We’ve gone from the assumption that there’s a necessary tradeoff between efficiency and equity to a state in which it’s almost de rigueur to point out the ways in which inequity can harm efficiency with quite some speed. Why even the OECD, while it hands homilies about how ‘reform’ is always the answer even if it’s relative absence pretty obviously not the central problem, now publishes papers which claim to calibrate the negative impact of income inequality on growth. Meanwhile at Troppo we’ve always been interested in those beautiful ways in which human utility and solidarity – efficiency and equity – competition and cooperation – can grow together.
One thing that’s always bothered me about the efficiency of the financial markets is the extent to which they privilege those with inside information. So we have a source of inequity – insiders capturing large rents on the information they have – and also inefficiency involving insiders investing resources, both physical and intellectual bandwidth in getting information ahead of rivals. I suspect most people see this as a bit of a boutique problem. A barnacle perhaps, to use the current vernacular, but the price of all that dynamism of financial markets.
I suspect, and know people in the markets who think it’s of the essence. Now for the purposes of considering the efficiency of the stock market, ‘inside’ information ranges from information that it’s criminal to trade on to information that you invested a lot of money to trade on a millisecond faster than another trader. Given that the information would have come to light (indeed in the case of high frequency trading was in the process of coming to light), the resources invested in the race to use the information is pure social deadweight cost (AKA waste).
Then there’s a whole industry which is mostly role-playing market savvy. The seminar and TV programs in which the great and the good disburse their wisdom and give their consumers the impression that, by tuning in they’ll ‘get the edge’. It’s mostly wasteful. Then again that’s a modern capitalist information market at work and it’s often quite difficult to work out what’s legitimate and what’s not, from both an equity and an efficiency perspective. Take information about whether the CEO and senior management of a firm are sound chaps and/or chapettes – something which is more easily judged if you can have lunch or go golfing with them. ‘The markets’ have a role in sorting out the sound from the unsound chap(ette)s. But they also get the lunches and sit in the business class seats next to the great and the good. . When I was at the BCA I was able to add to other investment considerations the extent to which it was clear that the CEOs I knew were pretty smart, hard working and sensible and the extent of the mediocrity and self-important silliness of others.
Whether, or the extent to which we could do better I don’t know. I’ve wondered whether, instead of constant release of information and constant trading, one might have quite limited periods of say two or three weeks once every couple of months before which firms are obliged to make as full disclosure as they can to the markets. This ought to reduce the rents going to the insiders. Of course it would also be a big change from what we do today and it’s not hard to think of important objections, not least the uncertainty approaching each opening of the markets. And this would address quite poorly quite a few of the insider and quasi insider trading issues I’ve raised above. So I don’t argue that this would be better. But it’s interesting, and fairly illustrative of how unambitious so much of our policy discourse is, that this kind of thing is so rarely discussed with any prominence.
I was prompted to set down these ruminations when I came across the abstract below which suggests that around 50% of the information that moved markets in the nascent stock markets of the eighteenth century was private information. Who knows what the incidence of such insider trading is today, but it’s significant. And then there’s all the other rents and resources commanded by insiders who ‘get the edge’ on public information and the faux insiders with the ‘get the edge’ schtick they sell to a credulous public. (I’ve not read the article, but would welcome comments from those who follow the link and do so.)
Those Who Know Most: Insider Trading in 18th c. Amsterdam
By: Koudijs, Peter (Stanford University)
This paper studies how private information is incorporated into prices, using a unique setting from the 18th century that, in many dimensions, is simpler and closer to stylized models of price discovery than modern-day markets. Specifically, the paper looks at a number of English securities that were traded in both London and Amsterdam. Relevant information about these securities originated in London and was sent to Amsterdam on board of official mail packet boats. Anecdotal evidence suggests that these ships carried both public news and private information. They sailed only twice a week, and in adverse weather could not sail at all. The paper exploits periods of exogenous market segmentation to identify the impact of private information. The evidence is consistent with a Kyle (1985) model in which informed agents trade strategically. Most importantly, the speed of information revelation in Amsterdam depended on how long insiders expected it would take for the private signal to become public. As a result of this strategic behavior, private information was only slowly revealed to the market as a whole. This price discovery was economically important: private signals had almost as much impact on prices as public information shocks.
