Copycats and Contrarians

by Michelle Baddeley

  Whistleblowers have been crucial in challenging corporate fraud, political transgressions large and small, improper and dangerous medical practices, and physical and sexual abuse. They are indispensable in catalysing essential change and reform of financial, legal and healthcare systems. Yet societal and institutional attitudes to whistleblowers are often conflicted. Partly this reflects a form of short-termism. The rewards from whistleblowing take a long time to become clear. The media, politicians and society as a whole may have pressing short-term imperatives which mean that they do not want the fuss of the scandals catalysed by whistleblowers.

  The ways in which we respond to mavericks demonstrate the negative social welfare implications of penalising a contrarian view. Whistleblowers are the most vulnerable of mavericks, and they often suffer severe penalties for their actions because the crowd is not necessarily inclined to welcome their dissent. Whistleblowers are often castigated for expressing a contrary opinion. Societal approbation reflects this short-term perspective. In the heat of the moment, we may jump to the conclusion that whistleblowers are nothing more than disloyal curmudgeons. In 2003, the United Nations weapons inspector David Kelly revealed to British newspaper journalists off the record and anonymously that he did not believe that sites he had inspected in Iraq were laboratories set up to manufacture biological weapons, as was the official line of the British and American governments at the time.30 Allegedly against his will, he was publicly cited as the source of information undermining assertions about the threat from weapons of mass destruction.31 He died soon afterwards. The official verdict was one of suicide, although doubts remain about the nature of his death.32 Kelly paid a heavy price for his whistleblowing.

  Unfortunately, David Kelly’s experience is not so unusual. In recent years, numbers of high-profile whistleblower stories have hit the headlines. Some countries are starting to recognise the long-term consequences of vilifying whistleblowers, and new legislation and institutions are emerging to protect whistleblowers’ rights and interests.33 We need incentives to encourage whistleblowing, and protections for those who are made vulnerable by it – such as the setting of regulatory limits and systems to ensure that they are not penalised. The media has lionised a small number of whistleblowers, recently and most famously Julian Assange and Edward Snowden, each of whom have now been the subject of documentaries and Hollywood movies. But, caught up in the buzz of fame, do whistleblowers really help the crucial cause of exposing wrong-doing? In this, Snowden’s elusiveness is more reassuring than Assange’s celebrity.

  Yet, despite these measures to protect whistleblowers, legislation remains difficult to implement if the consequences for those who speak out are irreversible. Added to this, the transgressions that whistleblowers are calling out are often dispersed across a number of different people, from perpetrators through to their allies, many of whom will have the motive and opportunity to conceal or destroy incriminating information. When evidence is missing, relevant authorities in the courts and elsewhere will not be able to identify precisely who is responsible and so the cases made by whistleblowers will be hard to prove.

  We have seen that herding has many negative implications, especially in today’s overconnected world. Mavericks bring benefits of their own in terms of new ideas and inventions, but they also restrain some of our copycat tendencies. In this context, mavericks are important to us because they counterbalance herding’s negative consequences. In order for mavericks to rebel against the herd we might need additional incentives for people to take those risks; the problem then is in deciding whether or not rebels are on the right path. How can we agree on policies to encourage the ‘good’ rebels and discourage the ‘bad’ ones, especially when there may be little agreement about what is good and what is bad in our complex modern societies? Democratic institutions, including a free and unbiased media, can help us as citizens to make up our own minds about rebels and other mavericks with the power to change our lives. Much of the world, however, enjoys neither a free press nor other democratic institutions.

  Mavericks also play a special role in the economy, reflecting the influence of two particular maverick types: entrepreneurs and inventors. We have already learnt something about the latter in this chapter, but in marketplaces, alongside entrepreneurs, inventors face some very specific constraints. Entrepreneurs and inventors may create their own reward in the sense of the enjoyment they get from building a new business or inventing a new gadget, but these activities are not cheap. Financing new business ventures and innovations is a struggle, especially for new and small businesses. This brings us to another side of the economy: alongside the entrepreneurs struggling to fund themselves, modern financial markets churn through trillions of dollars each day. How can entrepreneurs connect with some of this money? They must get past the gatekeepers of these global financial riches – creating a whole new set of problems for our copycats and contrarians. How can we ensure that speculators effectively channel money and finance towards the entrepreneurs and innovators with the best ideas for generating employment and economic success? We turn to these questions in the next chapter.

  6

  Entrepreneurs versus speculators

  The economist and statesman John Maynard Keynes was a colourful, fascinating character.1 His deep understanding of how economies work was formed by the very best education Britain could offer: he attended Eton College and went on to excel in his undergraduate studies at King’s College, Cambridge. His intuitive understanding of speculators and entrepreneurs reflected more than his intellectual gifts and deep knowledge, however. Keynes was well placed to understand the workings of financial traders’ minds because he traded himself – very successfully, all told, with a few memorable failures too. A possibly apocryphal tale from his Cambridge days is that he contracted to buy grain on forward markets. The contract date for the forward trade arrived before he had had a chance to sell his grain, and he was forced to store it in the King’s College chapel.2 Nonetheless, Keynes enjoyed considerable success with his idiosyncratic financial trading. Managing the college endowment as the bursar of King’s College, he achieved excess returns over market averages of around 8 per cent. A key to his success was his focus on equities and stock-picking.3 Keynes also had a good understanding of entrepreneurship. In chapter 12 of his 1936 magnum opus The General Theory of Employment, Interest and Money, he presented a powerful account of the psychology driving entrepreneurs to invest in their businesses. He was particularly interested in how uncertainty slowed them down.

  Keynes was arguably the greatest economist of the twentieth century. Part of his genius reflected his impressive practical and intuitive understanding of real-world business. He understood how entrepreneurs and speculators are motivated by social as well as economic drivers. He also understood how the symbiotic relationship between them plays out in the macroeconomy. Entrepreneurs need finance to invest in building their businesses. Fast-moving, liquid financial markets work well in providing businesses with finance quickly. Keynes’ enduring insights help to explain the 2007/08 global financial crisis and other episodes of financial instability. In a world filled with uncertainty, and when our conformist instincts dominate our financial choices, financial crises are not at all rare.4 And the impacts are wide-ranging: without government intervention, the interplay between business and finance will not deliver what an economy needs in terms of employment and production.

  Keynes was the first economist to explore the many ways in which social interactions between copycats and contrarians help and hinder business investment and finance. Financial markets have changed a lot since Keynes’ time. The complexity of financial market interactions has grown with the advent of modern technologies, including algorithmic trading. The decision of one trader can precipitate large and volatile fluctuations, as lots of other traders can almost instantaneously decide to follow along behind. Nonetheless, Keynes’ fascinating analyses embed enduring insights about the social incentives driving speculators and en
trepreneurs to be the copycats and contrarians of the business world.

  So, Keynes’ analyses are a good starting point for illustrating how the business world is as prone to interplays between copycats and contrarians as any other aspect of our lives. Are successful entrepreneurs more likely to be mavericks? Why are speculators more often copycats? How do copycats and contrarians interact in the economy? In this chapter, we will answer these questions by exploring how and why copycats and contrarians respond to social influences in their pursuit of profit and new business opportunities.

  The money convention

  Money is our starting point in analysing the social interactions between speculators and entrepreneurs. Money unifies speculators and entrepreneurs, but in perhaps surprising ways. Generally, when it comes to money, most of us have a copycat side to our natures. We follow a money convention.5

  How does the money convention work? Tangible forms of money – notes and coins – would be of no use to us if the rest of the herd were not prepared to take them as what economists call a ‘unit of exchange’ – in other words, we can exchange money for stuff, and our employers pay us money in exchange for our labour. Money has other purposes too, including its role as a unit of account. Accountants measure individuals’ profits, losses, incomes and tax bills using money as their measurement unit. At a macroeconomic scale, statistical agencies use money to measure national income and output. All this only works because we have evolved the social convention of using money for our economic and financial transactions. We swap around our otherwise worthless bits of paper and cheap metal without thinking too hard about how and why this works. A Martian visiting Earth may well be puzzled by the value we place on certain types of paper and cheap metal. She may be even more puzzled by the fact that all we need to do is wave a bit of plastic at a metal box and we can take away carloads of groceries and household goods. Most of us are paid our wages and salaries electronically and see nothing directly tangible in return for our labour. We just follow the social convention that is money because everyone else adopts it too, and because our central banks and governments endorse and support it.

  In our modern world, the money convention has become very complex, so complex that perhaps we have lost sight of money’s essential purpose in terms of enabling economic activity by boosting production and employment. The globalisation of computerisation has enabled the emergence of innovative financial technologies in the form of new electronic money and crypto-currencies – in recent years, most famously Bitcoin. Bitcoin does not share all the features of conventional money, but there are ways in which it could replace conventional money. People have bought Bitcoin as a speculative opportunity and it could, in theory, be used as a unit of exchange and account, though so far at least, most of us are unlikely to have used it in our economic transactions. Until a Bitcoin convention is more widely adopted, it and other crypto-currencies will struggle to be anything other than a speculative curiosity.6 Other alternatives to conventional money can be used in small communities, and some cities and suburbs have experimented with new, localised forms of money, such as the Bristol pound and the Brixton pound.7 Essentially, these community-based money conventions complement the money conventions dictated by governments and central banks. If the Brixton pound were not somehow convertible into pounds sterling, directly or indirectly, then very few people would use it. So, overall, money is still a convention that relies on copycats to survive. Whatever sort of money we use, it only works if enough of the herd believes in it as a unit of exchange.

  Our money convention is not silly. Even though money is an increasingly intangible instrument, it is nonetheless a clever and useful thing. Even old forms of money are economically efficient innovations. Before money we used barter, which is clumsy and involves very high transaction costs and search costs. In other words, it is inconvenient and time-consuming to use, especially when bartering something specialised and complex. Imagine, for example, you want to buy a new computer. In a bartering world, you would need to go and find someone with a computer they wanted to sell, and barter with them for something of yours they wanted to buy. Before the internet, you would have been confined to people you knew or living nearby – transport and travel costs would have been prohibitive. And even if you could find someone locally who wanted to get rid of their computer, you would have to have exactly what they wanted in exchange – an unlikely scenario. The chances of finding a neighbour willing or able to sell you exactly what you want are most of the time likely to be small. The chances that your preference for their possessions matches theirs for yours are even smaller. But in a world with money you can go to a shop, give the shop owners money that they can use to buy other things, and take away one of their computers in exchange. This explains why economies are more successful when they are populated by lots of copycats following a money convention.

  Tulipmania

  If money is a social convention then it needs a good proportion of copycats supporting it to succeed as a unit of exchange and account. Over time, however, money has morphed into something more. It has transformed into a way to make money out of money. Markets have evolved around the trading of money and other assets – and it is in these markets that the copycat speculators live. Financial assets tend to be relatively homogenous, what economists call ‘fungible’ – each unit is identical, and so can be swapped for another very easily. This makes financial markets very quick and liquid: they move fast and, superficially at least, smoothly. Speculators have entered this financial ecosystem to make profits from the trading opportunities available. Speculators move quickly, some would say impulsively.

  Financial history shows us that herds of speculators are a powerful force driving financial markets and financial instability.8 Indeed, speculative episodes are an enduring feature of financial markets.9 Destabilising speculative fads and frenzies have been common throughout history. In recent times, not much more than a decade passes before a new one emerges, from the South Sea Bubble of the eighteenth century to the 1929 Wall Street Crash, the 1997 Asian financial crisis, the dot-com bubble of the 1990s/2000s, the 2007/08 subprime mortgage crisis and a series of housing booms and busts in between. Financial herding is an important artefact of our social nature, and the herd is a crucial conduit for speculative bubbles.

  One of the most colourful historical examples of speculation was Tulipmania. For a brief period in 1637, speculators got very excited about tulip bulbs. It is not clear what triggered the excitement. There is some evidence that tulips were already fashionable, having been introduced to Europe from Turkey less than a century earlier. They were admired as an unusual and exotic flower. But interest had soon grown to such an extent that it tipped over into an extreme speculative frenzy. Traders followed each other into the tulip bulb market, chasing and initially contributing to massive speculative gains. For some of the rarer tulip bulbs, prices rose by up to 6,000 per cent. A particularly prized bulb, the exotic Semper Augustus, sold for around 1,000 florins at the height of the bubble – by various accounts more than enough money to buy either a smart townhouse, a small fleet of battleships or a drove of 3,000 pigs. The bust that marked the end of Tulipmania was as spectacular as the boom. By February 1637 most bulbs were relatively worthless, the tulip market all but disappeared. Those tulip speculators who had joined the frenzy late lost their fortunes.10

  Figure 7. Jan Brueghel the Younger’s tulipmaniacs: ‘Satire on Tulip Mania’, c. 1640.

  Tulipmania was not easily forgotten. Perhaps because it captures something essential about how our lives are driven by instinctive and unconscious motivations. In his painting ‘Satire on Tulip Mania’, Jan Brueghel the Younger depicted tulip traders as anthropomorphised monkeys, suggesting a primitive, basic and undesirable aspect to the speculative frenzy. Breughel’s monkey metaphor speaks to something of the tensions driving our evolved instincts to follow others, unfolding in financial markets as well as our ordinary lives.

  Rational bubbles

 
You might imagine that Tulipmania was the ultimate demonstration of an irrational speculative bubble. Certainly, from a group or macroeconomic perspective, it was destabilising and unproductive. But some economists argue that Tulipmania is entirely consistent with rational choice. They argue that rational speculative bubbles emerge as an inevitable consequence of speculators thinking carefully about the best way to make profits. For them, speculative bubbles are rational bubbles.

  There is some weight to this argument. If you were a tulip trader, by observing others you might rationally judge that it makes sense to follow all those other tulip traders and buy a bulb yourself. If you had 1,000 florins, you might even contemplate buying a tulip bulb instead of a town house if you thought you could sell the bulb to the next person to join the herd for 1,100 florins. You are not being stupid if you pay an exorbitant price for something today if you think there is a good chance you can sell it to someone else for an even more exorbitant price tomorrow. The real, inherent value of that tulip bulb is irrelevant (even if you could figure out what that was).11 The tulip traders who created the mania for tulips were just balancing the chances of the bubble persisting or bursting. For as long as the bubble was likely to continue, it was rational to spend a fortune to enter the tulip market, because that fortune might be magnified the very next day.