The financial crisis is a failure of markets which shows the need for state intervention. The crisis exists because markets are insufficiently developed.These two statements seem contradictory. But they are not. They are consistent. Markets are themselves public goods. And public goods can be under-supplied by the market.
I mean this in two distinct senses.
1. A well-functioning liquid interbank market is a public good, in the sense that it benefits everyone, by allowing credit to flow. However, right now each individual bank has insufficient incentive to contribute to the public good, as it would rather hang onto cash.
In pursuing its own interests, each individual bank is failing to contribute to a public good that would benefit all banks.
2. The coming recession is only a problem because insurance markets are inadequate. Put it this way. How would you fancy a week’s unpaid holiday next year? Answers range, I guess, from: “I’d rather not, as I’ve mortgage to pay and it’s a bit of a squeeze” to “good. I need to recharge my batteries and tidy up the garden.” Net, it’s no big deal.
And yet this is what recession means on average; one week’s unpaid holiday a year is equivalent to a 2.2 per cent fall in national income.
The prospect of a fall in GDP of this magnitude is a bad thing only because the pain of recession is concentrated in a few people; recessions see 4% of people lose half their income, not 100% lose 2%.
But minority losses are in principle an insurable event.
So why don’t such insurance markets exist? One reason is that they are public goods. No individual can appropriate the widespread gains that would come if we had such markets, so we‘ve had insufficient financial innovation in this direction.
All this suggests that the promotion of markets and state intervention can go hand-in-hand. We need - sometimes - the state to help promote markets.
In the case of the interbank markets, it could do this easily, by helping broker a move back to the co-operative equilibrium in which banks agree to lend to each other.
In the case of macro markets, it’s a little harder. I suspect one way of pushing them along would be for the state to give away short positions in GDP-related securities to the poor, along the lines that David Miliband proposed giving them carbon credits.
But that’s a policy for more rational times. The key point is that, sometimes, the state-market dichotomy is a false one.
Standing in the checkout queue of my favourite supermarket this Sunday lunchtime, the lady behind me, who was also buying a copy of the weekend edition of the FT, suggested that we'd probably all be better off if we simply let Tesco take over the government of Britain. On the evidence of performance, I was bound to agree.
Posted by: Bob B | October 12, 2008 at 07:11 PM
"Barclays has announced plans to raise £6.5bn without government help."
http://news.bbc.co.uk/1/hi/business/7666570.stm
Congratulations, Barclays.
Posted by: Bob B | October 13, 2008 at 08:05 AM
[So why don’t such insurance markets exist?]
Chris, the government does already provide unemployment insurance.
Posted by: dsquared | October 13, 2008 at 09:26 AM
Also, who backs these contracts if the issuing institution succumbs to the recession itself? A plan based on the assumption that CDS markets and the actors within them are more stable than the macroeconomy looks...how can I put this....utterly, wilfully batshit crazy in the light of current developments. It's at times like this S&M starts to feel like a highly sophisticated long term trolling exercise.
Posted by: Alex | October 13, 2008 at 10:09 AM
A slightly less "macro" way of doing it would be reviving unemployment insurance on the model of the old friendly societies, or through professional associations and trade guilds on the model Mike Malone proposed.
The problem is social atomization, with little in the way of intermediary institutions between the nuclear family and the absolute state. We need a revival of voluntary institutions, starting with extended households, and working up through fraternal lodges, trade associations, and the like, for the pooling of risk.
Historically, as Immanuel Wallerstein observed, capital has attempted to externalize much of the reproduction cost of human labor-power on the household economy, in order to avoid internalizing the cost in wages. But it has always attempted to draw the line between wage labor and the household economy so as to minimize the bargaining power of labor. When the household unit is too small and atomized to provide any economic cusion at all, capital is forced to internalize too many reproduction costs. But when the extended family or larger communal group is too large, or the possible lifestyle of a cottager living off the common approaches to close to comfortable subsistence, the risk-pooling capacity becomes so great as to undermine labor's dependence on wage employment at all. In the latter circumstance, labor is put in a position of being able to take offers or leave them, and tolerate prolonged periods of unemployment while waiting for an acceptable offer.
We need to restore such risk-pooling mechanisms, in the household and informal economy, as bases of independence.
Posted by: Kevin Carson | October 13, 2008 at 10:14 AM
P.S. dsquared: the problem is that, under the old mutuals, the pooled funds were viewed as the workers' money, set aside by them and governed by their rules. Under state unemployment insurance, the state decides when you're entitled to "your" money. And to paraphrase Adam Smith, when the state provides unemployment insurance for workmen, it has the masters as its counselors.
Posted by: Kevin Carson | October 13, 2008 at 10:16 AM
"And to paraphrase Adam Smith, when the state provides unemployment insurance for workmen, it has the masters as its counselors."
Quite so. Unemployment benefits (!) vary widely across EU countries and UK benefits tend to compare badly with the rates elsewhere in the EU.
Gerhard Schröder, the previous German Chancellor, put much effort into reducing entitlements at political hazard because there were circumstances where it was possible to receive a larger benefit by staying off sick than by returning to work - Angela Merkel and the Christian Democrats got the electoral benefit of that in 2005.
Btw there are commercial insurance schemes for some some personal financial liabilities - such a credit card debt - in the event of unemployment.
Posted by: Bob B | October 13, 2008 at 01:41 PM
@D2 - state-provided unemployment insurance is pathetically inadequate in the UK.
@Alex - it might sound strange, but it is theoretically possible for sellers of insurance not to behave like utter dickheads, and to price and measure risk tolerably reasonably. What we need, as I've said ad nauseam, is for such companies to overcome agency problems; perhaps mutuals or friendly societies are part of the solution, as Kevin says.
Posted by: chris | October 13, 2008 at 01:42 PM
"Economists have agreed on the fact that there exist different social models in the EU. Although each European country has its own singularities, one can distinguish four different welfare or social models in Europe:
"The Nordic model, in Denmark, Finland, Norway, Sweden and Holland.
"The Continental model, in Austria, Belgium, France, Germany and Luxembourg.
"The Anglosaxon model, in Ireland and Great Britain.
"The Mediterranean model, in Greece, Italy, Portugal and Spain. . . "
http://en.wikipedia.org/wiki/European_welfare_state
Posted by: Bob B | October 13, 2008 at 01:58 PM
[What we need, as I've said ad nauseam, is for such companies to overcome agency problems; perhaps mutuals or friendly societies are part of the solution]
EQUITABLE LIFE!!!! Sorry to shout, but this is like the seventh consecutive day that you've put up a post on "mutual insurance companies" as if they were a hypothetical entity that might be a nice idea to try, rather than one which had already been tried and flamed out spectacularly.
Posted by: dsquared | October 13, 2008 at 05:36 PM
[A slightly less "macro" way of doing it would be reviving unemployment insurance on the model of the old friendly societies, or through professional associations and trade guilds ]
which also do not exist any more, and for good actuarial reasons. Unemployment insurance - particularly generous unemployment insurance - has a huge moral hazard problem associated with it (the connection between the replacement rate and the unemployment rate has been noticed once or twice), and is utterly uneconomic to provide except on the basis of being allowed to choose ruinously overpriced premiums.
"Payment protection insurance" is effectively non-government sector unemployment insurance. It's notoriously horrifically overpriced on an actuarial basis, but this is the only way in which the private sector is able to provide it and I don't see why the mutual sector would do any better.
Posted by: dsquared | October 13, 2008 at 05:41 PM
dsquared: Things tend to "flame out spectacularly" based on the structural constraints within which they operate. Friendly societies operated in the face of hostility from the state through the early decades of the nineteenth century because they gave labor a base for independence against capital. They operated in the face of state hostility after the rise of the welfare state because they were seen as atavistic by the Fabians and SocDems. But by the accounts of people like David Beito (From Mutual Aid to the Welfare State) and David Green (Reinventing Civil Society), they functioned quite well despite the constraints put on them, until they were completely crowded out by the state in the 20th century.
Posted by: Kevin Carson | October 13, 2008 at 07:34 PM
This isn't really true Kevin - friendly societies went bust all the time. This was mainly because they didn't make use of actuarial science and set benefit rates too high, not realising that they were making themselves vulnerable to an aging membership (and obviously few young workera would join an existing FS with an old membership - much better to start a new one).
Posted by: dsquared | October 13, 2008 at 11:55 PM
No one has recently remarked on the timeliness of this deal reported as a minor, passing news item in the business press last July:
"Tesco is to compete with High Street banks after it has bought out RBS’s (RBS) 50% share in Tesco Personal Finance (TPF) in a deal worth £950 million."
http://www.financemarkets.co.uk/2008/07/28/tesco-to-enter-banking-market-following-rbs-buyout/
Events in retail banking in Britain have moved on swiftly since. From the news on Monday:
"The men at the top of Scotland's two big banks are to go, after the government announced a £37bn bail-out. RBS chief executive Sir Fred Goodwin has stepped down and RBS chairman Tom McKillop is to retire."
http://news.bbc.co.uk/1/hi/scotland/7666647.stm
Posted by: Bob B | October 14, 2008 at 06:10 AM
Readers will doubtless be reassured to know that banking issues are apparently no longer uppermost in the political news in Scotland. Another, more urgent matter now takes precedence:
"More than four centuries after she was executed in England for treason by her cousin, Elizabeth I, a row has broken out over the rightful resting place of Mary Queen of Scots, and her true place in the pantheon of Scottish heroes.
"For Christine Grahame, MSP, Mary was 'an iconic historical Scots figure' and this week the SNP member for the South of Scotland will begin a campaign in the Scottish Parliament to repatriate her remains from Westminster Abbey."
http://www.timesonline.co.uk/tol/news/uk/scotland/article4932480.ece
Posted by: Bob B | October 14, 2008 at 06:59 AM