One of the principal troubles with a certain class of people is a staunch belief that markets are the Baby Jesus. Daniel talked about this yesterday, but this analysis on the implications of Greenspan’s ‘confession’ got me all riled up for another take:
The failure of the Efficient Markets Hypothesis is, perhaps, an even more significant outcome of the crisis than the end of the Great Moderation.
The EMH implies that, provided governments get prices right (avoiding distorting taxes, internalising externalities and so on) it’s impossible to improve on the allocation of investment capital generated by private markets. The converse doesn’t hold automatically. Even granting that private markets are subject to bubbles and fads, and that their investment decisions may not make sense in the light of publicly available information, it doesn’t necessarily follow that governments can do better. Still, for large scale infrastructure systems, the case for leaving investment planning as, in Keynes words ‘the by-product of the activities of a casino’, looks a lot weaker now than in did before this crisis. Of course, for anyone who cared to look, the ludicrous investment decisions made during the dotcom boom had already undermined the EMH.
Once the EMH is abandoned, it seems likely that markets will do better than governments in planning investments in some cases (those where a good judgement of consumer demand is important, for example) and worse in others (those requiring long-term planning, for example). The logical implication is that a mixed economy will outperform both central planning and laissez faire, as was indeed the experience of the 20th century. I’ve written a more detailed version of this argument here here
For all my bitching and moaning, I believe the EMH gets it almost as close to right as possible; and when it doesn’t, I think the reasons it doesn’t have less to do with the fundamental chasm between rational and irrational behavior, but simple obfuscation. For instance: global warming, and the nations’ uniform lackluster response to it, is not a market failure anymore than a rained out baseball game is a baseball failure. Rather, the market never really got to have its say. If the externalities of energy consumption are so obscured that some people have no idea that they’re even there, well, you shouldn’t be surprised when there’s so much idiocy everywhere.
This happens whenever you isolate people from the consequences of their actions. Trust fund babies are fucked up weirdos because they’ve never had to earn a living and never had to deal with real people; the rules of the world, as they know it, are different from the rules of the world as we know it. Within their bizarro universe they are reasonable people; the problem is that their universe is a tiny subset of the larger universe. They’d all be just as fine and dandy as anyone else if the larger realities had been taken into account.
Is this just splitting hairs? I dunno. My point is that even in cases of “market failures” the first 80% of redress should be in making sure all the information required by the EMH is actually reflected in the market, not buried from ten levels of indirection in SEC filings, but right in front. A lot of people made some really, really stupid decisions because they honestly didn’t know any better. Fuck, if real estate gains twenty percent a year for the entire period of your awareness you’d be stupid not to buy in. You’re actually making a RATIONAL DECISION with the data you have.
And anyway, the market _is_ behaving efficiently, right now. Economic conditions were built on smoke and mirrors, and now they’re gone – that’s efficiency. If you find this sort of mega-efficiency to be too slow, or too clumsy, the first redress should be to reduce the grain of these giant market cycles. Give people the tools to be more rational and often times they will be. Creep carefully into the dangerous territory where the Government decides what’s the best economic policy, even a ‘hybrid’ policy, even one informed by behavioral- and neuro-economics.
(I wonder if I’ve ever written a post the legions of LSH readers have ever cared about less. Votes?)