The Information Society and Economic Instability

We are living in an information society: Most for the value produced by our economy is in intangible goods; most of the investments by firms is in intangible assets, such as IP or branding.

The price of intangible goods or intangible assets is more volatile than the price of tangible goods or assets: The demand for intangible goods can change more abruptly; since the recurring production costs are often negligible, change in demand will affect price, not quantity offered. 

Therefore, it is reasonable to expect an information economy to be less stable than an economy based on tangible assets and goods. The value of IP or of a brand is hard to assess, and can change rapidly. The value of financial assets can change rapidly, since their value is determined by volatile information.

The ability of the state and of financial institutions to dampen financial volatility and avoid positive feedbacks that carry the economy far from the optimum has tremendously improved since the Depression era. But the ability of the economy to change abruptly has also been enhanced. While government is reacting in the right direction and is doing so much faster than in the thirties, it is still possible that the reaction time is too slow, compared to the speed of economic change: Information and intangible assets have little mass, little momentum; small forces can move them very quickly.

Gaza and Morals

I understand the debate about whether Israel followed or broke Geneva Conventions in its fight in Gaza. I do not understand the moral indignation as I do not understand the moral logic of these conventions.

Killing innocent women and children is bad; but why is it worse than killing innocent soldiers? A soldier carries no stronger individual moral responsibility for the evils perpetrated by his country than a civilian. After all, nobody checks what crimes a soldier has committed before  killing him. Noncombatant immunity is one of the accepted principles of a just war, but I do not understand it -- even more so in an environment where the distinction between combatant and non-combatant is fuzzy. Neither the rocket attacks of Hamas on civilian targets in Israel nor the Israel attack on Gaza strike me as immoral -- just terribly wasteful and useless.

Destroying civilian buildings is bad. But, quite often, the target of a war is not the army of the enemy, but the civilian government of the enemy; The goal of the war is to force a government to change its policies. US bombed civilian targets in Serbia, such as bridges or power plants; it bombed civilian targets in Iraq. Russia bombed civilian targets in Georgia.

The target of a war is not the enemy army, but the enemy country. The same holds true of sanctions that are short of an all-out war. Sanctions on Iraq hurt the Iraqi people, not its army of leadership; the sanctions killed many Iraqis. Sanctions on South Africa at the time of the Apartheid did not discriminate between good South Africans and bad South Africans. Sanctions that are proposed on occasion against Israeli organizations do not distinguish between good Israelis and bad Israelis. If such sanctions can be moral than strikes against civilian targets can be moral. It is not a black and white issue, but a debate about the legitimacy of the cause and the proportionality of the means.

Hamas is an organization that wants to destroy the state of Israel. I think is is legitimate for Israel to try to destroy Hamas. With this goal in mind, the Israeli slaughter and destruction is proportional -- indeed it has been too moderate to destroy Hamas.

Closing the circle: Why are soldiers or civilians of a country at war "innocent"? The logic of a war is that it targets a country. a collective, not individuals. Soldiers or citizens suffer in a war because they are part of this collective. The logic is one of collective responsibility, collective guilt and collective punishment. A person that is part of a community bears responsibility for the actions of that community and can suffer consequences. As an American, I can be the target of acts of terrorism against America. I can be killed because I am American, irrespective of my own political opinions. A Gazan can be killed because he is a citizen of a Hamas state, even if he does support Hamas. If we support collective action and solidarity, than we should accept collective responsibility. Targeting civilian targets in Gaza is moral precisely because Hamas won elections and truly represent the population of Gaza.

Pricing Risk

Hedge funds, and arbitrageurs of all hues, make money by identifying pricing inefficiencies -- differences in prices between sets of assets that should have identical prices.: one buys (or promises to buy) the cheaper and sell (or promises to sell) the more expensive and makes money in the exchange, while moving prices so as to reduce the pricing gap and increase pricing efficiency.

It seems that the pricing inefficiency that has been exploited  by many hedge funds of late is that financial risk has been underpriced: hedge funds could get low interest loans to invest in risky financial deals, winning because of the gap between the low interest on loans underpriced by banks that did not price the risk correctly and the high income from risky transactions. Same can be said of investments in securitized mortgages: Intermediaries made money by selling high risk mortgage securities at prices that reflected a lower risk assessment. 

When the arbitrage is about misaligned prices of equivalent assets then the movement of prices due to offer and demand closes the gap, in  a self correcting process. If the arbitrage is about a misperception of risk, then the correction happens when risks materialize, lowering the value of the risky assets. But if the risks in question are about very rare but very consequential events, such as the crash in house prices, then the correction will happen rarely and the correction will entail a large shift in asset prices. 

Of course, one can ask why risk is mispriced, and explanations abound: the irrational theory of the economic agent (Tverski and Kahaner), the confusion between aleatory risk and epistemic uncertainty that seems to be deeply rooted in economic models for risk pricing, etc. But even in a perfect, rational world, if information comes in rare, discrete but very significant events, then the "correct" pricing of risk will change rarely but abruptly. 

Middle-East and the Cycle of Violence

Palestinians repeatedly commit acts of terror against Israeli civilians, men women and children. After a while  Israel retaliates against the terrorists and kills civilians, men, women and children in "collateral damage". A major act of retaliation cools down violence for a while, until the cycle starts again. The only way Palestinians can inflict pain on Israel is by targeting "soft" civilian targets; they only way Israel can fight terrorists that hide among civilians is by inflicting damage to civilians, too.

This is not new; this cycle is going on since the early fifties (see Qibya, Maale Akrabim...), and the pattern was set even before the establishment of the state of Israel.  When people or nations consistently repeat the same behavioral pattern then, no matter how irrational and destructive the behavior may seem, one is bound to accept that this behavior fulfill a deeply seated need of the acting parties. This need may be pathological, but it is real, nevertheless. 

One can speculate about the roots for this need. It could be, on the Israeli side, the "never again" pathology inflicted by the holocaust: never again be a victim, never again be weak. It could be, on the Palestinian side, that the core of Palestinian nationalism has always been the fight against Zionism. It can simply be that neither side can feel whole with only half of the land it feels it owns.

No matter what are the roots of this pathological cycle of violence, its long term persistence is a clear indication that both sides would need to alter in fundamental ways their worldview and core beliefs, in order to behave otherwise. Finding a reasonable compromise is not the issue; truces and arrangements of all kinds are palliative. 

What therapy can change the pathology of the Middle-East?

Israel -- Looking two steps ahead

Let's first look one step ahead: the creation of a Palestinian state side-by-side with Israel. A two-state solution is broadly accepted by the majority of the Israelis and, probably, by the majority of the Palestinians. It is not easy to achieve. Among the many obstacles:

• The split between Gaza Strip, controlled by Hamas, and the West Bank, controlled by the PLO and the weakness of the PLO that has diminishing support among Palestinians.
• The significant ability of extremists, on both sides, to put obstacles to peace through continued acts of violence and terror and provocations that cause progress toward peace to stall.  On the Palestinian side, this includes Hamas and other extremist organizations, possibly Hezbullah, and possibly Iran, Syria and other rejectionists country. Each player can veto progress, and it is hard, if not impossible, to make progress simultaneously with all the main players. On the Israeli side this includes the extremist settlers that are increasingly performing pogroms against Palestinians and people like the murderer of Rabin. 
• The inherent difficulty of achieving a compromise that will be far from the expectations of both sides.
• Jerusalem

The compromise that has been almost achieved in the aftermath of the Oslo process, and could be achieved again, would involve (according to Olmert) the creation of a Palestinian state based on the 1949-1967 armistice line, with possible exchange of territories to ensure that heavily populated Jewish settlements and neighborhoods established beyond the Green Line stay within Israel. This includes, in particular, the heavily populated Jewish suburbs North, East and South of Jerusalem. While Palestinians would not return to the territory of Israel, their symbolic right to do so would be recognized in some fashion. 

Suppose we get there -- not easy task on itself -- what next?

We have created a Palestinian state with two unconnected pieces of territory: the Gaza strip and the West Bank. Historical experience is not too encouraging for such arrangements: see Pakistan and Danzig.  

We have created a state that is weak and corrupt (as it already is, now); the Palestinian state will be riddled with irredentists that are not willing to accept the compromise, are not willing to accept the continued existence of the state of Israel and, in particular, are not willing to accept Jewish sovereignty in the heart of Jerusalem. They will have the means to continue with terror operations.

We have created a state that continues to be economically dependent on Israel and strongly integrated with the Israeli economy, if normal economic relations are established between the two states, or poor and hostile to Israel, otherwise, as disputes over water and other shared resources will continue.

We still have Israeli Arabs that are 20% of Israel's population being disenfranchised by the large socio-economic gap between them and the Jewish population and by the inherent discrimination of their citizenship in a state that defines itself as Jewish.

We still have religious or nationalist zealots on both sides that will refuse to accept the compromise of two states for a long time.

Geography implies that it is not practical to erect high walls and separate Israel from Palestine; such walls would cut the Gaza strip from the West Bank, and would largely cut the North of the West Bank form the South of the West Bank; they would cut hills where rain falls from the valleys that are irrigated by that water. Palestine can thrive only through a strong economic integration with Israel.  The large Arab minority in Israel will be a further motivation for strong ties between Israel and Palestine. 

Israel cannot continue, in  the long run, to be a modern, secular, democratic country and continue having laws that implicitly discriminate against its Arab citizens, such as the Law of Return; Israel is bound to become, over time, the country of the citizens of Israel, not the country of the Jewish people, whether in Israel or in the US.   Israel and Palestine can be at peace with each other only if they are secular states and the voice of nationalism is muted in both. Two such states with strong social and economic ties will become increasingly integrated: Jews will want to live in the West Bank; Palestinians will want to live in Israel and marry Israeli Arabs, if not Israeli Jews. 

Such an integration may not mean one state; people have dreamt of a Middle-East Union, patterned after the European Union. But it will mean that that the negative view of peace that inspires many Israeli and Palestinians will not come to be: For many Israeli, a peace means having the Palestinians behind walls and forgetting about them and their problems. Likewise, for many Palestinians  peace merely means not having anymore Israeli soldiers and settlers in their hair. But such a minimalist, negative view of peace cannot suffice, in the long term. A positive peace will be much harder to achieve and will take much longer to achieve -- most likely multiple generations. But it is important to understand that the current effort to achieve a two-state solution in the Middle-East is not the end, but just the beginning of the end. A true peace, a stable situation in the Middle-East, will require profound changes in both Israel and Palestine.

There could be, in principle, an alternative solution: the Gaza Strip joining Egypt, and the West Bank joining Jordany. This is where we would be now, without the six-day war. There is some logic in such an evolution: It avoids the problem of a split Palestinian country; most of the citizens of Jordany are Palestinians and there are still many ties between the West Bank and Jordany; West Bank + Jordany (the pre-67 Jordany) is a much more viable country than either alone from a geographic and economic view-point. But there are many obstacles to such an evolution: Palestinians, especially in the Gaza Strip, will oppose it. Egypt will oppose it, as long as it is opposed to the Muslim Brotherhood and Gaza is controlled by Hamas. A union of Jordany and the West Bank will probably mean a toppling of the Hashemite Kingdom. This alternative is unlikely; but then any alternative to the continuation of the conflict is unlikely.