Jeff’s Newsletter #13

Jeff’s Newsletter, Volume 13

1. Never go in against a Sicilian
This week I read a self-help book by Robert Putnam called Making Democracy Work. Putnam, who you may know from Bowling Alone and Our Kids, has spent his career thinking about the interpersonal requirements for a healthy democratic society. Some of the themes in those later, more popular books–social capital, group membership–seem to have been developed here in his academic magnum opus. His basic question is: what are the conditions for creating effective, representative political institutions? It’s a hard question to answer with international comparisons because each country’s history is relatively unique. But modern Italy provided an unusual opportunity: in 1970, Italy was divided into twenty administrative regions, all of which gained significant independent powers. Putnam took this as a natural experiment and sought, over the next 25 years, to determine which regions developed strong institutions and why. His main finding is that the regions with the strongest civic engagement–as measured by number of community and athletic groups, number of newspapers, and electoral turnout (especially for referenda as opposed to candidates who can help you personally)–had the best governments. Things get Hobbesian fast. For the less civic regions, “In the absence of solidarity and self-discipline, hierarchy and force provide the only alternative to anarchy.”

But perhaps this doesn’t satisfy you. Why, after all, do some regions become so “civic” in the first place? If you sense there must be something else going on here, you’re right: all the most civic regions are in northern Italy while the least civic ones are in the south. So 1970 proves an insufficient starting point. Try 1100. For the rest of the book, Putnam races through the last millennium of Italian history in an effort trace cooperative vs. hierarchical forms of social organization back to their roots. So much for the comparative political science, by the way. The basic story is that Italy was, historically, not a single country. You had Frederick II, the Holy Roman Empire, running a feudal state in Sicily and the south while small northern city-states developed banking,  long-distance trade, and mutual aid societies. While northerners learned to rely on one another, the story goes, southerners trusted no one except powerful lords or, later, mafia dons. Putnam: “The relevant distinction is not between the presence and absence of social bonds, but rather between horizontal bonds of mutual solidarity and vertical bonds of dependency and exploitation.” Or, if you prefer: “Never go in against a Sicilian when death is on the line.”

Putnam provides somewhat convincing evidence that regional differences in civic spirit are more stable over time than wealth levels. If you believe his story, you should conclude that small-scale norms of reciprocity and networks of civic engagement are the key to building a democratic society. But in a fickle land, who is brave enough to extend the first hand? And so we return, as always, to the prisoner’s dilemma. Besides all this good fodder for democratic theory, this book helped expand my conception of Italy. It struck me that since most Italian-Americans hail from southern Italy, Americans develop a wildly unrepresentative picture of what Italy is like. For example, Putnam observes strong separation of church and state in northern Italy and even negative correlations between Catholic religiosity and civic life.

2. Material for your next argument with your Boomer parents
A friend shared this post about reading (non-fiction) books vs reading summaries. My argument for reading books is that you’re not just looking for facts, you’re immersing yourself in a worldview or framework for making sense of anything you might encounter in the future. It is in that spirit that I would recommend David Frum’s strange, contrarian book about the 1970s, How We Got Here. This is not the most professional, authoritative history of the decade which I believe was the dawn of our current political situation. For that I would recommend Rick Perlstein’s series of Nixon books, or maybe Jefferson Cowie’s book about the end of labor politics (which is on my list). Frum’s book is strongest as cultural history and polemic. It embodies two worldviews to which I can hardly relate, but which I enjoyed inhabiting for a few days. One: the mind of a cultural conservative disgusted by the laxity, permissiveness, and decadence of America in the malaise of late modernity. Two: the mind of a Baby Boomer, consumed with disdain for his fellows and nostalgic for the Greatest Generation. Frum’s basic position is that the generations forged by the Depression and two World Wars developed an admirable set of values: obedience, loyalty to family and country, thrift, stoicism, faith in God and institutions. The Boomers, born into a world of increasing plenty, squandered these values and replaced them with narcissism, rebelliousness, profligacy, and promiscuity. The 70s were the moment of crack-up: “the rebellion of an unmilitary people against institutions and laws formed by a century of war and the preparation for war.” Vietnam and Watergate loom large in the telling of how Americans lost faith in public life and turned inward to self-fulfillment, but Frum emphasizes many other causes. One that really stood out to me was violent crime, which was the foremost issue on voters’ minds in the early 70s. What’s the story behind the crime wave of that decade? I feel like I haven’t read much about the underlying crime dynamics in the run-up to mass incarceration policies under Nixon and Reagan.

Frum’s narrative is most frustrating when he heaps sarcasm and scorn on women and minorities, a persistent thread in the book. His position is something like: disadvantaged groups surely deserve the rights they won in the 60s and 70s but what a shame that they haven’t made better use of them. Women have the right to get divorced, gay people have the right to have non-marital sex, liberals have the right to integrate schools through busing–but none of this makes a better or more virtuous society. Frum’s misreading of why America turned conservative after LBJ (paraphrase: conservatives just hate handouts to those who aren’t working; race is peripheral) damns the book to irrelevance as political history. I found the argument fairer when Frum turned his ire on the collective instead of subgroups. I’m willing to entertain the notion that California psychobabble, NIMBYism, aggressive tort litigiousness, and a culture of “do what’s right for you” (to mark a few 70s trends) really did mark the birth of a more selfish society. If nothing else, this book provides a slew of entertainingly contrarian ideas. Such as: without the Pentagon Papers there would have been no Watergate, Robert Moses was consistently principled for trampling on the property rights of rich Long Islanders just as much as the rights of Bronx tenement-dwellers, and deinstitutionalization of the mentally ill was irresponsible. Frum also does a remarkably good job illustrating his points with scenes from the popular movies of the day.

3. Regressive era
I have been on something of a Progressive Era Trutherism kick, trying to sort out the admirable, replicable elements of anti-corporate populism from the statist impulses and corporate capture that seem so often to go along with it. Thomas Leonard’s appearance on EconTalk was perfectly timed for all this. In his book Illiberal Reformers Leonard shows how the Progressive economists and sociologists–people committed to minimum wages, redistribution, and the plight of the American worker–were bound up in a eugenicist worldview of white supremacy. A leading argument for the minimum wage, for example, was that Chinese immigrants only needed meager portions of rice to survive and so were willing to work for almost nothing. Higher minimum wages would prevent them from undercutting American workers and thereby keep them out of the labor force. Do note that contemporary California ballot proposition extraordinaire Ron Unz supports a higher minimum wage for the same reason. The really interesting part of Leonard’s book is his diagnosis for why the Progressives, to an unprecedented degree in American intellectual history, thought of the State as a natural, organic community. He cites an explosive combination of their German social science training (I need to read a book about the importance of Prussian administrative reformers on all subsequent governance), Social Darwinism, and American social gospel idealism. The result is a conviction that the State is a natural aggregation of the People and should take the leading role in organizing economic and social life. Stay tuned for Gabriel Kolko’s The Triumph of Conservatism to see how this worldview (and the Progressive movement) is so easily captured by the powerful.

4. Chicks dig the long vol
I’ve been blazing through the excellent Invest Like the Best podcasts and learning just enough heterodox financial theories (without sufficient grounding in the basics!) to be dangerous. Here are two ideas that stuck with me.

First, Ted Seides, a guy who knows everything about hedge funds after a career of seeding them (investing the initial capital), was on talking about hedge funds. He was asked a simple and important question: since hedge fund fees are higher than most other investments, and hedge funds haven’t been doing so well (they just about broke even in 2015), why are people still investing in them? Seides explained that most hedge fund money comes from large asset allocators (pension funds, sovereign wealth funds, endowments) who are using the hedge fund part of their portfolio for a very specific purpose. Imagine an institutional investor that has most of its money exposed to stock market, a “long-only equity portfolio” as they say (so I’ve learned). What the investor could do is borrow money and sell futures pegged to the broad market index, thus hedging exposure to the market. It could then take any money left over and hand it to a hedge fund, which would pursue an investment strategy uncorrelated with the market. This hedge fund is now in the business of seeking portable alpha, extra returns with no exposure to overall market risk (beta). If you’re getting most of your returns from the index, you only hope for 1% or 2% returns from the hedge fund. But that’s still no guarantee that there’s any alpha to go around!

Second, Christopher Cole is an extremely pessimistic, contrarian hedge fund manager who is worried about market turmoil stemming from a global debt crisis, political instability, and maybe, in the long run, automation-induced social upheaval. He thinks we will live in interesting times. As such, his fund is oriented entirely around volatility. He says you should categorize hedge funds not by their asset class (fixed income, equity, macro) but by the nature of their exposure to volatility. “Regardless of the asset class, the true source of alpha seems to be moving between short and long volatility exposure—the volatility risk process and not the underlying asset. In 2008, many institutional investors woke up to the harsh reality that although they may have been asset-class diversified, in reality they were simply 100% short volatility.” Cole’s portfolio is designed to lose a little bit of money in most years and go up 40% when crazy things happen. His specific returns aren’t available for free but you can see an index of nine funds (including him) that take a long volatility bias here (down 1% last year, down 3% this year, up 45% in 2008). This whole concept was somewhat revelatory for me as my only two rules in investing are (1) diversify and (2) get out of the way. And then along comes this guy telling me that while I may be diversified in asset classes, I’m not actually diversified against volatility. A much more informed friend disputes Cole’s logic: “This could make sense in imaginary worlds where assets behave. The points at which these relationships break down and change directions would jeopardize a reading of the volatility tea leaves. You might short vol one day and be long the next if the relationship suddenly changes in gold and dollars.” In other words, positioning in volatility is extrinsic to security selection, not something you can engineer ahead of time. I need to think more about this. In any case, I’d highly recommend the interview with Cole. He applies his framework of making lots of small bets with rare, disproportionately nonlinear payoffs to film, improv, relationships, and more.

5. Where’s the quadrant for people who make 2x2s
In this edition of Weekly Framework, I present to you: a typology of knowledge-intensive organizations (from Blackler 1995: “Knowledge, knowledge work and organizations: An overview and interpretation”).

We talk about lots of organizations as “knowledge-intensive.” Blackler says we can distinguish them based on whether they emphasize collective behavior or key individuals and whether they work on familiar problems or novel problems. I find this most useful for thinking about automation. In the top left, picture a large accounting firm with detailed procedures. Almost everything can be automated. In the bottom left, picture a hospital, which relies on the “embodied competency” of its doctors. Certain tasks are susceptible to automation, but experts are still needed for charismatic persuasion. On the right side of the matrix, creativity becomes essential. In the top right, picture a digital marketing agency. Automation is a tool for distributing creative products out into the world at scale, but does not interfere with internal communication and collaboration. In the bottom right, picture a software-as-a-service company. This is the one automating everything else.

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