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Warren Buffett, once said: "If you've been playing poker for half an hour and you still don't know who the patsy is, you're the patsy."

I don't play poker, and I don't know for certain what a patsy is, but I have an uncomfortable feeling that if I started playing poker, I'd be it. I always thought that Warren's game of choice was bridge, but perhaps if he can't find a good partner he chooses poker as the least worst alternative.

Poker, and gambling generally, of course have a lot in common with investing. Speculation is the game of guessing what the marginal investor is about to do, and guessing better than all the other investors in the market. It's certainly tough, and there are a lot of patsies, not least because it really is a zero sum game if you ignore fees, and if you pay someone to gamble for you, it's a negative sum game.

The nature of investing is that you can buy something only if someone on the other side of the bargain thinks that what you are buying is worth more than what he is selling. Given that you're probably buying from a professional, it's as well to think long and hard about whether that bargain you think you are getting really is such good value.

The same sort of reasoning goes for all goods and services: the guy who sells you a cappuchino in the morning definitely thinks that it's worth a lot less than what you are paying for it. Of course he has 'overheads' - fixed costs of production that he has to recover from your payment for your coffee. Economic theory says that at the end of the day, once he's paid for everything there are no profits, or 'economic rents' left. If he has a great spot then the person he leases his shop from will get all the benefit of his higher than average turnover.

This theory all seems pretty reasonable until one thinks of certain industries and service sectors. How can there be no rents in investment banking, even retail banking, the hedge fund 'industry', private equity, corporate law, defence contracting, even something like public works contracting? Well, I think the answer is that, actually, it's all to do with who is on the other side of those profitable transactions. My contention is that the common factor is that the when firms in these industries do their high-margin transactions, the party on the other side is ultimately the public, often represented by an agent who isn't really that bothered about seeking out the best deal for the principal.

Nearly all firms love to be contractors supplying government agencies. It's wonderful to be a stockbroker doing transactions on behalf of a fund manager who is looking after savings for a firm which has, somewhere, some annuitants who are hoping to get a good pension out of those savings. The same goes for a shipbuilder who has the capability to build an aircraft carrier for the British Government.

High margins can arise from lots of factors - innovation in product or production technology, patents, brilliant marketing, cheap capital or low production costs. But the only enduring source is the absence of competition, which usually goes with consumers who do not have the incentive to seek out alternative suppliers, or are prohibited from doing so by regulation.  It's usually impossible to avoid paying the cost of these (set up your own hedge fund maybe?) but it is at least possible to buy the shares in some companies operating in that kind of business. Unfortunately many of the very high margins are associate with low capital requirements, so most, or all of the excess profits flow to managers, rather than owners, if they are different.

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It's generally considered that good institutions, like body of law, courts, constitution, make for a wealthy society. This is supposedly why the USA, UK, Denmark, Australia, Japan, France are wealthy countries. Although they have different laws and constitutions, they have functioning institutions.

This suggests that it should be easy to make a south american country prosperous. In fact as someone once said, if you ever need to check something in the US Constitution and don't have one to hand, you can go to practically any Latam country and borrow theirs, since it will be virtually a xerox copy of the US one, just as the Japanese one is.

But Japan is wealthy and Ecuador is poor. It is argued that the missing ingredient is trust. As a guy from Africa once said to me "you guys are incredible: you actually pay your taxes and expect the government not to steal them all, but to use them to build hospitals and run schools to teach your children - do you realise how implausible that outcome seems to a typical African?"

Large organisations are really important to get productivity improvements, and as I've blogged before, great productivity is the only thing that matters when it comes to enjoying a wealthy society. With large organisations, and great division of labour, productivity becomes enormously greater. Not just a bit, but unbelievably. In the past, Kings with wealth beyond the dreams of avarice would not have enough to pay for the production of a car which is remotely comparable with the most basic runabout as churned out by Korean factories today. 

But large corporations, and other institutions in society, can exist only with a large element of trust. To an extent once the institutions have 'got going' it's easier to keep them going than to start them from scratch. But still, individuals have to risk a lot, and trust a lot, to keep the show on the road.

This is similar to the problem with the firm - why, in practice, most of us work for large corporations, rather than entering into contracts with others for the supply of our labour. The legal contract lacks a lot when it comes to the selling and buying of labour. The 'old fashioned' feudal system, which requires a lot of trust, is alive and kicking and embodied in the modern corporation and is currently surviving even the extremes of inequality of income that we're seeing and the progressive erosion of the position of the employee, particularly in terms of what are usually called 'pension rights' but which many long-standing employees are discovering are not really rights at all when the profitability of the firm is at stake.

The problem with trust, in the context of Economics, is that it's very hard to model quantitatively, and therefore it's not really part of mainstream theory.  Somehow I think it needs to be incorporated, because Economics is failing, both to explain how the economy will evolve, and what poor countries need to do to get richer.

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Today the English language Wikipedia will be blocked out for twenty four hours to protest against the SOPA and PIPA acts that are currently going through the US congress. The background to the blackout, and some information on the acts themselves can be read on the anti-SOPA blackout page.

I must admit that I haven't read the details of these acts. Probably 99% of congressmen haven't either. But we all know that they will read as though they were dictated to Congress by the US media industry, particularly the Hollywood studios, and as a kind of last stand defence, the recorded music business which stands as an ever-present reminder to Hollywood of what might happen to them if these bills are not passed.

What will be conspicuous by its absence is the case that this IP will actually deliver economic rents to the studios resulting from their control of an artificially scare resource: the distribution network that they control, that is now being challenged by alternative channels available through fast internet connections.

The economic and political case is not entirely one-sided. People like to watch Hollywood films, because they have high production values which are partly the consequence of the high profits the studios can gain from their control of content and its distribution.  In effect they can obtain monopoly profits, because if you want to see Pirates of the Carribean 5 the only place you can get it from is Walt Disney Pictures. Of course a large part of these monopoly profits is diverted into the pocket of Johnny Depp, because he controls the supply of that essential ingredient of the franchise, namely Jack Sparrow.

Anyway, these acts will create new offences and give additional powers to the holders of this IP to support their position relative to what it would be without them. This takes power away from consumers and gives it to producers. In a democracy it seems odd that the democratic will of the consumers who would presumably overwhelmingly prefer these measures not to go ahead, is overriden. The resolution to this paradox was given by Mancur Olson in his book The Logic of Collective Action (the link is to Wikipedia which, of course, will be unavailable if you are reading this on the 18th, ironically).

Olson realised that because the return per capita on lobbying by small groups of vested interest was so great, and that organising large groups was so difficult, the small groups would progressively hijack the democratic process. Basically in large groups everyone assumes that someone else will make the effort - the famous 'free rider problem'.

Since I came across Olson's ideas I have realised that they have terrific explanatory power. When I see any proposal for a new piece of legislation I now ask myself: 'which industry/professional body will benefit from this?'. Invariably  the industry/profession will be heavily represented in the body of experts called upon to draft the legislation. Of course one group benefits from almost all new legislation: they lawyers themselves. Is it surprising that so many politicians are lawyers?

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Property rights are pretty important. They are probably the reason that capitalism won the cold war. They solve that most important of problems: the tragedy of the commons.

The classical economists identified certain goods that should be outside the control of single owners. Public goods, which are non-rivalrous and non-excludable, are such goods. Such goods should not be subject to property rights for fairly obvious reasons: imagine someone being able to charge for the air that we breath. However, it seems fairly clear that someone who has legitimately acquired land, and built a dwelling on it, should have fairly exclusive use of it. The exact rights are perhaps more subtle: what about the column of air above the plot, or the minerals below it. But the general concept that the house should be for the exclusive use of the owner seems reasonable.

We get into trouble when we extend property rights to what has been called intellectual property. If I invent a new way of solving a problem, should I be able to charge you for using it? The patent lawyers say 'patently, yes!'. I am not so sure. By giving exclusive use of land to a single owner, he can ensure that it is farmed just enough to maximise the yield. When it comes to an idea, then there is no point in restricting the amount of exploitation because the greatest yield is obtained by not restricting its use.

I think the law accepts that when it comes to techniques of solving equations (for example), but does not do it when it comes to finding cures for a disease. The argument is that drug companies will never invest enough in research and development if they cannot get the rent from exploiting their monopoly supplier status granted by the patent system for the term of the patent.

So the issue boils down to how to fund research into these techniques, drugs, software algorithms and the like. I don't really care about trade marks because consumers always have the option of buying a non-branded but otherwise equivalent product.

Alex Tabarrok has argued the case more eloquently than I can, and has argued that the weight of IP law in the USA has hampered innovation. Certainly it was argued that the patents taken out by Boulton and Watt delayed innovation in steam engine design because it prevented other engineers from incorporating condensers to their engines, as this was covered by the Watt patents, although Watt's own engines did not make full use of them.

An argument that I had not come across before, which I learned from Tabarrok, is that although each patent holder will expect a 'small' royalty for the use of their IP, many high-tech inventions rely on many patents. If a new phone requires the use of 20 patents, then the weight of paying a royalty cost of a few percent of the retail price for each of them will probably make the invention uneconomic. Google and Nokia can afford to purchase portfolios of patents (by buying Motorola in the case of Google) but new entrants into the sector will be forever kept out, resulting in a gradually ossifying oligopoly.

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As always I am indebted to, and influenced by, the good folks at Cafe Hayek.

A lot of people think that capitalism is great for making mobile phones, and cars, and computers, and wide-bodied jets, and even pharmaceuticals and replacement hips, and even for building your house, or representing one in court on a murder charge. But they don't really trust it for important things, like educating our children, or providing a general practitioner (physician).

The solution seems obvious: have a mixed economy. Let the private sector make the goods and services that it is good at providing, and leave the state to provide the rest. This seems so obvious that it hardly needs stating. But there is a problem, because some identical resources are used by both the private and public sector, not least land. Currently, even though there has been a major downturn in the price of houses, they are still more profitable per acre than other types of development.

In a real example where I live, there is a proposal to sell off some public buildings, for housing development. The buildings could be used for a public sector use, but almost certainly this use would not maximise the price to the seller. Politicians will become involved and make some decision, as they must when the market mechanism is prevented from operating. Unfortunately, politicians don't have the aggregating power of the market mechanism. They may 'take soundings' - ask around their associates, or even formally consult the electorate. But any kind of democrating aggregation is a very poor substitute for the powerful incentives of using prices.

It's not easy to estimate the cost of this effect, but I strongly suspect that it's quite a lot bigger than is generally recognised. Even perfect politicians who did not yield to the sort of incentives that Public Choice advocates will identify will struggle to see through to what voters really want, partly because they don't know themselves until they have to make choices on how to allocate their own resource. As someone said some time 'talk is cheap'.

Unfortunately it will be a long time before Ron Paul's remark is literally true, but at least he's doing a fabulous job of making people aware of what Mises and Hayek were saying all those years ago. 

There is an increasing concern about the inequality of income in our society. David Cameron talks about increasing the powers of shareholders to control executive pay. The Occupy movement is camped out in various financial centres.

It's not quite clear the top 1% is getting detached from the rest of us. It seems clear that it's more a sociological problem than a strictly economic one. The groups that are paid very highly are increasingly isolated from the rest of the community, certainly not sharing any schools, shops, and probably having gone only to the most elite and exclusive universities. They undoubtedly conclude that it's very hard to jump all the hurdles that have lead to themselves finding themselves in these positions, and it's only reasonable to conclude that such hard work must be recognised, not least financially.

In theory investors, shareholders of listed firms, and investors in private equity funds, ultimately the ordinary workers in the other 99%, employ the 1%. A naive analysis might conclude that this overwhelming majority might collectively exploit the minority. This is supposed to be the danger of democracy. In fact the opposite happens. The benefits for the 1% are far more clear and attractive than the costs to the 99% are. This is the insight for which Mancur Olsen got the nobel prize for economics in the 60's.

This analysis shows that no amount of exhortation or encouragement from the political class is likely to have any effect, but this is exactly what the politicians are attempting. This allows them to gain a few votes, without really having any danger of receiving the funding from the lobbyists, who like things just the way they are, thanks.

I recommend that you read John Plender in today's FT. He gets it.

Diaries didn't always exist. Blogs did not always exist. I understand that they started because there was a desire among some puritans to build up a ledger of their good works in order to have some evidence to present to St Peter at the gates of heaven.

I don't know if this is correct. I don't suppose many people have this in mind these days, or that there was ever an appetite for recording the debit side of the ledger (the side that records the acts that will count against St Peter's supplicant).

I just want to promote ideas that I find inspiring, educational or simply interesting. I cull these from a variety of places, but one evergreen source is Econtalk. Russ Roberts puts together an interview of about an hour ever week where he chats to someone, often an economist, about a topic that interests him. He has no producer, is not paid anything to produce this interview, but seems to do it purely for the enjoyment.

A talk that appealled to me recently was with Alex Tabarrok who contends that innovation in the US is drying up. He identifies a few causes, but notably the law relating to intellectual copyright, the decline in the quality of school teaching, the grade inflation in soft academic subjects, and the very high immigration barriers now being put up for highly talented individuals who want to migrate to the US.

It seems to me that the last cause may be one of regret for the US (if a country can really feel a human emotion) but isn't a cause of regret for the rest of us. I'm not sure about the argument about education, but I think that IPR protection does create a barrier to innovation. The purpose of property rights is to avoid the tragedy of the commons. The fact is that ideas can be consumed without limit without denying anyone else access to them ('non-rivalrous'?). The argument that people will not invent things unless they believe they will receive a stream of royalty income for seventy years seems just implausible. Listen to the podcast and decide!

I'm helping a close relative to obtain finance for a property he wants to buy. I have bought a lot of properties in my time, but every time I look for finance I am disheartened. The market is dominated by brokers, there are extremely few lenders, and those that are do not seem to give any kind of bonuses to those who want to borrow direct.

Brokers seem stil to push very short-term products, trackers or fixed rate deals that last for a two or three years, seemingly with the sole intention of forcing endless refinancing with endless refinancing fees. It's hard to see that any actual borrower would ever actually want a 2- or 3-year deal: transaction costs around house purchase would make it a disaster if you actually were going to move on that kind of interval. Although APRs are quoted there are so many flavours of fee that attach to mortgages that it's hard to be confident that the APR represents any measure of real cost. Especially given that the STV that kicks in after the fixed term might be competitive now but might be utterly usurous after a couple of years, especially if the lender decides that it's not interested in the UK market any longer.

The spreads over LIBOR or Bank of England repo rates being offered are still three or four (or five) times higher than a few years ago, except that lending criteria have been immeasurably tightened up, especially for commercial lending. 

The whole industry is a stitch up, the result of heavy regulation that prevents the likes of Zopa and other peer-to-peer lenders operating in this space. I wouldn't mind so much if these monopoly profits flowed to shareholders: at least then I could buy shares and get a benefit. It seems that all the excess income goes to pay very high salaries to senior managers in these banks.

The market has expressed it's take on the Vickers Report: it will be another piece of regulation that entrenches bank's anti-competitive position in the UK.

Infographic by Mortgage Rates

Read this and weep.

David Benson, writing in the FT, wrote:

"Regulatory barriers to entry in investment banking are now higher than before the credit crunch, creating an ever-stronger oligopoly still capable of generating supernormal profits. Following the bail-out of the banking system, the scale of public subsidy to the industry is also unprecedented, creating moral hazard from explicit state guarantees to unsecured creditors."

Lots of writers and bloggers, including John Kay in the FT, have pointed out that more regulation is not the answer to the question. The banking industry, and investment banks in particular, are some of the most highly regulated entities on the planet. The budget for the FSA is about half a billion pounds (here) which the FSA coyly states "is met from a levy on the firms we regulate", but of course in reality is met by customers of the regulated firms: do you imagine that when the FSA levy was introduced shareholder returns and staff salaries dropped to take up the strain?

I'm surprised that Benson was allowed to tell it as it is: investment banks get their supernormal profits from their privileged position in the provision of financial services, largely as a result of the very regulation that is designed to protect their customers, and taxpayers. Yes, it's true. Bankers don't get paid enormous salaries because they are smarter than the average worker, it's because they work in an industry where barriers to entry prevent economic rents being competed away.

So, it's just a matter of time before we start the cycle again, and banks build up a huge head of pride before they fall. There is an alternative though. Disintermediation is now easier than ever. It is perfectly possible for you to open your own dealing account and build up your own portfolio and do a lot better than that highly paid fund manager that you used to keep in Porsches. The City adds no value in routing funds from savers to borrowers. Just refuse to be part of it.