The Economics of Enough_ How to Run the Economy as if the Future Matters - Diane Coyle [106]
CAN MARKETS BE MORAL?
Few people, even among the most ardent fans of market solutions, will disagree with the proposition that the financial markets have, from time to time, brought scandalous demonstrations of greed. While most traders earning multimillion bonuses no doubt think of themselves as upstanding citizens, the rest of us find it hard to find many shining examples of virtuous behavior on Wall Street or in the City of London. In the notorious words of cinema villain Gordon Gekko (Michael Douglas in Wall Street), “Greed is good” is the motto of the markets, but not of Main Street. Likewise, the cartoon “rational economic man” is a selfish being, whereas real people make choices motivated by the moral sentiments of Adam Smith and illuminated by modern evolutionary biology. But does the immorality of the financial markets and the all-out free market ideology they embody in fact corrupt the rest of the economy? Does the efficiency of market outcomes come at a price?
One researcher who thinks so is Donald Mackenzie, an Edinburgh University sociologist. He labels the effect “perfomativity.”10 By this he means that the theory of free markets—based on self-interested individualism—becomes the reality of behavior on the part of people engaged in those markets. He points out that economics is not just a research discipline that seeks to understand the world but also, to paraphrase Karl Marx, changes the world though its impact on policy and decisions. Financial economics has been particularly influential in this respect. Mackenzie and his coauthors single out the influence of Eugene Fama’s efficient markets hypothesis, which says that stock market prices capture all available information about the value of the shares and investment managers can never consistently beat the market:
The efficient market hypothesis is not simply an analysis of financial markets as “external” things but has become woven into market practices. Most important, it helped inspire the establishment of index tracking funds. Instead of seeking to “beat the market” (a goal that the hypothesis suggests is unlikely to be achieved except by chance), such funds invest in broad baskets of stocks and attempt to replicate the performance of market indexes such as the S&P 500. Such funds have become major investment vehicles and their effects on prices can be detected when stocks are added to or removed from the indexes.11
Another example is the huge market for options (OTC derivatives), which were virtually nonexistent in 1990, small in 2000, and worth $604.6 trillion by the first half of 2009. Option pricing theory explains the growth—without the theory about what the prices of these derivative contracts ought to be, there could have been no trade in them. The theory created the reality of the market.
Needless to say, the financial crisis has severely undermined belief in the validity of the efficient markets hypothesis—although its creator, Eugene Fama, remains adamant that the theory is empirically correct. In a 2009 interview, he said:
Prices are good estimates of the underlying value of the asset. There are real risks of volatility in stocks, and this current episode is a good example. . . . This is not a financial recession. The financial problems are an offshoot. But nobody wants to believe that markets are efficient—especially not investment managers who proclaim that they know better.12
A wider question is whether the theory of financial markets has affected not only the reality of those markets, but the wider economy. There are two related questions: One is whether theory directly changes the way the markets operate, the outcomes in terms of prices