
Joseph Stiglitz: The Non-Existent Hand - cwan
http://www.lrb.co.uk/v32/n08/joseph-stiglitz/the-non-existent-hand
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LiveTheDream
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.

------
DaniFong
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
> 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.

------
lionhearted
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>

"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>

"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>

"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.

~~~
btilly
_> 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
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
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
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?

~~~
btilly
Your "dead zone" was described in Stiglitz' Nobel lecture by _the price system
both imperfectly aggregated information and that there was an equilibrium
amount of “disequilibrium.”_ However that is but one of many important effects
from information asymmetry, and many of the others you have probably not
thought about yet.

As for the size of the effects, economists disagree. It is true that Stiglitz
is inclined towards believing that they are large. His reasons for doing so
range from the personal (in particular time spent in Kenya) to the
professional. As well when you spend a large chunk of your life thinking about
the importance of an effect, you're going to be likely to think it important.

For more on this topic, I recommend reading through his Nobel lecture,
available at
[http://nobelprize.org/nobel_prizes/economics/laureates/2001/...](http://nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-
lecture.pdf).

Furthermore there are other factors that affect Stiglitz' thinking, and he
doesn't really have room to discuss them all, all the time. For example I know
he is very concerned that modern financial markets have externalized a lot of
risk to tax payers. It is rational to take a large risk if it brings a chance
of massive rewards on the one hand, and a bailout on the other. However banks
that do this will not even try to price certain risks correctly. And this
leads to systemic market failure modes.

