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Solow run

January 22, 2010

Nobel laureate Robert Solow has some interesting things to say about the risks of blind faith in financial markets: “The market evangelists, who tend to claim more for unregulated markets than solid theory can justify, are ideologically motivated,” writes Solow.

“They dislike and distrust governments so much that they overlook the exceptions and the implausible assumptions, and simply propose the blanket principle that the market knows best. What is improper in this manner of argument is the frequent casual hint that it is authorized by economic theory. Nothing so general is ever authorized by economic theory.”

Solow is especially critical of free-market fans who excuse everything that happens in financial markets: “What is inadmissible is the assumption that, if the market creates a large and convoluted financial system, the market must be right,” he writes.

While a functioning financial system is at the heart of a successful modern economy, he argues that this shouldn’t be an excuse for financial firms to do whatever they like – especially as some of their activities seem to benefit almost no one but themselves:

 “I have read that a firm such as Goldman Sachs has made very large profits from having devised ways to spot and carry out favourable transactions minutes or even seconds before the next most clever competitor can make a move,” writes Solow, referring to so-called high-frequency trading.

As The Economist reports this week, this sort of trading is “attracting suspicion” and coming under greater scrutiny from European and American regulators.

Solow, too, has doubts: “Now ask yourself: can it make any serious difference to the real economy whether one of those profitable anomalies is discovered now or a half-minute from now? […] It remains hard to believe that it all adds anything much to the efficiency with which the real economy generates and improves our standard of living.”

 To find out more about OECD work on financial markets, click here.

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