Monday, February 01, 2010

Bob Solow Dismisses High Frequency Trading

At the end of his review on this week's latest book on the recent economic crisis, liberal economist Bob Solow brings in this observation:
I have read that a firm such as Goldman Sachs has made very large profits from having devised ways to spot and carry out favorable transactions minutes or even seconds before the next most clever competitor can make a move...

Now ask yourself: can it make any serious difference to the real economy whether one of those profitable anomalies is discovered now or a half-minute from now? It can be enormously profitable to the financial services industry, but that may represent just a transfer of wealth from one person or group to another. It remains hard to believe that it all adds anything much to the efficiency with which the real economy generates and improves our standard of living.

This kind of reasoning has been going on for a long time, and while introspection is useful, it's really not good for figuring out what other people should do. Some guy thinks to himself, 'what's the use of that?', and decides the world would be a better place not only without that activity. The fact that an academic in Boston can't fathom how something helps the world seems rather unsurprising.

I'll say for the record that I think Puff Daddy is a waste of resources--I have no need for him, and can't understand his celebrity. There are many activities I not only don't do, I judgmentally think people waste time when they do them, but I'm not so arrogant to think that really means they must do something else. It took us decades to figure out that altruism could be based on enlightened self-interest (iterated prisoner's dilemma, reciprocal altruism), so it's a good idea not to throw something out merely because we haven't figured out its benefit in 'the big picture'.

A famous article in 1962 by Fisher, Griliches, and Kaysen (The Costs of Automobile Model Changes since 1949, JPE), argued that the improvements in cars from 1949 were all a waste! Using exacting logic, they noted one could have bought the same 1949 car for $700 less in 1961, and could have used that money to buy coats for the poor or some other 'obviously' better use (after all, 1949 car got from A to B just like the fancy 1962 ones). But, then, one could say the same thing about books: 99.99% of everything written today was said better previously by someone else. Better those people serve the poor or something more obvious than engage in frivolous or redundant work. One could go on and on, because most of the internet is frivolous (porn, games), much liesure activity pointless (football?), etc.

The only problem is with this insight is it isn't obvious how to spend money 'wisely', on say obvious public goods. For example, In the 1990's an activist Kansas City judge decided to mandate the state pay for a first class shool system. The results were typical:
Kansas City spent as much as $11,700 per pupil--more money per pupil, on a cost of living adjusted basis, than any other of the 280 largest districts in the country. The money bought higher teachers' salaries, 15 new schools, and such amenities as an Olympic-sized swimming pool with an underwater viewing room, television and animation studios, a robotics lab, a 25-acre wildlife sanctuary, a zoo, a model United Nations with simultaneous translation capability, and field trips to Mexico and Senegal. The student-teacher ratio was 12 or 13 to 1, the lowest of any major school district in the country.

The results were dismal. Test scores did not rise; the black-white gap did not diminish; and there was less, not greater, integration

William Easterly has discussed the issues of international aid, and how over $2 Trillion dollars have basically been flushed down the toilet. So, good intentions are neither necessary (the unintended benefits of self-interest) or sufficient (charity).

I think it's much better to let people spend their money the way they want (with a few exceptions), and equally importantly make money the way they want. It's a good thing that American car companies, in 1962, didn't think the 1949 model was 'good enough' and then spend it on something obviously of public good, like aid to Africa, or public housing. Such thinking leads to zero productivity growth, and without productivity, we can't pay for things like, public pensions, or actually create things we find really elevating (like the Large Hadron Collider, or Al Gore's Nobel prize winning power point presentation).


J said...

Faster computer trading, as a faster sausage filling machine, or a faster growing chicken hybrid line, improves the productivity of the "real economy" and it is morally just that its inventor should be rewarded. How old is Solow? That says it all.

How come that Al Gore's PPT is compared with the Hadron Collider?The Collider will either complete (or refute) the Standard Model. It may give rise to new industries such as the time-travelling industry or develope a transmutation technology (and turn worthless gold mining stocks).

Eric Falkenstein said...

Gore and LHC: both things people think have large benefits. Not that either necessarily will.

Anonymous said...

Solow notes that it is standard to assume that one profits in a capitalist economy by contributing to the social good. He then presents an example of a profitable activity that may not actually contribute to the social good, acknowledging that actually measuring the social good is a difficult task that he has not attempted.

You reply seems to amount to "it is standard to assume that one profits in a capitalist economy by contributing to the social good, PERIOD." That's not an especially interesting response IMO.

You don't need to be a genius econmoist to come up with models of behavior that work as Solow suggests.

# 56 said...

I am curious to hear your take on this:

Anonymous said...

My objection to intermediaries like Goldman Sachs is not that they don't contribute to the social good (whatever that might mean), but that it's illegal not to use them.

I have similar objections to licensing schemes of all types, including those in the securities and real estate industries. They do not increase competence or decrease crime, while funneling monopoly profits to the licensed firms.

No service can contribute to "social good" unless it's entirely voluntary on the part of the parties using it, including the choice of who is giving it.

Anonymous said...

We are always free to start our countries and experiment with different licensing systems. (This may involve overthrowing existing governments, but high barriers to entry are not infinite barriers to entry.) In the long run, more efficient systems will triumph over less efficient ones. In all likelihood, the system we have today is the most efficient one possible. Claims to the contrary should be treated suspiciously, just like claims that Microsoft's market share is unfair.

Anonymous said...

This is stupid post, or at best, one-sided cherry picking of the evidence. We shouldn't stop the "market" in melding private interests with the public purse (a la Iraq war.) Clearly we just need to wait around for the benefits - besides, what's half a million Iraqi lives?

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Mark J. Washenberger said...

"In all likelihood, the system we have today is the most efficient one possible."

"'Most efficient' at providing what?" is the obvious response. In the political process, both pro-social and anti-social needs are served. Let's be honest--usually it's the latter pretending to be the former. That's where your suspicion should come in.

J Mann said...

I agree theoretically, innovations are likely to have some social value. But what *is* the social value of slightly faster trading? Is it mostly more accurate pricing?

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