Tuesday, March 4, 2008

Free Markets vs. Cronyism

I will be on a short trip, so posting will be sporadic for the next few days. Before I go, I want to clear something up, concerning my views on extremism in free markets and their zealot acolytes.

Free markets (in this case financial markets, since they are my area of expertise) without tight regulation to even out the playing field as much as possible, rapidly deteriorate towards crony capitalism, i.e. a particularly virulent form of junglenomics. US financial markets were the envy of the world because a whole array of professional regulators (SEC, NASD, NYSE, FRB, etc) stood ready to send in the feds and bodily carry out manacled perps, in full view of their co-workers and the cameras.

No, it didn't always work out as it should have and many a big fish swam away leaving the minnows to fry in the pan. But mostly it worked, and the markets were the better for it. This is no longer the case and dominant positions now exist (or existed) unchecked in most markets and crony capitalism makes itself evident in many aspects of the US economy (Enron, for example).

Some people sadly still confuse freedom with total lack of regulation, thinking oversight interferes with a "natural" right to do as they please. In that case, their proper place is up in the mountains with the rest of the wild animals (Aristotle had something to say about them, people who do not wish to participate in a cohesive society and be bound by its rules). Others place absolute faith in the invisible hand, thinking it will even out everything all by itself. To my mind, they belong to the Flat Earth Society.

No doubt, they in turn will paint me a "commie", showing a complete lack of understanding about what communism is all about. Well, both communism and absolute laissez-faire don't work - in practice - because they both disregard human nature: man is no saint. He will no more gladly share everything he has with his fellow than he won't fall prey to unfettered greed for individual gain.

Free market capitalism is not antithetical to the common good - quite the contrary; it is just that human nature will always be governed by extremes of fear and greed and behavior must be governed by checks and balances, for everyone's benefit. Likewise for democracy, which can all too easily deteriorate towards mob rule or fascism, a fact understood very well by the writers of the Constitution. It is extremism that I rail against, not freedom.

Bottom line: excellence in market regulation leads to better and freer markets. And please... do not confuse quality with quantity, from either perspective: more is not better, but neither is less. Smarter, more effective, more efficient... that's better.

See you all soon.


  1. The strongest argument for strong, smart and effective regulation, especially in the financial field (so easily prone to corruption and manipulation)is the fact that those screaming the loudest for deregulation are the first to squeal for intervention when they bring the system crashing down on them and the rest of us who had no hand in causing the catastrophe. The cost of honest regulation can never be more than a small fraction of the harm avoided. The FDA is a prime example. Honest evaluations of new drugs by independent scientists with no financial ties to the pharmas can never cost more than the deaths and injuries caused by dangerous drugs strictly measured in monetary terms. Freedom is for individuals to do as they please with their own lives, not to defraud and prey on others.

  2. Interesting demarcation of responsibilities and liabilities, H

    My personal view is that “capitalism” – with whatever nuances one defines it - is not the “best” system for an economy / market, it is just the "least bad" system.

    The major problem with capitalism is that, at times, extremes occur; some people get very rich and capitalism permits them to do so; some people do not. These extremes may start out as a result of hard work or pure luck, someone was in the right place at the right time and made the right bet. His increased wealth creates competition – “why can’t I do the same” – but it also creates jealousy – “why can’t I have as much as he has” with an implicit assumption that it was luck, not hard work that created that wealth. Pervasive consumer advertising always holds out to us the joys of having more or better, of never being satisfied with what we have. We compare ourselves with the performance / wealth of our school buddies and feel enervated that we are doing better, or ashamed that we are doing worse. That is human nature. If these feelings motivate us to hard work, to increased competition, to the benefit of other consumers, employees – and if the owner of the business is willing to delay his own gratification - then good things can result; in contrast, problems come when these feelings result in shame/embarrassment and an attitude of “I know I can’t afford it but he/she has it, I want it and I want it now”

    Young people growing up in the Eighties used to be described as the “Me Now” generation; if so, what term are we going to use to describe those even more greedy and obsessive individuals growing up in the last few years?

    PS. I believe that one of the central tenets of capitalism is exactly that willingness to delay gratification alluded to above. We have not seen much of that in recent years!

    Bon Voyage and keep up the good work

  3. Hell, I agree. You cannot ever get away from integrity and good governence. But wanting this and getting it are two entirely different things. And statements to the contrary, there is no evidence 'split the difference' (also my own view, for what it is worth) is any better. It is a matter of what time frames you look at... now show me it that it holds true for all fractal timeframes, and I might believe you. This is your view (fine, it is your blog), but it is just that.

    @Anon who said... "The major problem with capitalism is that, at times, extremes occur; some people get very rich and capitalism permits them to do so"

    The implication of this statement: that non-capitalistic or regulated capitalistic systems do not have the problem of wealth concentration is most decidely false if not outright absurd. What do you think wealth is anyway? (this is probably the better question)

    The problem is many of you believe you see something as bedrock, yet the econophysicists clearly do not.

    There is no Holy Grail

  4. In response to Thai, I am the "Anon - Dome" contributor.

    Thai, your contributions to this blog have always impressed me, but the point to which you draw attention in my posting was not the important one. The important point is that we should think of capitalism as the least bad system yet invented.

    I assure you that I have heard of the term "oligarch" and that I do recognise the extreme disparities of wealth in, for example, the former Soviet bloc. One important advantage of capitalism, in contrast to (whatever you want to call the quasi-system that is in place in Moscow) is that, normally, more people have more opportunities to do what they want (in a business context), not what they are required to do by domineering forces such as government. Perhaps you would like to consider whether this in itself is one definition of “wealth”.

    I recognise that extremes have occurred recently in financial markets under capitalism, but I am willing to tolerate those extremes, because I believe that the extremes would be worse under any other economic system yet invented.

    Do not take this comment as approval for these extremes, it is simply tolerance. Yes, the perpetrators of the excesses - the modern robber barons, if you like - must be punished as an example to future generations. But let us not react in the wrong way – one of the largest killers of man in the Western world is the car, but we do not ban the car; we recognise its overall usefulness and create and enforce laws / regulations governing its use in order to prevent extremes occurring. We must adopt a similar approach in financial markets.

    H is right – “excellence in market regulation leads to better and freer markets” and “quality is important

    And, frankly Thai, my personal pedantic approach to the use of the English language would never permit me to believe that a comment such as “XYZ is good” ever implies “all other letters of the alphabet are bad”. That surely would be “most decidedly false if not outright absurd”


  5. I guess it's a situation of majority tyranny and the eventual lack of any freedom that a complete laissez-faire system will lead to.

  6. It seems that when you speak about current financial market, you are thinking it's a free-market. And your conclusion is : Something is going wrong now, so, it's because of free-market.

    But the point is that we are not in free-market. Free-market means that people do what they want until they hurts somebody or somebody else property. So people are personally liable of their actions.
    Now, you have bankers who did bad deals, and what are they doing ? They ask the central bank to give them liquidity. So, they don't take the responsability of their actions. Worse than that, by doing that, the central bank devaluate the value of the money. So, the buying power of the workers diminishes to go in the pocket of the bankers who don't want to take the responsability of their actions. So, the central bank is stealing the money of the people to give to the bankers.

    The simple existence of state monopoly of money supply which control the short term interest-rate only to supply money to the bankers who don't want to take the responsability of their actions and to destroy the value of the money of the common people imply that we are not in free-market.

    So, I agree whith you, we are in a really bad situation now. But if you want to blame something, it's not free-market you have to blame, but state monopoly and regulations.

    Jon Stewart from Comedy Central asks Alan Greenspan about this point last september, and Greenspan was clear, he said : "To the extent that there is a central bank governing the amount of money in the system, that is not a free market. Most people call it regulation."
    Look at : http://blog.t1production.com/jon-stewart-to-alan-greenspan-why-do-we-need-the-fed

  7. Hel,

    Nice post. Comments of fellow readers were also interesting.

    I recommend an article in the FT entitled "Disquiet on the western front of the credit world" for anyone who wants to know why mark-to-market accounting is being adopted at a snail's pace. It is very relevant to the topic of today's post, "Free Markets vs. Cronyism".

    Who are the winners and the losers? That's what decides whether mark-to-market happens quickly or not.

  8. Beginning with the New Deal government intervention in steering the economy to avoid crisis became the norm. Thus a re-coupling of public/private. With the advent of Volcker's war on inflation, the stage was set for privatization, de-regulation, etc., that took root during the Reagan/Thatcher administrations. Thus the shift in power away from some form of equity between capital and labor back to an emphasis on self-regulated markets as society's principle of organization. Now of course we are hearing the call to reverse the trend. The swing from an emphasis on state intervention to markets and back again reflects a larger dynamic that has too be taken into consideration: for whose interest does the government really promote? That is the real question.

  9. Dome-- sorry, I misunderstood your point.

    I agree with you.

  10. people are personally liable of their actions.

    Isn't that why the Republicans have been pushing "tort reform" so that business is sheilded from liability?

  11. Perhaps in a different era, this could have been considered an academic debate of sorts. Now, with 6.6 billion humans engaged in the first truly global economy (or environmental disaster if you prefer), the good of the "commons" is truly a life or death dilemma. Let's just let the market sort it out, ain't gonna fricken work anymore.

  12. Hell, You are really confusing. You will have good career as a politician. Can you make yourself a bit more clear about the following?

    Is the current crisis a result of free market (in its true sense), and so we need to bring strong government to fix the problems?


    Is the current crisis a result of US being in crony-capitalist system, where a small number of individuals and businesses control most of the political decisions abusing the name of 'free market', and therefore we need to bring the real free market back?

    If the second is true, how can more government controlled by the same set of individuals and bailing out the wrongdoers at the cost of prudent improve things?

    You mentioned that to prevent too fast increase in oil prices due to lack of fossil fuel, the government should start research programs investigating alternate fuel. Don't you believe if oil price is too high, there will be enterprising individuals trying to solve the problem on their own? Had all progress in Western society, starting from invention of printing press to steam engine, been made because government with foresights had large research programs to solve future problems?

    Or in single sentence,
    are you out of your mind?

  13. "in the first truly global economy"

    are you serious?? Have you checked the history of last couple of centuries?

  14. Greenie, I think you are being a little unfair.

    You separate flow of capital/business from the rules that goven that flow as if they were different things. Were there no 'government' in the universe at all to periodically interfere with economic flow, still a free market would develop rules on its own. Just like collaboration is a fundamental emergent property of evolutionary systems, so too are rules, since cooperation is not possible without them. Call rules whatever you like-- econophysicists do not functionally see them as any different than what many call government-- they are a fundamental consequence of the system driven by the fact that the economic benefit of collaboration are so powerful, yet collaboration is not possible without rules. You can't stop rules from forming even if you try.

    This was in fact one of the first discoveries Joshua Epstein and Robert Axtell of The Brookings Institution noted when they first started growing artificial societies on computers in a research project that has come to be known as sugarscape.

    And lo and behold, these rules do periodically become a hinderance to the very flow of capital they are trying to assist. This too is a fundamental emergent phenomena of ANY evolutionary system... It is a simple fact that bubbles (financial, information, ideas, etc...) are fundamental to ALL evolutionary complex adaptive system. And bubbles form according to any fractal analysis you can think of (group size, time frame, etc...).

    No rule system can prevent bubbles from forming for one simple reason... imagine people can predict the future. The natural tendency for people (groups) to profit from the information invalidates the very prediction. The natural tendency to maximize personal self interst changes the outcome itself. And this property is clearly present on ANY fractal scale you look, no matter how large or small you cluster groups (from the individuals to tribes to states to nations) self maximization alters the future and leads to bubbles. And this happens on ANY times scale you look at (wierd hunh?...)

    Most things we know today, looked at from tomorrows vantage, will seem to be bubbles. This will be true whether we live in a highly regulated system a relatively unregulated one. There is no getting around it.

    In fact, now that I remember, this is the very message of The Black Swan... We live in Extremestan, governed by fractals, power laws and scale invariance. But we think we live in Mediocristan, (many of the comments of this blog clearly perpetrate this error) with the eroneous view that life, fairness and our world is governed by Gaussian dstributions.

    A fractal Garrison Keillor might say "all the women are NOT strong, all the men are NOT good-looking, and all the children are NOT above average."

  15. Good post Hell.

    I think that what we are seeing in financial markets is like evolution everywhere else. A niche is found, it is exploited to the point where it can no longer be sustained, and then whatever exploited it dies out. Happens everywhere, all the time. Just sometimes the niche is exploited for a really long time, but when the time is up, the death is really big. And just like in evolution we do not learn from our mistakes. Look how many times a sabre tooth tiger has evolved and died out.


    Big teeth are a great idea until they get too big! Our financial markets are no different.

    While I agree with Hell's views on quality regulation, I'm just not sure that its possible to achieve and maintain it in the long run. The niches will always be exploited, as they have been since Methuselah. You can't cover all the niches. However, the Black Swan believers will be the inheriters of the space left behind when the exploiting is over.

  16. To paraphase Hell (I like the way he said this)...
    "Occamsrazor gets an A"