After the Rain : how the West lost the East Part 29

Even the most devout proponents of free marketry and hidden hand theories acknowledge the existence of market failures, market imperfections and inefficiencies in the allocation of economic resources. Some of these are the results of structural problems, others of an acc.u.mulation of historical liabilities. But, strikingly, some of the inefficiencies are the direct outcomes of the activities of "non bona fide" market partic.i.p.ants. These "players" (individuals, corporations, even larger economic bodies, such as states) act either irrationally or egotistically (too rationally).

What characterizes all those "market impeders" is that they are value subtractors rather than value adders. Their activities generate a reduction, rather than an increase, in the total benefits (utilities) of all the other market players (themselves included). Some of them do it because they are after a self-interest, which is not economic (or, more strictly, financial). They sacrifice some economic benefits in order to satisfy that self-interest (or, else, they could never have attained these benefits, in the first place). Others refuse to accept the self-interest of other players as their limit. They try to maximize their benefits at any cost, as long as it is a cost to others. Some do so legally and some adopt shadier varieties of behaviour. And there is a group of parasites - partic.i.p.ants in the market who feed off its very inefficiencies and imperfections and, by their very actions, enhance them. A vicious cycle ensues: the body economic gives rise to parasitic agents who thrive on its imperfections and lead to the amplification of the very impurities that they prosper on.

We can distinguish six cla.s.ses of market impeders:

1.Crooks and other illegal operators. These take advantage of ignorance, superst.i.tion, greed, avarice, emotional states of mind of their victims - to strike. They re-allocate resources from (potentially or actually) productive agents to themselves. Because they reduce the level of trust in the marketplace - they create negative added value.

(See: "The Shadowy World of International Finance".)

2.Illegitimate operators include those treading the thin line between legally permissible and ethically inadmissible. They engage in petty cheating through misrepresentations, half-truths, semi-rumours and the like. They are full of pretensions to the point of becoming impostors. They are wheeler-dealers, sharp-cookies, Daymon Ranyon characters, lurking in the shadows cast by the sun of the market. Their impact is to slow down the economic process through disinformation and the resulting misallocation of resources. They are the sand in the wheels of the economic machine.

3.The "not serious" operators. These are people too hesitant, or phobic to commit themselves to the a.s.sumption of any kind of risk. Risk is the coal in the various locomotives of the economy, whether local, national, or global. Risk is being a.s.sumed, traded, diversified out of, avoided, insured against. It gives rise to visions and hopes and it is the most efficient "economic natural selection" mechanism. To be a market partic.i.p.ant one must a.s.sume risk, it in an inseparable part of economic activity. Without it the wheels of commerce and finance, investments and technological innovation will immediately grind to a halt. But many operators are so risk averse that, in effect, they increase the inefficiency of the market in order to avoid it. They act as though they are resolute, risk a.s.suming operators. They make all the right moves, utter all the right sentences and emit the perfect noises.

But when push comes to shove - they recoil, retreat, defeated before staging a fight. Thus, they waste the collective resources of all that the operators that they get involved with. They are known to endlessly review projects, often change their minds, act in fits and starts, have the wrong priorities (for an efficient economic functioning, that is), behave in a self defeating manner, be horrified by any hint of risk, saddled and surrounded by every conceivable consultant, glutted by information. They are the stick in the spinning wheel of the modern marketplace.

4.The former kind of operators obviously has a character problem.

Yet, there is a more problematic species: those suffering from serious psychological problems, personality disorders, clinical phobias, psychoneuroses and the like. This human aspect of the economic realm has, to the best of my knowledge, been neglected before. Enormous amounts of time, efforts, money and energy are expended by the more "normal" - because of the "less normal" and the "eccentric". These operators are likely to regard the maintaining of their internal emotional balance as paramount, far over-riding economic considerations. They will sacrifice economic advantages and benefits and adversely affect their utility outcome in the name of principles, to quell psychological tensions and pressures, as part of obsessive-compulsive rituals, to maintain a false grandiose image, to go on living in a land of fantasy, to resolve a psychodynamic conflict and, generally, to cope with personal problems which have nothing to do with the idealized rational economic player of the theories. If quantified, the amounts of resources wasted in these coping manoeuvres is, probably, mind numbing. Many deals clinched are revoked, many businesses started end, many detrimental policy decisions adopted and many potentially beneficial situations avoided because of these personal upheavals.

5.Speculators and middlemen are yet another species of parasites.

In a theoretically totally efficient marketplace - there would have been no niche for them. They both thrive on information failures. The first kind engages in arbitrage (differences in pricing in two markets of an identical good - the result of inefficient dissemination of information) and in gambling. These are important and blessed functions in an imperfect world because they make it more perfect. The speculative activity equates prices and, therefore, sends the right signals to market operators as to how and where to most efficiently allocate their resources. But this is the pa.s.sive speculator. The "active" speculator is really a market rigger. He corners the market by the dubious virtue of his reputation and size. He influences the market (even creates it) rather than merely exploit its imperfections. Soros and Buffet have such an influence though their effect is likely to be considered beneficial by unbiased observers. Middlemen are a different story because most of them belong to the active subcategory. This means that they, on purpose, generate market inconsistencies, inefficiencies and problems - only to solve them later at a cost extracted and paid to them, the perpetrators of the problem. Leaving ethical questions aside, this is a highly wasteful process. Middlemen use privileged information and access - whereas speculators use information of a more public nature. Speculators normally work within closely monitored, full disclosure, transparent markets. Middlemen thrive of disinformation, misinformation and lack of information. Middlemen monopolize their information - speculators share it, willingly or not. The more information becomes available to more users - the greater the deterioration in the resources consumed by brokers of information. The same process will likely apply to middlemen of goods and services. We are likely to witness the death of the car dealer, the cla.s.sical retail outlet, the music records shop. For that matter, inventions like the internet is likely to short-circuit the whole distribution process in a matter of a few years.

6.The last type of market impeders is well known and is the only one to have been tackled - with varying degrees of success by governments and by legislators worldwide. These are the trade restricting arrangements: monopolies, cartels, trusts and other illegal organizations. Rivers of inks were spilled over forests of paper to explain the pernicious effects of these anti-compet.i.tive practices. The short and the long of it is that compet.i.tion enhances and increases efficiency and that, therefore, anything that restricts compet.i.tion, weakens and lessens efficiency.

What could anyone do about these inefficiencies? The world goes in circles of increasing and decreasing free marketry. The globe was a more open, compet.i.tive and, in certain respects, efficient place at the beginning of the 20th century than it is now. Capital flowed more freely and so did labour. Foreign Direct Investment was bigger. The more efficient, "friction free" the dissemination of information (the ultimate resource) - the less waste and the smaller the lebensraum for parasites. The more adherence to market, price driven, open auction based, meritocratic mechanisms - the less middlemen, speculators, bribers, monopolies, cartels and trusts. The less political involvement in the workings of the market and, in general, in what consenting adults conspire to do that is not harmful to others - the more efficient and flowing the economic ambience is likely to become.

This picture of "laissez faire, laissez aller" should be complimented by even stricter legislation coupled with effective and draconian law enforcement agents and measures. The illegal and the illegitimate should be stamped out, cruelly. Freedom to all - is also freedom from being conned or ha.s.sled. Only when the righteous freely prosper and the less righteous excessively suffer - only then will we have entered the efficient kingdom of the free market.

This still does not deal with the "not serious" and the "personality disordered". What about the inefficient havoc that they wreak? This, after all, is part of what is known, in legal parlance as: "force majeure".

Note

There is a raging debate between the "rational expectations" theory and the "prospect theory". The former - the cornerstone of rational economics - a.s.sumes that economic (human) players are rational and out to maximize their utility (see "The Happiness of Others", "The Egotistic Friend" and "The Distributive Justice of the Market"). Even ignoring the fuzzy logic behind the ill-defined philosophical term "utility" - rational economics has very little to do with real human being and a lot to do with sterile (though mildly useful) abstractions.

Prospect theory builds on behavioural research in modern psychology, which demonstrates that people are more loss averse than gain seekers (utility maximisers). Other economists have succeeded to demonstrate irrational behaviours of economic actors (heuristics, dissonances, biases, magical thinking and so on).

The apparent chasm between the rational theories (efficient markets, hidden hands and so on) and behavioural economics is the result of two philosophical fallacies which, in turn, are based on the misapplication and misinterpretation of philosophical terms.

The first fallacy is to a.s.sume that all forms of utility are reducible to one another or to money terms. Thus, the values attached to all utilities are expressed in monetary terms. This is wrong. Some people prefer leisure, or freedom, or predictability to expected money. This is the very essence of risk aversion: a trade off between the utility of predictability (absence or minimization of risk) and the expected utility of money. In other words, people have many utility functions running simultaneously - or, at best, one utility function with many variables and coefficients. This is why taxi drivers in New York cease working in a busy day, having reached a pre-determined income target: the utility function of their money equals the utility function of their leisure.

How can these coefficients (and the values of these variables) be determined? Only by engaging in extensive empirical research. There is no way for any theory or "explanation" to predict these values. We have yet to reach the stage of being able to quantify, measure and numerically predict human behaviour and personality (=the set of adaptive traits and their interactions with changing circ.u.mstances).

That economics is a branch of psychology is becoming more evident by the day. It would do well to lose its mathematical pretensions and adopt the statistical methods of its humbler relative.

The second fallacy is the a.s.sumption underlying both rational and behavioural economics that human nature is an "object" to be a.n.a.lysed and "studied", that it is static and unchanged. But, of course, humans change inexorably. This is the only fixed feature of being human: change. Some changes are unpredictable, even in deterministic principle. Other changes are well doc.u.mented. An example of the latter cla.s.s of changes in the learning curve. Humans learn and the more they learn the more they alter their behaviour. So, to obtain any meaningful data, one has to observe behaviour in time, to obtain a sequence of reactions and actions. To isolate, observe and manipulate environmental variables and study human interactions. No snapshot can approximate a video sequence where humans are concerned.

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Public Procurement and very Private Benefits

In every national budget, there is a part called "Public Procurement".

This is the portion of the budget allocated to purchasing services and goods for the various ministries, authorities and other arms of the executive branch. It was the famous management consultant, Parkinson, who once wrote that government officials are likely to approve a multi-billion dollar nuclear power plant much more speedily that they are likely to authorize a hundred dollar expenditure on a bicycle parking device. This is because everyone came across 100-dollar situations in real life - but precious few had the fortune to expend with billions of USD.

This, precisely, is the problem with public procurement: people are too acquainted with the purchased items. They tend to confuse their daily, household-type, decisions with the processes and considerations, which should permeate governmental decision-making. They label perfectly legitimate decisions as "corrupt" - and totally corrupt procedures as "legal" or merely "legitimate", because this is what was decreed by the statal mechanisms, or because "this is the law".

Procurement is divided to defence and non-defence spending. In both these categories - but, especially in the former - there are grave, well founded, concerns that things might not be all what they seem to be.

Government - from India's to Sweden's to Belgium's - fell because of procurement scandals, which involved bribes paid by manufacturers or service providers either to individual in the service of the state or to political parties. Other, lesser cases, litter the press daily. In the last few years only, the burgeoning defence sector in Israel saw two such big scandals: the developer of Israel's missiles was involved in one (and currently is serving a jail sentence) and Israel's military attache to Washington was implicated - though, never convicted - in yet another.

But the picture is not that grim. Most governments in the West succeeded in reigning in and fully controlling this particular budget item. In the USA, this part of the budget remained constant in the last 35 (!) years at 20% of the GDP.

There are many problems with public procurement. It is an obscure area of state activity, agreed upon in "customized" tenders and in dark rooms through a series of undisclosed agreements. At least, this is the public image of these expenditures.

The truth is completely different.

True, some ministers use public money to build their private "empires".

It could be a private business empire, catering to the financial future of the minister, his cronies and his relatives. These two plagues - cronyism and nepotism - haunt public procurement. The spectre of government official using public money to benefit their political allies or their family members - haunts public imagination and provokes public indignation.

Then, there are problems of plain corruption: bribes or commissions paid to decision makers in return for winning tenders or awarding of economic benefits financed by the public money. Again, sometimes these moneys end in secret bank accounts in Switzerland or in Luxembourg. At other times, they finance political activities of political parties.

This was rampantly abundant in Italy and has its place in France. The USA, which was considered to be immune from such behaviours - has proven to be less so, lately, with the Bill Clinton alleged election-financing transgressions.

But, these, with all due respect to "clean hands" operations and principles, are not the main problems of public procurement.

The first order problem is the allocation of scarce resources. In other words, prioritising. The needs are enormous and ever growing. The US government purchases hundreds of thousands of separate items from outside suppliers. Just the list of these goods - not to mention their technical specifications and the doc.u.mentation, which accompanies the transactions - occupies tens of thick volumes. Supercomputers are used to manage all these - and, even so, it is getting way out of hand. How to allocate ever-scarcer resources amongst these items is a daunting - close to impossible - task. It also, of course, has a political dimension. A procurement decision reflects a political preference and priority. But the decision itself is not always motivated by rational - let alone n.o.ble - arguments. More often, it is the by product and end result of lobbying, political hand bending and extortionist muscle.

This raises a lot of hackles among those who feel that were kept out of the pork barrel. They feel underprivileged and discriminated against.

They fight back and the whole system finds itself in a quagmire, a nightmare of conflicting interests. Last year, the whole budget in the USA was stuck - not approved by Congress - because of these reactions and counter-reactions.

The second problem is the supervision, auditing and control of actual spending. This has two dimensions:

1.How to make sure that the expenditures match and do not exceed the budgetary items. In some countries, this is a mere ritual formality and government departments are positively expected to overstep their procurement budgets. In others, this const.i.tutes a criminal offence;

2.How to prevent the criminally corrupt activities that we have described above - or even the non criminal incompetent acts which government officials are p.r.o.ne to do.

The most widespread method is the public, compet.i.tive tender for the purchases of goods and services.

But, this is not as simple as it sounds.

Some countries publish international tenders, striving to secure the best quality in the cheapest price - no matter what is its geographical or political source. Other countries are much more protectionist (notably: j.a.pan and France) and they publish only domestic tenders, in most cases. A domestic tender is open only to domestic bidders. Yet other countries limit partic.i.p.ation in the tenders on various backgrounds: the size of the competing company, its track record, its ownership structure, its human rights or environmental record and so on. Some countries publish the minutes of the tender committee (which has to explain WHY it selected this or that supplier). Others keep it a closely guarded secret ("to protect commercial interests and secrets").