Friday 15 February 2013

Food and Finance

It seems, from the cheap seats at least, that the Eurozone crisis has abated, so now the media is filled with a food crisis. For anyone not following the story, despite food being an important issue of public discourse, following the emergence of BSE twenty years ago and the GMO debate, it turns out things are not as transparent as one would hope and when Europeans have been paying for processed beef they have ended up eating dead horses.  This is no great surprise to someone who has occasionally bought a burger for £1.50.

I started thinking about the relationship between the food crisis and finance when a non-academic colleague asked me to explain the difference between a new Master's in Financial Engineering we have introduced and our existing programmes in Risk Management and Financial Mathematics.  My explanation was as follows
In the past, investors did the equivalent of buying tomatoes, onions, meat and pasta.  Today financial engineers sell investors ready made lasagne.  Risk managers make sure it is correctly labelled (the traffic lights/no horsemeat instead of beef) while financial mathematicians put a price on the lasagne.
This got me thinking about the failures of food regulation and financial regulation.   The changes in finance that have occurred over the past forty years mirror those in food.  In the 1960s investors had a limited choice of where they could put there money - the job of an investment manager at a life insurance company involved buying government bonds, and if you were particularly daring, Ford or Exxon stock. When Bretton-Woods collapsed in 1971 this benign environment became perilous, exchange rates fluctuated and governments responded by adjusting their interest rates while commodity prices became volatile.  The work of fund managers ceased to be sedate and became something of a high wire juggling act.  To make the juggling act easier, hedge funds, and then banks, started processing the volatile raw assets into investment vehicles designed to meet the needs of the fund manager.

Pretty much contemporaneous with these developments in finance, the UK food industry was making similar innovations.  As society changed and housewives went out to work the food industry started selling processed ready-meals.  Apart from convenience, ready meals are sometimes seen as being important in developing consumer tastes - the British menu is today much more varied than the traditional "meat and two veg" of the sixties.  The downside has been concerns as to the nutritional value of ready meals, and as a result there has been more and more regulation on the industry, particularly relating to labelling.

My problem is that despite significant effort (and expenditure) by regulators, the consumer does not seem to have been well protected.  This statement could apply to either food or finance.

In the aftermath of the Credit Crisis, the then Science Minister, Lord Drayson asked me to collate views from leading mathematicians working in finance what the causes of the crisis were. One academic (asked to be anonymous)  commented as follows
I was involved in a meeting to discuss new financial regulation. As a mathematician, I had anticipated that the discussion would be on the robustness of the underlying models being used. In fact the discussion focused on the processes to ensure financial institutions complied with the letter of the regulation.

What the academic observed was that as a result of detailed regulations, bankers stopped "thinking" about their models and processes and resorted to a "box ticking" exercise.  The regulations were so detailed that they responded by focusing on the legal issues around the regulations and not the substance  of their business.  One wonders if something similar has happened in the food industry.  If we pass the "traffic lights" all is well with our ready meal.

This issue was raised by Andy Haldane in his "The Dog and the Frisbee" paper presented last year when he argued that "less is more" in banking regulation.  If the regulations are too detailed, bankers can lose sight of the key issues. However, Haldane's arguments do not square with the views of his new boss, the Bank's Governor designate, Mark Carney.

In the conversations I had with bankers who were involved in Credit Derivatives after the crisis, the point was made that the emphasis in the business was "knowing the components" of a structured product (a ready meal) rather than having a whizz-bang pricing model (efficient food processing).  One suspects the food industry will start taking a closer look at its supply chain as well, now.

Just as EU bureaucrats discuss the Food Crisis, their colleagues are proposing new regulations on finance.  The Financial Transaction Tax that the EU are looking to implement has three objectives:

  • To tackle fragmentation of the Single Market that an uncoordinated patchwork of national financial transaction taxes would create;
  • To ensure that the financial sector makes a fair and substantial contribution to public finances and covering the cost of the crisis, particularly as it is currently under-taxed compared to other sectors;
  • To create appropriate disincentives for financial transactions which do not contribute to the efficiency of financial markets or to the real economy
The EU food labelling regulations share the first objective, but Europe does not tax salt-sugar-fat in processed foods and does not seek to hinder the development of innovative food products, even if they do not contribute to the nutritional well being of EU citizens.

Food and financial regulation are extremely important to the well being of Europe's citizens.  While Food Regulation will be developed in public, and as a result I do not expect the EU to implement a Food Transaction Tax.  However Financial Regulation is rarely considered outside the specialist media.  As a result, I worry that ill considered regulations will be implemented that do more harm than good.

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