Monday, September 29, 2008

The Market Solution!

As a believer in market solutions/mechanisms, the last few weeks have been trying, to say the least." How, in the face of all that has happened, can you still trust markets?" is a question that I have been asked. I could give you all the facile answers - it is not the market's fault... imperfect regulatory frameworks are to blame... errant traders are the reason.. but my heart is not in any of these explanations.
I think that markets did fail, at least partially, in this cycle, just as they have in other cycles in the past. The costs are being borne by all of us. Notwithstanding the failure (and others like it), here is why I still remain a believer in markets. Markets exaggerate the best and worst aspects of human nature. At their best, human beings are creative, innovative and capable of bouncing back from the worst of adversity, and markets allow them to have maximum impact. From the Model-T Ford to the Google search engine, financial markets have allowed entrepreneurs to reach beyond their local markets, reach a broader marketplace and change the world in the process. At their worst, human beings are short term, greedy and not particularly rational, and markets feed into these emotions. When markets are good, we exalt them and when they are bad, we detest them.
So, here is the question. Would we be better off without financial markets? The good of markets, in my view, vastly outweighs the bad. While that may seem debatable at this point in time, consider two of the fastest growing economies in the world - India and China. For centuries, the people in the two most populous countries in the world stagnated under controlled economies (with colonial powers, royalty and central governments - socialist or communist- all promising a better future, but not delivering). In two decades, markets have done more to bring the the poor out of poverty in these countries than the rulers from prior generations. I may be an optimist but I do trust markets more than experts, when it comes to the big issues of the day!


Fresco said...

Dr. Damodaran,

Being a relative newcomer to anything financial, I've only recently started reading more deeply about stocks/investing/finance and subsequently have been more interested in the current financial crisis that I probably would have been otherwise. Within the past few days, I've discovered your website/courses and this blog, and after reading your expressed optimism of the market's ability to rectify itself, I wondered what kind of intervention (if any) you might consider reasonable to help alleviate the existing uncertainty within the economy.

Thank you!

Freddy Escorcia

Mahesh Sethuraman said...

While I do agree that both India and China have grown a lot more in a free market environment than under controlled and socialistic environment. Since I know more about India, let me restrict my argument to India alone.As much as the markets have opened up it is still a fairly regulated market.The currency is not completely convertible, FDI Investment limits still exist in most of the sectors, Securitization is not a big industry here, CDS doesn't even exist. SLR IS 25% and CRR is 9%. Infact Dr.Stiglitz makes a reverse case for the same. He believes that its no conincidence that the two fastest growing economies - India and China - are still controlled economies to an extent. And that's also the reason why we were insulated from South Asian Crisis of 1997. The argument is not "markets or not" but "markets with what degree of freedom"?

Adrián said...

When we talk about markets seems like we are talking about something weird, some strange, odd. There is people over there, people that buy and sell, save and invest, produces, work. In this case people that took to much risk even not understanding the probable effect of it.
The free market is people doing all the above without monitoring. But us Dr. AD said in the post, they are greedy too. That's why people need to be monitored. Because they behavior may hurt others, or make them loose money, jobs, etc. There's not such thing us free market, the invisible hand is the government hand trying to put fences so we do not cross and hurt each other.