Lately I've been wondering if the efficient market hypothesis was actually more true a century ago than it is now.
Not because anything fundamental has changed about economics, but because baselines have shifted to the point that what we expect an efficient market to look like may be very different from what what people expected it to look like in the early 20th century. So, basically, people's definition of "efficient" has subtly changed.
A century or so ago market economies hadn't caught on to the same extent. In the 1950s you had Khrushchev coming to visit Iowa to learn about US agricultural productivity. He visited family farms, talked to people about how they did things, and then went back home to tell the USSR's farmers that they needed to plant corn everywhere, including in places where the climate is not even remotely suitable for growing corn. All this time talking to family farmers about how they make their own decisions about the best use of their own land, and he somehow still failed to pick up on the idea that maybe the secret ingredient in the sauce was that the USA generally let farmers run their own farms.
Sure, the USA's capitalist economy still had charlatans, including agricultural charlatans, and wasteful fads for bad ideas, rent-seeking behavior, pork barrel politics, etc. But maybe it was still easy to see that situation as efficient at the time, because one's reference for comparison included being able to see the greater amount of damage that a planned economy allowed a charlatan like Lysenko to do from his position of power within the Soviet Academy of Sciences.
I think it absolutely was. Even 50+ years ago there was far more competition in any number of industries and investors looking at a particular widget maker could compare numerous companies and analyze the operations and strategy of each before picking which one(s) to invest in. Today we assume EMH when competition has become increasingly rare... so everyone from consumers to investors have fewer options yet somehow efficiency is supposed to exist.
Today most just pile into the megacaps and generally assume 'these guys are the biggest... they must be the best.' Sure, there's a small window of competition in the VC world where money piles into non-public companies for a few years before a winner is selected (often having nothing to do with having the best product/service or even being the most efficient or profitable... it's all about who scaled to the finish line the fastest) and either becomes the 800lb gorilla or gets gobbled up by one.
> Lately I've been wondering if the efficient market hypothesis was actually more true a century ago than it is now.
Probably.
A century ago, the companies which approached monopoly were in industries that had either huge economies of scale or very strong network effects. The United States Steel Corporation was an example of the first, and the Pennsylvania Railroad an example of the second. Even railroads were somewhat local monopolies - the Pennsylvania never merged with the Union Pacific. Not that the government at the time would have let them.
What changed?
- Better transport and communication. Selling to country-sized and world-sized markets became feasible.
- Computerization. Big companies used to have huge clerical plants of people pushing paper. Some of that paper pushing scaled faster than linearly, so the bigger the company, the worse it got. The administration system of big companies couldn't get out of its own way. It's forgotten now, but pre-computer, railroad companies had no idea where most of their shipments currently were. Paperwork was nailed to the side of boxcars and traveled with the load. As late as the 1960s, auto companies were struggling to figure out where their vehicles in transit on rail cars had gotten lost.
Today the mechanics of tracking everything is a non-problem. Walmart, Target, and Amazon work fine. Planetary-scale companies are possible and common.
- Bigger banks. Until the 1980s, US banks could not operate across state lines. Until the 1990s, nationwide banks did not exist in the US. This limited large business access to borrowed capital. Most companies were primarily funded by equity, supported by national stock markets.
I think the hypothesis was more true in the past, but mostly because both the necessary dependencies it is based on are less true today than in the past, and the products and services are more complex today.
Back when anybody could start building furniture the cost of entry was low and competition high. Switching costs were also low.
The cost of entry for a smartphone which is truly different are astronomical, many previously unregulated products are now strictly regulated, so costs of entry is no longer low and therefore competition is also low. For many services like software switching costs are very high. Firms need to be large to produce the complex products which introduces internal inefficiencies which are hard to avoid.
Realizing a day later that I misspoke in the first sentence. "Efficient market hypothesis" is something else; I should have said something like "idea that freer markets are more efficient".
Not because anything fundamental has changed about economics, but because baselines have shifted to the point that what we expect an efficient market to look like may be very different from what what people expected it to look like in the early 20th century. So, basically, people's definition of "efficient" has subtly changed.
A century or so ago market economies hadn't caught on to the same extent. In the 1950s you had Khrushchev coming to visit Iowa to learn about US agricultural productivity. He visited family farms, talked to people about how they did things, and then went back home to tell the USSR's farmers that they needed to plant corn everywhere, including in places where the climate is not even remotely suitable for growing corn. All this time talking to family farmers about how they make their own decisions about the best use of their own land, and he somehow still failed to pick up on the idea that maybe the secret ingredient in the sauce was that the USA generally let farmers run their own farms.
Sure, the USA's capitalist economy still had charlatans, including agricultural charlatans, and wasteful fads for bad ideas, rent-seeking behavior, pork barrel politics, etc. But maybe it was still easy to see that situation as efficient at the time, because one's reference for comparison included being able to see the greater amount of damage that a planned economy allowed a charlatan like Lysenko to do from his position of power within the Soviet Academy of Sciences.