In the first post I made that case that auction (market exchange) is the most efficient and just mode for allocating limited goods in society. In the previous post I made the case that face-to-face communities are very different from commercial society. Face-to-face community provides us with intimate knowledge of others and it provides a level of solidarity that cannot be achieved among more than a few people. For these reasons, face-to-face communities can use allocation modes other than auction quite effectively. But it is also for these reasons that we cannot view society as a family writ large.
When we talk about a market economy we we are talking about coordinating production, consumption, and exchange between millions of people who have no knowledge of each other. It may be helpful to think about markets metaphorically as an urban transportation system. We can imagine two extremes. One extreme would be complete anarchy with people driving where and how they wish with no restraint. The other extreme would be akin to an air traffic control system where no one moves without express permission and everyone precisely follows the path they have been given.
Economist-theologian Paul Heyne develops this metaphor an essay “Income and Ethics in the Market System.” (Chapter 3 in “Are Economists Basically Immoral?” and Other Essays on Economics, Ethics, and Religion) Below is lengthy excerpt from that essay.
It’s [the traffic system] a radically individualist system, to begin with. Drivers sit in their own vehicles, cut off from any communication with the other drivers who surround them, pass them, meet them, and cross their path. There are citizens-band radios, of course, but it’s my impression that drivers use them to communicate with people who aren’t close by and whom they don’t expect to encounter. I’ve seen no evidence that drivers use citizens-band radios to work out problems of potential conflict on the freeways during the rush hour, or generally while driving in urban areas.
On the contrary, drivers formulate their plans quite independently, with no knowledge of the plans that have been or will be made by others whom they’re going to encounter. Each of us decides what time to leave for work and what route to take, and we do so without even consulting anyone else. The choice of both ends and means s made by individual drivers who characteristically don’t have the slightest inkling of what others are going to do. There is currently no grand plan, no overarching design constructed by the Department of Commuting to make sure that you and I aren’t planning to occupy the identical road space at the same time. (The urban traffic system, in short, is not like the air traffic control system.)
Now one could correctly say of this system, as Adam Smith said about investors in his day: Each person intends only his own gain. But is that selfish? Is it selfish of me, while driving, to focus exclusively on getting to my chosen destination as quickly as is consistent with my person well-being? Is it selfish of me to ignore completely, not even to think about, the welfare of other drivers? If in fact I start to wonder where other drivers are going and whether their missions might be more urgent than mine, I’m beginning to daydream, and I become to that extent a greater menace not only to my own welfare but also to the welfare of other drivers in my immediate environment. An important insight emerges from this: Responsible, ethical behavior will often require an exclusive preoccupation with the technical task at hand. Driving in traffic is an example that we will all concede. So is the act of performing surgical operations; surgeons don’t operate on close friends or relatives, because the personal relationship could easily introduce considerations irrelevant to the task at hand and inimical to success.
Might this also be true of most activity in the market? We’ll return to that question.
Meanwhile, let’s note in the traffic situation what harm is likely to be done by people who decide to insert “morality” into their decisions. What will a driver accomplish if he refrains from advancing when the light turns green, perhaps because he's running early and suspects that some in the cross-traffic are running late ? He will almost certainly not persuade the cross-traffic to go on red; he will delay people behind him, who could well be on much more urgent missions than his own; and he will increase the likelihood of an accident by introducing substantial new uncertainties into the calculations of drivers who are observing and trying to anticipate his erratic behavior. And, of course, if everyone decided to be “unselfish” in this manner, traffic would come to a halt, as drivers regularly got out of their vehicles to discuss the relative urgency of their current goals and to insist that the welfare of others be advanced before their own.
Is this also generally true of ordinary market activity, that it would come to a halt, at enormous cost to all participants, if they were all to act consistently on the principle of advancing the welfare of the most needy or the most worthy – rather than focusing on the accomplishment of their own personal goals? To that question, too, we’ll want to return.
I have not mentioned a very important aspect of traffic systems: They are not systems of complete anarchy. There are definite rules of the game that must be obeyed by participants if the system is to work. Drive to the right, stop for red lights, stay close to the legal speed limit, and, above all, do not touch the cars around you. We even have rules for suspending the rules. Everyone stops and yields to vehicles with sirens and flashing lights, and uniformed police officers may trump all the rules.
Heyne goes on to point out that some rules are somewhat arbitrary (driving on the right) but necessary for clarity and stability … so people can react and cooperate with the actions of others. Then he writes:
Let me now try to summarize in one sentence the social system for moving traffic with which we are all familiar. It is a system in which individuals pursue their own interests on the basis of the situation they perceive, obeying a few clear and stable rules of the game.
And let me follow that up with an equally brief definition of capitalism, or a free-market economy. It is also a social system in which individuals pursue their own interests on the basis of the situation they perceive, obeying a few clear and stable rules of the game.
Looking at Consequences
What emerges from the traffic system? Some fatal accidents. More damaged fenders. A certain amount of anxiety. Occasional incidents of personal nastiness. But if those were the principal consequences of the system's operation, none of us would participate. The fact that we do play the game, and we do so voluntarily, because we expect to be better off by playing than not playing. We venture into traffic every day, and we regularly get back home in satisfactory condition. The system works. Judged by its consequences, it's a success. I don't doubt that improvements will be made in the system in the future as they're discovered and we learn how to implement them. But the system works astonishingly well as it is right now, with all its warts; and no one really knows how to design a better system for enabling people who live in dense population clusters to move about quickly, freely, safely, comfortably, and inexpensively.
Social Cooperation as Mutual Accommodation
One of the elements that make it work is the mechanism of mutual accommodation that it embodies. This mechanism becomes especially important and visible in large cities during the rush hours. Have you wondered – we too seldom ask such absurdly instructive questions – why it never happens that everyone using the freeway chooses to drive in the same lane? Just too unlikely, you might think. But isn't it also most unlikely that each of the four alternative lanes on the freeway will be chosen by precisely twenty-five percent of drivers? And yet that''s roughly what happens every day, morning and evening. A coincidence too improbable to be believed – until we notice how and why it happens.
A lane carrying fewer that one-fourth of the traffic will move more quickly; that advantage will be noticed by a few drivers traveling in adjacent lanes; they will respond by changing lanes. As they do so, they slow down the the lane which they enter and accelerate the land which they left. Through the continuous process of marginal adjustments, initiated by individual drives responding to the perceived advantages to themselves of changing lanes, the traffic is continuously adjusted to keep each lane moving at approximately the same speed. And thereby the sum of the time traveled by all of the commuters together is minimized. ...
... In a market economy, the changing net advantages that participants perceive are communicated not by different land speeds but primarily by changing relative prices. When suppliers and demanders aren't accommodating each other very well, relative prices start to move. The prices that rise relative to other prices induce suppliers to offer more and demanders to ask for less. The prices that decline encourage demanders and discourage suppliers. These responses begin to close the gaps that had opened up between what producers were offering and what users were requesting, which in turn checks the relative price movements that had induced the mutually accommodating responses. Changing money prices serve both as information and as incentive in the remarkable system of social cooperation that we call a market economy. (32-36)
No metaphor is perfect. We could probably develop a similar metaphor from biology as Eric Beinhocker does in his 2006 book Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics focusing on evolution. But the basic point is this: A market economy is neither anarchy nor is it a centrally directed system. It functions within a set of rules. Therefore, the first and foremost thing markets need are rules. Optimally people will internalize the rules and live by them, but human nature being what it is, we know there must also be "referees" who enforce rules.
While most agree that neither anarchy nor total control are effective ways to run transportation systems or economies, there is frequently disagreement about what constitutes "fairness" within the rules and how well (both in terms of justice and efficiency) the economy can be adjusted to meet social ends. Libertarians tend be skeptical of both the ability of political decision-makers to have sufficient knowledge for adjusting the economy and of politicians' ability to do what is just and efficient versus that which is politically expedient. They tend to believe that solutions will emerge outside of political intervention. Liberals tend to believe sufficient information can be gathered for well-informed adjustments and believe the risk of non-interference in the market is greater than unintended consequences that may emerge from market intervention.
Michael,
I like some of your examples and stories that relate the complicated issues associated with supply & demand, and the bigger picture of allocation of resources. The answer will be known when Creation and God's people are restored to his Glory in Jesus. Until then the free market system with limited control and regulation solves a host of issues for the majority of people. The poor will always be with us and one way to help that is to provide helping hands like education, necessary health care, basic food needs and housing. I don't have answers on how to do that, but I know if the "Church" did it's job we all would be better off. Especially the poor ! Can you imagine what would happen if all Church goers gave just 11% (a good starting point) of their income what the "Church" could really be and do? What an impact could be made on those who don't know Jesus.
Posted by: David | Apr 06, 2010 at 05:23 PM
Thanks David. I'm grinding slowly toward how I would address the issues you raise. Some will come in the next post. More toward the end.
Posted by: Michael W. Kruse | Apr 06, 2010 at 06:26 PM
Not necessarily pertinent to this post, but on the general topic of free market capitalism, I'd be interested in your comments on this news-item: http://tinyurl.com/novultures
Do you see the action of the churches as interfering with the free market system? How would you assess vulture funds? I'm genuinely curious as I have an intuition as to where this series is moving and I think that vulture funds probably stand outside that paradigm.
Posted by: PamBG | Apr 08, 2010 at 10:50 AM
"Do you see the action of the churches as interfering with the free market system?"
Possibly. But market systems sometimes need interference. :-)
I'm not that familiar with vulture funds. When it comes to debt cancellation, I think that has to be taken on a country by country basis. I suspect some of the same dynamic is it work.
I think a false assumption about many emerging nations is that debt is their big problem. Corruption and policies hostile to economic growth are generally bigger problems. Eliminating debt will not magically improve the lot of the poor. Too often the canceled debt is never seen by the poor but retained by powerful dictators and elites. My basic point is that is usually more complex than surface financial calculations might make it appear.
Posted by: Michael W. Kruse | Apr 08, 2010 at 11:13 AM
I think a false assumption about many emerging nations is that debt is their big problem. Corruption and policies hostile to economic growth are generally bigger problems. Eliminating debt will not magically improve the lot of the poor.
Probably true. But not really pertinent to the practice of buy $X million in debt and then turning around and using the legal system to force the country to repay $XY million (where Y > 1).
I was just curious. Although you have actually dodged the question. :-)
Posted by: PamBG | Apr 08, 2010 at 03:02 PM
Hmmm ... It wasn't intended as dodge. I thought I was giving you the standard economist answer to nearly all economic questions: It depends. :-)
"...buy $X million in debt and then turning around and using the legal system to force the country to repay $XY million (where Y > 1)"
In the generic sense, without knowing other variables, I would have no problem with this. But the other variables are critical. For instance, if the debtor nation is run by tyrant who has appropriated the borrowed money for himself, canceling debt is not going to help that country. Keeping the debt obligation in place can be used as leverage to reform corrupt behavior. On the hand a nation that suffers less from corruption and has instead encountered hardships that are mostly due to the vagaries of the global economy should simply have their debt canceled ... no debt to turn over to a vulture fund. And yet, even with some poor countries, establishing a track record of repaying debt makes them an attractive target for future investment.
So I don't have objection to the idea in principle but I might have considerable objection depending on its application.
I'm also just being honest with you. I simply don't know that much about vulture funds and haven't read up on them. A little more research might push me more on direction or another.
Posted by: Michael W. Kruse | Apr 08, 2010 at 03:39 PM