The Insanity of Market “Efficiency” as Defined by Such Economists as Robert Lucas

29 07 2010

Bill Clinton based his impeachment defense on what he thought was a clever semantic argument. Whether he had sex with Monica Lewinsky all came down to how you defined the word “is.”

Some mainstream economists are also resorting to the “semantics” strategy in their defense of traditional ‘neo classical’ economics. Robert Lucas is a case in point.

In August of 2009, one year after the beginning of the US economic collapse, Nobel winning and Chicago economist, Robert Lucas defended economic theory in an invited article for the Economist magazine (August 6, 2009). In the article he was resolute that macroeconomic theory and in particular the efficient market hypothesis was well and good. Nothing was wrong — despite its utter failure in comprehending the collapse.

His was a spurious, quibbling argument and exposes the vacuousness and  impotence of mainstream economic thinking.

The thrust of his argument was that “we economists never claimed that we could predict when the market would turn. Therefore, we and our theory are off the hook.” Well, in fact, he and his kind of economists did claim that market changes were predictable. His whole life work was to make macro economic phenomena more mathematically analytical i.e. predictable. He even noted in the article how his colleague Mishkin was running models for the Fed in 2007 when the wheels were starting to come off the economy. What were they running mathematical models for if not prediction? Was it some kind of electronic game to idle away the hours of boring testimony from the various regional Fed-bank governors?

Lucas also defended the efficient market hypothesis of Eugene Fama (circa 1900) that

“the price of a financial asset reflects all relevant, generally available information.”

And he went on to say,

“The term “efficient” as used here means that individuals use information in their own private interest. It has nothing to do with socially desirable pricing; people often confuse the two.”

Lucas’ defense of the efficiency of the market – regardless of definition of efficiency – misses the point of the criticism of economics. The point of criticism is that the pricing mechanism is not sufficient by itself to efficiently allocate resources. Economists should know this. To simply defend economic theory by saying that prediction was never a promised component of the theory, is like an auto maker who makes a car without a steering wheel and then denies any responsibility for the inevitable injuries that result by saying that predicting when the car would crash was never part of the bargain.

An automobile manufactured without a steering wheel is categorically defective. The probability of crashing is 100%. To absolve oneself of blame because you cannot say when the car will crash, even though you know the answer with 100% certainty if it will, is pure deviousness.

The question was not when our economic system would crash, but if it would or not. It was clearly going to crash and it did. Lucas and economists of his ilk should have known this. Lucas seems to think that booms and bust, also called by economists, “the business cycle,” is just one of many sub-fields within economics, and one that he personally is not all that interested in. He seems to think that when everyone is making money, that the economy is simply “in equilibrium.” (for more on the fallacies of equilibrium-thinking and the efficient market hypothesis, see Eric Beinhocker’s excellent overview of a completely new direction in economics called complexity economics in “The Origin of Wealth.)

Lucas’ position is particularly galling when you further consider that his economic beliefs are of the positivist-mathematical school. His life work in economics has been the introduction of mathematical techniques and analysis in order to make economic phenomenon more predictable. By denouncing any culpability regarding the economic collapse and defending economic theory, by saying that prediction was never an objective of economic theory, is brazenly devious, incoherent and hypocritical. He at least has to admit that his mathematical and predictive bent in economics has been profoundly misguided and terribly wrong.

A few months prior to Lucas’ article, a bank in Southern California ordered the destruction of newly built tract homes. The homes weren’t selling and it was more “efficient” to the banks to destroy them than to try to find occupants.

These homes in part had patio covers, gazebos and fences made from old-growth redwood trees. “Old growth” trees are those that are older than 1000 years. Some trees are even 2000 years old. They were saplings at the time that Jesus walked on the earth.

Lucas pointed out in his article that his use of the word “efficiency” has nothing to do with what is commonly understood to be efficiency. In fact, Lucas’ notion of efficiency is the opposite of what most people consider efficient. That is, to Lucas, “inefficiency” is the common way to describe the market process.

The inefficiency that Lucas champions is to cut down 2000-year-old redwood trees, build homes that nobody wants, and within a year or less of construction, demolish the homes and bury the wood in the ground.

Lucas’ cherished “market efficiency” starts here.

Two thousand year-old redwood tree cut down in order to make patio covers for tract homes, that subsequently are torn down and thrown in landfill. In Robert Lucas’ world, this is the “efficiency” of capitalism and should be celebrated.

Capital intensive logging is more efficient according to economics conventions. Watch the following video clip, which makes my stomach turn. The equipment operator here makes $15 per hour.

The most efficient way of cutting trees is clear cutting. The above photo shows what the forest looks like afterwards.

From here, the wood is cut to into lumber and sold to developers.

Here is a news excerpt about what happened next. Note the remnants of the redwood trees in the background.

Tuesday, May 05, 2009


A bank in San Bernardino County decides to scrap homes instead of selling them, giving new meaning to the housing crunch.

The area was supposed to have 16 new homes in Victorville off the 395 in Bear Valley Road, but the homes never sold in the midst of the housing crash.  The bank that repossessed the property said that clearing the rubble instead of putting more money into the homes that hadn’t been completed was the cheapest fix.  Victorville residents like Brooke Bollinger have watched for weeks as a 16-unit neighborhood was flattened. Four completed model homes, along with a dozen homes still under construction, have been bulldozed in the last three weeks.

We have to stop listening to economists like Robert Lucas.


Alan Greenspan’s Mea Culpa

10 01 2010

On October 23, 2008, Alan Greenspan admits to Congress that his belief in free markets was mistaken.

Rep. HENRY WAXMAN (D), California: [October 23, 2008] You have been a staunch advocate for letting markets regulate themselves. And my question for you is simple. Were you wrong?

ALAN GREENSPAN: Yes. I found a flaw, but I’ve been very distressed by that fact.

Rep. HENRY WAXMAN: You found a flaw in the reality.

ALAN GREENSPAN: Flaw flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

Rep. HENRY WAXMAN: In other words, you found that your view of the world, your ideology, was not right.

ALAN GREENSPAN: Precisely. No, that’s precisely the reason I was shocked because I’ve been going for 40 years or more with very considerable evidence that it was working exceptionally well.

RON SUSKIND: You see Greenspan at the hearing table after the collapse, and you see a crushed man, really.

ROGER LOWENSTEIN: He said that the premise that you could trust the markets to regulate themselves was misplaced.

JOSEPH STIGLITZ: After almost two decades of public service, he realizes that the economic philosophy that he had pushed so hard, resisting regulation of derivatives he realized that there were some fundamental flaws in that whole philosophy.

JOE NOCERA: It was a pretty incredible moment that after a lifetime of faith in a certain way the world worked, that Greenspan would say, “I was wrong.”

ROGER LOWENSTEIN: It struck me as someone admitting that the core belief that had animated, you know, basically, a 20-year, 18-year career as Fed chief was wrong. It’s stunning, but it doesn’t undo the damage.

BARNEY FRANK:  That was a very important moment … comparable I think to [Secretary of Defense under Kennedy and Johnson] Robert McNamara’s confession of error with regard to the Vietnam War, because what Greenspan was saying was not simply that “I called that one wrong; this one I was off by X,” or “I miscalculated.” He was saying: “My fundamental approach was wrong. I thought that the market would be self-correcting. In my view, what happened was not supposed to be able to happen.” And that is very important, very profound, and will have a big effect, because as we go forward for the rest of this year, we are going to be adopting regulation now, which people like Alan Greenspan used to resist. Greenspan’s acknowledgement that the market is not as self-correcting as he thought is now going to be a very important piece of that argument. …

From the PBS Frontline documentary, The Warning: