A couple of days ago I posted about how the "Free market" and the values on which it is based are opposed to the U.S. Constitution and the values on which it was based. I suggested that one has to choose which is more important: the selfish desire for money fundamental to the "free market" or the cooperative intent at the heart of Constitution.
In that discussion (and here) I have put "Free market" in quotes, because "free market" is a loaded term that is understood in many different ways by many different people. One common understanding is that for a market to be "free", we need to eliminate all regulations. As I have argued in the past, markets can't exist without regulation. If there are no regulations that keep people from cheating, lying, and stealing, then we don't really have a market at all. Certainly there is no version of free market theory that suggests that the best social outcomes will result from allowing one producer to undersell another by virtue of selling a toxic product. But without regulation, how do we know which product is the bad one? It is regulation that allows us to discover which firm packed salmonella-laced food.
So I want to stay away from the idea of "free markets" which has been so badly polluted.
And yesterday, I was also critiquing free market theory as an unrealistic fantasy. All of which might lead one to believe that I'm really hostile to the theory. But I'm not; I'm just hostile to out-and-out blindness to obvious issues.
What I want to write about today is how important the notion of competitive markets is in a democracy, and how, indeed, democracy itself is a form of competitive market.
Adam Smith's invisible hand operates, I have argued, because markets, when operating properly, use the supply/demand dynamic to set market prices that force efficient use of resources and encourage innovations that allow even more efficient use of resources. This is, I believe, not just a beautiful idea, but one that plays out well both theoretically and empirically.
Theoretically, I wish to note, also, how this idea of the efficiency of a competitive market is the same kind of efficiency that underlies the notion of a democracy: through the exchange of ideas, the polity is able to make the best possible decision; it is the competition of ideas that allows the best plans to be made.
One theoretical aspect that I won't go into here is the body of theory about the processes of design and planning that argue for the importance of incorporating diverse opinions (and I'll admit to bias here, since this is what I studied in graduate school and this is one of the basic premises of the book that I co-wrote with my mentor about the work of his mentor (The Universe of Design)).
The theoretical aspect that I will discuss here is that markets do a good job of disseminating information: this is a common notion in "free market" theory is almost all its forms. A diversity of options allows for consumers to choose, and the market then reflects the emergent wisdom of the multitude. Thus the market's diversity allows freedom of choice, and this freedom of choice allows the market to capture the diverse opinions of all people. In principle democracy should operate in a similar fashion: the interests of all people are considered when making a plan.
Empirically, I will note that the US economy was its strongest in a period that the Sherman Antitrust Act was strongly enforced (the 40s through the 70s).
I will also note the parallel with diversity of biological populations: diverse biological populations are much more stable; monocultures are much more liable to boom and disastrous bust.
In short, competitive markets--where buyers and sellers have a number of real options--allow for a diversity of opinions to be heard and tested and ultimately adopted in a way that suits the needs and desires of the many. In short, it is a system by which the allocation of resources is determined by the people for the people. When competition is eliminated--whether that is through a political totalitarian government, or through the consolidation of monopoly power in some market--then the emergent wisdom of the marketplace is eliminated, along with the corresponding freedom of choice.
Wouldn't it be great if the markets supported a diversity of opinions? Wouldn't it be great if democracy was reflecting the needs and interests of the majority of people?
Wednesday, January 18, 2012
Monday, January 16, 2012
Fantasy economics
I thought about calling this post "Santa Claus Economics" but choose the more general term.
If I said I was going to solve the nation's economic problems by harnessing the productive might of Santa Claus and his ability to determine good from bad, you'd try to lock me up.
But most people who answer to the rallying cry of "free market economics" basically are believing in something just as fantastic.
In a famous passage, Smith invoked the idea of "an invisible hand" leading the capitalist to an end that is good for both the individual and society. And invisible hand. No shit. But they don't lock you up for professing to believe in free market economics.
Smith did not actually mean that there would be an invisible hand, of course. Smith actually described a whole system of how goods are exchanged, how people behave, etc., all of which lead to the good social result. Smith's work describes the mechanism by which socially good ends are going to be achieved through the selfish agency of the actors.
This whole system that Smith describes is complex and depends on many different notions of how the world works.
Some of the premises on which Smith builds--I'm thinking specifically of the idea of the rational actor which underlies Smith's descriptions of the decision-making processes of people--have been shown to be false. Nobel-prize winning work by psychologists Daniel Kahneman and Amos Tversky shows that people don't make rational decisions at least if we define rational in a classical sense of using Bayesian probabilistic reasoning and logic. But I don't want to go there now--I just want to note how the larger scheme of an economic theory is dependent on many different ideas, some of which are problematic.
The work as a whole describes a manner of functioning. Is is this operation of the market which is supposed to lead to optimal solutions--but the operation of the market to be optimal really needs to meet certain criteria.
Current free market theories as they appear in political debate, however, don't include any of the discussion of the mechanism that has to operate; the debate is generally boiled down to "We need less regulation; regulation is what is destroying the market" as if, once all regulation were removed, the markets would somehow automatically lead to the optimal result. This is the fantasy. It's not as if some invisible hand is waiting for the regulators to say "OK, go do whatever you want now" before it then leads producers to the betterment of society. The invisible hand doesn't exist. If the market isn't functioning in the way that it is supposed to, then it won't lead to good results.
This is clear in Adam Smith's work.
The basic premise of Smith's social betterment is based on the idea that supply and demand will operate to force market prices to match what he called the "natural price"--which we might interpret as what things are really worth. This leads to an efficient allocation of resources, and is one of the underpinnings of what helps the market produce good outcomes. And then, in addition to efficient allocation, there is the possibility for innovation to lead to more efficient use of resources, and the innovator, by being able to produce more efficiently, will reap a profit by virtue of having a more efficient system. Thus, basically, the free market promotes the general good by leading to efficient allocation of resources and by encouraging innovation. This basic premise is, I believe, generally sound, even given problematic assumptions like the non-rationality of people. Or if not generally sound, at least pragmatically sound.
But it is a basic premise in Smith's work, as well, that there are many market conditions under which this efficient allocation of resources does not occur, and in which innovation is squelched. It is clear from Smith's work that one sort of condition that will lead to this inefficient market operation is concentration of power in the hands of a monopoly who can then set the price however it wishes, with no regard for the "natural price". This basic premise was generally accepted until recently. In the 1890s Republicans wrote the Sherman AntiTrust Act, which assumed--as did Smith--that competition was necessary to make the market work.
But in the last decade or two, at least in the political debate, the importance of competition has been completely ignored. The fantasy now is that if there is no regulation, then the market will naturally lead to the best solutions, even though in most markets there is a small number of very large firms that can essentially set the prices as they will to maximize their profits.
If one is going to believe in a theory like laissez-faire economics, then one should at least have some idea about how it works, otherwise you've got nothing but a fantasy. And other people can use that fantasy for their own gain.
In the unregulated markets of the US, what we have is a small number of firms making huge profits, but the efficient (and equitable) allocation of resources that would occur in competitive markets does not occur because the markets are not competitive, but rather are characterized by monopoly or oligopoly power. Thus things are not being sold for what Smith would have considered their "natural price"--for example the wages of laborers have not increased, even though the productivity of labor (which would determine the "natural price") has. And innovation is squelched, too (look at how US technology which was the unquestioned world leader 40 years ago no longer has nearly the same dominance).
The big firms, who are well-represented in the government, use the idea of the "free market" as a rallying cry (and a point of loyalty--because questioning the free market means you must be a marxist), all the while they are doing their best to keep the markets from ever being freed from the power of their firms.
Wouldn't it be great if people stopped believing in some fantastic invisible hand? Wouldn't it be great if people understood how markets work, so that they could see that currently markets aren't working that way?
If I said I was going to solve the nation's economic problems by harnessing the productive might of Santa Claus and his ability to determine good from bad, you'd try to lock me up.
But most people who answer to the rallying cry of "free market economics" basically are believing in something just as fantastic.
In a famous passage, Smith invoked the idea of "an invisible hand" leading the capitalist to an end that is good for both the individual and society. And invisible hand. No shit. But they don't lock you up for professing to believe in free market economics.
Smith did not actually mean that there would be an invisible hand, of course. Smith actually described a whole system of how goods are exchanged, how people behave, etc., all of which lead to the good social result. Smith's work describes the mechanism by which socially good ends are going to be achieved through the selfish agency of the actors.
This whole system that Smith describes is complex and depends on many different notions of how the world works.
Some of the premises on which Smith builds--I'm thinking specifically of the idea of the rational actor which underlies Smith's descriptions of the decision-making processes of people--have been shown to be false. Nobel-prize winning work by psychologists Daniel Kahneman and Amos Tversky shows that people don't make rational decisions at least if we define rational in a classical sense of using Bayesian probabilistic reasoning and logic. But I don't want to go there now--I just want to note how the larger scheme of an economic theory is dependent on many different ideas, some of which are problematic.
The work as a whole describes a manner of functioning. Is is this operation of the market which is supposed to lead to optimal solutions--but the operation of the market to be optimal really needs to meet certain criteria.
Current free market theories as they appear in political debate, however, don't include any of the discussion of the mechanism that has to operate; the debate is generally boiled down to "We need less regulation; regulation is what is destroying the market" as if, once all regulation were removed, the markets would somehow automatically lead to the optimal result. This is the fantasy. It's not as if some invisible hand is waiting for the regulators to say "OK, go do whatever you want now" before it then leads producers to the betterment of society. The invisible hand doesn't exist. If the market isn't functioning in the way that it is supposed to, then it won't lead to good results.
This is clear in Adam Smith's work.
The basic premise of Smith's social betterment is based on the idea that supply and demand will operate to force market prices to match what he called the "natural price"--which we might interpret as what things are really worth. This leads to an efficient allocation of resources, and is one of the underpinnings of what helps the market produce good outcomes. And then, in addition to efficient allocation, there is the possibility for innovation to lead to more efficient use of resources, and the innovator, by being able to produce more efficiently, will reap a profit by virtue of having a more efficient system. Thus, basically, the free market promotes the general good by leading to efficient allocation of resources and by encouraging innovation. This basic premise is, I believe, generally sound, even given problematic assumptions like the non-rationality of people. Or if not generally sound, at least pragmatically sound.
But it is a basic premise in Smith's work, as well, that there are many market conditions under which this efficient allocation of resources does not occur, and in which innovation is squelched. It is clear from Smith's work that one sort of condition that will lead to this inefficient market operation is concentration of power in the hands of a monopoly who can then set the price however it wishes, with no regard for the "natural price". This basic premise was generally accepted until recently. In the 1890s Republicans wrote the Sherman AntiTrust Act, which assumed--as did Smith--that competition was necessary to make the market work.
But in the last decade or two, at least in the political debate, the importance of competition has been completely ignored. The fantasy now is that if there is no regulation, then the market will naturally lead to the best solutions, even though in most markets there is a small number of very large firms that can essentially set the prices as they will to maximize their profits.
If one is going to believe in a theory like laissez-faire economics, then one should at least have some idea about how it works, otherwise you've got nothing but a fantasy. And other people can use that fantasy for their own gain.
In the unregulated markets of the US, what we have is a small number of firms making huge profits, but the efficient (and equitable) allocation of resources that would occur in competitive markets does not occur because the markets are not competitive, but rather are characterized by monopoly or oligopoly power. Thus things are not being sold for what Smith would have considered their "natural price"--for example the wages of laborers have not increased, even though the productivity of labor (which would determine the "natural price") has. And innovation is squelched, too (look at how US technology which was the unquestioned world leader 40 years ago no longer has nearly the same dominance).
The big firms, who are well-represented in the government, use the idea of the "free market" as a rallying cry (and a point of loyalty--because questioning the free market means you must be a marxist), all the while they are doing their best to keep the markets from ever being freed from the power of their firms.
Wouldn't it be great if people stopped believing in some fantastic invisible hand? Wouldn't it be great if people understood how markets work, so that they could see that currently markets aren't working that way?
The "free market" vs. the U.S. Constitution
Just the other day, a friend of mine posted the following comment on facebook:
It seems like even claiming that there is a problem with the "free market" will get you called a Marxist. In this post, I'm going in the opposite direction; in this post I'm going to suggest that standing up for the "free market" is un-American--specifically, it is opposed to the U.S. Constitution.
You may have noticed by now that I keep putting "free market" in quotes. The reason for this is because there is no such thing as a "free market"--rather there is a variety of economic theories which describe economic behavior, and these theories are not uniform in what they consider "free" for a market.
A couple of years ago I wrote a post in which I discuss the effect of classical "free market" theory on moral values (The Free Market and the Death of Compassion.), and I will take that as a starting point. In that post I quote John Maynard Keynes saying ""foul is useful and fair is not; avarice and usury and precaution must be our gods" and a longer passage from Adam Smith's Wealth of Nations:
We can see in both of these quotes that the individual actor is called upon to act in his or her own personal interest, without attention to the needs of others or any sort of "public interest". In short: "free market" theories call for selfish behavior. Such behavior, however, is in stark contrast to the values set forth by the authors of the U.S. Constitution, as we can see just by looking at the preamble:
Let me emphasize those opening words: "We the People." This is a document about people working together. It is about people working together for the public good--not a bunch of people acting selfishly and trying to maximize their own gain. By this basic analysis, we can clearly see that the principles guiding the creation of the United States are principles of cooperation and of people working together for a larger shared public good. In the preamble, too, we can see hints (at least) that we should care for the welfare of all, not just individually.
In short: the basic principles behind the formation of the United States are principles of cooperation towards a greater social good. The principles behind "free markets" are selfish principles. These two value systems are in conflict, and--as the bible suggests--one can only serve one value system at a time:
So which is important to you? The "free market" or the U.S. Constitution? If you say that the "free market" is more important, then I call you out as being opposed to American values and being opposed to American democracy.
There's a mountain more that could be said on this subject, but I don't want to get too deep in here. Before closing, however, I will address one argument--it is claimed (by Adam Smith and those who follow) that the selfish aims of the individual actors will lead to the greatest social good, and therefore that by acting selfishly, one promotes the overall good of the society. There are several responses I could make to this, but one is that the values of the people in the society are part of the society and part of what makes a society good or bad. The good that Adam Smith predicted was limited to a prediction of wealth: the free market increases wealth. However, what if we measure the quality of a society in more complex terms--in terms of wealth and other factors? In that case, the increase in wealth predicted by Smith's theories might well be counterbalanced by a corresponding decrease in other factors that contribute to a good society.
Ultimately both Adam Smith (and following free market proponents) are putting forth a recipe for how to create a better society. So, too, were the framers of the U.S. Constitution. One of these recipes says (explicitly) that social interest and a sense of social responsibility are bad. The other puts a sense of social responsibility at its very heart.
So the next time someone tells you how great the "free market" is, just say "yeah, as long as you don't believe in the Constitution."
This post is long enough now, but really these issues are complex. The critique of "free markets" that I posted here is a critique of certain aspects of this complex economic theory. In the current political climate of the US, the complexity of real issues is swept under the table in favor of a sound-bite logic suitable for 30-second answers on televised debates and televised commercials. The real complexity of issues that needs to be addressed isn't: in this case, I want to point out that there is a huge gap between "free markets" as often propounded by the media and politicians, and the idea of a controlled non-market economy (which is often called Marxism, though that is not really what Marx was talking about). Just because I don't blithely accept any and all claims that the "free market" is the best social system, doesn't mean that I don't believe in the value of a market economy. Indeed, if the "free market" is defined properly, then I even agree with "free markets."
But wouldn't it be great if people actually cared about the Constitution, with its guarantees of political freedom, more than they cared about their own personal gain? Wouldn't it be great if people held the good of society--the general welfare--as a value to be honored instead of serving mammon?
"I'm not a marxist but I think that somebody needs to point out to all those who say that controlled economies don't work that, right now, the Chinese and their controlled economy are burying us."As it happens, I had been accused of being a marxist just a couple of days before that, because I had suggested that market power tends to end up in the hands of a few small firms.
It seems like even claiming that there is a problem with the "free market" will get you called a Marxist. In this post, I'm going in the opposite direction; in this post I'm going to suggest that standing up for the "free market" is un-American--specifically, it is opposed to the U.S. Constitution.
You may have noticed by now that I keep putting "free market" in quotes. The reason for this is because there is no such thing as a "free market"--rather there is a variety of economic theories which describe economic behavior, and these theories are not uniform in what they consider "free" for a market.
A couple of years ago I wrote a post in which I discuss the effect of classical "free market" theory on moral values (The Free Market and the Death of Compassion.), and I will take that as a starting point. In that post I quote John Maynard Keynes saying ""foul is useful and fair is not; avarice and usury and precaution must be our gods" and a longer passage from Adam Smith's Wealth of Nations:
He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security ; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain; and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.
-- Wealth of Nations, Book IV, chapter II
We can see in both of these quotes that the individual actor is called upon to act in his or her own personal interest, without attention to the needs of others or any sort of "public interest". In short: "free market" theories call for selfish behavior. Such behavior, however, is in stark contrast to the values set forth by the authors of the U.S. Constitution, as we can see just by looking at the preamble:
We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.
Let me emphasize those opening words: "We the People." This is a document about people working together. It is about people working together for the public good--not a bunch of people acting selfishly and trying to maximize their own gain. By this basic analysis, we can clearly see that the principles guiding the creation of the United States are principles of cooperation and of people working together for a larger shared public good. In the preamble, too, we can see hints (at least) that we should care for the welfare of all, not just individually.
In short: the basic principles behind the formation of the United States are principles of cooperation towards a greater social good. The principles behind "free markets" are selfish principles. These two value systems are in conflict, and--as the bible suggests--one can only serve one value system at a time:
No man can serve two masters: for either he will hate the one and love the other; or else he will hold to the one, and despise the other. Ye cannot serve God and mammon.
-- Matthew 6:24
So which is important to you? The "free market" or the U.S. Constitution? If you say that the "free market" is more important, then I call you out as being opposed to American values and being opposed to American democracy.
There's a mountain more that could be said on this subject, but I don't want to get too deep in here. Before closing, however, I will address one argument--it is claimed (by Adam Smith and those who follow) that the selfish aims of the individual actors will lead to the greatest social good, and therefore that by acting selfishly, one promotes the overall good of the society. There are several responses I could make to this, but one is that the values of the people in the society are part of the society and part of what makes a society good or bad. The good that Adam Smith predicted was limited to a prediction of wealth: the free market increases wealth. However, what if we measure the quality of a society in more complex terms--in terms of wealth and other factors? In that case, the increase in wealth predicted by Smith's theories might well be counterbalanced by a corresponding decrease in other factors that contribute to a good society.
Ultimately both Adam Smith (and following free market proponents) are putting forth a recipe for how to create a better society. So, too, were the framers of the U.S. Constitution. One of these recipes says (explicitly) that social interest and a sense of social responsibility are bad. The other puts a sense of social responsibility at its very heart.
So the next time someone tells you how great the "free market" is, just say "yeah, as long as you don't believe in the Constitution."
This post is long enough now, but really these issues are complex. The critique of "free markets" that I posted here is a critique of certain aspects of this complex economic theory. In the current political climate of the US, the complexity of real issues is swept under the table in favor of a sound-bite logic suitable for 30-second answers on televised debates and televised commercials. The real complexity of issues that needs to be addressed isn't: in this case, I want to point out that there is a huge gap between "free markets" as often propounded by the media and politicians, and the idea of a controlled non-market economy (which is often called Marxism, though that is not really what Marx was talking about). Just because I don't blithely accept any and all claims that the "free market" is the best social system, doesn't mean that I don't believe in the value of a market economy. Indeed, if the "free market" is defined properly, then I even agree with "free markets."
But wouldn't it be great if people actually cared about the Constitution, with its guarantees of political freedom, more than they cared about their own personal gain? Wouldn't it be great if people held the good of society--the general welfare--as a value to be honored instead of serving mammon?
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