Markets Are Not Magic

This is probably motivated by the post on Ayn Rand.

To listen to some commentators is to believe that markets are the solution to all of our problems. Health care not working? Bring in the private sector. Need to rebuild a war-torn country? Send in the private contractors. Emergency relief after earthquakes, hurricanes, and tornadoes? Wal-Mart with a contract is the answer.

Whatever the problem, the private sector - markets and their magic - beats government every time. Or so we are told. But this is misplaced faith in markets. There is nothing special about markets per se - they can perform very badly in some circumstances. It is competitive markets that are magic, though even then we have to remember that markets have no concern whatsoever with equity, only efficiency, and sometimes equity can be an overriding concern.

In order to work their magical efficiency, markets need very special conditions to be present. There must be full information available to all participants. Product quality, locations and prices of alternative suppliers, every relevant piece of information must be known. Not quite sure if the wine is good or not? That's an information problem. Not sure if the used car has problems? Don't know where any gas stations are except the ones beside the freeway in a strange town? No way to monitor the quality of the building built in Iraq with U.S. aid? No way to be sure if consultants are worth the amount they are being paid? Information problems are common and they can cause substantial departures from the perfectly competitive, ideal outcome.

There also must be numerous buyers and sellers, enough so that no single buyer or seller's decisions can affect the market price. For example, if a firm can affect the market price by threatening to limit supply, the market does not satisfy this condition. If, as some claim, CEOs are in such short supply that they can individually negotiate their compensation, then the market is not producing an efficient outcome. Whenever there are a small number of participants on either side of the market - suppliers or demanders - this is potentially problematic.

In order for markets to work their magic, the product must be homogeneous. That is, the product or input to production sold by all firms in the market must be perfectly substitutable so that as far as the buyer is concerned, one is as good as the other. If some buyers favor one brand over another, if CEOs are perceived to have different and unique talents, if government favors one contractor over another due to political contributions, this condition does not hold. In many cases the variety may be worth the inefficiency, not many of us would want just one style and color of shirt to be available in stores, but the inefficiency is there nonetheless.

In order for markets to work their magic there must be free entry and exit. Most people understand free entry, but free exit is sometimes less evident, so let me try to give an example. Starting a blog on Blogger or TypePad is easy. Entry is a snap and you can be up and running in no time at all. It's easy to join the competition and start supplying posts. But suppose that later you decide you want to switch to, say, TypePad from Blogger (or the other way around). That is not so easy. There is no way, at least no simple and convenient way, to export all of your old posts from Blogger and import them into TypePad, a significant barrier to exit if a large number of posts must be moved. Whenever barriers exist in markets that prevent free movement into and out of the marketplace or between firms within a market (on either side - there are sometimes barriers to purchasing as well), markets will underperform.

The list goes on and on. In order for markets to work their magic, there can be no externalities, no public goods, no false market signals, no moral hazard, no principle agent problems, and, importantly, property rights must be well-defined (and I probably missed a few). In general, the incentives that the market provides must be consistent with perfect competition, or nearly so in practical applications. When the incentives present in the marketplace are inconsistent with a competitive outcome, there is no reason to expect the private sector to be efficient.

Markets don't work just because we get out of the way. When government contracts are moved to the private sector without ensuring the proper incentives are in place, there will be problems - waste, inefficiency, higher prices than needed, etc. There is nothing special about markets that guarantees that managers or owners of companies will have an incentive to use public funds in a way that maximizes the public rather than their own personal interests. It is only when market incentives direct choices to coincide with the public interest that the two sets of interests are aligned.

If there is no competition, or insufficient competition in the provision of government services by private sector firms, there is no reason to expect the market to deliver an efficient outcome, an outcome free of waste and inefficiency. Why would we think that giving a private sector firm a monopoly in the provision of a public service would yield an efficient outcome? If the projects are of sufficient scale, or require specialized knowledge so that only one or a few private sector firms are large enough or specialized enough to do the job, why would we expect an ideal outcome just because the private sector is involved? If cronyism limits the participants in the marketplace, why would we expect an outcome that maximizes the public interest?

There is nothing inherent in markets that guarantees a desirable outcome. A market can be a monopoly, a market can be perfectly competitive, a market can be lots of things. Markets with bad incentives produce bad outcomes, markets with good incentives do better.

I believe in markets as much as anyone. But the expression free markets is often misinterpreted to mean that unregulated markets are all that is required for markets to work their wonders and achieve efficient outcomes. But unregulated is not enough, there are many, many other conditions that must be present. Deregulation or privatization may even move the outcome further from the ideal competitive benchmark rather than closer to it, it depends upon the characteristics of the market in question.

For government goods and services, when incentives consistent with a competitive outcome are present, we should get government out of the way and privatize, and there are lots of circumstances where this will be appropriate. There is no reason at all for the government to produce its own pencils and pens, buying them from the private sector is more efficient so long as the bids are competitive.

When competitive conditions are not met but can be regulated, the regulations should be put in place and the private sector left to do its thing (e.g.  mandating that sellers disclose problems with a house to prevent asymmetric information or mandating that government funded projects be subject to competitive bidding and monitoring to ensure contract terms are met). There's no reason for government to do anything except ensure that the incentives to motivate competitive behavior are in place and enforced.

But rampant privatization based upon some misguided notion that markets are always best, privatization that does not proceed by first ensuring that market incentives are consistent with the public interest, doesn't do us any good. There are lots of free market advocates out there and I am with them so long as we understand that free does not mean the absence of government intervention, regulation, or oversight, even libertarians agree that governments must intervene to ensure basics like private property rights. Free means that the conditions for perfect competition are approximated as much as possible and sometimes that means the presence - rather than the absence - of government is required.

Comments

[supersaurus]

the simple statement that "markets are always best" appeals to people who want to substitute religion for economics.

[Real Person from the Real World]

NYT 4/4
....far more people work under contracts than are directly employed by the government. Even the government’s online database for tracking contracts, the Federal Procurement Data System, has been outsourced (and is famously difficult to use).
....While flagrant cases of fraud and waste make headlines, concerns go beyond outright wrongdoing. Among them:
Competition, intended to produce savings, appears to have sharply eroded. An analysis by The New York Times shows that fewer than half of all “contract actions” — new contracts and payments against existing contracts — are now subject to full and open competition. Just 48 percent were competitive in 2005, down from 79 percent in 2001.
####

Contractors are a RED HERRING. We don't have smaller gov't, we just pay Thru the nose, for someone else to do the work.

[Gabriel M.]

Compare the real with the real, please. You haven't shown you can do better than (the maybe flawed) unregulated markets.

More precisely, you haven't shown that regulation can do what you claim it would. So it's faith on both sides, to say the least.

Case in point, the government is bound by the same private information issues as private actors. How would you expect to improve on that? Groves mechanism? Nation-wide?

But, beyond that, you subject markets to unnecessarily stringent conditions. Townsend, for example, has some nice results in that direction. Core convergence theories are also interesting.

Nevertheless I must insist that you can't applied the same scrutiny to government regulation also. In what circumstances does it fail? Or maybe I should ask, in the interest of brevity, in what circumstances it doesn't.

Theory might be fine and nice, and the Pareto criterion might be interesting, in certain circumstances, but the historical record is pretty clear. -- Picking on perfect competition is easy. Picking on the record of laissez-faire nations isn't.

The problem with "contractors" is mainly that government is doing things it has no business doing in the first place.

[quartz]

Especially important as you note is competition. This is why the frequent conflation of free markets with capitalism or corporate interests more broadly is incorrect. As noted by Adam Smith, companies hate competition and want the market rigged in their favor. The proper role of regulation is to make markets work better by taking steps that increase competition, lower barriers to entry, increase disclosure of information, etc., while a large amount of corporate lobbying is about reducing competition or tilting th playing field to favor one group over another.

[Idaho_Spud]

The govenment got out of the way in Darfur. Should be the perfect place for a libertarian to see if theory and practice really jibe.

[Scot]

Excellent post. I guess the only point I would make is that you have the same kinds of principal/agent problems with government. Have to consider the public choice implications of government, too.

Government action can't be brought in as deus ex machina.

Again, excellent, thoughtful post. Keep 'em comin'.

[ken melvin]

Markets are Stone Soup! Great post.

[anne]

http://www.nytimes.com/2007/02/04/washington/04contract.html?ex=1328245200&en=a8333bd1bc365aa5&ei=5090&partner=rssuserland&emc=rss

February 4, 2007

In Washington, Contractors Take on Biggest Role Ever
By SCOTT SHANE and RON NIXON

WASHINGTON — In June, short of people to process cases of incompetence and fraud by federal contractors, officials at the General Services Administration responded with what has become the government's reflexive answer to almost every problem.

They hired another contractor.

It did not matter that the company they chose, CACI International, had itself recently avoided a suspension from federal contracting; or that the work, delving into investigative files on other contractors, appeared to pose a conflict of interest; or that each person supplied by the company would cost taxpayers $104 an hour. Six CACI workers soon joined hundreds of other private-sector workers at the G.S.A., the government's management agency.

Without a public debate or formal policy decision, contractors have become a virtual fourth branch of government. On the rise for decades, spending on federal contracts has soared during the Bush administration, to about $400 billion last year from $207 billion in 2000, fueled by the war in Iraq, domestic security and Hurricane Katrina, but also by a philosophy that encourages outsourcing almost everything government does.

Contractors still build ships and satellites, but they also collect income taxes and work up agency budgets, fly pilotless spy aircraft and take the minutes at policy meetings on the war. They sit next to federal employees at nearly every agency; far more people work under contracts than are directly employed by the government. Even the government's online database for tracking contracts, the Federal Procurement Data System, has been outsourced (and is famously difficult to use).

The contracting explosion raises questions about propriety, cost and accountability that have long troubled watchdog groups and are coming under scrutiny from the Democratic majority in Congress. While flagrant cases of fraud and waste make headlines, concerns go beyond outright wrongdoing. Among them:

¶Competition, intended to produce savings, appears to have sharply eroded. An analysis by The New York Times shows that fewer than half of all "contract actions" — new contracts and payments against existing contracts — are now subject to full and open competition. Just 48 percent were competitive in 2005, down from 79 percent in 2001.

¶The most secret and politically delicate government jobs, like intelligence collection and budget preparation, are increasingly contracted out, despite regulations forbidding the outsourcing of "inherently governmental" work. Scott Amey, general counsel at the Project on Government Oversight, a watchdog group, said allowing CACI workers to review other contractors captured in microcosm "a government that's run by corporations."

¶Agencies are crippled in their ability to seek low prices, supervise contractors and intervene when work goes off course because the number of government workers overseeing contracts has remained level as spending has shot up. One federal contractor explained candidly in a conference call with industry analysts last May that "one of the side benefits of the contracting officers being so overwhelmed" was that existing contracts were extended rather than put up for new competitive bidding.

¶The most successful contractors are not necessarily those doing the best work, but those who have mastered the special skill of selling to Uncle Sam. The top 20 service contractors have spent nearly $300 million since 2000 on lobbying and have donated $23 million to political campaigns. "We've created huge behemoths that are doing 90 or 95 percent of their business with the government," said Peter W. Singer, who wrote a book on military outsourcing. "They're not really companies, they're quasi agencies." Indeed, the biggest federal contractor, Lockheed Martin, which has spent $53 million on lobbying and $6 million on donations since 2000, gets more federal money each year than the Departments of Justice or Energy.

¶Contracting almost always leads to less public scrutiny, as government programs are hidden behind closed corporate doors. Companies, unlike agencies, are not subject to the Freedom of Information Act. Members of Congress have sought unsuccessfully for two years to get the Army to explain the contracts for Blackwater USA security officers in Iraq, which involved several costly layers of subcontractors....

[anne]

Markets, markets for all, we got markets.... Nice essay, Mark.

[Laurent GUERBY]

Excellent post, this was the view not so long ago of reasonable european politicians. Some economics obvious rule even has constitutional status in France, here is the preamble of 1946 constitution (which has constitutional value):

"Tout bien, toute entreprise, dont l'exploitation a ou acquiert les caractères d'un service public national ou d'un monopole de fait, doit devenir la propriété de la collectivité. "

In short: all de facto monopolies must become the property of the state.

But now "free market" fundamentalism is all over the place there too, capitalizing of the wide power and democratic deficit of european union institutions.

The latest mess is about energy, here are two articles by European Tribune web site editor Jerome Guillet about it have been printed in the press (Foreign Policy and Financial Times):

"Don't Blame Gazprom for Europe's Energy Crunch"
http://www.eurotrib.com/story/2007/2/2/2651/17810

"Liberal markets create an addiction to gas"
http://www.eurotrib.com/story/2007/1/31/163656/489

[jamzo]

"I believe in markets as much as anyone"

this phrase defines the problem

and it leads to the constant framing of issues as markets vs government

[Laurent GUERBY]

I copied part of your post and linked the rest at European Tribune:

http://www.eurotrib.com/story/2007/2/4/111010/0648

[anne]

Notice that the President is both inventing markets to undermine governing agencies, while creating a political commissariat to undermine the efficiency and fairness of all that government must do even under a market investing President....

http://www.nytimes.com/2007/01/30/washington/30rules.html?ex=1327813200&en=cfa88d4738fced9a&ei=5090&partner=rssuserland&emc=rss

January 30, 2007

Bush Directive Increases Sway on Regulation
By ROBERT PEAR

WASHINGTON — President Bush has signed a directive that gives the White House much greater control over the rules and policy statements that the government develops to protect public health, safety, the environment, civil rights and privacy.

In an executive order published last week in the Federal Register, Mr. Bush said that each agency must have a regulatory policy office run by a political appointee, to supervise the development of rules and documents providing guidance to regulated industries. The White House will thus have a gatekeeper in each agency to analyze the costs and the benefits of new rules and to make sure the agencies carry out the president's priorities.

This strengthens the hand of the White House in shaping rules that have, in the past, often been generated by civil servants and scientific experts. It suggests that the administration still has ways to exert its power after the takeover of Congress by the Democrats....

[Carolyn Kay]

And it’s because of the need for regulation, to keep the least scrupulous from running all over the rest of us (which hasn’t been working so well since 1994), we need to make sure that government can’t be shrunk to a small enough size to be drowned in a bathtub. In fact, government has to be at least as powerful as the most powerful combination of business interests, to protect us.

And quartz,

It's human nature, the need for at least the illusion of certainty and security, that drives business leaders to carve up markets, fix prices, and do all the other things we need regulations and enforcement to keep them from doing. That need will never go away. So the need for government will never go away, either.

Carolyn Kay
MakeThemAccountable.com

[Meh]

Gabriel M. your notion that someone should provide proof for the idea that the decision should be made on case by case basis sums up your problem.

[Bernard Yomtov]

Excellent post. Should be required reading for anyone interested in economic matters. I do think it is unfortunate that we have come to use the phrase "free markets" as a synonym for "competitive markets." That leads to a lot of misunderstanding.

Gabriel M. asks you to compare real to real. Fair enough, but two points need to be made:

1. Market-worshippers typically don't do this. Instead they insist that markets are ideal in all but the rarest of circumstances. That is, rather than comparing "real to real" they compare "negative stereotype of intervention" to "idealized image of market."

2. The "laissez-faire nations" are very far from operating unregulated economic systems. I don't think the historical evidence refutes Mark's points.

[bakho]

Yglesias explains why government contracting is not free market:

The Trouble With Contracting

The trouble with government work, as opposed to the private sector is that there's a lack of efficiency. It's important to understand, however, that there's nothing intrinsically efficient about private sector work. No magical "it's the free market" dust comes and renders private enterprises effective. Rather, the idea is simply that an inefficiently run private enterprise (and there are many) would simply go out of business. An inefficiently run government office, by contrast, goes out of business when it loses political support and sees its budget grow as long as it maintains political support. Thus, you see public sector dollars flowing to whatever there's a strong political constituency for, whereas private sector dollars flow to wherever well-managed firms are meeting demand.

Then enter government contractors which, as The New York Times points out, have exploded to unprecedented levels under George W. Bush and the late unlamented Republican congress. Here you have private enterprises displacing government. Why? For the private sector efficiency, of course! But you don't actually get that efficiency. It's still a government program. Funding is still being determined by political support. The cash doesn't go to companies that can do a really good job, it just goes to companies that have political clout -- i.e. ones that recycle a share of their profits into campaign contributions. It's essentially the worst of both worlds, since you get the inherent problems of the public sector plus the need for owners to be taking a slice off the top in profit margins. It is, however, a very good deal for politicians interested in union-busting and for politicians interested in raking money in from government contractors. Shockingly, the GOP loves it.

http://www.matthewyglesias.com/archives/2007/02/the_trouble_with_contracting/

[Haralambos]

I will be sending a link on to several friends. I come here almost every day because of the consistently excellent explanations and the true value added to my understanding of economics. Thank you, philosopher in Greece

[spencer]

Outstanding.

[Not an expert]

What an excellent review of basic economic principles. They need to be reviewed from time to time just to keep our heads screwed on straight. For those who tout the "magic of markets" in any argument, my favorite canard is when they begin spouting about the mysterious "invisible hand" of the market.

[mrrunangun]

In "The Cash Nexus" Niall Ferguson takes a whole book to illustrate that it is the strength and flexibility of a nation's financial system taken as a whole-which is in large part determined by its legal system as it applies to finance and commerce-that determines a nation's potential for power. It is not possible to separate finance and commerce from regulation. It is in the aims of, and degree of corruption in, the regulation that differ so much between the successful and unsuccessful economies.

[Bruce Wilder]

Oh, fear and loathing.

I regard libertarianism with intellectual contempt, and reflexive "privatization" as thinly disguised reactionary, interest politics.

But, I don't like the frame of this post. "Markets work their magic" -- oooh, yuck! "Magic"! Shudder. "there can be no externalities, no public goods, no false market signals, no moral hazard, no principle agent problems, and, importantly, property rights must be well-defined . . .In general, the incentives that the market provides must be consistent with perfect competition" Eeegad! Lists. Magic and perfection???

Although I agree with the sentiment, this is very poorly framed, as a matter of philosophy and economics.

The reason to think through the case of perfect competition is theoretical: it is the best way to work out what is meant by a variety of concepts, including, centrally, the concept of "efficiency" itself, and the relation of market prices to efficiency.

The central problem of economics is not markets, per se, but organization: the organization of human effort in a scheme of distributed and (partially) decentralized decision-making, combined with a highly specialized division and application of resources in production.

Markets are not an alternative to government regulation; nor are administrative hierarchies (aka bureaucracies) alternatives to markets. They are different -- and in an approximately efficient world, complementary -- means of organization.

When Bush "privatizes" some government function, he is not substituting a market for a bureaucracy -- he's substituting a private bureaucracy for a public one, at higher net cost, so that a political supporter can make a profit. All the economic mumbo-jumbo is just a smokescreen to hide graft. Duh.

But, the philosophical frame, which treats a theoretical analysis of perfect competition as a template for mapping the world troubles me more than the thin disguise worn by Republican corruption.

The kind of economic performance, which inclines the economic laity to believe in the power of business is not the product of perfect competition, or anything remotely like it. In contrast to the static, profit-less efficiency of the anonymous firm, bereft of strategic power, which inhabits the conceptual world of perfect competition, the exemplars of capitalist accomplishment -- from Cornelius Vanderbilt, Andrew Carnegie, George Hearst and John D. Rockefeller through to Bill Gates -- have been monopolists or near-monopolists, adept at strategic investment and dedicated to building great, vast organizations -- and dare I say it, bureaucratic organizations: railroads, steel companies, Standard Oil (now Exxon-Mobil), Microsoft. What General Motors or Toyota, Boeing or Airbus, Oracle or Google, McDonalds or Sony, have to do with the theory of perfect competition in markets I can scarcely imagine. Magic, indeed.

[Bruce Webb]

What Spud said.

Libertarians are fond of claiming "An armed society is a polite society" in their absolute 2nd Amendment stance. They write novels around that concept, you want some classics pick up the Weapons Shops by deCamp or Beyond this Horizon by Heinlein.

Then you have Iraq. It seems that every Iraqi man and boy has at least one AK47 and pretty free access to RPGs. By Libertarian lights it should be the most polite place in the world. Somehow I don't think the chaos there is purely the fault of the Black and Decker drills.

Which won't stop the clowns from suggesting that the solution to school violence is to give each teacher a gun.

On markets. The biggest threat to free market fundamentalists is a big government solution to a big social problem that delivers efficiently. In reality that happens all the time. My medium size town has beautiful streets, roads and parks, all provided by the City's Public Works Department with city crews. But good government is like air, you don't notice it until it is absent.

Which is why my own pet project is so important. Social Security is not just important in itself, it is also a huge symbol, and one that has been used with abandon by Free Marketeers. Its widely proclaimed imminent failure has been used for decades by the Economic Right to validate their theory of unfettered markets and privatization. A solvent Social Security system drives a theoretical stake through their vampirish hearts. And they know that full well.

Social Security is not fundamentally about the numbers. It is about the New Deal kicking Objectivism in the teeth. A seventy two year battle to kill Social Security and validate unfettered private market solutions to everything is coming to a climactic moment. And privatizers are losing. They don't like losing and tend to lash out. Watch for it.

[CL- Oregon Girl]

Bravo, now if only the White House could read...

[mrrunangun]

Idaho Spud,
Darfur does not illustrate the government's ignoring a situation. Indeed the government there is vigorously supporting the campaign of one group of its citizens to despoil another group of its citizens. It is unusual in the lengths to which the despoilers have been allowed to go. Royal and totalitarian governments have used divde et impera as an instrument of domestic politics routinely. As for our government, it's wisely decided Darfur's none of our affair. Would it were so wise about Iraq.

[dissent]

In the real world, faith in markets operates as a quasi-religious faith, with one caveat: all morality has been stripped away. So the market god is essentially an avaricious, greedy deity.

The right wing has been ascending since about 1980 (earlier if you think Carter was an aberation due to Watergate). During this period of increasing dominance in "free" markets, the USA has become brutalized. Look at:

• the per cent of our population that we imprison, compared to any other industrialized nation.


• the per cent of our population that has no health insurance, compared to any other industrialized nation.


• cost of college tuition, compared to any other industrialized nation.


• the insecurity of our middle class.


• levels of inequality and political and economic dominance by corporate and financial elites.


• the decline of class mobility and the rise of stratification.

With this as the background, we brutalized Iraq. For our (sick) fantasies, we destroyed a country. Iraq is the tragedy that demonstrates our sickness of mind and heart.

I am sick to death of the right wing. Thanks to you guys, I have learned to both hate and despair for my country. And a large part of your insanity is the 'Market God'.

Of course I hardly view hard core religious godliness as the antidote. Fundamentalists are among the most selfish and arrogant creatures on the planet: they will kill anyone and destroy anything if they can convince themselves that by doing so they get more 'heavenly brownie points'. I have noticed that while many neo cons and conservatives have examined their mistakes with anguish wrt Iraq, the fundamentalists have remained silent. No remorse, no reflection, no regret. They waded neck deep into a river of blood and they don't notice, let alone care.

Listen, market dummies: there are no short cuts. No short cuts to good judgement, good character, good policy. No short cuts to education. No short cuts to a clean environment. No short cuts to democracy. No short cuts to community values.

Grow up. Get real. The "free" market solution to these problems is easy and BOGUS. Haven't you done enough damage? When are you going to learn from your mistakes?

Lastly, I resent that you have absconded with the word "free". You have violated a beautiful word and concept.

[Lafayette]

MT: "There must be full information available to all participants. Product quality, locations and prices of alternative suppliers, every relevant piece of information must be known."

Markets are a meeting place for two agents: the consumer and the supplier.

For markets to be fair and equitable there must be equilibrium between the two agents. Not too few consumers and not too few suppliers. The opposite is not necessarily true. Too many consumers and too many suppliers and the market will be provoked to find another equilibrium that stabilizes demand with offer.

What makes a market move? In a modern society, birth rate furnishes what is necessary for a market to expand and grow. This is a necessary but not sufficient attribute. We are all born consumers, but people do not all consume in the same manner.

Too few consumers and certain markets are not "fair". Telephony, once dependent upon distance, is just such an example. The market for urban telephony was not the same as the rural one. Rural telephony was expensive to access for a very small market. Some utilities are still like this. Electricity comes to mind. Schooling is another.

So, there are "conditions" that can provoke the state to make the markets more fair, such that all can avail themselves of necessary services. The state can therefore license certain activities based upon the condition that the total market is served and not just the juiciest pickings.

What else can the state do for markets, especially new ones? Again telephony comes to mind, particularly the mobile kind. In Europe, the countries agreed on a standard (GSM) and all countries were to implement that mobile communication protocol - assuring that each country had at least three companies offering the service.

This provided an impetus not only to concentrate investments in only one protocol, which proved expensive enough to develop. It also assured that with only one kind of network, the equipment vendors would easily achieve breakeven on the products they offered. This helped to keep prices low and to promote a uniform market expansion from Iceland in the northwest to Greece in the southeast.

In the US, genuflecting to the conventional wisdom that only markets know what is best for markets, allowed a patchwork of different standards to battle it out till a bloody finish. This meant, inevitably, that the US was as much as three to four years behind Europe in the development of an integrated coast-to-coast system.

The state therefore can and should become involved in areas where markets cannot assume the entire burden of bringing forth an offering that is uniformly available, inexpensive and state-of-the-art. (Health services is just one such market that comes to mind. America, once again, must play catch-up with Europe.)

Markets are, yes, faulty mechanisms ... but the alternative is even worse.

[Lafayette]

LG: "In short: all de facto monopolies must become the property of the state."

In fact, it was the state that created monopolies in the first place.

Postal services, telephony and telecommunications and electricity/gas all come to mind ... they were state monopolies in most of Europe.

The idea, at first, was sane. Europe needed reconstruction after WW2 and the best way to channel Marshall Plan aid was through the state. So, the politicians created these crucial monopolies for public utilities.

Unfortunately, someone forgot to tell the politicians that these state monopolies were no longer necessary once the infrastructure was built and running smoothly. What happened was inevitable. Union syndication took control of the labor force and politically made life miserable for the government as regards running the monopolies. A strike at any given public monopoly effectively shut down the service nationally, causing extensive disruption - thereby giving the unions enormous bargaining power.

Thirty years later, Europe is still contending with modern infrastructures for some services, but run like feudal fiefs. In France, the circumstance is made even more complex by the fact that members of a certain school (ENA) not only run the government but have also run the state monopolies - which meant that the inefficiencies due to a lack of competition have been paid by the consumers through higher than necessary pricing.

This worked for the better part of 40 years, from 1950 to 1990 (or thereabouts), when the winds of deregulation blew in from Brussels and each country slowly, slowly, ever so slowly started to melt the icebergs into a series of smaller but more efficient torrents.

It is a long and difficult process. That France is the slowest to have moved towards deregulation surprises no one. It is hindered by a political class that thinks “national champions” are what is best for France. One cannot imagine why.

[dissent]

Markets are, yes, faulty mechanisms ... but the alternative is even worse.

I look with envy and despair on those European countries whose citizens have a much higher quality of life, precisely because they don't believe this hogwash, and regulate their markets!

[donna]

"To market, to market, to buy a fat pig..."

Hey, if markets are so great, why is it impossible for me to go down to my local store and buy a fat pig, huh? Or a chicken, for that matter.

Markets suck. ;^)

[Dan Hirschman]

Fabulous post!
My only quibble is this idea that only "sometimes" does the government need to get involved, i.e. when something goes wrong. Let's take just one of the necessary pre-conditions - well-defended property rights - and think about how massively impossible that condition would be without a strong, functioning, involved government. Especially in the modern (and problematic) era of intellectual property rights, a strong government with the capability to legislate rules for such property rights, enforce such rules and decide disputes is vital. Add to that all the sorts of communal property that needs to be distributed (radio frequencies and the like) and all adds up to a pretty involved government pretty quickly. The myth that you can ever have a functioning market in the modern world without the government is just that, a myth, and should be fought. We can argue about the degree and character of government entanglement (not intervention; as government is a prerequisite to a functioning market) with markets, but where can we find a functioning market with no government to at least protect property rights?

[JRossi]

Excellent post. So managing a macroeconomy, like other complex jobs, requires intelligence, judgment, an ability to see reality clearly, a willingness to make mid-course corrections based on new information. Unfortunately, our president is a damn fool. Much of our punditocracy and power elite consists of damn fools, ideologically-blinded damn fools, and cynical players. I hope things get better in a couple years.

[js paine]

mark

nice summary

[Lafayette]

dissent: "I look with envy and despair on those European countries whose citizens have a much higher quality of life, precisely because they don't believe this hogwash, and regulate their markets!"

Come live here ... so you can better appreciate our regulated markets.

And our 10% unemployment (average rate) for the past 25 years.

[liberal]

Lafayette wrote,

In fact, it was the state that created monopolies in the first place.

Postal services, telephony and telecommunications and electricity/gas all come to mind ... they were state monopolies in most of Europe.

The idea, at first, was sane. Europe needed reconstruction after WW2 and the best way to channel Marshall Plan aid was through the state. So, the politicians created these crucial monopolies for public utilities.

True. But telephony was a state-sanctioned private monopoly in the US, for a much more general reason---at the time it was a natural monopoly.

While recent decades saw this monopoly as eventually unnecessary, it performed extremely well in its day. IIRC the book The Trouble with Computers describes large productivity advances within the Bell system, created despite the lack of competition. Bell also produced one of the most important technological innovations of the last century---the transistor, without which there'd be no computer revolution.

And the problem with inertia in the dismantling of state or state-sanctioned monopolies works also in the other direction: The empirical evidence is conclusive that a single payer system for health insurance is simply more efficient than a private market, but there are enormous political obstacles to overcome in the replacement of the private system with a monolithic, more efficient public one.

[liberal]

Lafayette wrote, And our 10% unemployment (average rate) for the past 25 years.

It's true Europe has a high unemployment rate, measured fairly. It's also true that the difference with the American rate is exaggerated because of differences in the definition of who's in the labor pool.

[liberal]

Dan Hirshman wrote,

Let's take just one of the necessary pre-conditions - well-defended property rights - and think about how massively impossible that condition would be without a strong, functioning, involved government. Especially in the modern (and problematic) era of intellectual property rights, a strong government with the capability to legislate rules for such property rights, enforce such rules and decide disputes is vital. Add to that all the sorts of communal property that needs to be distributed (radio frequencies and the like) and all adds up to a pretty involved government pretty quickly.

Unfortunately, this is an example where government gets it wrong much of the time (though as you rightly point out there's no possible just or efficient private mechanism).

At least today, in the US, so-called "intellectual property rights"---perhaps better known as "economic rent collection certificates"---are far too strong, and government shows no sign of changing this. It's a classic case of the political power of rent collectors, albeit one that notional right-wing "libertarians" usually seem to get wrong (many of them siding with the rent collectors).

An even bigger issue is land rent. Without government regulation, you get Somalia, something libertarians refuse to acknowledge. Unfortunately, things are still pretty suboptimal, insofar as government largely serves to stuff the pockets of land owners full of money, in return for nothing, as Henry George pointed out more than a century ago, which is both inequitable and inefficient. (It's by far the most important example where efficiency and equality are directly and not inversely related. Not equality of outcomes, of course, but a fundamental equality---that of access to natural resources that no man created.)

The point being implicit in your Add to that all the sorts of communal property that needs to be distributed (radio frequencies and the like) and all adds up to a pretty involved government pretty quickly. Namely, natural resources and other sources of economic rent must be allocated by government for reasons of both efficiency and equity.

Of course, government often gets things wrong and ends up creating rent collection opportunities.

[Lafayette]

MT: "When government contracts are moved to the private sector without ensuring the proper incentives are in place, there will be problems - waste, inefficiency, higher prices than needed, etc."

Not all markets function optimally. They must sometimes be assisted.

Take real estate, for instance. If a state is to assure basic needs of its citizens, then it must take into account that not all of its citizens can afford proper housing.

There is nothing wrong with the state buying land and having private enterprise build suitable, lower-priced accommodation for a poorer class of citizen. The point is to make housing affordable at a price that a working individual (at the poverty line) can afford.

One cannot expect the market to attend these needs, since businesses will be seeking only those markets that give a superior yield. This clearly leaves the poor out of sight.

Much of what Thoma writes seems to give markets a sentient attribute, as if they knew the difference between right and wrong, between fairness and unfairness, between openness and closeness. They don’t, obviously.

Markets are virtual aggregates of agents (buyers/sellers) who negotiate a product/service for a price. They often require state intervention to assure that either the buyer or seller is behaving in a manner that allows markets to be orderly.

And, markets often require the state to by catalytic, without which the market would not even exist unless the state assures its existence.

[Laurent GUERBY]

Lafayette, unemployment rate in 2004 for male 25-54 in the USA was 4.6% and in France it was 7.4%, so 60% higher.

Huge problem in France?

Now, let's check another number for the same period and the same population: the employment rate. In the USA it was 86.3% and in France it was ... 86.7% (all OECD normalized numbers).

You read well: more people working AND 60% more unemployment in this subset of population.

Lafayette, one of these day you'll try to look at the real world, and when you do so you'll stop using unemployment numbers. Ping me when this happens :).

As far as state monopolies are concerned, I'm greatly enjoying all the "economists" who say that privatization and free markets has created broadband by "market magic".

When you look at reality again, in Frane it is the state that FIXED THE PRICE of last mile connection BY LAW. Yep, just like in Soviet economies, price fixing by the government. And my broadband is cheap and works great. Magic?

[Lafayette]

liberal: "It's also true that the difference with the American rate is exaggerated because of differences in the definition of who's in the labor pool."

Unfortunately, that is not as true as you may think.

Look at the BLS date which is massaged to report international unemployment rates that are comparative with American stats.

Even comparably, Europe has had higher rates generally for far too long. And, it is the conventional wisdom that this is due to regulated markets.

NB: I think it is also due to the lack of mobility across Europe. If a Spaniard loses his job in Barcelona, he’ll not likely find one in Berlin.

[Lafayette]

LG: "Ping me when this happens :)."

Ping.

"As far as state monopolies are concerned, I'm greatly enjoying all the "economists" who say that privatization and free markets has created broadband by "market magic"."

What the hell do you mean by this? Explain yourself.

Vous préfériez peut-être vous expliquer en Français? 8^0

[Lafayette]

LG: "When you look at reality again, in Frane it is the state that FIXED THE PRICE of last mile connection BY LAW."

France did no such thing.

When it should have privatized the telephone network, a socialist government caved into union pressure and allowed France Telecom to keep possession of and to "maintain" the lines, for which it obtains a very handsome 14€ per month, about three times what it should cost the consumer. (It did this to save jobs at feather-bedded France Telecom, so the consumer simply ends up paying indirectly for France Telecom personnel who would othewise be unemployed.)

Not only, but by doing so, the incumbent operator maintained a lion's share of the telephony market until only recently when, finally, competition was able to force open the market with lower pricing. This obliged France Telecom to bring Wanadoo (its broad-band operator) in-house in order to save itself from utter self-destruction as the telephony market was going to hell in a hand-basket.

As for broadband, the price is fixed by competition and not the state. The state has only fixed the line maintenance fee and not the cost of establishing the last mile. (A friend just moved into a newly constructed house here in France and, believe me, HE PAID THROUGH THE NOSE FOR THAT DAMN LAST MILE TO HIS DOOR! Eighty euros, to be precise, to install a line from the street to her house, about fifteen meters away.)

And, I'll not start ranting about EDF, another wooly-haired mammoth (of a "Champion Nationale") from the ice age. That would only make you angrier, wouldn’t it?

[ucscuple]

A perfect post. I really liked that!

[Jonathan Goldberg]

Bruce:

Weapon Shops (The Weapon Shops of Isher) is by A. E. van Vogt, not deCamp.

And it's IMHO not in the same class as Beyond This Horizon, which is well into tinfoil hat territory.

[Noni Mausa]

dissent: "...faith in markets operates as a quasi-religious faith, with one caveat: all morality has been stripped away. So the market god is essentially an avaricious, greedy deity."

Yep, name of Mammon.

Bye the way, keep a sharp eye out for irony and sarcasm on this site, plus context -- it might help you keep your blood pressure down.

I tend to think of the uncontrolled corporations and markets as large and useful farm animals, which need to be tended and controlled.

OF COURSE the cow is going to try to get into the alfalfa, and the horses will want all oats and no hay. OF COURSE they have no inherent morals -- where would they get them?

They are capable of things which most individuals and communities are not, just as the horse can pull the plow (I sure can't)

But this doesn't mean the horse should have sleep in a gold plated stable and eat his oatmeal with brown sugar,heavy cream, and a dab of fresh butter.

Noni
hungry now...

[James Kroeger]

All excellent points, Mark.

I would only add that---while it is true that competitive markets are unsurpassed in reducing costs and optimizing raw economic efficiency----cost minimization is not always the sole benefit we seek from productive industries. As we all know, firms also compete with each in providing higher levels of quality to consumers. Higher quality services are usually not the lowest cost services.

The Quality Variable becomes even more important to citizens living in economically advanced societies. In poor countries, it is understandable that gains in efficiency would be more important than any other consideration. But the richer an economy becomes, the more interested participants will be in spending some of their increased purchasing power on higher quality services/goods, even if the price paid to achieve those higher levels of quality is higher cost (more 'waste'). None of this should be news to those who provide goods and services to the wealthiest members of society.

More on this: Government Bureaucratic Waste vs. Private Sector Efficiency

[Movie Guy]

Speaking of markets...

Superbowl

A man had box seat tickets for the Super Bowl.

As he sits down, a man comes down and asks
if anyone is sitting in the seat next to him.

"No," he says. "The seat is empty."

"This is incredible," said the man. "Who in
their right mind would have a seat like this for
the Super Bowl, the biggest sporting event in
the world, and not use it?"

The first man says, 'Well, actually, the seat
belongs to me. I was supposed to come with
my wife, but she passed away. We had dreamed
of the Colts getting to the Super Bowl for years
and we vowed we'd be there when it happened."

"Oh .. I'm sorry to hear that. That's terrible. But
couldn't you find someone else, like a friend or
relative, or even a neighbor to take the seat?"

The man shakes his head. "No. They're all at
the funeral."

[realpc]

I doubt there are many free market advocates who think markets are perfect. I think almost everyone agrees with most of what Mark said -- nothing is perfect, everything is complicated and difficult. We all know that, or we all should know that.

It's only ideological fanatics who think they have a simple cure-all. Everyone else knows that freedom depends on free enterprise and private property. We also know that freedom depends on rules and regulations. We must have an elected government with the power to make and enforce laws, a government that has at least a minimal desire to keep things at least somewhat fair.

You can find a wacko libertarian here and there who wants to eliminate all regulations. You can also find Marxists who want to hand their lives over to an all-powerful government, and would force us all to do the same.

Everyone else, the overwhelming vast majority, thinks approximately what Mark said in this post. That is the common sense of the American public outside academia. That is why the left-right dichotomy is obsolete and nonsensical. We all believe the same thing about economics and government.

Believing and achieving are too completely different things, however. Once you get past the artificial unrealistic ideologies, you have to deal somehow with the messy complicated realities.

[Winslow R.]

I liked the post, but...

Markets create 'efficient' solutions that maximize markup.

Government create 'optimal' solutions that maximize the ability to govern.

To expect government to increase market efficiency through regulations that increase competitiveness is a stretch unless it is in the interest of the majority of voters or at least those in power.

This article may alert the general population to pay closer attention. Perhaps we need an independent fourth branch of government to alert us to the foibles of the other branches. The Fed reserve would love to claim the mantle but is too closely tied to the banking industry.

How about a competition to find the most uncompetitive, highly regulated market with the most barriers to entry? Banking would get my vote.

[Lafayette]

NM: "OF COURSE they have no inherent morals -- where would they get them?"

Wherever DO they get them? On the boob-tube.

Do you expect Americans to obtain a sense of social solidarity whilst watching Oprah (or whatever her name is)? They watch Oprah because she is an eminently successful woman ...

The role model of values in America has become a class of elites who have been successful at accumulating delirious amounts of capital. This class numbers in the tens of thousands within a nation of nearly 300 million people.

Each nation seeks/creates their role models and America has done a marvellous job at crafting theirs. The media is complacent in giving Americans what they seek - heroes Americans can adulate.

To change American mentalities is a monumental task, so ingrained has the rat-race to riches become.

I don't see the political leadership on the horizon to change grassroot mentalities. (On both sides of the aisle, millionaires are everywhere.) And, whilst the grassroots are fixated on TV talking-heads for their information and values, neither might one see any change happening in the near future.

Social values are taught (and learned) in the schools. (The families are generally inept at inculcating these values, since they are embedded in an entirely different mindset.) Start there, in the schools, and in a generation or so, some interesting changes just might appear.

[Lafayette]

realpc: "You can find a wacko libertarian here and there who wants to eliminate all regulations. You can also find Marxists who want to hand their lives over to an all-powerful government, and would force us all to do the same."

You could, and it would be a good idea to do so.

Find both, and from the bracket, you have a fairly good idea that the truth is somewhere in between.

People, in general, shy from extremes unless imposed upon them by totalitarian governments. More and more, it can be seen from Europe, that democracies are shifting towards the center in a effort to nurture the "cash-cow" but also share more fairly her rich milk.

One can only hope Americans find the center (once again) as well.

[pipo]

Excellent post, Mark. This stuff is really in fashion in my small country of Greece, where the pseudo-right-wing-neo-liberal government want to privatize the state electicity monopoly. I have an BSc in Economics and even I understand that the economies of scale at asparsely populated country of 11 million are exhausted way too rapidly to have anything but a state monopoly.

[Cyrille]

I realise this is a bit on the fringe of the actual topic but I read so much mischaracterisation of France that I must correct...

It's easy to rant about "socialist governments caving in to union pressures", but it would make absolutely no economic sense to build several landline networks from scratch. Even in Thatcherian England, networks tended to stay unique, with several operators.
Now, it is highly debatable whether the landline network "should" be privatised (just because the everything private arguments are fashionable now does not mean they are the only ones around), but the fact is that it WAS privatised. France Télécom is no longer an administration, it is a private company.

It seemed clear to me that Laurent Guerby meant the recurrent fee when he talked about the fixed price for access. Now, is 14€ a month "very handsome", and three times what it should cost to the consumer? Well, I could point out that it is the fourth lowest price in Europe, for the most modern network at the moment (maybe excluding Monaco. I'm talking real countries). Which is not necessarily absurd, as more modern networks will often be more efficient, but also carry higher bandwidth, and anyway you need to repay investments at some point. So, one of the cheapest for the most modern network seems like a reasonable deal.
But if that's not enough, the thing is, this role was open for competition last year (the universal operator licence runs for four years, and was reattributed last year). Of course, all the competitors had been screaming for a while that the subscribtion was far too expensive, so here was their chance to be the one receiving it.
How many companies bid?
One. France Télécom. In the face of that, the state allowed competitors an extra period of time to submit a bid, knowing what France Télécom's bid was. You don't often get such a nice treatment in a competitive bid.
Nevermind, they still failed to submit a bid.

On what grounds "should" it cost three times less? You see, in a city like Paris, it's not very expensive to provide the last few yards. Routers are very concentrated, and the like. But the law states that the universal operator must provide to EVERYONE. And at the same price. A price that is so hefty that no one wanted to have it if it meant actually having to provide the service.

Yes the telephony market is going to hell in France. Is that a sign that the incumbent operator is being protected? When the whole industry recognises that France is the country where regulation is most heavily AGAINST the incumbent? When the previous president of the telecommunication regulatorion agency, a mere 10 weeks after the end of his mandate, was given a position at the board of the biggest alternative operator? Is that really a sign that his work had been biased in favour of the incumbent?

As for broadband, no, France Télécom's prices are not just fixed by competition. Nor by the state. FT must get full approval from the regulator (which is independent from the government) before making a commercial offer, and in fact often does not get it (or must wait for a competitor to do it before -thereby spoiling the effect).

Now, for a new connection, it is free when the line is already built. So, I invite you to reflect how below cost 80€ is for a connection involving infrastructure works. Still, even that used to be a lot cheaper for the consumer (or actually completely free), but must be charged more as a byproduct of competition. You see, alternative operators recommend to their prospective customers who don't already have a line that they buy an FT line and cancel it during the 15 days where you can do it legally for free. And then buy it from the alternative operator -who will therefore not have to pay for installation. Customers who go for this legal but dishonest trick get a discount...

No time to go into EDF? Too bad: when the European commission forced competition, it got as a result a... doubling of the price. Nice isn't it? You see, the French production was cheaper than production from other countries, something that was reflected in the prices (which was fair, since that was because state investments, paid by taxes, made it cheaper). Now that prices reflect competitors' prices, mostly Germany's... it's twice as much! And if we were to build several networks it'd be a lot worse still! How wonderful!
Want to talk about the catastrophe that is the British rail system yet?

Still, I'm not in favour of all powerful state monopolies. And the French mega public services companies have many, many shortcomings (in part because the state used them to delay the rise in unemployment by hiring for life people who could not find jobs in the 70s). But let's not invent other ones. And let's not pretend that the private sector brings universal bliss.

[reason]

James Kroeger...
nice to read a comment from you again. I like your discussion on your link a lot - a lot clearer than your comment.
I wish you would take the criticism (from several of us) that you need to open up your model a bit so that it is relevant in a globalised world and for small countries. I think they would then be more convincing. But I like your ideas, they are a novel and valuable way of looking at things.

[reason]

A read of Jane Jacobs "Systems of Survival" might be appropriate at this time.

[Lafayette]

LG: "Want to talk about the catastrophe that is the British rail system yet?"

Every time the French left wants to criticize the success of deregulation in the UK, they come out with "the disaster at British Rail". What disaster?

Like most of the French "gauche-idiote", you are in self-denial confronting an ineluctable dismantling of statist semi-private companies that are replete with feather-bedding (over-staffed personnel).

French statism was nurtured by the post-war reconstruction and, in particular, a political class of ENArque elitists of both the right and left. They constructed these mammoth state enterprises for ... themselves and their careers. (Latest example of note: After the recent disaster of the Airbus 380, the ENArque President of the company was fired ... only to be replaced by another ENArque.)

Yet another "ENArchist", Martine Aubry, whilst Minister of Labour, introduced the 35-hour week that plunged French hours worked annually to 1543 hours - compared to 1731 in the US and 1668 in the UK and 1789 in Japan (OECD figures, 2004). Even with a productivity per hour worked that is identical to the US, France’s total labour productivity is tepid.

The French did not invent "dirigisme". Perhaps the Romans did. But, they have developed it to a high degree of fine art. Unfortunately, that is one reason why France has been in a mess for the past 15 years. It’s political elite lacks leadership in the direction France needs to take and is immobilized by a desire to remain in office serving the same pap it has for decades – always more state aid to rescue terminally sick industries.

This immobility is also why 2 million of your compatriots have left the country in hopes of finding a job in the face of a staggering level of unemployment and the lack of job creation. Please explain how a level of unemployment that has varied between 9 and 11% for the past QUARTER OF A CENTURY is "normal" for a modern economy.

France has smouldering two generations of lower-class youths who have lived on unemployment benefits. And why? Because social charges have made French unskilled labour uncompetitive and therefore unemployable. (Wait till the Spring round of rioting in the suburb starts again ...)

And, what is the solution of the French left? Punish with fines companies that move their production off-shore, which condemns them to bankruptcy.

With that sort of idiot thinking as economic policy, France is no where near understanding that it is seriously sick ... never mind considering what would be a reasonable cure.

But, surely, Segolene will make all well again. (When pigs sprout wings.)

[Lafayette]

cyrille: "As for broadband, no, France Télécom's prices are not just fixed by competition. Nor by the state. FT must get full approval from the regulator (which is independent from the government) before making a commercial offer, and in fact often does not get it (or must wait for a competitor to do it before -thereby spoiling the effect)."

Well, considering that FT is a 500 kilo gorilla in a market consisting of midget chimps, one can understand why. It has about 50% of the market share, so its preponderance in the market is considerable:
1 Wanadoo 48.2 %
2 Free 17.4%
3 Neuf Cegetel 12.9%
4 AOL 6.3%
5 Tiscali / Alice 5.8%
6 Tele2 5.8%
7 Club-Internet 3.3%

Besides, the broadband market pricing is strangely uniform (as if it were, in fact, decided by the state authorities). I pay 20€ for my interconnect from a sub-label of FT where, otherwise, I would be paying 30€, which is the average market price for a simple, unbundled DSL interconnect.

Even at 20€, this is a lucrative market for a company that is only offering pipeline access from a fixed line to the internet backbone. I figure total "actual cost" of offering this fixed-wire service is somewhere between 3 and 5€. This means their margins are anywhere from 600 to 1000%.

"No time to go into EDF? Too bad: when the European commission forced competition, it got as a result a... doubling of the price."

Yes, why? Because the main suppliers in Europe did not want to separate thier businesses, that is, production and delivery.

The delivery system is unique and owned by EDF, so it determines prices. Just like FT and telephony/broadband.

If both companies were separated from thier delivery components, then they would have to compete only on production (of electricity, of broadband services to fixed-wire houses) and a real reduction of prices would occur.

Not to worry, Brussels WILL force the companies to separate production from delivery. It is only a question of time.

[Lafayette]

"I have an BSc in Economics and even I understand that the economies of scale at asparsely populated country of 11 million are exhausted way too rapidly to have anything but a state monopoly."

Then you must have skipped a lesson somewhere.

The above excuse is no reason whatsoever to have a state monopoly.

The electricity utility can be made private (and for profit), but supervised by a state authority to assure that both rural and urban customers are serviced - as well as the quality of the service proffered.

[Lafayette]

"Markets create 'efficient' solutions that maximize markup."

Not always. A market can very well be established by which competition actually minimizes markup. In which case, business opt for small margins but high volume to obtain profit objectives.

Examples? The internet is full of them.

[bakho]

We buy our electric form an electric co-operative. We are part owners. As owners, we get to vote on policies that minimize costs to customer-owners. This is much better than a private for profit regulated monopoly utility.

[reason]

Bakho...
I know there has been much academic interest in the demise of co-operatives. The problems have not been bad management, but lack of access to cheap capital (and economies of scale as well). Maybe the much predicted but ever delayed demise of "casino" capatalism will turn this around. I think we have big problems with our financial architecture, but unless something big goes wrong, I don't think much will happen. We live in interesting times.

[James Kroeger]

Reason:

I wish you would take the criticism (from several of us) that you need to open up your model a bit so that it is relevant in a globalised world and for small countries.

Hi Reason. Thanks for the kind words. I've actually tried a couple of times to address some of your concerns about the dependency of my claims on a closed economic system. I suspect you may not have read them. (If you did, you didn't respond to them.) Here's one:

James Kroeger - welcome back. But please think about debt and foreign exchange when you talk about printing money. If a country is completely without foreign debt, and had very steep import taxes I would agree with you.

...All else equal, if a country decides to eliminate unemployment through increased government spending [of newly printed dollars] and it causes an increase in measured inflation then we should expect that country's currency to lose value in the FX markets. (Since our price increases would make our products less competitive in the global market against currencies that are not inflating as rapidly as ours). The depreciating dollar would automatically make our prices more competitive around the world and make imported goods more expensive to us.

(It's good to keep in mind that when/if a government increases the money supply by simply printing more money, the initiative would not be inherently inflationary if it is accompanied by a compensating increase in additional output. The extra dollars would be needed to maintain price stability at a time when additional output is being produced/consumed. It is only after the unemployment rate has dropped to zero that any additional spending of newly printed dollars would be purely inflationary.)

Of course, if the government were to continue to increase its spending of printed dollars after all the unemployment in its economy was 'soaked up', it would generate excessive inflation; inflation that would provide little or no additional benefit to society while at the same time increasing anxiety within the population about their [mostly unwarranted] fear of hyperinflation. That's when the govenment would want to stretch out or postpone some of its spending plans on infrastructure.

If a country that decides to inflate is heavily in debt to other countries, it could expect foreign banks to be less eager to lend to it. But keep in mind that when foreign banks lend you money in your own currency, they are simply lending money to you that existed in domestic banks anyway before before it was sold to them (the foreign bank) in a FX transaction. It would otherwise have remained in a domestic bank, available for lending to domestic customers. That is to say, whenever foreign banks lend Americans dollars, they get those dollars from an American bank that would have had that money available for lending if it had not sold those dollars to a foreign bank in a currency transaction.

It doesn't matter if foreign banks won't lend to us. Our own banks will. Savings incentives issues are irrelevant because the Fed can make up for any shortfall of savings deposits by simply injecting any amount of "created money" it wants into the banking system, money that was never saved by any saver.

If our prices are inflating as a robust clip, and China does not want to allow our currency to depreciate against the Renminbi, it will continue to provide the same number of Renminbi to us for each dollar that they are providing today. In other words, they would respond to America’s increased demand for Chinese goods (since we'd have more dollars from inflated incomes to throw at their market) by giving us ever more Renminbi, allowing us to stimulate their economy further. The only time they are going to want to stop giving us that power is when they have arrived at a zero unemployment rate themselves. That is when they are going to allow their currency to strengthen against the dollar, not before.

I guess I just don't see the flaw that you are implicitly referring to, Reason. :)

Here's another:

Contrary to what many have suggested to you (Curt Dolittle), a country like the United States is free to set its own economic course, in part because international trade accounts for such a small percentage of our economy. In a floating exchange rate regime, the US can expand its output though increased domestic [government] spending and discover that there is no response arising out of 'international capital flows' that the Fed could not handle, if it was willing to accept the higher rates of inflation that I am talking about.

The number one consideration is that over time, a higher inflation rate will weaken America’s currency against other countries, (all else equal). Our goods & services would become more expensive to our international competitors and we'd have more dollars to throw at their exports. They'd buy less from us because our prices would be going up and theirs wouldn't (a-e-e). Our imports would stimulate their economies. The dollar should weaken (a-e-e) for this reason alone.

But doesn't this assume that our central bank is keeping domestic interest rates low enough that firms are not discouraged from borrowing? Yes it does. It assumes this because, floating exchange rates or not, international capital flows or not, our central bank’s policy will be to keep domestic interest rates low enough that firms will continue to borrow and invest. There are two scenarios to consider.

If China, let's say, did not want the dollar to weaken vs. the Renminbi, it would continue to sell more and more to the Americans at the lower rate of exchange that it has heretofore chosen. It will continue to stimulate the Chinese economy. This is a prospect that they would probably welcome. So they would continue to use all the dollars they are receiving from American importers and spend them on US treasuries or other assets. That would keep the Renminbi from appreciating vs. the dollar. That would mean that the exchange rate is essentially fixed.

All this would mean for us is a that the Fed wouldn’t have to create as much money out of thin air in order to maintain its target interest rate. If, alternatively, the PBOC decided to let the Renminbi appreciate against the dollar, the Fed would maintain interest rates at the target level it chose by simply buying assets with new money. You see, if the central bank’s goal is to maintain full employment, it can do so no matter what central banks in other countries do.

What if the European Central Bank feared that our increased demand for European exports would 'overheat' their economies and so they decided to drive interest rates up to reduce inflationary pressures? How would that affect us? Some would voice concern that American investors would be attracted by the higher rates in Europe and the fact that the Euro was an appreciating currency. The only way this could hurt our growth is if it cause our interest rates to increase, but we’ve already said that the New Enlightened Fed would not let this happen. It would simply replace any of the 'capital' that private investors are moving overseas.

I know that you’ve been told that all nations are slaves to "international capital flows", but that is not, in fact, the case.

Do these arguments answer any of your reservations? What remains unanswered?

[Carolyn Kay]

dissent,

Concern among right-wing rich families began after Goldwater's ignominious defeat in 1964, but became a movement after Lewis Powells' 1971 memo hit Chamber of Commerce members. The memo outlined a game plan for "saving" American capitalism that has been followed pretty faithfully since that time.

Those who took Powell seriously began a campaign to convince Americans that greed is good, unfettered markets are necessary, government is bad, and all those other things Americans hear over and over again to this very day from the right-wing stink tanks and media operations funded by those families.

In the six years I've been involved in politics, I haven't been able to convince progressives that we need a similar infrastructure on our side.

Carolyn Kay
MakeThemAccountable.com

[reason]

James Kroeger...
umm.. Actually no. I think the key can be found here:

It doesn't matter if foreign banks won't lend to us. Our own banks will.

Fine if you are the US and (still) have the global currency - otherwise you can't ignore the possibility of a debt trap. Please find a formulation that would work for Belgium or NZ. And the US could eventually turn into the new jumbo sized Argentina. Do you see what I'm getting at? Nobody is going to accept that you can always inflate your way out of trouble, because there are real international terms of trade and debt issues to be faced. Hyperinflation has happened in the past, quite often. What works with a closed economy won't necessary work when economies become very interdependent.

As I said before, I like your ideas a lot, I just don't think the unemployment solution is as simple as you paint it, and it costs you credibility. Your comparitive welfare arguments make intuitive sense, and could probably find some econometric support.

Maybe you should talk to the Georgians (Henry George fans). They also have ideas I like a lot, it is just that I don't see how to practically implement them (the how do we get from here to there in reality question).

[Cyrille]

For the upteenth time, Noël Forgeard never went to ENA (I should know, he was one of my father's childhood friends). Come on, I know there is a lot to say against France, so stop inventing things!

[Cyrille]

You "figure" that providing the internet costs around 3€ a month. And on what basis, pray? The service is so cheap to offer that NOT ONE company other than France Télécom wanted to offer it for 14€ a month. It is even more ludicrous when you yourself state that those 14€ must be paid (of course, it is actually less for alternative providers, but they still pay 9€). So, if they need to pay 9€ for access to the network, how can it be 3€ in the end? Besides, all internet providers also provide services with it.
And anyway, your anti-French religion should compare with other countries. France is universaly recognised as the best value for money in the world for internet access. So complain away...

What disaster of the British rail system? Well, terrible problems with schedule, increased accidents, licencees not meeting their commitments, increased difficulties to know the possible trips, absurd timings (like 2 trains 2 minutes apart doing the same travel on a very minor line), obscenely high prices discouraging the use of public transport...

Not all is well in France that is for sure, but there are more people trying to come to France than to leave it. So 2 million French people abroad, and maybe 10 million foreigners in France. Some jobs must have been created. Not enough, but some...

As for personal attacks, they are silly. I am in denial? Well, I authored a study for the French embassy in London that promoted privatisation of public transports on principle, provided a number of conditions, some of which were not in place in the UK, leading to the many problems that they had. Admittedly, had global warming been as accute a problem then as it is now (I knew it was coming, but not so quickly), I may have written a different opinion, as lowering the prices for public transport (even making it free if needed) will probably become a crucial issue. Still, I do not have an invariable mantra. I seek to look at things as they are. You, on the other hand, are in theology there. The conclusion is revealed and you will stop at no facts twisting to get you there.

To see you get into totally unrelated ranting against all things French when I only talked about France Télécom (with an aside about EDF and the British rail system) was not a discussion, it was merely country assassination. So your point is "it must be bad because everything French is bad". Next, we'll have the wonders of privatisation and competition in the healthcare system I guess?

[John H. Morrison]

I agree with a comment expressing dislike for the framing of the "magic of the market." Whenever one reads "magic" in the context of markets, one should think "conjuring," "slight of hand," "mirrors."

The article mentioned one requirement for the "magic" to work: perfect information available to all. I would like to add a second: perfect rationality, the ability to perfectly process the information. In other words, nobody should have any trouble making 100% in all my freshman physics exams. :-P

One should realize that the two conditions are mutually contradictory. If one knew that one was going to die in a plane crash, and knew all the circumstances surrounding his death and those leading to his death, he would rationally avoid those circumstances. (If it's too late by the time he finds out, he didn't have perfect information beforehand.)

Uncertainty is inherent in gambling, including stocks and bonds, foreign currency, and commodities. Noise traders are required to get the market moving to satisfy predictions. In gambling, foreknowledge of the result is called cheating. Bubbles are caused by persons led by the herding instinct (tulip bubble), persons who don't recognize the bubble (dot.com bubble), or persons who "rationally" think that they can sell higher to a greater fool.

Uncertainty is an inherent part of everyday life as well as economic life. Far worse is the irrationality, fundamental cluelessness, even the pathological illiteracy of too many supposedly educated and literate persons. "When you're explaining, you're losing" is a symptom of this.

Other examples include ignoring a requirement (in an exam) to use only 100-Ohm resisters, not understanding the question "how long ago did (something) occur?", dividing by vectors. (Another example is when advanced pure mathematics sounds like gobbledygook.)

What is the response of certain free-market economists to the problem of human irrationality? One is "that's their problem." That response is irrational in that they don't recognize that human irrationality violates their premises, and consequently renders their conclusions wrong.

There is, of course, much discussion about market failures due to incomplete information and incomplete rationality. The term "market failure" seems like a frame that assumes the problems as small perturbations on the basic framework.

Paul Krugman, "Peddling Prosperity," gives the example of "almost rational" response. A family's fully rational response to increased Federal deficit spending might be to save just a little more for the future increased taxes to pay off the spending. On the other hand, an almost-rational response might be to do nothing to change their behavior. In this example, a small change in rationality results in the complete disappearance of the response.

This and other examples (tragedy of the commons) suggests that the perturbation series in incomplete rationality and information has radius of convergence equal to zero.

Moreover, how can complete ignorance or complete cluelessness be considered a small perturbation on perfect information and perfect rationality?

says...

Prof Thoma - some comments on your article.

First, you need to distinguish more clearly between buyers and sellers - the example of Blogger does not work because it is confusing about cost of exit for a buyer or seller.

Second, the role of enforcement of contracts and fairness are critical. I tend to believe market fairness is as important as competitiveness of the markets.

Third, transparency is an important tool to achieve fairness. Middlemen have important and vital roles, but the fees need to be made clear to both buyer and seller. Too often middle roles are hidden.

Fourth, try not to focus on the Financial Markets as they are a special case. The necessary disclosure of information to avoid fraud that is so important is not always necessary in other markets as there is a buyer beware criteria present.

[Lafayette]

Mr. Mystery (probably a student of Prof. Thoma): "try not to focus on the Financial Markets as they are a special case. The necessary disclosure of information to avoid fraud that is so important is not always necessary in other markets as there is a buyer beware criteria present."

Pray tell, do explain this bit of fine logic.

What's so special about financial markets that a buyer beware attitude is not necessary? Where were you when the dot com bubble burst in January of 2000? And, how about the string of disclosures the companies were kiting the numbers to look better on the markets?

Obviously, all that was not fraud but mere exaggeration.

My broker was still hyping Hi-Tech in early 2000, totally oblivious to the fact that an implosion was not only possible but perhaps overdue. Why? Because he had a securities sales quota to meet.

And now, I trust, he is eating dirt for a living.

[James Killus]

I believe that economics is a science, and that “the market” is a phenomenon that is described by economics. In that sense it is like gravity. One doesn’t look at a crashed aircraft and say, “That’s gravity in action.” One doesn’t step off a balcony and say, “Let gravity decide.” So why should one look at poverty and say, “The market in action.” Why should one point our horribly inefficient and baroque health care system and say, “Let the market decide?” Why would you look at someone lumping people into a group by skin color and say, “That’s rational.”

At its core, the Conservative Movement is very clear about what it wants, more money for corporations and rich people, criminal penalties for certain drugs and sexual behavior, control of information and the public discourse. Movement conservatives seem to have no problem gimmicking markets whenever is necessary to advance those goals. But whenever there is some attempt to do something that is inconsistent with the Movement agenda, the market becomes inviolate, and the “problem,” like racism, poverty, health care, is made to vanish by sprinkling it with magic market fairy dust, which is pretty potent stuff, provided you want to trudge along the same old path and call it flying.

http://unintentional-irony.blogspot.com/2007/02/magic-market-fairy-dust.html