Overhead Allocation vs. Theft
by J Tsimeskes
Overhead Allocation vs. Theft
I was readingDean Baker’s excellent post today on high speed trading. My initial reaction was that this was simply theft, high frequency traders supply absolutely no value to anyone but reduce the gains made by legitimate traders.
The first comment, however, made me think. SteveB asks “I don’t understand how the tax solves the problem. Wouldn’t it just increase the spread between buy and sell prices, and make the exchange even less efficient?” This would be an instance where the government and private thieves are doing almost exactly the same thing. So why are they different?
An easy way to answer this is to compare what the government does to overhead. While the private thieves are simply skimming other peoples money a new government tax is more like a business adjusting how it applies overhead across its various business units. The new tax assigns more of society’s cost to the trading sector while allocating the costs away from other productive activities.
While perhaps not the best way to describe government’s role, the overhead analogy does bear a certain appeal for communicating government’s role to the business minded. As organizations grow larger and more complex their direct costs tend to decline while overhead increases. A local mechanic shop is likely to have very high direct costs and low overhead compared to a company like Ford, yet Ford will be far more efficient despite so much of its costs accruing to overhead.
Something similar is happening as government’s role expands. Modern society is vastly larger and more complicated than it was a few centuries ago. Modern businesses require employees with a much larger capital investment, does anyone think the graduates of a one room schoolhouse would be qualified for a Wall Street trading job? Modern capital markets are vastly more complex and trust between corporations requires a much more active oversight role today than it did in the past. I could go on ad nauseam, but the basic point is that modern businesses exist today only as a result of a large supply of social and institutional capital. Without this capital many would still exist but in a much smaller and less productive form.
So while a financial tax would result in a roughly similar decrease in profits accruing to the parties to the transaction this money would be going to indirectly support the activities of the traders. Resistance to these kinds of taxes are ultimately akin to a business unit arguing against the allocation of overhead assigned to it. While this can increase the book profitability of the unit, this often makes the enterprise as a whole less efficient since the individual unit is unlikely to have a full appreciation of the overall costs of the organization. This makes the organization as a whole less productive since costs are misallocated.
At an extreme, anti-tax fervor can be compared to a dirty salesman who asks for his project to be costed at “true”* cost and then goes ahead and sells at near list price, driving his margins and commissions way up by robbing the organization as a whole of the portion of cost allocated to overhead (many organizations have a sufficient level of control to prevent this from being done too blatantly, I don’t think the 113th Congress is one of them).
Another point is that as more of our productivity results in overhead rather than direct cost it becomes increasingly easy for the egotistical and/or unscrupulous to argue that the increased productivity is the result of their efforts rather than from efficiencies stemming from an organization as a whole. This happens at both the national level and within organizations, with direct costs so low it also becomes more difficult to assign the overall productivity of an organization to individual members. Since Americans tend to be so individualistically oriented we are rarely satisfied with assigning results to the system, instead preferring to allocate costs and production to individual people; even when this is conceptually incomprehensible.
*I’ve run into a few organizations where the salesmen assume that the marginal product cost is the true cost. It can be very hard to make these folks understand that overhead really matters.
cross posted with J Tzimiskes
I will make a comment about overhead that is OT. Management often thinks overhead is a cost that should be eliminated, so you end up with maintenance, IT, etc being starved of resources and expected to do ever more with less. Sort of like taking away the garbage trucks while asking the garbage collectors to gather up more trash with fewer people.
As I’ve followed this issue the past 2 days, the “skimming” concept I believe is incorrect and minimizes the damage.
They are not “skimming” they are artificially driving the market to create an arbitrage situation. It is all false when compared to the minimal concept of 2 people coming to agreement on a price.
I’ve also heard people say because it is computers it’s not illegal. This makes no sense. A computer program does not produce intent. Only the human who wrote the program or set up the system can create intent.
Carolannie,
I think it goes to the adage: You have to spend money to make money*
*Unless you financialize your economy in which case you just devise systems to monetize to your pocket that which others have spent on.
The way I evaluate the issue is to compare with total transaction costs back when the Brokerages acted as a Cartel and commission rates were fixed. The markets did function then all be it with significantly lower volume. Perhaps IPO’s did not happen as much although in the 1950s you had the IPO of Ford Motor. (Henry’s descendants owned 100% of the company before then). So even big IPO’s were possible. If the market worked well back then a 10 basis point transaction tax would not be a problem.
Having taught managerial accounting for 25 years, JT here should not be using business examples when he apparently does not understand what he is talking about regarding direct costs and overhead.
What is “true” cost anyway?
Or maybe he just cannot write what he is thinking.
‘An easy way to answer this is …”
It seems that it can be answered more easily. HFT is a tax on productive trading that provides no benefit. If the government took the same tax, it could at least use the revenue to reduce the deficit.
Further, the purpose of the government tax is to eliminate HFT, so it does not need to be as large as the dead weight tax imposed by HFT.
I caution on applying the word “tax” to what the HFT is and it’s resultant effect.
The HFT is not creating a tax in the common man use of the word. It is instituting a crime.
Just as greed is the wrong word and selfish is the correct word.
A Tobin tax is not the only possible solution. I like it in combination with each of the following. There could be minimum holding periods – even a few minutes would probably be highly effective, but I would like to see days or weeks. Also, there could be automatic transaction delays. Again, minutes might do the job, but hours would be better.
When I was working and wanted to trade in my 401K account, I always got charged the intraday high on a buy, and received the intraday low on a sale.
Neat system, eh!
We get screwed at every turn.
JzB
jazz:
You forgot the other side. Take your 401k investment along with the company’s and invest at the EOM or 12 times a year rather than 26 times. There maust be a few pennies of interest being absorbed somewhere.
Save the Rustbelt,
I’ll admit that I was being sloppy with my terminology, it had been a long day and I was writing quickly. Also, the analogy collapses the more weight is put upon it so I wasn’t worrying too much about whether I wanted to imply that the relationship was like that between direct and period costs or some other way of splitting out costs; at this level of precision the analogy doesn’t work anyway.
Regarding true costs, I’ve often questioned exactly what it means myself without getting a straight answer. Yet, in the three sales jobs I’ve held in my life it was a concept applied at each. This post was more aimed at the salesperson level of business expertise then someone with a deeper understanding, hence the deliberate usage of a sloppy term. As far as I can gather from talking to people in these organizations “true” cost is most akin to marginal product cost with some kind of firm specific amount added on.
It’s actual usage is that in the inventory system a cost is often shown which theoretically has the overhead added to it. In practice, in at least one organization I worked for this cost actually represented the market price less the desired margin for the salesperson to sell at meaning that even if the company made a great deal of margin on the product the salesperson only got a commission on a fraction of that (I wasn’t there very long). “True” cost was the cost that only managers could see which was the lowest point they could override the unit cost to when a salesperson was working on a large sale. I found the concept bizarre and asked about it, it seemed that it was close to marginal cost but since senior management had substantial flexibility behind even this cost I have a certain degree of skepticism regarding “true” cost actually being marginal cost.
Short story though, many salespeople (barring the non-zero probability that I have simply worked at three companies with non-standard business practices) will be far more familiar with the concept of “true” cost than they will with marginal product cost, even if true cost is a bullshit term with no meaning in accounting. Since the analogy doesn’t hold up under deep scrutiny I saw no need to be precise with my terminology and instead used terms that would be intelligible to a colleague on one of my former salesteam’s even if my accounting professor or a colleague in the accounting department at work would call bullshit on the details.
Though if I had known this would be cross-posted I probably would have taken the time to choose my terms more carefully. (whew that got long, sorry)
And there I am being sloppy with terminology again. In the first paragraph to be consistent should have paired product and period costs. That’s closest to how I was thinking about this but didn’t want to use the terms because I didn’t want a general reader (which would be most readers on my own blog) to get hung up on the words product and period.
You are doing fine
What I find interesting about this is the amount of money being swindled from the traders.
That is, one article noted a hedge fund person who estimated that this system of computer networking was costing him about $300 million per year. He knew something was not right, but was never motivated to do what the person from the Bank of Canada did; research and find a solution to the swindle.
Now, when $300 million /year being stolen via cheating is not enough to motivate one to resolve the bleed, it shows that even in the tippy top of the money world people are numb to the rigging of the system. Referring to our financial system as a game and as gambling truly is the correct response. It is the senior citizen sitting at the slot machine knowing people who have been ruined by what they are hoping to beat and win.
$300 million lost, he thought maybe there was a snitch in his company but never really did anything about it. Here’s a econ psych question to be studied: What percentage of the total does it take to motivate someone to take action against that loss? What circumstance does one have to be in to be motivated?