Market Fundamentalism

[mendeleev 68]

I don't know...the Marx/Lenin theory of economics couldn't do any worse than Bush/McCain theory of Economics.

I saw this statement, a quip, really, on the Russia forum right before leaving to visit my wife’s family there last month. I’ve been thinking about it off and on since.

On the airplane, I read George Soros’s new book, “The Credit Crisis of 2008 and What it Means … A New Paradigm for Financial Markets”. Soros talks about a phenomenon he calls Market Fundamentalism, a near-religious belief that modern economic theory reliably and accurately describes real-world markets, in spite of observations to the contrary. Key to the market fundamentalist creed is the postulate that markets tend toward equilibrium. For Adam Smith to first make this argument, he had to assert that market participants had perfect knowledge of market conditions. Now, who has perfect knowledge on anything at all? To remedy this problem, post-World War II economic theorists in the West developed theories of rational expectation. The key postulate here is that market participants, pursuing their self-interest, make decisions assuming other market participants do the same. Regrettably, this postulate is contradicted by experimental evidence.

Soros argues that, occasionally, markets develop dynamics where, for a while, perception is reality and bubbles form. These bubbles move markets far from equilibrium. Problem is, it is hard to tell when this is or isn’t happening. The inevitable correction is invariably painful. Bubbles could not form if modern economic theory accurately described financial market behavior.

As soon as I got home, I found an Essay in the October 30th issue of Nature (vol 455, pg 1181) titled “Economics needs a Scientific Revolution”. The author, Jean-Philippe Bouchaud, a member of the physics faculty at École Polytechnique in Paris and an analyst at Capital Fund Management (an interesting combination), criticizes conventional economics as a discipline more like religion than science. He ticks off a number of postulates of modern economics: the assertion that all market participants are rational; the belief in an “invisible hand”, whereby market agents, in pursuit of their own self-interests, maximize benefit to society; and the axiom of market efficiency, asserting that market prices faithfully reflect all known information about assets. He is stupefied by modern economic sentiment that “[t]hese concepts are so strong that they supersede any empirical observation”. This sort of intellectual construct is not science but rather religion. Those who assert these ideas as truisms not to be questioned are reasonably considered market fundamentalists. That ideology has been dominant in Republican circles, and very influential in Democratic circles, since about 1980. Many varieties of religious fundamentalism threaten society, not least of which is market fundamentalism.

Economics likes to model itself on physics, pretending that they are similar disciplines. Physics has made great accomplishments, theoretical and practical. The flagship achievement of economics, Bouchaud accuses, is its inability to predict or avert crises, including the current global credit crisis.

Bouchaud makes interesting prescriptions for how economics needs to evolve as a science, and how universities need to change how it is taught. But this doesn’t help the rest of us in the real world. Markets, left without adult supervision, tend toward excesses that the rest of us have to clean up. More effective government supervision of markets is needed – but government regulation is sometimes not optimally disinterested either. Nevertheless, the post-war historical period shows that western market capitalism was reasonably stable until the deregulation craze started by Reagan and Thatcher took full root. The current crisis began in the USA before it went global. At a number of levels, our capital markets operated with no effective supervision. Continental European capitalism, with its greater levels of government regulation, has been a lot more stable. Theirs is not an ideal economic model. But we have a lot to learn from the Europeans as we rebuild a more stable economic system.

[w¡n9Nµ7 §£@¥€r 123]

He ticks off a number of postulates of modern economics: the assertion that all market participants are rational; the belief in an “invisible hand”, whereby market agents, in pursuit of their own self-interests, maximize benefit to society; and the axiom of market efficiency, asserting that market prices faithfully reflect all known information about assets.

Good post, novotul.

Economics is one of two majors I had in college. While that was a long time ago (almost a decade), I do remember that the rationality of actors and the access to 'all known information' were assumptions, not assertions. IOW, the conclusions of what would happen were based on assumptions of rationality and access to perfect information. I always believed the assumptions were in place to facilitate further discussion, not to replace our knowledge of actual human nature and the actual information asymmetries of real world economic systems.

Of course, I could be wrong. It was a long time ago and I was by no means a straight A student

[Blues Fairy 0]

And how is regulation possible without access to 'all known information'? Wouldn't it do more harm than good?

I think the argument can be made equally that regulation, not de-regulation, creates the mess, because it's usually driven by political interest and not economic logic.

[w¡n9Nµ7 §£@¥€r 123]

And how is regulation possible without access to 'all known information'? Wouldn't it do more harm than good?

Depends on what information isn't known and to whom isn't known. In a world where all information is open to all actors, and all actors are rational, regulation wouldn't be necessary. Markets would self-regulate.

The problem, of course, is that information isn't really open (why do the words 'classified' and 'confidential' even exist?) and even if it was, actors aren't rational - not by a long shot.

[rebeccajo 14]

I had an interesting discussion with a guy at work yesterday about pure socialism, which he says is defined in "Das Kapital". In his opinion, that economic model isn't possible (in it's purest sense) because there always ends up being parties who decide to either parlay the system for personal gain or greed.

I contend that our economy isn't pure capitalism either, and I believe that mostly because our tax code offers 'breaks' to businesses that don't exist in the pure, free wheeling capitalist notion.

[Niels Bohr 72]

I think in a perfect world where everyone treats everyone literally, equally, then Marxism would've been a very perfect solution. However, due to the diversity of people's level of greed, Marxism is a bad idea.

Bush's policy is nowhere near in comparison to Karl Marx. Bush hadn't reformed an entire democratic process. His ideas are based on to the knee-jerk approach, guess and test method. On the other hand, Karl Marx reformed the entire democratic process.

Alot of people who are not aware of Marx's works get their information from many mis-informed people. They believe Karl Marx is bad person. He essentially isn't a bad person. Had the world treated everyone equally meaning equal land space, money, etc...then Marx's ideas would most likely work.

But, history showed that this won't work due to the simple fact of human nature. Everyone have different levels of desire.