Posted by: Paul Chiariello | April 15, 2011

What Market Fundamentalists are Forgetting About the Market: Arguments #1-8 to Remember

This is an post in response to market fanaticism and dogmatism.

I hear too often that “the government is evil,” that “they’re just stealing your money,” or that “the Market will provide everything cheaper and more efficiently” regardless of what these people are talking about.

Any person who has read an ounce of history about communism will pause and worry if history is simply repeating itself.  Instead of the Capitalists, it’s Government; instead of communism’s ‘New Man,’ it’s the omnipotent interpretation of the Market.

The purpose of this article is not to bolster the bastions of red communism.  But instead that seeing and focusing on only one color will get us into the same exact kind of trouble.

To clarify: yes, the Market is great and should shoulder a large portion of the economy, but we also need a balance because it is no ‘answer’ that will usher us into utopia if allowed to take over.


Below is a list of 18 things the Market cannot account for or problems it cannot surmount in principle.

-1) Myth of Rational Decision Makers

For quite a while it’s been becoming obvious that people aren’t rational decision makers, but often make irrational and/or emotional decisions.

I won’t go into this one too much, but it’s important because it’s at the root of many long held misconceptions about economics.

People are social and emotional animals and are swayed to make economic decisions – hiring, buying, etc – for much more than rational interest.  For instance,

1) Consumer loyalty where mere ‘habit’ or ‘familiarity’ with a product influences decision making.  This is coupled with the ‘imperfect information’ point below.  Basically, because of this and a number of other similar points, prices often reflect arbitrary traits of their products.

2) Psychological association.  The common tactic used by companies of associating a product with things that are repeatedly shown with it, i.e. sex and parties in beer commercials.

3) Herding or Groupthink.  People are incredibly susceptible to their group’s stereotypes about products and preferences, which are usually met not by rigorous and rational deliberation but vested interests and emotions.

4) Irrational and historical discrimination plays a large factor in economic decisions, especially employment.  This not only hurts the market itself but also is a gross injustice.

5) The gambler’s fallacy where individuals incorrectly calculate the chance of return or success as increasing over time instead of calculating it as the probability of each decision.

6) The money illusion, in which people naturally interpret money as having nominal and not real value.  The idea of fiat money is extremely new in human culture and the fact that it has no intrinsic value itself is nearly impossible to grasp in a day to day, much less broadly theoretical, way.

7) Sunk costs.  This is the economic idea that, again, is so counter-intuitive to how we actually think.  For instance, I invest in a piece of project.  It goes well I invest more.  But then it starts to go down hill  I put in more and more money to get it out of the hole and the more I put in the more I become attached to the success of the program.  By the end of it, I’ve stopped trying to rescue it not because I realized it would be a bad investment to do so, but because I don’t much more to invest.  This can also be seen with war the idea of sinking lives and money into a war that is looking un-winnable.  People count everything they have already invested, and use that as justificaiton to invest more instead of rationally looking at the current cost-benefit of further investing.  From this comes the saying “cut your losses,” an obvious yet very counter-intuitive piece of advice.

8) Underaged and mentally impaired.  I’d also like to mention here those that cannot fully make informed decisions about the benefits and costs that many decisions will have on them, allowing for the opportunity for others to take advantage of them.  Extending this idea a little, it’d be foolish to think that any of us were on the other end perfectly wise, mature and intelligent to be able to fully see those costs and benefits either.

9) I could go on for quite a while.  Behavioral Economics has been around long enough now that they are accumulating pretty long lists.  Click the link if you are not convinced yet on this point.

-2) Imperfect Information

This is another big core problem with markets.  For outlining issues of information asymmetry George Akerlof, Michael Spence, and Joseph E. Stiglitz were awarded the 2001 Nobel in Economics.  Also check out the articles on complete information and the related concept of perfect information.

Complete information is one of the theoretical pre-conditions of an efficient perfectly competitive market.  For markets to work efficiently all consumers (including employers who ‘buy’ workers labor) must know all things, about all products, at all times – including inflation rates, and other economic stats.  This simply isn’t remotely possible.  In other words,

1) Connecting buyers and sellers.  There may be the perfect product, service or employee waiting out there, but the consumer just doesn’t know about them.  You may be stuck with a sub-par worker just because you can’t physically connect with the guy or gal that’s looking for the job and would be perfect for it.

2) Doing all of the research.  Another incarnation is the consumer who wants the healthiest food for their kids.  What should they do?  Well… there’s tons of research on every thing out there, which must be updated constantly.  We may be able to do this for one or two things we desperately care about, but can’t practically for even a handful of things.

3) Transparency and Quality of Info.  Businesses simply aren’t transparent.  Take Enron.  You may be ‘informed’ and research a topic as thoroughly as you can, but it’s extremely difficult to weed out ‘good’ from ‘bad’ information.

-3) Advertising Wastes –

These are the result of the fight that sellers engage in over both our emotional decision making processes and our ignorance.  They also cost millions of dollars which are necessarily added to the price of the goods and services they advertise.  This is an incredible waste.

If everyone decided to put up their information for the public in some directory (assuming everyone had time for endless and constant research) costs for advertising would be eliminated.  All businesses could cut their costs, consumers could buy more and everyone’d be happy.  However, when one person starts advertising and gets extra attention (and profits) it becomes unprofitable not to do the same.  And whenever the bar is raised, everyone has to do the same.  Companies merely start running faster and sweating more just to keep the same spot in the race.  Classic game theory.

-4) Negative Externalities

This is again one of the big problems with the market.  Negative externalities can be defined as a cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit.  I’ll get into the positive externalities in a bit.

1) General dis-harmony of the market.  This simply shows that the market isn’t perfect.  Businesses don’t work in harmony and if left up to themselves the best will rise from each niche and work smoothly with all the rest for the best outcome.   Two quick examples.  a) A few years ago there were major national issues about power in Kenya because the hydro-electro dams were breaking down.  Later it was found that this was because of the massive deforestation which increased erosion and silt in the rivers.  b) Another global issue that I’ll illustrate with the US is the relationship between farming and fisheries.  At the mouth of the Mississippi is a massive fishing industry.  However, in the past decades a lot of businesses have been affected by the wash out from fertilizers from farmers north along the river.

2) Problem with pricing externalities.  Large businesses are not the only place where negative externalities occur.  Regulating externalities so that they do not weaken the market as a whole and unjustly hurt others is extremely difficult, if not impossible in many situations.  Some great examples of this are second hand smoke or pollution from vehicle exhaust.  When a number of individual actors decide to enjoy a cigarette or a ride, they create an atmosphere which can dramatically affect the environment and others’ health.  In the fishery or other examples, businesses may be able to sue, but how do you do the same with such an amorphously defined perpetrator and victim?

3) Systemic risk. This is a widely used term but is particularly relevant in banking.   This is the econ term for when a bank takes a risk… and loses.  This is widely seen to be controlled by well-designed banking regulations.  If your memory isn’t so good, I’ll let you follow the links.

4) Tragedy of the commons.  This is a classic issue.  It is commonly illustrated by a group of farmers using the same fields.  They all have incentive to overgraze.  But when they do, they all lose–as there is soon no more left for any of them.  The more up to date illustration is open seas fishing with 90% of large fish stocks already depleted.

5) Well, for more please go to the article on externalities.   They list a lot more that I don’t have time to.

-5) Positive Exaternalities

Similar to above, these are when there are good (as opposed to bad) side effects or spillovers.  However, the market has the same problem.  With negative spillovers the market does not include them in its pricing mechanism and therefore over produces.  On the other side, because again the market isn’t including it in its pricing mechanism, it under produces positive externalities.

1) Everyone wants, but who pays? This is a case where there is a public good but it is either too expensive for one person to be able to cover the cost or the benefit isn’t big enough for one person to put in the effort.  The best examples of these, respectively, are roads and lamp posts.

2) What protects them protects you.  There are two classic examples of when people protect themselves they protect you and society in general.  Namely, health and education.  (Another classic example is how fire proofing your own house protects your neighbors).  Markets produce entry barriers, i.e. costs.  Markets produce goods for those who are willing and able to pay for them.  Not everyone is ‘able’ though.  So when that poor guy living next door to you can’t get his vaccines, you and your kids are more at risk.  Education and democracy is a great example.  Let’s assume you have an amazing education yourself, would you rather live in a country of ignorant or well-informed people?

3) The power of numbers.  Some investments may not be profitable or inventions useful until they reach a certain scale in which the cost-benefit changes.  The best examples of this are prices for solar energy and cell-phones.  A coordinated, long term effort may be needed where the risk may otherwise be too high or costly for market actors to cover.  While solar energy may have enormous social benefits, these benefits are not factored into individual companies cost-benefit analysis.   The point at which such analysis becomes profitable is also beyond a certain tipping point which takes a massive long term investment to reach.  This is also covered more in number (10) below with long term research.

4) Disequilibrium between private costs and social costs.  In sum, externalities arise when someone weighs the costs and benefits, but only includes those that affect themselves, as per the graphs below.

Click to enlarge.

The best ways that anyone has yet decided how to deal with adjusting the private and social costs is by taxing (as with cigarettes), criminalization (harmful narcotics), subsidies (sustainable energy), government provision (lamp posts) or regulations (as with banking).

-6) Control of Illicit Goods, Services, Practices

This is, in part, related to the discussion of externalities.  However it includes other issues as well.

1) Morality.  There are few people who think that some goods and services should be banned because of moral issues.  Personally I am extremely liberal with what I think, if anything, should be banned.  But I’ll add it nonetheless.  Some biggies includes prostitution, narcotics, abortion services, slavery, use/harming of endangered species, ecological degradation, etc.

2) Harmful externalities.  This is another rationale for why some things like narcotics should be controlled completely, instead of merely taxed, because of their extreme harm to users and/or others.

3) Paternalism.  Again, tied to a lot discussed above and widely debated.  But still many of us think some degree of paternalism is necessary.  The classic example of this is demanding and enforcing the use of seatbelts, bike lights and helmets.

-7) Human Rights and Compassion

The market operates on prices, which are a combination of buyers and sellers making a cost benefit analysis which will influence their decision about their willingness and ability to act.  Regardless of arguments about positive externalities, human rights issues are inalienable and can only be denied by an absolute inability to provide.  If you don’t believe they are ‘inalienable,’ hopefully you at least have some human compassion.

In order to ensure that individuals are provided access, if physically possible at all, to quality education and health, a system of providers must be ensured.  A market cost benefit analysis will almost by definition conclude that, though possible to provide, it may not be profitable to educate or treat certain individuals.

It is this argument that I find personally very compelling, but that may only be because I don’t like when little kids die of treatable diseases.

-8) Barriers to Entry

This is a market inefficiency that results from a variety of things.  Some are positive, such as regulations which I discuss above.  Others include economies of scale, advertising issues/brand names, lack of capital, predatory pricing and so on.

In a perfect or ideal market system there would be no barriers to entry.  Anytime someone has an amazing service or good, they would be able to compete with others.  However, there are a wide variety of arbitrary and counter productive issues with realizing a possibly superior product.

A huge issue under this is when a business gains a monopoly or a group of businesses form a collusion.  There are tons of issues that result when a single actor gains complete control over a market, including increased consumer prices, lower quality, absolute entry barriers, etc.

-9) Opportunistic Behavior

-10) Long Term and Poverty Research

-11) Inequality and Diminishing Returns

-12) Security Issues –

-13) Slow Pace of Change in the Market

-14) Entrepreneurs and Crisis Cushioning: the Safety Net

-15) Myth of Equality of Opportunity v Outcome

-16) Myth that the Poor are Poor Because They are Lazy

-17) Myth that People Need Monetary Incentives


I hope if you have read this whole thing you do not become an extremist socialist/communist.   If so you’ve missed the point.

All I want to point out is that issues concerning society and economics are complicated and there is no one rule that if we stick to we can read utopia.

If you work on the system “The Market is better,” then you’ll miss lose out from all the things it can’t do.  You’ll be acting on a maxim that is incapable of finding the exceptions.

In order to find the best course of action we need to completely ignore whether the market or government can cover more ground and focus on what we iactually want: a healthy, educated society and so on.  Then we need to look at the very complicated pictures before us and weigh all of our options.  And this needs to be done on a case by case basis.



  1. […] Numbers 1-8 Click on the […]

  2. Nice post, Paul! The “people form emotional attachments to products” argument is particularly important to keep in mind in our consumption-driven society.

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