… but castles built on sand!

In the first of these two posts on the power of the human imagination I covered the case of religion. This one is on:

Free Market Fundamentalism

I will firstly look at the false doctrine which has monopolised economics thinking for 35 years and then at the specific case of the thinking that caused the 2008 global crash.

Religious Style Dogma

Neoliberalism – what I call free market fundamentalism – began to have an impact on Western political thinking, particularly in the US and UK, from the late 1970s. Its ideas began to take hold from work by Milton Friedman and others, drawing on Friedrich Hayek, at Chicago University. Chile, under the dictator General Pinochet, was an early practitioner of these ideas, with disastrous results for the majority of Chileans. The ideas then took hold in Western governments, in influential bodies such as the World Bank, International Monetary Fund and World Trade Organisation. Central to the new doctrine was the rejection of Keynesian economic ideas, the supremacy of the free market, lower taxation and reduction in the role and scale of government.

The effects, over the past 35 years, can be summed up as follows:

• Economic growth in the developed countries slowed to about half of the rate of the previous 30 years
• Income and wealth inequality increased dramatically: only the very rich have seen a rise in living standards
• The scale and frequency of major economic crises increased.

It’s obvious to me that this 35-year experiment actually failed with the crash of 2008, but government and other key institutions have carried on as if nothing wrong has happened. University departments have been teaching this doctrine as if it were the only way to run an economy. This has led to students from several universities holding protests demanding that their syllabuses are widened to explain the 2008 failure and to include teaching rival economic theories.

The dominance of free market fundamentalism has all the hallmarks of old-style religion. And just like such religion, it is based upon false premises:

1. The only motive human beings have in making (economic) decisions is the pursuit of material self-interest. Not so: see my earlier post Being Human II: The Four Cs, or as highly-regarded Cambridge economist Ha-Joon Chang puts it: “… we have many other motives – honesty, self-respect, altruism, love, sympathy, faith, sense of duty, solidarity, loyalty, public-spiritedness, patriotism and so on” from 23 Things They Don’t Tell You About Capitalism (2010).
2. Market participants (companies, individuals) know what they are doing, i.e. they make rational decisions. Again, to quote Chang: “The world is very complex and our ability to deal with it is severely limited”. A trivial example is people queuing at a busy bus stop so that everybody doesn’t have to remember the order in which people arrived. 1978 Nobel prize-winning economist Herbert Simon wrote about “bounded rationality”, which describe how people’s ability to make rational decisions is severely restricted when faced with complex problems. Government regulations, the notorious “red tape”, work by restricting choice and simplifying problems, reducing the risk that things may go wrong.

As we saw in part 1 of this post, it is possible to build great cathedrals and great intellectual arguments on false assumptions. The same applies to the advocates of free market fundamentalism. The next section illustrates the crucial example which led to the 2008 global financial crash.

A Case Study: Fool’s Gold

Gillian Tett is a highly respected journalist for the Financial Times. She has a PhD in social anthropology from Cambridge University. She wrote the book Fool’s Gold in 2009. She uses her anthropologist’s insight to tell the story of the group of highly intelligent, innovative bankers who invented the complex new financial products which led to the 2008 crash.

The story starts in Florida in 1994, when a group of J.P. Morgan employees held a conference to develop ideas to develop the market in derivatives. These are complex products which “sit on top” of traditional loans and mortgages. But these traditional products are bundled up and repackaged in a way in which they can be sold again in a different form which, on the face of it, reduces the risks of default. These clever people worked out that at this bundling and repackaging process could be repeated and re-sold. Banks could then earn commission several times over on ever-more complex products based upon a given set of “real” assets (e.g. property). The whole scheme involved complex mathematical models using the ever more powerful computers becoming available.

There was one problem, however. In a certain set of highly unlikely circumstances, there was a risk of huge losses derived from assets worth a fraction of the money at stake. But the computer programs which produced the figures for the products did not contain any way of expressing this small risk. The risky circumstances were so unlikely that J.P. Morgan and subsequently all its competitors launched these new products and made a lot of money.

Actually, there was another problem. Once everyone in banking had jumped on the bandwagon, nobody other than the original group understood about the tiny risks. Neither did the financial regulators. In other words, nobody selling the products knew what they were doing.

But – wait for it – there was a third problem. Those tiny risks weren’t as tiny as the original clever people thought. Most people who’ve looked at the workings of markets will have heard about “bulls” and “bears”. These exemplify the lemming-like behaviour of market traders when sentiment changes from optimism to pessimism. (A good example is when, in 2010, George Osborne falsely compared the UK economy to that of Greece). When the markets got themselves into one of these spells of irrational behaviour and everyone started selling, the whole house of cards fell down. Matters were saved from getting much, much worse by the intervention of those institutions so hated by free market fundamentalists: national governments. This means that the original clever people got their models wrong.

So deregulation – leaving markets to themselves – is crazy when they don’t make rational decisions: they don’t know what they’re doing!

Conclusion

So people don’t behave like Hayek and Friedman said they do. And the only people who have benefited from continuing the pretence are the super-rich, large corporations and the politicians who represent them.

Overall Conclusion

By linking together this and my previous post, my overall point is that it is possible to build a very sophisticated logically consistent set of ideas (and real objects like cathedrals) based upon false assumptions. Other obvious examples are the Tea Party movement in the USA and our own UKIP. Modern communications makes it easy for like-minded people to network their ideas for mutual reinforcement, untroubled by inconvenient truths.

These towering “castles” can look very impressive. They can bring great joy and comfort, for example, in my “magical” Lincoln moment. But they can also bring tremendous grief and pain – think of murdering pro-life extremists in the USA motivated, ultimately, by the loopy idea of “ensoulment”. The more impressive-looking these “castles” become, the more likely people are to believe the whole package of ideas is true. But if real foundations don’t exist, these are no more than castles built on sand.