(I recently stumbled across this on my computer. It looks like it was an email I was writing, and then decided to copy the text and stick it in a Word document to come back to "later." Judging from the time-stamp on the file, that was in 2005. I have no idea who my correspondent was. I've stripped out the extraneous stuff from the email.)
I’ve been shifting my basic sense of where markets belong in the firmament of economic theory. In preparing my “Hunger and Excess” course for this fall, certain inadequacies of markets have impressed themselves upon me with renewed force, leading to an epiphany of sorts, which expressed itself as two contradictory facts and a reconciliation. The contradictory facts are, on the one hand the manifest faults of markets (expressed for me particularly in terms of food and environmental issues) and, on the other, the abject failure of the “non-market” of the Soviet system. The reconciliation is a recasting of why markets are good, what they’re good for, and a reassessment of their place in society.
A sensible food culture would promote moderate portions and healthy ingredients, as well as good body image, health through reasonable exercise and diet (not neuroticized forms of exercise and diet) rather than medicalizing the problem. Instead, we have market forces pushing oversized portions of undernutritious food; unrealistic body ideals; and pharmaceutical solutions to problems that are better addressed through changes in behavior. In this instance and others (most prominently the environment), the market is not merely missing the optimal outcome, it’s actually taking us away from it.
Yet it is the default standard in our culture. The market outcome is assumed to be the right one, unless you can specifically explain why it isn’t, and any deviation from the market (other than a subsidy to a corporation) needs a strenuous justification (and even those subsidies need at least an attempt at a justification).
Part of the explanation is the conspicuous failure of the most conspicuous alternative to the market. Communism rejected the market and created a spectacular mess. Even strident critics of the market usually acknowledge that the Soviet model was anything but an improvement.
If the alternative to the market created such a disaster, doesn’t that mean that markets should be the default? The answer is no, and the key to understanding that is to reappraise specifically what it is that markets do so well, which is two things.
First, as Hayek most notably outlined in his debates with Lange, markets are unparalleled as information processing systems. They take dispersed information about consumer preferences, resource availability, and technological possibilities, and make it transparent in the form of prices. The Soviet planners tried to replace that function with explicit planning and failed miserably.
Second, as Adam Smith pointed out, they provide unparalleled incentives to efficiency, defined as meeting the consumer preferences that the pricing system reveals, at least cost, as defined by the prices of labor, technology, and resources that come out of that same pricing system. That is, markets provide an incentive to make good use of the information that the market’s pricing function makes available. They also provide incentives to make more resources available and to expand technological possibilities. The Soviet planners tried to replace the motivation of self-interest with visions of the New Soviet Man, who would selflessly work for the greater good, and the failed miserably.
Rejecting those two functions of markets – their informational and motivational roles – will lead you to catastrophe. But that doesn’t mean that market results are optimal, or that they’re the best outcome that can be had in practice, or even that markets should be the automatic default.
The information that markets so brilliantly process includes serious misinformation about the prices of natural resources. And market incentives are not limited to the desirable expansion of resource availability and technological capacity and the expeditious satisfaction of the consumer preferences revealed by the pricing system. There is also an incentive to shift those preferences toward things that can be profitably sold and away from things that yield little or no profit.
Judging by the number of restaurants following each business model, there is apparently more aggregate profit in a model of cheap food in large quantities rather than good food in adequate quantities. Many cases of high blood pressure and prediabetes can be treated at little or no cash cost through changes in activity levels and dietary habits; a good doctor will present that option, but the treatment of such conditions through medication gets a lot more publicity, because nobody can charge you for eating right or getting off your ass. Our preferences are not given, but malleable, and the incentives to change them in ways that are profitable for firms are not necessarily (not usually?) incentives to change them in ways that make our lives better.
Even the incentives to expand resource availability and technological possibilities are distorted both by the wrong information about underlying natural resource conditions and by the preferability (from the entrepreneur’s perspective) of things that can be sold. Technologies that save labor but use up resources are highly valued, reflecting the market’s inaccurately low price of resources. In agriculture, there are technologies that would be socially optimal (relatively high efficacy, combined with low cash cost, and highly desirable environmental characteristics) that get little to no research funding from the private sector (and not that much from government, either) because they don’t involve much if anything to sell.
Information processing is distorted by the manipulation of preferences that theory naively assumes are “given.” The development of technologies is distorted by considerations of what can be sold rather than what accomplishes social goals with minimal aggregate inputs.
An optimal society would respect the market’s informational and motivational capabilities while correcting the misinformation input regarding resources and (here’s the trickiest part) curbing the incentive to manipulate preferences. (Is it worse to have them potentially manipulated by open government than definitely manipulated by private action?)
In a way, obviously none of this is new: markets have some well known problems. What I’m moving toward, however, is a view that our thinking is limited by the reflexive treatment of the market as the default. The research program of mainstream Western economics has become, When is it OK to mess with the otherwise sacrosanct market? Shouldn’t we instead be asking, What are our goals? and, How do we get there? In answering that second question, good economic practice would entail recognizing markets’ power as information machines and creators of incentives, and it would rely on markets where those two functions are important. Beyond that, no special status.