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| Image credit. Continued from here. |
1.
We have seen in the last sequel that the mainstream theory of free markets is based on untenable assumptions which amount to disregard for time, space - and hence the human condition.
However, if the theory of efficient markets is of such poor quality, how come open economies work so well? How do we account for the leap that mankind has taken along with the spreading of capitalism? How are we to explain the huge difference in performance between free markets and command economies?
Let us keep this need for a realistic analysis of free markets in mind. Perhaps we will be brought closer to it by paying attention to the imperfections of capitalism. With that, let us turn to Keynes new thinking:
2.
Keynesian strictures aim at the omission of uncertainty in models of efficient markets. As we have seen, the latter operate under the assumption of complete knowledge, which is conveniently forgotten for all the complicated maths and promising expertise of our economic sages.
At any rate, by definition, complete knowledge removes uncertainty. It stands to reasons, decisions taken in the presence of complete knowledge ( = absence of uncertainty) should not be interfered with by impositions of plans that do not take this perfect knowledge into account. But this is exactly what happens, according to the theory of efficient markets, when individual economic agents freely choosing their courses of action based on complete knowledge are subjected to an overriding scheme, notably a plan by government, necessitating revision which, by assumption, amounts to debasing the optimal individual plans.
I suppose, this is what Davidson is arguing, and he seems to add that in the face of spurious assumptions of complete knowledge and absence of uncertainty, we may actually be in need of a third party helping us coping with the real inherently risky world whose uncertainty is prone to be economically ruinous to the individual as well as the community at large.
While I begin to feel that Davidson is onto something, the array of arguments presented to support his case does not always strike me as meticulously coherent.
Perhaps this is because the failure of the efficient market model is not exclusively due to the omission of uncertainty. Cannot economic plans add up to a well-coordinated whole even in the face of uncertainty? I suppose, daily experience would support the idea. So, there must be quasi-equilibrating mechanisms at work, and it is their malfunctioning as well that makes for crisis. However, Davidson is both right in pointing out the absurdity of the certainty assumption and in demonstrating that in the real world the well-coordinated whole is liable to perennial break down - precisely on account of incomplete information causing people to misjudge the future.
Perhaps he is even right in insinuating that incomplete knowledge is the root cause of capitalist crises - but then, this can be truthfully said of socialism as well. So, I suppose, for a complete explanation of specifically capitalist crises we need to incorporate into the picture a number of additional features, which Davidson omits or accomplishes only insufficiently in the present chapter 4.
3.
The core argument goes as follows: Euclidean economics supposes that people have complete knowledge and therefore are able to properly assess all conditions ever relevant to their economic plans. The outcome is efficient - however, I suppose, we need additional features to warrant the claim of efficiency. Never mind, Non-Euclidean economics recognises that people lack complete information and are therefore bound to take faulty decisions, resulting in inefficient outcomes. Reflexivity is a case in point; the term coined by Soros, meaning: markets are not shaped by the decisions of omniscient economic agents but are often moved by sheer guesswork and perhaps even educated surmise, but still: mere surmise. Reflexivity seem to imply: markets may move on false or bad information thus veering off the path of efficiency - mind you, again, "efficiency" seems one of the additional features one would have to look at more closely to assess the full picture of the Davidsonian criticism.
In a way, capitalism is, contrary to the efficient market theory, an admission that the world is uncertain. A sign of which being the prominence of contract under capitalism. Contracts are instruments helping people to attenuate, not abolish, but attenuate uncertainty, by helping to increase the predictability of economic claims and liabilities. The same holds for (a) financial assets, which, among other things, allow people to store and retrieve purchasing power as a hedge against unexpected needs, and (b) markets, which enhance these features by increasing the liquidity of financial assets, that is the ability to adjust the level and terms of stored purchasing power and to deploy it at short notice.
Now we are coming closer to "the additional features" I have been mentioning above, for markets will not always work in "orderly fashion," as Davidson phrases it. Precisely because of uncertainty and reflectivity. People's uncertainty is part of the reason why they cannot ensure efficient outcomes. Your investment strategy intended to ensure retirement income may founder on the rocks of markets that are overly volatile as they are prone to be moved by unpredictably changing and erroneous informational input - resulting from uncertainty.
Uncertainty may also induce people to save, i.e. spend less than they would otherwise, use their money for other purposes than purchasing goods and services on offer. If a large enough number of people save a large enough amount of purchasing power, the economy at large will be affected. Businesses will sell less, their expectations regarding future sales deteriorate, and with declining profitability prospects and worries of facing losses, they will find it harder to maintain former levels of employment. With more people out of work, the economic situation of firms is further impaired.
However, there is a way out of this vicious cycle, and this is the Keynes Solution: government might step in, stimulating demand by financing projects which put firms and worker back to work. With more money in their pockets, people will take up consumption and create brighter business prospects for the private sector, which will overcome under-capacity production, even make new investments and push up the level of employment.
Shortly, we will see, why government should be able to assume this role without necessarily causing economic havoc from inflation or over-indebtedness leading to insolvency or excessive burdens on futures generations.
Keynesian strictures aim at the omission of uncertainty in models of efficient markets. As we have seen, the latter operate under the assumption of complete knowledge, which is conveniently forgotten for all the complicated maths and promising expertise of our economic sages.
At any rate, by definition, complete knowledge removes uncertainty. It stands to reasons, decisions taken in the presence of complete knowledge ( = absence of uncertainty) should not be interfered with by impositions of plans that do not take this perfect knowledge into account. But this is exactly what happens, according to the theory of efficient markets, when individual economic agents freely choosing their courses of action based on complete knowledge are subjected to an overriding scheme, notably a plan by government, necessitating revision which, by assumption, amounts to debasing the optimal individual plans.
I suppose, this is what Davidson is arguing, and he seems to add that in the face of spurious assumptions of complete knowledge and absence of uncertainty, we may actually be in need of a third party helping us coping with the real inherently risky world whose uncertainty is prone to be economically ruinous to the individual as well as the community at large.
While I begin to feel that Davidson is onto something, the array of arguments presented to support his case does not always strike me as meticulously coherent.
Perhaps this is because the failure of the efficient market model is not exclusively due to the omission of uncertainty. Cannot economic plans add up to a well-coordinated whole even in the face of uncertainty? I suppose, daily experience would support the idea. So, there must be quasi-equilibrating mechanisms at work, and it is their malfunctioning as well that makes for crisis. However, Davidson is both right in pointing out the absurdity of the certainty assumption and in demonstrating that in the real world the well-coordinated whole is liable to perennial break down - precisely on account of incomplete information causing people to misjudge the future.
Perhaps he is even right in insinuating that incomplete knowledge is the root cause of capitalist crises - but then, this can be truthfully said of socialism as well. So, I suppose, for a complete explanation of specifically capitalist crises we need to incorporate into the picture a number of additional features, which Davidson omits or accomplishes only insufficiently in the present chapter 4.
3.
The core argument goes as follows: Euclidean economics supposes that people have complete knowledge and therefore are able to properly assess all conditions ever relevant to their economic plans. The outcome is efficient - however, I suppose, we need additional features to warrant the claim of efficiency. Never mind, Non-Euclidean economics recognises that people lack complete information and are therefore bound to take faulty decisions, resulting in inefficient outcomes. Reflexivity is a case in point; the term coined by Soros, meaning: markets are not shaped by the decisions of omniscient economic agents but are often moved by sheer guesswork and perhaps even educated surmise, but still: mere surmise. Reflexivity seem to imply: markets may move on false or bad information thus veering off the path of efficiency - mind you, again, "efficiency" seems one of the additional features one would have to look at more closely to assess the full picture of the Davidsonian criticism.
In a way, capitalism is, contrary to the efficient market theory, an admission that the world is uncertain. A sign of which being the prominence of contract under capitalism. Contracts are instruments helping people to attenuate, not abolish, but attenuate uncertainty, by helping to increase the predictability of economic claims and liabilities. The same holds for (a) financial assets, which, among other things, allow people to store and retrieve purchasing power as a hedge against unexpected needs, and (b) markets, which enhance these features by increasing the liquidity of financial assets, that is the ability to adjust the level and terms of stored purchasing power and to deploy it at short notice.
Now we are coming closer to "the additional features" I have been mentioning above, for markets will not always work in "orderly fashion," as Davidson phrases it. Precisely because of uncertainty and reflectivity. People's uncertainty is part of the reason why they cannot ensure efficient outcomes. Your investment strategy intended to ensure retirement income may founder on the rocks of markets that are overly volatile as they are prone to be moved by unpredictably changing and erroneous informational input - resulting from uncertainty.
Uncertainty may also induce people to save, i.e. spend less than they would otherwise, use their money for other purposes than purchasing goods and services on offer. If a large enough number of people save a large enough amount of purchasing power, the economy at large will be affected. Businesses will sell less, their expectations regarding future sales deteriorate, and with declining profitability prospects and worries of facing losses, they will find it harder to maintain former levels of employment. With more people out of work, the economic situation of firms is further impaired.
However, there is a way out of this vicious cycle, and this is the Keynes Solution: government might step in, stimulating demand by financing projects which put firms and worker back to work. With more money in their pockets, people will take up consumption and create brighter business prospects for the private sector, which will overcome under-capacity production, even make new investments and push up the level of employment.
Shortly, we will see, why government should be able to assume this role without necessarily causing economic havoc from inflation or over-indebtedness leading to insolvency or excessive burdens on futures generations.
4.
We are dealing with an interesting ideological structure. Using false premises (complete knowledge), classical economists have developed a theory that appears to explain the workings of a remarkably well-functioning type of economy. The relative success of capitalism vouchsafes the respectability of a grossly erroneous theory. Capitalism works well despite the unnoticed errors of a theory purporting to reveal the secrets of its success. Credibility by association gives the theory of efficient markets a head start in the race for explaining and handling capitalism. But it is a theory that puts a lot of wrong ideas into our heads.
Continued here.
We are dealing with an interesting ideological structure. Using false premises (complete knowledge), classical economists have developed a theory that appears to explain the workings of a remarkably well-functioning type of economy. The relative success of capitalism vouchsafes the respectability of a grossly erroneous theory. Capitalism works well despite the unnoticed errors of a theory purporting to reveal the secrets of its success. Credibility by association gives the theory of efficient markets a head start in the race for explaining and handling capitalism. But it is a theory that puts a lot of wrong ideas into our heads.
Continued here.
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