Its late afternoon, you’re in your library perched on your dark red leather chesterfield, which is floating on a sea of richly ornate silk Persian rugs. You are admiring your collection of literary works. You know… they say you can judge a persons intellect by the number of books they own, and boy are there a lot of books on the shelves (the dark mahogany shelves).
The sheer size of the collection is somewhat intimidating, but deep down you suspect that its not just the size of this collection that impresses but rather its depth. It’s the depth that truly separates the intellectual lambs from the lions (at this point I should confess, its not my library, it actually belongs to the Lone Ranger).
Your pleasant moment of solitude is welcomingly interrupted by your six year old son/daughter who, with a look of adoration in their eyes, approaches you in a quiet and respectful manner. However, something is not quite right. Their perfectly angelic face seems to carry a look of concern or confusion. They sidle up to you and ask in a well behaved manner.
“Daddy can I ask you a question?”
“Of course you can. Every thing I have I give to you. The lessons I’ve learnt, the wisdom I’ve acquired, my mathematical and financial nouse. It’s all there for you whenever you need it.”
“Daddy … Daddy in class today Ms Doe said that the western free market based capitalist system had collapsed … what does this mean Daddy?”
The Hairy Bitch strikes again!
I promised my wife I would not call our child’s grade one public school teacher the hairy bitch, and to the best of my ability I will try not to. It’s just that I can’t think of anything else to call the lovely self righteous Ms Doe.
I’ve had enough. Enough of the politically motivated morality the lovely Ms Doe seems intent on ramming down my child’s throat.
It started with plastic. My son now thinks plastic is evil — nude food day …absurd. It should be renamed soggy sandwich day or unhygienic lunch day. Plastic was quickly followed by saving whales, recycling, walking instead of driving … who knows where it’ll end.
Well this is my stand. I am going to blog the biach. And it all starts now with a defense of free markets.
The land of the free
Apparently free markets are the root cause of everyone’s problems. Free markets are the reason the world has gone to the dogs. Free markets are responsible for freddy mac and fanny may, they are responsible for the apparent insolvency of Iceland, free markets destroyed general motors, and unfettered free markets have brought the
When I sat down to write this post I asked myself a simple question, in the face of all the recent market hate that has been floating what are the fundamental aspects of free markets that my son/daughter should be made aware of before his/her public school teacher starts brainwashing him about the evils of the modern world? And I’ve boiled it down to five things. Five is a good number and is probably the extent of a 6 year olds attention span… so five it is, and these are:
- Markets are natural — they are an elemental part of the human experience, markets have been with us since the first cave man stood up and scratched his nuts.
- Markets are relevant to you — they are not populated solely by mysterious mustachioed Argentinean water barons that smoke cigarillos and have really hot girlfriends
- Markets don’t fail — they don’t actually sit exams
- Markets are efficient —actually they are more than just efficient, they are the super troopers of allocation.
- Some people hate em — happy clappers, nutjobs and entrepreneurial parasites hate markets.
Before we get started we should be clear what it is exactly that we are talking about. What are markets? Apologies if your not actually six years old.
In economics the term market refers quite clearly to the act of exchange between a potential buyer and a potential seller. Markets may be shallow with few participants or deep with many. They may be based on barter or alternatively be pecuniary in nature. They may be accompanied by formal structures that constrain people’s behavior, alternatively they may be informal with no or little constraint on the structure or form of exchange. Whichever form they take their very essence will always be the voluntary and beneficial exchange between two participants.
1. Markets are natural.
They are an innate part of the human experience. The act of exchange and markets themselves, have been around for the full extent of known human existence. They are not an invention of Adam Smith or David Ricardo. They are not an unnatural artifice of evil capitalists. Markets/trade/exchange have been with us since we climbed down out of the trees.
Lets take a trip back in time and see if this is true
- 3rd century
- Lets go all the way back …6000BC. Historians have shown that prehistoric man had established trading routes throughout the Mediterranean and the
2. Markets are relevant to you
Market participants are not mysterious foreigners. Markets are composed of you and me of our mothers, fathers, siblings and, heaven forbid, even the odd Nanna. Markets are not some obscure abstract things that do not impact on you. You are part of not just one but many markets. These markets are not populated by moustache wearing foreigners. Markets are composed of many people, individuals buying and selling goods and services, of people pursuing their dreams and ambitions.
The point here is that whenever someone mentions market failure (discussed below) what they are saying is that the participants are not making the correct decisions … that you and me and your nanna have somehow got it wrong and need to be protected from ourselves.
The next time you hear someone mention market failure take it personally, because what they are saying is that you are in effect too stupid to do the right thing. And while I don’t condone physical violence you need to question them and make them defend their contention.
3. Markets don’t fail
Aside from the obvious anthropomorphic issues, markets don t fail. Well actually they do sometimes fail, but when economists talk about market failure they are talking about something specific, something technical.
What they are talking about is the inability of markets to provide the optimal allocation of resources. They are saying they can observe one of a number of specific phenomenon that are stopping the market from achieving a more efficient outcome (just to make things quite clear … they are not saying that the market is crap and we need government to step in).
There are four basic forms of market failure and all of them are overrated. They are:
- Alleged abuse of market power. This occurs when a monopoly starts charging exorbitant prices and acting like an evil profit maximiser. I say alleged because in most cases the data shows that monopolies have provided lower prices.
- The existence of externalities (positive or negative) — an externality occurs when the market does not take into account the impact of an economic activity on outsiders. For example, the market may ignore the costs imposed on outsiders by a firm polluting the environment. This issue is somewhat confused, as often the externality itself results from the lack of a market in the ‘externality’ (see carbon trading schemes).
- The existence of public goods — that is goods that exhibit properties of non rivalness and non excludability, not goods that are provided by publicly owned corporations or utilities. For example Water is definitely not a public good. The amazing thing about this failure is that it’s dolled out quite liberally as a justification for government intervention despite the fact that actual public goods are extremely rare.
- Where there is incomplete or asymmetric information or uncertainty. Yes markets may breakdown when there are too many unknowns. But the thing is, when something is unknown or uncertain this means its unknown or uncertain, not its unknown or uncertain for participants in a market but widely understood by bureaucrats in cubicles. If the actual participants in a market are a bit unsure about something you can bet your next pay cheque the government has not got a clue.
Here are a couple of quick observations about the practical implications of calling market failure.
Firstly, its been my experience that market failure outside of an economics text book is one of the most abused concepts in modern government. For a start quite a lot of alleged market failure is not actually technical failure but simply the market producing outcomes that the bureaucrat finds undesirable. Maybe there should be a fifth type of failure called Cubicle Failure — a markets inability to please a government bureaucrat or minister.
Secondly, the question that should be asked is not if the market has failed (so what if it has) the question is what set of arrangements provide for the best outcome. Are markets with all their failure better than central planners with their own set of failures … let me rephrase is it better ….let people make up their own minds or should we entrust 20 year old civil servants to make up our minds for us? Which approach provides for a more efficient or effective outcome (I know where my money is).
Lastly, I recently heard a fellow economist make the following syllogistic statement
..a properly functioning market that provides for optimal outcomes must by definition be perfectly competitive perfect competition is an abstract concept that only exists in textbooks (very true) therefore all markets are in a state of failure …
oh be still my beating heart.
What crap! Markets are human institutions and as such are never going to be perfect and so what if they’re not? The application of a bench mark that can’t be met is a meaningless exercise. The real question is a relative one … Are markets the best way?
4. Markets are efficient
The statement should read ‘markets are the most efficient’. Don’t believe me? Then ask yourself where would you prefer to live … Hong Kong or
There are a number of reasons why markets will always be more efficient than a bureaucrat. The principle one is information. In a market information doesn’t need to be collected, collated and analysed. Each participants knows what their tastes are, what there requirements are, what they want when they want it and how much they can pay for it and also how much they value it relative to other goods or services. They then go out and find what they want by engaging a seller or a number of sellers.
These sellers by the way know what they are good at selling . They know what it costs to produce and acquire all the stuff they need to make the stuff they want to make (and if they don’t the market makes sure they get kicked out on their arse).
The thing is there is no way in hell our 20 year old civil servant can begin to process this information. No matter how big and complex his model is, he will always stuff it up.
5. Some people hate em
Happy clappers, nutjobs and entrepreneurial parasites hate free markets.
Happy clappers want to save you from yourself, entrepreneurial parasites want to suckle on the public teat or alternatively stop their competitors from providing cheaper better goods and services … and nutjobs … well they hate markets because … just because
What about the rest of us
Aside from the happy clappers, entrepreneurial parasites and nut jobs why do seemingly normal people appear to hate free markets? This is a hard question to answer. A more specific narrowly focused question that I have often asked myself is why do some economists (given all that they know about markets) seem to hold a base dislike and distrust regarding free markets.
My theory is that bureaucrats and economists invariable fall somewhere on a spectrum between those that believe people are generaly smart and those that believe people are generaly stupid. Those that err on the smart side (I confess to being one of them) hold that markets are the optimal mechanism for the allocation of resources. Those that believe people are stupid (with the obvious exception of themselves) see market failure everywhere and will inevitably seek to control markets either through public ownership or by levying rules and restrictions that constrain people’s behavior. They are the regulators and they are here to save the world.
This lot of pushy bastards are more aligned with the ideology of guys like Maynard Keynes or his current stooges Stiglitz or Krugman. They know what’s best and they are more than willing and able to help you help yourself (whether you want it or not).
On the other hand, economists that believe people are on average smart generally seek to uphold free markets, lessen regulatory interventions and abolish planning regimes.
So my son/daughter, the next time the hairy bitch complains about free markets you should remember that markets are the most human of all institutions; they facilitate our dreams and provide a forum for us to express our aspirations. They have been and will continue to be a fundamental part of the human condition despite the best efforts of the heroes of social democracy.