November 30, 2014

The LEAP by Ulrich Boser
The science of trust and why it matters

Security expert Bruce Schneier wrote an excellent book called ‘Liars and Outliers’ that smartly maps out the ways that people can be pressured to act in the group’s self-interest. In the work, Schneier argues that there are a number of crucial pressures that can ‘induce’ trust. For instance, Schneier points out that morals can sustain cooperation. Schneier also argues that reputation which is what operated within eBay can help create compliance.

But when a system of cooperation evolves into a society, Schneier argues that we need institutions and when we are dealing with a stranger, we are generally more trusting if we know that there is someone else who will go after a stranger who betrays us.
Clark Rockefeller was a con man whose actual name was Christian Karl Gerhartsreiter. The first case of the case is clear. Rockefeller earned people’s trust by becoming part of their group.  In fact, the very first step of Rockefeller’s con seems to have been to try to burrow himself into a web of social connections. Whenever the con man arrives in a new city or town, he would slowly insert himself into the local church community. Rockefeller would usually progress from churches to private clubs. He had membership cards for the India House and the Lotus Club in Manhattan. In Boston, he was on the board of directors of the Algonquin Club. They gave Rockefeller access to insider knowledge, for one. Rockefeller knew which names to drop, what clothes to wear, which parties to attend.

One of the most important explanations of social capital comes from Robert Putnam. In his seminal book ‘Bowling Alone’, Putnam argues that social capital is the amount of connectedness within a group of individuals. For Putnam, social capital is more than just the number of friends you might have on Facebook or the number of email addresses in your Gmail account; the sociologist argues that social capital is a type of group's goodwill. In his book, Putnam also draws a distinction between types of social capital. Bonding capital accordingly is what connects us across social lines, and it seems that it was a type of bridging capital that allowed Rockefeller to push his scam. Rockefeller’s con as the con of a network.

Rwanda’s genocide exploded in April 1994. After a gunman missiled down President’s plane, Hutu extremists rolled out an extermination campaign against the minority Tutsis. The violence was fast and brutal and often executed by hand. The death toll eventually reached 800,000. Why didn’t Tutsis and other Hutu moderates see the signs that a mass killing would occur? After all, there were all sorts of cues that genocide was imminent. There had also been mass killings in 1959, 1963, and 1973.

Our approach to risk - or our judgment to whom to trust - isn’t totally logical. The bottom line is that our approach to risk isn’t always rational. If we were perfectly logical, if we could predict when genocide was about to happen- our mental formula for risk should look something like this:

Risk = Probability x Consequence

But within our brains, our mental risk formula actually looks a lot more like this:
Risk = Probability x Consequence x Dread.

The dread factor changes everything and generally we dread things that have certain attributes. Gruesomeness issues of control, uncertainty, graphicness - these all change the dread factor as Ripley and other experts argue.

As Philip Zimbardo argues in his thoughtful book, ‘The Lucifer Effect’, “Ordinary people, even good ones, can be seduced, recruited, initiated into behaving in evil ways under the sway of powerful systematic and situational forces”.

Why did the players take the game so seriously? As per Marcus Solomon, that game was a way for the men to build a sense of identity, a way of developing their shared values, an approach that brought them together as a community.

A few years ago, the New York Times ran an article titled, “Why waiting is torture” and the piece gave an unambiguous explanation for queue rage: it is fairness. When Someone cuts in front of us, it offends our sense of justice, and we are willing to go a long way to make sure that people who arrive later than us don’t get served before us.

In Ovid’s epic poem ‘Metamorphoses”. Ajax is a man of grit and strength, of muscle and devotion. he is the most athletic, most loyal soldier in the Greek army and Ajax believes that because of his size and steadfastness, he deserves one of the most treasured price of the Trojan War, the precious armor of Achilles. The issue, as philosopher Paul Woodruff describes his book “The Ajax Dilemma”, is that Ajax has to compete against Odysseus. Wily and inventive, smart and slick, Odysseus is the man who figures out a war past both Scylla and Charybdis. Odysseus, then is the charming brain to Ajax’s loyal brawn and he wants the precious armor too.

King Agamemnon has Ajax and Odysseus each give a speech in front of a panel of judges, arguing his case. In battle of words, Ajax is doomed and Ajax is conquered by his sorrow and the warrior eventually impales himself on his sword, killing himself.

On one side, it is clear that Odysseus should win the armor as he is inventive genius and without his idea for Trojan horse, the Greek might still be laying siege to Troy.  On the other hand Ajax was very loyal and worked hard. This is called Ajax dilemma and the message is simple: Fairness alone isn’t enough. Leaders also have to create a feeling of community and that is where things went so wrong for Ajax.

Political trust is different from social trust. Political trust measures our faith in government and it is crucial for any large scale community. Confucius argued that trust was more important for a leader than food and weapons.
Our nation's lawmakers have become beggars in Brook Brothers clothing. They are constantly searching for cash. They spend huge amounts of time soliciting groups for money. When the Congressional Campaign Committee recently gave a presentation to new lawmakers, they recommended that new members of Congress spend at least four hours a day dialing up donors. As writer Alex Blumberg recently argued, our nation's lawmakers have two jobs, During the day, they pass -or don’t pass- laws. At night, they work as telemarketers. “Most Americans would be shocked, if they knew how much time a US senator spends raising money”, Senator Dick Durbin told NPR.

In 2012 election cycle, almost 30 % of the cash came from some 30,000 very wealthy individuals. Very rich people wants political influence.

I first came across Fenton and the connection between trust and Couchsurfing in the excellent book “What’s Mine Is Yours” by Rachel Botsman and Roo Rogers. In their book, they detail the rise of what they call ‘collaborative consumption” and they argue that sites like Couchsurfing can work “to bind us together”.
It might be hard to believe that technology can promote trust. An iPad is supposed to foster isolation. People believe that Facebook makes us lonely. But it turns out that technology can kick-start our cooperative ways. One way to understand this idea is to start with some phone calls that came into the BMW service desk some years ago. The German car company had put in a new GPS system that spoke to drivers in a female voice and a short time later, men started calling the car company and complaining. Basic reason was male drivers don’t trust directions from a woman. Because of the spate calls, BMW ultimately recalled the device and the reasons were obvious: The male drivers didn't like women telling them what to do.  Our brains often view devices as social beings and if you are the types of man who doesn’t think that a woman should be giving you directions, then you don’t want a woman’s voice giving you directions.
One of the reasons that we have such a negative view of technology goes back to the television. In Bowling Alone, for instance, Robert Putnam suggests that TV has gone a long way to corrupt our sense of togetherness. he suggests that television watchers are less engaged, less friendly, even less happy and Putnam argues that as much as 15% of civic apathy lies at the feet of a what he calls the TV generations

How we create a more trusting and trustworthy society?

The first lesson, we need to do more to consider the perspectives of others. Do I interact with people who look different from me? Do I engage with people who have diverse political views? Do I spend time with people who make more or less money than I do?

The second lesson is that trust is ultimately a choice. We want people to have their own sense of right and wrong. We want people to have a feeling of autonomy. As a society, we don’t want to force trust. We want to grow trust.

The third lesson is one that football coach Bill Walsh might have expressed best: “Success belongs to everyone”.

At micro level, we need to focus on ourselves. If we want the faith of others, we need to ask: Am I honest? Am I dependable? Do I deliver results? For individuals, the trust-building process doesn’t so much begin with faith. It begins with reliability and performance and we often overestimate how much others believe that we are trustworthy.

At macro level, the questions around trustworthiness are similar. Do our institutions inspire trust by being productive, transparent and accountable? Does our society promote justice and equality? Does our economy ensure that everyone gains?

There is no doubt that many of our institutions could do better. Just consider our nation's ever-growing levels of inequality. Because of the yawning gap between rich and poor, we are less likely to trust and less optimistic about our future. When it comes to our faith in others, trustworthiness is the difference between trusting well and trusting poorly and this sort of trust. That means stronger communities. That means a deeper social fabric. That means understanding that trust is ultimately a risk - one that might not always pay off. But above all, it is time to leap.

Books referred in the book
Liars and Outliers by Bruce Schneier
The man in the Rockefeller Suit by Mark Seal
Bowling Alone by Robert Putnam
The Lucifer Effect by Philip Zimbardo
What;s Mine is Yours and by Rachel Botsman and Roo Rogers.
The man who lied to his laptop by Clifford Nass

The end of Normal by James K Galbraith

The end of Normal by James K Galbraith

The great crisis and the future of growth

With respect to greatest catastrophes of modern history, writers turn from what happened to why. Nassim Taleb (The Black Swan), Nouriel Roubini (Crisis Economics), Raghuram Rajan (Fault Lines), Joseph Stiglitz (freefall) & Paul Krugman (End this Depression Now) are some of these writers.

“The Black Swan” view is perhaps the simplest possible explanation of the great crisis; it holds that there is nothing, necessarily to be explained. Like black swans, crises are rare. The failure to predict an event that happens rarely is unfortunate, but it is not a sign of scientific failing. The Black Swan view calls our attention to the predictive limits of even the best theoretical apparatus. The notion that financial crises are scarce is a mirage, reflecting the fact that they don’t generally happen at short intervals to precisely the same people and less in the richest countries than in poorer ones.

The “Fat Tails” view deflates the notion of Black Swans. It admits that extreme events are not rare. As a matter of habit and mathematical convenience, modelers typically assume that this distribution of errors is normal (or Gaussian), so that the relative frequency of extreme events is known. Fat-tailed distributions are mathematical monstrosities just as much as they are harsh features of real world. They are hard on forecasters, rough on speculators, and hell on people who have to live with the disasters that they imply will occur.

The word “Bubble” conveys something that seems to be a bit more specific. A bubble is a quasi-mechanical process - a physical phenomenon with certain properties. It inflates slowly and it pops quickly. These traits imparts an apparent completeness to the concept of bubbles that, together with repetition, has made it a very popular term for describing financial dynamics.

A common feature of these three themes - Black Swans, Fat Tails, and bubbles - is that they depict the economic system as having a normal non crisis steady state. Normality is interrupted but not predictably so. Crisis are therefore inherently beyond the reach of preventive measures. These themes entail certain fatalism. They work to reconcile the laissez-faire approach to regulation with a world in which terrible things happen from time to time.

Consider how Lawrence Summers introduced an essay in FT in early 2012: “ On even a pessimistic reading of the American economy’s potential, unemployment remains 2% points below normal levels, employment remains 5m jobs below potential levels and gross domestic product remains close to $1tn short of its potential. Even if the economy creates 300,000 jobs a month and grows at 4 %, it would take several years to restore normal conditions. So a lurch back this year towards the kind of policies that are appropriate in normal times would be quite premature”.

Did increasing inequality cause the financial crisis? The roots of an argument along these lines are quite old. A version may be attributed to Karl Marx, who foresaw a crisis of realization associated with aggressive wage reductions accompanied by an increasing capital intensity of machine production. Put simply, there would be too many goods and too little income to by them. Inequality of incomes would lead to a general glut or a crisis of under consumption.  The consequence would be mass unemployment, unless or until capitals found external markets that could absorb their goods. Marx saw in this imperative the drive of the European bourgeoisie for empires in India and Africa and for forcing open the markets of Japan and China.

The early new Deal lawyer Jerome Frank wrote in a 1938 book titled Save America First: “The total national income is bound to shrink alarmingly unless a large enough number of citizens receives some fair share of it. The fate of those Americans who receive relatively high incomes is therefore inextricably bound up with that of those who receive low incomes. The former cannot prosper without the latter do”.

The 1970s became a decade of debates over economics. the control that mainstream Keynesians had enjoyed over the high ground of policy setting came under challenge from the mode interventionist left and from the laissez-faire right. There were, in principle, four different ways to proceed and the 1970s saw brief , partial implementation of three of them.

First, we could have devalued the dollar, suppressed wage gains with incomes policy, ramped up the competitiveness of our industry, expanded our exports and covered the import bill with tariffs quotes alongside ingenuity and hard work. This would have been the classical mercantilist strategy, well known since the 18th century with variations pursued by both Germany and US in the 19th century as well as by Japan after 1945. And this strategy would be the one followed later by China, another oil importer in the 1980s and 1990s.

A second line of thinking was to bind oil producers to the US, to accept their high prices and to recycle the revenues through arms sales and private commercial bank lending. US secretary of state Henry Kissinger advanced this strategy in the Nixon and Gerald Ford years, supported by oil industry and the banks, and implemented it mainly through alliances and partnerships rather than with a large US military presence in the Persian Gulf.

A third possible approach for the US was to tackle the issue of oil imports directly with a strategy of conservation and efficient use. America could have cut its consumption of oil, moved to alternative source of energy and to new transportation systems.

Fourth option was to figure out a way to get the oil without actually paying for it; that is to work out a system that would permit America to import physical product for cash and ultimately for dollar-denominated debt, that cost nothing, in immediate resources (or as economists say, “real”) terms, to produce. The fourth option in other words, was to put the oil on a credit card that would never be paid. This solution was of course ideal from every political point of view. And it would become the dominant solution to the problem from the early 1980s onward - the secret of the Age of Reagan.

Paul A Volcker became chair of the Board of Governors of the Federal Reserve System in August 1979 and Reagan took office in 1981 Jan. These two men would restore American power, preserve the American lifestyle in broad terms and set the course of economic expansion in America until the century’s end.

Volcker used strategic price that America continued to control - namely, the world interest rate - as a weapon against the price of the strategic commodity that American no longer controlled, which was oil. Over the 1970s, as oil prices rose, much of the world gone into debt, mainly due to commercial banking system of the US. Thus most of the world, was vulnerable to the interest-rate weapon. Two notable exceptions were China and India, which had steered clear of commercial bank debt.  Under the pressure of high interest rate, the real value of US dollar (weighted by trade) rose by 60 percent. High interest rates plunged the indebted countries of the developing world into a 20-year depression, removing them from effective competition for the world’s resources.

High interest-rates, a strong dollar, and capital inflow lifted constraints on US imports, so that Reagan tax cuts and military spending program could restore economic growth in the US, whatever the price of oil and whatever the trade deficit. But ultimately even the oil cartel could not withstand the strain of the larger global depression, alongside the Iran-Iraq war. Prices fell and so, the mid-1980s, this most critical resource was flowing cheaply to the Global North once again.  In a few more years, the combined pressure of debt, high interest rate and low would energy prices would help stress the USSR - an energy supplier- to the breaking point. When the USSR collapsed in 1991, so did its internal demand for steel, nickel, gas and many other products, including oil, which eventually found their way to the world buyers, further depressing prices.

In remarkable essay, “How did economists get it so wrong” Paul Krugman surveyed how leading economists thought - or failed to think - in the run-up to the crisis. Krugman’s essay is about two groups, which he calls ‘saltwater’ and ‘freshwater’ economists. They tend to call themselves New Classical and the “New Keynesians” even though one is not classical and the other is not Keynesian. One might speak of a “Chicago school” and an “MIT school” with the latter loosely extended over Harvard, Yale, Princeton, Berkeley and Stanford.

Krugman contends that the economists “mistook beauty for truth”. The beauty was the “vision of capitalism as a perfect or nearly perfect system”.

Efficiency is a matter of design, scale and control. Big animals are efficient. They live a long time, range over great territories and can often consume a wide range of foods. Yet they are not numerous, not flexible, slow to reproduce, and therefore may be vulnerable to extinction if conditions change, cutting the surplus and making it raising of young more difficult. Small animals on the other hand, are numerous, short lived, adaptive, reproduce in large numbers, invest little in offspring and are the species survivors in hard times. The same rule applies to business firms and whole economic systems. Great companies flourish when resources are cheap and conditions are stable for a long time. Small companies come and go. The bigger the firms, the larger the share of fixed costs in total costs. Networks, infrastructure, trained personnel, management, research and capital equipment are among the fixed costs as are pensions incurred in past labor.

Victorian expansion and foreign investment were financed partly by bonds with no redemption date, called consols. They were financial instrument suited for an empire on which the sun would never set. A second instances is the US and its sphere of influence after 1945. Part of the goal of the postwar world order known as Pax Americana was to liquidate previous empires: notably the bankrupt British and what remained of the French. USSR is another such instance.

USSR operated with very high fixed costs. It had high overheads. To produce anything at all, those fixed costs had to be paid. And they had to be paid whether or not output reached the consumer and whether or not the consumer wanted that output when it did. In the USSR, a major source of collapse was the diversion of natural resources (oil & gas, esp.) to external markets in order to pay down bank debt. This hurt domestic production, making the pressure to buy imports irresistible. And when the borders opened to external trade, no one wished to by house-made products (textiles, appliances, even food) anymore. Demand for USSR goods collapsed, just as domestic demand had collapsed in Eastern Europe when the iron Curtain came down. Under the new private-economy rules, goods that couldn’t be sold were not made. Output collapsed and employment and incomes.

In the collapse of the early 1990s, industrial production in the former USSR dropped by around 40%. Factories closed, workers were not paid, systems of health care and education stopped working, and basic investments in housing and infrastructure ended. Living standards plummeted and death rates - esp. from violence and alcohol abuse - soared. The male life expectancy declined from around 78 to 58. Anyone who could take money out of the country did so. The govt. was unable to tax, so it issued debt, internal and external until the day in 1998 when it made the decision to cease paying on those debts. At that point, ruble collapsed and the destruction of the old order was complete.

US is also an advanced society with very high fixed costs. We pay high, fixed prices for defense, education, health care, and transportation and for public services of all types, including safety and environmental protection. We were once endowed with cheap energy and abundant raw materials at home and we built our industrial capacity to take advantage of that. No longer. We pump our domestic energy these days from the ocean floor, in the Gulf of Mexico, from Alaska, and by fracking at high cost in hard rock.

It is true that we are more efficient than the USSR- but how much, esp. recently? We have the virtue of business competition and therefore some redundancy that Soviets did not enjoy, but again, by how much? And many of our most advanced sectors such as aerospace, microchips and computer operating system are dominated by near monopolies. If they fail at that they do - such as producing aircraft safe enough to fly - then the American world position could be threatened quite quickly.

Yet good command of economic principles was not sufficient to foresee the Soviet collapse. And two decades later, we discovered that a good command of economic principles did not help foresee the world financial crisis either. Perhaps the problem with the economic principles or the way they have been understood.

And that is the reason for this book.