Market will organize the self
motivated act of decision making agents toward promotion of social welfare,
using the invisible hand of competition. Market is a blind watchmaker system. Like
evolution it is the system which organize disorganized working environment to
unified process of fitness creation (see Dawkins’s, 1982, 1986, 2006; Smith,
1982, 1988 and Hamilton and Axelrod 1981). In market producers are producing to
maximize their long term profit, individuals are trying to maximize their
welfare, workers are trying to have better life, countries are trying to have better
economy and soon. The problem is when everybody tries to promote his/her/its
own interest, what is the grantee that our collective interest will be promoted?
This can be granted, to some extent, by invisible hand of market competition
(Smith, 1776; Poulton and Lyne, 2009 and Hayek, 1988).
Why do the baker and butcher feed
us? This is because it is their self interest to do so in a competitive market
(Smith, 1776). Why do Apple, Samsung and Microsoft supply us new and improved
gadgets at ever decreasing price? This is because under competitive system, the
reliable way they can make high profit is through creation of dynamic
comparative advantage and reduction of cost. The world may not be this perfect,
since firms do also try to get profit by industrial espionage, political
manipulation, tax avoidance, extortion, market power, market manipulation, free
riding, corruption and soon. But still competition is very effective in
improving fitness is not open for doubt. There could be debate in level of
optimal competition that could be allowed in given context (Williamson, 1991,
1993, 2000, 2005, Berger, 2009; Wong, 2004; List, 1909 and Stiglitz, 2001).
However the lion share of competition in improving performance is beyond any
doubt. To understand market we need to see the reason for its development and
the reason why it leads to efficiency.
One of the most important reasons
why market is needed is because human behavior has large junk of bounded
selfishness in its intrinsic nature. Ethics, morality, fairness and identity do
bound selfishness. But they will not undermine selfish nature of humanity in general
(Mezgebo, 2014). There is huge
collection of experimental evidence in gift exchange games, which is able to
show the fact that there is sense of fairness in humanity; that is in addition
to our selfish nature. See Fehr and Fischbacher (2002), Camerer (1997), Rabin
(1998), Camerer and Loewenstein (2004), Ensminger (2000), Smith (1976) and Henrich
(2000) for some reviews. Based on this and other points, some may insist human
beings are not selfish at all. But we should notice the question if fairness is
learned or natural is still in debate; but based on those experimental results selfish
nature of humanity is not debatable at all. Just see your follow man in all
history and if you cannot see selfishness in his nature, you are really blind.
We may doubt fairness of humanity, which is actually hardly invisible. But it
is absurdity to doubt selfishness of humanity; unless we keep cheery picking of
few facts, by focusing on what we like only, so to justify our premature
closure.
For example fairness is socially learned treat which
declines with experience is documented in experimental result of Binmore
et al. (1985), Weg and Zwick (1991), Harrison and Mccabe (1988) and Neelin et
al. (1988). Another, experimental evidence by Ensminger (2000) found that fairness
is context specific. In which people may compete in some areas of their life
and act fair in other areas of their life. All results cited above, however, do
clearly show the fact that: selfishness may not be the only innate nature of
human beings, but still it is the dominant nature of human beings all around
the world.
Still there is another counter
agreement of using modern market oriented human behavior to understand innate
human behavior in general. This is because market itself can create artificial
selfishness that we observe (Callon, 1998). The logical rejection of
selfishness emanates from the fact that society can influence individual
behavior and goal. If society promotes selfish goals as right goals, people
will become selfish. If society promotes nobility, people will become noble in
behavior. If being great warier or being priest of a church is assumed by
society as right goal of life, people will define their goal as such. How do
societies influence individuals? First since peoples’ thinking itself is
harmonized by culture, this will frame their mind to think as such (Callon, 1998).
Actually Callon (1998, page 5) seems to imply our way of life is framed by
society as the society see it fit.
Rather than postulating that the ability to
calculate is an intrinsic property of homo sapiens, it is the culturally or
socially constructed dimension of this competence which is emphasized.
Irrespective of the mediations through which this influence is supposed to be
exercised, it is asserted that in all cases certain social structures or
cultural forms favour calculation and selfish interests while others induce
agents to be altruistic, disinterested, generous and even to give freely.
In addition most social
scientists and large group of institution economists do accept the fact that if
anyone diverges from such communality of goals in significant manner, it will
be formally and informally sanctioned by society and those who follow it will
be promoted (see Mwangi and Meinzen-Dick, 2009; Williamson, 2000; Cox and
Fafchamps, 2006; Nabli and Nugent, 1989; Akerlof, 1998; Kuran, 1987; Biggart and Beamish 2003;
Bardhan, 1987, 1989; Field, 1979, 1984;
Pierson, 2000; North, 1971, 1992, 1994; Haltiwanger and Waldman, 1985; Hodgson,
1997, 1998). Given the above fact people will behave selfishly in selfish
culture, but this does not mean people are selfish by nature.
But such argument is not based on
biological foundation at all; is not completely consistent with history, is not
consistent with cross cultural experimental evidence that is available and far
worst it has logical problem. Let’s start from one of the logical problems of
the above idea. The theory says society is using carrot and stick to create
conformation. The same carrot and stick, which is used everywhere, is creating
selfish nature in selfish cultures. The question is if I am not selfish at all,
why do I follow the mass because of incentive? The above theory does directly
justify the selfish nature of humanity than opposing it. The theory which is
built to reject selfishness is built on selfish human being after all. All
social sciences do accept the fact that society uses carrot and stick to create
conformation. The problem is such common postulate demands selfishness of some
sort as foundation.
In addition large junk of evidence in experimental and
behavioural economics done in diverse cultures and with different level of
economic development, including hunters and gatherers, do justify the fact that
people have moral side of life but they have dominant selfish nature too (see
Fehr and Fischbacher, 2002; Camerer, 1997; Rabin, 1998; Camerer and Loewenstein,
2004; Ensminger, 2000; Smith, 1976, Henrich, 2000). From biology the basic mind
sense is not elastic enough to be filled whatever we like as clean slit, but it
will bound us to be consistent with innate nature of humanity (Pinker, 1997, Cosmides
and Tooby, 1994a, 1994b, 1996, 1987 and Hayek, 1945, 1964, 1988). The very
nature of biology is built in strategic selfishness (Dawkins’s, 1982, 1986,
2006; Smith, 1982, 1988; Hamilton and Axelrod 1981; Pinker, 1997, Cosmides and
Tooby, 1994a, 1994b, 1996, 1987 and Hayek, 1945, 1964, 1988). History wise
people may die for national pride, clan, idea, ideology and soon. But always
they always scarify their happiness to promote what is theirs and to fight what
is not theirs. What society can change is what is the definition of the self or
identity, not the dominant role of selfishness in human nature (Mezgebo, 2014).
People from the current ruling party of Ethiopia do give up their personal
happiness to promote their ideology and political view point in civil war which
lasted for 17 years. But they did not become Angles or Jesus then after! They
actually developed us verse them mentality. Ones us is defined they were
savages beasts in attacking their enemy (them). What is elastic is the nature
of identity not human selfishness. This is another logical problem of the
counter agreement.
Yes, the self could be flexible
as people see themselves in terms of overlapping identities (UNDP, 2004;
Mezgebo, 2014), but still the enlightened and strategic selfish nature of
humanity is undeniable fact then after (Mezgebo, 2014). Investor may spend
resource to promote industrialization for profit, employment creation, national
identity and patriotism, whichever is the dominant motive. But the investor
will promote his factory, way of life and thinking to promote personal, social
and national interest as the investor see it in long run is undeniable. He is
still selfish as he is not promoting development of foreign country, what is
changed is the dominant identity in his character from being ego centric to
patriotism. Self interest, no matter how we define the self, could be
effectively coordinated in some cases by invisible hand of competition and
market prices.
Market uses high powered
incentives to link performance with incentive (Williamson, 1991, 1993, 2005; Macher
and Richman, 2006; Baker et al., 2002 and Masten, 2000). Such link will be
effective when the selfish behavior is dominant and signaling of performance is
not very costly to overweight market performance (Holmstrőm and Roberts, 1998).
When people are selfish the best way to motivate them to do things for society
is to give them incentive which is directly related to performance. Actually
the performance of market improves as signaling cost, cost related to information
asymmetry, declines in comparison to positive welfare impact of market (Stiglitz,
2001).
We should notice life, including
market, is learning process with experience accumulation. In this process
linking performance with incentive is very important as selfishness becomes
dominant character of human behavior. If we can signal performance without
prohibitive cost, market which uses high powered incentive will be very
effective way to motivate people to do what they are expected to do. In this process
right form of exchange institutions which can create least cost efficient
signaling, like double auctioning in place of single auctioning[1], can
guide economic agents with bounded rationality toward optimality is well
documented in experimental markets (Plott, 1986; Smith, 1964, 1967, 1982, 1990;
Roberson and Smith, 1982; Easley and Ledyard, 1983 and; Gode and Sunder, 1993).
This is stick and carrot process to condition decision making agents toward
higher fitness.
The second critical reason why market
is needed is because of the existence of limit on human intelligence and the
existence of information asymmetry. The problem is production and consumption
decisions are done by large army of unorganized producers and customers all
over the nation, if not all over the world. In this process production and
consumption decisions needed to be coordinated. But no one has all the
information, nor the managerial capacity to coordinate all those decisions toward
higher fitness (Hayek, 1945, 1964, 1988 and Stiglitz, 2001). This is why market
competition is needed to act as invisible coordinator, like the blind watchmaker
of evolution, of course with the help of human foresight (Smith, 1776; Hayek,
1945, 1964, 1988). We let the selfish beings compete for fitness. If it can
work for evolution, there is no reason to doubt why it cannot work for economy
too.
In this process market prices do play
important role in communicating the choices and capabilities of different
decision making agents (Hayek, 1945, 1964, 1988). The invisible hand needs
visible prophet to coordinate agents toward specific goal. The visible prophet
of competition is market prices. The preference of customer in competitive
system is expressed by prices, as customers compete formally or informally. At
the same time preference of producers and their capability to supply is also
communicated through prices. As long as both demand and supply are expressed in
competitive system, the interaction of demand and supply will generate market
prices which are important index of supply and demand. The entire disorganized
effort of everyone to promote self interest is coordinated by competitive
market prices in effective way to promote collective fitness (Smith, 1776; Hayek,
1945, 1964, 1988; Poulton and Lyne, 2009 and North, 1992).
The third reason why market
mechanism is efficient in long run is it has capacity for self correction in
long run. Problem of credit, risk, information, technology and soon represent
problem of production and exchange in short run. In the other side of the same
coin they represent opportunity for profit in long run. The development of
banking in current Italia, the development commodity exchange in USA and the
development of diverse institutions like networks, option trading, future
trading, share cropping and so on are adaptive institutional solutions
developed by society with formal or informal market to solve its structural
problems. Problem of market in short run are profitable opportunity in long run
to develop mitigating institutions (North, 1991 and Stiglitz, 2001). This is
evolutionary process of competition for fitness. As result it is often very
ugly, sluggish, never assured in all cases and in some cases very inhuman
process. However it is important edge of market over other organizations. In
simple words by producing incentive structures that evolve over time, market and
exchange institutions will determine the growth, stagnation or decline of any
community over time (North, 1991).
This simple undeniable fact can
be told as perfect market story to organize our thought in simple manner (Aumann,
1985), to explain complex market structure and its morality by using fairytales
of children (Morgan, 2002) and also to impose market morality on society (Callon,
1998). There is reason to doubt such fairytales, which will be introduced below;
but there is no reason to doubt the importance of competition and market for
high performance. That is why market is taken as organization of selfish decision
making agents with goal of collective fitness promotion. Viewed from different
angel, market is built from matrix of institutions, which coordinate the
self-promoting act of individuals to ward social welfare maximization (North,
1992). The fundamental institutions of market include the following (Hayek,
1988)
1.
Clearly defined property right
2.
All exchange of property right to be based on free will
3.
And enforceability of contract in cost effective manner
The optimality such market institutions
are what determine the optimality of the market as organization (North, 1991,
1992, 1994; Plott, 1986; Rodrik, 2004). When people are selfish in their action,
if property right is not having functional protection and exchange is not based
on free will; how can we assume the baker will waste most of his/her time and
resource to produce the best quality bread, using the least cost combination of
inputs? Why not steal it from someone else? Why do customers pay high price
when they need more bread? Why not force the baker to produce more? We should
notice those are fundamental institutions for market efficiency. In imperfect
world which does not fit the static fairytale of neoclassical economics known
as perfect world, alternative institutions will evolve to fill the gap and this
will lead us to complex mix of market institutions (North, 1991, 1992, 1994).
This is why we have norms, values, moralities, commercial cods, tax codes,
business norms, and diverse organizations with their own institutional matrix
to make market functional. We are not assuming the world is created for market
but large junk of our institution is crated and modified to fit the dynamics of
market as dominance of market rises. Now let’s turn to fairytale of dominant
economics schools.
Any neo-classical micro economics
text book will show us that under its assumptions static free market is Pareto
optimal. The model can show market allocation will result in best possible resource
allocation. As result there is no way to improve market allocation as market
will attain what is best possible. The central assumptions of perfect market are
1)
There are large
number of buyers and sellers: Every agent will take the market price as
given and is price taker in the market. Nobody will have the power to fix
price, which is determined by market demand and supply as collective action of
all participants is mediated by competition.
2)
There is given
and fixed technology: In the economy technology is given and anyone can use
that technology without any restriction. This is one reason why the model is
static than dynamic.
3)
There is perfect
mobility of factors: Factors of production, like capital, labor, land and
raw material, can freely move from one firm (location) to another without any
need for additional cost.
4)
There is perfect
information: There is perfect information about price, output, market
demand, market supply and so on. By implication there is no risk and judgment
is done under perfect information in world without uncertainty.
5)
Entry and exit
is free for all: Since there is free entry and exit, nobody can earn any
abnormal profit and only the fittest will survive
6)
There are no
public goods and externalities: All benefits and costs are accruing to
those who are responsible either for the consumption or production of the goods
and services.
7)
Decision making
agents are rational: Human beings are making the best possible decision on
time use, production, consumption and saving, after considering all important information.
Under these assumptions, micro
economic text books will show us that market will result in the best possible
resource allocation or Pareto optimal resource allocation. Means there is
nothing that can be done to improve market efficiency. What can be attained is
already attained and there is nothing that can be changed. The market is Pareto
optimal when
1.
There is Pareto
efficiency in consumption: It is not possible to increase utility of
customer by changing the composition and quantity of goods consumed by the
customer. Means customers are generating the best possible utility that can be
generated from the limited resource that society posses.
2.
There is Pareto
efficiency in production: It is not possible to increase level of
production by improving input composition and efficiency of input use in
production. Means what can be produced from the limited resources is already
produced and there is nothing that can be done to improve it farther.
3.
There is Pareto
optimality in distribution: Goods and services that can be produced from
the limited resources are distributed optimally. Means there is nothing that
you can change to make some one better off without making another person worse
off.
If these assumptions are right,
resource allocation which is the cornerstone of any development effort can be
coordinated by market forces only (Kirsten, et al., 2009). In other words, the
institution needed to achieve rural development is market only. Free market
will provide optimal inputs to the rural residents and will create optimal
market for their output, without any bottlenecks. If these assumptions are
right, rural and national development could be as simple as letting the market
free or getting the price right (World Bank, 1991). From philosophical angle,
with large junk of logical inconsistency in which we have no time to debunk,
Rand (1964) did also reach the same conclusion. While swimming in certainty of
perfect market in their risk free and certain life, decision making agents, who
are atomistic and socially independent rational beings, will march to heaven
from hell called state and social over reach in the economy toward rational and
fulfilling life. What they need is the prophet of truth which can give them the
perfect life and heavenly light of eternal happiness in form of neoclassical
economist and philosophers like Rand[2].
The problem is that the orthodox
theory is looking in the bright side of the street, when the developmental key
is lost in the dark side of the street (Kirsten, et al., 2009). In general many
prominent economist who are not part the orthodox neoclassical school do reject
perfect market theory as painfully out of touch with real world (Stiglitz,
2001; Cimoli, et al., 2006; Rodrik, 2007; Berger, 2009; Chang, 2007, 2001; Kaldor,
1972; Young, 1928; Lee and keen, 2003; Subramaniam and Panth, 1996; Hodgson,
1998; Kirman, 1989; Colander, 2003 ,2005a, 2005b; Haavelmo, 1997; Richter,
2001; Hahn, 1991; Pagano, 1989; Rabin, 1998; Camerer and Loewenstein, 2004; Selten,
1999; Holland, 1992; Clark, 1918; Reinert, 1996; Keen and Standish, 2006; Keen, 2002; Blaug, 2002; Cartwright ,
2002; Pettit, 2002; Akerlof, 1998 and Wong,
2004). This is nicely summarized by Stiglitz (2001, page 11-12)
The model virtually made economics a branch
of engineering (with no aspersions to that noble profession), and the
participants in the economy better or worse engineers. Each was solving a
maximization problem, with full information: households maximizing utility
subject to budget constraints, firms maximizing profits (market value), and the
two interacting in competitive product, labor, and capital markets.
The problem is that in order to
reach such mathematically precise conclusion, which can show market allocation
is the only perfect solution for representative customer and representative
producer, they have to assume many things which are unrealistic. For example Selten
(1999, page 3) stated
Full rationality requires unlimited
cognitive capabilities. Fully rational man is a mythical hero who knows the
solutions of all mathematical problems and can immediately perform all computations,
regardless of how difficult they are. Human beings are very different. Their
cognitive capabilities are quite limited. For this reason alone the decision
behavior of human beings cannot conform to the ideal of full rationality.
Similar but extreme form of
rejection of such fairytale is also presented by Keen (2002, page 4 and 5) in stating
Virtually
every aspect of conventional economic theory is intellectually unsound;
virtually every economic policy recommendation is just as likely to do general
harm as it is to lead to the general good. Far from holding the intellectual
high ground, economics rests on foundations of quicksand. If economics were
truly a science, then the dominant school of thought in economics would long
ago have disappeared from view. ….. But economists, despite the abysmal
predictive track record of their discipline, are forever recommending ways in
which the institutional environment should be altered to make the economy work
better.
However rejecting perfect market
theory is not the same as rejecting the high efficiency of market coordination
(Hayek, 1945, 1964, 1988; Poulton and Lyne, 2009 and North, 1992). Most authors
when they reject perfect market, they are grooming state intervention as legit
without qualification. That is why this has to be clear from the start. Rejecting
performance of competitive market is like rejecting evolution in biological
science. Market may not behave in perfect sense as it is assumed in perfect
market. After all evolution does not promise perfection and market cannot give
us perfection at all. Far worst evolution is clearly inhuman process. Yes
market is not as savage as evolution. This is because first people use
foresight to adapt to it, as much as possible, and second such problems are opportunity
for profit making in long run. See North (1991) for historical evidence to back
the above fact.
Market will not only reduce its
inefficiency but also will also reduce its savageness in long run. In general the
blind watchmaker system of market, backed by foresight of decision making
agents, will lead to high efficiency is simple reality of day to day experience
and historical experience. This process
is not perfect but it will work to generate high functionality. This is why
market based society will end up dominating others (Hayek, 1988). Perfect market may not explain
reality but it does explain large junk of advantage that can be generated from
property right enforcement, free will based exchange and enforcement of
contracts in competitive system.
Turning to perfect market theory,
we should recognize it is not scientific truth (McCloskey, 1987, 2002) but it will help us to organize our thought
into scientific common sense. This is nicely stated by Aumann (1985, page 8) as
following
In my view, scientific theories are not to
be considered ‘‘true’’ or ‘‘false.’’ In constructing such a theory, we are not
trying to get at the truth, or even to approximate to it: rather, we are trying
to organize our thoughts and observations in a useful manner.
The above conclusion is not
necessary true as theory of physics did not stand in the same ground as
economics. However we should recognize the fact that the loud cry of heterodox
economists is found in similar shallow ground in all the models they build. In
historical schools there is cheery picking and synthesizing of facts to conform
own bias in theory formation. In mathematical model building of the heterodox
schools similar absurd assumptions are imposed on models to make them
operational, because we lack knowledge of alternative framework to start our
thinking (Stiglitz, 2001 and Aumann, 1985). Stiglitz (2001) did clearly
acknowledge this problem in his modeling of real world problem in his Nobel
Prize lecture. However at this point our models are story telling (Morgan, 2002,
page 197) in addition to being scientific common sense
In
the context of a complex world, models are an accepted way of representing the
economic world in a simpler way so that we can think about its features. By
asking questions and then manipulating models, we are able to tell ourselves
stories about the hypothetical world portrayed in the model. But these stories
also help us to explain the real world, for it is these stories, an integral
part of modeling, rather than the typically unrealistic assumptions from
economic theory, which make the stronger connections to the real world. We
expect these stories to be related to our questions about the world, our
typical experience of the world, and to the kinds of events we find in our world.
We don’t expect them to be exactly true to any particular events of the world.
If they were, they would not be stories. But nevertheless, they connect by the
questions that prompt the story, by the fact that the events they portray
correlate to events in the world, and by the congruence of outcomes. It is by
telling stories about the economy that we most effectively connect our models
to the facts of the world.
In real sense of a model they
don’t satisfy the condition of good model at all (McCloskey, 1987, 2002). But still they are useful not only to organize
our knowledge, but also for simulation of alternative policies. Let’s explain
the second point. If used with care and when they are relevant to the question
at hand, a consistently built perfect market or other kind of market models
which are somehow related to real world can be our rat, monkeys and insect as test
subject in medical experiment of human medicine.
Animals are not human, as
homo-economies and his world is very different from us. Monkeys do approximate
us better, followed by rats. None of those beings are perfect model to humanity
no matter their level of similarity and distance. You can imagine McCloskey (1987, 2002) shouting animal
experiment is not science, after all a single gene can change the entire
conclusion. But good is not enemy of perfect, of course when used with care.
In some cases they are perfect
model which satisfy the condition set by McCloskey (1987, 2002). Say in testing if the atmosphere of given
location can sustain life or not. Even in medical experiment in which single
gene can make huge difference, it is very logical to test new medicine in close
and distant relative animals, before experimenting with human beings. For McCloskey (1987, 2002) it is not conclusive
and may be not useful but it saves many lives when used with care. This
is because we learn a lot from experimentation on rats if used with care. We
should notice the more similar is the animal to humanity the more reliable most
experiments will be and this will justify the needed to build more accurate
models. However we should not under estimate the importance of modeling how
imperfect it is, after all human mind is built on imperfect modeling of the
world (see Pinker, 1997, Cosmides and Tooby, 1994a, 1994b, 1996, 1987). The
problem of modeling is not they are imperfect, all models, are imperfect even
in physics. Otherwise it would be end of science and prominence of technology.
Our mind is the best example for imperfect model based analysis. The problem is
some models are not continuously exposed to reality check so they could be
improved.
Our mind uses common senses and
mind senses which are not accurate in many areas of our life. This is well
proven fact in many studies of psychology, evolutionary psychology,
experimental economics and behavioral economics (Cimoli, et al., 2006; North,
1971, 1992, 1994, 1999; Stiglitz, 2001; Arrow, 1969; Hodgson, 2007; Nelson, 2006;
Williamson, 1971, 1976, 1979, 1991, 1993, 1998, 2000, 2005; Hodgson, 1998; Macher
and Richman, 2006; Smith, 1991; Loomes, 1998; Pagano, 1999; Simon, 1962, 1985; Vanberg,
2002, 2004; Rutherford, 1995; Cosmides and Tooby, 1994a, 1994b, 1996, 1987; Nelson
and Nelson, 2002; Conlisk, 1996; Rabin, 1998; Camerer and Loewenstein, 2004; Selten,
1999; Goldberg, 1990; Kahneman and Tversky, 1982; Gigerenzer, 1991; Clark,
1918; Neale and Bazerman, 1985; Cachon and Camerer, 1996; Camerer et al., 1993;
Akerlof and Yellen, 1985; Aumann, 1985; Grether, 1990; Neelin et al., 1988 and Weg
and Zwick, 1991). Mind senses and common senses are neither perfectly
applicable in all problems nor they are perfectly rational. But it does not
mean they are useless. When used with care and when corrected by reality, our
common sense and mind sense created the miracle we call our civilization. The
problem of the dominant economics school is not their models are useless; but
because they are used by dogmatic mind which has no interest to learn and
improve them.
So the real question is: does
perfect market theory has role to play beyond rat experiment, in this imperfect
world. The standard approach used in larger developmental economics is to
accept market failures, which will be introduced below, as real and to focus
then after on how to mitigate them in the due process. If the real world can be
made to behave like perfect market then we could have automatic development
through market forces (Akerlof, 1998).
Akerlof (1998, page 23) can give us
good summery in the following form without rejecting the failure of perfect market
theory
There
is a standard model of economic behavior, the Arrow-Debreu general equilibrium
model of perfect competition. While this model may not be entirely adequate as
a description of economic reality, it is most useful as a standard of comparison.
For in equilibrium in this model, subject to the careful qualifications of
Pareto optimality, peoples' lives are as pleasurable as they possibly can be,
given their tastes and productive capabilities. Consequently, to understand why
peoples' lives are not as pleasurable as they might be (in the Pareto sense),
it is necessary only to know why the real world fails to correspond to the
Arrow-Debreu Utopia.
The point is we should identify
the failures and remedy them to move toward perfect market as much as possible.
But this is challenged as absurd by many thinkers. For example Cimoli, et al. (2006,
page 2) stated
Conventionally, one would start from the
very general question when are public policies required from the point of view
of the theory and, as known, the standard answer would be "when there are
market failures" of some kind. However, albeit quite common, the “market
failure” language tends to be quite misleading in that, in order to evaluate
the necessity and efficacy of any policy, it takes as a yardstick those
conditions under which standard normative (“welfare”) theorems hold. The
problem with such a framework is not that "market failures" are not
relevant. Quite the contrary: the problem is that hardly any empirical set-up bears
a significant resemblance with the “yardstick” - in terms of e.g. market
completeness, perfectness of competition, knowledge possessed by decision
making agents, stationarity of technologies and preferences, “rationality” in
decision-making, etc. (the list is indeed very long!). In a profound sense,
when judged with standard canons, the whole world can be seen as a huge market
failure!
In addition
Herrick and Kindleberger (1983, page 96) stated even though neo classical see
development as simple as making the market work, socio cultural and political
institutions do influence the process of development. But
in neo classical economic analysis, the
operation of perfect competitive market tends to be seen as circumscribing the
limit of economic efficiency. Other systems are compared with market oriented
system, the usual question being the extent to which they can match its
performance. The possibilities of exceeding it are seldom considered.
The authors
also add the conclusion which states when development is perceived as market
perfecting process stagnation is wrongly associated with market failures and
none economic forces (Herrick and Kindleberger, 1983). Similar views are presented by Chang (2001, page 6)
In the neoliberal framework, the ideal
market is equated with the ‘perfectly competitive market’ of neoclassical
economics. However, the neoclassical theory of the market is only one of the
many legitimate theories of market, and not a particularly good one at that.
There are, to borrow Hirschman’s phrase, many ‘rival views of market
society’….. And therefore the same market could be seen as failing by some
people while others regard it as normally functioning, depending on their
respective theories of the market.
Objectively the problem can be
seen from two angles. The first one assumes perfect market to be optimal under
its assumptions. But given its
assumptions are unrelated to the real world, the logical question is does it
have any use? The second one logically rejects the perfect market as optimal allocator
of resource in dynamic sense. The logical question that follows then is if it
is not the best, given other theories can lead to superior dynamic efficiency,
why use it?
If perfect market can be proven
as efficient under its assumptions and if used with care, it could be still
useful in guiding our behavior in world filled with imperfection. The problem
of development is often ignorance about answer to the question: where are we
going in long run and how will things evolve in long run? Say our problem is
going from point A to point B in one location. A mad man draw a straight line
that connects A and B, then he assumed we are made for walking, with perfect
legs which never gate tired, and we have perfectly paved road that connect A to
B. His recommendation is run directly from A to B following this line to reach
destination. The problem is the real world is rough mountains terrain with deep
valley followed by dangerous cliffs in areas where the market is highly
dysfunctional and markets are none existence. When the mad man at barrel of gun
forces you to run toward cliff, he is very dangerous person. But his madness is
not without use, if you have freedom to be practical. The line gives you long
run direction that you have to follow in moving from A to B, while being
practical in due process.
If you are in middle of nowhere and
the only consistent knowledge you have is this map, how imperfect it is in
mapping the terrain and in modeling your nature, do you discarded it as
useless? The next step is to identify the failures of the map of the mad man
and the roads that have to be followed to deal with them. This is where
solutions in form of identification of market failures of traditional schools
of economics, institutional structure of the real world developed by new
institutional economists and political economy, and information problem
explained by information economists becomes handy in mapping the terrain and
the jungle of the real world. Those creative works, with the useful map of the
mad man, will guide us to move from point A to B though trial and error. This
is where most economists spend their time and energy.
Yes it should be used with care,
after all in allegory of the cave the one who saw the sun cannot easily rule in
darkness without becoming fool of the cave as unpractical man or mad king of
the poor. Knowing perfection gives you tool that should be used with great care
in adapting it to imperfect reality (Pluto, 380 BC). Even though the dominant
school of economics, which is presented as fool here, has serious assumption
related problems, the mathematical and theoretical consistency used in building
the micro and macro model for representative economic agent is really worth of
great admiration in comparison with most social sciences. Yes the emperor is
naked and his arrogance in trying to teach heavenly fashion at barrel of gun to
the world is terribly amusing. But still the emperor does and will remain
emperor of social science. This is because the mad man used the best known method
to connect A to B, which is consistent mathematical logic. More importantly the
dominant schools conclusion, to let the markets and prices free, is right not
because they are perfect in modeling, but because market is often reliable.
Yes there are many markets and in
theory some can be better than the market of this mad man. You can build line
which shows how to go from A to B in real world, but in practical thinking the
alternative roads which are mapped are fragmented, incomplete and highly
inconsistent from model to model. They show nothing than limit of perfect
market for real world and small map with incomplete knowledge. The emperor is
emperor not because of its strength. The emperor is emperor because weakness of
all its rival lords. The problem of building models which reject perfect market
in its entirety is well acknowledged by Stiglitz (2001), despite being the
prominent critic of such madness. At end of this section the reason for
fragmentation of heterodox ideas in economics will be explained from metaphysical
point of view and metaphysical limits of social science will be explained in
next section.
The serious problem to orthodox
theory is observed due to the fact that in dynamic context it can be shown the
perfect market allocation is not optimal allocation at all. The mad man really
lost it in dynamic sense. The map is really dangerous, when it is not the
shortest path from A to B. The problem comes from the fact that under dynamic
comparative advantage, in which dynamic comparative advantage is not only followed
but can be created, perfect market is neither optimal nor perfect. The idea
that productive capability lead to trade (List, 1909) verse free trade leads to
generation of productive capability (Smith, 1776) is old debate which vibrates
still in our time (Chang,
2001; Kattel et al., 2009; Reinert, 1996; Berger, 2009; Wong, 2004 and
Stiglitz, 2001). But it is true both are just partial true. In some case trade
crates market value for resource, technology of production and institution of
organization. This in turn will create comparative advantage as result. In
other direction comparative advantage leads to trade.
Ignoring the irrelevant debate,
the question is do we have to focus on static comparative advantage and let
market develop comparative advantage for us in dynamic sense (World Bank, 1991);
or do we need to crate comparative advantage by conscious choice (List, 1909; Chang, 2001; Kattel et al.,
2009; Reinert, 1996; Berger, 2009; Wong, 2004 and Stiglitz, 2001). Perfect
market is not efficient from dynamic point of view, because it will not lead to
technological progress and will not utilize economies of scale advantage
(Stiglitz, 2001; Chang, 2001; List,
1909 and Berger, 2009).
This is because profits have to be kept at normal level by high competition and
the model demands perfect information. If there is high competition economies
of scale advantage will not be attained in manufacturing and learning process
of industry will be killed (Berger, 2009; Wong, 2004; Chang, 2001 and List, 1909). In addition
perfect information will kill the chance for innovation by creating free rider
problems in technological developments (Stiglitz, 2001).
There are absurd schools who say
scarcity is not problem of economics. For example see the book edited by Berger
(2009) on circular and cumulative causation. This is good example to show how
absurd the heterodox lords who fight the mad emperor of the orthodox city are
making the naked mad emperor as socialite of the world. However a good model
that can explain the conflict is to understand the fact that under scarcity there
is allocative efficiency, technical efficiency and growth efficiency (Stiglitz,
2001). In trying to solve allocative and technical efficiency in static sense,
perfect market will lead to growth inefficiency (ibid). If you are house
servant without capital and high education, the perfect market theory will
demand that you focus on specialization as house servant. If you need to be
business man or doctor, the market will guide you through prices the mad man
says (see World Bank, 1991). Then following the efficient market you will
progress to be business man or doctor, and that is if it is will of market. We
should know this does not emanate from working of market principle, it emanates
from dogmatic believe on perfect market of the mad king.
Then the other side of the
problem known as political economy or heterodox economics will tell you, you
cannot be house servant to be slave of the rich people. After all what kind of
father sends his children to work under static comparative advantage than
building comparative advantage by sending them to practical or theoretical school
that makes you rich (Chang,
2001; Kattel et al., 2009; Reinert, 1996; Berger, 2009 and Wong, 2004)? This
is the debate of perfect market verse perfect state schools. All of them do acknowledge
imperfection of their favorable sward. The problem is they just ignore it in
practice, and will always say let the market free and the let the state free!
Guess if you are house servant, how disillusioned and numb you will feel in the
due process. You have to ask those who say let the state free where is my Santa
who can send me to school? Then you have to turn to those who cry let the
market free, is market for me or am I for market?
Any practical human being cannot
ignore all kind of efficiency side by side. A house servant has to think how he
can balance the need to meet current need while saving to the future from both
technical and allocative efficiency point of view. Then without destabilizing
what is possible now he has to build comparative advantage by taking different
courses or by starting new business that can run by current comparative
advantage. This again should lead to sustainable growth in income in long run. This
is common sense. You cannot build industrial development ignoring the
comparative advantage that you have now. You need resources for progress and survival;
after all you are not fathered enough by rich nations around the world to have
lovely time of development under childhood. You are poor man in dark world
sometimes crying about missing ladder and sometimes being fathered. So use the
resources at your disposal critically to build comparative advantage in highly
rewarding activity.
You cannot ignore today for the
future because today is what support your future and you cannot survive
otherwise. But you have to be smart enough to build comparative advantage in
highly rewarding areas with careful observation. This is development in simple
words. That is why even the existence of alternative source of efficiency
neither discount technical and allocative efficiency of static market, nor
justify the existence of market dogma that you have to follow as word of God to
make the price run wild like prophet of almighty God. Find the proper balance
by trial and error, taking the accumulated knowledge into account, and make it
work. This is simple answer because South Korea did not grow by economists,
China did not follow will developed theory toward progress and England did not
develop general theory toward progress before agricultural and industrial
revolution, there was a lot of learning process with trial and error that lead
to their success. Economists did not come before but after success with their
dogma to explain the success of practical people with real problems. If market
management and price distortion works to generate dynamic fitness, please
distort it by all means. But don’t distort it because your intellectual master
brainwash you to think that is how it is done, the devil is always in the
detail. We will come back to this issue at end of this section and next section
from metaphysical foundation. That being said, let explain market failures
next; so we can map the real world better. Market failures can be classified to
traditional and none traditional market failures. Traditional market failures
are market failures which are developed by orthodox school and none traditional
market failures are market failures developed by the heterodox schools.
[1] In
single auction either buyer or seller bid to buy or sell. In double auction
both buyers and sellers bid to buy and sell. It is well documented in above
stated experimental; research papers double auction is more efficient than
single auction.
[2]
Risk free life and certainty under market is not assumption of Rand (1964) but
she do also share her own share of absurdity which are not listed here too.
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