Pat Gunning asked:
Robin, what in your opinion is their place in the long run development
of the capitalist system?


And Robin Neill Replied
The nature of economic agents and markets being what they are,
bubbles are a necessary, if unfortunate, joint product of
the Very Long Run processes of invention and innovation -- the
"creative destruction" that is the great success of the capitalist
market system.
Robin Neill



I see, Robin. It seems to me that what you are referring to by the
"great success of the capitalist market system" is the long run growth
of economic wealth. I don't agree that Schumpeter's creative
destruction -- and therefore bubbles -- is a necessary characteristic
of the capitalist market system, but perhaps we define this term
differently. I certainly agree, however, that the capitalist system
(markets) provides agents with incentives to invent and innovate,
which is responsible for the growth economic wealth. Inventions and
innovations, like all competition, has pecuniary external effects; but
this is not what is usually meant by "creative destruction."

Unfortunately, the capitalist system in the US (which provided the
incentives to invent and innovate), as it has been known in the past,
seems under threat due partly to the recent bubble and partly to
politicians who do not seem to appreciate the incentive to innovate
and invent.

Ignorance of economics by politicians is not a proper subject for the
list. However, whether the recent bubble was due to the incentives
provided by the capitalist system or due to government intervention
is. Was the recent bubble a product of the incentives of agents in a
capitalist system operating according to invisible hand principles? Or
was it a product of the incentive divergence produced by a combination
of federal deposit insurance, regulation of financial institutions,
regulation of the agencies that rate securities, and intervention in
the housing market? I would not be so quick to attribute it to
capitalism. And I would be especially beware of using Popperian
historicism to provide a rationale for making a judgment.

In his review, Professor Sylla seems to agree with Reinhart and
Rogoff's thesis that "the financial crisis of 2007-2009...has many of
the characteristics of previous crises." However, the existence and
extent of deposit insurance and its failure to be sufficiently funded
to protect depositors is something new. So too is the magnitude of
liberation of financial institutions from strict regulation in an
environment where depositors and stockholders (and the parents of
future generations of taxpayers) rely on regulation to keep the
lending and investing policies of such institutions in check. Then
there is the regulation and, therefore, influence of the government on
the agencies that rate financial assets like mortgage backed
securities (Moody's for example). Finally, there are Fannie Mae and
Freddie Mac. A very large proportion of the facts relating to the most
recent crisis are highly complex and unique, it seems to me.

As I see it, history is history. And economics is economics. Economics
is necessary to make sense of the history of capitalism. But, aside
from helping us to recognize invention and innovation, capitalist
history contributes very little to our understanding of the current
capitalist system. The reason is, evidently, that invention and
innovation cause the manifestations of the system to change. History
contributes even less to our understanding of political economy; since
regulations, laws and even a constitution are subject to the
inventiveness and imagination of combatants in the political arena
that are largely outside the purview of classical economic theory.

Bubbles are bubbles. But this does not imply that yesterday's bubbles
help us understand today's. Human beings are not machines and,
accordingly, are not destined to repeat yesterday's errors, even if
they lived in yesterday's environment, which of course they do not.

Pat Gunning
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