How can we
make sure markets stay free?
For a transaction to be without compulsion either party should be able to walk away from it. A trade with one party under the gun is certainly not free. Neither is one where one party cannot walk away because it would jeopardize their survival in some other way. For markets to be free, everyone must be guaranteed their survival requirements. The existence of free markets, and their desirability, is a fundamental tenet of Finance. If markets are not free the entire justification for the system falls apart at the outset.
Does not giving essentials away
go against the most basic principles of Finance?
No. Textbooks sometimes simply assume "manna falls from heaven" to ensure everyone's survival needs are met regardless of whatever happens in the markets. The idea of free trade applies to trading surplus goods against surplus wealth. If you go to the market with $100 and cannot find sneakers you like within that price, you can simply walk away. This is free trade. If people could go to the market with $100 each and could not buy enough food for the day, it would not be rational to expect they will satisfy themselves with supply-demand theory. The utility of essentials without which you could not survive that day is pretty much unbounded. It cannot be modeled alongside the utility of sneakers in your favorite color.
Why would anyone work
if they got the essentials for doing nothing?
Finance also assumes that people should want to maximize their wealth. If people wanted to maximize their wealth why would they stop working at the essentials? All it means is they would not be forced to work under undesirable conditions just to be able to survive. Free trade, without compulsion, should apply to trading your services for money as well.
So why not
just give away the essentials?
Why even start with a weird assumption such as manna from heaven? The problem is operations of markets cannot be separated from economic activities geared towards survival. Unless it can be proven that operations of free markets themselves will lead to everyone getting their survival needs, which does not happen, giving away essentials to everyone would involve taking from those who produce and giving it to those who cannot, again violating free market ideas.
One problem is that time is one resource that is truly limited for everyone. What if you did not have enough time in a day to earn enough to be able to survive? The poor are not always free to work harder to survive, especially if they get the short end of the stick because their work is not traded freely as it is for survival. On top of that they will have to increase their skills and knowledge while paying for ever-higher education, or retraining, as lower-skilled jobs disappear and take care of any negative health effects from overwork and overstress, all the while saving for rainy days and investing in their future when they will no longer be able to work. No one has more than 24 hours a day.
Another issue is that not everyone wants more money at any cost. There is no fundamental reason why everyone should only want more money either.
Does neither fundamental assumption apply
in real life to our current socioeconomic systems?
Not really. Manna does not fall from heaven. More than ten percent of all people are chronically malnourished, and many others work simply to make ends meet. At the same time the condition that everyone wants more money is not an absolute condition. What it really means is that everything else being the same, people would rather have more money than less. If you were never under threat to your survival would you still continue to take on as many additional jobs as you could work in a day, regardless of the pay, simply to make more and more money?
What does it matter
if the assumptions are wrong?
If you start with wrong assumptions, you will never really be able to explain what you are trying to model without running into internal contradictions. Try explaining the geography of the world assuming the earth is flat. Is Alaska really on the other side of the world from Russia? How would it help if we created a very complicated and sophisticated model that took into account current and predicted wind patterns, to save fuel flying from Alaska to Russia west to east? Often we have to show the world on a flat surface, but that does not mean we will decide on airline routes based on such a map. The same applies to using financial models based on assumptions that are false. Even as our ability to model more and more complex systems has improved, the result has been innovations like derivatives, which represent some of the most sophisticated models that were created to better manage risk. They are now better known as weapons of mass financial destruction. Entire economies have been destroyed, along with innumerable lives, and youth unemployment has reached such proportions that we are coming up with acronyms like "NEET" and characterizations such as "lost generation" which is "permanently scarred in terms of lifetime earnings". This, for developed economies. The millions fleeing lesser-developed countries should be an indication of the situation elsewhere.
Cannot our models
work around the assumptions?
In science we always assume something for simplicity, and then create models, hoping to test their predictions against observed results. If the predictions do not match the results of the experiment, we refine the assumptions and the models. Unlike physical sciences, in social sciences we cannot really run controlled experiments and are restricted to historical data for testing. To make things worse the outcomes depend on our beliefs. If everyone believed the stock price for a company should be $100, it becomes that because that is exactly what people will be willing to pay you for it. The more complicated the model, the more difficult it becomes to test. The same applies to markets which are now a complex jumble of trading algorithms which are supposed to compete against each other, may the best one win. Not every algorithm can be right. All except perhaps one have to be wrong. The problem is different algorithms can give predictions closer to the outcome at different times. In fact we really cannot say which one is right because beliefs in models impact the actual results and, as has been said, markets can always stay irrational longer than you can stay solvent. If we did have a model that could predict just the impact of interest rates on economic activity would the Board of the Federal Reserve need to vote?
all the experts?
If you have ever watched a discussion on television you will know that there are at least as many views, on what needs to be done to fix the mess we find ourselves in, as there are experts. All views are supported by reams of scientific studies and data, and are argued quite eloquently. The arguments are not just a sign of a free market of ideas. They also mean that at least one side is wrong, more than likely, all. Such arguments have persisted for hundreds of years and no one side has, as of yet, convincingly proven its case against all others. We are beginning to see market forces at work with regard to expert opinions as well. People are more willing to go against expert advice although that does not mean knee-jerk reactions are the right thing either.
So how do we
go about fixing things?
We have to make our assumptions realistic and then design a system that gives us the desired result, given the assumptions. This does not mean making things more complicated. If we had a globe instead of a flat-earth map, everything in the world would make much more sense. Instead of making our equations easier to set-up, and solve, by assuming markets are free because manna falls from heaven and that everyone wants more money, we have to accept that different people want different things and we cannot predict who would necessarily want what, even when; and that markets cannot be free if people are forced to trade their time, labor and resources simply to be able to survive.
The interesting question is how could we ensure everyone obtained their survival needs without imposing economic regulations that are expensive to implement and monitor, stifle economic activity, and also often simply lead to workarounds and corruption. Can we make sure everyone gets what they need to survive, without having to force those who produce it to simply give it over?
Of course no one can presume to have the final answer to such a question, but the question is important enough that we need to explore and discuss all possible avenues. In the end it is always about money. Do we really understand what money is? It is not something fundamental to nature. We define it. We create it. We give it value.
Instead of assuming people are all rational where rationality means whatever the person doing the modeling thinks is rational, and taking the nature of money as a given, we could try and assume that people are what they are and see whether we can define money in such a way that our system can provide essentials to all without economic regulations. This is the approach we explore in the book.