Shaking things up

The case for our institutions, even if they need to change

Photo by Jon Tyson on Unsplash

Hello,

Welcome to Known Unknowns a newsletter that, like all of us, is like it or not, along for the ride.

Higher risk less reward

I am ultimately an institutionalist. Albeit a strange one, I resist any structure institutions try to impose on me, but I am still an institutionalist. I’ve spent some time at international organizations, have reverence for the rule of law, still infer authority from people at top institutions, and write for traditional media because I believe it makes me better. And yet, I am cautiously optimistic about the shake-up our institutions are undergoing. They need to change. Institutions lost trust for many good reasons—they overstepped in their mission, stopped trusting the public they were meant to serve, and became overtly political and wasteful. I still think they, on balance, do more good than harm. This is exactly why they need to be reformed. I want them to work and be better. Two weeks ago, they were on a path that would only bring them further into irrelevance, and they’d become totally irredeemable. Something needed to change, and it probably needs to be a bit radical in parts.

Odds are, the shake-up will go too far. Perhaps that may help us see why the institutions we built were so valuable. But there will be costs along the way. Take the global trading system. I still believe that big multilateral trade deals are better than bilateral deals. The big deals require global economic cooperation, which is why we have not just the WTO, the IMF, the World Bank, the OECD, and all the others. Global cooperation is now seen as resulting in “worse deals.” Even if many of the Trump tariffs are just bluster, the concept of more bilateral deals further undermines global cooperation. The idea that we are better off with more cooperation may seem counterintuitive. After all—don’t we get better deals by just looking out for our own interest? Sometimes that is true, but by “less good,” I mean we get less bang for our buck. Bilateral deals are less efficient because we don’t account for all the information and get less diversification. It all adds up to less efficiency, which means we pay more and get less, take more risk, and get less reward.

I wrote about the financial aspect of this for Bloomberg. The flip side of more fragmented and political trading relationships is more fragmented capital flows. This means financial markets will be less diversified, which translates to more risk for the same reward (or vice versa), and that means lower growth and more risk. The last few decades were, in many ways, a golden era. Technology and globalization meant capital flowed all over the globe, lowering poverty and promoting growth. And in exchange, we all got more growth for less risk. But it was not meant to last, in part because institutions no longer did what they were supposed to do—which is promote diversification—and at times instead made the world less efficient or pushed other agendas. There were also some not great deals. Even if it was economically successful, the old order became less sustainable politically as our institutions became more political and more focused on reducing rather than facilitating risk.

This is not just a Trump/Musk thing. Recall that the Biden administration wanted to cede economic interests to political ones (that walled-garden), and it turns out it’s a slippery slope. Many Biden supporters who are outraged by tariffs now spent many years railing against neoliberalism. What did they think the alternative was?

They will soon find out. The fact is, as much as I cheer change, we must recognize there are trade-offs. If we give up diversification and care more about our political aims than economic aims, we end up with less growth and more volatility.

Maybe that is what we have to do. Perhaps we need to re-examine and reform our objectives and the institutions we had. The world changes, and so should our institutions and objectives. If we do, we might just end up in a better place.

On to tax reform.

DEI

One thing that has eroded trust in our institutions is the zeal with which they have adopted Diversity, Equity, and Inclusion (DEI). It started well-intentioned enough—the idea that all employees, no matter their background, should feel welcome at work and have a fair and supportive work environment. But it morphed into a strange new religion that imposed politics and values on a wide range of people, making them feel uncomfortable and discriminated against.

There are many aspects of DEI, but perhaps the most controversial was hiring preferences based on gender or race. It was justified by the rather facile argument that if you look different, you think differently, and if you get a bunch of different-thinking people in a room, better decisions would be made. There are obviously many problems with this chain of reasoning, starting with the assumption that how you look says anything about how you think. Yet somehow, a small library of studies from consulting firms (mostly) emerged, supporting the idea that diversity leads to bigger profits. However, several more rigorous studies from academics have since disproved this argument. Diversity may not harm profits, but it certainly doesn’t improve them either. There is no business case for it, though a well-run workplace where people feel it is fair and where they feel valued is good for business. Whether the current form of DEI helps or hurts those efforts remains an open question.

Now that many companies are dropping their DEI efforts, while others are holding onto them, I hope they can all be honest about their reasons. Without a profit-based justification, it comes down to values. Do you see race-based hiring as righting a terrible historical wrong, or do you see it as another form of discrimination? Both sides have valid points.

If our institutions are going to survive this period of tumult, they must become more transparent and honest about their objectives. Claiming diversity is necessarily good business has never made much sense and made it seem like a fraud.

In other news

I was on the CFA podcast with the wonderful Lawrence Siegel.

Until next time, Pension Geeks!

Allison