such high levels of pesticides).
On the other hand, if farmers grow a lot of different types of crops (“polyculture”) , then a pest might get some crops, but the rest will survive.
I believe that the same principle applies to our financial system.
If power and deposits are concentrated in a handful of mega-banks, problems with those banks could bring down the whole system.
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Moreover, the mega-banks are huge holders of derivatives, including credit default swaps. JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley together hold 80% of the country’s derivatives risk, and 96% of the exposure to credit derivatives.
Even though JP, B of A, Goldman and Citi are separate corporations, they are so interlinked and intertwined through their derivatives holdings that an attack by a “pest” which swarmed in on their derivatives could take down this “monoculture” of overly-leveraged, securitized, derivatives-heavy banking.
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Our current banking monoculture threatens not only the biggest banks, but the entire financial system. Pesticides become less effective as pests develop resistance – and, as a byproduct, we poison friendly critters. Likewise, the giants “creatively” work their way around regulations so that the regulations are no longer effective (or at least not enforced, and regulatory capture is widespread. And too much regulation stifles productivity,as an unintended byproduct.
Having power and deposits spread out among more, smaller banks would greatly increase the stability of the financial system. And having more power and deposits in banks using a wider variety of business models (e.g. among banks that aren’t heavily invested in derivatives and securitized assets) will create a banking “polyculture” which will lead to a much more stable financial system.
In other words, if we decentralize power and deposits and increase the variety of banking models, we will have a healthier financial system, we won’t have such an urgent need to try to micromanage every aspect of the banking system through regulation,and the regulations we do have will be more effective.
By the way, I would argue that that is one of the reasons why Glass-Steagall was so important: it enforced diversity – depository institutions on the one hand, and investment banks on the other. When Glass-Steagall was revoked and the giants started doing both types of banking, it was like a single crop cannibalizing another crop and becoming a new super-organism. Instead of having diversity, you’ve now got a monoculture of the new super-crop, susceptible to being wiped out by a pest.
The kinds of things which threaten depository institutions are not necessarily the same type of things which threaten investment banks, hedge funds, etc.
(Remember that things are less diversified and more centralized than they appear. And see this.)
This is true in reporting, trading, and many other areas.
Decentralization Will Help Many of Our Problems
The Founding Fathers enshrined separation of powers as the very basis of our government, as a way to ensure that centralization would not lead to tyranny. (The Iroquois actually appear to have developed the idea of separation of powers and inspired the Founding Fathers. See this and this.)
Everything has becoming too centralized.
We’ve previously noted that liberals and conservatives tend to dislike different portions of the malignant, symbiotic relationship between big government and big corporations:
Conservatives tend to view big government with suspicion, and think that government should be held accountable and reined in.
Liberals tend to view big corporations with suspicion, and think that they should be held accountable and reined in.
This post shows that both are right.
We’ve gone too far in centralizing governments, the financial sector and other organizations. We have overshot the mark … and gone from efficiencies to inefficiencies of scale.
The answer is more decentralization.
For example:
- Decentralization – not some more bigger, more centralized solution – is the key to our energy problems
- Micro-generation and micro-farming can make this a much better world
- Use local currencies – including gold and silver – whenever possible
- We don’t need the big banks. Use micro-loans and work with your friends and neighbors
- We don’t need full-time, life-long politicians. Get involved in local politics and other efforts you can impact. Get involved in direct democracy
- Forget the dying, dinosaur mainstream media. We need to “be the media” ourselves
It is time to take power away from those that are hurting all of us by putting our time, money and energy into smaller, more local organizations.
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None other than F.A. Hayek showed how centralization impares good economic decisionmaking in his work. His Nobel Prize lecture was "The Pretense of Knowledge".
Ludwig von Mises approached the topic from a different direction. He shows that the one-size-fits-all decisions of a central planning committee will be at odds with regional and local differences and by imposing the one solution, causes price distortions. Prices are a signal that all the independent participants in the economy must have in order for each of them to make their own profit/loss calculation. Central planning causes prices to be a mirage.
In my opinion, when a central bank prints massive amounts of money in an attempt to fix its time value, they destroy interest rates and lending standards as the primary signal for long term projects.
I would also add that moral hazard is a factor of human nature. It is impossible for government to declare that the largest financial institutions are Too Big To Fail and that policy to not impart increased risk not only to the actions and planning of the executives of those companies, but also to those in government charged with regulating them.
TBTF takes us exactly in the wrong direction. It greatly increases concentration of assets and makes the government the risk partner of the company. We should instead require a sliding scale of reserve ratios. If reserve ratios increased as the bank grew, that would make the size self limiting. In long enough time, every fractional reserve bank hits its limits and would fail except for government rescue. We should be sequestering risk and loss, not socializinging it.
proLiberty, you have all things exactly right. What worries me most about our country is how few people, even here at ZH, understand these basic facts about human nature, economics and nature itself of which human nature and ecomomics are just subsets.
My favorite analogy from nature is when E.O.Wilson the great bioligist discovered to everyone great suprise that in an ant hill, all the ants were acting independently based upon their own inherited nature and were not directed by the queen or any other ants and that any attempts to direct them from above resulted in absolute failure of the colony. The same is true for flocks of birds and schools of fish as it is for man. This is of course analogous to Adam Smith's great chessboard example and both are congruent with Hayek's insight about indidual actors in free markets and society. Centralization simply does not work except in very limited circumstances and when it is implemented it must be carefully limited, thus the great insight of our foundng fathers in attempting to provide us with a very limited central government. It worked great for a couple of hundred years until it was dismantled by a few men who had the great hubris to think that they could be Adam Smith's great chessmaster of life and markets. Franklin Roosevelt and Barack Obama come to mind as recent examples. We few of course can see where this central planning and control is leadng us as it led the Chinese dynasty of old. Since the majority in our dying democracy no longer sees it I think our great enlightenment experiment aka The United States of America is sooner or later doomed. It could be later of course for as Adam Smith also wisely observed "There is a great deal of ruin in a nation.", meaning of course that it can take longer than one thinks to completley destroy one. Accordingly, I generally agree with the doom and gloom of many ZH'ers around her but if they error I think they sometimes overestimate the efficiency of the central planners as they go at their destructiion.
Good points.
As for efficiency though, remember, breaking shit is really, really, easy. The only difficult thing they do is to try and keep the facade shiny and clean while doing it. (failure to do so is when we see the "scandals" emerge)
If there has ever been a better acceptance speech, I have not seen it.
Hayek kicked them all squarely in the balls.
I like to use it as a reference for my argument that there are no true experts, but only various degrees of amateurs attempting to understand reality in some fashion while operating under the influence of beliefs, which may or not be coherent, regardless of how well they fit the model.
exterminate
exterminate
exterminate
Time to call the Doctor.
.
...said the Ogron.
http://en.wikipedia.org/wiki/Ogron
http://iaith.tapetrade.net/doctorwho/images/ogron.jpg
This system depends on leaders..Lesders that have some moral foundation..I see nothing of this anywhere in our politi ....
We face the same situation we had in the 30s...and the consequences are the same...
The devolution of society is of no benefit to anyone in the long run...
Listen to President Roosevelt's Inagural address:
http://m.youtube.com/watch?v=MX_v0zxM23Q
Where are our real leaders?
Agree in general, but with respect to micro-farming, that may be a little to far to the left on your efficiency curve. Micro-energy generation, however, probably has the added benefit of resilience, and there are a lot of hot unused roofs out there.
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Too many things but still this one:
bureaucratic insularity.
It could happen no even less than in a US citizen society.
US citizens are agents of uniformity. Since their rise, the world has got much less diverse.
It is quite useless to take into account similar points of view. It is useless to take consultation from people who will offer the same solutions.
Where is the diversity in US citizen nations? All US citizens think alike, want alike and are angry they not the ones leading the process.
It is simple so they cannot be an insularity. Once in position, US citizens tend to act the same.
Say hello to the new boss, same as the old boss. it is useless to interview candidates for the position of boss.
Cat herding and ethnicity, so we still think the tower of Babel was a bad idea? Free trade and balance of acounts gets them everytime. Alpha monkeys with revisionist history of liberal cargo cult central planners never ends GW.
Bollocks and stupidity, so we still think that Mercantilism is a good idea? Gammas with revisionist history of mythically preserved supply side raindances never seem to end either.
Ok george, I like you stuff, but you have a really bad habit of quoting yourself and the links go to your stuff. so I followed the prescott link, to another article of yours, and then followed to the bloomberg source. well in that link prescott doesn't say tpo break up the big banks, he says let them fail when they should and don't bail them out.
Letting them fail and not bailing them out MEANS they'll be broken up. They are not broken up because the government keeps bailing them out and propping them up, instead of letting market forces work.
GW, did you refer to « Nobel prize winning economist Ed Prescott » as a way to back-hand discredit him? ... Ha! ... Like Mr 'Nobel Peace Prize Obama'? ... Aren't those Nobels just for sale now? ...
Re the ascendancy of the West in the later mediaeval era, there is a view - especially among Russians - that what really fueled the Italian Renaissance and all the other European developments ...
Was that the Christian Crusaders went and stole most of the gold in Constantinople ... It was Catholic Crusader Christians who actually first conquered and sacked and looted the Orthodox Byzantine Empire capital, enabling its eventual conquest by the Turks ... and that gold perhaps became the foundation of Western European wealth
Shortly after the gold was 'liberated' in Constantinople ... Italian cities started minting the first significantly large amount of gold coins since the fall of the Roman Empire (though there are one or two from Charlemagne's time)
But no doubt, as your article suggests, the diversity of early modern Europe - flowers of different kinds blooming - also fostered progress and development, and enabled events like the Reformation to take place
+1 for getting the "liberated gold of Constantinople" right - though I would add it's even more important that this gold was then leveraged by the first banking techniques that evolved during the Italian Renaissance, including the first accounting scams, the first "mountains of debt" and the techniques needed to build them, market them and then use their breakups or near-eternal-zombie-status for political reasons - including the grand-scale use of mercenary armies that are only possible by some kind of leverage.
sadly, there is not much new under the sun
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IMO the thing is in a way much simpler:
The MegaBanks are too big. They are a trust. Antitrust is needed. Break them and reform the system.
The MegaCorps are too big. Most of them behave likes trusts thanks to lobbying. Reform that. Here the US Dems claim to want to do something, but they won't.
The US Federal Government is too big. Too powerful. Here the US Reps claim to want to do something, but they won't. The answer would be actually quite easy: revert that Amendment that stole in 1913 the most important influence of the States: the right to send Senators.
The reformation took place on the spoils of the catholic church.
Same as same.
This has got to be one of your worst blogs, George. You've completely missed the boat by confusing the trees for the forest. I thought you might recover when i read the last line, but then you failed again. YES! We have to take power away from the central planners, but by advocating that power to go small you have abandoned the opportunity to reclaim Liberty by placing all those powers to some vague governing body??? WTF are you talking about George, you've just transferred those centralization of powers to a new boss. Do you think that the unprincipled men stealing from America will go away? They will not.
All those powers have to go back into the Congress and the constitutional execution of those powers (which now become fiduciary duties when they execute those powers on our behalf), back into the Public Forum to be presented, discussed, compromised, and voted upon. This is the only means to provide the transparency American's require in order to be able to render the Consent of the Governed, and thereby justify that government. It is only at this point the people control the government, if not, the government controls the people.
This is the definition of both Liberty and tyranny. You call tyranny centralization. Do you understand your error? Just how the hell do you think it got centralized? It is the conscious effort to weasel the constitutional powers of Congress away from the Congress. Because these powers were taken from Congress and are now operated by, "cunning, ambitious, and unprincipled men" for their own engrandizement, and "this is the customary weapon by which free governments are destroyed." (George Washington's Farewell Address)
What you want is Liberty in all its decentralized shades of political, social, economic justice and its bounty. Am I getting close, George?
Hello? Is anybody in there. I've sent you this information before, you just don't read it. I wrote a book to explain it and offered to send it to you for free. I get no reply. I start the Super Pac for all Americans, Elect A New Congress at www.electanewcongress.com, and I send that to you, hell, both you and Tyler... in one ear and out the other. Well, you can do what you like, and if you want to bitch about things and sit on you self-rightous thumb that's your right. But if you want to actually do something to change it all, check out www.electanewcongress.com. Here is the single catalyst of the change both you and everyone else seeks.
There it is, take it.
Serfs Up America!
A group of 535 people seizing unprecedented power early in the 20th century is how everything got so centralized in the first place. Your theory that if they only had more power, that hyper-centralization would somehow magically come out the other side and result in decentralization is...interesting.
It's kinda like how I drink in order to sober up.
There is a real issue to discuss ... whether some central power is needed to fight central power abuse ... but I don't think you need to be so hard on GW ... though you do praise GW on your website.
In South America, early 1800s liberator Simón Bolívar said that if the region he helped liberate from Spain did not stay united ... and separated into the several different countries like we see them today ... they would remain weak ... subject to games by people like the Americans. And he was right.
Here in Europe, we still hotly debate whether the benefits of the French Revolution could have survived, if Napoléon and a strong central French state had not been able to fight the neighbours who wanted France to revert to its ancien régime.
The EU has gone too far in some aspects, but we do need some strong degree of unified co-operation here or else we would be more under the heel of the American bully
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You are right that the Congress should be 'supreme' in America, as the US Constitution says ... Indeed in particular, Congress should be using its power to remove any and all judges not in 'good behaviour', and removing the recent Presidents for their criminality ...
But your site and programme does not, I think, have wide appeal. People in America are used to elections being corrupted and hijacked, by the bought-and-hired corporate media if not by the black-box voting machines.
Americans see what happened to the truly popular Ron Paul, and if he can't do more even with millions of grass-roots supporters, what is the hope for anyone else?
The idea of an American 'Super Pac for the people' sounds nice but if you started to gain traction they would likely find some pretext for the courts and judges to harass you, shut you down and steal your assets.
America is probably too far gone for some bureaucratic or election 'device' to be a cure ... they have armies of media and lawyers and bribed judges ready to destroy anything or anyone in that mode
« America is at that awkward stage. It's too late to work within the system, but too early to shoot the bastards. » - Claire Wolf, '101 Things To Do 'Til The Revolution'
tu -- +1 --
New ideas are not new-- the same pundits noises can be heard through american history-- every jibe against the big banks were heard before during the Jackson admin and even in bibical history. Every cartoon by WB has had its counterpart in politics many times before--every call to arms, every reformation idea and every wave of the flag has happened before.
The thing that is new is stuff of tech-- Its ubiquitious and bigger than the guttenburg printing press or the assembly line and growing exponentially. It is a world educator and changer and will make govts obsolete--You heard it from me.
The evil that is government has been around for perhaps 10,000 years.
It is no longer needed but the problem is that it is still wanted.
Evolution always lags behind reality.
New American:
Sorry, I haven't had time to look at your website to review your plan.
Could you give us a summary of what you're proposing?
Apparently it involves brief spats of guerilla self-marketing with no follow-up.
Sorry, I haven't had time to look at your website to review your plan.
Could you give us a summary of what you're proposing?
______________________
That is the best comment.
I disagree with him, George. This is one of your best posts ever on here. It actually proposes a sensible solution, rather than just megaphoning the problem.
It's just a shame that the first half focussed [yet again] on the banks rather than central government.
The big banks will collapse under their own weight if they don't have central government to support and backstop them.
They were only able to get this far BECAUSE they were able to buy into the depths of government. There are no checks and balances if everyone has been bought out. The poor constitution assumes that there are at least some good, honest people in the three branches. MegaLOL at the assumption.
It's time to write and adopt a new constitution, a ruthless one. The old one has been trampled upon and the people don't understand it.
There is a very clear reason why no schoolchildren are assigned to read and analyze the constitution in full. If you don't think that your fourth grader should be reading the constitution or can understand the constitution and its implications, you have been brainwashed to be a useless debt-accumulating consumer.
He is absolutely right! We all need more decentralization in this world.
I agree we do need more decentralization in this world, but the forward motion trends towards centralization. That is sad because most people do not understand nor do they want to how increasing centralized power actually decreases personal power. Look at our choices for President this fall? One will just move slower towards centralization than the other.
The gubbamint has also made all decentralization a crime. Collecting rainwater? You're committing crime, buddy. Growing your own tomatoes? That's not FDA approved! Packing your kid a nice classic, well-rounded, tasty, brown paper bag lunch? Sorry, we're gonna have to throw that away - it doesn't meet our "nutritional standards." Wanna drink raw milk? What are you, a druggie? Anything but relying on the state is a crime.
There are only two ways to go: extreme centralization, NWO, and comprehensive totalitarianism, or gradual decentralization, grassroots governments, and free life. As I've said before, we're all in this together. Either we all come to decent conclusions and work together to keep the ship afloat, or we all drown.
What you propose would require an adult conversation. Unfortunately, I don't see any in positions of power.
Trudat. The sad thing is that for decentralized grassroots government to work, everyone has to voice their opinion and take responsiblity for themselves, their neighbors, and their community, something that only one in a thousand is actually willing to do. Responsibility is a bitch and a half to take up - it's easier to put your critical thinking skills on the backburner and do useless things instead. What is rampant and should not be is apathy. When apathy has permeated all aspects of life, society is fucked.
I have always said, we can fix most of everything if we teach one generation of kids the right stuff the right way from start to finish. In my humble opinion, that's all it takes. I know exactly how to execute the solution from the ground-up (as opposed to the current top-down solution) given the current paradigm, though centralized parties will not allow such things.
giant corps require govt mandated monopolies to survive-- gaint govts need giant corps to survive-- giant labor needs giant govt and giant corps to survive ----effect change which will do the least damage to the individual--govts are obsolete!!
Forget about "isms". Just look for weaknesses in the centralized apparatus and create decentralized alternatives.
They figured out a pretty good way of keep things decentralized back in 1789..
and the government of the United States of America is now committing all of its resources to assure that never happens again.