It would help to distinguish between at least three broad types of markets: financial markets which trade risk; goods and service markets which trade products between businesses and to households; and public service markets which provide government funded services but are not necessarily managed by government agencies (and could for example be run for profit).
Even such a simple definition shows how silly the politics has already got. When Sarkozy talks of the end of capitalism he’s beginning to slide into the goods and services territory – and to industry protection and state support policy. Even more bizarrely, the recently-dug-up speech which Brown gave at the SMF in 2003 is very much focused on the use and limits of markets in public services and is not a general theory of markets. (Amusingly it also talks a lot about the problem of state failure replacing market failure, a risk probably rising in significance daily.)
This ‘contagion’ effect is unfortunate: the financial crisis has some very specific and technical causes and shouldn’t lead us to hasty conclusions about the operation of goods and service markets (and junking long established competition policy) nor about public service markets (and putting unnecessary brakes on bringing the benefits of markets into public services when and where they can add value). In so far as there are general lessons about markets to be found from the financial crisis it’s the importance of good information for them to work effectively and of careful ‘agent-design’ (e.g. that the bank knows who the ‘right’ people to lend to are, and there’s no third party ready to benefit from misselling). But we knew all this already and the three broad market types I described each have specific features and come with very detailed theory as well as evidence and practice in how they work.
Perhaps it’s a good example of how societies – and politicians – respond to crises:
- We have to find historical precedence: so the current economic crisis is rivalled only by the Great Depression of the 1930s. (Actually it’s a poor comparison: we remember the Great Depression for the one in three who became unemployed and the almost half pushed below the poverty line, a human consequence that the current problems will have nothing to compare to, and not the fall in stock values.)
- We must all somehow be affected: perhaps this is some sort of solidarity effect, or maybe that people are perversely jealous of the attention a crisis gets. But it’s amusing that almost everyone is trying to claim relevance to the credit crisis at the moment. I’ve lost count of the number of times I’ve recently heard policy makers say things like “in the current turbulent times [environment/ social/ education/ insert random policy area] is now more important than ever”. Why don’t we just let the macroeconomists have their moment in the limelight and acknowledge that constitutional reform or what’s in the school curriculum isn’t the most pressing issue right now?
- Something must be done: we have to find the general lessons and apply them in all forms and in all places. So we get an equal and opposite reaction with for example politicians getting lukewarm on markets in public services. This is also a particularly common response following disasters whether natural or man-made with disproportionate reactions like with health and safety measures that represent extremely poor levels of cost-effectiveness.
- Obfuscation and denial of the root cause: a sensible reaction would be to say something’s gone wrong with (parts of) financial markets therefore we need to (1) stop this from worsening (2) limit the consequences elsewhere (3) reduce the chance of this happening again. We’re close to doing (1) now and attention is beginning to shift to doing (2) and (3) through fiscal measures and regulatory and banking reform. This will expend enough political time and effort without trying to fix all other areas of life with some element of market in. Arguably, even talking about the failure of ‘financial markets’ is far too loose a description – it is only some elements we now have problems with that will require fixing (e.g. subprime mortgages, derivative swaps) and the rest is effect on rather than cause of.
Anyhow I’ll be listening closely at the conference to whether (and for how long) each speaker drones on in generalities about the financial crisis and attempts to make convoluted links to other areas. I suspect the politicians will be the worst offenders...
2 comments:
Allow me to provide a lefty, fatalistic counter-argument....
Firstly, the financial market and goods and services markets are completely linked. Cooking up "fake" money - and trading services of dubious value for real commodities and products - is the way westerners can enjoy the standard of living we currently do, at the expense of other parts of the world. Recognising there's a problem with the financial system can lead to identifying an inherent problem in the terms of international trade.
Secondly, the financial crisis is a stark reminder that we can't blindly trust the status quo of market, plus checks and balances supposedly provided by government. While they work smoothly for a while, is this just masking their long term inadequacy?
We can survive the catastrophic failure of financial markets, but not the catastrophic failure of real markets.
Just as governments have an understanding of the flaws in the financial market - yet choose to fuel the problem by encouraging ever-increasing indebtedness, so they do the same in the real economy. We opt for short-term consumption maximisation by demanding increases in fossil fuel use and depleting resources at a rate that is not just inefficient but is on-track for catastrophe.
When they lead to slightly inefficient outcomes or allocations, market failures are an interesting challenge for policy-makers. But when they lead to economy-wide financial bankruptcy or death to the planet, it's right that we at least ask the question of whether they can be trusted (albeit with a few policy tweaks) to deliver our destiny.
I guess my question is do we know anything more about how markets work, or how they should be managed than we did before the crisis? If not, then there's little in terms of policy substance about 'markets' we can say at this stage.
Financial markets and goods and services markets are quite different. It's hard to envisage complete failure of all goods and services markets simultaneously. For example, we could have a 'drought' or shortage in one market but we'd substitute for something else. But financial markets are the basis of trading risk between markets and the unit of exchange for 'real' things so systemic failure here has a clear effect on other services.
We regulate financial markets (evidently badly) because of this external effect, whereas we regulate electricity markets beacuse we are concerned about market abuse not because of some external effect on say fish markets or newspapers. Similarly government regulates (or pays for) markets in health and education beacuse of concerns for social outcomes (and other reasons like public goods).
I'd argue there is real economic value in carving up risk and return in more advanced ways (e.g. better risk management gets me a cheaper mortgage and allows me to spend more in the 'real' economy). So a key objective of future financial regulation must be to allow for such innovation, but obviously with more safeguards than at present. In so far as investors (both people and countries, like China) have got burned I don't see that as representative as a inherent inequity in trade, at least not something that could be perpetuated in the long-term. Though the trade effect is important and not something that's been picked up: when we look back on the long period since the early 1990s such rampant consumer growth probably won't be repeated again without underlying fundamentals.
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