Governments and Markets

OK, I posted a rant over in the comments at Ace’s place. And if I’m gonna spend 15 minutes writing, I’m gonna make sure I at least get credit here…

Markets are in the long term rational. Not in the short term, but over time, they act in a rational manner. That’s the effect of a large group of people each acting in their own self interest, for their mutual benefit. We must always remember that individuals often act irrationally, and so do groups over short terms, but that groups that choose to act together tend to act rationally over the long term. So, we will posit that markets act rationally. And thus, rational actors like to operate on the basis of information. We have two types of information- empirical, and inferred. Empirical information is always past history. That is, it is something we have measured that has happened in the past. Inferred information can be either past history, or a projection of the future, often based on past trends. Inferred information is imprecise. Call it a SWAG (Scientific Wild Ass Guess), or just a best estimation on the available information. In both cases, the market works better with information, rather than in its absence. Uncertainty breeds unhappiness in the markets. Some level of uncertainty is needed for the markets to work. Investors must have an idea that there is a potential for gain, or they wouldn’t invest. But there must be some risk involved, or there would be no need for rewards (dividends and capital gains). The natural level of risk is inherent to the market, and all the players are cognizant of that. What upsets markets greatly is outside influences on them. Anything that changes the accepted rules of the market had a detrimental influence on the market. Why? Because if the rules can change once, they can change again. It’s like playing baseball and finding out in the 9th inning that your side only gets two outs.

Any and all government intrusion into the markets has the effect of introducing uncertainty into the marketplace. If there is no government intrusion at all, that is a known level of interference, and there is thus no uncertainty introduced. But when the government intrudes in any way into the marketplace, that introduces a level of uncertainty into the market. If government intrusion is rare, the markets will stabilize around the new rule set, but still have a slightly higher level of uncertainty, as the market has seen that there is the potential for government intrusion.  As a hedge against the intrusion of the government into markets, entities will assume government interference in the market, and hence work to influence that interference in ways that benefit them (at least in the short term) and work against their competitors. This is in effect market players working the referees to change the rules in their favor, in the middle of the game. {see Dodd, Christopher; and Frank, Barney}

Eventually, government interference leads to unfairness in the market, where some competitors have an advantage. And where an artificial advantage exists, eventually, the markets will cause a failure that should have been corrected earlier. When a mortgage is defaulted in this environment, we often see that it is a mortgage that was a bad risk from day one. We see the same thing with corporations that influenced the government to skew the market rules in their favor. They were able to operate for a while, but in the end, the fall was that much greater. If the corporation had not been able to change the ruleset to artificially benefit them, they never would have been in a position to have a catastrophic failure. Or rather, if they did fail, such failure would not have been catastrophic to the markets as a whole.

Virtually every single government intervention into a market is done with the intention of promoting fairness. Not just our government, but any intervention at all, throughout history. But make no mistake, the government has its own vested interest, to maximize revenues into its coffers. That’s no sin, in and of itself. I think we can all agree that the government needs some level of revenue to operate. But governments efforts to induce “fairness” into a market, where by definition, there are winners and loser (tho most interactions are actually between winners and winners to a lesser degree), is to artificially remove risk. When you artificially remove risk from a portion of the market, it just doesn’t go away, it is just defered. And worse, it isn’t just defered, it is more widespread.  Pretty soon, the problem becomes systemic. And anyone who has worked on any centralized system will tell you that a problem in any portion of a system soon spreads to the entire system.

And of course, we have an entirely different level of government interference in the markets. Fannie and Freddie. Here, we have Government Sponsored Entities. These are supposedly private companies set up by the federal government that competed in the private sector.There was a polite fiction that they were not guaranteed by the government, but everyone knew that was a lie. As events proved, they government would indeed cover their assets.  Given that they were sponsored by the very government that both set the legal rules of the marketplace, and printed the money, was there any way for a private company to compete with them? Of course not. Not surprisingly, may companies found a modus vivendi with them, either co-opting them, or being co-opted by them. As a final insult to the free market, these government sponsored entities used the fiction that they were not part of the government to actually lobby the government. To put it bluntly, they bribed the members of Congress responsible for their oversight with sums that private companies could not. Is it any wonder that the laws of the marketplace soon benefited Fannie and Freddie in an artificial way?

In a perfect, hypothetical world, there would be absolutely no government interference into the markets. Sadly, we don’t live in a perfect world. But I think I’ve made the case that government intrusion in the markets should be limited to those actions that promote transparency, not fairness.

14 thoughts on “Governments and Markets”

  1. I kind of agree and kind of don’t. The free market is like a spring that provides a corrective force whenever it is pushed or pulled. But when the weight on the spring becomes large enough to affect its springiness, then the market can’t apply corrections without some major upheaval.

    So giant corporations, interlaced financial systems, monopolies, etc., often require intervention by an outside force to restore the system’s capability to operate as a free market. The problem is that having intervened, the government often decides that it should stay involved. And, as you say, the interventions have a permanent effect on the way the market behaves.

    So I think that, unfortunately, some level of intervention will always be required. But it sure would be nice to have a government that knew when to stop intervening.

  2. The problem is that the big corporations come running to government when they make mistakes (or when they want exemptions to the rules). They paid for politicians (campaigns, speaking fess etc.) and then collect on their investment.

    True free market would not care if a buinsess is “too big to fail” or is a “national institution” etc.

    It’s a load of bull.

    They (AIG, Citibank etc.) made the mess they should clean it up. The big three need to adapt or die. That is capitalism.

    Geoff, their are forces on the left that see government as the be-all, end-all. They look for any excuse to intervene.

    As long as they can organize, march and produce propaganda, they will keep pushing class warfare and big government.

  3. I agree with all your points, cb, but in the case where you have a company like Microsoft, which has started defining market forces instead of responding to them, somebody has to step in. Otherwise you’ll end up with Windows Me.

  4. Geoff, interestingly, natural monopolies have their advantages. Without the natural monopoly of Windows, we would probably still be facing the array of operating systems that couldn’t interface. So the monopoly rationalized the market. And the market has responded to that monopoly in interesting ways. See open source operating systems. If you can’t sell the product for less than the competition, give it away. And yet there are people making good money from an open source software.

  5. XBraqd/

    Really spreading yourself around today aren’t you?–Flt Deck, Lex’s replies, Ace’s, here…. 🙂

    I would add as a predecessor of Microsoft the early days of AT&T whose near monopoly rationalized and made possible this nation’s communication’s systems.

    And I don’t.have.any.charts.or.graphs.either.


  6. Virgil, your good. Charts and graphs is an inside joke with Geoff.

    The only reason we don’t like you is that you’re Air Force.

    But thanks for the excellent example of Ma Bell.

  7. It is true that the standardization of operating systems promoted the adoption of computers. But it is not true that the amalgamation of the operating system with office suites, email clients & browsers, computer languages, etc. was advantageous to the market or necessary for its growth.

    And in both the cases of AT&T and Microsoft, the natural monopoly slowed innovation once the market was mature. And finally, just to put another graphless* nail in the coffin, we have standards committees in every field now – there is, for example, a standards spec for Blu-Ray, so that a variety of companies can build players and generate content. The same goes for HTML (except when Microsoft gets involved). So the natural monopoly isn’t always a prerequisite for commonality.

    Not that the number of operating systems has been reduced, anyway. In the old days we had UNIX, DOS, and the Mac OS. Now we have LINUX/UNIX, Windows, and the Mac OS.

    *There is a graph in the latest post at my page, of course.

  8. Geoff, I’m not really defending monopolies. I understand their detrimental effect upon mature markets. I’m just against the government intervention to either form, or bust monopolies. You yourself show a method of mitigating the chances of monopolies being formed.

    As to the nature of Ma Bell, I’d say it was formed mostly as a natural monopoly, but it certainly didn’t maintain that monopoly naturally. It did that through the intervention of the government, via strangulation by regulation.

  9. Back to the question of government intervention. Teddy Roosevelt thought the trusts and railroads had to be busted Part of the genius of capitalism is it’s ability ti adjust to disruption from within and attacks from without. It worked out. At least the motivation to end monopolies at that time dealt with inequalities and corruption in some business.
    I have issue with motives that stem from redistribution of wealth. By punitive taxation. That’s government intervention gone wrong. Redistribution of wealth is not the government’s business nor should it dictate how much profit any business makes, regardless of size and productive capacity.

  10. The left is as word games. “Re-distribution”, “fairness” etc.

    Like the old soviet union’s “Sluggesly Progressing Schzioprinea” (the ‘illness’ that dissenters ‘sufferd’ from as the Sovs tried to ‘cure’ them).

    It’s all a game. The end result is a newspeak that makes dissent almost impossible.

  11. “Redistribution of wealth is not the government’s business nor should it dictate how much profit any business makes, regardless of size and productive capacity.”

    Its OK to say this when you are part of the 3% of people who own 80% of the worlds wealth. But if you are poor, yet you still work 8-10 hour days in a physically demanding job (or 2 or 3) and you see rich people taking the money you have made, losing your money by gambling on market force, yet still getting paid well, driving BMWs and having holiday homes in
    the hamptons, it’s a little hard to swallow. This is wealth redistribution, but from the poor to the rich. You are saying this is OK with that statement, but the reverse is not.

    Who is to say the wealthy person is better than the poor person? Democracy gives them both a single vote. Capitalism gives the wealthy a bigger vote in the market place, but hurts the poor much more than the wealthy.

    One thing I always notice is that those in control of the wealth tend to think “leave the markets without intervention” in a survival of the fittest scenario. Survival of the fittest existed once with humans but we evolved from it to form complex social systems where individuals look after and help those that can’t, in the knowledge that helping those that are less well off now, will have benefits in the future. Look inside yourself and you will notice the product of this evolution when you see an old lady that can’t cross a road or a sick child on the street. Non intervention suggests we go back to the days of tribalism and class systems with markets as the battle ground.

    In a non government intervention market place that many people want to move to, if you are a wealthy investor who has made good business decisions to get yourself there, then you make some mistakes and lose your some wealth, you are killed and your investments and wealth are taken over by someone else. All people who cannot contribute to the economy now or in the future (disabled, people with below average IQ, people with different thinking, non conformists) are killed as soon as the trait appears, sometimes at birth. They are not useful to an economy that will need to support them, so they must die because if they live they will use up resources that could be used somewhere else. How does that sound?

    We need government to help the poor, week and hungry to become stronger, to set the rules according to the will of the people and to perform the role of justice. We need markets to make the most efficient use of resources through competition and a place where people can swap what they don’t need for what they need. We need high participation from individuals in both markets and governments. Everyone needs to think ethically and not greedily, do the best they can, and humanity will advance. Thinking “full state control” or “full market control” will take you down one of 2 roads that lead to revolution or destruction.

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