Efficient Market Hypothesis and Government Intervention (Especially Fiscal and Other Discretionary Counter-Cyclical Action)

Hoisted from the draft cue from 1/21/14:

Some of the disagreement over gov’t intervention in the economy is likely the result of disagreement over the Efficient Market Hypothesis.  

The EMH has a lot of forms:

-from the strongest forms (claims like the market is always exactly right at all times, either by definition or by a necessary causal link, and maybe even produces a pareto optimal outcome, or an optimally efficient outcome, or a welfare-maximizing outcome, or a distribution ally fair outcome in which people are compensated exactly in proportion to their contribution, or any combination thereof, etc.)

-to the medium forms (claims like the market tends toward these desirable features)

-to the weakest forms (claims like the market tends towards one, or some, or all of these features only more than any individual or group intentionally could; so the market could be wrong, but in all possible cases [even in those cases of the market being wrong], we have more reason to believe the market than any individual or group [after all, assuming only that there's isn't anything new under the sun/i.e. that it's pretty rare for people to be totally unique or do things totally uniquely, as opposed to like Newton and Leibniz independently coming up with calculus, it is more plausible that there are other bits of knowledge elsewhere in the world that would integrate into the market not included in the centralized expertise than that this single centralized expertise came up with all the knowledge the market already has, and then some it hasn't.  In other words, how likely is it that any individual or group (defined sufficiently small to conform to our purpose of technocracy; i.e. you can't define a 'group' as half the world population because that couldn't work to give expert advice) could come up with some knowledge the rest of the world hasn't come up with yet? 

when we address the findings/recommendations of any expert or group of experts, 

Those who support gov’t intervention tend to disagree with the EMH and argue instead that markets can be inefficient/irrational, and that gov’ts can be less so.

For example, what exactly changed so rapidly in 2007-2008 (or even just over a few months in 2008 and into 2009) that the market was rational/efficient to cut aggregate spending and economic activity?  Did some real shock precipitate it?

No.  Well, what could have changed?  Preferences?  What preferences?

Not for any particular commodity or asset.  

What about leisure, or saving/putting off consumption?  It seems pretty unlikely that enough people changed their preferences so much all together to be lazier that caused it.

What about the preference to carry or offload risk?  This is the candidate most EMHers point to as the preference change most likely to have caused the crisis and recession (us Cochrane, for example, I believe.  Maybe Fama…).

So, to these EMHers, the crisis and downturn does not disprove the EMH because the market rationally responded to changing preferences.  Thus, the market did not act irrationally, and consequently the crisis and downturn do not prove the necessity of gov’t intervention. 

This is correct as far as it goes.

But if this analysis is correct and a change in preferences of carrying or offloading risk (really, in the risk of a downturn) justifies the market contraction, then these EMHers are missing the forest for the trees.  

If the only real change is from confidence in a continuing good economy to skepticism of it, then gov’t should still intervene.

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Copied from email drafts folder, for comparison (not sure which one is most updated/comprehensive version):

Some of the disagreement over gov’t intervention in the economy is likely the result of disagreement over the Efficient Market Hypothesis.  

The EMH has a lot of forms:

-from the strongest forms (claims like the market is always exactly right at all times, either by definition or by a necessary causal link, and maybe even produces a pareto optimal outcome, or an optimally efficient outcome, or a welfare-maximizing outcome, or a distribution ally fair outcome in which people are compensated exactly in proportion to their contribution, or any combination thereof, etc.)

-to the medium forms (claims like the market tends toward these desirable features)

-to the weakest forms (claims like the market tends towards one, or some, or all of these features only more than any individual or group intentionally could; so the market could be wrong, but in all possible cases [even in those cases of the market being wrong], we have more reason to believe the market than any individual or group [after all, how likely is it that any individual or group small enough for technocratic purposes could come up with some knowledge the rest of the world hasn't come up with yet? ]). 

Those who support gov’t intervention tend to disagree with the EMH and argue instead that markets can be inefficient/irrational, and that gov’ts can be less so.

For the market to be rational, there would have to be a reason for the recession.

What exactly changed so rapidly in 2007-2008 (or even just over a few months in 2008 and into 2009) that the market was rational/efficient to cut aggregate spending and economic activity?  Did some real shock precipitate it?

No.  Well, what could have changed?  Preferences?  What preferences?

Not for any particular commodity or asset.  

What about leisure, or saving/putting off consumption?  It seems pretty unlikely that enough people changed their preferences so much all together to be lazier that caused it.

What about the preference to carry or offload risk?  This is the candidate most EMHers point to as the preference change most likely to have caused the crisis and recession (us Cochrane, for example, I believe.  Maybe Fama…).

So, to these EMHers, the crisis and downturn does not disprove the EMH because the market rationally responded to changing preferences.  Thus, the market did not act irrationally, and consequently the crisis and downturn do not prove the necessity of gov’t intervention.  

This is correct as far as it goes.

But if this analysis is correct and a change in preferences of carrying or offloading risk (really, in the risk of a downturn) justifies the market contraction, then these EMHers are missing the forest for the trees.  

If the only real change is from confidence in a continuing good economy to skepticism of it, then gov’t should still intervene.

The rationality of the market's action does not refute the desirability of market intervention to change that action if that action's rational status is contingent on its being performed.

The actions of market participants, in changing their investment profiles to reflect their decreased optimism and increased pessimism about the coming state of the greater macroeconomy, i.e. to become more risk-averse, that together make up the actions of the market as a whole, are a rational response to a coming contraction.  

Gov't intervention advocate: we need to intervene in the economy to mitigate as much as possible the contraction resulting from the financial crisis and generate a strong recovery.

EMHer: you're saying the gov't knows better than the market does.  

GIA: The market is behaving irrationally right now, so yes, the gov't can do better at the moment.

EMHer: the market isn't behaving irrationally.  

GIA: Well, just a few months ago, GDP was much higher and better distributed, and unemployment much lower, and now the economy is a wreck.  What happened between then and now to make this economy so bad for people despite still behaving rationally/efficiently, as you allege?  There were no wars or natural disasters, or other hindrances to our productive capacity.  

EMHer: But technological facts of production are only part of it.  That stuff determines the possibilities, and human preferences determine which of those we actually go for.  And human preferences have changed.

GIA: What?  Have 9 mm people all become significantly lazier, and decreased their preference for work and increased their preference for leisure, and decreased their ability to put off consumption, all at the same time?  

EMHer:  No, but the preference to bear risk has changed.  People are less willing to bear risk.

GIA: Risk of what?

EMHer: Risk of losing their assets.  People are willing to bear less risk on their assets in a bad economy.  

GIA: So, the market contracting is a rational/efficient response to the [prospect of] market contracting?  

EMHers say that we should go with the market response/action, a contraction, because, in virtue of it being the response/action taken by the market, it is the most rational/efficient way to go.  But contraction is only the rational/efficient action of the market because the market expects contraction, making that expectation of self-fulfilling prophecy.  (Obviously, there is some CAP here, too).

"Kansas and Missouri fight for corporate investment and jobs"

2 states in a tug-of-war for workers that's costing millions

Perfect example of a collective action problem.  

(In this case) the dynamic forces them both/each to expend a lot of resources, which each only negate the other's; thus, both sides incur substantial cost(s) while providing basically no net gain.  This outcome is suboptimal for both as there are better possible outcomes for both sides, indeed a single alternate possible outcome that would be better for both sides.    

But if such a universal improvement, a pareto improvement in other words, is possible, then how both sides still experiencing this avoidable problem?

But both sides are also essentially forced into it; it's the rational thing to do.  After all, if they don't do it but the either side does, then they'll lose out even more.  Only if both sides stop doing it is the outcome better for both.  Thus, some agreement and coordination, presumably with mutually-acceptable/accepted enforcement provisions/measures in case of cheating/going back on,--in other words, law--is necessary for the best possible outcome in these kinds of cases.

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As a typical/paradigmatic case/example of a common collective action problem, this example is important because it may be able to illustrate to those not otherwise sympathetic to centralization and government action/intervention/activism the soundness of the deductive case for it's being optimal policy in some circumstances, namely when the conditions sufficient for a collective action problem are present and the benefits yielded justify the costs incurred (and also maybe necessary is that no other pathology of government is worse than freedom's/market's pathology in this case/area).  

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Hopefully states and localities can recognize this problem and band together resolved not to compete with other states and localities for economic activity by bidding with taxpayer money.  If federal legislation is not possible, then states should band together in the model of Common Core or National Popular Vote plan.  

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Similarly, but more controversially, the same collective action problem that applies to individual states in the whole country also applies to individual countries in the whole world.  For this reason (among many others), it seems necessary that some level of world government will be necessary.  

In the same way that individuals voluntarily surrender some rights and assume some responsibilities in order to live in society, and just also as states voluntarily surrender some rights (nuclear non-proliferation for instance, or use of land mines) and assume responsibilities (to defend other states) in order to enter treaties with other states, gaining alliances and allies, states will, at least will need to, establish a common world government.

Too many collective action problems otherwise: impossibility of universal currency devaluation, Piketty on a global wealth tax, financial regulation, etc.

The process of globalization is a one-time only phenomenon, though of course long and difficult and must be managed right.  But the costs are mostly related to the process (as in economic, distributive costs, as there are arguments for other social and cultural costs) and not the outcome, so the economic benefits of the hopefully-long-lived outcome likely outweigh the costs of the temporary process.  

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This phenomenon should also be taken into account when evaluating the economic and employment performance of different states, for the purpose of discovering/learning what policy should be undertaken at the federal level to boost employment or economic performance otherwise, or adjudicating between which candidates for federal office are better for the economy and employment than others' (which now sounds similar, even identical to the last question).

Conservatives' and Liberals' Moral Psychology

This is an old column but I came across when someone else things to it as part of a response to one of his current columns on ideological diversity.  It discusses how liberals give us to charity than conservatives and the implications of that, in the context of the public policy debate in which Liberals are widely agreed to be more generous public spending/public resources/public funds/the budget to the downtrodden.  

I've read/heard elsewhere that this finding disappears when you control for religion, so it's religion and not conservatism that makes people more charitable, and it's in religion and not liberalism that makes them less so. (check to see if this is in the column, and check to see if it's true)

More recently, it's been discussed some from the unearthing of a 1981 quote from Bernie Sanders that he does not believe in charity.

This might seem to accord with my analysis on liberals and conservatives and their differences on collective action problems: liberals favor coordinated solutions to collection action problems and conservatives don't, in general. 

Maybe this is because liberals overestimate/overprotect free-riding/action of unenlightened self interest, so they don't believe uncoordinated action can solve it, and maybe it's because liberals see themselves and those around them, who are also highly likely to be liberals, free-ride/act of unenlightened self-interest frequently/most of the time, i.e. that liberals free-ride/act on it unenlightened self-interest more than liberals do.

Maybe because they're less generous slash more vicious/less virtuous, or maybe it's because they have a different technical/positive view/belief, i.e. they believe and uncoordinated solution is less likely to happen, and are just taking the rational action rashly taking the action consistent with that belief.

Test both of those 

Maybe liberals just think that they don't have to do it, and it will even get done more efficiently by government.

The pros think they just should not have to do it.

Are they doing it out of defensive free-riding or initial free-riding?

Bleeding Heart Tightwads - NYTimes.com

Procrastination and a Theoretical Confirmation

Hoisted from the draft queue from 2/12/14:

Andrew Sullivan points to a recent study in neuroscience showing that, neurologically, we think of our future selves as different people from our current selves, and that those for whom this is especially true are more likely to prefer short-term gratification over long-term gratification than those for whom this neurological fact is less true.

This is another example of experience following theory, as I've previously noted that if you combine the concept of collective action problems with the concept of splitting people into 'time-slices', you can account for procrastination without precluding rationality.

Climate Change Response, Collective Action Problems, and Coordinated Policy Solutions

Back in September at the United Nations Climate Change Summit, President Obama spoke about the threat of climate change, what the U.S. has done to combat it, and what still needs to be done by the U.S. and the world.

He alluded to the nature of the problem as one of collective action among multiple global partners, saying "in each country, there is a suspicion that if we act and other countries don't that we will be at an economic disadvantage."  But he continued, "but we have to lead.  That is what the United Nations and this General Assembly is about."

Introduction to Collective Action Problems

It would be simple if the problems in the world were the fault of certain evil individuals. By getting rid of those individuals, we could greatly improve things. But social problems are much more pernicious and more deeply embedded in the world when they are the outcome of the actions of good people. How could that be? How can good people produce much wrong? A lot of the time, it’s because of their environment, which structures their individual behavior into collective action problems.  

I've already written a (not totally) tongue-in-cheek post about a particular collective action problem, but this post is more of an introduction to the topic. Collection action problems are a very common theme on this blog because so many different and seemingly unrelated political issues can be distilled down to the problematic dynamic that results when many individuals’ actions each play only a marginal role in determining whether the outcome those individuals commonly experience is good or bad. The issues that make up the enduring dispute over political economy and the size and shape of the state, those that pretty consistently pit liberals against libertarians and conservatives, are often reducible to problems of collective action and how best to address them. These issues are ripe for controversy because the market system that we usually employ to distribute our collective duties and resulting benefits, uncoordinated self-interested action by rational individuals leading to optimal outcomes for all as though chosen by an invisible hand, does not apply as neatly in these cases. Instead it leads to an avoidably bad outcome. This is not to say that the faintest example of a collective action problem calls for any and all government action, but just that there is more reason to be wary of market outcomes in such cases and so more reason to consider alternatives.

Procrastination as a Collective Action Problem

It looks like I'll be widening the scope of this blog very significantly pretty early, with a post on philosophy that is not quite political.

It was appropriate to post about procrastination in light of the absence of any new posts for a considerable time for a young blog.  Hence, a post on the form inherent in procrastination.

So, procrastination is a collective action problem among the many different time-slices of a person.  The you that exists in any particular moment values the quality of its own experience more than that of the you that exists at any other moment; in other words, there is a preference for immediate consumption over future consumption which is inversely proportional to the ability to delay gratification.

Economic Problem of Self-Reference

What goods should government provide for, directly like public schools or indirectly like health insurance and mortgage subsidies, and what goods should be left to the free market?

In a concrete instance of a problem of self-reference, the government should provide for the prerequisites of the market.  The market itself cannot provide these things by definition.

What are such prerequisites?  One example, one that is uncontroversially provided for by the public sector, is the protection of negative rights, i.e. to bodily autonomy and property.  But what else is needed for a functioning free market?