What is the Efficient Market Hypothesis and How it Works and Doesn’t Work in Practice

Are Markets Really Efficient in Delivering Optimal Outcomes for All Stakeholders?

Are Free Markets really “free” in the real world? Are market forces allowed to deliver efficient outcomes or do governmental and private entities interfere in the workings of markets and distort the outcomes?

Moreover, does Crony Capitalism introduce bias against the smaller players and favours the biggies? While economic theory holds that markets are efficient and the Efficient Market Hypothesis has long been held as Gospel, the reality is somewhat different as the history of the business world is replete with examples on how various stakeholders pervert the workings of markets and ensure that gains are not equitable.

For instance, subsidies and tariffs are one example of how governments favour certain economic actors over others. Next, short selling and gaming the equity markets is all too common leading to distorted outcomes.

With deregulation of markets, private players have become all too powerful and this was seen in the way in the recent Texas snowstorm, power prices went up the roof as the deregulation of the energy market meant that private producers jacked up the prices when demand soared and the supply was scarce and weak.

What Does the Efficient Market Hypothesis Has to Say About Natural Economic Forces?

So, what exactly does the Efficient Market Hypothesis has to say? The theory holds that markets when left to them deliver optimal outcomes when compared to controlled markets that are the hallmark of socialist and communist countries.

For instance, the Efficient Market Hypothesis says that the natural forces of Demand and Supply tend to deliver equilibrium conditions.

When there is excess demand, prices tend to go up until there is excess supply when prices began to fall. Similarly, prices fall when there is a glut or excess supply and which then leads to a situation where demand rises so fast that prices begin to rise as well leading to equilibrium.

In other words, if markets are left to the discretion of natural economic forces of demand and supply, then the optimal outcomes are delivered leading to periodic bouts of equilibrium and disequilibrium that tend to cancel out each other.

Indeed, this is the reason why the economic theorists always stress that the Hidden Hand of Markets works in ways that tend to favour optimal outcomes.

However, the catch here is that markets must be governed by the natural laws of economics and not distorted by governmental and private economic actors.

Why Crony Capitalism Distorts Markets and Reasons for the Ongoing Farmer Protests

This is where the Efficient Market Hypothesis is often criticized by leftist economists as they point to Crony Capitalism and other perverse interferences in the natural workings of markets.

For instance, if governments favour certain industrialists and entrepreneurs over others, then there is the possibility of distortions as these favoured entities begin to jack up prices as they operate in sectors where competition is minimal or nonexistent.

Indeed, this has been happening worldwide since the 1970s when the Third Wave of Globalization led Economic Growth resulted in a few people becoming Billionaires over the expense of others.

This can also be seen in the ongoing protests by farmers against the Farm Laws in India where the anger is not so much against the entry of private players as it is against the distortions of price and who buys the agricultural produce from the farmers.

In other words, while many welcome competition in markets as it leads to optimal outcomes, they are also vehemently against what they see as attempts to stifle competition and the creation of monopolies.

This is also what the broader resentment in India is as many perceive the government favouring Ambani and Adani over other business groups.

What are Monopolies and Oligopolies and How They are contrary to Economic Principles

Therefore, it can be said that the Efficient Market Hypothesis does not work well in the real world.

This was also seen in the way the Great Recession of 2008 saw Big Banks and Hedge Funds gaming the markets and then crashing them without any fear of consequences.

This is the reason why the Efficient Market Hypothesis has come under heavy criticism in the last decade or so.

Moreover, while many thought that the Technological Revolution would eliminate the Middlemen and put more Power into the Hands of the People, the opposite happened as Big Tech giants are now the New Monopoly Players.

In addition, the ongoing Fourth Industrial Revolution is leading to Oligopolies that are defined as being bigger than Monopolies and where a Few Business Groups control most of the economic activities in a nation leading to Humungous Power in their hands.

These groups then use that power to dictate terms to the rest of the players as well as leaving consumers with little choice except in buying their products as there are few or no alternatives.

Further, markets are also distorted through biased auctions and supposedly open market transactions that are anything but free, fair and transparent.

Need New Economic Theories for This Century

Last, while this is not intended to be a screed against the Efficient Market Hypothesis given that the theory has ensured major benefits to the common people over the last century and half, we must also not forget that markets tend to become inefficient over time due to the reasons discussed above and hence, the present upheaval is a time to reflect on whether we need new theories that can serve us in this century.

To conclude, markets work efficiently only when there is no interference and hence, what we need is a truly independent market left to economic forces.