Posted by: Paul Chiariello | April 20, 2011

What Market Fundamentalists are Forgetting about the Market: Arguments #9-17 to Remember

For Numbers 1-8 Click on the Link.

-1) Myth of Rational Decision Makers 

-2) Imperfect Information –

-3) Advertising Wastes –

-4) Negative Externalities –

-5) Positive Exaternalities 

-6) Control of Illicit Goods, Services, Practices 

-7) Human Rights and Compassion 

-8) Barriers to Entry 

-9) Opportunistic Behavior 

There are a variety of opportunistic behaviors which inhibit the market system.  Most people passively ignore many of these because they naturally hold to many of the norms that are necessary for a market system to be maintained.  Another factor that is necessary for limiting such behavior is the need for contracts, central to the market system, to be enforced.

1) Unobserved quality.  This is a point which largely follows under the points on imperfect information.  However, it is important to reiterate.  Without any kind of oversight body, actors have constant incentive to cheat.  A common market response may be, “well, actors would volunteer for oversight because such a stamp of approval gives their product an edge.”  Well, no.  a) Seeking such a stamp is decided on a cost-benefit analysis and it can be almost guaranteed many would opt not to if the benefits of cheating outweigh the value of the stamp.  b) The oversight committee in a pure market system is a cost-benefit analyzer as well.  Who oversees the oversight committees?  A parallel system would be needed that works on a different incentive structure and therefore different allegiances (i.e. votes and constituencies).  c) This adds to the already immense burden of research needed to be done by non-rational consumers, which are discussed in (1) and (2).

2) Enforcement of Contracts – Loans are a particular problem in this.  Each actor has incentive to cheat on any agreement which is not automatically made, i.e. we hand each other payment and goods at the same time.  Contracts that agree trades will be made over a period of time are basically impossible without some kind of neutral arbitrating body.  If such a body is paid for by those that use its services, instead of market bolstering and just results, decisions will on average be influenced by natural inequalities in ability to pay.  Whoever can get the best lawyer, pay the judge the most or fake the best evidence will be rewarded.  This can be alleviated if a pay system is disconnected from those immediately partaking in the service.

This will be discussed more below by complicating a conversation I had about a possible private police/investigative system.

3) The Hold up problem.  This is another classic issue with game theory.  Basically, one side invests or is in a position of need where they lose all bargaining power.  By rewriting an agreement or taking advantage of the loss of the ability to bargain, actors are forced in agreements they otherwise wouldn’t make..

The most common illustration of this issue is Crassus of Rome, a contemporary of Julius Caesar, who started a private fire company.  When a fire started a group simply meandered over to the fire and as the house was burning down bargained for the price.

-10) Long Term and Poverty Research 

One key problem that markets simply do not have incentives for is long term pure research and research into issues that affect the poor.

1) Intrinsic goods.  On this I’ll mention two bigs ones – beauty and knowledge.  The market works solely on a cost-benefit way of thinking.  Tied in with slightly positive externalities, it is good to have beautiful things around and to increase the general pool of knowledge, even if there is no profit involved.

Take public sculptures and gardens.  The only possible market mechanism to provide these kinds of things is under advertising.  However, it is obvious they would under-produce such goods, given the ability of market actors to freely do this and the observed scarcity, even counting non-market actors, such as governments, adding to them.

Knowledge so that we know more, even if no benefit is within view, is also a  good which cannot be accounted for by market logic.

2) Long term research. Market actors are amazing at producing some R&D.  However, if the pay off for research is too far away, say a 10-20 year longitudinal study, then the investment simply becomes not worth it.  Many things that require such studies, no matter how much good can come of it for society, are simply not possible.

Here it is also important to mention research and development which is for the public good.  Most notable is the internet, whose most key feature is its inability to be controlled, while also being basically free.

3) Research on Poverty Issues.  Again, a cost benefit analysis does not take into account suffering of others.  If a disease affects the poor, e.g. those buyers who may be willing but unable to pay, you can bet it won’t be produced.  This is the reason why we have hundreds of the brightest minds ever working on the next patent on pain medication, but virtually none working on dozens of diseases which kill thousands per year.

-11) Inequality and Diminishing Returns 

This is the idea that with each extra unit of input, you get less in return (or output) for that unit.  This goes for adding workers to a project, fertilizer on a field, hours of studying for a test and most anything else.  This is called the law of diminishing returns, and it has many implications for economics.  Here I’d like to focus on how it completely alters how we normally view the value of society.  (*This is actually (in part) what I wrote my Senior Term Thesis on in undergrad.)

Let’s assume that money represents those things that we actually value, such as healthcare, education, nutritious food, leisure activities, security for the unexpected.  We obviously want a society to have as large a pie as possible.  Most people accept that re-distribution makes a smaller pie and slows or stops the growth of the pie.  So the argument goes that if you increase the size of the pie, even though the poor still have a small slice in relative terms, the size of that slice will have increased from what it was previously.  I agree with this, but don’t completely agree with extremist versions of trickle down economics.

However, the general picture that this kind of reasoning is in part based on is flawed.  It compares two pies: one smaller and more evenly distributed, and one bigger but unevenly distributed.

The main issue is the reliance on the money illusion, which I discuss in the very first point above on irrational/emotional human reasoning.  We see each unit of money, which determines the size of the pie, as equivalent on both both graphs and within each graph.  But because the value of money only represents what it can buy, each extra dollar is actually worth less in the hands of a richer than a poorer person, if we value it buy how much well-being it can buy.

Think of it this way.  You have Fred with $1 million and Larry with $1,000 to spend on health care.  Assuming they are normal health wise, if you have a $1,000 to give one of them and you want to get the most bang for your buck, who do you give it to?

The conclusion to all of this is that you may actually have a larger pie counting the absolute number of dollars, but if all of them are concentrated in a few individuals, you have a smaller pie if you add up the value of the dollars.  This is because each physical dollar actually counts for less in the hands of a rich compared to poor person.

Staying on the issue of health, this is why the US is one of the most wealthybut least healthy developed countries in the world.

Also, I mentioned Trickle Down Economics and that I somewhat agree with it.  However, I believe it quickly gets to a point, especially if accompanied by a lack of welfare programs, where massive gains in the upper class correspond with no gains in the middle and lower classes.  See graphs below.

Inequality in the US
Inequality Internationally in OECD Countries

-12) Security Issues –

There are a number of issues in security that the market simply cannot provide for.  However, most Anarcho-capitalists (ACs) believe that public security and courts should be left for the market to provide.  Unfortunately an even superficial questioning of such market managed courts and security systems turns up a variety of injustices and inefficiencies.

1) Victimless Crimes. It is accepted that in an AC market system a victim is needed to hold a perpetrator accountable.  If so there will by definition be no victimless crimes.  I personally think that for a number of such crimes currently this is a good thing.  But you need to decide for yourself if the worst narcotics or weapons of any kind should be produced and provided freely on the market where anyone (children, criminally insane, manically depressed, terrorist, etc) can buy them.  Until there is a victim there is no one to seek a case against a criminally insane man with an automatic rifle or a child slowly developing drug addictions.  And if such a preventive force is formed who will they look for?  Well whoever is on the wrong side of the guy or gal with the biggest wallet.  Also the notion of victim is difficult to assess.  Is there a victim when a person exposes themselves to non-consenting minors?  What about public erotic, though sincere, affection?  Casual homosexual affection?  Inter-racial affection?  Not wearing your hijab and showing your hair?  At some point along this line you’ve probably stopped saying yes.  But there are lots of people who will disagree.

2) Security Arms Race.  Security becomes a race just to keep your place.  If you have enough money, you can get better security.  In fact literally Wild West style there is nothing to stop you from a personal army and hiring assassins, except of course other private armies.  So to just plain keep yourself protected from the other guy you have to engage in a Cold War race.  Of course collusion to maintain peace is an option, but game theory may not maintain such a balance as there would be massive pay-offs to build a secret army and surprise the defenseless.

The general solution to this is obviously to concentrate power in a regularly shifting body which has a series of internal checks and balances, i.e. the government.  Despite the second amendment fears, this has worked out beautifully since… well… since it began.

3) Investigative forces simply become rich tools.  If a body is stripped of its identifying features and dumped in an abandoned lot in a poor neighborhood, who will investigative forces charge to even begin to investigate?  They can’t charge the poor soul who’s land it was dumped on – there is none.  Nor the victim’s family or those that it would charge – they need to investigate to even find them.  Nor the perpetrator – obviously.  The rationale behind any investigation on whether it should even start or not is a cost-benefit analysis of the likelihood of identifying the victim, identifying the perpetrator and most importantly whether either of them have any money.

Very simply, it isn’t worth doing business a lot of times in cases that affect the poor.  And, if it is worth it for the investigating corporation, imagine a world were poor Joe’s sister is raped and murdered and has to spend his life savings just to find and then in a costly court case try to convict the perpetrator.

-13) Slow Pace of Change in the Market 

This point is important because a balance is needed between markets and the government in order to affect timely decisions.  I am not arguing the government is a speedy machine compared to market forces.  Often it is the reverse, however, there are clear cases that the government as a decision making and executing method is better than the market.

This is because of the first and second point above: people are irrational/emotional decision makers, and people are uninformed.  Of course not wholly, but to a large enough degree that collectively we (collective buyers and collective sellers) can’t make decisions fast enough.

1) Social Consensus. It takes a long time for a society to change its norms and to come to a consensus on scientific issues (which often mix with the former).   Examples of this are: a) the health risks of smoking cigarettes.  If the government did not place regulations on age and raise the price through taxes we would certainly have a lot more and heavier smokers (and also a less healthy population spending more on health care, raising its costs). b) racism and moral issues is a huge issue.  None of the civil rights movements (much less slave trade itself) would have gained the victories they did without the use of executive government force.  Eventually change would come, maybe, but explain that to the Little Rock Nine who would have been violently denied an education because they were black if it were not for the government stepping in.  c) global warming and ozone depletion are huge issues that if left to lay public opinion, one issue which producers would be listening to, debate would be simply go on until it were too late to do anything.

2) Corporate Propoganda.  As we see with most of these issues, the average person does not have the weight of decisions saliently on their shoulders nor the time to do the research needed into ‘debates’ on these issues in order to make a decision.  Of course corporate hired scientists and advertising campaigns are targeted at policy makers as well as constituents, but at least the former have the time and responsibility to make the decisions.  If left only to consumer demand to regulate the production of cigarettes, greenhouse gases or CFCs, the richer the corporations that would profit from them are, the more they can pump into hiring their own scientists, commericials and simply influencing or creating the illusion of a debate about the harmful effects of their products.  Even though there is of course the chance of corruption, government courts can provide a forum for investigation whose decisions do not rely on incentives that are not reliant on the profits that result from the decision and can provide an equal playing field for dissenters as well as vested interests.

-14) Entrepreneurs and Crisis Cushioning: the Safety Net –

Briefly and simply, safety nets provide an economic stabilizing mechanism.  This can extend to countries in general and also individuals within a society.  safety nets do create moral hazard and cheaters who take advantage of the system.  But no one will give up their insurance policy on anything simply because it would force them to be more careful.  Accidents happen and safety nets often have greater benefits that risks, not to mention moral hazard can be a good thing, as I’ll discuss below.

1) Entrepreneurs can better afford risk – Moral hazard creates more risky behavior.  However to a degree this is a necessary thing in a market economy.  Take health care for example.  Since health care is part of what employers use to purchase your labor it is provided through a market mechanism.  However if I then get a great idea for a business, a risk no matter how good of an idea, I forgo my health care (or greatly add to the costs, and risks, of the venture).  By providing universal health care this cuts the cost and risks of entrepreneurs engaging in what a healthy economy requires of them.

2) Cushioning in an economic crisis – Straightforwardly, during a crisis more people lose their jobs and thus their income.  If education and health were tied to not only consumers’ willingness but also ability to pay, then a crisis would result in a less educated and less healthy population almost by definition.  Lowered income also cuts consumption, which is a driving force for the expansion of producers.  If a re-distributive organization were to briefly step in and maintain higher levels of health and education and also maintain better levels of consumption, then a crisis would not only be less severe but also be more easily recovered from.  In the same vein is the fairly constant role of the social safety net for the poor, which basically follows the same logic and function.

-15) Myth of Equality of Opportunity v Outcome

Again and again it is argued that what is important is equality of opportunity and not outcome.  “If we ensure everyone has the same outcome, then we’d all be poor and there would be no incentive to work.”  People would know that their extra work would not have any personal rewards.  However prima facie true this appears to be, equality of outcomes is a requirement of equality of opportunity.

We are not all equally set up on a line and then told “GO!”  Where you start, your level of opportunity, depends on your parents and your environment.  If education, for example, is left up to the successes of your parents to accumulate capital – both physical and social/cultural capital – then we are arranged each with vastly different starting lines.  Society is not made up of individuals in a vacuum.  Ladders for social advancement are not only difficult to find, but have gatekeepers which include prestigious (and expensive) education, having the right contacts, extra tutors and coaching, and so on.

A system that runs more on what capital you start out with to determine your outcomes, independent of your efforts and abilities, is not only unjust but it also dooms all but the very luckiest and most exceptional to a fate of unfulfilled potential.  This last point, for those that value innovation and social and economic growth, is important.

In conclusion, it is simply not a decision between valuing outcomes or opportunities.  We must ask the complicated questions of which outcomes affect which opportunities and how much?  What should be done about it?  How can we provide a system that rewards individuals’ hard work and talents and not some other arbitrary characteristic?

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

This is a common understanding for those that don’t understand the point made above in #15.  But to add to that, I would like to share one set of studies.

There tons of studies that look at SES (socio-economic status) and health, and they all pretty much show a strong correlation.  The healthier you are, the higher SES you have (*note: this doesn’t disagree with my diminishing returns argument because that was about the value of individual units of additional wealth while this is about total wealth.)

But you may say that the lazy poor simply don’t value their health as much, can’t forsee the consequences of their health choices or of saving for their old age/rainy days.

Well, no.  Overwhelmingly, the poor suffer from more stress related diseases, such as high blood pressure, psychiatric disorders, heart disease, etc.  These are caused most often by lack of control, predictability and social supports – i.e. not the kind of environment you want to stay in if you have much choice.

Therefore the stereotype of the lazy poor porch dweller on welfare versus the stressed out suit-wearing businessperson is pretty much ‘scientifically’ wrong.  The reality of it seems to be more along the lines of the single mom with three jobs whose slum lord just turned off the heat and the fat boss who spends most his time on the golf course and foreign resorts eating expensive food.  Of course there are lots of people that fit into all of these stereotypes.  I’m just pointing out that if you subscribe to the former set, you should question how prevalent or representative it is of reality.

Here’s one study I find most striking: In a study by Snowden D, Otswald S,and  Kane R called (1989) “Education, survival and independence in Elderly Catholic Sisters 1936-1988” and in a few other articles by them, researchers concluded that SES during youth (pre-sisterhood) years was the most predictive factor for later health issues.  All of the sisters had lived in the same environment, doing the same work, eating the same food, with the same friends with the same medical care for 50 years.  Yet the stress of the social and economic status of their youth was the largest determinate of their health problems in old age.

-17) Myth that People Need Monetary Incentives 

Over and over again I hear that the problem with communist Russia, or anything that hints at an alternative to pure a pure market system, is that there are no incentives.  This is simply wrong.

1) Voting Incentives – The government has incentives.  If they don’t provide the people with what they want, they lose their jobs.  This is obvious and I find it dumbfounding when people say government elected officials have no incentives.  This system is of course far from perfect in creating the right incentives to get those things in society that we actually value.  But as I have been writing about above, the same is true for the market and price incentives.

2) Social Incentives – People are social and emotional creatures.  This causes problems in many areas of the market based solely on monetary price incentives as I discuss in a number of points above.  Therefore, any society must be formed around the basic principle that people make decisions on things for reasons other than monetary profits.  As the saying goes, money doesn’t buy everything.

People regularly make even economic transactions with no profit for themselves.  I urge you to check out Kiva.org.  A site that facilitates loans to poor entrepreneurs.  Individual internet surfers simply donate the use of their funds, with no monetary gains in return.  Why?

3) Open Source Movement – This is a beautiful example of the counter-intuitive idea that if you don’t charge people for it and/or let people put in the work to create it free of charge, it works out better.

The best example of this is Wikipedia, which I have purposefully used extensively in links throughout this post.  According to the market, competition among suppliers, monetary incentives for those who create in and fuel through charging consumers should create the best encyclopedia.  However it turns out if you don’t charge, and let anyone who wants to work on the encyclopedia (without compensation) you get can get a better product faster.

Why does this work for encyclopedias, programming, traveling, and so many things?  Well, as I mention above, people are social and are not driven purely by monetary profit.  People like to see their work used, commented on, appreciated and enjoyed.  People like to be part of something bigger.  People enjoy helping others.  People enjoy the expansion of knowledge and creating a better world.

——————————

I hope if you have read this whole thing you do not become an extremist on the socialist/communist end.   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 reach utopia.

If you work off the idea “The Market is better,” then you’ll miss and lose out on all the things it can’t do.  You’ll be acting on a maxim that is incapable of finding the exceptions.  If you think there are no exceptions, you are simply ignorant and ideologically blinded.

In order to find the best course of action we need to completely ignore whether the market or the government can cover more ground and instead focus on what we actually want, i.e. a society that is healthy, educated, etc.  Then we need to look at the very complicated picture before us and weigh all of our options.  And this needs to be done on a case by case basis, not with bumper sticker slogans and Utopian cure alls.

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