“How Markets Fail” by John Cassidy

ISBN 978-0-141-03651-9. “How Markets Fail – The Logic of Economic Calamities” by John Cassidy was published by Penguin in 2009 (although this is a review of the 2010 reprint which has an extra “Afterword” at the end covering 2009 to 2010). Cassidy is better known for his 2002 work “Dot.Con”. He is an economics journalist whose work can be found gracing the pages of the Sunday Times and the New York Post. Judging by the accolades on the cover pages this work was very well received by the establishment achieving “Book of the Year” in The Economist, The Times, The Evening Standard and the Daily Telegraph. Let’s be clear: this is mainstream.

So it may surprise many readers just how, essentially, “radical” this work is. Cassidy has deconstructed not only the free market fantasies that rule in Wall Street and the City of London he has also taken on the entire of our Economics Academia. Something stinks and he is not afraid to tell his readership this Emperor has no clothes. Twice he reminds readers of the words of Ben Friedman:

“Few ideas offer more appeal than a model that is simple, elegant and wrong.”

Cassidy is challenging the idea that there are any simple solutions in economics. You cannot wrap the world up in a mathematical equation and expect the free market to be self-stabilising. He calls this expectation “utopian economics” as opposed to market failures that he brands “reality-based economics”:

“Rather than supplying a single, all encompassing way of thinking about the world, reality-based economics basically says that things are complicated, and no one theory can explain everything. Competitive markets sometimes work well; in other cases they send the wrong price signals.”

Of course this is the weakness of reality-based economics. It is difficult and hard to teach. Politicians like simple solutions and utopian economics seems to offer that: a pseudo science of “invisible hands” creating stable markets where everyone’s satisfaction is optimised. This illusion has been gaining ground since the 1970’s and triumphed with the election of Thatcher and Reagan. However, for all the initial wrongs they put right something strange happened on the way to free-market utopia: bits of it seemed not to work as expected. In essence, the market failed. In the field of science such a new observation would be built into the models and something done to understand why. In the dismal profession of economics dogma has reigned unchecked to the point that it is damaging society both past, present and future. But with dogma comes power, hence it prevails.

Cassidy has not really tried to explain WHY the dogma prevailed. He doesn’t delve into power-politics. His simple explanation is just that: utopian economics is simple and seems to have an easy answer to everything. It is easy to peddle, particularly to an electorate suspicious of their Government.

“The notion of financial markets as rational and self-correcting mechanisms is an invention of the last forty years.”

…writes Cassidy on page 36 before he starts the first half of the book that largely delves into where this dogma came from. To wrap up a history lesson inside an economics book may not be everyone’s cup of tea but, actually, this is the best bit. In the second half of his work Cassidy goes into detail as to why the Financial Markets crashed in 2008. If you do get a hold of this book do read the first half for a concise history of the origins of free-market dogma. In sometimes reads like a murder-mystery whodunnit with twists and turns leaping across continents more times than James Bond. We certainly learnt a lot. But as the above quote points out, regardless of the origins of the neo-liberal agenda in ancient economic texts, the twisting of its conclusions to suit ideology is a modern invention. Cassidy writes of Hayek:

“When I began studying economics at Oxford during the early eighties, Hayek was widely seen as a right-wing nut.”

Quite! Yet, in our times he is considered as another free-market visionary. How we have re-invented our own history to suit our political dogma is quite Stalinistic in its stature. We simply airbrushed out the details that didn’t suit us. In the 1960’s some of the central tenets of modern free-market economics had already been debunked:

“Once they assimilated the negative result and realised its implications many of the brightest young scholars gave up on general equilibrium and switched to game theory”

Fifty years ago our brightest minds realised the failings of the free-market yet, why, forty years ago did this re-invented dogma arise? This was the birth of a modern religion. It is faith-based, as all these ideologies are, and it rejects heretics. Writing of Mandelbrot’s criticisms of quantitative techniques used in Financial Markets to calculate risk:

“By the 1980s, many MBA students were being taught that the efficient market hypothesis was a description of reality, and Mandelbrot’s strictures had largely been forgotten. ‘Modern finance was the official religion,’ Mandelbrot later recalled. ‘My hypothesis contradicted it; and I was about as welcome in the established church of economics as a heretical Arian at the council of Nicene.’ “

Clearly the mechanics of this new religion were not realistic:

“…but to a Chicago economist, that is not a valid criticism: the test of an economic model is its explanatory power. ‘The relevant question to ask about the ‘assumptions’ of a theory is not whether they are descriptively ‘realistic’, for they never are, but whether they are sufficiently good approximations for the purpose in hand,’ Milton Friedman wrote”

This air of unreality in economic models coming out of the Chicago School and its ilk had not gone un-noticed in the world of Business. Mark Dadd, top economist at AT&T and Chair of the National Association for Business Economics said “It’s very academic, very mathematical and it […] is nothing like as useful to the business community as it could be.” – a view shared by Joseph Stiglitz.

So on we journey through the recent history of the rise and rise of neo-liberal conservative agendas. On the way we visit Climate Change via the Stern Report and its famous conclusion about Global Warming being “…the greatest and widest ranging market failure ever seen.” All to no avail of course. Since the new religion required absolute unquestioning devotion to the perfection of the free market then there was no room for the concept of “failure”. Hence climate change became a logic bomb that could only be rationalised into the economic models IF it didn’t exist. Hence climate change denial.

We learn here about Cecil Pigou (1877-1959) an economist who proposed the use of taxation to address market failure in the environment. He lent his name to the “Pigou Club” of economists who support the imposition of higher taxes on petrol and other sources of carbon pollution. “From a Pigovian perspective” writes Cassidy “the central problem is that carbon is too cheap“. A stable climate is a public good and a private tax is required. This is more widely accepted than some of us realise. The Pigou Club included Alan Greenspan and George Shultz. The Club wanted to move beyond the rhetoric that said:

“(1) Taxes are bad; (2) Pigovian taxes are taxes; (3) Pigovian taxes are bad. Such a simplistic mindset makes it impossible for people to discuss in a responsible way the relative merits of the different tax systems.”

Cassidy moves onto his major case study pretty quickly: the failure of Financial Markets. He starts by looking at the problem of “hidden information” and how deposit insurance creates a moral hazard. Banks are encouraged to take bigger and bigger risks because they know their losses will be socialised. They personally are rewarded in the good times but not punished in the bad times. Indeed Banking and Finance is a special case and even the great-godfather of modern free-market economics Adam Smith recognised this. Financial systems are not and never will be totally free market systems.

This leads us neatly onto the subprime crisis of 2007. It followed a property bubble that was ripe for the bursting. But a note here for the Occupy Movement: this author is at pains not to demonise the market players. He sees them all as just cogs in a great machine all following a totally rational set of decisions. Indeed in the USA it was Federal Policy to require banks to lend into the subprime market. It was deemed to be a social good that disadvantaged people get their foot on the property ladder. To Cassidy it is not the individuals that are the problem, it is the system that is so easily destabilised and corruptible.

Although the author is keen to show that the Emperor had no clothes on that is the limit of his radicalism. He mentions the perception of equity and injustice only in passing when discussing “moral hazard” but this book is not a rallying call for the end of Capitalism. Those who are expecting that will be disappointed. What Cassidy is telling us (with over-whelming evidence) is that the system needs fundamental reform to bring it into the world of reality-based economics. And he isn’t idle in suggesting many, many good ideas for the removal of such moral hazard. Seemingly none have been pursued. We are where we started back in 2007 and it could all so easily happen all over again. We have “disaster myopia” – next time it will be different…. but, in reality, next time is ALWAYS the same as last time. We will always make the same mistakes.

John Kenneth Galbraith once quipped that in America the only respectable socialism is socialism for the rich. Even so, such Corporate welfare is often conducted with great stealth in order not to upset the free market dogma or the electorate. Cassidy concludes:

“During an economic crisis, when markets have failed, even many conservative economists are relieved to see the government step in: practically nobody is willing to risk creating another Great Depression by relying on free enterprise. But that, surely, raises the question of why anybody believed in utopian economics to begin with”

But nobody is asking are they? Not really. Not outside the mass Occupy Movement. Within two years of the crash business in the Financial Markets was back to normal. Back to business as usual. Cassidy betrays his own exasperation when debate in Washington turned to healthcare reform pitched as a battle between ONLY liberty and socialism:

“either you are for free markets or you are a rabid government interventionist. This is absurd. If this book hasn’t succeeded in anything else, I hope it has demonstrated that the idealised free market is a fiction, an invention: it has never existed, and it never will exist.”

He believes we are trapped in “an antiquated rhetorical tug-of-war” reduced to “intellectual slogans and sound bites“. The author fears that:

“Incentives for excessive risk taking will revive, and so will the lobbying power of banks and other financial firms. If these special interests succeed in blocking meaningful reform, we could well end up with the worst of all worlds: a financial system dominated by a handful of firms that are ‘too big to fail’ but that can take on as much risk as they please, secure in the knowledge that if things go wrong the taxpayer will be there to bail them out. Such an arrangement would amount to crony capitalism writ large..”

This book is highly recommended. It is not the howl of anger from the streets. Yet it remains a book showing great sadness that we live in a system beholding to powerful interests that preach a creed that clearly they DO NOT BELIEVE IN – when it suits them. This ideology will weaken our communities and the ties that bind us. It removes our resilience and sucks the wealth from the many to the few. It is not a basis for sound finance let alone reality-based economics. For it is a dose of reality we all need.

This work is a shot in the arm. Yet the drugs don’t work. Something far more radical has to happen for that to occur. It won’t happen on the streets on demonstrations or marches to end capitalism. It will happen when the people choose to use the free market to invent an alternative. The free market can yet still work if it can be freed from those who consider their positions untouchable. Power must eventually flow the other way if democracy is to prevail. It doesn’t require socialism or the end of free markets. It just requires a vision – a new way for us to use the tools available to us. And most of all we need tolerance of a the free market of ideas. Let’s go and experiment.

About post-carbon-man

A passionate advocate of a peaceful transition to a sustainable political-economy, Mark hails from a working class farming background. Today he is a Company Director and Chairman of the Low Carbon Chilterns Co-operative. Whilst at University (Engineering Masters) he was active in Conservative Student politics but has had no affiliation since. He has travelled widely on business covering the USA, Europe, Middle East and Central Asian Republics. In 2007 Mark founded Post-Carbon-Living and a year later co-founded Transition Town High Wycombe. He lives with is wife & daughter in a home they retrofitted to be carbon-neutral. Today he blogs about surviving politics on a shrinking planet and is passionate in his rejection of Nationalism.


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