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yesthattom

markets are not self-correcting

http://www.chinadaily.com.cn/opinion/2009-12/31/content_9249981.htm

The first lesson is that markets are not self-correcting. Indeed, without adequate regulation, they are prone to excess. In 2009, we again saw why Adam Smith's invisible hand often appeared invisible: it is not there. The bankers' pursuit of self-interest (greed) did not lead to the well-being of society; it did not even serve their shareholders and bondholders well. It certainly did not serve homeowners who are losing their homes, workers who have lost their jobs, retirees who have seen their retirement funds vanish, or taxpayers who paid hundreds of billions of dollars to bail out the banks.

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I always had a different theory as to why Adam Smith's hand was invisible -- It is kept hidden because it's always giving us the finger.

The problem stems from the gov't hand of interference. If the bankers who gambled -- and gambled badly -- had been allowed to fail, then future bankers would have been FAR less willing to make the incredibly bad financial decisions that their predecessors had done. The problem with the mortgage crisis has its start in Fannie/Freddie, lenders for whom it was tacitly understood were backed by the Federal Teat. In other words, they didn't have to live with the outcome of their bad decisions, so they were willing to make them. Other lenders followed suit, and lo and behold, you have a meltdown.

If the gov't had just LET THEM FAIL, then the "negative reinforcement of failure" (which is a necessary part of a truly free market) would have ensured that such decisions never happened again.

You're allowed to risk "everything" and win big, it's how societies are made great, but for the system to work, you have to be willing to step back from those ginormous failures and say "that's the bed you made, now lie down in it", instead of helping them out.

The "invisible hand" works well in these conditions:

- a commodity with a large number of sellers and buyers

- (relatively) low barriers of entry

- all information about the commodity is freely and equally available to everyone

- consistent rules of fairness, binding agreements, and lack of fraud are well enforced

When you have corruption, or a relatively small number of dominant players, or vastly unequal information among buyers and sellers, or a variety of other things that upset the above formula, the invisible hand's power grows weaker and weaker, and other effects take over.

It's not that the invisible hand doesn't work or doesn't exist, it's that it doesn't apply to everything, and too many people are under a near-religious belief that we should pretend it does.

Consistent with "all information about the commodity is freely and equally available to everyone" is the notion of the "invisible hand" being 18th century parlance for a "feedback loop." In a perfect system information about corrupt sellers propagates instantly to all buying agents, which rationally act to shun them for honest ones. (Obviously assuming that the other conditions you enumerated hold; e.g., lower barriers of entry, large numbers, enforced rules, etc.) The inherent complexities of modern economies severely impairs this feedback. For example many producers will have a hand in making a given product, any one of whom can be dishonest. And that is but one product among many thousands the buyer has to choose from. Given the limit in human cognitive capacity, it is impossible to adequately chase down all the supply links to ultimate manufacturers and analyze the fitness of everyone down along the chain that contributed in some way to crafting the widget. That is, for a given widget there may be up to dozens of different manufacturers that have had a hand in creating it; and that's not including the other services that ensure that widget gets to the store shelf for consideration. (I.e., everything in the logistics chain)

I assert that this is a key component of the engine of corporate corruption. Because the bad guys aren't likely going to get caught and punished, they can engage in unethical practices that gives them some advantage over the honest ones. The dishonest companies then, over the aggregate, gain control over the market and drive out the honest companies. Turn the crank on the system and it eventually converges into a homogeneous collective of "too big to fail" entities that have managed to seize control not just of the markets, but their encompassing polities as well.

And so such a system has a natural basin of attraction for fascism were corporations control significant aspects of governance. However there may be sufficient checks in the local "ecosystem" (i.e., the government) to ensure that this doesn't happen, the process is greatly slowed, or converges to "neo-Fascism light" where there is some sort of inhibiting upper-bound to corporate influence.

Apologies for my havering. I've been up all night. :\


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