The Power of Ideas

In the interests of full disclosure, the following post was written by Google Notebook LM’s “blog” report writing feature. It references a paper titled “When Ideas Trump Interests,” by economist Dani Rodrik I read a while back but never got around to writing up.

Over to Notebook LM ….

Introduction: The Hidden Force in Politics

It is a common and cynical view of politics: powerful “vested interests” and special interest groups always get their way at the expense of the general public. We see it as a battle of raw power, where lobbies and elites push their agenda, and the rest of us pay the price. This perspective is so ingrained that it forms the foundation of most modern models of political economy.

But what if this view is incomplete? In his paper, “When Ideas Trump Interests,” economist Dani Rodrik challenges this conventional wisdom. He argues that before we can even talk about interests, we have to talk about “ideas”—a powerful, often overlooked force that shapes what those interests are, how actors understand the world, and what they believe is possible. This perspective doesn’t dismiss the role of powerful groups, but it places them in a new context where their influence is not a foregone conclusion.

This post will distill the most surprising and impactful takeaways from Rodrik’s argument. We will explore how ideas about our identity, our understanding of the world, and our policy imagination are the true drivers of political outcomes.

Three Surprising Ways Ideas Shape Our World

The standard political playbook focuses on interests and power, but the real story is often more complex. Here are three key insights that reveal how ideas, not just interests, shape our world.

Takeaway 1: Your ‘Interests’ Aren’t Fixed—They’re an Idea About Who You Are

The concept of “self-interest” seems simple enough—we all want what’s best for ourselves. But Rodrik argues that before anyone can pursue their interest, they must first have an idea of their “self.” Who we believe we are fundamentally determines what we value and, therefore, what we pursue.

This identity isn’t fixed or purely economic. We might see ourselves primarily as a member of a social class (‘middle class’), an ethnic group, a religion, a nation (‘global citizen’), or a profession. These identities dictate our priorities, which can easily override purely material concerns. As the source text notes, abstract ideals and moral conceptions can be powerful motivators:

“humans will kill and die not only to protect their own lives or defend kin and kith, but for an idea—the moral conception they form of themselves, of ‘who we are’”

This is a profoundly counter-intuitive point because it helps explain a wide range of “anomalous” political actions. When people vote against their immediate material interests, it’s often because an idea about their identity—their values, their community, their place in the world—has taken precedence.

Takeaway 2: Policy Is Driven by Beliefs About How the World Works

Policymakers and political groups don’t operate in a vacuum; they act based on their “worldviews,” or their mental models of how the economy and society function. These underlying ideas create the entire framework for political debate and lead to vastly different policy preferences. Think of the great economic debates: laissez-faire vs. planning, free trade vs. protectionism, or Keynesian vs. Hayekian economics. Each position stems from a different core idea about how the world works.

The 2008 global financial crisis is a perfect case study. It’s easy to blame powerful banking interests for the policies that led to the meltdown, and they were certainly a factor. However, their success was enabled by a prevailing set of ideas that favored financial liberalization and self-regulation. The argument that won the day wasn’t that deregulation was good for Wall Street, but that it was good for Main Street—that it was in the public interest.

But this isn’t a one-sided phenomenon. As Rodrik points out, the other side of the debate was also driven by ideas. Many observers argued the crisis was caused by excessive government intervention to support housing markets. This view wasn’t just a cover for other interests; it was grounded in powerful ideas about the social value of homeownership and the need to correct for the financial sector’s inattentiveness to lower-income borrowers. Powerful interests rarely win by nakedly arguing for their own gain; they seek legitimacy by framing their goals within a popular and persuasive idea. This is critical because it tells us that changing policy isn’t just about overpowering an opposing group. It requires challenging the underlying ideas and narratives that give that group’s position its legitimacy in the first place.

Takeaway 3: Political Gridlock Can Be Broken by Creative Policy—Not Just Power Shifts

A common argument in political economy is that entrenched elites often block efficient, growth-oriented policies because they fear losing their political power. If a new policy threatens their position, they will fight it, even if it benefits society as a whole. This creates a state of permanent gridlock where progress is impossible.

Rodrik offers a more optimistic counter-argument, introducing a concept he calls the “political transformation frontier”—the set of maximal economic outcomes elites believe they can achieve without losing power. The standard view assumes this frontier is fixed. But Rodrik argues that new policy ideas can shift the entire frontier outward, creating win-win scenarios that allow for progress without directly threatening elite power. The key is not to overpower the elites, but to reframe the problem with an innovative solution.

China’s “dual-track” reform is the prime example. In the 1970s, liberalizing agriculture would have created huge efficiency gains but destroyed the state’s tax base. Instead of abolishing the old system, Chinese leaders grafted a market system on top of it. Farmers still had to meet state grain quotas at fixed prices, but they were free to sell any surplus on the open market. This creative idea allowed China to gain the benefits of market incentives while protecting the rents and power of the state sector. The Communist Party was strengthened, not weakened.

This principle is a recurring pattern, not a one-off. A similar dynamic played out in Japan after the Meiji restoration. There, elites spurred industrialization but designed it in a way that would “strengthen the centralized government and increasing the entrenchment of bureaucratic elites.” In both cases, a creative idea allowed elites to pursue economic gains not as a threat to their power, but as a means of consolidating it. This takeaway has an optimistic implication: many political problems that seem impossible may be solvable with the right innovative idea.

Conclusion: It’s the Ideas, Stupid

The traditional view of politics as a raw contest of vested interests is compellingly simple, but ultimately incomplete. Interests are not fixed, pre-ordained forces. They are shaped and defined by ideas—ideas about our identity, ideas about how the world works, and ideas about what is possible.

As Rodrik’s work powerfully argues, the failure to see the role of ideas leads to a pessimistic and static view of political change. By putting ideas back at the center of the analysis, we see that political outcomes are not inevitable. The source text concludes with a thought that perfectly captures this shift in perspective:

“What the economist typically treats as immutable self-interest is too often an artifact of ideas about who we are, how the world works, and what actions are available.”

This leaves us with a final, crucial question. If ideas are this powerful, perhaps the most important political question isn’t just ‘who has power?’ but ‘which ideas will define our future?’

Capital requirements – looking past the numbers

Too often I see discussions of capital requirements reduced to simple comparisons of nominal factors like risk weights and capital ratios. This is particularly the case when looking at the impact of these factors on competition between large and small banks.

This post by Cetier1 uses New Zealand data to highlight the discrepancy between official requirements and market-driven behavior. It argues that while regulatory capital requirements set a floor, the market’s perception of risk and return ultimately dictates banks’ actual capital levels. Cetier illustrates that smaller banks often hold significantly more capital than required, while larger, “too big to fail” institutions may hold less, suggesting the market’s acceptance of their lower ratios.

Finding ways to help smaller banks compete with the big banks remains a worthy objective but this I think offers a useful reminder that risk weights are just one part of a complex topic.

Tony – From the Outside

Stablecoin crossover with mainstream finance grows

Unfortunately most of this post by Marc Rubinstein is behind a paywall but the free to read component offers a useful summary of areas where stablecoins are starting to extend their utility into conventional areas of payment platforms and not just being a vehicle for trading crypto.

Personally I have no interest in crypto trading and I still find the instant payment capabilities provided by my (Australian) bank to be more than adequate but this is a development worth keeping an eye on

I may be missing something – let me know

Tony – From the Outside

Moneyness: Trump-proofing Canada means ditching MasterCard and Visa

I am a banking nerd I fear but the mechanics of payment systems is actually more interesting and important than I think is widely understood. I for one am regularly learning new insights on how the payment systems we take for granted actually works.

— Read on http://www.moneyness.ca/2025/03/trump-proofing-canada-means-ditching.html

Tony – From the Outside

Before monetary policy was king

We seem to take it for granted but this post by JP Koning on his Moneyness blog is a useful reminder that the reliance on Central Bank independence and interest rates as our main tool of monetary policy is a relatively new phenomenon.

The post discusses some economic policy experiments undertaken by some European countries post WW2 that took a radically different path. He also identifies some interesting parallels with the challenges we faced as we emerged from the COVID lockdowns.

Here is a flavour of the post

“In times past, central banks tended to lean heavily on changes in the supply of money, which may explain why in 1945, their main response — in Europe at least — was to obliterate the public’s money balances rather than to jack up interest rates to 25% or 50%.”

Read the whole post here

http://jpkoning.blogspot.com/2024/11/setelinleikkaus-when-finns-snipped.html

In the interests of full disclosure, I am an avowed fan of economic history but this is worth reading.

Tony – From the Outside

APRA proposes to simplify the capital adequacy framework by phasing out Additional Tier 1 (AT1)

APRA recently announced that it had concluded that AT1 instruments had not been shown to act effectively in a going concern scenario and were worse than Tier 2 capital in a resolution scenario leaving it with three choices:

  • Maintain the status quo while monitoring to see whether a solution emerged from international developments (either Basel redesigning the instruments or some kind of market solution)
  • Unilaterally redesign AT1 to make it more effective in Australia via some combination of a higher trigger for conversion, a new discretionary trigger and/or restrictions on the investor base
  • Simplify the capital adequacy framework by replacing AT1 with Common Equity Tier 1 (CET1) and/or Tier 2

APRA summarised their conclusion in favour of the “Simplify” option as follows:

“Replacing AT1 with more reliable forms of capital will enable banks to more quickly and confidently use their capital buffers in a crisis scenario and is expected to reduce compliance costs for banks. It will also strengthen the proportionality of the prudential framework by embedding a simpler approach to capital requirements for small and mid-size banks compared to the new requirements for large banks,” Mr Lonsdale said.

Under APRA’s proposed approach:

  • Large, internationally active banks would be able to replace 1.5 per cent AT1 with 1.25 per cent Tier 2 and 0.25 per cent Common Equity Tier 1 (CET1) capital.1
     
  • Smaller banks would be able to fully replace AT1 with Tier 2, with a corresponding reduction in Tier 1 requirements.

One thing we can all agree on is that phasing out AT1 does make the framework simpler, I have questions though:

  1. How does removing AT1 makes it easier to use capital buffers in a crisis?
  2. Does the option to convert to CET1 have no value in a going concern scenario?
  3. Just how risky are these AT1 instruments from an investor perspective?
  4. Will the debt market happily accept the smaller banks switching from AT1 to Tier 2 (i.e. if the debt market and rating agencies do see some value in having AT1 then will the smaller banks be required to hold CET1 instead)?
Does removing AT1 make it easier to use capital buffers in a crisis?

APRA questions whether AT1 discretionary distributions will in fact be cancelled when a bank is under stress and losses are eating into the capital buffers because “… the market signal effects from canceling distributions are considered more detrimental than the minor benefit of additional financial support“,

I don’t disagree that adverse signalling is a concern with any capital management action but I am not sure that this particular example is as big an issue as it is presented to be. This is partly because the dollar value of the AT1 distributions is so small that they don’t really help very much. By all means suspend them at the time that ordinary dividends have been suspended completely but otherwise respect the seniority of these instruments in the capital stack and loss hierarchy.

This brings us to adverse signalling concern that seems to be a significant factor in APRA’s analysis. Clearly you can cut ordinary dividends without the adverse signalling constraint so why is this a problem for AT1 distributions?

  • I suspect the problem is that the seniority of AT1 to CET1 creates the reasonable expectation on the part of AT1 investors that ordinary dividends should be required to do the initial heavy lifting on loss absorption and capital conservation and that AT1 distributions should come into play only when the ordinary dividend is cut to zero
  • APRA itself also acknowledges that the actual financial support created by cancelling the AT1 distributions is “minor” which begs the question why should the A1 distributions be cancelled when the loss absorption and capital conservation requirements can be easily achieved by increasing the reduction in ordinary dividends.
  • Once you get to the point where ordinary dividends are completely cancelled, there is room for AT1 distributions to be cancelled as well without the adverse signalling concern, especially if the bank is reporting losses.

Sometimes this is not the way it has played out. Part of the reason that this logical, predictable hierarchy of loss absorption can be disrupted lies I think with the overly complex way that the Capital Conservation Ratio (CCR) is applied. An explanation of why the CCR is overly complex is a whole topic in itself that I will leave for another day. The people who best understand this point are those working in stress testing who have had to calculate the CCR in a stress scenario (you really have to get into the detail to understand it).

The CCR issue could be addressed by simplifying the way it is calculated and I imagine there would be broad agreement that simplicity is always a desirable feature of any calculation that has to be employed under conditions of stress and uncertainty. The main point I want to make is that “simplifying” the application of the way the CCR is used to conserve capital might be a useful place to start before you decide to get rid of AT1 completely.

The bigger question I think is whether the option to convert AT1 into common equity has no value, either in a going concern scenario or in resolution.

APRA argues that

“Rather than acting to stabilise a bank as a going concern in stress, international experience has shown that AT1 absorbs losses only at a very late stage of a bank failure. … If AT1 was used in Australia APRA considers it would not fulfil its role in stabilising the bank before non-viability was reached.” 

In one sense, late conversion is a feature as opposed to a bug in the design of AT1 instruments. They are designed to convert as a last resort when the 5.125% CET1 Point of Non-Viability is crossed so it should not be a surprise that they convert relatively late in a stressed scenario. Perhaps more importantly the conversion option is calibrated to a point where a bank has run through the standard set of options for conserving and rebuilding capital buffers.

APRA acknowledges that the trigger could be set higher so that conversion happens earlier but asserts that “... this could undermine recovery plan actions and the usability of capital buffers“. So far as I could determine, the only reason cited to support this conclusion is that “A higher trigger, if exercised, may operate as a negative signal to the market at the very time when regulators are aiming to restore confidence“.

The statement regarding market signals is interesting. The conversion trigger, wherever it is set, is something that the “market” is well aware of, so the potential for adverse signalling seems to imply that the situation in the bank is much worse than was commonly understood by the market. If that was not the case then conversion is simply an outcome that the market should have been anticipating. A related concern for APRA is that international experience has shown that banks have failed with CET1 ratios much higher than 5.125 per cent, further reducing the potential value of the PONV trigger in their eyes.

It is obviously true that banking has an unfortunate history of seemingly solvent banks very quickly being found out not to be solvent (or maybe just perceived to be insolvent – much the same thing in practice), let’s call this Scenario 1. This still leaves a lot of other scenarios in which a bank has taken a large hit and just needs an infusion of new common equity to rebuild and survive.

Remember that APRA is proposing to replace 1.5% of AT1 with .25% of CET1 (and 1.25% of T2) for the big banks, while the smaller banks simply swap AT1 for Tier 2. For the bigger banks, the extra 0.25% CET1 arguably makes no real difference to the outcome for a Type 1 scenario, but a bigger block of convertible capital could be useful in the other adverse scenarios. For the smaller banks, they just have less options. So the capital framework proposed by APRA is simpler for sure but it is not obvious that it is better.

A related question is just how risky are these instruments from the investor perspective

The theory is that AT1 should be less risky than common equity because they pay investors a predetermined income distribution and have a more senior position in the loss hierarchy. Clearly we are all comfortable with retail investors holding common equity so in theory it should be ok for them to invest in something less risky.

This nice theoretical framework can get a bit messy in the real world for a couple of reasons:

  • Firstly, the CCR as currently implemented can result in AT1 distributions having to be cut in conjunction with the ordinary dividend thereby disrupting the simple hierarchy in which AT1 only comes into the frame once cutting the ordinary dividend has totally exhausted its capacity to satisfy the CCR
  • Secondly, there have been instances in which loss absorption has been achieved by the write down of the AT1 instrument rather than by conversion to common equity (thereby absorbing loss in a way that benefits common equity at the expense of AT1 investors and violating the loss hierarchy benefits that the AT1 investor though they were paying a premium for.
  • Even if conversion does play out as expected, there remains a risk that the value of the ordinary shares received on conversion continues to fall before the AT1 investors can convert them into cash. Indeed, the simple fact that a block of shares is being issued to investors who are not long term holders can itself contribute to a decline in the share price.

Most of these problems (not all) seem to be fixable:

  • Simplifying the way in which the CCR must be met would help reduce the potential for AT1 distributions to be required to absorb loss sooner than would be expected under the principle that AT1 ranks senior to ordinary equity
  • Similarly, loss absorption at the PONV can also be implemented in ways that respects the hierarchy of loss that AT1 investors believed they had contracted to. I am open to someone making the case that the option to write off AT1 has some value but mostly it just seems to introduce complexity and raise doubts about the seniority of the AT1 instruments.

The potential for AT investors to receive less than par value via the conversion is I think a risk that can’t be eliminated but I am not sure that it need to be eliminated. In the event that the shares received on conversion are sold for less than the conversion price, AT1 investors are still likely to have realised lower losses than those experienced by ordinary shares under the same scenario. Investing at this end of the capital stack is about relative risk and reward, the real question is whether the risk is correctly valued.

It is possible that APRA still concludes that retail investors are unable to accurately assess and price the risks. In that case, you retain the option of restricting the sale of the instruments to sophisticated investors and institutional money. That seems to me like a perfectly reasonable compromise that retains the useful features of these AT1 instruments. I just don’t see that the case has been made to completely eliminate the options that AT1 offers.

Last, but not least, we come to the question of what the debt market thinks about the proposal for smaller banks to completely replace AT1 with T2.and perhaps more importantly what do the rating agencies think?

I have to confess that I don’t know. It does seem to me however that something is being lost. The consultation on the proposal is currently open and more informed minds than my own will I hope be addressing that question in the feedback they offer.

I am speculating here but the only way that I can rationalise the policy option proposed by APRA is that they have concluded that the CET1 levels they have established in response to Unquestionably Strong target set by the 2014 Financial System Inquiry have rendered other forms of “going concern” capital redundant. The rating agencies will clearly have an opinion on this question.

I have been a long way from the front line on these issue for some time but that is my 2 cents worth – as always please let me know what I am missing.

Tony – From the Outside

Japanese housing

At face value the value of Japanese housing might appear a bit off topic for an Australian based banking and finance blog. I believe however that anyone interested in banking probably needs to understand the economics of the housing market in which the banking system operates. Housing affordability is also a recurring topic of debate in Australia without much evidence the problem is being resolved.

With that bit of context, I offer up a post that Noah Smith wrote in response to an essay written by the BBC’s outgoing Tokyo correspondent reflecting on his time in Japan. Noah’s over-riding argument is that Japan is not as stagnant as the BBC correspondent contends. He makes a number of counter arguments but the one that caught my attention is his assessment of the Japanese housing market.

Noah notes that the BBC correspondent opens his article by complaining that Japanese houses tend to depreciate instead of appreciate:

In Japan, houses are like cars.

As soon as you move in, your new home is worth less than what you paid for it and after you’ve finished paying off your mortgage in 40 years, it is worth almost nothing.

It bewildered me when I first moved here as a correspondent for the BBC – 10 years on, as I prepared to leave, it was still the same.

Japan was the future, but it’s stuck in the past

Noah argues that what appears like a problem to someone who is accustomed to expect that house prices should always go up is in fact a strength of the Japanese system …

Weirdly, this is presented as a chronic problem — something Japan should have fixed long ago, but hasn’t. But in reality, depreciating real estate is one of Japan’s biggest strengths. Because Japanese people don’t use their houses as their nest eggs, as they do in much of the West, there is not nearly as much NIMBYism in Japan — people don’t fight tooth and nail to prevent any local development that they worry might reduce their property values, because their property values are going to zero anyway.

As a result, Japanese cities like Tokyo have managed to build enough housing to make housing costs fall, even as people continued to stream from the countryside into the city.

Increased supply is often talked about as a big part of the solution to the housing affordability problem in Australia. Depreciating real estate is clearly not something that the Australian public is going to embrace any time soon (at least not until the political power of renters outweighs home owners) but the Japanese model is interesting none the less if only to see how a society functions under this model.

Tony – From the Outside

Stablecoins – what are they good for

Not a fan of crypto but this Odd Lots podcast offers a concise update on the use case for stablecoins.

Also concludes with an interesting summary of three things that crypto tends to mis about conventional finance, banking and money

omny.fm/shows/odd-lots/the-booming-crypto-use-case-thats-happening-right

Tony – From the Outside

Moneyness: Monetagium

JP Koning is a regular source of interesting insights into the history of money. Here he delves into the history of currency debasement as a form of taxation and how rulers figured out better ways to extract the revenue they wanted. The analogy with the Mafia is a nice touch.

— Read on jpkoning.blogspot.com/2024/05/monetagium.html

Tony – From the Outside