Saturday, 16 February 2013

The Invisible Invisible Hand

Economists often talk about the invisible hand of the market. This fictitious and rarely spotted phenomenon is supposed to make sure that a freely flowing market will come to some sort of optimum. This need not be the global optimum and it might be time dependent, but this is there argument against regulation as the system is self-regulating.

The problem is that this invisible hand has some pre-conditions for it to work.

The market has to be transparent. Everyone has to have the same amount of knowledge or ignorance about how the market is going to move. Anyone who has preferential knowledge can fix the market. This is why insider trading is illegal to prevent those with insider knowledge using it to their advantage. But the general case will be that people will try to get ahead in their knowledge compared to their opponents and so in this arms race there will always be a leader (although usually temporary). So there is never a level playing field and there is always some aspect of "insider" or preferential knowledge.

Secondly the market has to be free. This means free from regulation, free from influence of special interest groups, free from subsidies. Now these are a lot of frees that rarely if ever exist. Protectionism and national interest mean that governments interfere not only through regulation but also through subsidies. The EU has its famous farm subsidy the CAP. The US has protectionist policies for steel and agriculture through subsidies and preferential agreements. All of these influences are further supported by the policies of the World Bank and the WTO through the international trade agreements. These agreements make sure that there is an imbalance of power in globalised markets.

So unless some clever economist can show that there is a genuine free market that is free from any inequality of trade or knowledge then I will not expect to see any invisible hands for the market making an appearance in the near future.

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