Narconomics

February 28, 2016

There is a long tradition of economists engaging with the workings of the illegal drugs trade. I am a big fan of popular economics books. And in this area they can provide some real insights into the trade for the layman. In Naked Economics Charlie Whelan talked about the constant Apple-like innovation of the drug traffickers. Faced with their product literally being sniffed out at customs, they decided to bypass border controls altogether, using small boats to transport their illicit export across the sea and into the United States. After the U.S. Coast Guard began tracking fishing boats, the drug traffickers, just as the “rum-runners” had done during the era of Prohibition, invested in go-fast boats, small, fast boats designed with a long narrow platform and a planing hull to enable them to reach high speeds. And when U.S. law enforcement brought in radar and helicopters to hunt down the go-fast boats, the drug cartels innovated yet again developing less easily detected semi-submersibles from the 1990s. When the U.S. Coast Guard first seized a narco-submarine 145 km southwest of Costa Rica carrying several metric tonnes of cocaine in late 2006, they dubbed it “Bigfoot”, because they had heard rumours that such things existed, but none had actually been seen.

In False Economy Alan Beattie asks why Africans do not grow coca and make cocaine, which, like coffee, grows well at high altitude. Cocaine has had terrible effects on the places where it is grown. But Beattie is asking the question from a purely an economic perspective. And the conclusion is pessimistic. The larger coffee-growing regions such as Uganda, Ethiopia, and Rwanda could participate in growing this higher-value crop. At the moment Africans are not doing the production and the intermediate transport of the crop, but are stuck in the relatively low-paid and high-risk part of the supply chain, the final cross-border smuggling. The climatic conditions may be somewhat worse, and there is a relative shortage of large plateaus useful for growing coca. But the main explanation is the lack of infrastructure – transport and logistics in Africa are so poor, and the politics so unstable, that it is simply more efficient to make it in South America and transport it to Africa from there. As it is grown on plantations that take several years to reach productive maturity, coca does not result in quick profits: According to Beattie, given the way that illegality multiplies the financial, logistical, and human-resource management challenges of production and transport, an absence of trust and reliability is even more crippling for an illicit crop than a legitimate one.

In the first Freakonomics book Steven Dubner and Steven Leavit looked at the ethnographic work of a sociology student Sudhir Venkatesh about the Black Disciples, a criminal gang in Chicago involved in the distribution of crack cocaine. The leader of the gang, JT, was a college graduate himself, a business major. The top 120 men on the Black Disciples’ pyramid were paid very well. But the pyramid they were on top of was massive. The 120 represented just 2.2% of the gang membership but they took home well over half the money. It sounds like a standard capitalist enterprise. The foot soldiers, who earned just $3.30 an hour, less than the minimum wage, had a lot in common with a McDonald’s burger flipper or a Wal-Mart shelf stocker. That is why they were still living with their mothers. You also need to factor in the danger of the job. If you were a member of J. T.’s gang for all four years, your chances of dying were one in four. A timber cutter, which according to the Bureau of Labor Statistics is the most dangerous job in the United States, would stand a 1-in-200 chance of being killed over the same period. Even a death row prisoner in Texas, a precarious position if ever there was one, would have a lower chance of death. Why do people do it? Like budding sports stars or Hollywood actors they were motivated by the idea of succeeding in an extremely competitive field in which as well as glory and power, you will be paid a fortune. As Leavitt and Dubner point out, to the kids growing up in a housing project on Chicago’s south side, crack dealing seemed like a glamour profession. The highly visible and highly lucrative job of gang boss was what they aspired to.

Now there is a new book out. As opposed to the ones I have already cited this is a book exclusively about the $300 billion global drug trade. The title, Narconomics: How to Run a Drug Cartel, may be provocative, but I think the book is just common sense. The conceit of the book, written by the Economist’s Tom Wainwright, is how drug cartels mimic the strategies of the big corporations. To anyone with a basic understanding of economics this is perfectly obvious. The tactics of a Coca-Cola or Wal-Mart, brand value, mergers, human resources, franchising, logistics, offshoring and even corporate social responsibility, are dome of the topics that Wainwright looks at in this work. I haven’t read the book yet, but I did hear the author interviewed on NPR’s Fresh Air programme. It was a fascinating conversation.

For example, he shows why attempts to disrupt the cocaine supply line have had precious little impact on the price, which has remained at around $100 per pure gram for decades. There have been massive programmes of crop eradication with airplanes and helicopters dumping tons of weed-killer on these Andean terraces in Colombia. An economist would assume that if you cut supply, then the price will go up, ceteris paribus – other things being equal. Comparing areas in Colombia where crop eradication has gone on with areas where it hasn’t, you see the price of coca leaf – the wholesale price of coca leaf doesn’t really change. The theory is that the cartels in the area have what economists call a monopsony, a monopoly on buying in the area. In other words, they’re the only ones who buy the products so they are not forced to pay higher prices. This is, incidentally, the same criticism that is made against the big supermarket chains here

There is another factor undermining the effectiveness of the crop eradication programmes. The economics of the supply chain mean that even if you could increase the price of that coca leaf, it’s unlikely to have very much impact on the final price of cocaine in the U.S. or European markets. Why not? Wainwright explains that you need about a ton of coca leaf, which once it’s all dried out will fetch perhaps $400, in a country like Colombia. Say the price doubles, then it will be $800. But in the United States a kilo is worth $100,000. If you double the price of the source material, the impact on the consumer price will be less than 1% – $100,400. All this effort is being expended into raising the price of coca leaf, when in fact that’s only a small part of the cost of the final product.

Wainwright looks at the Zetas “franchise”. This was the cartel which expanded most rapidly while he was based in Mexico. The Zetas are a pretty brutal bunch – they are the ones who around beheading people or hanging them off bridges. What is the secret behind their rapid expansion? Starting from the northeast of Mexico they have now spread all over Mexico, and now into Central America. What they do is go to local areas and they find out who the local criminals are, people who do the drug dealing and extortion and all the other kinds of crime. Then they make them an offer: “OK, you can use our brand; you can call yourself the Zetas, just like us.” They may train them in how to use weapons, and they supply them baseball caps with embroidered logos and they give them T-shirts with their logo on. In return for this the Zetas receive a share of all of the money that their “franchisees” get from their criminal activity. Los Zetas franchisees typically diversify into activities such as extortion or kidnapping to earn additional profits.

I don’t know why I’m using quotation marks. The Zetas franchise is exactly like the kind of franchising model that many well-known companies, such as McDonald’s or KFC, use. And it comes with all the same advantages and disadvantages of franchising. In particular, the interests of the franchisers and the franchisees are not always well aligned. The interest of headquarters, whether it be KFC, or the Zetas, is to have as many branches in a local area as possible, because they take their money as a slice of the income of the local franchisees. The latter on the other do not want stiff competition eating into their profits. Unlike the Sicilian Mafia, which is a strong monopoly, the Los Zetas “brand” can easily be falsified.  Given the chaos of criminal competition, virtually anyone can claim to be a Zeta without taking many risks. Extortionists can, at a relatively low risk claim to be affiliated with Los Zetas to gain extra leverage over their victims

In the end Wainwright is sceptical about the War on Drugs. He is rightly contemptuous of such initiatives as a major UN conference on drugs held in 1998, whose title was ” A drug free world: we can do it.” What planet do they live on? This futile war has failed at a cost of hundreds of thousands of lives and billions of dollars. The author does make the point that while remain illegal , anyone who buys them have blood on their hands; when consumers  in New York or London buy a gram of cocaine for a hundred dollars they are paying the salaries of Mexican hitmen. But we need a change – the best way (or maybe the least bad way) to deal with drugs, is by legalizing them:

I think the choice we face really is between a world where drugs are controlled by governments and prescribed by pharmacists and doctors, and a world where they’re dealt by the mafia, and given that choice, I think the former sounds more appealing

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Narcocorridos

February 28, 2016

According to Wikipedia the narcocorrido (drug ballad) “is a subgenre of the Mexican norteño-corrido (northern ballad) music genre, a traditional folk music from northern Mexico, from which several other genres have evolved. This type of music is heard on both sides of the US–Mexican border. Besides from being heard in Mexico, it is widely heard and produced throughout all Latin America. It uses a danceable, accordion-based polka as a rhythmic base. The first corridos that focus on drug smugglers—the narco comes from “narcotics”—have been dated by Juan Ramírez-Pimienta to the 1930s. Early corridos (non-narco) go back as far to the Mexican Revolution of 1910, telling the stories of revolutionary fighters. Music critics have also compared narcocorrido lyrics and style to gangster rap and mafioso rap.

Alt.Latino, an NPR, programme looked at the phenomenon:

They provide the vicarious pleasure of listening to the exploits of poor men made rich in a country where social mobility is difficult, poverty is crippling and government corruption is rampant. In that way, they might not be that different from telenovelas: escapist entertainment that’s not always wholesome, and that can celebrate toxic behaviour.

Here are a couple of examples:


It’s the culture, stupid: CQ in a globalised world

February 21, 2016

Cultural intelligence: an outsider’s seemingly natural ability to interpret someone’s unfamiliar and ambiguous gestures the way that person’s compatriots would.

 People who are somewhat detached from their own culture can more easily adopt the mores and even the body language of an unfamiliar host.

 You will not disarm your foreign hosts simply by showing you understand their culture; your actions must prove that you have entered their world.

Christopher Earley Elaine Mosakowski from an article on Cultural Intelligence in the Harvard Business Review, 2004

______

Howard Gardner famously identified eight intelligences musical-rhythmic, visual-spatial, verbal-linguistic, logical-mathematical, bodily-kinaesthetic, interpersonal, intrapersonal, and naturalistic. Later he was thinking of adding existential and moral. Then Daniel Goleman started to popularise research into emotional intelligence. After that came Spiritual Intelligence. Danah Zohar argues that while computers can have IQ and higher mammals EQ, only humans possess SQ. It is linked to humanity’s need for meaning, vision and value. In the words of Zohar it allows us:

to dream and to strive. It underlies the things we believe in and the role our beliefs and values play in the actions that we take and the shape we give to our lives.”

And now along with IQ, EQ and SQ we have CQ. The latter stands for Cultural Quotient, which measures the capability to function effectively in a variety of national, ethnic and organizational settings. Academic researchers have been researching this question for over a decade now. The CQ concept was first introduced by two business researchers, Christopher Earley and Soon Ang, in their 2003 book, Cultural Intelligence: Individual Interactions Across Cultures. I came across it through the work of Professor David Livermore, President and Partner at the Cultural Intelligence Center in East Lansing, Michigan and author of a number of books on the subject including The Cultural Intelligence Difference and Leading with Cultural Intelligence.

Hard-nosed business leaders may struggle to see the connection between cultural intelligence and the bottom line. But, according to Livermore, both individuals and companies benefit from having a high CQ. Research done among 30,000 professionals from more than 50 countries by Livermore and his colleagues at East Lansing has found that people with higher CQs are consistently more personally and professionally effective. They have an edge in the competitive job market, suffer less burnout and enjoy greater personal satisfaction when posted overseas. Companies benefit too in understanding new markets, carrying out international negotiations, unifying multinational teams and developing global marketing plans. It is not good for a company when an employee working abroad has to go home early because he has been unable to adapt to a new culture.

CQ is not a static number and can be enhanced. There are four capabilities typically present among those with high cultural intelligence – CQ drive, CQ knowledge, CQ strategy, and CQ action. You can see in this video:

Livermore identifies ten dimensions of cultural value that are helpful ways to compare one culture with another. This is an extension of the work of Geert Hofstede. The Dutch social psychologist, a former IBM employee, is Professor Emeritus of Organizational Anthropology and International Management at Maastricht University in the Netherlands. He became well known for his pioneering research on cross-cultural groups and organizations. He developed cultural dimensions theory, which describes national cultures along six dimensions. Here I will look at five of them.

Identity: Individualist vs. Collectivist

The cultural value of individualism versus collectivism is about the degree to which personal identity is defined in terms of personal, individual characteristics versus group, collective characteristics. In individualist cultures the ties between individuals are loose people should look after themselves and their immediate family. Collectivist cultures are about strong, cohesive in-groups often the extended family. People see themselves primarily in relationship to others and not fundamentally as a unique individual. The “American dream” is surely the classic representation of individualism. However, it is not about capitalism and socialism which are predicated on individualism and collectivism respectively. Livermore points out that in Scandinavia, which has been socialistic in orientation; everyone is expected to pay very high taxes. Nevertheless, the overall culture is individualist. The highly privatised economies of China and Singapore exist within extremely collectivist cultures. The individualist culture index is dominated by the Anglosphere United States (91), Australia, United Kingdom, the Netherlands and New Zealand. At the other end of the spectre all the countries are Latin American – Guatemala (6), Ecuador Panama, Venezuela and Colombia.

Authority: High vs. Low Power Distance

Power distance addresses the amount of hierarchy and inequality that is regarded as proper and normal within a society. How does your culture teach you to address elders and those with more authority? High power distance cultures expect even adult children to defer to their parents on big decisions. In low power distance cultures, children are treated more equally. In education high power distance cultures tend to emphasise rote learning and mimicking the teacher. The parent-child relationship is mimicked by the role of teacher-child. In the world of work in high power distance cultures, employees often prefer an authoritarian hands-on boss, not the kind who likes to delegate and get ideas from the group. Looking online I found the countries with the highest power distance were Malaysia (110), Guatemala, Panama, Philippines and Mexico. Austria (11), Israel, Denmark, New Zealand and Ireland had the lowest power index.

Risk: High vs. Low Uncertainty Avoidance

The uncertainty avoidance index is the degree to which most people within a culture tolerate risk and uncertainty. Japan (92) has a high uncertainty avoidance index, yet excessive drinking after work is common among many Japanese businessmen. This may be a way of releasing the pent-up anxiety. This difference will play out in educational contexts. Students in the United States consider answering a question even if they are not sure about the answer, whereas Japanese students tend to answer a question only if they are absolutely sure they know the answer. The countries with the highest uncertainty avoidance are Greece (112), Portugal, Guatemala, Uruguay and Belgium. On the other hand, Singapore (8), Jamaica, Denmark Sweden and Hong Kong, on the other hand are said to be happy with some ambiguity and uncertainty.

Achievement: Cooperative vs. Competitive.

This refers to the extent to which cultures are oriented around being competitive, focusing on achievement, success, and results, or cooperative prioritising nurturing, supportive relationships. Geert Hofstede referred to this as masculine and feminine, with the idea being that the cooperative cultures are more in line with what has stereotypically been thought of as more feminine traits—nurturing, caring, compassionate—and that the tough, competitive cultures are more in line with masculine traits. Livermore wisely avoids this problematic term. I would have imagined the U.S.A. higher up on the list but the top five most competitive are Japan (92), Hungary, Austria, Venezuela and Italy.  In contrast, Sweden (5), Norway, Netherlands, Denmark and Costa Rica are said to be the most cooperative.

Short-Term versus Long-Term Orientation

There’s one more way that researchers have compared the time orientation of different cultures: short-term versus long-term orientation, or present versus future emphasis. This is largely about how we’ve been socialized to think about how long we’re willing to wait for results and rewards. Is the work we do primarily oriented around seeing some kind of result in the very near future, or is it more oriented toward slow results that will be realized a long way ahead? Long-term orientation is most often associated with Confucian culture, but there are other cultures that operate this way too. With the emphasis on long-term rewards means that there are high savings rates. Anglo cultures like North America, the United Kingdom, and Australia are some of the most short-term oriented cultures; businesses are oriented around quick results that show up in quarterly earnings and booming stock prices. People are usually much quicker to spend money, so the savings rates are much lower. The long term orientation index is dominated by Asia – China (118), Hong Kong, Taiwan, Japan and South Korea top the list. The short-term list is more disparate – Venezuela, Uruguay, United Arab Emirates, Turkey and Switzerland. Spain is just above this five.

There are other dimensions explored by Livermore: direct versus indirect communication, being versus doing lifestyle, particularist versus universalist rules, neutral versus affective expressiveness, and tight versus loose social norms. I don’t have space to look into these, but you can find them online.

To be honest, this is too much data to really take in. Defining intelligence precisely is problematic. We are not talking about absolute values here. They are on a continuum. I also think cultures can change. There are myriad examples of this. Schools in the west there used to have a high power distance between teacher and student. Globalisation must also be playing a role in changing national mores, but there can also be important national backlashes. I’m not sure how scientifically rigorous these dimensions are, but they do at least provide an interesting framework in which to think about how cultures differ.


Cultural intelligence: the competitive edge for leaders

February 21, 2016


The rise and fall of the opinion poll

February 14, 2016

Election polling has had some high-profile disasters in recent years. Sometimes it might be the ideology of the polls. In the 2012 US presidential election, Republican strategist Karl Rove, appearing on the Fox News election night special claimed that Mitt Romney would become the 45th president of the USA in a landslide. They got it horribly wrong – the election wasn’t even close. President Barack Obama was elected to a second term, with the national popular vote percentage being 51.1% to 47.2%, and the Electoral College vote being 332 to 206, for Obama and Romney, respectively. Rove and fellow Fox pundit Dick Morris had been persuaded by the numbers their pollsters had been giving them for weeks, showing a clear Romney lead. Those numbers were wrong, and they remained wrong right up until election night. Polls in Israel seriously underestimated Prime Minister Benjamin Netanyahu’s strength. He is quoted as saying: “I always lose the election in the polls, and I always win it on election day.” But, it is the U.K. example which has been the most flagrant in recent years. Pollsters predicted a close election only to see the Conservatives win easily. Polls are now as untrustworthy as the politicians whose popularity they measure. How did it come to this?

The first opinion poll was carried out in Delaware on July 24th 1824. It was conducted to predict the result of the US presidential election contest between Andrew Jackson and John Quincy Adams, and it predicted a Jackson win. It was wrong. The man most associated with is history is George Gallup, whose company, founded in 1935, is still going today. Gallup actually wanted to work in journalism; his goal was to become a newspaper editor. But when he was at university there was no journalism course, so he studied psychology instead, finally obtaining a PhD. He then set about measuring American public opinion. Initially he was not interested in elections. However, there was a significant credibility gap. How could he show that his surveys were accurate? He needed an activity where his results would be tested. He started asking people their voting intentions so that he could then predict an election. This was to prove extremely popular – people just loved these predictions. What began as a stunt to promote his real business just took off.

Gallup’s great triumph was in the 1936 U.S. presidential election. With a sample of 50,000 voters, Gallup’s organisation correctly predicted Franklin Roosevelt’s victory over Alf Landon. This was in contrast with Literary Digest, whose poll of over two million returned questionnaires predicted that Landon would be the winner. In polling it is quality not quantity. Gallup went further. Using a random sample smaller than theirs, but chosen with the same methodology, he was also able to correctly predict the results of the Literary Digest poll. The Literary Digest people had made heavy use of telephone directories. The trouble was that those whose names were included were not a random sample. They were disproportionately well-off voters, the type of people who hated the New Deal and saw FDR as a class traitor.

When public opinion survey research started in the 1930s, the response rate was well above 90%. People were less jaded and cynical about the political process. It was like a civic duty and there was the novelty factor. Someone would come to your door to talk about politics fro 45 minutes. Now in age of greater cynicism, information overload, the decline of landlines, robocalls and the rise of mass marketing the figure is around 10%.

This has important implications for polling accuracy. The characteristics of who agree to be interviewed may be markedly different from those who refuse. Some households use mobile phones only and have no landline. This tends to disproportionately include minorities and younger voters and occurs more frequently in metropolitan areas. These are just a couple of examples of the biases that can skew results. Another factor is known as response bias. This is how responses do not always reflect what the voters think. This may be down to unscrupulous pollsters trying to produce a certain result. But it might also be the respondents who are deliberately lying. This could be to screw the system or they may feel embarrassed to admit who they are voting for. In U.K. elections we talk about the Shy Tory Factor, in which Conservative supporters are reluctant to reveal their preference for the Nasty Party. The wording and order of the questions is also vital as was satirised in the Yes Prime Minister video.

Pollsters do now seem to be facing a crisis. They are now competing with data analysts. As I pointed out in the introduction, they have had a number of cock-ups in recent years. If they keep making wrong calls, the public will stop taking notice. They are up against the growth of Big Data. The star of the prognosticators at the 2012 U.S. presidential elections was Nate Silver. Curiously, he never conducted a single poll himself. Instead, what he did was aggregate the data from existing polls and other sources and put it through his own analysis to come up with his predictions. Silver and his team must have done something right; they correctly predicted the winner of all 50 states and the District of Columbia. Is this the end for traditional pollsters? We shall see. But I think opinion polls, love them or hate them, will continue to play a massive role in our elections.

 


Yes Prime Minister – how to rig an opinion poll

February 14, 2016


Finance – too much of a good thing?

February 7, 2016

A country can be prosperous only if it has a well-functioning financial system, but that does not imply that the larger the financial system a country has, the more prosperous it is likely to be. It is possible to have too much of a good thing. John Kay in Other People’s Money

I have just finished reading John Kay’s Other People’s Money. Kay is not your typical populist anti-system finance basher. That makes his critique all the more damning.  The book is divided into three parts. The first part, Financialisation, looks at how the financial sector grew in size, revenues and sophistication from the 1970s up to the 2008 GFC. In the next part, The Functions of Finance, he explores the necessary underlying functions of a modern financial system. The final part, Policy, suggests some solutions for our malfunctioning financial system.

Kay recognises the finance sector’s critical roles:

  1. acting as a payment system
  2. directing savings to productive investments
  3. offering a service for managing personal finances across the life cycle and generations
  4. providing a marketplace for transferring and managing risk

It is these core functions from which banks have abandoned. And they have strayed into dangerous territory. Deposit taking has become a source of funding for uncertain, long-term risk taking. There is a lot of exchanging bits of paper. If banks want to make profits they need to take on extra risk. He compares their strategies to tailgating on the motorway. This high-risk approach will work most of the time until it doesn’t. There will be occasional devastating crashes. These risky strategies are often encouraged by the   skewed incentives bankers face. By taking risks they get all the upsides – the possibility of huge bonuses. On the other hand, if their bets are wrong there are no downsides for them – the bill for their mistakes will be picked up by shareholders or, ultimately, taxpayers.

When things are going well, there’s no problem. But it’s a fool’s paradise. Kay introduces us to the concept of the “bezzle”. It comes from economist J.K. Galbraith’s Embezzlement, an account the Wall Street Crash of 1929. In the period, which may be weeks, months or even years, between the commission of a crime and its discovery both the embezzler and the mark feel they are winners. The latter feels no loss at this stage. Thus there is a net increase in psychic wealth. It is this increase that the Canadian economist called the bezzle. Only later does the victim realise that he has been royally screwed. A variation on the theme was provided by Warren Buffett’s business partner Charlie Munger. His insight was that there does not have to be any criminal act involved – mistakes or self-delusion will do the job just as well. Febezzle, functionally equivalent bezzle, was the term Munger coined to describe the wealth that exists in the interval between creation and destruction of the illusion.

What we can do about it? In the last third of the book Kay looks at reform, which is not the same as regulation. What we do not need is more complex regulation. We have enough of that already. As I pointed out in A sceptic’s guide to regulation the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act had no fewer than 2,319 pages. Regulation is not the solution. Some of finance’s worst excesses come from what is known as regulatory arbitrage. The website investopedia has a nice definition:

“A practice whereby firms capitalize on loopholes in regulatory systems in order to circumvent unfavourable regulation. Arbitrage opportunities may be accomplished by a variety of tactics, including restructuring transactions, financial engineering and geographic relocation.”

And then you have regulatory capture, the way the industry is able to take control of the regulatory institutions. Kay bemoans the fact that financial regulation suffers from a faster-spinning revolving door compared with other industries. Many of the regulators themselves either come from the sector or hope to work there in the future.

The fundamental problem is the structure of the industry itself. Kay puts it this way: “We need some of the things that Citigroup and Goldman Sachs do, but we do not need Citigroup and Goldman Sachs to do them.” Instead of the vast behemoths that we have now Kay would like to see smaller more focussed institutions. For example, banks that accept deposits should have strict restrictions on the kind of assets that they hold. The intermediaries who handle other people’s money should be held to high standards of customer care, and be liable to civil and criminal penalties. And it is vital that these penalties should affect individuals, not corporations. The principle of individual responsibility needs to be re-established. When a corporation is fined they just pass on the cost to shareholders.

Above all, the finance sector should not be judged as a special case. If an activity is not profitable without taxpayer money, it should not occur. Banks must be allowed to fail. I have to say I’m not particularly optimistic about the future. I see little evidence of things getting better.