In theory, theory and praxis are the same (Anonymous)


Praxis and theory

Theory and praxis
There is a difference between theory and praxis. In physics, you have Newton's law of gravitation. It is a fundamental theory but it is not enough to construct an airplane; no matter how much you know about gravitation, in praxis you also need the laws of aerodynamics. If you miss the effect of metal fatigue, you can get a crash no matter how well you understand gravitation and aerodynamics. And if somebody puts a bomb in the luggage department, no physical laws will help.
In economics, different schools are fighting each other. Left vs right. Regulation vs deregulation. Friedman vs Keynes. Chicago vs Vienna. There might be some truth in them all. Some have been more successful, some less. No one is without problems. Building an airplane is different, there they work together. There is no fight between the gravitationist school and the aerodynamicist school.
If your intention is to make a plane crash so you can cash the insurance, you don't need that much knowledge. If you want to make the crash look like an accident, you need more. If you know that the investigators are friendly, not that much more.

The First Fundamental Theorem of Welfare economics
Within economics, a common premise is that the businessman pursuing his own interest promotes the interest of the society. Some economists wanted proof. So they used mathematics, they made their calculations and they proved the First Fundamental Theorem of Welfare Economics (FFTWE). link
Besides being something that ought to be promoted, what is the interest of the society? As far as I can make it, it has to be something like general standard of living. This concept is too vague, you can't use it in mathematics. So instead, the economists used Pareto improvement and Pareto optimality to prove FFTWE.
A Pareto improvement is when you reallocate resources in a way that makes at least one person better off without making anybody worse of. If you make Pareto improvements until it is not possible find any more, then you have Pareto optimality. link
It is difficult to reconcile this with some sort of general standard of living. Pareto optimality starts with the present society and "improves" it to reach an optimum. Pareto efficiency can show a preference for status quo; as an extreme example, a Pareto 'efficient' equilibrium can be one where one person has all the goods and all the others none. I can see but one use of the FFTWE: it enables bank cronies to say that there is a mathematical proof that the bankers are promoting the interest of the society. link
It's not just FFTWE. It does not matter if they just talk from inner conviction or use some theoretical models, it won't work. In modern times, no other field has such a disastrous series of predictive failures as economics. link

The Invisible Hand

Adam Smith
In 1776, Adam Smith published The Wealth of Nations, by many seen as the first modern work of economics. One idea, that of The Invisible Hand, has become something of a catchword in financial circles, implicitly or explicitly used as an excuse for any looting done by the financial elite. A magic formula that they either do not understand or deliberately distort. A magic formula used against critics, just the way Harry Potter is using a magic formula against vampires or whatever he is using magic formulas against.
Adam Smith did not see the Invisible Hand as some sort of magic cure-all remedy for all financial problems. On the contrary, although he was for free market, he was against free marketers. He urged for the most suspicious attention when listening to suggestions from business; he warned for a business-dominated system allowing business to collude against consumers, forming monopolies and influencing laws and politics. He was a man ahead of his time. link

The invisible hand
The idea behind the invisible hand is not difficult to understand. Two quotations from The Wealth of Nations give us what we need:
"It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages". link
" directing that industry in such a manner as its produce may be of the greatest value, [the businessman] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. [...] By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good."
Those were the days. In those days, those in the gravy did not affect that looting was good for the public good. There was no "Greed is good" meme.

Production or looting, what pays best?
Life is more complicated than what Smith says. Henry Ford was successful pursuing his own interest but he was interested in more than money, he also wanted the satisfaction of making a good job. In spite of what Wall Street wants you to believe, good pay often is detrimental to performance. This has been demonstrated in several studies, both in controlled experiments in academic surroundings and in investigations of how real life managers perform in real life companies. link
Smith talks about production. About the butcher, the brewer, the baker contributing to society, producing the greatest value by pursuing their own interest. A banker investing in car manufacture is indirectly contributing to productivity. A banker looting customers, taxpayers, maybe even his own company, interested only in money for himself, is contributing no more than an honest to God embezzler looting the bank account of somebody else.
Smith says that pursuing your own interest can be good, not that greed is good. There is a difference. Greed makes you try harder, although not necessarily more efficiently. If production pays best, you try to be productive. If looting pays best, you try to loot.

Self-interest symmetric, knowledge asymmetric
Self-interest is something most of us have. Not only the butcher but also his customer. It is the customer's self-interest that makes him chose a butcher with higher quality or lower price. It's the customer's self-interest that makes the butcher strive for higher quality or lower price, it's the customer's self-interest that makes the invisible hand work.
While self-interest is symmetric, the purchase is asymmetric. Maybe the seller knows what he sells, maybe not. As long as he knows what he gets, it does not matter. He gets money. It does not matter if he gets coins, bills, check or a wire transfer, he is only interested in the amount. For the buyer it is different. For Smith's butcher, free trade works. His customer knows what he gets. Even if he does not know what the butcher puts in his sausage, he has a good chance to assess the quality of the ware he buys, the proof is in the pepperoni.
Some wares are more difficult to assess. Tobacco and leaded petrol are detrimental to your health; when regulations came, the industry strongly opposed them. Selling the worst securities possible to you and your pension fund is detrimental to your economy, and the banks are still unregulated. Like the tobacco and lead companies, the banks deliberately hide information about their wares. Hiding them as business secrets. The banks hiding them in CDOs, through repos, through special firms. When the law takes the side of the banks most of the time, the banks has even less incentives to work for the satisfaction of their customers.

Free market assumes knowledge
In theory, free market assumes that both parts are knowledgeable. The first fundamental theorem of welfare economics assumes that both parts have perfect information. link
Perfect competition is something similar. It assumes a lot. Large number buyers and sellers, no barriers of entry and exit, perfect factor mobility, perfect information, zero transaction costs, profit maximization, homogeneous products, non-increasing returns to scale, property rights, rational buyers, no externalities. Most assumptions might not be critical to the functioning of a free market, for example perfect factor mobility and zero transaction costs. Perfect information is hardly attainable. You can call hiding information to maximize profit a lot of things but free market it is not. link

Federal supervision dwindles
To find out if the banks engage in some sort of untoward behavior, you have to examine them. Once, regulators and the FBI were actively pursuing criminal conduct within the financial sector. Not so any more. References to the criminal referral coordinators disappeared or were removed from the bank examiners' manuals. FBI staffing for white collar crime has been cut drastically. Elite bankers behind the fraud epidemics now have de facto immunity from prosecution. link According to the Fed, documents relating to widespread legal violations are "trade secrets". As lawyers have been eager to establish, management have a right to protect violations of law as important sources of profit. link

Quid without quo
In theory, the economists know that for the free market to work, the buyer has to know what he buys. In practice, that's something he just disregards. You can say that this is a free society. If you don't like the ware, don't buy it. If you are not sure, you are free to investigate. To Adam Smith, the free market consists of trading where both parts are permitted to pursue their own gain. Believing that free market will still work when the buyer can't investigate is believing that a balance scale will still work if you cut one arm off.

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