Drawing from the Future: The effects of bias of ‘now’ versus ‘later’

By: Procyon Mukherjee

Zurich, 28th January 2010

I was fascinated by four books recently and I would draw some lessons from these to shape a line
of thought that this generation of ours built on a relatively higher flow of available credit and
lower interest rates is running the risk of passing on to the next a ‘generational burden’, that
could well be difficult to cope with; asymmetry in acquisition of debt or in the increased leverage
that assets have been subjected to (the ballooning bank assets is a proxy for debt, while higher
leverage and gearing is a phenomenon that aims at a higher growth of assets for the purpose of
higher wealth generation for the society or any individual) in this generation as compared to the
previous and the same for the future is quite an interesting study. Our previous generation left us
with virtually little debt and we are building on that base, not so favorably for our next, unless
we have good reason to perpetuate this activity. In other words we are assuming that bank assets
can grow without stops at the same pace as now without bringing any peril to the future, when
long term productivity growth is yet to see any major innovation to rely on. The peril we have
seen recently though, when losses were socialized, but public memory is always short (and also
the realization that weight of the Turkey can only grow up to Thanksgiving, thanks to Taleb for
enlightening us). Our biggest assumption is that if economic growth can be sustained all the debt
could be eventually paid back at no great cost to the future. But I am not very certain about this
as I find the increased tendency of individuals and corporate in taking further debt (many use it
for paying back debt if only the balance sheet permits), at great satisfaction of all the
constituencies involved, banks in particular, as they become the greatest beneficiary from such
transactions. The central banks on the other hand who create the initial assets, thus passing the
first liabilities on to the banks, have the responsibility and the overriding accountability to deal
with this problem that we keep transferring to the future.

The first book that I would cite is the Age of Turbulence by Greenspan and here he had
referenced a Harvard Business students case study in the Chapter ‘Modes of Capitalism’ that
when these students were asked what would they choose, a salary of $ 100000 when their peers
were drawing twice this salary or $50,000 when their peers were drawing half, the result was
overwhelmingly in favor of the latter. I find in this example the crux of the modern generation’s
bias towards arrogating ‘more than the others’ (lawfully let me assume) in relative terms rather
than earning more or less in actual terms (the example however was used by Greenspan to
exemplify the point that happiness is linked to one’s relative position in the pecking order and
consumption is linked to that as well). The analogy that I draw from this example is that if ‘less
than others’ is not acceptable and ‘more than others’ is not available, one is being pushed to
accept a neutral solution although that in actual terms could be lot less desirable and sub-optimal
but still acceptable. This I would like to mark as an exhibit that this generation assumed a much
higher discounting rate for the value of money (even though the actual inflation rates that this
generation enjoyed could be much lower than the previous) thus making them believe that
having money now than later was more important. This is however not so explicit in Greenspan’s
example (the first option is only not chosen because it would need an investment in time and
other factors that would enable a person to draw more salary than the peers which one is not
willing to invest because of the higher discounting factor), however it is clear from many
examples of the recent times that the short term cash awards or bonus pools have bloated to
allure people to commit to acts that would raise returns in the shorter term, while its impact on
the longer would be difficult to measure.

Here I would digress a little bit to bring in the next topic that the rational thinking generation of
ours had settled on a belief that sustained higher profits could be achieved under conditions of
higher productivity growth, while it could still be maintained for some sections of the economy
when the overall productivity growth is seen less forthcoming, if certain special conditions could
be created through a blend of factors, monetary expansion and low interest rates being the two
minimum pre-conditions. The explosion of the financial sector and the spate of innovations
stemming from products that helped to create solutions for mitigating risks, packaging risk and
transferring risk, creating special purpose vehicles to channelize much higher fund flow into
asset building, creating a trading ground for new commodities and assets that were unheard
before and making derivatives instruments available for variety of transactions electronically that
multiplied its use are some examples. We cannot lose sight of the fact that the last twenty years
moved hordes of highly talented people towards Finance and much of this came from the field of
basic Sciences like Physics, Mathematics, Statistics and of course Economics (I do not know
how much the greater Society lost in the process), I am carefully avoiding Management Science,
which perhaps has far less to do with basic Sciences and had already attracted the best talents for
whatever reason it was worth.

My next point is on the subject of high profits in the context of fairness and justness, or let me
rephrase the question, if a profit-making organization has a choice of high profits now versus
steady profits for a longer period, what would it choose?. And here I would draw my next lesson
from the book, The Idea of Justice by Amartya Sen. Professor Sen introduced the topic of
‘Reasoned Scrutiny’ in his very first chapter ‘Reason and Objectivity’ in the section Ethical
Objectivity and Reasoned Scrutiny and he had used this phrase in several other places in the
book, but I was touched by the power and influence of this phrase more than any other in the
entire book. In fact the answer to the puzzle introduced in the beginning of the three children and
the flute problem or Kenneth Arrow’s cake problem in his General Possibility theorem, lead us
to reasoned scrutiny with an impartiality (taking from Rawls), ‘sufficient to convince all
reasonable persons that it is reasonable’.

What would ‘Reasoned Scrutiny’ applied to this piece of puzzle make us do on the question of
‘now’ versus ‘later’? Do all sections of the people whether wealthy or poor, young and old
behave in the same manner to this question? If the larger populace responds with a clear
conscience that enjoying now versus later is the unambiguous choice, the world would need
always a high discounting rate for money (I doubt that our previous generation ever got
abstracted to this phenomenon). And this in itself would make our behavior quite different. But
is the whole community aware of the cost of this choice on the future times, when the real debt
would have to be paid back with the principal, or are we saying we can just pass it on the future
indefinitely? But I think the world is divided on this topic, otherwise savings in one part could
not have been overwhelmingly more than the other part (East Vs West) or parts of the developed
West also could not have taken different views on emphasis to be put on social safety net (clearly
this is much more predominant in Europe than in U.S.).

Here I am confronted with a state of disorder that leads me to question the foundation of these
principles, as Kenneth Arrow’s impossibility theorem suggests that ranked preference of
individuals cannot be transferred to a community wide ranking while also meeting a certain set
of criteria or more discrete options to choose from. In fact Sen had raised these issues in a
number of places in the book and had gone back in the solace of ‘reasoned scrutiny’. In fact in
his latter chapters on Part IV of the book on public reasoning and democracy, he had struggled to
deal with the issues that only demonstrate the limits of democratic processes in shaping public
opinion and in channelizing actions towards a common end that could be based on justness. I
find it very difficult to accept that the society of ours believes that high profits of firms should be
the driver of all growth in the society and this is biggest driver of overall good for the society. I
say this because only a fraction of the market capitalization of firms is buoyed by the cash or
profit generated by its own performance, it is the larger community of people, the shareholders,
who help to create the market capitalization directly or indirectly by trading on the basis of future
projections that are primarily based on not just the current performance but the perception that
they create about their ability to steer into the future. Growth of profits and goodness have also
become almost non-egregiously similar in intent, as this had hardly been challenged once we
settle on the general consensus that the process of creative destruction plays the role of the
invisible hand to even out the general anomaly that might result from the pursuit of profits
(Greenspan had mentioned this a number of times in his book making references to Schumpeter);
self interest as a driver of all economic activities is beyond dispute, but my question is on its
effect on ‘now’ versus ‘later’.

Here the designing of the incentives for the society to behave in a certain manner is of paramount
importance. If incentives are designed that would channelize public interest towards activities
that would spur growth in order to consume more now versus later, this must be examined
against the broader ills it might bring to the later period. This is beyond the business cycle effects
that I am talking. Here one should not lose sight of the fact that the foundation of growth lies in
the three fundamental pillars, education and development of people, presence of an environment
that fosters the market participants to make reasoned scrutiny and presence of innovation as a
driver for productivity. If the society’s incentives are not designed to spur any of these, we have
a problem. But the question is better and more informed part of the society in form of
shareholders have already usurped part of the decision making towards the end that higher profit
making is the one and only option and making them now is even more important than making
them later. The banks being doled out large sums of money from the Central Bank is actually
increasing the appetite even further. When there are no visible signs of productivity growth or
innovation, we have seen quite some frenzy in the stock markets in expectation of such signs. In
fact sometimes we wonder whether the stocks mirror the future expectations or they mirror the
sentiments in absence or presence of information which may not be the sum total of all available
information, but a hazy view mired by informed views of interested sections of the society
(Keynes in his most famous book had already provided the first insight that it the convergence of
a herd behavior that makes the stocks move up or down through his brilliant example of voting
for a beauty pageant).

I find in the design of incentives a lopsided view, on one hand we tax the casinos which deal
with Millions of Dollars while we leave the stock markets untouched that deal with Billions! No
wonder Dow Jones had moved from 2000 in 1988 to 6000 in 1996 and to 13000 in 2006.

For the economy as a whole for example there are very pressing arguments on the other side of
the growth paradigm. I find quite puzzling the “growth paradox” that shows that unless there are
broad adjustments made to the quality of life and living, very high growth could actually create
more degradation to the living standards of the larger population and could outweigh the benefits
it brings to the smaller population. I would try to work further on this arena through my own
research, but I find this quite interesting that 8% growth in India (growth is an absolute necessity
in India unquestionably, as large sections of people and a growing population need to come out
of depravity) could be a curse when there is widespread absence of the institutions that are
needed to coordinate the demands that it would place on the habitat; absence of educational
institutions, absence of a judicial process that has a demonstrated track record and the law
enforcement executive wing of the government that also has a similar track record to act fairly; I
ignore the deficiency in the information arena and the pitfalls of the informational exclusion that
pervades the lives of millions and that causes divisiveness to multiply and the inimitable lack of
instruments to deal with deficiencies around ‘right to property’, which according to Greenspan is
one single biggest factor that influences a society to prosper.

Growth of profits (I am talking of more than average) for an organization beyond a certain point,
could actually bring in concerns that such growth could only stem from asymmetric power,
something that does not augur well with the ‘balance of business’ amongst the stakeholders; if
one tracked the rise of great monopolies, one would see that they finally lost to the conditions
that helped to multiply the disparity between the constituents that eventually brought their
demise. However in the shorter term oligopolies have helped to favor the argument, to a limited
extent and for the privileged few, who could assume more power due to some favors that they
received from the environment either justly or unjustly.

Conventional wisdom had long ordained that very high profits could be sustained in an oligopoly
if lack of competition could be blended with asymmetries in information amongst the market
participants; concentration of talent in the banking industry of U.S. in particular and the
seemingly innocuous reference to bonus pools to attract them is a reflection of the dire need for
the continuum of practices that augur well with the needs of the oligopoly that is hardly
benevolent in nature to the needs of the greater society. I have to refer to banking as the most
vivid example in this regard although we must give full marks to its ability to innovate
continually. But Banking must support the economy to allocate resources that produce wealth
and assets that becomes meaningful for both our current and future generations, as passing
burdens to the next generation for the enjoyment of the current leads us nowhere. By putting a
higher discounting rate, which the high bonuses only proclaim, we seem to be doing the reverse,
which is similar to arrogating more now that could have been enjoyed later.
 

Here I would introduce the lessons from the third book, the classic written in 1948 by Paul
Samuelson, Economics. In his section on interest rates he remarks, ‘Even if the authorities
should succeed in forcing down short-term interest rates, they may find it impossible to convince
investors that long-term rates will stay low. If by superhuman efforts, they do get interest rates
down on high-grade gilt-edged government and private securities, the interest rates charged on
more risky new investments financed by mortgage or commercial loans or stock-market
floatations may remain sticky. In other words, an expansionary monetary policy may not lower
effective interest rates very much but may simply spend itself in making everybody more liquid.’

Here Samuelson is raising a very good question that all the interest lowering efforts by the Fed,
which was primarily aimed at easing money flow when the broader economy showed signs of
sluggishness, could well be used by the society (and more importantly its elite who are more
informed than the others) towards making choices that may not improve factor productivity. To
make the example simple, the Banks could have other more ‘profitable’ options than lending
money to institutions that are aimed at longer term growth of the economy, which is embodied in
the intent of ‘factor productivity growth’. The best and the recent example is that we found Bank
assets exploding with the TARP funds in just about half a year after the Lehman Brothers
collapsed, and some of these assets moved into the domain of commodities which showed signs
of over-heat, although the rest of the economy never showed any real signs of recovery. This
asset growth of banks were in some areas of the economy that neither created any new job, nor
helped to stop further loss, clearly this is a remiss. The financial crisis had already taught us how
supply of money at low interest rates could help to increase prices of assets, while not having any
effect on inflation and this condition to prevail all that would be needed is a perpetuation of the
low interest rate regime and a less aggressive view on the long term interest rates to be
simultaneously dominant; quite an achievement this though as the major achievement of the
talented individuals in the world of finance just found out ways to achieve this near miracle.

The overall economy mirrored private sector balance sheets as well. The increase of wealth
followed the increase of public debt, almost proportionately. Again the question is at what cost to
the future generation? The point to be noted is that banks become the free rider, as we have seen
that bankruptcies have a peculiar and special way of insulating banks from the general pillage,
only if they could be made very big, again proving my moot point that growth must be pursued
as the single biggest item. The current fixation of our society and generation on this aspect needs
a careful and reasoned scrutiny. This cannot just be left to the invisible hand to take care; in fact
it would be too risky.

The last book that I would reference is the one by Geoffrey Sachs titled, ‘Commonwealth:
Economics for a Crowded Planet’. In his chapter ‘Overcoming the Importance of the Market’, he
has given the brilliant example of picking fish from a lake. If reasoned judgment of the
fisherman leads him given the available alternate choices, to pick up more fish now than the rate
of depletion, he is actually drawing from the future, for which he would have to pay a price some
day. I find in this example what my entire essay is trying to portray, our reasoned scrutiny today
leads us to believe that there are going to be always choices available in the future that would
counter-balance the depletion rates or there would be factor-productivity growth or alternate
modes of sustaining livelihood in this world of ours. This assumption is only right if our ability
to invest in these elements is incentivized by the society. For example if part of the higher
consumption now or earnings now is set aside to propel us towards these tendencies, that could
be a way of a solution that would stop this constant withdrawal from the future. Otherwise
economic choices set by the market could lead to very efficient outcomes for the moment with
regressive influences on the future.

Procyon Mukherjee

Zurich

January’10