Why we WANT the Market to Boom and Bust

You always hear people complaining about a the fact that a Free-Market has boom and bust cycles, and how that is a bad thing. The reality is that you really do want the market to boom and bust, whether you know it or not.

What is a Boom?

According to the Oxford American Dictionary :

a period of great prosperity or rapid economic growth : a boom in precious metal mining | [as adj. ] a boom economy.

Usually when we talk about booms, we are talking about the economy as an average.  But individual people or groups can also have booms when others are not. For example, during a nationwide recession, some ice cream parlors still see a boom.

During an overall boom in a nation-wide market, prosperity is translated into an average rise in standard of living. People can afford to buy more goods, housing, etc.  Jobs are typically easier to find and keep.

What is a Bust?

A bust is the opposite of a boom.  The word bust (as opposed to decline, etc) is used because it can be abrupt and unforeseen.  Many times when people talk about a bust they are talking about the Stock Market, but it can also be used to describe an individual or group’s current level of prosperity as being relatively low.

During an overall boom in a nation-wide market, less prosperity is translated into an average decline in standard of living.  People cannot afford to buy as many goods, housing, etc as they could during average or boom times. Typically jobs will be cut/lost and harder to find and keep.

Standard of Living

The value of currency and relative value of goods is always changing.  When you talk about how wealthy or well-off someone is, it doesn’t really make sense to talk about how much money they have.  To measure wealth, you have to measure the amount of goods and services are available to you and the amount you can afford.

Increasing your standard of living comes by being more efficient.  Being more efficient means you can get more work done with the same amount of input.  If you can get more goods and services with the same amount of money or work output (in other words, if you can be more efficient), then your standard of living is higher than before.

Regulation (Socialist) vs Free-Market (Capitalist) Approach

Those who cite booms and busts as major flaws and disadvantages to a Free-Market usually suggest solutions that include more central/government regulation on the market in order to “prevent this from ever happening again.” Opponents to regulation say that more regulation chokes the efficiency of the private business and raises costs.

Socialist and Capitalist approaches to managing an economy each have advantages and disadvantages.  Let’s explore those.

Socialist Approach

The Socialist approach to managing the economy includes heavy regulation and ownership of resources and assets by a central body, normally a government.  Each or most aspects of the economics of the market are controlled by the central body. Decisions about where to ship and use resources are all made by the central body.

Analogy

Socialism is very similar to a group of people marching in a formation following a single leader:

Environment for Efficiency

A group of people marching to a uniform pace/cadence can be very efficient.  Militaries across the world use this method of travel because it increases the speed at which a large number of people can travel.  A single person in the formation controls the movements of all of the individual members.  If the group wants to change direction, the leader identifies a need to change and then issues orders to the group to execute pre-defined steps in order to achieve the new speed, direction, etc.

Watch how each person plays a part in this video of a group of people marching and changing directions:

Marching is only efficient under certain conditions, however. Some of these conditions include: each person must know how to follow the directions of the leader, must be able to hear the leader, must react within one step to a new direction.  The leader must know where they are going, how to get there, how to give directions, etc.  There must be enough room for the group to get through.

Capitalist Approach

In capitalism, each individual player in a market must manage his own assets, resources, etc himself. Groups of individuals can band together to create a private company to perform the functions of an economy.

Analogy

If Socialism is like a group of people marching, then Capitalism is like a bunch of different people all trying to reach the same place, but not necessarily together or in the same way:

Environment for Efficiency

When individuals or small groups of individuals all attempt to travel, it isn’t always efficient. Some people may actually go a direction opposite the objective. Others may not take the shortest route to get there.  The term “herding cats” comes to mind.  When compared to marching towards a known objective, marching is significantly more efficient.

This approach does have advantages, however. Unlike the marching formation of a group, the group is not dependent on the competency of a single leader, less room is required to maneuver, etc.

Socialism vs Capitalism with a known objective and environment

So, in the case of marching towards a known objective under conditions favorable to marching, marching is more efficient.

Translated to economics, this might mean that in the right environment with a known objective, knowledge of the right way to get there, efficient communications, etc, that a Socialist economy would enjoy a higher standard of living because they would probably be more efficient.  If they have a higher standard of living, then you could say that they would be wealthier than the Capitalists.

Socialism vs Capitalism with unknown objectives and changing environment

What if the objective wasn’t so clear or constantly changed? What if the ideal conditions for marching were not always present?  Let’s look at the efficiencies of Socialism and Capitalism in a few of these cases:

In this chart, we can see what the hypothetical efficiency of marching under different conditions might be.  Here, we can clearly see that marching is very efficient in conditions close to ideal, but extremely inefficient if those ideal conditions are not met.

In this chart, we can see the same for what it might be for individuals or small groups. In this chart, we can see that different conditions can have an affect on individuals or small groups, but that overall the efficiency stays within a range of 60-80% or so.

And when you put the two charts together, you can see that while individuals and small groups might not ever be as efficient as marching (at it’s most efficient), for any given condition the efficiency is pretty good.

Marching Analogy Translated to Economics

While Socialism (marching) might, under specific circumstances, be extremely efficient, under anything but those circumstances it can be extremely inefficient.  While Capitalism (individuals and small groups making their own decisions) might seem only mildly efficient when compared to Socialism at it’s best, it is much more efficient when used in non-ideal or unpredicted circumstances or conditions. This is because each individual in Capitalism can make their own decisions (so you have exponentially more brainpower working on the problem), they are more agile (you don’t have to wait on the group to make a decision), and one bad decision by an individual in Capitalism most likely has very little impact on the rest of the individuals.

What is a Bust, and Why is it a Good Thing?

A “bust” in capitalism is simply a period of significant turbulence. People may loose their jobs, companies may go bankrupt – the average person or group is not doing as well as it was before the “bust.” But a bust is also a time where the complex system of the Capitalist economy is re-aligning and improving itself to meet present needs.

In our marching analogy, a bust would be the result of a significant change in the environment, let’s say you were marching with a cadence and then the leader started to be wrong or go the wrong way. For a time, your efficiency would significantly reduce. If you were marching with a group, you might never reach your objective or it would take someone in the group a long time to rebel, and only after substantial evidence. If individuals or small groups saw the smartest person going the wrong way, they might quickly stop following them and try another way to go.

Once the system has adapted and starts going the correct direction, you have recovered from the bust. In this analogy, you recover from a bust in a more free-market approach more quickly than you would from the socialist approach.

The hard truth about life is that conditions/environments will never be the same forever. A product that is popular now might not be popular in 10 years. The fastest way to adapt to a changing environment is to maximize the number of people who are making micro-decisions.

Alternatives to Busting?

So what is the alternative to a bust? If a bust is a set of relatively violent changes, the alternative would be slow changes. But the problem with slow changes (arguably what you might be able to achieve in a social or state-run economy) is that they will probably occur slower than the economy itself is changing. By the time a change is made, the solution that might have once worked might no longer be a solution to the problem or change.

Additionally, a slower change means that the disparity that would have caused a bust in a free-market will be closed or solved slower in a socialism. It could take the ‘state’ 10 years to solve a problem that a free-market could solve in 2 or 3. That gives the free market at least 7 more years to start prospering again, where the socialism has to wait until the state takes action.

Can you Avoid a Bust?

I am going to go ahead and say it: YOU CAN’T AVOID A BUST! Busts will happen. That is life. We are simply not a smart enough species to be able to determine when the floor will drop out of a huge and complex system like the economy.

A socialism might not have busts, but they have problems that are far worse. They are less efficient, less innovating, and all members of socialism have a lower standard of living. These are not things I am making up, these are historical facts. This article doesn’t aim to establish this point, so you will have to wait until I write that article. In the meantime you should agree that a free-market is the best solution to the complex problem of getting people the goods and services they want and need.

But a bust lets you know that they system is working. A bust will occur when too many people have made decisions that will turn out to be the wrong decisions, or as a result of some external catastrophe. It is like stretching a rubber band very far… and then it snaps back. The snap is the economy slapping itself back into equilibrium, or perhaps a bit to the other side of the spectrum until it does equalize.

What to do in a Bust?

The best thing people can do in a bust is to learn or try to learn the lesson. How did we get here? What did we do wrong? People should then make the harder decision which is: decide what changes (if any) you should make to your individual behavior. The questions, however, are not: what did we do so wrong that the free-market economy busted? The question should be: the free market is telling us that what we had was not sustainable… what were we doing that was not sustainable?

The incorrect thing to do is to ask this: what system-wide changes do we need to make? This should not be the first or even 10th question to ask. Don’t ask how to avoid busts in the future. Don’t try to change the rules of the free-market. Now, at some point you must ensure that the free-market is tuned correctly, but that really should just be a check to make sure of a few key principles:

  1. Are cheaters routinely held accountable for cheating?
  2. Are people allowed to accumulate and keep wealth? (aka: is there incentive to do hard and valued work?)
  3. Are people’s individual ideas and properly being properly protected, if those people so choose?
  4. Are there any restrictions placed on trade that change the natural costs and payoffs (that don’t provide for the above principles)?

That may not be an exhaustive list, but if your free market allows for those things then it should provide the framework for all participants to be prosperous, produce valued work/goods, and promote innovation and a high standard of living.

A child who is spanked (we will call the spanking a ‘bust’) asks himself the question “which actions led to me being punished?” He usually doesn’t ask “how can I change the system so that I am not punished for doing wrong?” And a good parent uses spankings or some other form of punishment to communicate to a child that a behavior is not acceptable. Parents that don’t do that will probably end up with spoiled children or children that don’t otherwise know why some of their actions are not acceptable. A free-market is a system that properly disciplines a child. A socialism is a parent that allows bad actions to continue unchecked… or unchecked infrequently or too far down the road to produce a change in behavior.

Conclusion

Busts are a necessary and desirable quality of a free-market. Without them, we wouldn’t get ‘wake up calls’ when there were serious imbalances in the economy. And really, if you think about it, a free-market is simply comprised of the individual decisions of numerous participants. If a bust does occur, it is as a result of the actions all the participants… and this is a more accurate vote than any election… and what could be more fair than the natural, individual results of each individual’s actions?

We should be thankful for busts, because they give us a clear indication that a certain product, set of products, or industry has significant problems and that we should waste our precious resources of time, money, and blood, on those efforts.

Citations to this discussion:

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