Externalities: the decisive factor in the fall of Capitalism?

[Ol' Dirty]

N.B., Externality: An incidental condition that may affect a course of action

Our economic system treats environmental degradation as an externality—a cost that does not enter into the conventional arithmetic that determines how we use our "resources." -- Barry Commoner

In capitalist terms, an externality is any decision by an individual (firms included- that affects -nagatively or positively- the well being of another individual. A positive externality would be the beautification of a neigborhood, increasing the market value of housing, while a negative would be the effects of a firm dumping effluent into a public resevoir.

The modern world faces a combination of huge problems that might do humanity in: environmental degradation and climate change. In the 21st century, we may see the total depletion of essential aquafers, the desertification of most arable land -such as the Great Plains of North America, the Yellow River Valley, the Niger River Delta, the Nile-. These problems have been created by negative externalities. And while minor environmental damage has been done by agrarian, preindustrial societies, industrial capitalism has caused possibly irreversible environmental damage through the irresponsibility of transnational firms and capitalist reprasentative governments, as well as unnacountable autocratic states.

The loss of environmental stability will lead to millions -and likely billions- of human deaths over the next two centuries. Losses might be total.

Capitalism has acted much like a cancerous growth: it must grow indefinately until its limits are reached to stay alive. This malignant cancer is threatening to consume the entire planet, and with it humanity.

I believe that capitalism might not find its end in a discontented working class: its excecutioner might be its own success.

The left has long talked of "Socaialism or Barbarism," and it may be correct. Either the majority of humans -the proletariat- ends capitalism or we, as a race, will revert back into barbarism.

[Lynx]

Well, the proposed solution to environmental problems by capitalists is to transform some of the externalities into new markets. So far, this has not worked well, case in point: carbon emissions trading.

[More Fire for the People]

I agree. John Bellamy-Foster has called environmental destruction 'the second contradiction of capitalism'.

[h9socialist]

Environmental degradation is hardly an "externality." It is endogenous to the system. But unless the Left understands that part of socialism is learning to live within the limits of the planet, we will fall into the same trap as the capitalists. I'm a believer in the notion that there needs to be a great deal of Green with my Red.

[gilhyle]

The loss of environmental stability will lead to millions -and likely billions- of human deaths over the next two centuries. Losses might be total.

You could be right, as matters turn out, but I cant help noticing the similarity of form between such arguments and those of, lets say, St Augustine who argued that the existence of Jesus created a second, more important, reality distinct from history and society. In other words, environmmentalist arguments operate to overide the oppositions of class, which has in turn the effect of reinstating the dominant power relations as those which must be wielded to deal, as a priority with the environmental issue.

Let me put it another way - it often operates like a new stagism. It used to be argued that the national question must be resolved first and then we will get to the social question An even more confusing way of putting this was to say that the national and social questions were one seamless struggle - but the effect was the same: to prioritise national struggles over class struggles.

Probably this is not what you intend to say. But its what your comment brings to my mind.

BTW your definition of an externality seems to leave out the key point - namely that the given consequence has not been priced or appropriately priced by the interaction of supply and demand.

[GPDP]

BTW your definition of an externality seems to leave out the key point - namely that the given consequence has not been priced or appropriately priced by the interaction of supply and demand.

This is what intrigues me the most about markets. Do you think this is a problem with a capitalist market, or markets in general?

[h9socialist]

Frankly markets are just playing-fields where capital fights it out, and the winner always ends up being the one most tuned into the needs of capital. To be honest, the idea of "market socialism" is about as consistent as "jumbo shrimp." So I think that the most honest answer to your question is "yes."

[Invariance]

Broadly speaking, there are two main explanations of stock market and financial volatility.

The first (and dominant paradigm) is the efficient markets hypothesis (EMH); the market's volatility is due to the random arrival of new information that affects equilibrium value of shares. If it were not for the arrival of new information, the market would be a-okay. It is an exogenous hypothesis; that instability is due to external factors...

On the other hand, there are endogenous theories of instability; i.e. theories which attribute instability due to the market's own internal dynamics. The three most interesting being: the fractal markets hypothesis, the inefficient markets hypothesis and the financial instability hypothesis. The following descriptions are extremely basic and limited.

Essentially, the FMH argues that the stock market's prices don't follow a random pattern predicted by the EMH but follow a more complex pattern called a fractal. A normal distribution which an average value of zero and a standard deviation of one will throw up a number greater than 1, 15% of the time, a number greater than 2 just over 2% of the time, and a number greater than 3 only once every 750 times etc. The standard deviation of daily movements on the Dow Jones Industrial average is ~ 1%. So,if we were following the EMH then extreme movements - e.g 5% fall in just one day would be extremely rare events (the odds of any such even having occured even once during the 20th century would be just over 1 in 100). In reality, however...there were over 60 such daily downward movements (and over 50 daily upward movements) of 5% or more during the 20th century... In other words, extreme movements occurred roughly 10,000 times more often than for a random process. Thus, the evidence is fairly strong that the process is not random at all. I won't bother going into all the detail of this theory, because it is focuses on statistical predictions versus explanations on why the market behaves how it does. But here's a good description: "FMH takes into account the daily randomness of the market and anomalies such as market crashes and stampedes. It proposes that a (1) market is stable and has sufficient liquidity when it comprises of investors with different time horizons, (2) these investors stay in their 'preferred habitat' (time horizon), no matter what the market information indicates, (3) the available information may not be reflected in the market prices, and (4) the market prices trend indicates the changes in expected earnings (which mirror long-term economic trends)." The important difference being from the EMH is that all investors are not assumed to be the same.

Next is the inefficient market hypothesis, mainly formulated by a man called Bob Haugen. Haugen argues that the stock market is a 'noisy stock market, that overreacts to past records of success and failure on the part of business firms, and prices with great imprecision.' Unlike the EMH, the 'new information' can include the most recent movements of the stock prices themselves. Although he doesn't reference Keynes, his argument is similar to one proposed by Keynes in 1936:

[Keynes comparing investing in shares to] "those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects average opinion to be." (Keynes, 1936).

In the same way, investors trade on the basis of how they think other market participants will, on average, expect the market to react to news. In today's stock market, the major news will always be the most recent movement in price stocks, versus the 'real' news from the economy. Haugen argues that there are three sources of volatility: event-driven, error-driven and price driven (EMH only models the first - the other two can't exist in the equilibrium of an efficient market). The second results from the market overreacting to news and then over-readjusting itself once the initial mistake is obvious. The third is where the market reacts to its own volatility, building price movements upon price movements (in the same way that once one neighborhood dog starts barking it will cause a reaction which will make other dogs continue barking which perpetuates the barking of all dogs...). Haugen argues that this endogenous instability accounts for over three-quarters of all volatility...with severe consequences. If the stock market has a role in directing investment then its valuations will direct them very badly - you will have companies which will in the long run turn out to be worthless being funded (which will be wasted), whilst worthy investments beneficial to the economy will be ignored. There are some other informative arguments he gives, but hopefully you can understand the basics of his view that the market itself creates its own instability.

Lastly, there is the Financial Instability Hypothesis (FIH), coming from Minsky. Minsky begins his analysis at at time where the economy is prospering - the rate of economic growth equals or exceeds that needed to reduce unemployment, but firms are still conservative in their portfolio management, which is shared by banks who are only willing to fund low-risk investments. This behavior is a result of a recent financial failure where many investment projects collapsed and banks therefore had to write off bad debts. Hence their current conservatism.

However, with the combination of the growing economy and conservative funding, most investments naturally succeed. It becomes evident to bankers and managers that 'Existing debts are easily validated and units that were heavily in debt prospered: it pays to lever.' (Minsky, 1977). Hence, investment projects are evaluated on less conservative estimates of expected success. They are more happy to loan and invest. This sets off a growth in investment and asset prices.

Okay, this post is going on too long, so I'll cut a long story short; the boom collapses as it becomes clear that the profitability of certain businesses is poor and their ability to pay back their debts is non-existent. You can actually read the whole thing here (it is quite short), but a lot more complex than I have just explained it. This is also a good article on it.

So, there are a number of interesting theories which explain the instability of the market which is inherent to the market (without even going into various radical Marxist theories, of which there are many). The whole 'externalities' talk is nonsense; it relies on supply and demand analysis, equilibrium, perfect competition and so on and so on. Those theories are internally inconsistent and have no resemblance to reality, and only serve as an ideological prop for the free market. There are far better alternatives.

[Jonnydraft]

In terms of environmental degradation, social marginalization and so on, discounting is also inherent to capital - and should not be overlooked.

[gilhyle]

This is what intrigues me the most about markets. Do you think this is a problem with a capitalist market, or markets in general?

I thin its a problem with markets as such which takes its significance from the pervasiveness of capitalism which spreads market relations in a way which was never the case before.

Arent there Jumbo Prawns ? Are they awful ?

The various theories of why financial markets over price and underprice assets seem to me a separate point.