What if ‘efficient markets’ is a tautology?

This idea gelled today dur­ing a lec­ture by Paul de Grauwe on ‘Gov­er­nance of a Frag­ile Euro­zone.’ He men­tioned the fact that finan­cial crises are often cases of mul­ti­ple equi­lib­ria — with suf­fi­cient con­fi­dence from investors, inter­est rates remain low and the gov­ern­ment remains sol­vent; whereas with insuf­fi­cient con­fi­dence, inter­est rates spike and the gov­ern­ment can be made insol­vent by the fear that it will become so.

In both cases, how­ever, the mar­ket was ‘right’. If investors are col­lec­tively opti­mistic, the mar­ket will prove them right; if they are col­lec­tively pes­simistic, the mar­ket proves them right there as well, even though the under­ly­ing con­di­tions are iden­ti­cal between the two pos­si­ble outcomes.

So what if the whole idea of ‘effi­cient mar­kets’ is merely a tau­tol­ogy? That is, it has no explana­tory power, but is sim­ply triv­ially true, no mat­ter the actual out­come? This is an idea that fits well into some of my pre­vi­ous argu­ments, where I have claimed that mar­kets are ‘ratio­nal’ only in the sense that they are the sum of best-​​strategies for all participants.

I think this is pos­si­ble, and if so, it is a rev­o­lu­tion on par with the over­throw of Say’s Law. Effi­cient mar­kets define our present mode of eco­nomic thought as much as Say’s Law did in its time (it said that defi­cient demand was log­i­cally impos­si­ble) — and to throw it out and start from scratch would mean a rad­i­cal rein­ven­tion of the basic forces that define ‘right’ and ‘wrong’ in mod­ern economics.

If mar­kets are only triv­ially effi­cient, then they are, as I have argued, infe­rior modes of orga­ni­za­tion. If they are not just occa­sion­ally, but gen­er­ally, a Key­ne­sian beauty con­test — then we have got to set mar­kets in their place as a means rather than an ends. If the ‘wis­dom of the mar­ket’ is in ret­ro­spect noth­ing more than the dic­tum ‘what is, is right’, then again we have to build social orga­ni­za­tions from a whole new foun­da­tion in order to cre­ate a world that we think is right rather than one that sim­ply is.

27 September 2011 – 7:34 pm | By Benjamin Daniels | Posted in Economics | Comments (252)