- Bubbles are an inefficient way to allocate capital since they lead to “excess” investment.
- There has always been lots of chicanery in bubbles.
- Lots of people get hurt in bubbles.
All of these assertions are true. They are similar to the arguments advanced against the necessary chaos of democracy itself. Winston Churchill answered by saying that democracy is the worst form of government, until you consider the alternatives. So let’s take these assertions one at a time.
What are the more efficient ways to allocate capital? A czar of investment? That was tried somewhere once or twice and didn’t work. A wise ministry of investment like Japan, Inc. had when xenophobes were afraid that that the Japanese economy would swallow the world? Japan is still trying to recover from that.
I think that the “excess” investment is necessary. It is necessary to fund the entrepreneurs, most of whom will fail. It is necessary to create an incentive for taking great risks. And, most important, the excess investment leads to overbuilding.
Overbuilding is good, not bad, for society as a whole. Overbuilding is forward pricing of infrastructure which makes new industries possible. When railroads were overbuilt and the price of transportation plunged below what was needed for recovery of invested capital, that was bad for investors in railroads but it was great for the transportation-dependent industries, many of which couldn’t have existed without these order-of-magnitude lower costs for transportation. The low prices created NON-secular elasticity: greater demand because new industries became possible. These new industries resulted in new volumes of traffic which eventually made the lower prices bearable for the railroads – although not for the original investors.
Same thing happened with the Internet. Overbuilding. New industries. Bankruptcies certainly. And a paradigm shift – I say a liberating one – in the way we communicate and obtain information.
Certainly every bubble has had its share of frauds. I’m writing a murder mystery set in the Internet bubble which is full of shady characters. There are no excuses for the parasites at Enron or the accounting fraud at WorldCom. Crooks go where the money is; there are even people who find tsunami relief an irresistible target. But to puncture all bubbles because they tempt thieves would be like burning all the crops because they attract rats.
And, again, consider the alternatives. In government-controlled economies the tax of corruption is often over 100%. The more government control, the more corruption and the less innovation.
Finally, it is true that lots of people get hurt in bubbles. And it’s an oversimplification to say they deserve it because they were greedy. But it is a lesser evil for some people to get hurt by the risks they chose to take than for there to be no investment sufficient to fund radical infrastructure change. If the alternatives are a government which taxes me to fund what a politician finds it expedient to fund or a lottery in which I get to choose whether or not to play, give me the lottery every time. And, if I get to think about what I invest in (even though I am usually wrong), this is marginally better than a lottery and a hell of a lot better than a tax.
That’s why I like bubbles. I concede all the negative assertions of the bubble-busters. Now all they have to do is come up with something better.