The Failure of Market Failure | #4 | Venture Capital in the 21st Century

What are the rationales for State support for technical innovation? Adopting the Neoclassical approach of "market failure", Nelson and Arrow suggested that private business firms will invest less in research & development than is socially optimal. Empirical estimates suggest that the gap between private and social benefit is quite large. This has served as a justification for the large increase in State investment in basic research since WWII. But historically, State intervention in innovation was driven by concerns for national security and economic development. Janeway suggests it is better to think in terms of national systems of innovation, rather than market failure.

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In this eight-part series, Bill Janeway investigates the relationship between #venturecapital and technological #innovation, and the interdependent roles of entrepreneurial firms, the mission-driven State and financial speculation in the overall innovation system.

Credits: Matthew Kulvicki, Nick Alpha, Gonçalo Fonseca, Athullya Roytman, Kurt Semm

[krcalder]

At the end of the 1920s, the US was a ponzi scheme of inflated asset prices.
The use of neoclassical economics and the belief in free markets, made them think that inflated asset prices represented real wealth accumulation.
1929 - Wakey, wakey time.

That's a big market failure.

How do you get meaningful price signals from the markets?

The US trusted free markets in the 1920s, but by the 1930s, the free market thinkers at the University of Chicago were in the doghouse.
The free market thinkers at the University of Chicago were just as keen as anyone else to find out what had gone wrong with their free market theories in the 1920s.
The Chicago Plan was named after its strongest proponent, Henry Simons, from the University of Chicago.
He wanted free markets in every other area, but Government created money.
To get meaningful price signals from the markets they had to take away the bank’s ability to create money.

Henry Simons was a founder member of the Chicago School of Economics and he had worked out what was wrong with his beliefs in free markets in the 1930s.
Banks can inflate asset prices with the money they create from bank loans.
Henry Simons and Irving Fisher supported the Chicago Plan to take away the bankers ability to create money.
“Simons envisioned banks that would have a choice of two types of holdings: long-term bonds and cash. Simultaneously, they would hold increased reserves, up to 100%. Simons saw this as beneficial in that its ultimate consequences would be the prevention of "bank-financed inflation of securities and real estate" through the leveraged creation of secondary forms of money.”
Real estate lending was actually the biggest problem lending category leading to 1929.
Richard Vague had noticed real estate lending balloon from 5 trillion to 10 trillion from 2001 – 2007 and went back to look at the data before 1929.

Henry Simons and Irving Fisher supported the Chicago Plan to take away the bankers ability to create money.
“Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.
This 1920's neoclassical economist that believed in free markets knew this was a stable equilibrium. He became a laughing stock, but worked out where he had gone wrong.
Banks can inflate asset prices with the money they create from bank loans, and he knew his belief in free markets was dependent on the Chicago Plan, as he had worked out the cause of his earlier mistake.
Margin lending had inflated the US stock market to ridiculous levels.

The IMF re-visited the Chicago plan after 2008.
I think they must have some idea what the problem was.

You need to keep bank credit out of the markets to get meaningful price signals.
You don’t need to go all the way with the Chicago Plan.
Central banks can use credit/window guidance to direct bank credit for product purposes and away from financial speculation.
This was the secret of the Asian Tiger economies before they discovered financial liberalisation and had the Asian Crisis.
The dusty and forgotten tool, lurking at the bottom of every central banker’s toolbox, which they can use to create financial stability and meaningful price signals from the markets.

[Stroporez]

Mathematical economics and evolutionary economics, now we are getting to interesting parts.

[officialtea-rvgf]

with respect, the "incentive" economic argument clashes with the teaching theory of intrinsic motivation. in other words, the economy doesn't need incentives. incentives are for young children???

[olivergough]

The content of your videos are great, the editing is very bad