6 ms·

Joseph Stiglitz: The Non-Existent Hand

46 points by cwan 17y ago

lionhearted 17y ago
This is politics very thinly veiled as economics, and there's also a lot of misinformation in it. But one thing in the piece stands out as so incredibly wrong but often repeated, that it must be debunked and re-debunked and argued against until the reality of things becomes common wisdom: > They provided support for the movement which stripped away the regulations that had provided the basis of financial stability in the decades after the Great Depression This is not the case. The financial system is incredibly complexly regulated, and the regulations are growing each year. They're too complex for lay people to understand. As such, you get a phenomenon called regulatory capture - http://en.wikipedia.org/wiki/Regulatory_capture http://en.wikipedia.org/wiki/Regulatory_capture "Regulatory capture occurs when a state regulatory agency created to act in the public interest instead acts in favor of the commercial or special interests that dominate in the industry or sector it is charged with regulating. Regulatory capture is a form of government failure, as it can act as an encouragement for large firms to produce negative externalities. The agencies are called Captured Agencies." Regulatory capture always happens in large money industries where the regulations are too complex for lay people to understand and get upset about. Regulations grow each year in banking, every single year - and the regulations inevitably benefit the banking industry, who have lobbyists, experts, panels who are deeply interested in getting their way. This is very important: The entire financial system is created by regulation. We use paper money because it's required to use in the United States. The U.S. dollar, for instance: http://en.wikipedia.org/wiki/Legal_tender http://en.wikipedia.org/wiki/Legal_tender "Legal tender or forced tender is an offered payment that, by law, cannot be refused in settlement of a debt, and have the debt remain in force.[1] Currency is the most common form of legal tender." From there, the printing of money is created by regulation, the banks are beholden to the printing body, and so on, and so on. This mess is indeed a failure of regulation - the regulation created it. The entire financial system, top to bottom, is probably the most heavily regulated in the world. Regulation created it. It's already heavily regulated. The regulations are twisted over time to benefit the banking industry itself. I'd encourage everyone who hasn't read it to the Austrian theory of the banking cycle: http://en.wikipedia.org/wiki/Austrian_business_cycle_theory http://en.wikipedia.org/wiki/Austrian_business_cycle_theory "The theory views most business cycles (or, as some Austrians prefer, "credit cycles") as the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings." It's a very interesting theory, and pretty convincing to me. Central banks set interest rates artificially low, people borrow a lot, inflationary bubbles happen, things crash. Today it's bad mortgages derivatives, yesterday it's bonds, before that it's the stock market a few times, next it's something else. A country with legal tender laws ("you must accept this kind of money"), money of no inherent value (which would act as a natural check to printing more), an agency that can create that money at will (the Federal Reserve), and uses this new money to set interest rates artificially low (which it does) - this always leads to crashes, always. We don't need more regulation, we need to tear the whole mess down. Politicians have proven repeatedly that they can not be trusted with the ability to print money that you're required by law to take.
- joe_the_user 17y ago
  This is politics very thinly veiled as economics The line between policy and economics has been thin. Just because your particular viewpoint several wikipedia page doesn't mean you have to paste them here.
- btilly 17y ago
  > They provided support for the movement which stripped away the regulations that had provided the basis of financial stability in the decades after the Great Depression This is not the case. The financial system is incredibly complexly regulated, and the regulations are growing each year. They're too complex for lay people to understand. As such, you get a phenomenon called regulatory capture... You have utterly missed the point. And the rest of your rant just goes farther afield from the article. Stiglitz claims that there are specific regulations which were responsible for several decades of financial stability in the USA. He further claims that these regulations have been removed. There is, in fact, a great deal of support for both claims. He does not claim that there are now no regulations. He does not claim that all regulations are good. And it is a safe bet that he has spent more time thinking about regulatory capture than you have. Now get off of your pedestal, go read what the Nobel laureate has to say, and you just might learn something useful about economics.
  - lsd5you 17y ago
    That is pretty condescending. I am not a libertarian and I even agree with the sentiments of the article, but the analysis offered in the article was very weak and the OP is right to be skeptical.
    - btilly 17y ago
      The article was meant to be a book review aimed at an economically sophisticated audience, and not an airtight argument for a thesis. I would suggest researching the various ideas that were brought up. It is worth noting as well that in many cases Stiglitz is not saying, "This is what is true." Rather he is saying, "Here are several important schools of thought that were ignored, but which are relevant to the current crisis."
alan-crowe 17y ago
There seems to be a huge leap in paragraph two. Stiglitz writes "if markets were as efficient in transmitting information as the free marketeers claimed, no one would have any incentive to gather and process it." The implications of this observation have a degree of inevitability which I work though below. Suppose you want to make money on the stock market. If you could work out the true value of the companies listed there you could manage a portfolio by buying underpriced stock and selling it later. Perhaps you hire a team of PhD economists to do the valuations for you. Suppose their valuations are accurate and you make money on your trading. Your friends will be envious at first. If however it turns out the money you make trading fails to cover the cost of running your research team, you will end up having to sell your yacht and your friends will laugh at you. What is the relationship between research costs and prediction accuracy? We might at first guess 1/x. However, if we had spent a million dollars to get a 10% accurate prediction, do we really think that a second million would get us to 5% accuracy? The biggest issue is that stock values depend on the future and the future is usually exponentially sensitive to initial conditions. Perhaps the accuracy with which our research determines initial conditions is inversely proportional to the cost, but that still leaves an exponential divergence.A reasonable first guess is that if we want an accuracy of x% the research will cost exp(1/x). Meanwhile we need to take a stab at the function form of the profit from trading. Perhaps it is proportional to the difference between the true price and the market price, but that ignores the question of how long we have to wait before we can sell and realise our gains. The dynamics of the market are at issue. The traditional saying is "markets can stay irrational longer than you can stay solvent.". Well, yes, but the more prices are out of wack, the faster the pressure for a correction builds up. Dynamics is difficult. Let's just guess that the profits from trading on difference btween true price and market price have a form something like x tanh x. Putting these together and equating marginal chances leads to what I call the "dead zone" theory of markets. Market prices are wrong and bumble about in a dead zone around the true price. Reasonable functional forms give quite firm edges to the dead zone. An interesting follow question asks for the probability distribution of the true price in the dead zone. Perhaps there is a strong central tendency, but what might produce it? Perhaps the distribution is uniform across the dead zone? Or maybe psychological factors push the dead zone so that the true price is at one end or the other. (If only we knew which!) However I want to get back to Stiglitz' book review. The reasoning that Stiglitz adumbrates leads to the notion of a dead zone of some definite size. Three responses are the pessimistic, the "markets fail, use markets" of Bryan Caplan and Stiglitz's maneouvre. A pessimist could follow up with a critique of modern society that claims it is out of control and heading for disaster. The pessimistic critique could insist that technological challenges and uncertainies make the future unmangeable and unplannable, and futher more market solutions will not help because the dead zone is huge; Adam Smith's invisible hand might as well not be there. A free-market advocate need not be much embarrassed by even a large dead zone. How should production and exchange be organized? It is a choice between competing options and the difficulties that give rise to the dead zone seem to place heavy burdens on the alternative options. Stiglitz treats the dead zone as huge, so large that "Adam Smith's hand was not in fact invisible: it wasn't there." I don't know why. The dead zone clearly has to exist, but that sheds no light on whether it is large or small. I'm not managing to make much sense of economic discussions. Does efficient-market-theory" really deny the existance of the dead zone? Do the opponents of efficient-market-theory really believe that because the dead zone exists it is necessarily huge?
DaniFong 17y ago
I believe the Nobel laureate has the wrong title. It is not as if there's no market efficiency, no collective pricing that occurs from the interaction of individual agents. But individual, selfish agents do not always act in the public interest. Some economists call the problem of externalized costs "the Tragedy of the Commons." But a lot of commons aren't visible, which doesn't make for a great tragedy. So I (and some others) have taken to calling that problem "the Invisible Foot."
- anamax 17y ago
  > But individual, selfish agents do not always act in the public interest. That assumes that "the public interest" is well defined and knowable. It may be in a very small number of cases but, in general, when someone invokes "the public interest", they're trying to get you to go along with what they want, the "public" be damned. And no, it's not the frauds who do the most damage, it's the do-gooders, the true believers, by a large margin. The frauds can be bought off.
LiveTheDream 17y ago
Markets can act irrationally even if the players are acting rationally. This is because of players acting in their own self-interest. For example, if an investment bank takes an enormous risky position that backfires, it may appear irrational. Then consider the massive severance package and/or political support that protects the executive or firm! Now that risky position isn't so risky after all. I think my point is that "rational" acting is not a clear-cut term that describes a market and its players. Let's take a look at another player, Joe Homebuyer who has access to easy loan money and can buy well out of his price range. Given that home prices had risen consistently for so long (perhaps longer than Joe Homebuyer has been living), at what point does the overvalued price of the house become irrational? Maybe it's when the mortgage-to-rent ratio is too far off, maybe it is some other trigger, but Joe Homebuyer thinks he has protection anyway because he cannot conceive of the possibility that prices will drop. All of his experience shows only gains for this purchase. So, is buying that overpriced house rational or irrational? Seems rational to Joe, but irrational to people with more information about the market.

46 points by cwan 17y ago

This is politics very thinly veiled as economics, and there's also a lot of misinformation in it. But one thing in the piece stands out as so incredibly wrong but often repeated, that it must be debunked and re-debunked and argued against until the reality of things becomes common wisdom: > They provided support for the movement which stripped away the regulations that had provided the basis of financial stability in the decades after the Great Depression This is not the case. The financial system is incredibly complexly regulated, and the regulations are growing each year. They're too complex for lay people to understand. As such, you get a phenomenon called regulatory capture - http://en.wikipedia.org/wiki/Regulatory_capture http://en.wikipedia.org/wiki/Regulatory_capture "Regulatory capture occurs when a state regulatory agency created to act in the public interest instead acts in favor of the commercial or special interests that dominate in the industry or sector it is charged with regulating. Regulatory capture is a form of government failure, as it can act as an encouragement for large firms to produce negative externalities. The agencies are called Captured Agencies." Regulatory capture always happens in large money industries where the regulations are too complex for lay people to understand and get upset about. Regulations grow each year in banking, every single year - and the regulations inevitably benefit the banking industry, who have lobbyists, experts, panels who are deeply interested in getting their way. This is very important: The entire financial system is created by regulation. We use paper money because it's required to use in the United States. The U.S. dollar, for instance: http://en.wikipedia.org/wiki/Legal_tender http://en.wikipedia.org/wiki/Legal_tender "Legal tender or forced tender is an offered payment that, by law, cannot be refused in settlement of a debt, and have the debt remain in force.[1] Currency is the most common form of legal tender." From there, the printing of money is created by regulation, the banks are beholden to the printing body, and so on, and so on. This mess is indeed a failure of regulation - the regulation created it. The entire financial system, top to bottom, is probably the most heavily regulated in the world. Regulation created it. It's already heavily regulated. The regulations are twisted over time to benefit the banking industry itself. I'd encourage everyone who hasn't read it to the Austrian theory of the banking cycle: http://en.wikipedia.org/wiki/Austrian_business_cycle_theory http://en.wikipedia.org/wiki/Austrian_business_cycle_theory "The theory views most business cycles (or, as some Austrians prefer, "credit cycles") as the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings." It's a very interesting theory, and pretty convincing to me. Central banks set interest rates artificially low, people borrow a lot, inflationary bubbles happen, things crash. Today it's bad mortgages derivatives, yesterday it's bonds, before that it's the stock market a few times, next it's something else. A country with legal tender laws ("you must accept this kind of money"), money of no inherent value (which would act as a natural check to printing more), an agency that can create that money at will (the Federal Reserve), and uses this new money to set interest rates artificially low (which it does) - this always leads to crashes, always. We don't need more regulation, we need to tear the whole mess down. Politicians have proven repeatedly that they can not be trusted with the ability to print money that you're required by law to take.

joe_the_user 17y ago
This is politics very thinly veiled as economics The line between policy and economics has been thin. Just because your particular viewpoint several wikipedia page doesn't mean you have to paste them here.
btilly 17y ago
> They provided support for the movement which stripped away the regulations that had provided the basis of financial stability in the decades after the Great Depression This is not the case. The financial system is incredibly complexly regulated, and the regulations are growing each year. They're too complex for lay people to understand. As such, you get a phenomenon called regulatory capture... You have utterly missed the point. And the rest of your rant just goes farther afield from the article. Stiglitz claims that there are specific regulations which were responsible for several decades of financial stability in the USA. He further claims that these regulations have been removed. There is, in fact, a great deal of support for both claims. He does not claim that there are now no regulations. He does not claim that all regulations are good. And it is a safe bet that he has spent more time thinking about regulatory capture than you have. Now get off of your pedestal, go read what the Nobel laureate has to say, and you just might learn something useful about economics.
- lsd5you 17y ago
  That is pretty condescending. I am not a libertarian and I even agree with the sentiments of the article, but the analysis offered in the article was very weak and the OP is right to be skeptical.
  - btilly 17y ago
    The article was meant to be a book review aimed at an economically sophisticated audience, and not an airtight argument for a thesis. I would suggest researching the various ideas that were brought up. It is worth noting as well that in many cases Stiglitz is not saying, "This is what is true." Rather he is saying, "Here are several important schools of thought that were ignored, but which are relevant to the current crisis."

alan-crowe 17y ago

There seems to be a huge leap in paragraph two. Stiglitz writes "if markets were as efficient in transmitting information as the free marketeers claimed, no one would have any incentive to gather and process it." The implications of this observation have a degree of inevitability which I work though below. Suppose you want to make money on the stock market. If you could work out the true value of the companies listed there you could manage a portfolio by buying underpriced stock and selling it later. Perhaps you hire a team of PhD economists to do the valuations for you. Suppose their valuations are accurate and you make money on your trading. Your friends will be envious at first. If however it turns out the money you make trading fails to cover the cost of running your research team, you will end up having to sell your yacht and your friends will laugh at you. What is the relationship between research costs and prediction accuracy? We might at first guess 1/x. However, if we had spent a million dollars to get a 10% accurate prediction, do we really think that a second million would get us to 5% accuracy? The biggest issue is that stock values depend on the future and the future is usually exponentially sensitive to initial conditions. Perhaps the accuracy with which our research determines initial conditions is inversely proportional to the cost, but that still leaves an exponential divergence.A reasonable first guess is that if we want an accuracy of x% the research will cost exp(1/x). Meanwhile we need to take a stab at the function form of the profit from trading. Perhaps it is proportional to the difference between the true price and the market price, but that ignores the question of how long we have to wait before we can sell and realise our gains. The dynamics of the market are at issue. The traditional saying is "markets can stay irrational longer than you can stay solvent.". Well, yes, but the more prices are out of wack, the faster the pressure for a correction builds up. Dynamics is difficult. Let's just guess that the profits from trading on difference btween true price and market price have a form something like x tanh x. Putting these together and equating marginal chances leads to what I call the "dead zone" theory of markets. Market prices are wrong and bumble about in a dead zone around the true price. Reasonable functional forms give quite firm edges to the dead zone. An interesting follow question asks for the probability distribution of the true price in the dead zone. Perhaps there is a strong central tendency, but what might produce it? Perhaps the distribution is uniform across the dead zone? Or maybe psychological factors push the dead zone so that the true price is at one end or the other. (If only we knew which!) However I want to get back to Stiglitz' book review. The reasoning that Stiglitz adumbrates leads to the notion of a dead zone of some definite size. Three responses are the pessimistic, the "markets fail, use markets" of Bryan Caplan and Stiglitz's maneouvre. A pessimist could follow up with a critique of modern society that claims it is out of control and heading for disaster. The pessimistic critique could insist that technological challenges and uncertainies make the future unmangeable and unplannable, and futher more market solutions will not help because the dead zone is huge; Adam Smith's invisible hand might as well not be there. A free-market advocate need not be much embarrassed by even a large dead zone. How should production and exchange be organized? It is a choice between competing options and the difficulties that give rise to the dead zone seem to place heavy burdens on the alternative options. Stiglitz treats the dead zone as huge, so large that "Adam Smith's hand was not in fact invisible: it wasn't there." I don't know why. The dead zone clearly has to exist, but that sheds no light on whether it is large or small. I'm not managing to make much sense of economic discussions. Does efficient-market-theory" really deny the existance of the dead zone? Do the opponents of efficient-market-theory really believe that because the dead zone exists it is necessarily huge?

DaniFong 17y ago

I believe the Nobel laureate has the wrong title. It is not as if there's no market efficiency, no collective pricing that occurs from the interaction of individual agents. But individual, selfish agents do not always act in the public interest. Some economists call the problem of externalized costs "the Tragedy of the Commons." But a lot of commons aren't visible, which doesn't make for a great tragedy. So I (and some others) have taken to calling that problem "the Invisible Foot."

anamax 17y ago
> But individual, selfish agents do not always act in the public interest. That assumes that "the public interest" is well defined and knowable. It may be in a very small number of cases but, in general, when someone invokes "the public interest", they're trying to get you to go along with what they want, the "public" be damned. And no, it's not the frauds who do the most damage, it's the do-gooders, the true believers, by a large margin. The frauds can be bought off.

LiveTheDream 17y ago

Markets can act irrationally even if the players are acting rationally. This is because of players acting in their own self-interest. For example, if an investment bank takes an enormous risky position that backfires, it may appear irrational. Then consider the massive severance package and/or political support that protects the executive or firm! Now that risky position isn't so risky after all. I think my point is that "rational" acting is not a clear-cut term that describes a market and its players. Let's take a look at another player, Joe Homebuyer who has access to easy loan money and can buy well out of his price range. Given that home prices had risen consistently for so long (perhaps longer than Joe Homebuyer has been living), at what point does the overvalued price of the house become irrational? Maybe it's when the mortgage-to-rent ratio is too far off, maybe it is some other trigger, but Joe Homebuyer thinks he has protection anyway because he cannot conceive of the possibility that prices will drop. All of his experience shows only gains for this purchase. So, is buying that overpriced house rational or irrational? Seems rational to Joe, but irrational to people with more information about the market.