[Another important work from the prolific Perelman pen, this time casting an analytic eye on the inner workings of the markets. To read more, go to: http://website.lineone.net/~resource_base Mark] The Natural Instability of Markets: Expectations, Increasing Returns and the Collapse of Capitalism by Michael Perelman Preliminaries The Fragile Foundations of the Triumphant Market With the collapse of the Soviet Union, capitalism now proudly proclaims its ultimate triumph. Formerly socialist states frantically scramble to remake themselves as market economies. In the United States, everything left of the political center has all but disappeared from the national political dialogue. Markets are supplanting virtually every kind of service that the state previously supplied. Public schools, public prisons, public streets, and even police work are being privatized. Even so, I am confident that capitalism's victory will be temporary. The market system is so familiar and our institutional memories so short, we tend to forget -- even if we knew in the first place -- that capitalism is, by its very nature, an inherently unstable system. Today, even World Bank publications admit that financial crises have become more frequent and more severe in recent years (see Caprio and Klingebiel 1997). Capital has enjoyed moments of triumph before, but they have always been followed by a subsequent disaster. We need to take a step back to recognize just how strange markets are. In a market society, individuals generally do not cooperate directly. Instead, they indirectly coordinate their activities by flashing numbers (prices) to the rest of society. That this system worked at all was a source of amazement to those who watched the market system in its formative years. Adam Smith's metaphor of an invisible hand reflected the almost magical appearance of market forces (Smith 1776, IV.ii.9, p. 456). Recurrent depressions and recessions taught many of Smith's successors that the market is not necessarily benign. Over the past few decades, however, this lesson has all but completely worn off. With dangerously few people today aware of the breadth of the risks associated with a market economy, we are less prepared than ever to come to grips with a crisis. We have thoughtlessly dismantled much of the regulatory system, which is supposed to contain the risks of crises, along with the welfare system, which was meant to cushion society from the consequences of crises. With these conditions in mind, the time has come for an analysis of the causes of crises within a market society. This book shows why the force of competition tends to create instability and depression. I am not aware of any other contemporary book that specifically addresses the subject of why markets have an inherent tendency to fall into crises. This book also takes a fresh look at competition. Nobody before has tried to ask exactly what competition does. This book shows why competition is often not very effective. Competition takes on a significant force only during times of depression and recession. When competition does become strong, it is unselective, destroying fit and unfit alike, while wreaking havoc on society. This book also suggests that within a market society, we can gain some of the benefits of competition, without adding to the dangers of a depression, by keeping wages high as a means of putting pressure on business. In this way, we do not get the deflationary pressures associated with normal competition. Environmental protection serves the same purpose. In part, the absence of books that address the consider the natural instability of markets is understandable. The capitalist world has not seen a major depression for more than a half century. In addition, economists are naturally predisposed to find order in the economy. After all, if the economy were absolutely disorderly, they would have nothing to contribute. In addition, the training that economists undergo conditions them to emphasize the tendency of the economy to be stable rather than any forces that might make for instability. Finally, economists are a relatively conservative lot. To the extent that they work to justify the status quo, they have strong incentives to portray the economy as stable. If a problem arises, then some outside force, typically the government, is to blame. As Milton Friedman, perhaps the foremost advocate of laissez-faire of the twentieth-century United States, once wrote with embarrassing self-satisfaction, "The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by inherent instability of the private economy" (Friedman 1962, p. 38). For Friedman, as for most economists today, markets are natural. Markets have natural rates of unemployment and and natural rates of interest. Anything that interferes with the free functioning of markets is unnatural, if not downright perverse. In truth, markets are not natural any more than they are stable. In this book, I will make the case that markets would be even more unstable than they are except for the inertia created by laws and customs that supposedly impede markets. Despite the best efforts of economists, most people intuitively realize that the economy is not stable. I suspect that few people feel a need for economists to tell them why the economy is stable. They are not interested in economists' fixed-point theorems and the other parts of the mathematical apparatus of economic stability theory. Instead, rightly or wrongly, people often look to economists for predictions that can prepare them for unexpected changes in the economy. They are more concerned about the possibility of a reversal in the stock market or a disorder that might cost them their job. In fact, when people learn that I am an economist, more often than not, the first question they ask me is, "will the stock market go up or down?" Little, if anything, in our training as economists equips us to predict the future course of the economy. In all modesty, when asked if the stock market will go up or down, I can confidently answer "yes." Of course, I am certain that it will go up. I am equally sure that it will go down. I do not know which will happen first. I do not know by how much or when it will go down or up, but it will go. I am far from alone in my ignorance about the future. Nobody else has accurate information about the future. We can only make educated guesses about what is in store for us. Unfortunately, in our educated guesses, most of us, economists included, overestimate our education and underestimate the degree to which we guess. If we have to rely on guess-work, we have a good reason to predict stability. Suppose that economies crash about once every thirty years. On any given day, the economy will stand a chance of less than one in ten thousand of crashing. If I am concerned about my reputation for accuracy, if someone asks me if the economy will crash tomorrow, I would be well advised not to stick my neck out to predict such an unlikely event. If I am wrong, I will look foolish. If I proclaim that nothing will happen tomorrow, I will probably be proven to be correct. If a crash should occur, my reputation will still be relatively untarnished, since I know that just about all of my colleagues will be wrong as well. Just as geologists know full well that San Francisco will eventually experience an earthquake, I know that the economy will again suffer another severe depression. So, now the time has come to discuss why the economy is unstable, as well as the surprising source of the relative stability that we do enjoy. In the process, we will also take note of the analysis of those few economists who have glimpsed the nature of this instability. So, buckle up and enjoy the ride. _______________________________________________ Crashlist website: http://website.lineone.net/~resource_base
