Insights from Digital Economies: The Efficient Market Hypothesis “Is Plainly False”

By
Yanis Varoufakis

Yanis Varoufakis, professor of economics at the National and Kapodistrian University of Athens, began his presentation at the 67th CFA Institute Annual Conference by explaining that he was a “a living, breathing contradiction.” Not only was he a Greek economist, he was also a skeptical enthusiast — finding many of the claims surrounding technological innovation to be fascinating but also dubious.

During his time as economist in residence for Valve Corporation, Varoufakis studied the social economies that emerged spontaneously within multiplayer video games, such as Team Fortress 2 (TF2), and he shared his digital economy insights with the audience.

“Econometrics Is a Travesty”

“In our standard work,” said Varoufakis, “we economists have to use econometrics if we want to make sense of economic data.” But he went on to explain that one of the problems with econometrics is that “you only need to have seen how econometric data is put together to decide that you most definitively do not want to use it.” (For example, see Varoufakis’s recently published criticism of the figures provided by ELSTAT, the Hellenic Stasticial Authority, over their calculation of Greece’s primary budget outcome for 2013.)

Digital economies, on the other hand, offer “a full information set, making sampling superfluous,” and they allow economists to “change the economy’s underlying values, rules, and settings, and then sit back to observe how the community responds, how relative prices change, [and] the new behavioral patterns that evolve.”

“Arbitrage Opportunities Seem to Survive Perfect Information”

Varoufakis explained that “the quicker [market] equilibrium is achieved, the greater the market’s efficiency, and the worse the prospects of profiting from arbitrage.” In the case of digital markets, the transparency of information available and the speed at which it is distributed “ought to procure instant equilibration.”

This idea was tested by observing the opportunities for arbitrage available in the TF2 marketplace, which did not decrease over time. “This community of switched-on, keen, perfectly well-informed traders can still leave room for considerable, and variable, arbitrage,” which means that the efficient market hypothesis “is plainly false,” according to Varoufakis.

A Currency-Resistant Economy

Varoufakis was surprised by his observations of the TF2 economy because he had expected to see a transition from a barter economy to an economy that used a common unit of currency as it grew more sophisticated. By the time economies are sophisticated, “they have ceased to be based on barter — for reasons similar to why we have not developed hugely sophisticated training wheels for professional cyclists.”

The TF2 marketplace, however, continued to function as a barter economy. Varoufakis found that “there are ‘islands’ within the community within which some item has become the island’s currency but has failed to acquire a universal monetary role.” As an aside, he suggested an implication for geopolitics: It meant that “in the international arena, there is no natural tendency for some currency to dominate, to become the reserve currency that enjoys an exorbitant privilege.”

No Currency Market, No Labor Market

Drawing parallels between his own observations and Robert Radford’s article about cigarettes functioning as currency in a World War II prisoner of war (POW) camp, Varoufakis noted that neither video game economies nor the POW economy had functional labor markets or money markets. “In the POW camp, there was a fledgling market for lending cigarettes,” he said, “but it proved highly unstable and crashed, due to high default rates and an institutional inability to exact interest.”

Varoufakis thinks that without money markets (or debt markets), few macroeconomic insights can be gained from virtual economies. “Debt is to capitalism that which hell is to Christianity — seriously unpleasant and absolutely essential.”

Does Bitcoin Need a Central Bank?

Bitcoin was designed to mimic the gold standard, which was eventually replaced because “capitalism cannot breathe under an exogenous quantity of money.” According to Varoufakis, “no depoliticized currency is capable of powering an advanced, industrial society.”

Even video game currencies are managed by a central authority. “Game companies, essentially, play the role of central banks, increasing or decreasing the exchange rate between in- and out-of-game money in a bid either to deflate bubbles or to re-inflate the economy after a bust.”

Varoufakis has previously written about the reasons why he finds bitcoin unsuitable for managing economies in the real world, but during the talk, he noted that “bitcoin’s technology offers us opportunities for creating new instruments that are supportive of existing monetary policy.”

Corporations: “The Last Remaining Vestiges of Pre-capitalist Organization”

Although corporations operate within markets, Varoufakis suggested that they “can be thought of as market-free zones. Within their realm, they allocate scarce resources between different productive activities and processes hierarchically — with no recourse to markets or prices.” The digital products developed and traded in online economies — and other technological advances, such as 3D printing — threaten the ability of corporations to protect their allocation decisions from the direct influence of market forces.

Varoufakis has posted a transcript and full recording of his speech, including his thoughts on politics and the future of democracy, on his website.

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Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: W. Scott Mitchell

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