Markets as a tool for resource allocation

Markets do good things. We don't want to eliminate markets because of the value that they bring in terms of determining how to allocate resources. We don't want to hinder the operation of markets in ways that keep the markets from setting good prices.

So, for example, we don't want to set up situations where a more efficient producer is elbowed out by one of less efficiency because of undue regulation--for example, we don't want some sort of tariff on Acme widgets, just because Acme's competitor is friends with the King (or whatever the government--Adam Smith, from whom the notion of free markets being best is generally derived, was writing about free markets in opposition to monopolies granted by the English government). We would not, in a free market, want to favor some firms because of political connections.

On the other hand, if we are counting on the market to do a good job of allocating resources, we have to have regulations that make sure that resources are being allocated effectively. Perhaps most importantly, we need to be sure that a producer is not able to sell cheaply by avoiding some costs, or by transferring some costs to others. Pollution is a good example: if Acme widgets dumps toxic waste and someone else has to pay for safe disposal, then the market is not correctly valuing the product, and resources are being allocated inefficiently.

Let's talk through an example, imagine that the cost to make up a widget is one dollar--seventy cents of the cost is parts and labor, and the other thirty cents is cleaning up the toxic waste. If Acme widget is actually paying the costs of making the widget, then it cannot stay in business selling for less than one dollar. If they can't stay in business selling widgets for more than a dollar, paying the full costs, then, according to the theory of free markets--the theory of unregulated markets as efficient allocators of resources--, they shouldn't stay in business. If Acme doesn't pay the cleanup costs, however, they can make a profit at a lower cost, and the resources necessary for cleanup do not get factored into the market, and so the market doesn't lead to the desirable outcome.

In short, if you want markets to give good guidance on resource allocation, then it is necessary to have regulations that prevent inefficiency of resource allocation, and it is necessary to eliminate regulations that create inefficiency.

Anyway, despite all the cries for free markets during elections and during debates on legislature to which they are opposed, most of those who have called for free markets have also supported legislation that destroyed the efficiency of market allocation.

Wouldn't it be great if markets did a better job of helping allocate resources?

Markets don't exist with out rules and regulations

If I'm going to talk something called "Fair Market Theory", I want to start with at least some sort of discussion of what a market is. This is important, because of how often we hear calls that regulation will ruin some industry and lead to worse because it will damage the operation of the market.

A market is a place where goods and services are bought and sold. This basic definition has in it some implications that are crucial. What is it, after all, to buy and sell something? The market is a market only if people follow basic rules and regulations about how buying and selling work.

Crucial among these things--though sometimes overlooked by free-market proponents--is that what goes on in the market is actually buying and selling, not cheating, lying and stealing.

If people can seize goods by force, that's not a market.
If people can sell sawdust as flour, that's not a market.

This kind of regulation is crucial for a market to be a market. It's also a crucial, though unstated, presumption of basic explanations of why free markets are supposed to lead to good outcomes. Markets are supposed to lead to optimal social outcomes by supporting efficient use of resources and innovation. Free market theory doesn't claim that free markets are good because they allow people to get rich selling sawdust as food.

And we can see that free market theorists generally will not object to regulations in areas like truth in advertising laws (or will object less).

But if a market needs some regulation to achieve its optimal goal, how much regulation is enough and how much is too much? The question is not whether we can create a market without any regulation at all--without any regulation at all, there is no market, there is only the strong and ruthless preying on the weak and honest. A market only becomes a market when the buyers and sellers can believe that their goods and persons will be safe, and that generally they will receive money for what they sell, and they will receive the goods or services that they pay for.

There is no such thing as a market without regulation, and there can be no such thing as long as people are willing to cheat, lie, steal, and kill for their own gain.

Wouldn't it be great if people didn't cheat, lie, steal, and kill?
Wouldn't it be great if markets were set up to protect market participants from such threats? Wouldn't it be great if there were market regulations that made lying, cheating and killing into crimes?

Fair Market Theory

For a long time, I've thought about what I call "Fair market theory" as an alternative to Free Market Theory. I decided that I wanted to put it down in writing...or at least try, so in the next few days/weeks/who knows how long, I'm maybe going to write about what I think fair market theory could do for the world.

I did a google search for "fair market theory" and didn't find hardly anything at all...but it does look like, perhaps, the economist Paul Krugman has used the term in a way like I'm thinking of it.

Why do I care? I think free market theory--which has taken such a hold on the American and international consciousness--is a flawed theory, and that the flaws are both theoretical and empirical.

Not that I think that anyone will actually read what I have to say, but just in case there's someone out there who finds this blog and is interested in non-politicized reasons that free market theory is flawed.

I want to be clear that "free market theory" is not a form of government. Questioning whether "free market theory" should guide governments--especially a democracy--is not an unreasonable pass time for a person living in a democracy who is interested in the the best preservation of the freedoms of living in a constitutional democracy that protects the civil rights and liberties of its citizens.

Wouldn't it be great to live in a country where the rights guaranteed by the Bill of Rights were also guaranteed by the government?