Only $4.2 Trillion has been spent so far. $13 trillion is committed, and most of it won't ever be spent if the economy recovers. If the US economy doesn't recover, then inflation will be an even lower concern than than it is now.
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
We are talking instead about capital productivity -- a return on investment in physical capital. And that is a problem that is entirely solved by simply lowering the costs of investing by reducing the prices of physical assets -- a crash.
There will certainly be more assets that are written down, but that does not mean that they are still over-valued. It just means that the market has overshot the equilibrium on the way down, as the famous international economist Rudiger Dornbusch explained in a seminal paper years ago. It just means that the current, risk-averse market can't value future income from capital investments as highly as it should. It is the opposite of what was happening during the last few years when the market was overvaluing the expected future income to be generated from capital investments, driving asset prices higher and influenced by too much buying power through credit in the hands of the capitalist elite.
How would central control be worse than this?
And besides - you already have central control. It's just not democratically accountable.
it's aready top down central control in everything but name, and to really twist it round that's what they holler we should be terrified of.
it reminds me of beck and crew railing that obama's getting ready to put anyone who doesn't wanna be a socialist in FEMA camps, when anyone with a brain cell left knows those were built by reichwing nazis to put anyone who did want socialism in.
mindfuck city, do reptiles ever rest? ~Government budget deficits are not nearly as dangerous as the deficits we have created in vital and complex natural systems.~ Naomi Klein.
But general statements can't be analysed, so let us look at a simple example. There are 10 hungry people, and one cake. Let's see how various allocation solutions fare. These are simple ones I thought up in one minute, no doubt there are others.
a) Market solution: the price of the cake rises until only one person can afford to buy it.
b) Political favoritism solution: the president's nephew gets the cake.
c) Rationing solution: the cake is cut into 10 pieces and everyone gets 1 piece.
d) Round-robin solution: people are numbered from 1 to 10, and whoever's turn it is gets the cake.
Now all these solutions have upsides and downsides, yet I don't see how you can single out the market solution as superior. In cases a), b), d) only one person gets the cake. In case c), everyone gets a small piece, although as a result the potential of having a full cake is not realized since it has been deliberately destroyed.
If you repeat this toy problem several times, in case a) always the richest person gets the cake. In case b), it's always the nephew. In case d), everyone gets the cake 1/10 of the time. Politics only enters as a parameter in case b). Only cases c) and d) above ensure that everybody eats some cake. Case a) converges to case d) in the special case that everybody is comparably rich and the cake costs so much to buy that the person who buys it becomes relatively poor. If however the cake price is small in comparison to a person's wealth, then the same person always gets the cake for a very large number of replications. -- $E(X_t|F_s) = X_s,\quad t > s$
Are markets always good allocators of resources? No. In fact there are almost always problems with them. But the bigger problem is that it just can't be shown that, except in very specific conditions, any other system can allocate resources as efficiently as markets -- only more equitably if some assumptions about equity are agreed upon beforehand, which is almost impossible to do in itself.
So I'm on pretty safe intellectual ground with the general statement that, as of now, no system has been discovered that can better allocate social resources than a market system, and that's one reason why that system has caught on so well throughout the world in the last 200 years.
Nobody (neither am I) is claiming that market systems aren't widely studied, although how you leap from study interest to (quasi?) unanimous support against alternatives is beyond me.
What I'm pointing out to you is that you're making wild and unsupported claims about the optimality of market mechanisms versus all alternatives, yet you haven't given one shred of proof, or even qualified your claim by pointing out the underlying axioms sine qua non those kinds of optimality claims are meaningless.
I've given you a toy problem that you should have been able to pick apart like a hungry dog a bone, but you respond with generalities and yet another claim that markets are superior in all except perhaps very specific conditions. When was the last time you actually proved something? Most people I know need lots of assumptions to prove just about anything, but admittedly they're not Nobel Prize material.
So I'm on pretty safe intellectual ground with the general statement that, as of now, no system has been discovered that can better allocate social resource than a market system, and that's one reason why that system has caught on so well throughout the world in the last 200 years.
(*) No, I'm not picking on you, but I am picking on your argument. -- $E(X_t|F_s) = X_s,\quad t > s$
I didn't address your "toys" because I thought you were being rhetorical. Yours is the game introduced by radical political scientist Deborah Stone (I'm a fan), but you've exaggerated and misstated the game. Her purpose was to show how images of fairness can be confused around arguments of efficiency and equity, like you have, and exploited for the purposes of power -- the surrender of individual interests to those of a group. But to play it honestly, you need to allow the cake to be subdivided in any scenario, not just the rationing one.
The market solution, once allowing for subdivision of the cake into portions like you do with the rationing solution, can always be shown to be the most efficient because it's the only scenario that allows individuals with enough power to determine for themselves how much cake they really need relative to other things they might have. If a person has nothing to exchange for cake or anything else, then the person won't get anything, but that's still an efficient outcome, which is the only thing I've argued. It's not an equitable outcome, however.
The political favoritism solution is also misstated relative to the other solutions. Once subdivision of the cake is allowed, political favoritism becomes the most general solution, and it can be shown that the market solution is a subset of the political favoritism solution. It is not as efficient as the market solution because individuals can no longer be assumed to have enough power to determine their own needs for cake relative to other things, because constant rights to exchange can no longer be assumed - those rights are now dependent upon political contest, and a political (i.e. group) authority can shape individuals' preferences for cake, which means that the resulting allocation is necessarily less efficient than a market allocation where people have unchecked power to determine their needs relative to what they have.
c) Equal rationing: It is neither as efficient and only by chance more equitable than a market. It is another subset of the political favoritism solution but in this one people are assumed to have equal needs for cake. A more equitable AND more efficient solution would be "each according to his need." But need can only be determined subjectively, which only the market or open political contest allow for.
d) Round robin. Again, this is only an attempt to address equity, not efficiency. It substitutes chance for need, which means it is both less efficient and almost certainly less equitable than a market solution.
Once subdivision of the cake is allowed, political favoritism becomes the most general solution, and it can be shown that the market solution is a subset of the political favoritism solution. It is not as efficient as the market solution because individuals can no longer be assumed to have enough power to determine their own needs for cake relative to other things, because constant rights to exchange can no longer be assumed - those rights are now dependent upon political contest, and a political (i.e. group) authority can shape individuals' preferences for cake, which means that the resulting allocation is necessarily less efficient than a market allocation where people have unchecked power to determine their needs relative to what they have.
Markets are social constructs. Individuals can never be assumed to have enough power to determine their own needs and preferences independent of group authority and political context (nevermind right to exchange...). Someone always has "market power," because markets are a social construct.
Economic models ignore this very basic fact about markets at the peril of talking nonsense.
That's where the work of Stiglitz (hardly a pro-market economist) is important. While showing that market-based policy frameworks are probably greatly flawed, even in efficient allocations to say nothing of equitable allocations, because of the information asymmetry problem he also shows that none of the other policy frameworks for allocating resources thus far observed in any society will be able to be more efficient than a market-based solution in general. (There are very specific exceptions, such as health care, for example.) Why? Because instead of better solving the information asymmetry problem they tend to exacerbate it by removing more sources of truth from the system rather than adding more sources of truth to it.
Take, for instance, the scenarios above in martingale's cake distribution game: in scenarios b,c,and d, the information asymmetry problem is worsened, not improved, so the solution MUST be less efficient, except by dumb luck. In b, the political solution without providing for a market to determine who really needs the cake will only determine what the political authority determines the need is, through some non-exchange contest of some kind. In c, information is also restricted by assuming that everyone needs one piece of cake. Likewise in d, where information is restricted entirely to chance. Only in a market solution that provides for aportioning the cake can efficiency be better ensured than any other system.
Markets fail to exist when trust is sufficiently impaired, as the recent financial market problems have proven. So the fact that markets do exist in various commodities is evidence that a degree of reflexivity and honesty has already become well developed.
Among the market participants. Many people who are part of an industrial monetary production economy are not a part of any market, under this definition. On the labour "market," for instance, individual workers cannot be considered "market actors" - their relationship to their place of employment is more akin to that of feudal serfs to their landlord than it is to a buyer or seller at an auction. Which is to say nothing of the people who are touched by the externalities of market actions.
None of these people need to trust the market actors in order for markets to form, so market actors do not need to show them honesty and reflexivity.
Markets are not at all perfect or optimal because there are always some stakeholders excluded. However, markets are still able to include MORE stakeholders and provide more truthful information about the stakes than other means of determining who gets what in society, which means they're more efficient.
Regarding labor markets, I think you're being too harsh on life of serfs. There's actually little basis for saying that life is any better today for commoners than it was then for commoners in feudal periods, except in absolute material goods (which, for many, is everything of course). As the eminent economic historians Fernand Braudel and Karl Polanyi have written about at length, serfs may have been more or less tied, on the one hand, to the land they were born to (and with immigration restrictions today, has that really changed?), but on the other hand, state-level political authorities had almost no role, least of all economic, in their lives which revolved almost entirely around communal and family-level production and distribution. State power intervened in trade, not in production, most of which was agricultural.
Quite true about externalities and market failures. However, that only addresses what's wrong with markets, not what's right about any other system. Externalities are also a problem in ANY system of figuring out who gets what in society, and, because of the information asymmetry problem, a system that restricts sources of true information can almost never be better at accounting for externalities than a market-based system.
Bluntly put, Joe Q. Median has a vote in a parliamentary system. In a great many parts of the political economy, he has no vote under a market system, because Joe Q. Median is not a market actor. So for the majority of the population accountable democratic government is superior to market economics simply on the count that the latter disenfranchises them while the former does not.
A lot of successful regulation is about cutting the big market players down to a size where Joe Q. Median can become a genuine market player. But this requires continual political vigilance, because markets are better at forcing market actors to cease being market actors than they are at making room for new market actors.
And then of course there are the sectors where there can be no "market" because the logistics of the production won't permit it. That could be due to the returns on economics of scale being sufficiently high that any gains from market forces would be offset by the cost of maintaining sufficient numbers of separate systems to have a meaningful market. Or it could be due to the risk of cascading failures making the independence of market actors impossible. Or it could be due to the ability of large market actors to take the political system that maintains the market hostage. Or some combination.
You are still being too broad for my liking, although I expected that you would be: If you frame every question in the form of a market allocation problem, then you can certainly claim that market mechanisms are the right things to look at and their optimization is key, but the price for this generality is that your initial formulation is artificial and has inbuilt structural assumptions which can be widely off reality.
As a vivid example of this, a few years ago some economists proposed market based solutions against the (then highly publicised) email spam problem. To paraphrase and cut a long story short, in paper after paper, they proposed that provided a market could be formed, the preferences of email users and spammers would both be served well. This was of course ludicrous to all the engineers, as it not only failed to address the issue that spam is fundamentally unwanted in an absolute sense, but the implementation of such a market would face insurmountable technical complications of identitification and trust against which merely solving spam would be easy.
One anecdote does not of course make a law, but I find it quite entertaining that market formulations (and thus, market-based systems) should have relevance outside of (what I would consider) a rather narrow area of the sciences. Another recent concept which always makes me chuckle is the "stock market of ideas", but I digress.
In your responses to the cake problem, you rely on subdivision to formulate a modified market system that can represent the other approaches I outlined. It is trivial to claim from there that if one of my so called solutions is representable as a configuration in some such market (with certain unstated assumptions), then an optimal solution within this formulated market cannot be worse than mine. However, this does not actually compare the two approaches to the cake problem on equal terms.
If you allow subdivision in your alternative market formulation and wish to simulate the same outcome as (for example) rationing, then your first difficulty is to make the subdivision occur through the market mechanism. If the cake is initially whole, some player must first acquire it (whole) or some player starts off with the (whole) cake as a given. This player then must be enticed to subdivide it for selfish reasons, that is, according to their individual preference. In the market, this requires an incentive (perhaps a monetary premium) which other players must supply to obtain their piece of cake.
However, rationing needs no such premium since the subdivision is imposed, ie as a specific alternative to having a market in the first place. Equivalently, the players obtain their piece of cake without exchanging something for it, that is, the last owner simply divides the cake for zero market incentive. Needless to say, this doesn't happen unless you suppose eg altruism or some degenerate preferential function. Thus, in the normal case one can expect that the rationing configuration is simply unreachable.
You might also point out that a subsequent market can or will form off the rations, which would be subsumed in the proposed market replacement of rationing. However, this is false, for the same reason as above. Unless you can guarantee that all the players can traverse at some time, through market forces, a simultaneous configuration which is identical to the one represented by rationing, then you don't know that rationing followed by a subsequent market is truly equivalent to an initial market without rationing.
Now if you accept that the true rationing configuration is unreachable, then you have no real basis for comparing it with the (or a) market optimum. Your claim of efficiency is therefore also in trouble. The best you can do is compare with a case where players are initially poorer, having already exchanged something for their piece of cake. Alternatively, you would have to adjust the comparison by crediting everyone except the owner of the cake with an amount equal to the premium required for the subdivision, although I doubt this would technically give the right answer.
The mere existence of the market has therefore imposed a cost, when compared with a non-market solution as above. Note that I'm talking about the players only, if you wish to account for the cost of distributing rations, then you would also have to account for the cost of setting up, and continually policing, the proposed market, etc. This would quickly get complicated, which is hardly a recipe for convincing great numbers of people.
So where does the claimed superiority of markets stand? -- $E(X_t|F_s) = X_s,\quad t > s$
Look at it this way:
Assumptions: People have different preferences for cake relative to other things and people have some initial endowment of other things. (These are pretty reasonable assumptions.)
Definition: Efficiency is greater (meaning that people are better off) where people's endowments of cake and other things better match their preferences. The sum of the differences between final endowments and preferences for them is total social inefficiency.
Question: Under what conditions will rationing an equal portion of cake to each person better match their preferences than allowing people to exchange their initial endowments for portions of cake? In other words, when will total social efficiency under central rationing be less than under a system of trading things for portions of cake?
I believe the answer to that question, provided all trivial issues of equivalency are taken care of (such as by assuming zero costs, disinterested initial government distribution, etc.) is that rationing will be better only if, by sheer dumb luck, it turns out that each person's preference for cake relative to other things is the same. In such a case there are no possible gains from trade and people can be made better off ONLY by giving them more cake or other stuff.
(The mathematical proofs for this are provided in the first and second fundemental theorems of welfare economics, which of course include the very narrow assumptionis of perfect information, no externalities, etc. But the fact that those assumptions don't occur in the real world does not mean that markets are inferior to other allocation methods, particularly on the scale of large societies. Rather, they just provide the conditions under which it is possible to argue that non-market allocation methods might be better in specific cases.)
It can be instructive here to relax the assumption of rationing equal portions of cake. Let's say that the agent in charge of rationing is smart enough to know what each person's preferences for cake are and that there is enough cake to fill each preference. Then it is also possible that rationing will be more optimal than trading.
This leads to the question: Under what conditions can a central, distributive political authority in charge of rationing be trusted to have better knowledge about the preferences for cake and other stuff than a system that allows at least some feedback of preferences from consumers?
Looked at this way, you can certainly find cases where it is not possible to say that markets are more efficient than central rationing, but I think it would be unreasonable to use those cases to argue against my claim of the general (not specific or always) superiority (to date) of societies organized around market mechanisms for allocating things over other systems yet attempted (as opposed to merely theororized). Getting feedback is usually a necessary part of optimizing distribution, so a superior system than markets must show a better way of providing such feedback in a complex social system.
I disagree with the way you phrase the question: The fundamental theorems do not actually help in comparing any two specifically given allocation systems or algorithms. In this case, the generality they claim is misleading.
Let v be an initial allocation of goods, and let's use those theorems to obtain a maximally improved allocation which I'll write as f(v). (Improvement in any sense you like, eg total social efficiency. This leads to a comparison operation which I'll write >= ), The only thing I care about is that f(v) can be obtained through a sequence of trades starting from v, and if there are several possible f(v), we'll just pick one or if you like we can refer to all of them as f(v). Thus there is a real humanly implementable algorithm to arrive at f(v) from v, and I'm not trying to be tricky.
Now as long as you can represent the outcome of an allocation algorithm as a vector v, then you know that f(v) >= v. So naively put, one can say that optimal allocations are always achievable as the result of market mechanisms, therefore there's no need to consider non-market mechanisms at all. (I think that's what your point of view is more or less.)
BUT, this is not the real question. The real question is: If you have two algorithms, which respectively achieve the allocations v1 and v2, then what can you say about v1 compared with v2? In the rationing example, v1 = the uniform cake subdivision, and v2 = f(w), where w is the allocation where one particular individual owns the whole cake.
Now the fundamental theorems tell us that f(v) >= v for all v, which is great, but irrelevant. We actually want to know does v1 >= v2 or v2 >= v1 ? (since those are the outputs of the rationing algorithm v1 = Ration(w) and of the market algorithm v2=f(w) respectively).
Now in general, it's not possible to calculate the comparison of v1 with v2. There are very few general methods that can settle this sort of question. One is to say that there is a unique optimum. In that case f(w) >= v for all v trivially, in particular f(w) >= v1. But a system with a single global equilibrium is pretty rare. Another method is to say that there is a sequence of trades w->v1, in which case we can claim f(w) = f(v1) and so v2 >= v1. But this too is far from obviously true [this is my longwinded method above].
So I consider the question v2 >= v1 as undecidable in general, and even more so if one decides to apply market dynamics to questions which arise in other fields. One can certainly formalize some sets of preferences and impose conditions on the dynamics of some players until the market formulation coincides with the question one wishes to solve, but in so doing even the weak assumptions in the fundamental theorems are likely to be violated, and certainly one has to presume that there will be many equilibria and degenerate effects.
Note that it is not even clear that f(w) >= f(v1), where f(v1) is the output of an initial rationing step v1 = Ration(w) followed by a market trading step. We simply don't know if w and v1 both belong to the domain of attraction of the exact same equilibrium, or what the actual relationship between the two target equilibria might be otherwise. -- $E(X_t|F_s) = X_s,\quad t > s$
Another method is to say that there is a sequence of trades w->v1, which case we can claim f(w) >= f(v1) and so v2 >= v1.
It is quite true to say that I can't compare a rationing outcome and an auctioning outcome unless both outcomes are optimizing over the same criteria, which is given, a priori, by what one believes matters in life in the first place. That is why we can never say that capitalism is better than feudalism, or that either of those social systems is better than the social systems of ancient Mayans, Aztecs, or preent tribal cultures in the Amazon, for example. Different things were or are deemed important to different people.
However, different forms of capitalist social organization, as well as communist or socialist forms -- examples of what anthopologists call "modernity" -- all occur within the basic utilitarian framework of the world. That is, all "modern" means of organizing society, like both Adam Smith and Karl Marx, all agree that "better" can be reasonably defined as achieving a closer match between what people want and what they ultimately get. Outside of modernity, we can't compare rationing to markets, but inside we can by arguing around efficient and equitable solutions -- how much there is, and who gets it.
It is not at all as trivial, mathematically, as you claim, even if you accept my premise of efficiency as a definition of better, principally because there is no way to say that efficiency has more claim than equity, which means that markets, themselves, cannot achieve socially optimal outcomes, because markets have nothing to do with equity, which is a value determined as subjectively as efficiency but over different objectives. However, we can still conclude empirically that social systems that share honest information about real wants and real resources are likely to be superior within the parameters of modern society to social systems that restrict such sharing of information. I advance that markets, combined with democratic governance structures, are more likely to provide a socially desirable allocation of resources given conditions of modernity, than other allocation systems and governance structures.
Are there possible exceptions or significant problems and even contradictions with markets? Of course there are. But given the currently observable counterfactuals -- fascism, authoritarian socialism (e.g. Venezuela vs. Brazil), communism, for example (let me know what I'm missing) -- can you honestly argue that other social systems have not proven inferior to markets?
Certain kinds of markets are good at doing certain things, just as certain kinds of government structures are good at doing certain things. Broadly speaking, markets appear to be good at providing material goods that individually take up a small fraction of the median income, have a respectably high turnover within the lifetime of a single individual and are reasonably easy to transport from one place to another.
OTOH, markets are exceedingly poor at making infrastructure that actually works (education, electricity, trains, payment clearing systems, pensions). And markets are completely unable to allocate non-local costs (systemic risk, cascading failures) and long-term costs (environmental destruction, resource depletion, failures due to insufficient maintenance). Or at least markets do not seem to be able to allocate those costs in a way that does not threaten to destroy the social structures that enable markets to exist.
Goods with moderately high turnover but which are largely immobile and take up a large fraction of the median income (real estate, mainly) have decidedly mixed empirical results for markets compared to central planning.
That there is a private real estate market beside the government pool does not detract from the fact that the government housing is centrally planned according to criteria that have to do with social policy, city planning and similar criteria.
Examples of centrally-planned, non-market housing that immediately come to mind in otherwise market-based societies are state-run prisons, some mental health institutions, military barracks, and some refugee camps. It's centrally planned if there are no choices and exchanges involved on the part of the receiving agents.
The council owns over 5,000 properties that are rented to tenants. We provide services to tenants including housing repairs and providing a local neighbourhood manager. In this section of the website you can apply to join the housing register or to move between council houses, pay your rent online, have your say in tenant participation, plus other services. We are introducing a new choice-based lettings system and also administer the council tenants' right to buy scheme. Also see the housing advice section for information on sheltered housing, emergency accommodation and other ways we support the housing needs of the district.
The council owns over 5,000 properties that are rented to tenants. We provide services to tenants including housing repairs and providing a local neighbourhood manager.
In this section of the website you can apply to join the housing register or to move between council houses, pay your rent online, have your say in tenant participation, plus other services.
We are introducing a new choice-based lettings system and also administer the council tenants' right to buy scheme.
Also see the housing advice section for information on sheltered housing, emergency accommodation and other ways we support the housing needs of the district.
In fact, if you are going by that definition of "market," any reasonably industrialised country with even a half-evolved monetary system qualifies as a "market economy." I fail to see how that is helpful to a political or economic analysis that deals with a tolerably technologically sophisticated society.
You are arguing, unless I'm missing something, that I can't define "better" as the minimization of preferences and actual outcomes.
My own argument above is purely mathematical, and applies with *your* definition of what is desirable. While I personally don't care what function is being minimized, I am happy to work within your framework exclusively. Thus: let's completely ignore the social dimension.
All my argument uses is that there may be several distinct equilibria in a market, which are implied by the preferences (fixed once and for all). If you begin with some allocation vector, then market dynamics will converge (under appropriate conditions...) to some equilibrium vector. I also grant you that. The identity of this equilibrium vector will depend upon the starting point. Two distinct starting points may end up in two distinct equilibria. If you do not agree, say so now.
Maybe I should answer your previous question at this point.
I don't have a more complete solution of this problem at this point, but neither do you(?) of the converse:
Question: If I give you two arbitrary starting points (initial endowment distributions), can you predict which starting point leads to the smaller total social inefficiency? Alternatively, if I give you a single starting point, can you describe all starting points which either 1) have a greater social inefficiency than the particular equilibrium vector reached by the first point, or 2) reach some equilibrium whose total social inefficiency is greater than the total social inefficiency of the particular equilibrium reached by the first point.
I believe you cannot, in any practically useful sense. For example, if I propose an actual carbon trading market for the world, exactly which initial endowments of carbon credits should be allocated to everyone in the market to reach the equilibrium point whose total social inefficiency is smallest of all the equilibria? Can you calculate it? -- $E(X_t|F_s) = X_s,\quad t > s$
If you begin with some allocation vector, then market dynamics will converge (under appropriate conditions...) to some equilibrium vector.
Not on any kind of time scale that's experimentally interesting.
I agree with your attacks on the validity of the underlying mathematical assumptions, and while I've used such arguments myself before, in this thread I am not. Instead, I am pointing out that the welfare theorems aren't very deep when it comes to comparing economic allocation methods, and cannot support, even under ideal mathematical conditions, the claims about the superiority of markets vs non-markets.
The only thing a market can do is improve or "polish" an allocation in some sense. This is at best a local optimum in general, not a global one. To obtain a global optimum, it is therefore necessary to study non-market mechanisms. -- $E(X_t|F_s) = X_s,\quad t > s$
I guess I'm less charitable when it comes to permitting blithe assumptions that asymptotic solutions are interesting. Once burned twice careful, I guess. (a project of mine involved a relaxation time scale to the asymptotic solution that turned out to be around 19 orders of magnitude greater than the experimental time scale - a fact that failed to become apparent until we'd already spent two weeks and a bit on it...).
For an extra challenge, substantiate that "markets" have "caught on so well throughout the world in the last 200 years." 'Cause a lot of what is being called "markets" sure looks like political cronyism to me. The political unit enforcing the cronyism isn't a state in the traditional sense of the term, but a decision doesn't become magically apolitical - or uncorrupt - just because it's being made in an unaccountable boardroom rather than a democratically accountable parliament.
Willeb Buiter: Useless finance, harmful finance and useful finance (April 12, 2009)
Financial markets are inefficient in any of the ways specified by James Tobin in a great 1984 paper - information arbitrage efficiency, fundamental valuation efficiency, functional efficiency or Arrow-Debreu full insurance efficiency.[1] Financial markets even often are technically inefficient. A market is technically or trading efficient if it is liquid and competitive, that is, it is possible to buy or sell large quantities with very low transaction costs, at little or no notice and without a significant impact on the market price. We have seen many examples, from the ABS markets and the commercial paper markets to the interbank markets of massive and persistent failures of technical or trading efficiency. Even in those financial markets that are reasonably technically efficient, like the US stock market, the foreign exchange markets and the government debt markets, Tobin saw frequent departures from efficiency in the less restricted senses of the word. He accepted that financial markets possessed what he called `information arbitrage efficiency' that is, that they were informationally efficient in the weak and semi-strong sense. You cannot systematically make money trading on the basis of generally available public information. Clearly, however, trading profitably on the basis of insider information is possible. He did not believe that financial markets consistently possessed `fundamental valuation efficiency': financial asset prices do not necessarily reflect the rational expectations of the future payments to which the asset gives title. Key financial markets, including the stock market, the long-term debt market and the foreign exchange market are characterised both by excess volatility and persistent misalignments, that is, prices deviating persistently from fundamental valuations. Tobin also contested the notion that the financial markets delivered `value for money' in the social sense. "the services of the system do not come cheap. An immense amount of activity takes place, and considerable resources are devoted to it." (Tobin [1984, p. 284]). Tobin referred to this aspect of efficiency as `functional efficiency'. Finally, the system of financial markets can be efficient in the technical, information arbitrage, fundamental valuation and functional senses without possessing what Tobin called Arrow-Debreu full insurance efficiency, that is, without supporting Pareto-efficient economy-wide outcomes. The reason is that real world financial markets interact with labour and goods markets that are inefficient in every sense of the word. When financial markets are inefficient, the distinction between fundamental, exogenous variables and endogenous variables disappears. CDS prices can become quasi-autonomous drivers of the bond prices. The tail can wag the dog. The redistributions of wealth associated with the execution of derivatives contracts can trigger margin calls, mark-to-market revaluations of assets and liabilities, forced liquidations of illiquid asset holdings through fire-sales in dysfunctional markets, defaults and bankruptcies. Activities in derivatives markets, including futures markets, can feed back on sport markets and real production, consumption and storage decisions. Unbridled derivatives markets may be liquid, but the question is, to what purpose? If, as I believe, there is no economic rationale for `naked' CDS positions (that is, CDS that do not insure an open default position in the underlying security), then liquidity of the CDS market only serves those who want to trade naked CDS. This, in my view, only wastes real resources through (a) churning and (b) unnecessary bankruptcies.
Even in those financial markets that are reasonably technically efficient, like the US stock market, the foreign exchange markets and the government debt markets, Tobin saw frequent departures from efficiency in the less restricted senses of the word. He accepted that financial markets possessed what he called `information arbitrage efficiency' that is, that they were informationally efficient in the weak and semi-strong sense. You cannot systematically make money trading on the basis of generally available public information. Clearly, however, trading profitably on the basis of insider information is possible.
He did not believe that financial markets consistently possessed `fundamental valuation efficiency': financial asset prices do not necessarily reflect the rational expectations of the future payments to which the asset gives title. Key financial markets, including the stock market, the long-term debt market and the foreign exchange market are characterised both by excess volatility and persistent misalignments, that is, prices deviating persistently from fundamental valuations.
Tobin also contested the notion that the financial markets delivered `value for money' in the social sense. "the services of the system do not come cheap. An immense amount of activity takes place, and considerable resources are devoted to it." (Tobin [1984, p. 284]). Tobin referred to this aspect of efficiency as `functional efficiency'. Finally, the system of financial markets can be efficient in the technical, information arbitrage, fundamental valuation and functional senses without possessing what Tobin called Arrow-Debreu full insurance efficiency, that is, without supporting Pareto-efficient economy-wide outcomes. The reason is that real world financial markets interact with labour and goods markets that are inefficient in every sense of the word.
When financial markets are inefficient, the distinction between fundamental, exogenous variables and endogenous variables disappears. CDS prices can become quasi-autonomous drivers of the bond prices. The tail can wag the dog. The redistributions of wealth associated with the execution of derivatives contracts can trigger margin calls, mark-to-market revaluations of assets and liabilities, forced liquidations of illiquid asset holdings through fire-sales in dysfunctional markets, defaults and bankruptcies. Activities in derivatives markets, including futures markets, can feed back on sport markets and real production, consumption and storage decisions.
Unbridled derivatives markets may be liquid, but the question is, to what purpose? If, as I believe, there is no economic rationale for `naked' CDS positions (that is, CDS that do not insure an open default position in the underlying security), then liquidity of the CDS market only serves those who want to trade naked CDS. This, in my view, only wastes real resources through (a) churning and (b) unnecessary bankruptcies.
Efficiency: not wasting resources. Most of economics deals with the social efficiency gains by allowing freely negotiated exchanges of things between individual actors. This means that although no new wealth is created when exchanges occur between individuals, the amount of already produced wealth that is usable by individuals increases dramatically -- the so-called gains from trade.
Although you didn't ask it, equity, or fairness, is also an important element but, like wealth, it is a completely relative term, dependent upon subjective determination of needs and wants. Every economic change can be be divided into just two effects regarding how social welfare is impacted: and efficiency effect and an equity effect.
Although it can be shown (Stiglitz has the Nobel Prize for this, as well as Arrow in another sense) that, in the real world, the assumptions of effective omnipotence and omniscience on the part of market actors doesn't exist and means that markets cannot be efficient, it has also been shown that no other system yet devised is superior to markets (Stiglitz again) and that other means of allocating resources are almost always worse, especially in large-scale social systems like nation-states, because of the inescapable information asymmetry problem -- that it is rational for people to lie to each other for personal advantage.
Efficiency: not wasting resources
Quite regardless of any other criticism that may be applied to the efficiency of markets, it must be noted that market transactions do not actually reflect the underlying resources, unless externalities are priced in. And since many externalities cannot be assigned a fair value through anything but a collective political decision, the efficiency of markets becomes inherently and inseparably entangled with political and regulatory systems.
Most of economics deals with the social efficiency gains by allowing freely negotiated exchanges of things between individual actors [my emphasis]
Thereby becoming, to a greater or lesser extent, inherently counterfactual right from the first axiom. In some cases, the error introduced by this simplification is negligible (in a well regulated market, where no non-state player has excessive market power, the state player(s) are democratically accountable and so on and so forth). In others (transnational corporations having budgets comparable to a mid-sized sovereign state, lack of effective regulation of cross-border capital flows, etc.), not so much.
To these two considerations must, of course, be added the information asymmetry issues raised by Stiglitz.
It's a question of whether markets are BETTER able to minimize the biases toward the powerful and the crooked than other means of allocating resources.
There's a reason that the OECD capitalist countries are so powerful and have so much higher standards of living than the formerly (and currently) communist countries.
You mean apart from colonial militarism and outright theft?
You're being terribly naive if you really think that markets make people rich without any other factors.
While the OECD basks in its financial superiority, most - if not all - of the countries benefit from straightforward colonial resource extraction of both materials and labour from the rest of the world.
We are not talking about labor productivity here (low individual incomes relative to individual productivity), which can be looked at as returns on investments in human capital. That is a separate distributional issue that is not strongly linked to the current economic crisis -- there is not relationship yet hypothesized between countries suffering in the current economic recession and human capital levels in terms of education and individual compensation.
When labour productivity goes up, some combination of the following must happen:
Increased consumption can happen either through
A) Tax-financed fiscal and industrial policy (which usually ends up being redistributive),
B) Increased real median incomes, or
C) Loan-financed spending (public or private).
But,
A) Is prohibited by The WestTM's official religion.
B) Is considered ideologically unacceptable.
This leaves only C) which is precisely what lead us into this mess.
You missed investment, which would be four possibilities of increased labor productivity, not three. It is entirely possible that investment can increase in addition to or even in lieu of consumption.
You also missed a fourth possibility on how consumption (or investment) can be increased: D) Plunder. Through use of power, strong groups can simply take resources from other, weaker groups. This means that it is entirely possible and even sustainable for a strong enough group of political elites (such as, say, the financial-governmental-academic-military class of the United States) to redistribute wealth from other laborers and capitalists throughout the world when needed to prevent a collapse of the social system.
I was wrong when I said "no relationship has yet been hypothesized" between labor productivity and the current economic crisis. There is, of course, a very solid hypothesis, called Marxism, for that. What I meant was that a decline of labor productivity has not been advanced as a cause of this crisis. Your argument, however, is the opposite, and it's the Marxist one. Most schools of Marxism also predict that redistribution of resources from some capitalist countries to others (e.g. WWII) allows a recreation of the relationship between capital and labor that can conceiveably provide for an eternal capitalist system. (Something which Marx himself hadn't considered.) Plunder by some capitalists of the wealth of others allows capitalism to continue by recreating the conditions of surplus profit in plundered areas.
What are some examples of plunder in a modern economy? War, of course, is one -- the devaluation of capital through physical destruction of capital and labor. Another one, however, is when a lender must transfer wealth to borrower who defaults or otherwise changes in payment arrangements (e.g. inflation). The borrowers, on net, have gained in the current crisis by not repaying banks, and strong, national borrowers such as the US, gain at the expense of foreign lenders such as the Chinese, by both not repaying investments in things like mortgage-backed securities and by paying effectively negative real interest on the only available means of insuring wealth -- government securities. Both involve massive transfers of resources from back weaker capitalist states to stronger ones.
Plunder, in this way, is not prohibited by western ideology. (I'd argue, rather, that it is central to it.)
I further take as a given that actual investment in the real, productive economy cannot take place without an activist industrial policy, and that even the private sector parts of a successful industrial policy will end up being more or less redistributive from rich to poor, on account of its tendency to promote near-full employment.
But your note on plunder as a means of increasing consumption is well taken. I'll have to mull over it for a bit to see what that means for the model. But I suspect that it will end up being rolled into the Ponzi lending bullet, because it's equally prone to frequent and messy crashes (if anything, the crashes in question are even messier).
They still haven't fallen sufficiently and we're already in the grip of a debt-deflation recession... The brainless should not be in banking. — Willem Buitler
