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How Markets Fail: The Logic of Economic Calamities

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  • Posted June 10, 2010

    I Also Recommend:

    The best explanation for the 2007 - 2009 financial crises I have read so far

    (My review is of the unabridged audio book, in digital format.)

    Mr. Cassidy's book is a comparison of reality-based economics verses utopian economics and how these opposing viewpoints relate the financial turmoil during the last part of the decade. The book is almost 3 books in one. The first part discusses the overview of utopian economics, which is the belief that free market forces and minimum government interference lead an economy to its best outcome for the greatest number of people. This "invisible hand" view originally started as a good approximation for microeconomics and how competition can, on the small level, lead to better productivity. Unfortunately, this approximation morphed into a macroeconomic dogma, with the ultimate belief that free markets are near perfect and should be allowed to play out naturally. The second part of the book, reality-based economics, is more of a mix of different examples of how utopian economics fails, rather than a unified theory. It seeks to show how human behavior can cause unexpected results which deviate dramatically from what we would expect under a perfectly rational free market. Since humans have limited knowledge and rely on rules of thumb and personal biases, we must take this into consideration when thinking about economic policy. Mr. Cassidy shows many examples of how unexpected "spillovers" from a free market have an overall negative effect on the economy.

    In the third part of the book, Mr. Cassidy uses the basic ideas introduced in the first two parts to explain how we got ourselves into the debacle which started in 2007. And unlike many other books on the subject, the author manages to do so with little blame or judgment on any one person or government entity. His "rational irrationality" explanation does an excellent job of showing how the various economic players were only following their own rational interests (or interest of the company or organization they represented), as opposed to some conspiracy theory of how Wall Street or the government did this to us. It would be much easier to point fingers or label Wall Street executives as corrupt or greedy. But that would not help us understand how to prevent this sort of thing from happening again.

    In his conclusion, the author states, "Effective government is a matter of getting the balance right between autonomy and coordination." This one sentence pretty much sums of the thesis of the whole book. And indeed, Mr. Cassidy provides compelling arguments to back up his thesis. Easy to understand as well as entertaining, I highly recommend this book.

    1 out of 1 people found this review helpful.

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  • Posted July 22, 2011

    One of the best books on economics available

    Warning: if you devoutly read the Wall Street Journal editorial page and worship Ayn Rand, you will hate this book. Anyone else with a basic knowledge of economics and an open mind will learn a lot from When Markets Fail. Read it twice, it's that good. Cassidy does a great job of explaining, well, why markets fail (Unlike many books, the title is very accurate here).

    0 out of 1 people found this review helpful.

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  • Posted January 27, 2011

    I Also Recommend:

    Fine study of the free market's bankruptcy

    In this brilliant book, financial journalist John Cassidy traces the rise and fall of free market ideology. Part 1 traces the story of utopian economics from Adam Smith to Alan Greenspan; Part 2 looks at reality-based economics and Part 3 at the crisis.

    He pops the illusions that capitalist economies are harmonious, stable and predictable. He observes, "Markets encourage power companies to despoil the environment and cause global warming; health insurers to exclude sick people from coverage; computer makers to force customers to buy software programs they don't need; and CEOs to stuff their own pockets at the expense of their stockholders." As he notes, "the American health care system is chronically inefficient." The USA spends twice as much per person as Britain, yet its life expectancy is far lower.

    Life has proved the free-market theorists wrong: Nobel Prize winner Robert Lucas said in 2003 that the 'central problem of depression-prevention has been solved'. Federal Reserve Chairman Alan Greenspan said in 2005 that falls in house prices, 'were they to occur, likely would not have substantial macroeconomic implications'.

    But there are always uncertainties, imperfect information, monopolies and spillovers. Probabilistic risk is not the same as inherent uncertainty; actuarial tables of mortality are accurate, but the future is still unknowable.

    The new financial instruments, far from spreading and thus diluting the risks of subprime, focused them into the centre of finance capital, the giant global banks, unleashing the crash. World industrial production fell 15 per cent between April 2008 and March 2009. In the USA alone, more than 5 million jobs went between September 2008 and June 2009.

    Pursuing individual (or corporate) self-interest can be rational, yet bring irrational effects, can be individually optimal but socially sub-optimal. In the financial markets it causes positive feedback and disaster. In the real world, it leads to pollution, congestion, overfishing, desertification and deforestation. As Cassidy warns, "blind reliance on self-interest and the market is a recipe for further environmental catastrophes."

    He writes, 'the biggest lesson we have learned . Wall Street needs taming'. Otherwise, it's back to crony capitalism. But the regulatory changes proposed so far aren't enough. As he notes, "no thought has been given to splitting up the essential utility aspects of the financial system - customer deposits, check clearing, and other payments systems - and the casino aspects, such as investment banking and proprietary trading."

    Cassidy concludes, "Imposing restrictions on the biggest hedge funds and private equity firms could well lead to a drastic shrinkage in these industries, which would be no great loss. Much of the activity that such firms engage in amounts to a zero-sum game, which doesn't yield any economic gains for society at large."

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