[5 March 2009]
This post from Willem Buiter presents an interesting way of thinking about markets, not as theoretically convenient constructs to suit economists’ models, but as improbable, fraught and fragile institutions. They are not transparent and frictionless; they don’t function automatically. Exchange, as such, uses up resources above and beyond what is exchanged, and these costs must be borne. Markets are never “free.” His case is elegantly argued, and it’s worth reading the whole thing. But here’s his distillation:
The conclusion, boys and girls, should be that trade - voluntary exchange - is the exception rather than the rule and that markets are inherently and hopelessly incomplete. Live with it and start from that fact. The benchmark is no trade—pre-Friday Robinson Crusoe autarky. For every good, service or financial instrument that plays a role in your ‘model of the world’, you should explain why a market for it exists - why it is traded at all.
Buiter’s point is to discredit the efficient markets hypothesis—the theory that markets aggregate information from investors and interested parties and prices permit efficient capital allocation. If markets themselves impose costs, these costs distort prices. And if prices reflect the future value, who knows how far that is? Buiter says such models presume “a friendly auctioneer at the end of time - a God-like father figure - who makes sure that nothing untoward happens with long-term price expectations or (in a complete markets model) with the present discounted value of terminal asset stocks or financial wealth.” No such figure exists, and the models bear little resemblance to what goes on in actual economies.
As a result, economists henceforth, according to Buiter, will be forced to use “behavioural approaches relying on empirical studies on how market participants learn, form views about the future and change these views in response to changes in their environment, peer group effects etc.” In other words, they will have to find tools to study how and why confidence ebbs and flows. They will become philologists of happy talk.
An aside—I wonder if the notion of autarky offers a different way to conceive of what is happening in the recession as the economy contracts: The costs of maintaining markets—the trust, credit, contract enforcement, disclosure and so on—has suddenly become too high to justify the amount of exchange we had before. The sum of social needs hasn’t changed; it has fallen below some critical threshold that makes them impossible to satisfy and thus superfluous. Perhaps we experience this as a retreat into self-sufficiency at a personal level—not merely a return to thrift (though that is a part of it) but a move toward a fantasy of autarky in which we are able to maintain ourselves by our own efforts without the vagaries and exploitations and chaotic dangers of exchange and markets. But of course autarky is basically impossible; it’s a dangerous delusion to think that we can exist without be part of a community—markets included. It seems short-sighted to collapse the idea of community into markets, and make them one and the same for all intenets and purposes; but it’s equally wrong to be tempted by recession into thinking that community can exist without thriving markets, that we can somehow be better off when we are exchanging less.