Institute for Financial Transparency

Shining a light on the opaque corners of finance


Economists and transparency

“Nobody makes good investment decisions when blindly betting” summarizes my approach to transparency.  While occasionally a blind bet will work out well, there is no reason to believe blindly betting will be successful over time.

This approach to transparency just happens to be consistent with Adam Smith’s approach which he laid out in the invisible hand.  A necessary condition for the invisible hand of the market to work properly and set prices so resources are allocated efficiently is both buyer and seller know what they are buying or selling.  The invisible hand doesn’t work if the necessary information isn’t available.  There are three conditions under which the necessary information isn’t available: the buyer doesn’t know what he is buying; the seller doesn’t know what he owns and is selling; or both buyer and seller don’t know.  There is no reason to think the result of a transaction in the presence of asymmetric or no information will achieve any sort of optimal outcome.

Needless to say, the invisible hand and the use of price to efficiently allocate resources is the foundation on which the economics profession and its theories is built.

Naturally, you would therefore assume economists would never suggest blindly betting yields the same optimal outcome in the efficient allocation of resources as buyers and sellers having the information they need.  After all, economists have a vested interest in promoting the notion their theories are actually useful.

Of course, this assumption is wrong.

Economists are some of the leading voices for the notion investors blindly betting yields the same positive outcomes under the invisible hand as investors having access to full information.

In an appendix in Transparency Games, I provide 60+ examples of claims I have heard that effectively amount to investors blindly betting yields the same positive outcome.  Many of these claims were made by distinguished economists.

For example, several economists have claimed too much disclosure is as bad as opacity as the buyer or seller cannot assess the disclosed information.  If it were only the buyer and seller who could assess the disclosure this might be true.  However, in the real world, both buyer and seller can use trusted third party experts to assess the disclosure for them.  As a result, in the real world, there is no such thing as too much disclosure.

Of course, in peer review journals, economists don’t reject papers based on the reality that buyers and sellers can use trusted third party experts to assess all the information disclosed for them.  Instead, they accept the notion too much disclosure is as bad as opacity by arguing even with this fundamental flaw in the paper, the paper has some merit.

No it doesn’t.  A fundamentally flawed paper is meritless by definition and should never make it into a peer reviewed journal.

The fact a fundamentally flawed paper can make it into the most prestigious peer review journals (here’s looking at you Rogoff and Reinhart with their Excel error showing this time its different), shows just how low a bar there is for acceptance into an economic journal.  I would estimate the bar is set somewhere between say 6 to 10 feet underground.

More importantly, it shows how the economics profession doesn’t even understand the extent to which it is dependent on the idea nobody makes good investment decisions when blindly betting.

On the bright side, the willingness to accept papers saying blindly betting yields the same results as the invisible hand does explain why the economics profession missed warnings about the financial crisis that started on August 9, 2007.  The economics profession couldn’t be expected to warn about an opacity driven financial crisis when it thinks you get the same efficient allocation of resources from blindly betting that you get from transparency where investors know what they own and are buying.