Monthly Archives: February 2009

A follow-up to the previous post…

So, I realized that I didn’t include a pontentially useful tidbit in my previous post. This has to do with recognition of market failures, such as those which result from incomplete information. Neoclassical economists–at least, the serious ones—acknowledge that markets do have failures, but they tend to believe that markets will tend to sort themselves and that rational decisionmaking will dominate irrational decisionmaking. Unfortunately, there is no good evidence that this is the case, making it another belief. I don’t think anyone would claim that the present crisis is the result of rationality, or that the S&L crisis, particular sub-crises of the Asian financial crisis of 1997-1998 (Hong Kong in particular)…I could keep listing them, but I think the point is evident.

Of course, government is more than capable of failure, as it is another collection of people just like a market. Just to pre-empt people, I certainly do not advocate a centralized, dirigiste economy. Rather, I’m looking for reasonable controls to protect people from our collective ability to be completely irrational…

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Self-restraint, Greenspan, and Beliefs

There are several issues which I tend to have with Alan Greenspan’s economic ideology, most of which center around his strong tendency to believe in things. Now, I have nothing against believing in things per se, but, when it comes to believing in things against all available evidence, then I begin to have a problem. I could write several posts about different aspects of this—which I reserve the right still to do—but for now I’ll just have a brief comment on this observation of his:

“We need not rush to reform. Private markets are imposing far greater restraint at the moment than would any of the current sets of new regulatory proposals.”

So, the justification for not rushing to reform anything is that private markets are “imposing far greater restraint” than any regulatory proposal? Okay, we should not be too hasty in assembling new regulatory schemes—I can agree with that—but is not this “far greater restraint” which the private markets are exercising simply the flip side of what got us here in the first place? We have gone from the irrational exuberance of the tail end of the Greenspan era/beginning of Bernanke and into a  time of irrational suspicion and doubt. Even though he admits that heightened regulatory rules will be necessary, Greenspan still believes that restraints on the market should be based on the assumption of a rational market controlling its own urges—this is precisely contradictory to all available evidence. Markets do not function rationally as a norm; indeed, it seems that irrationality predominates and has throughout history.

Markets are collections of people, all of whom are acting without coordination, with incomplete information, and with a distinct preference for maximizing personal gain. None of the preceeding is meant as a value judgment. Rather, it is a simple definiton which leads to some distinct conclusions. The orthodox/neoclassical economics to which Greenspan subscribes requires that rational decisions be the result of this mix—I would question why anyone would come to such a conclusion. Without complete information, one is at best approximating rationality when one makes a decision—one cannot know that it is rational without knowing the entirety of the situation. Without coordination, people can make individually rational decisions but are unable to control the actions of others. To use a basic example, you may have the perfect information required to know that your bank is illiquid but solvent, but you cannot stop everyone else from engaging in a run which breaks the bank. In the neoclassical world, bank runs on solvent institutions would never occur—but they have in our world (in order to pre-empt such irrational actions, the FDIC was created, because it was understood that people would not tend towards rationality).

If irrational behavior is present in even very simple situations like the one just illustrated, it boggles the mind to imagine that highly educated, intelligent people can believe that rationality predominates in far more complex situations. This is where we return to the issue of belief—neoclassical economics has a very strong belief  in the rationality of actors in the market and thus in the market itself tending towards rationality. Designing a regulatory system based on this assumption, which Greenspan prefers, is foolish.

Instead, what is needed is an assumption of irrationality with which to guide our development of new regulations—whether that leads to attempts to provide information and coordination abilities to enhance the possibility of rational decisionmaking or whether it leads to tight constraints on the complexity and independence of the market from control, it will have a better end result than a regulatory scheme which has as its basis a patently false assumption.