Are the effects of bubble bursting worth it?
This is a great discussion, and I feel lucky to be a part of it.
As an economist, I also feel obliged to say a few words about opportunity cost. It may be the case that the processes following a bubble are useful for the economy, as Dan posits.
Those processes may even be valuable enough to justify the massive dislocations that occur when bubbles burst; in my new book, "Connected: 24 Hours in the Global Economy," I also discuss the helpful effects of adverse shocks. But the inflation of bubbles requires a lot of the economy's resources - things that could have been used in other ways - and that could be a separate cause for concern.
Just think about how bubbles form. Promoters, as Dan calls them, step into public spaces to whip up hysteria surrounding certain types of assets, practices, technologies, you name it. Then speculators and ordinary investors decide to jump onto the bandwagon. Those folks, clearly, could have put their money somewhere else.
This wouldn't be a problem if all bubbles formed and burst instantaneously. But many take a long time to burst, or to slowly deflate - sometimes a decade or more. During that time, the resources committed to the bubble could have been allocated differently in the economy. So now I ask again, if you add opportunity cost into the equation, are the salubrious effects of bubble bursting still worth it?
I'm looking forward to having my teeth set on edge, especially after identifying myself as an economist....
Depends. Were all those resources that were invested in the bubble actually being used (or intended to be used) for purposes which meet some disinterested observer from another planet's definition of "productive"?
If $500 billion is withdrawn from musty old trust funds where it was being invested in dying industries at rates of return that satisfied the trust babies' needs, invested in the bubble, transferred to a new generation of bubble-com millionaires, then "lost" when the bubble pops has the money been lost? Or just taken from where it was gathering mold and exposed to some new sunlight in a different part of the US / the economy?
I am not convinced myself that all current investment in the US is working 24/7/365 at maximum effectiveness or efficiency, efficient market hypothesis notwithstanding. Having the things shaken up a bit can be a good thing, even if it means that Old Line Company has to pay a bit for for its gilt-edged bonds.
sPh
May 14, 2007 2:02 PM | Reply | Permalink
I've got mixed feelings about the whole discussion. It would appear that the bubble is an effect of unreasonable demand and not related to anything intrinsically good or bad about the enterprise. There's no reason to expect or not to expect that it's paved the way for much of anything. By definition, in fact, it means that something is past. Maybe fiber optics will be a great thing that just didn't yet come to fruition, or maybe it'll leave us with a network of the wrong materials, when technology finds another form of broadband delivery (say, power lines).
Moreover, its bursting is good only in the sense that, in the usual justification of failures in a gloriously efficient market, some things were dumb in the first place, the Schumpterian housecleaning. The whole shebang seems to me to be trying too hard to find the next pop-economics generalization, the next Malcolm Gladwell truism.
Finally, what's there to debate? You can argue that some bubbles would burst more safely and sooner if regulation insisted on full disclosure, as may apply to subprime lenders. But mostly regulation can't keep businesses from going under.
John
http://www.haberarts.com/
May 14, 2007 2:11 PM | Reply | Permalink
I am 100 percent in agreement with John that we must resist the "next pop-economics generalization, the next Malcolm Gladwell truism" - and I would add "the next mundane object whose development explains all of world history."
I would respond to sphealey with a question: Where does the money go during a bubble's inflation? It depends on whether we're talking about the primary or the secondary market. In the primary market (e.g., IPOs), you're just plowing new money into an enterprise - that's pure bubble, and the money could have gone elsewhere. In the secondary market, someone is selling you the assets for which you're paying higher and higher prices. They could put the money elsewhere in the economy. But historical experience suggests that there is a very real tightening of finance for sectors that aren't part of the bubble.
May 16, 2007 12:48 PM | Reply | Permalink