Sunday, February 19, 2012

Economics Made Easy — Think Friction

Barry Schwartz, a professor of psychology and author of Practical Wisdom and The Paradox of Choice, with an interesting opinion piece in the Sunday Times:

...What stands in the way of efficiency is friction.

When automobile manufacturers struggle to squeeze as many miles per gallon as possible out of their car designs, friction is the enemy. Their aim is to design a vehicle that uses every ounce of fuel to move the car forward.

And so it is in the world of finance. As the historian Niall Ferguson reminds us in his book “The Ascent of Money,” hard as it is to imagine, people didn’t always have money. The invention of money went a long way toward reducing the friction, the inefficiency, in financial transactions. No longer did the farmer have to bring sacks of potatoes to the marketplace to trade for eggs and milk. Money was a medium of exchange that greatly reduced what some have called the financial coefficient of drag.

He continues

ALL these examples tell us that increased efficiency is good, and that removing friction increases efficiency. But the financial crisis, along with the activities of the Occupy movement and the criticism being leveled at Mr. Romney, suggests that maybe there can be too much of a good thing. If loans weren’t securitized, bankers might have taken the time to assess the creditworthiness of each applicant. ... These are all situations in which a little friction to slow us down would have enabled both institutions and individuals to make better decisions. And in the case of individuals, there is the added bonus that using cash more and credit less would have made it apparent sooner just how much the “booming ’90s” had left the middle class behind.

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