Forever blowing bubbles

In a Wall Street Journal op-ed (PDF) Paul Rubin* suggests that bubbles and crashes are a natural part of capitalist markets. More to the point, the very factors that have recently increased the efficiency of markets – notably the internet – have also facilitated the formation of bubbles.

Technology is double-edged, as always: the internet facilitates both the functioning and malfunctioning of markets. Of course, the difference between function and malfunction is in the eye of the beholder. As John Sterman famously said, “There are no side effects—only effects.”

While this is a perennial problem, the internet may have caused a qualitative change in the degree of interconnection, which leads to significantly less resilience. Note the paradox: The internet is more resilient as a communication system, but it causes the systems that use it to be less resilient.

The corollary is that regulators face an impossible task: one can’t eliminate the downsides of the internet without simultaneously eliminating the benefits.

My study of the complex adaptive systems literature leads to the same conclusion:

• more interconnected systems are less resilient
• crashes are healthy, because they allow new entrants to flourish
• the regulatory task is not to avoid crashes (this just makes the eventual correction worse) but to manage them

As if the regulatory job weren’t tough enough, the political challenge is even harder. “This should never happen again” are the first words out of a politician’s mouth after a catastrophe. That’s what people want to hear, but it’s not realistic – and not desirable either. It will surely happen again, and it’s necessary for renewal and innovation. Managing crashes includes both reducing their severity and mitigating their impacts.

[*] Paul Rubin is a professor of economics and law at Emory University and a senior fellow at the Technology Policy Institute. He served in a senior position in the Federal Trade Commission in the 1980s.