Wednesday, November 18, 2009

What only free market can do

A reader linked this post about free markets. It claims that the value of the free market is not that it motivate people by their greed but other things. I can only agree with that. The communist countries those workers who didn't work enough were deported as "traitors". Beat that motivator. Yet the soviet economy remained weak.

The post claims that the market is the place of chaotic experimentation: "Centralised systems experiment too little. They find reasons why new proposals will fail – and mostly they are right. But market economies thrive on a continued supply of unreasonable optimism. And when, occasionally, experiments succeed, they are quickly imitated." I disagree with that. After all, not "the market" makes the experiment, but a person, with his own resources. No one in the free market would invest in new, unproven ideas. The new companies started in a garage of the owners or their parents. They became large after they proved themselves. But after they proved themselves they could get the support of government officials too. After all the Soviets sent man into space first. That's not a bad development sign.

The other claim is that the market "is the most effective way to protect society from rent-seeking – a culture in which the principal route to wealth is not creating wealth, but attaching oneself to wealth created by others.". Again not true. The "worker" was the ethos of the socialist countries. He was idolized in artwork (don't comment on their art value please), strike that, work was mandatory, the country provided fake jobs to keep 0 unemployment. There was absolutely no rent-seeking culture among the common people. The rent-seeking culture belong to the social-democracies, where work is taxed, and non-workers get welfare.

He is right on "Honest feedback is not welcome in large bureaucracies, as the UK government’s drug advisers can testify. In authoritarian regimes, such reporting can be fatal to the person who delivers it." however that's true in every system, that's why he himself used a democratic government as bad example. Corporation managers are just as stubborn and critic-silencer as Soviet bureaucrats. True that they can't execute you, but they don't have to either. If they fire you, you are dead to the company.

I think the big difference between markets and any kind of non-market system is the handling of morons. The morons are people with good intent, with no hostility towards the system, but with no skills either, therefore their results are poor. Social people find it pretty hard to get rid of these people as without "bad intent" they are not considered people who deserve "punishment". So the useless worker won't be fired until he risks the survival of the company. If there is no market it doesn't happen. In the socialist block, several thing were highly sub-optimal, it was known to be sub-optimal by most, except those who did it, and since there was no competition, they were never forced to face with the true value of their work. The Soviet economy was destroyed by the drunken worker who got the same salary as others for his useless work, and the dumb manager who ordered useless works.

Free market is meritocracy, here no one asks why you failed. If you failed, you failed.

I'd like to emphasize that every non-market system is unable to handle morons, not just the Soviet-like. Democracy for example cannot get rid of welfare leeches. In small communities, the untalented relative or friend of someone gets job.

Anti-market activists claim that free market caused the current economic crisis. I disagree, despite I'm 100% sure that proper regulation (for example loans cannot exceed 50% of the recipient current wealth and monthly payments cannot exceed 25% of his income) could fully prevent the collapse of the loaning and derivatives market.

What caused the crisis then?

Bad question. The good question is what is the crisis? Answer will come tomorrow.

34 comments:

Yaggle said...

"Proper regulation" - I am glad you used this term in a positive light. Just using the word "regulation" right now in the U.S. gets you branded as a socialist or even a communist. I have said over and over to backers of U.S. Republicans/right-wingers that capitalism has to have some type of regulation or it will not work. The free market with no regulation basically devolves into some form of a pyramid scheme that will eventually collapse on itself. I believe that Karl Marx was correct in identifying the problems with capitalism, and that it is overly volatile and unsustainable, which is why I believe in regulation. I do not believe his conclusion that capitalism will eventually evolve into communism, and that workers need to own what they produce. I think people like money better. This concept 'meritocracy', I basically believe in, is the only way a system can be fair to everybody. In a business, it is essential that in some way, you treat the better workers more favorably than the worse workers. In an economy, the same is true and so failure must never be rewarded.

Anonymous said...

The market "is the most effective way to protect society from rent-seeking – a culture in which the principal route to wealth is not creating wealth, but attaching oneself to wealth created by others."

This is patently untrue, but not for the reasons you point out. One only needs to look at this chart to see that free market leads to the inverse, leeches who produce nothing taking an ever-increasing share of corporate profits :

http://media.artdiamondblog.com/images2/FinanceIndustryPayAndProfitsGraph-thumb-468x399.jpg

It's also incorrect to imply that stupid people taking out loans they couldn't afford is the source of financial woe - regulation is necessary not to prevent stupid loan-takers, but to prevent dishonest loan-writers from packaging loans with a sky-high default rate, and then bribing (pardon me, "compensating") rating agencies to rate them well above their actual value. In a properly running market, people with a high risk of default aren't given loans because it's impossible to hide the high risk long enough to sell it to an unwitting third party.

A great example of the "bad" (that you are probably going to ignore so you can blame it all on ignorant people) is Goldman Sachs, who rated their own toxic mortgage packages highly, and eagerly sold them to counterparties even as they secretly short-sold the selfsame mortgages they were endorsing. They made a LOT of money on the financial fallout from the housing crash, because they knew exactly what would happen if they continued to inflate the bubble. Of course, now they have turned over a new leaf and no one should blame them - oh wait, no, they continue to front-run other investors and milk the deeply dysfunctional High Frequency Trading cash cow (look it up, there's no way in hell anyone can argue this practice adds value for anyone - it is wasteful greed, period). This takes place out in the open without fear of retribution because the populace is busy arguing over a health care bill (aka "what new and exciting way would you like your insurance company to screw you over"). Of course, according to GS head honcho Lloyd Blankfein, they're just "doing God's work." Well, bless their benevolent little hearts.

http://blogs.wsj.com/marketbeat/2009/11/09/goldman-sachs-blankfein-on-banking-doing-gods-work/

Anonymous said...

"The good question is what is the crisis?"

The crisis is caused by the industrial-military complex and its part of their agenda to form the new world order. Not a troll post, i am serious with this.

Laura said...

" The communist countries those workers who didn't work enough were deported as "traitors"."

In theory. In practice, anyone who actually did work in communist countries was considered "an idiot". In Romania for example there was a rime line which translates rougly as "long, often breaks are the key to great success"

mat said...

The crisis is the perception by the unwashed masses that their money is no longer worth as much as it once was.

The amount of money in the system didn't change much, but peoples perception of what their money was worth did.

This perception is fanned by sensationalinst media headlines trying to explain things that the reporter doesn't fully understand to an audience that doesn't fully understand.

As to what caused the crisis, in my limited and ill informed opinion (as i'm sure many others know far more about it than I do), short term rewards drove the industry to offer loans to people that could not repay them. Proper regulation and a longer term incentives structure would have made a difference.
A financial industry driven by a short term bonus structure with no regard to what will happen the year or decade after is just asking for trouble.

debussy said...

I agree with Laura, and just to add to what she said, the Soviet Union had a moto: “From Each According to His Ability, to Each According to His Need.”
The problem was that most people were trying to show less ability and more needs.

Anonymous said...

There are two problems with the "free market":

In theory it's a meritocracy but in practise it's a oligarchy because the way the "free market" is currently setup leads to money aggregation. Now if everyone started at the same line you may argue that but that is not the case. If you are lucky and get born rich, you won. You can be the biggest moron on the planet, you will have a better life than almost all more intelligent beings on the planet.

The second problem is, and that cues into the first, that the concept of the free market (in theory, supply & demand) relies on the principle of completely available information. However, this is not the case and especially the supply side will do any- and everything to prevent that from happening because it would hurt them.

Ephemeron said...

Each and every attempt to solo Molten Core at level 60 has failed. Does this mean that it's impossible to do it at level 80?

The failure of Soviet Union doesn't mean that planned economy can never work. It might simply indicate that Soviet Union lacked the necessary tools for its successful implementation: computers to process the massive amounts of data, Internet-powered instant feedback to identify problematic areas, CCTV monitoring to control work performance, and so forth.

Niz said...

In Ukraine, almost everyone stayed late to work after hours.
What made me go :o was that engineers were paid less and seen as worse than workers. For example, a 40 y/o blue collar earned more than a 60 y/o engineer.
Both my in-laws were engineers and they got really low wages.

Anonymous said...

The more I read this Blog the more I am afraid of your very short sighted political opinions, like Socialism and wellfare are for loosers, and only US capitalism garantee a free world Where meritocraty is the rule.

Well I don't get how a millionaire's son or a roch star daughter has merits to be rich. I don't see the freedom in the freedom to have 2 jobs and not being able to feed your childs.

I don't see the communism in wellfare, evryone can have problems in their lives, problems that can ruin your entire life without wellfare becomes just life accidents when you have wellfare.

Open your mind, try to think one step further the ambiant political discours, Obama can do that maybe you can too.

debussy said...

@Anonymous
Gevlon is from Hungary, a country similar to Poland and Romania, which were not fully integrated into the Soviet Union, but rather used as the barricade between USSR and the west. Under the influence of Soviet power, but denied any real benefits the other 15 republics were getting. As a result the citizens of these countries quickly embraced anything that came out of USA, as the word of god. Jeans, Dollars, Reaganism and the ideals of Free Market quickly became the symbols of people like Gevlon.

Beffe said...

"What caused the crisis then?

Bad question. The good question is what is the crisis? Answer will come tomorrow."

Tomorrow ? It was answered 30 years ago. Our ever escalating debt due to interest is finally so large that we can't even pay the interest.

Some heavy reading but interesting:
http://www.perfecteconomy.com/

http://www.youtube.com/view_play_list?p=4F0FC0AC39B3086A

Tonus said...

"No one in the free market would invest in new, unproven ideas."

I disagree. It is true that most of the time, companies and investors go with the proven, money-making formula, sometimes way past the point where they should have done something different.

At the same time, there are people who make risky investments all the time, looking for that diamond in the rough that will change them from "being wealthy enough to invest" into "being rich beyond expectations." And of course, when they do find that big investment, everyone else piles on and dilutes it.

It is this kind of high-risk payoff that leads to things like the speculative internet boom that the US had in the late 90s. People invested enormous sums of money in unproven ideas that weren't very realistic. And it was driven by greed, by the desire to cash in before it all collapsed. The 'morons' were the ones left holding the bag when the bottom fell out, because they assumed the gravy train would go on forever.

That said, free markets can work whether or not the market is full of goblins or socials or morons. Someone needs to create a commodity, and someone else needs to buy it, and that dynamic always exists. If there are lots of one type or another, the market will adjust as needed in order to keep the money moving.

Anonymous said...

This is sad. Even Adam Smith thought that "free markets" were without fraud. Regulation is supposed to stop fraud. A free market is not supposed to be about speculation and buyer beware.

Subtracting that part of the equation a free market free of fraud and abuse is more efficient than a command economy.

Even sadder is now its become protect me from fraud but allow me to defraud others. Allow me to keep my profits, but when I fail for my own moronic risks I took give me billions of dollars. And of course only the rich get this treatment if you are poor or middle class tough.

This is not a free market.

Anonymous said...

Q: What is a venture capitalist?
A: An investor who provides start-up money for "new, un-proven ideas" in exchange for part ownership of the company. If the company succeeds, the venture capitalist can sell their ownership (stock) at potentially huge profit. If the company fails (and most do), the venture capitalist usually looses everything they invested.

Capitalism absolutely DOES support trying out "new, unproven ideas", we even have a term for the people that do it.

Sidhe said...

I pretty much agree with everything Gevlon posted on this thread.

Though I still consider that "good intentioned" morons should get help (not free money or welfare, but opportunities to become "non-moron").
For example, with free and public education up to and including college, the moron can become educated, get a decent job, and become a useful member of society instead of a "leech".

A problem in my country for example, is that goverments prefer to either a) Give welfare, or b) Dump "useless" morons, instead of using the solution I proposed above.

The "a" group does it to earn easy votes, the voters become "clients" of the bribing goverment/political party (they buy them with "social plans", as they call welfare here).

The "b" group tries to exclude as much people from the system as they can so these people become "cheap workforce" and have less negotiation power in the employer-employee relationship. (Thus employers get richier, and employees have less freedom instead of more freedom, since necesity reduces freedom to choose, for example, a fair treat)

The point "a" is in my opinion the worst of some self-styled "social democracies" (there are good social democracies, but these are not those. Give people chances, not free money).

The point "b" reflects what for me is the worst of savage unregulated capitalism. It calls itself "free" but it devolves into a de facto slavery system.

Morrissimo said...

What caused the crisis?
* Continued weakening -- or removal altogether -- of basic necessary regulation (see: continued weakening and eventual repeal of Glass-Steagall)
* Lack of enforcement of laws already on the books (see: the FDIC's failure to abide by its Prompt Corrective Action mandate)
* Government legislators and regulators complicit in outright fraud (see: current US SecTreas failure to pay taxes, actions at FRBNY with AIG's counterparties in late 2008)

As far as the US is concerned, ultimately all of our representatives are responsible for the disaster that is upon us -- going all the way back to the false-flag populist legislation of the early 1900s. But who put our representatives there ...and left them there?

That's right. It was us. US voters. Kept just fat, dumb, and happy enough to not pay attention ("Jeepers, civics is hard! And look! American Idol is on!"), after nearly 100 years of neglect we decide that we all of a sudden want our republic back.

As they say in the American south, "that dog won't hunt."

Nate said...

"After all, not "the market" makes the experiment, but a person, with his own resources."
As other people pointed out, venture capitalists, banks extending small business loans, and maxing out your credit cards are all ways that 'the market' can buy into an inventor's new idea.

"

Anti-market activists claim that free market caused the current economic crisis. I disagree, despite I'm 100% sure that proper regulation (for example loans cannot exceed 50% of the recipient current wealth and monthly payments cannot exceed 25% of his income) could fully prevent the collapse of the loaning and derivatives market."

So why should we limit who someone can loan money to? Sounds awfully like enforcing social behavior on people. Look if I want to toss my money at poor people and never see it again, why shouldn't I be allowed to? Perhaps not the best use of my money, but if I have enough why not toss it onto the streets and see people fight over it? Not socially responsible you say, why should I care?

Also making risky loans isn't necessarily just tossing away money. As long as I price that risk in I can still make a profit, and if others are reluctant to enter the market, well all the more money to come to me as I can control a bigger share of it.

So the question is why is that proper regulation? Are there risks I shouldn't be able to take with my money? What if it was dressed up as a charity instead to circumvent such a rule, why would making such loans be illegal and against the spirit of a free market?

haverage said...

Meritocracy is not "true". Inheritance goes against meritocracy. In America, being white, being protestant, having white protestant parents, having upper class parents, having parents who went to Ivy League schools is what will get you ahead.

Anyone who makes money from income will not make it big time. You failed to make it big, who's fault is that? Not yours in the way that you claimed.

Most millionaire money is made from investment, not income. Real world investment is completely different than being a scribe and pumping glyphs out for 30 minutes a week.

Anonymous said...

First of all, the root of the issue in the US goes back to the fact that most of the "defaulted" loans were government issued/guaranteed. Basically, this meant that, when times were good, the people/government got little to no benefit from the loans, but when things got bad, we had all the responsibility/pain. Couple this with regulations requiring mortgage brokers to write a significant percentage of their loans to unqualified applicants to meet affirmative action/low income lending goals and you end up where we are now at.

Anonymous said...

Idiots guide to financial Crisis.

1. Borrow Money from goverments, pension Funds + investers at example rate of 3%. This is also called a bond.

2. Loan this money out at 6%+

3. ??/

4. profit.

5. Crisis if the people you loan the money to cannot repay.

chimei said...

Meritocracy is not a free market.

In the UK it certainly doesn't work. For a start, if you pop out of the right womb (an upper class, wealthy and possibly well related family) you are leagues ahead of your normal working or middle class counterparts. You can simply buy your way into the best education and take the high paying job, continuing the cycle for your children. (Basically ascribed status)

Anonymous said...

Anon a few posts above mine nailed it. For the better part of 20 years U.S. politicians (from both sides of the aisle) have pushed banks and lenders to lower lending standards on home mortgages. Data came in in 1991 that showed blacks and hispanics were declined for mortgages more often than whites. Instead of considering the fact that blacks and hispanics typically have less inherited wealth and slightly lower average credit scores than whites (and asians, who got approved for loans more than whites)the politicians immediately jumped to the conclusion that it was rascism. Presidents from both parties and members of congress overseeing lending practices have made "home ownership" their pet projects ever since. They threatened justice dept. lawsuits and initiated quotas for lenders. Sub-prime and other "creative" loans were the result of lenders trying to find ways to lend to individuals that they knew didn't look good on paper and wouldn't have lent to without the government breathing down their backs. Government regulation created the current problem and will create more by trying to "solve" it with more regulation.

Vvdb said...

The crisis is that we reached the limit of 'securities' we have to pawn for a loan. Countries just gave the ultimate security, their 'ability to bounce back'. In 1 year we will be in the same situation as last year.

Anonymous said...

There are quite a few more evils coming out from communism than not it "not being able to deal with morons":

1. corruption. (post-)communist countries notoriously do not have the means or the will to put corruption to an acceptable level. Everything withing the country functions with corruption taken for granted.

2. centralization/over-regulation/suffocation of economy: When the government controls and/or influences 50% 60%+ of the economy, combined with the corruption on all levels of society, the economy lingers, unemployment is high, and changes are very slow.

3. negative selection: combine corruption and powerlessness to deal with morons through a meritocracy, and you have a larger and larger number of morons populating decision-making and other strategic spots creating even less incentive to deal with corruption and morons that feed it.

4. lack of political freedom that stems from lack of economic freedom creates a nation of lazy-assed workers with high feelings of entitlement that promote silly things like "buy only cars made in our own rotting factories" that at the same time cost like a low end Japanese car but with 10% of the quality, which in turn gives politicians the alibi to slap 50% import tax + 40% other kinds of taxes on importing foreign cars.

I could go on and on. Please, if you havent actually lived in a fucking (post-)communist society, do not fucking extol its virtues.

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Anonymous said...

So I live in Michigan in the USA and we have it pretty rough up here.(considering)

Anyway, I tend to view this blog as nearly on the money all the time. Morons are morons and regardless of what you do there is only one way to change a moron, educate them.

Where I live the government has made it so easy to live without work people all around me are doing it.

There is a solution to the problem in America, bring the jobs back somehow. But before this happens we need to entice people to actually work.

I wish that people had to either
(A)be in school or
(B)work
and take mandatory drug tests in order to receive welfare. I mean half of the complaints I hear are "they wont pay me enough to do the job". Well instead of big brother giving us money to continue doing drugs and being worthless why not implement regulation to welfare and enforce some positive action in that persons life?

Anyways I love the blog, Keep up the great work Gevlon I may not see you as always right but you give a good perspective.

Jeff said...

Proper regulation also includes removing the perverse incentives to inflate stock value at the expense of future earnings.

Look I live in America, I'm well informed regarding our system. I am a full supporter of the free market and believe that the role of government is to promote competition. Note I said promote competition, not promote business. This is what the current US system does. By purchasing access to legislators by writing bills that govern the industries they represent, by being the largest percentage of people in the room, (by most estimates there are 7-9 health care lobbyists on Capital Hill for every member of congress) Money pays for access which pays for preferential legislative action.

The numerous bubbles were not the fault of the free market, they were the logical result of an ever more regulated and controlled market.

Pop quiz: Scientific opinion says burning hydro carbons is bad for the environment, has said it for decades, it has been evident for over a century. All American national security types say it is bad that most of our energy comes from people who would rather see us dead. Energy derived from renewable sources is ultimately cheaper through the entire supply chain. So why is the US against it?

Answer: Entrenched interests in the hydrocarbon production of power are spending every dime required to keep their monopoly. This is a regulated market, not a free market.

Sven said...

@Anonymous (Michigan)
It's illusory to believe that welfare is funding drugs - welfare recipients simply don't receive enough money to pay for significant drug consumption. The drug buyers are getting money somehow, either by working (there are many "functioning" drug addicts who can still hold down a job, just as there are many functioning alcoholics) or crime.

@Jeff
The problems you described aren't caused by regulation, they're caused by bad regulation. If there was a pure free market, hydrocarbons would beat renewables hands down, because they're simply cheaper. The mere fact that scientists say it's dumb can't beat that - they don't get to set the prices in a free market.

Of course, the prices of hydrocarbons will rise eventually as the oil starts to run out, but we can't afford to wait that long - global warming is too far gone. What's needed is better regulation, not an absence of it. The Germans and Danes have got this one right.

JT said...

I saw an episode of Frontline, a program here in the US, called "Breaking the Bank". Their style of show is as close to an unbiased documentary as you can get. If I recall they covered just about every step of the market collapse and its causes. You can view the episode online at pbs.org

Anonymous said...

Michigan again.

@Sven
I can understand that if you consider substantial drug use as the problem then yes welfare does not give enough money for "substantial" but if you see what I see, and that is priorities being shifted so that the drugs are bought before other things, you would think it was substantial.

A real life example is that my sister in law who is young and should still be supported by her mother has to rely on me and her sister(when we have two children of our own) to buy her necessities (bra, underwear, pads)while her mom has plenty of money to buy prescription pills and marijuana. I am a proponent of Marijuana but if it messes with your priorities it might as well be crack.

Besides all that, is it really wrong to expect people who expect to live for free to undergo a drug screen? Or be forced to at least be trying to better themselves by working or going to college?

Anonymous said...

Please people, Stop thinking that you are not richer because of welfare or unemployed ppl they only represent en TINY fraction of the insane money lost miused or stolen by big venture capitalists and or politics.

I can't understand why everyone only complain about welfare when politics from all sides are brought to courts for public money abuse.

what's worse ? a guy who don't work and get 500$ a month to live or a politic with millions in Bank who steal another million from tax money ?

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Klepsacovic said...

"here no one asks why you failed. If you failed, you failed." Actually the best part is that someone does ask why: The person who failed. The problem (the failing person) is his own solution because he is the one who analyzes and corrects his behavior.

If I start a business and it fails, I am motivated to find and correct the mistakes on my part that lead to the failure. This might mean better advertising, a better product, different location, maybe an entirely different market.

There are some times when collectivism is needed. Some ventures are simply too expensive for private investment. But overall, the self-correcting action of the free market works pretty well.

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