The Infailability of the Market in Fixing Market Failures
December 30, 2009
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Posted by Michael S. Langston
In a great piece over @ The Christian Science Monitor, Arnold Kling & Nick Schultz argue well that Markets fail. That’s why we need markets:
…This seemingly paradoxical view is based on several overlapping strands of research in economics as it pertains to development, history, technology, business expansion, and new-firm formation. According to this view, entrepreneurs at work in the economy – in finance, high tech, manufacturing, services, and beyond – are constantly experimenting, creating new business models, techniques, and technologies that upend the established order of things.
Some new technologies and innovations are genuine improvements and are long-lasting welfare enhancers. But others are the basketball equivalent of pump fakes – they look like the real deal and prompt market actors to leap hastily into action, only to realize later that their bets were wrong.
Given this dynamic, markets are unpredictable, prone to booms and busts, characterized by bouts of exuberance that are rational or irrational only in hindsight. But markets are also the only reliable mechanism for sorting out this messy process quickly. In spite of the booms and busts, markets drive genuine long-run innovation and wealth creation.
Not as eloquently as they did, I wrote about this earlier in the year (here):
…the dynamic system of the United States might have felt more pain that other countries during this crisis, but due to the mostly decentralized economic model, we will recover more quickly than most…
It then seems for most people to become a question of risk adversity. Do we allow for individual freedom and understand that sometimes failure is a part of the process? Or do we constantly attempt to control individual behavior for fear of potential negative consequences?
Only if we first believe in the premise that by trading freedom for stability, we actually get stability. The CSMonitor article continues:
…When governments attempt to impose order on this chaotic and inherently risky process, they immediately run up against two serious dangers.
The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good.
The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves – but in far more pernicious ways.
Economists call these political entrepreneurs “rent-seekers.”…
…This gets to the key difference between markets and governments. When innovation-driven excesses and imbalances are recognized in the marketplace, the system can correct itself quickly. This is less the case when government policy failure occurs.
Because political failure is less publicly tolerable than market failure, the temptation becomes for policymakers to avoid acknowledging their role in creating or perpetuating problems. Or they double down on bad bets. So rather than recognize the government’s central role in the housing boom and bust and quickly changing its ways, we see the federal policy apparatus continuing to throw good money after bad in the mortgage market and on Wall Street….
I wrote about this “doubling down” (here):
…For those playing the home game, this means we are taking a problem caused by excessive credit and government incentives and trying to fix it by:
- Preventing the normal contraction that needs to happen by artificially propping up failed business and bad home purchasing decisions.
- Keep money cheap by keeping interest rates very low.
- Then, repeat the same process that got you to the recession in the first place by incentivizing the market to buy a commodity (housing) which is still overvalued in some places….
& made the perplexed statement (here):
…I’m not really into prediction making as it’s obviously fraught with so many problems, but I’ll never understand how the solution to cheap money and an over investment of housing, is to keep money cheap and incentivize home buying…
As historically known, the vast majority of centralized government intrusions into free markets and free people has led to disastrous consequences. NBER research suggests that two of the reasons for the current global economic crisis are due to unfree markets:
…The inability of emerging economies to absorb savings through domestic investment and consumption due to inadequate national financial markets and difficulties in enforcing financial contracts; the currency controls motivated by immediate national objectives;…
Everywhere we look objectively, freedom gives us more of everything. Do you want to fix healthcare? Using the government will likely lead to higher rates and more control, using individual freedom however doesn’t cost much as has been proven in other avenues such as food. Something I think is just as important as healthcare, but been left to the market unlike health care.
& the market has responded. Food costs as a percentage of disposable income has decreased from 23.4% in 1929, to just 9.6% in 2009 (here).
Meanwhile health care costs continue to increase with government regulation. In just the past 5 years spending on health care as a percentage of GDP has continue to go up and is projected on that trend still. In 2005 spending was 15.9% of GDP whereas in 2009 is it 16.9% and projected to be 19.5% in 2017 (here).
It seems that the overwhelming majority of evidence suggests to honestly help the most needy, freedom is not only a moral good, but a requirement for anything approaching success…. yet what seems to be an irrational fear of “economic crisis” many people can’t see the forest for the trees.
Categories: Business, Economics, Free Market Principles
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Tags: Business, Consumer Spending, Creative Destruction, Culture, Decentralization, Economic Research, Economics, Free Market Principles, GDP, government spending, Health Care Reform, Legislation, Market Failure, national bureau of economic research, nber, Policy Analysis, Politics of Fear, Regulations, Risk Adversity, Risk Assessment, The Christian Science Monitor
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I kind of disagree, but I do see your point.
Very informative post. Thanks!
Hollis – it’s quite alright – most people disagree with me. & If I turn out to be wrong in the marketplace of ideas, hopefully my failure will still push the argument that the number one priority for people should be freedom and liberty, I’m perfectly ok with that.
Having said that, I do believe the premise of freedom is right – people have been talking recently about “evil” capitalists, when in reality capitalism is only the realization of freedom in the economic realm. We still currently, mostly anyway, believe in individual freedoms, just not completely in economic freedoms.
I’m stunned Alan Simpson agreed to participate in this debt program meeting. Simpson suffers no fools…ever. So why agree to board this ship-of-fools, probably to become little more than an element of plausible deniability for Obama’s failed presidency? I don’t get it. I suspect he means well but at 79 years of age, doesn’t entirely understand the unholy meat-grinder that modern national politics has become. Then there’s Erskine Bowles….yet another Clinton bootlicker morphed out of thin air like the ever present and ever nauseating Lanny Davis. Will we never be shed of these people? Well, at least there will be fireworks for entertainment while our nation sinks further into debt…and despair.
Here’s the problem. Traders are in control of your money. If they make money (no matter how) they get a nice huge gargantuan bonus. If they don’t perform, they are fired, there is no middle ground. This is the state of the banking culture and the root of all our problems. It can be expressed with one word: greed!
You can certainly attempt to blame greed and without question, greed exists, but it’s really about human nature and incentives.