Posts Tagged ‘Free Markets’

The passing scene – October 7, 2015

October 7, 2015

Why Free Markets Make Fools of Us by Cass R. Sunstein for The New York Review of Books.  (Hat tip to my expatriate e-mail pen pal Jack)

The TPP has a provision that many will love to hate: ISDS.  What is it, and why does it matter? by Todd Tucker for the Washington Post.  (Hat tip to naked capitalism)

Hillary Clinton says she does not support Trans Pacific Partnership by the PBS Newshour.

Q: Is the Obama Administration Complicit With Slavery? A: Yes by Eric Loomis for Lawyers, Guns and Money.  Slavery in Malaysia is overlooked for the sake of the TPP.

Houston is a lot more tolerant of immigrants than Copenhagen is on Science Codex.  (Hat tip to Jack)

Science Saves: The Young Iraqis Promoting Evolutionary Theory and Rational Thought to Save Iraq by Marwan Jabbar for Niqash: briefings from inside and across Iraq.  (Hat tip to Informed Comment)

The Amazing Inner Lives of Animals by Tim Flannery for The New York Review of Books.  (Hat tip to Jack)

Is the chilli pepper friend or foe? by William Kremer for BBC World Service.  (Hat tip to Jack)

Free enterprise and the failure of feedback

February 7, 2014

The advantage of a free market economy over a centrally planned one is the feedback provided by the law of supply and demand.  If the supply of something decreases, the price increases and demand (at the increased price) decreases until the increased price brings forth an increased supply.  This admittedly is a crude system, but it is superior to central planning because it is impersonal.  It does not require a genius to make it work.

Ian Welsh, in a recent post, pointed out that one of the main reasons for the collapse of the Soviet economy was lack of feedback.  In a command economy, the planners need correct information.  I question whether any relatively small group of people could assimilate the information needed to direct a large and complicated economy.  Welsh, on the contrary, said the Soviet economy actually was successful for a time, but broke down when the feedback system failed.  Too many people within the system found it to their advantage to manipulate information for their own advantage.

The present-day U.S. economy is not all that different.  Our big corporations and financial institutions have become little miniature Soviet Unions, in which feedback does not work, either internally or externally

The advantage of capitalism v. central planning, is that information is sent through prices, supply and demand.  This information feedback, however, is still game-able by power blocs.  The exact strategies are different than in a command economy, but the end result is the same.  The West and America are currently undergoing this exact problem.

The entire financial crisis was about inaccurate feedback, and broken feedback loops: it was about the financial and housing industries deliberately damaging the feedback system.   Then, when it finally went off a cliff, they destroyed the capitalistic feedback system, which when properly operating, makes companies go bankrupt, by obtaining bailouts due to owning western governments.

There are myriad other problems with feedback in the developed world right now, from massive subsidies of corn and oil, to oligopolistic practices rife through telecom and insurance, to the runaway printing of money by banks, to the concealment of losses by mark to fantasy on bank books, to the complete inability and unwillingness to price in the effects of pollution and climate change.

via Ian Welsh on The Fall of the USSR.

Here is how lack of feedback plays out in an individual firm.

This company is being managed by the quarter. We have executives who have no vested interest in Walmart. All they care about is their salary and bonus. So when they make poor decisions, for example this Christmas when they had a One Hour Guarantee for multiple items. This was a complete [financial] disaster but yet the executive praise what a big success it was. […]

You know what direction us managers were given to do in January? Remember Walmart’s fiscal year ends January 31st. You guess it, cut hours. For the poor decision made by executives at Walmart who could care less where the company is at in 10 or 20 years, we had to cut hours. 

Not only that we had to cut all expenses. Home office put a hold on all our ordering of supplies and try explaining to customers you don’t have toilet paper for the rest rooms. We had to cut all our part-time associates from 32 hours to 25.5 hours. All our full-time associates had their hours cut too. […]

Do you know how hard it is to go to someone that make $8.85 an hour and tell him, sorry but I have to cut you down to 25.5 hours. These people can barely pay their rent as it is and with no notice we cut their hours.

via Decades of Greed: Behind the Scenes With An Angry Walmart Manager.

I don’t have a good answer to this.  It is a moral problem as much as or more than it is a structural problem.  I don’t see how any complicated economic or political structure can function unless there is a critical mass of people who care about the truth, and care about the common good, especially but not only at the top.

Those loaded words, “free markets”

October 25, 2012

The free exchange of goods and services is necessary for the functioning of a modern industrial economy.  It is not just because freedom is good in itself, although it is.  It is not just because free competition spurs companies to produce better goods at lower prices, although it does.

It is that in order to makes decisions within a modern economy, it is necessary to compare relative values.  You can’t do that unless you know the prices of things, and the only non-arbitrary way to set prices is through agreement of a willing buyer and a willing seller.

So the economics profession is perfectly right to start with the concept of free markets as a premise.  The problem is when that concept is taken to a self-defeating extreme.  Free markets are not the same thing as the absence of rules and regulations.  If that were so, Lebanon under the warlords or Haiti after the earthquake would be the greatest free market countries in the world.  The New York Stock Exchange draws investors from all over the world because they have confidence that a listed company’s financial report bears some semblance to reality, and that a broker is not trying to rip them off.

To say that rules and regulations as such are inconsistent with the free market is like saying traffic lights and speed limits are inconsistent with free driving.  You could make the argument that individual drivers are better able than traffic police to decide when to stop and start and how fast to go, but that is not a freedom that would be meaningful to me.

The test of a proposed law are regulation is (1) whether it is consistent with basic Constitutional rights, (2) whether it promotes the common good and (3) whether it can be enforced impartially.

For insight into what happens when decision-makers decide that “free markets” can function without law and regulation, I recommend Yves Smith’s book, ECONned: How Unenlightened Self-Interest Undermined Democracy and Corrupted Capitalism and her web log, naked capitalism.

A reality checker for economic illusion

October 25, 2012

I recently read a number of books during the past couple of years about Wall Street and the events leading up to the 2008 financial crash.  The latest is ECONned: How Unenlighted Self-Interest Undermined Democracy and Corrupted Capitalism.  It was published two years ago, but unfortunately is still as relevant as it was then.

What this book offers that the previous ones didn’t is an analysis of how bad policies were based on unproved but widely accepted economic theories, and how these theories continued to be accepted even though evidence had proved them wrong.

One example is the Arrow-Debreu Theorem, a mathematical proof that for any commodity at any given time, there will be a price that will clear the market—that is, leave no sellers with unsold goods or buyers with unsold orders.

econnedThe Arrow-Debreu Theorem assumes perfectly competitive markets, buyers and sellers with equal information, no buyer or seller big enough to influence the market, separate markets for different locations and a futures market with no limits on time or place.

In other words, it assumes conditions that never were and never will be.  It is like the joke about the physicists who came up with a formula for predicting the outcome of horse races, based on the assumption of spherical horses racing in a vacuum.

Nevertheless many economists decided that the Arrow-Debreu Theorem proved that you should work for unconstrained markets, especially unconstrained futures markets, with the idea that this would bring you closer the ideal of the market-clearing equilibrium price.  They persisted in advocating this even after the Lipsey-Lancaster Theorem, which showed that unless every single one of the Arrow-Debreu conditions were met, partial fulfillment would be useless or even harmful.

Some of Smith’s other examples are:

  • The Capital Asset Pricing Model, which says that risky investments can be made relatively safe through diversification.  The fact is that in a market crash, the prices of all securities fall, because investors sell their better investments to cover their losses.  I found this was true in 2007 when my diversified mutual funds all collapsed in price at the same time.
  • The Black-Scholes pricing model, which says that you can figure out what’s a good price on an option to buy a stock or bond based on the stock or bond’s “beta” (the history of its variability).  But this ignores all the outside factors that could affect the price of a security—the effect of a bad tomato harvest on the stock of a ketchup company, for example.

Even more fundamental economic concepts aren’t always true, Smith pointed out.  Economics is the study of how people respond to material incentives, but that is a narrow and inadequate way of looking at human behavior.  The typical human being is not trying to maximize utility in isolation from everything and everyone else.  Sometimes raising the price of something means you get less of it, rather than more, because somebody may have a target amount of money they’re trying to make, and quit when they reach it.

The economics profession has sought to distinguish itself from the other social sciences by greater reliance on mathematical rigor.   The equations don’t necessarily reflect reality, but they enhance the intellectual authority of economists in the eyes of those who are mathematically unsophisticated.

Yves Smith does not say that fundamental economic concepts or mathematical economics are completely wrong or completely useless, only that they are not the whole truth and should be subject to a reality check.

Yves Smith

About half the book is devoted to the claims of financial economists to understand and hedge against risk.  The financial crash of 2007 was partly due to financiers who didn’t understand risk.  They didn’t understand that if a larger enough number of people are hedging against the same risk, there is nobody left to bail them out.  That is why Long-Term Capital Management Company, a hedge fund headed by two Nobel economists, collapsed in 1998 and would have brought down a large part of the U.S. banking and finance industry along with it, if it hadn’t been bailed out by the Federal Reserve System.

There also were many financiers who understood the risk very well, but were nimble enough to push it off onto those who didn’t.   They were given free rein because of a more fundamental fallacy—the belief that individual pursuit of material self-interest always works for the general good.

I think Smith is too harsh in her judgment of the economics profession.   As she noted, many economists saw that an economic crash was coming, and issued warnings, but they were disregarded.  Economists are developing new tools, such a behavioral economics, which overcome some of the limitations of past theory, but they do not influence policy.   But it is the economists who were wrong, not the ones who were right, who guide the U.S. government’s policy.

Yves Smith is the pen name and Internet handle of Susan Webber, a graduate of Harvard Business School, who formerly worked in corporate finance for Goldman Sachs and headed the mergers and acquisitions division of Sumitomo Bank, and now has a consulting firm called Aurora Advisers Inc.  She knows whereof she speaks.

Click on naked capitalism for her web log.  She and her contributors produce outstanding investigative financial journalism and commentary on conventional economic thinking.

Click on the following three links for a good summary of her book

ECONned Part I: The Theory Behind the Great Recession,

ECONned Part II: Shadows of a Crash and

ECONned Part III: Insuring Financial Stability.