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Saturday, 4 December 2010

Weird Markets

Animal, Mineral or Vegetable?

Most of economics, and lots of life, revolves around a single concept: that of the "market". Yet despite the untold reams of papers, books and data generated in the name of the subject there’s a hole at the centre. This can be summarised simply: what, exactly, is a market?

This is akin to biologists suddenly recognising that they don’t actually know what an animal is despite the fact that they’ve been studying the behaviour of the things for centuries. If the existence of markets is the core assumption upon which economics exists what happens if either it turns out they’re a figment of the imagination or even simply just one way of many of understanding the world of human financial interactions?

Studying Students

Psychology has long faced a similar problem. Most psychological research has been carried out on the people most easily available to the researchers and as most studies happen in wealthy, developed nations it’s the inhabitants of these places that have been most studied. In fact most researchers work on university campuses and so most studies use the denizens of these atypical environments.

Western university students are the most researched group of apes on Earth.

For a long while psychologists made an important assumption – that the similarities between their subjects and the rest of the world were overwhelmingly more important than any differences. The idea was that people are the same everywhere, so it wouldn’t matter which group you chose to investigate. Of course, for most of us it’s difficult to square the idea that a group of subsistence peasants scratching a living in Africa are psychologically the same as a bunch of middle class, barely adult, over-nourished students from Wisconsin, but obvious irrationality has never stopped any academic from pursuing a research grant to its logical conclusion.

In The Weirdest People in the World the researchers take issue with this on the basis that people from WEIRD (Western, Educated, Industrialized, Rich and Democratic) societies aren't truly representative:
"The sample of contemporary Western undergraduates that so overwhelms our database is not just an extraordinarily restricted sample of humanity: it is frequently a distinct outlier vis-à-vis other global samples. It may represent the worst population on which to base our understanding of Homo sapiens."
Basically 96% of all subjects come from just 12% of the world's population, from North America, Europe, Australia and Israel. Is this representative?

No. And the non-random use of an unrepresentative subset of humanity means that researchers are falling prey to a tricky little problem known as selection bias: meaning that any conclusions drawn may be wrong.

Studying Differences


Anthropologists, on the other hand, have always been more interested in the differences between groups rather than those within them and their investigations have become more and more important as the consequences of globalisation lead to an increasing homogenisation of cultures. We’re all becoming more similar because we’re all living in an increasingly similar world, not because we’re built that way.

The problem for psychology was that by assuming the particular subset of people that they were studying was representative of wider humanity they ended up with various theories that argued that certain behaviours were universal, and therefore somehow natural, when in fact they were simply adaptations to a local environment. Human behaviour, it turns out, is incredibly adaptable and flexible, and is often deeply rooted in cultural norms that have their origins way back in the mists of time.

Studying Markets

Economists may have a similar problem. Just as psychologists made the mistake of studying an unrepresentative sample of human behaviour so economists may be investigating an unrepresentative sample of market behaviour. Just as psychologists had difficulty defining a person economists have difficult defining a market. We shouldn’t be too surprised because biologists sometimes still have problems defining an animal: these are hard problems.

At the heart of this debate is the fundamental question: what, exactly, is a market? In modern economic theory it’s hard, nay impossible, to find an answer to what ought to be a pretty straightforward question. John Lie, in The Sociology of Markets, suggests:
"In point of fact, the absence of or ambiguity of the market concept is as old as economics itself. JE Cairns (...), for example, criticized Adam Smith because "it is not quite clear ... in what sense he [Smith] uses the word 'market'..." The market, it turns out, is the hollow core at the heart of economics."
The reason for this isn’t hard to divine: most economics is based on the idea that there is only one sort of market, which is the one that they study, so there’s no need to define something that’s perfectly obvious. All markets, everywhere, are supposed to be representative of each other just as all people, everywhere are supposed to be representative of each other.

Only, if we're only studying WEIRD markets, that's probably not true.

Economic Anthropology

If free markets are simply a local adaptation to the environment we’ve found ourselves in they may be the equivalent of the psychologist’s pet research students. After all, most economics researchers come from wealthy nation states whose economies are based on free market economics – so perhaps studying these is simply academic myopia, or self-interest. Is there an equivalent of anthropology for economists where we can see a range of possible behaviours instead of simply a single example which we take as the only possible one?

Well, as it turns out there is. Just as psychologists have anthropologists to bounce their badly calibrated theories against so economists have ... cultural anthropologists. There are, in turns out, a whole range of different types of market behaviours out there, some of which bear only the faintest resemblance to the standard models bandied about by first world academics. This paper by Adrian Zenz points out many of the issues at the heart of the debate: how, exactly, do you apply free market economics to Panamanian peasants who have no concept of "profit"?

To some extent this may not matter. Market economics of the traditional kind is, it seems, out-evolving the alternatives. The development of a market economy in communist China is perhaps the most striking example of the power of the free markets. Of course free markets have never truly been free, because they’ve always been embedded in power structures and politics so China’s command and control culture isn’t as much a change as many seem to think.

Environmental Economics

In another way, though, it does matter. If we lose sight of the fact that the free market economy as we know it is only one way of organising ourselves economically we lose the power to argue against it. Worse, perhaps, it starts to become the dominant paradigm for the organisation of everything, including factors outside of finance. Just because something is organised and optimised according the rules of the market – whatever they are – doesn’t mean it’s right. It doesn’t mean it’s wrong, either, it’s just one way of analysing a problem.

Consider, for instance, the terrible problem the world is having figuring out how to manage the destruction of the environment caused by industrialisation and globalisation. Leaving aside national factors and questions of fairness for a moment, many environmentalists see the issue as straightforward: we’re destroying natural environments that can’t ever be replaced. However, to try and manage this the environmental movement is cloaking itself in the garments of the market. See, for instance, this TEEB report on The Economics of Ecosystems and Biodiversity.

Think, Don’t Measure

So we have to find ways of valuing the ecosystem in order to quantify the damage we’re causing and to set this against the value created. If we’re going to build a dam and destroy irreplaceable natural conditions in order to alleviate drought and feed millions of hungry people we need to measure the value of what we’re destroying against what we’re adding.

Well, I’m sorry, but this is rubbish. You can’t justify shooting someone or not by comparing the value of their life (although economists have estimated this as well) against the cost to the environment of keeping them alive. That’s stupid even in pure economic terms since you’re comparing one fictitious, impossible to estimate number with another that’s even more fictitious and impossible to estimate. You justify not putting a bullet in their head on moral grounds, not economic ones.

Yet this is where the logic of the market leads us, to a place where all decisions are determined by economics, a subject that doesn’t even know what it is that it’s studying. We wouldn’t accept a universal standard of behaviour set by the example of college students and we shouldn’t accept a universal standard of societal behaviour set by economists. Some decisions lie outside the remit of the markets and if it turns out these are hard problems to solve then so be it. Better to try and think for ourselves than to rely on an invisible hand connected to a non-existent brain. Now that'd be really weird.


Related articles Economic Parasites, Adam Smith's Monkey Business, Economic Value in Aitch-Two-Oh

3 comments:

  1. I think it's great when people explore the most fundamental questions. These are the ones we are always messing up!

    The stock market is an extremely unusual type of market. Much of our problem with it derives from the fact that we pretend to ourselves that it works in the same way as other markets.

    In all other markets that I can think of, the price of a good is derived from the working out of conflicting positions taken by sellers and buyers. Sellers always want high prices. Buyers always want low prices. They work out their differences and meet somewhere in the middle.

    In the stock market, the buyers love high prices! How many people do you know who put money into their 401(k) accounts regularly complain about the rising price of stocks in the way that they complain about the rising price of bread and the rising price of movie tickets? The problem is that most of the people buying stocks already own some -- they adopt the bias of the stock owner (a seller) even though in reality they are more buyers than owners. The people planning to buy lots of stocks over coming years are often found rooting for price increases!

    The job of any market is to set prices properly. So the stock market does eventually perform this essential function. But it can only do so by crashing and bringing about an economic crisis because of the lack of any price discipline in this funny sort of market where buyers of the product being marketed favor high prices being set for it.

    For the stock market (and our free-market economy) to survive, we need to create tools that effectively make the point that net buyers of stocks should favor low prices. Only by educating people to the dangers of Buy-and-Hold (which posits that ignoring price can work) can we make the stock market function in the manner of all other markets.

    Rob

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  2. Good piece. Among other things, reminds me of Douglas Rushkoff pointing out that the market is engineered, not an ineluctable fact of nature. It is "a social construction enforced with gunpowder."

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  3. "Dangers of buy-and-hold"?

    When I look at a chart, the only thing that I can say with certainty is that, over time, markets go up.

    The whole of our WIERD system conspires to make this so.

    The only danger of buy-and-hold is assuming that you choose the date to realise profits.

    Have faith in the long trend and retire when your investments hit the expected value. This might mean you have to wait 5 years longer than suits.

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