Unintended Consequences of Regulations: Contracting Companies

recent New York Times article tells the tale of two janitors. One at Eastman Kodak in the early 80's had their education paid for and later worked her way up to CTO, later going on to be a senior executive at other companies. The other is at Apple today and doesn't even directly work for Apple. She has minimal benefits and no obvious path for career advancement. That's in large part because she works for a company that contracts out her labor and not for Apple directly*.

The narrative the Times advanced is that companies chose to focus on their core competency and have outsourced other work. Most modern tech companies have decided to focus on their most productive employees and are letting contractors deal with the supposedly interchangeable employees working on low skill problems.

What many people don't see is that this is not an economic relationship that has sprung out of thin air. A lot of it can be interpreted as a company's logical response to the regulatory environment. There are at least three different areas that incentivize companies to keep low skilled workers at arms-length, only hiring them through secondary employers. There are laws around unionization, legal risks from the Equal Employment Opportunity Commission and the Affordable Care Act has made the choice even more clear from a cost perspective.

At first glance, it's obvious why laws about unions would cause companies to choose to contract their labor. For companies that are innovating quickly, becoming unionized raises the spectre of what happened to Detroit auto companies. The long term accumulation of rules and resistance to automation that would cost jobs helped cause the Big Three to fall far behind their more nimble competition from Japan. As Steve Babson puts it in "Working Detroit: The Making of a Union Town"

"The absence of union factory rules gave Japanese management the flexibility to change workloads and reassign jobs without opposition but it also left workers with little protection against speed-up of favoritism."

Today's tech companies need to move fast and keep up with a quickly changing technology landscape, so their instinct is to avoid unionization. How do they do this? First, they spoil their workers more than any union ever did. Companies provide meals, social events, gym memberships and some tech companies even do laundry for employees. This is a multi-purpose policy, not only do these perks discourage talk of unionization, they are also meant to encourage employees to spend more time at work and make them less likely to leave the company even when they are being paid significantly under their market price.

But keeping the higher skilled employees is only part of the equation. The second is keeping employees that are likely to unionize outside of the company. Low skilled workers are most likely to form unions. Unions might possibly strike and upset the sympathetic high skilled employees. The laws empowering the National Labor Relations Board grants union employees specific protection. But those protections stop when they target employers other than their own. From the NLRB FAQ:

"A union cannot strike or picket an employer to force it to stop doing business with another employer who is the primary target of a labor dispute."

After looking at this rule, it should be obvious why companies would want to avoid giving employment status to a class of workers that are unionized or might decide to form a union in the future. By hiring these workers through another employer, they are shielding themselves from the more inconvenient aspects of labor law.

Next we have the Equal Employment Opportunity Commission. The EEOC does not only look for employers who are discriminating in hiring based on age, race, sex, etc. They will also punish treatment of employees based on these factors. If a corporation wants to treat some employees as first class employees with more benefits and another group as second class, they would have significant legal risk when the second group consists of employees that are more likely to belong to a protected class. (And the Times piece does mention how there are legal requirements that employees are offered the same health insurance and 401(k) benefits.) The EEOC will be collecting pay data by sex, ethnicity and race. Under this scenario, it will look a lot better for everyone involved to continue contracting out the low paid jobs.

On top of all of this we have the Affordable Care Act's impact on full-time employment. The ACA puts the burden of providing healthcare fully on full-time employers while leaving part time employers and contract workers almost completely off the hook. The question of who should be responsible for healthcare payments is a political question, but it should be applied equally to all types of employment relationships. Two part-time employees working 20 hours a week should cost an employer the same as a single full-time employee working 40 hours a week. That's not the case today, the 40-hour workweek employee is more expensive. And rather than be the bad guys who are hiring part time workers to avoid paying for health insurance, it is easier for corporations to pay another company to hire and manage workers in this manner.

When designing and implementing policy, it's hard to account for the long-term impact. In this case, the incentives created by multiple regulatory bodies have combined to raise the risk and cost of full-time low-skill employees. They are highly incentivized to hire another company to shield them from a direct relationship. Laws that were originally intended to protect people and keep society integrated might be serving to bifurcate it even further.


*On top of the low wage she pays inordinately high rent to live in the area. A significant part of the struggle of low wage workers in the Bay Area comes from the lack of affordable housing. Most people should realize by now that this is an artificial hardship imposed on the poor by voters who think they are preserving the character of their neighborhood, preventing sprawl or protecting the environment. In reality, the main concern of voters is boosting the value of their house after they have locked in the amount of taxes they have to pay thanks to California’s Proposition 13.

Bill Gates: Pulling up the Ladder

There is a social phenomena called Pulling up the ladder. The basic idea is that when a person or group has success in a certain way, they advance policies that prevent people from having the opportunity to succeed in a similar manner.

Pulling up the ladder is seen in NIMBYism. Established residents who built their houses in a neighborhood pull up the ladder when they decide that extra rules and permits are needed and that no one else should be allowed to build a home in their neighborhood as easily or as cheaply as they did. Pulling up the ladder is seen when practitioners promote occupational licensing that forces new entrants to go through thousands of hours of training and low paid apprenticeships, but grandfather in current practitioners who do not have to follow these burdensome rules. 

Bill Gates provides us with an egregious example of pulling up the ladder in a recent interview with QZ.com when he advocates for the taxation of any robots that replace human jobs.

Certainly there will be taxes that relate to automation. Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed and you get income tax, social security tax, all those things. If a robot comes in to do the same thing, you’d think that we’d tax the robot at a similar level.


There are many ways to take that extra productivity and generate more taxes. Exactly how you’d do it, measure it, you know, it’s interesting for people to start talking about now. Some of it can come on the profits that are generated by the labor-saving efficiency there. Some of it can come directly in some type of robot tax. I don’t think the robot companies are going to be outraged that there might be a tax. It’s OK.

First, anyway you cut it, this is just really bad policy. Companies utilizing robots should be taxed with the same rules as every other company. Tax theory is not something that can be covered in a short blog post, but there are two frameworks that make it easy to see why this is a bad idea.

One framework favored by some economists is that taxes should be designed to force people and organizations to internalize negative externalities. This is called a Pigouvian tax. If a certain behavior is not good for society, then raising its price will reduce the harms to society while generating revenue. This type of approach is exemplified by those pushing for a carbon tax. Carbon is identified as harmful, and raising the price of release carbon into the atmosphere will likely result in less carbon released into the atmosphere (improperly implemented, it also incentivizes more manufacturing in countries that do not have carbon taxes). Cigarette, alcohol and sugary drink taxes are often justified under a similar approach, as consumption of unhealthy goods can create significant costs for the healthcare system*. The flipside to this logic is obvious. Taxes should also encourage, not discourage, desirable behavior. A tax designed to explicitly raise the cost of research and investment relative to other activities would be a very bad idea.

Another framework is that taxes should avoid unnecessarily distorting economic behavior. Even economists who promote Pigouvian taxes would agree that a tax that changes behavior without purposefully targeting a desired externality is a poorly designed tax. Taxes that can be avoided with additional work from lawyers and accountants are particularly inefficient. Resources devoted to getting around the tax may make sense for individuals and companies, but are a deadweight loss to society. The value-added tax, other than encouraging exports to countries without value-added taxes, is both easy to enforce and does not skew behavioral incentives significantly. It is therefore widely used across the developed world outside of the United States.

So it’s pretty obvious why trying to apply an additional robot tax on companies would be a bad idea. Measuring whether a robot is taking a job is not a simple task, and companies will be incentivized to make the use of automation unrelated to any losses of jobs. The tax would cause significant amounts of new inefficiency as companies on the verge of automating significant tasks would spend lots of money trying to figure out how to minimize or avoid the robot tax. 

But even worse, taxing the implementation of robots in existing companies would slow down the adoption of new technology. If implemented only in the United States, the robot tax would also cause U.S. companies to fall behind places in the world where the implementation of robots was not discouraged by taxation. If the United States wanted to permanently relinquish its status as the country at the forefront of the production-possibility frontier, this tax would be a great way to start.

What makes Bill Gate's suggestion particularly egregious is that the source of his wealth came from the widespread distribution of labor saving technology, software! The following is from the BLS summary of Occupational changes during the 20th century.

The growing use of computers and other electronic devices, which simplified or eliminated many clerical activities, caused the post-1980 decline. Automated switching and voice messaging affected telephone operators; personal computers, word-processing software, optical scanners, electronic mail, and voice messaging, secretaries and typists; accounting and database software, bookkeepers; ATM’s and telephone and online banking, tellers; and computerized checkout terminals, cashiers.

Imagine what would have happened to Microsoft if every time it sold a spreadsheet tool it had to pay a tax for the number of bookkeepers it replaced. Or if all users of Microsoft Office were taxed for the secretaries and typists that were no longer needed. If the United States applied the policies Bill Gates now suggests now to software in the 1980's, the digital revolution would have been strangled in its infancy and Bill Gate would not be in the position he is in today. Specifically taxing companies that implement cutting edge labor saving technology is silly. It wouldn't have been a good idea then and it's not a good idea now. 

Bill Gates has led a unique life over the past few decades so he might not realize this, but our society could still be a whole lot richer. It is still far from wealthy enough to implement any reasonably sized universal basic income. Safety nets, retraining and regulatory reform have important roles to help workers displaced by our fast evolving economy. But the last thing we want to do is implement taxes that slow down innovation or encourage innovative companies to locate its business outside our borders.

So please ignore Bill Gates when he blithely suggests that anyone using robots to replace labor should have to pay extra taxes. Not only is he advocating for pulling up the ladder behind him, listening to him would impoverish our future. Our society cannot afford to treat labor saving innovation like a negative externality to be taxed.

*Somewhat morbidly, unhealthy behaviors that shorten life expectancies actually seem to reduce total costs on the healthcare system.

Donald Trump Brings Regulatory Budgeting to the US

On January 30th, the White House issued a new executive order targeting regulatory reform. The rule has been promoted, by both the White House and the media, as the rule that forces regulatory agencies to get rid of two rules for every new rule they issue.

Both Canada and the UK have used one-in, one-out rules, with the UK switching towards implementing two for one. The statement below is from a policy paper by the Conservative and Liberal Democrat Coalition government in December 2012 as they switched one One-In, One-Out (OIOO) to One-In, Two-Out.

It is clear that the OIOO rule has delivered a profound culture change across government as demonstrated not only by the continuing increase in deregulatory measures but also in the high number of Departments in credit at the end of the OIOO period.

Building on this culture change, Government is now pressing Departments to deregulate further and faster to free up business from unnecessary red tape and deliver growth. From January 2013, our rule is doubled to One-in, Two-out (OITO). The Red Tape Challenge will continue to be an important vehicle for Departments to reduce regulatory burdens and identify OUTs.

Given the UK’s experience, it makes sense that Trump is starting with two for one. He is not a man of half measures.

But the number rules are not the most important aspect of this policy. A single rule could have a miniscule impact, and repealing two of them might not matter if the new rule imposed gigantic costs. The executive order does not overlook this:

In furtherance of the requirement of subsection (a) of this section, any new incremental costs associated with new regulations shall, to the extent permitted by law, be offset by the elimination of existing costs associated with at least two prior regulations

Trump essentially told the agencies that he is capping the costs they are imposing on the economy. They can reduce costs by being more efficient, or by prioritizing their rule making around the most important problems. He is giving every agency a regulatory budget.

The idea of a regulatory budget is simply applying the concept of a budget to regulations. If applied correctly, government agencies are only be allowed to impose a certain amount of cost on society regardless of their net benefit. As agencies are eager to remain relevant and fix the greatest problems of the day, they will be incentivized to remove or remake some of the costlier rules. The benefits of regulatory policy are not ignored, they are taken into account by the amount of cost each agency is allowed to impose on the economy. Trump’s executive order is designed so the regulatory budget of agencies will be increased or decreased, as needed.

During the Presidential budget process, the Director shall identify to agencies a total amount of incremental costs that will be allowed for each agency in issuing new regulations and repealing regulations for the next fiscal year.  No regulations exceeding the agency's total incremental cost allowance will be permitted in that fiscal year, unless required by law or approved in writing by the Director.  The total incremental cost allowance may allow an increase or require a reduction in total regulatory cost.

While the order looks sound, implementation will be key. First, there is the question of how these costs are measured. The direct cost of paperwork and compliance are not the only costs imposed by regulations, there are also indirect costs that are difficult to take into account but which are often larger than the direct costs.

Second, there is the question of prioritizing the right rules to cut. Right now, this order has implemented partial regulatory budgeting, probably the best that can be done without support from Congress. The costs that the agency can impose, along with the number of rules, has been capped. And while we know the total number of rules issued by each agency, we do not yet know the costs and benefits associated with each rule. Only some rules have been analyzed, and many of those analyses are out of date. Agencies enforcing many costly rules with few real benefits should be made to cut much more than two for one, while agencies providing significant benefits in excess to their costs might be given increase in their regulatory budgets. This is an approach favored by Cass R. Sunstein, one time head of Obama’s Office of Information and Regulatory Affairs.

It is important to remember that regulatory budgeting isn’t some new crazy idea. Canada and the United Kingdom have applied regulatory budgeting. In British Columbia, the Deregulation Office used a regulatory budget approach to cut the number of requirements to 55% of their 2001 level. This is made easier in Canada and UK because the ruling party of coalition in a parliamentary system can change the law. In the US, when an agency gets rid of an outdated and costly rule, they may run into legal obstacles if that rule was legislatively mandated.

It would be best if the agencies were operating under the explicit orders or Congress and the Executive branch to create real change. This isn’t just about rolling back inefficient regulations, it’s also about making the government work far more efficiently. It’s a good start.

Short Answers to Hard Problems

"Explanations exist; they have existed for all time; there is always a well-known solution to every human problem — neat, plausible, and wrong." - H.L. Mencken

What will it take to get health spending under control?

Price transparency. First party payments. Data portability and interoperability. Eventually, computer assisted technicians.

What can be done to help the US middle class?

See above. YIMBY. More learning by doing.

Is there a low risk way to really help refugees?

Charter cities, not camps. 

How do we fix inequality?

Wrong way to frame this question. Stop the rent seekers. More experiments in educational signaling.

What will it take to create peace in the Middle East?

Alternative energy. Nuclear power. Drill baby drill.

How can we reverse the political bifurcation of society?

Destroy the walled gardens. Bet on beliefs. A common enemy.

How do we prevent AI from taking over the world?

We don't.

The GOP's Monetary Weakness

With the election over and Donald Trump's team taking control of the administration, one government agency that people on the right should be worried about is the Federal Reserve. This is an independent institution that is capable of destroying the GOP in the midterms, it can make the reelection of Donald Trump in 2020 very difficult. The irony is that many conservatives, even those who are supportive of both Trump and the GOP, are concerned about the Fed for the wrong reasons and would like to push the Federal Reserve towards policies that will result in electoral losses for Trump and the Republican Party.

Conservatives have historically preferred tighter monetary policy than liberals. Looser monetary policy, in the form of lower interest rates and higher credit creation, can look helpful in the short term while leading to harm in the longer run. The long run harm can be the capital misallocation predicted by Austrian business cycle theory and other theories. It could be the higher probability, however miniscule, that the central bank will eventually be used to monetize debt and spur hyperinflation. Or might just be the simple risk of inflation expectations among the public suddenly becoming unanchored, leading to a return of 1970's style stagflation.

Worries about too loose monetary policies are often well founded, particularly when inflation is getting out of control. But our current environment is one in which inflation has remained subdued for many years. The Personal Consumption Index Price Index remains well below the Fed's target of 2%.

The 5 Year, 5 Year Forward Inflation Expectation Rate is hovering around 2%. The CPI has recently been slightly higher than the PCE price index, so the market is still forecasting that inflation will be below the Federal Reserve's target. 

The Federal Reserve has recently started to act more boldly in hiking rates to normalize monetary policy. It is worrisome that they are acting on forecasts that have been consistently wrong in the same direction. Looking at their end of the year December projections for GDP growth, they have had to continually revise down their growth estimates throughout this cycle. 

They are acting before there is any real inflation and without strong evidence that this time their forecasts of renewed growth and inflation are correct after being wrong for so long. 

The Federal Reserve is tightening policy more than other countries around the world, which has led to a very strong dollar. The US trade weighted dollar index is the strongest it's been in 10 years. 

Many economists are already concerned that programs which encourage exports while discouraging imports will strengthen the dollar and counter some of their potential impact. When we combine that with an aggressive Federal Reserve, the impact of positive steps taken to boost exports can be significantly countered by a strengthening currency.

And tight monetary policy doesn't just strengthen the dollar, it can hasten a cyclical downturn that turns people against the party in control of government. In the early 90's, George H.W. Bush lost for many reasons. But he would not have been vulnerable if the Federal Reserve wasn't hiking rates into his re-election campaign. Perhaps more significant was what was happened in Argentina, where market friendly economic reforms of the 90's were reversed after conservatives drove their country into a depression caused by the Peso's peg to a strengthening dollar through the late 90's and early 00's. They could have unpegged the peso at any time, but they were too busy fighting the last battle against hyperinflation to implement a more reasonable monetary policy.

Trump has mentioned previously that he wants to get rid of the low interest rate environment. If he appoints nominees who are too quick to move in that direction, raising rates before growth and inflation warrant action, it could counteract any economic growth generated by his supply side reforms in the short and medium run. And if that causes electoral losses, the reforms themselves could be reversed and no long run benefit will exist either. As Scott Sumner has said, monetary policy is the Achilles heel of the right.

The Irony of Hanukah

This week we celebrate Hanukah, the miracle of the one-day supply of oil lasting eight nights. It also commemorates the rededication of the Second Temple. It is a wonderful holiday that provides Jewish children with a winter holiday full of presents, rituals, songs, comfort food, games and family time. It is a holiday that is more fully embraced by Reform Jews who want to provide their children with a Christmas-like holiday than by the more observant Jews. Orthodox Jews still see observing the celebration as an important mitzvah, but Hanukah is not among the most important holidays. Rosh Hashanah, Yom Kippur, Passover and even observing the Sabbath are all more significant. 

The miracle of the oil and the rededication of the Second temple came about thanks to the Maccabees. In Hebrew school, I was taught that the Maccabees were the guerilla warriors who fought against the Seleucid empire. It is easy and fun to root for the ingroup against the outgroup. But it wasn't just a war against the Seleucid empire.

The other group that Maccabees fought against were the Jews who were adopting Hellenistic Judaism. According to I, Maccabees, Mattathias, the leader of the Maccabees, started the rebellion by killing a Hellenistic Jew. Hellenistic Jews were the Jews who tried to adopt the local customs. The Maccabees who opposed them wanted to keep the congregation strictly separate from all foreign peoples.

It is somewhat amusing that one of the most popular holiday of Reform Jews is one which celebrates the results of a civil war in which a historical parallel to Orthodox Jews slaughtered the historical parallel to Reform Jews. 

Happy Hanukah!

Trump and the Trade Deficit

When Trump or his supporters mention the trade deficit as a problem, they are treated as ignoramuses. It is assumed that they don’t understand that there are gains from trade and that the idea that countries producing goods or service in which they have a comparative advantage making everyone better off is too complicated for them to understand.

But people complaining about the trade deficit have obviously heard this argument many times before. To harp on this basic point as if they don’t understand it is extremely counterproductive. Some of their favored policies to fix the problems may have too many unintended consequences but they are right to point at our trade deficit as a symptom of significant problems.

In 2015, the current account balance, which includes the balance of trade, net income and cash transfers, was -2.7% of GDP. We are not very close to potential crisis levels. So why are people who understand gains from trade still so worried about trade deficits?

For one, comparative advantages are not stable ratios in the long run. When those who worry about trade deficits look at manufacturing going overseas, they don’t just see a company taking advantage of low priced labor. They see technical knowhow being given to future competitors. The Chinese factory next week is going to lower prices for US consumers and expand profit margins of a US company at the expense of a few workers in the US. A few years later, the foreman leaves and sets up a competitor and starts undercutting the US company’s prices when they sell to the rest of the world. What used to be a comparative advantage for the US vis-à-vis the rest of the world is now one for China.

From a global perspective, everyone is still better off. Chinese workers are rising from poverty and European consumers get even cheaper goods than when they were buying them from the United States. But from a nationalist perspective, America loses. Reducing certain types of technology transfer is not a crazy goal, it’s what needs to be done at some level to keep the United States richer than the rest of the world. There are good and bad ways to reduce the transfer of technology. The best policies to police technology transfer are very complicated as companies have global supply chains and many types of technological expertise are not going to be easy to attain or reattain. And perhaps more difficult for politicians to navigate, there are always rent seeking corporations who would like to charge domestic consumers higher prices in the name of protecting American competitiveness.  

Even many of those in the anti-Trump camp understand the need to prevent technology transfer intuitively when it is framed differently. Many are still lobbying for ways to remove immigration barriers for talented students trained by our world class colleges. Sending those college graduates back to their country of origin transfers technology the same way that moving production overseas does. What’s obvious is that protecting our technological edge is a policy that can make Americans better off when applied properly.

Another aspect of the trade deficit is that it indicates that America is not as efficient as we would like. If companies were less restrained by regulatory hurdles, it’s very possible that the United States would be the low-cost leader in far more categories and exporting far more goods and services than it does now. If the EPA was less stringent it’s obvious that we would be importing fewer commodities because we’d be producing more. And if it happens that whole industries are being threatened in the United States, looking to streamline the regulatory and compliance costs could solve the issue more effectively than implementing tariffs against the new low cost competitors. There are real political tradeoffs when it comes to policies that create our trade deficit, the policy disagreements aren’t about whether there are gains from trade.

Trade deficits aren’t just about production; they are also about consumption. Increasing debt levels, both personal and governmental, allow for consumption in excess of production. US citizens are living better now, but it’s at the expense of a run up in debt and potentially their future quality of life. If economic growth is healthy then kicking the can down the road makes sense, let those richer people of the future deal with the problem. But that’s a big if for many people living in communities who are not finding the same opportunities as their parents in the global market thanks to consistent technology transfers abroad and the increasing cost of doing business in the United States.

Many economists will point out that the United States is a safe haven where people around the world park their money, and that’s a good thing that helps create our trade deficit and current account deficit. But just look at Switzerland, also a widely acknowledged safe haven. They have a trade surplus and current account surplus of around 10% of GDP. It’s nice that everyone wants to invest in the United States, but it would be better if US citizens had even more wealth to invest in the rest of the world.

The trade deficit is a symptom of many underlying problems. There is basically no way that a blanket policy of tariffs to brute force the deficit into a surplus will make things better. But if many of the inefficiencies and problems of the United States economy were fixed the deficit would go away. The trade deficit is representative of real problems and there are things that politicians should be doing to address them. 

I Voted

For most of my life, I've been pretty skeptical of democracy. My basic perspective was if three wolf and a sheep are voting on dinner, should the sheep legitimize their decision to eat him by voting for grass? In this analogy, the sheep would be the productive part of society while the wolves are the rent seekers, big and small. 

The sheep analogy is flawed, because there are not just three wolves and one sheep. There are lots of sheep and lots of wolves. Who is a sheep and who is a wolf can change depending on the issue. While in many cases the sheep are vastly outnumbered it can still be close in other cases. If a sheep wants to have a chance of influencing other sheep and sympathetic wolves to oppose the wolves then they would be well served to have their actions and their words in alignment. The message "Don't vote for the wolves, and in fact it's so broken I'm not even going to vote" is not credible.

And if there is a group of wolves, and those wolves are beatable if the other sheep just recognize the wolves for what they are, then it makes even less sense to mix messages. Right now the group of newly exposed wolves is the rent seeking homeowners. People who own homes that vote to keep the supply of new homes restricted drive up prices of their homes at the expense of anyone looking to rent or buy a house. Anti-construction policies have driven real estate prices in the San Francisco Bay Area up to absurd enough heights that many people are starting to notice. And while the times that a couple of votes can swing a national election are few and far between, there are plenty of opportunities for small groups of voters to swing local elections.

So I voted. I looked at which politicians were pro-growth and gave them my support. I looked at which rent seeking organizations supported or opposed propositions and voted directly against their interests (Unfortunately, sometimes there are rent seekers on both sides).

While the act of voting individually might not be economically rational, there are things that make it slightly less costly. Earlier this year I filed some paperwork with the state government. The justice system figured out where I lived and put me on the list for jury duty, so the downside to registering and voting became really marginal.

Most people would end this post telling the reader to vote. I would like to make the more modest suggestion that if you are already being called for jury duty and like discussing politics, there is little downside to registering to vote before the next election.

Feigned Weakness and Politics

The concept of faking a weakness is an age old strategy. Feigned retreats have been utilized by armies since ancient times. I'm partial to Dan Carlin's description the Mongol use of this tactic. For those who have not yet listened to his excellent telling, the mongols would pretend disarray and retreat and run. Most of the killing in ancient warfare occurred during the retreat, so the Mongols would be chased in a less than fully organized fashion. Once the enemy lines were stretched out in pursuit the Mongols would turn on the pursuing army and deal them a devastating blow.

A similar stratagem is used in modern politics. Every candidate in this day and age has strengths and weaknesses. But the public does not have a large enough attention span to cover multiple topics. The best line of attack is to find a flaw in the candidate that is representative of their many problems and push hard when it appears they are weak. 

Sometimes the weakness is not real. In 2008, some people thought that the allegation that Obama was not born in this country could be that type of attack. This attack was never going to work. Obama might have been ruled a natural born citizen of the United States no matter where he was actually born as his mother was from Wichita, Kansas. Furthermore, the long and short form birth certificates proving that he was born on US soil definitely existed. But rather than fully confront this attack when it first appeared to be growing he feigned retreat. The allegations were called racist and insulting and not worthy of response. 

In fact, the allegations being labeled as racist and insulting created a good incentive for him and his team to not respond immediately. Not responding in Obama's birther case served many purposes. First, it was a refusal to give any respect to a group of crazy people attacking him. Second, it made many of his opponents look bad. Demanding the birth certificate of the first non-full caucasian president appeared quite racist. But more importantly, it filtered some of the most enthusiastic attackers of Obama into focusing on an issue that he knew would not get out of control. At a time when his advisors with Wall Street connections might have been vulnerable to attack or the handling of the stimulus might be critiqued the birther movement's existence encouraged many of his critics to instead focus on running directly into a brick wall. 

Over time, the refusal to fully parry the birther movement created its own suspicion and attracted additional curiosity. The White House was forced to release his longform birth certificate to end it. But between 2008 and April 2011, a lot of his critics were charging at windmills rather than challenging him on policy.

Hillary Clinton's Wall Street speeches could be seen as a similar feigned weakness. When she was fending off Bernie Sanders from the left, the transcripts were a real weakness. But once she was past the primaries and moving towards the center for the general the speeches were no longer a large negative. Their release might impact enthusiasm among younger Bernie supporters, but that's about it. But by refusing to release them she created a feigned weakness for Trump and others to attack her. Considering her long history of controversy, any efforts here only served to reduce time spent on issues where she is potentially vulnerable.

In Clinton's case, Wikileaks released these speech notes sooner than she would have liked. It was unfortunate for her team not because the releases exposed anything too nefarious (though supporters on the left might be upset to learn that she is an anti-pot candidate), but because the emails were a feigned weakness that could soak up a significant percentage of attacks.

So the next time you see a politician refusing to counter an attack that seems easily parried if they are innocent, consider the tactical implications. Perhaps they want more of their critics charging at windmills. 

Or maybe they really are hiding something. They're politicians, after all.

The Falling Stock Holding Period Myth

One common financial fallacy is for people to divide the stocks outstanding by their volume and call that the average holding time. This makes today's average holding period of a stock seem very small, and the resulting chart can be used by those who want to paint today’s stock market as more short term than ever. 

The below tweet is not an atypical example of this phenomena. 

When I found the source of this chart, a newsletter by Alan Newman, the argument that it was buttressing was not surprising. 

“Thus, we are making the case that every year from 1997 may fairly be presumed manic in nature.”

Except that these charts are absolutely the wrong way to look at things. The rise of high frequency trading and the decrease in trading costs thanks to electronic trading has meant that market makers are trading a lot more than they have in the past. Thanks to the improvement in technology, transaction costs for investors have fallen across the board. Measured stock market volatility has also gone down, though there are likely tail risks associated with this volatility decrease such that the worrywarts are not completely wrong. But either way, the rise of high frequency trading says nothing about the changing time preference of today’s investors.

So how should we measure the time horizon of today’s investors? One way is to look at the median holding period of non-market making investors. It turns out that someone has already done this work, it just doesn’t get as much airtime as the average holding period because the data doesn’t tell a crazy story about investors. Martijn Cremers and Ankur Pareek have saved us a lot of trouble, because in 2014 they published a paper introducing the concept of Stock Duration. 

Stock Duration is a measure of how long institutional investors, who have to report their quarterly holdings to the SEC, have held a stock. The paper focuses more on quantitative investment strategy, but they included a measure of Stock Duration over time at the end.

 Source: Martijn Cremers and Ankur Pareek, Short-Term Trading and Stock Return Anomalies: Momentum, Reversal, and Share Issuance April 17, 2014. Figure 1, Panel A.

Their sample looked at the median duration of the largest 1300 stocks most commonly held by institutional investors. And the median stock duration increased during the period when high frequency traders started drastically increasing trading volume.

In another duration focused paper, they analyzed how duration and other factors drove the returns of US mutual funds with over $10 million AUM. In order to accomplish this, they calculated a Fund Duration metric. Fund Duration measures the average holding period of each stock in a fund and requires that a fund have at least two years of history. The aggregate of this metric again counters the narrative that investors are becoming more short term oriented.

Source: Martijn Cremers and Ankur Pareek, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, 2015. Appendix A, Table A3

When we look directly at mutual funds, they are if anything becoming more long term oriented.

Source: Martijn Cremers and Ankur Pareek, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, 2015. Appendix A, Table A3

It’s possible that mutual funds are now furiously trading in and out of their stocks between SEC quarterly reporting periods, but the relatively stable fund turnover ratio suggests otherwise. So while investors will always do many stupid short sighted things and many still have incentives driving them towards short term oriented thinking, the somewhat widespread idea that more investors than ever are thinking short term is probably not correct.