Economic Theory

Rod Carr is a leading New Zealand economist. In a recent article called Markets Have No Morals, he explained the benefits and the flaws of the standard economic theory that has prevailed for the past fifty years. In this post, I tease his comments out a bit to make them clearer. The words in italics are mine.

Benefits
The 1980s saw an explosion in enthusiasm for using markets to allocate scarce resources. That enthusiasm set off a period of rapid and comprehensive deregulation and privatisation.

• Taxes, tariffs, and subsidies were ‘inherently bad’ as they caused resources to be “misallocated”.

• The pursuit of profit was “inherently good” as resources would flow to their most valuable use.

• Least cost was assumed to create the most value for society (least cost alcohol or tobacco harms society).

• Markets are effective at efficiently allocating scarce resources.

• Markets allow producers and consumers to act in self-interest, leading to the best outcomes for society. (Pareto Optimal in the limited sense that no one can be made better off without making someone worse off, which is not really optimal at all).

• At the time, there was little doubt that markets could allocate financial capital more efficiently than politicians, technocrats, or corporate conglomerates (The global financial crisis showed that this is not true).

• The market acolytes were in control at the World Bank, the International Monetary Fund, the World Trade Organisation and most central banks and Treasury Departments in the world, taught, advised and acted to promote light-handed regulation, tariff-free trade, low taxes, private property rights and market-based solutions.

Assumptions
Markets are ruthlessly efficient at allocating privately-owned scarce resources with a price, provided:

• Price is determined in free market exchanges between many buyers and many sellers (most markets are not free).

• Complete information is available to all participants (rarely true)

• Search and transaction costs are trivial and .

• All the impacts, costs and benefits, are reflected in the prices buyers are willing to pay and

• Sellers are willing to incur (producers push many costs onto the community).

However, this set of ideal circumstances is rare (It probably never occurs). Economists build economic models based on their assumptions, so there models do not match reality.

Selfish, Myopic and Reckless
Markets are myopic, reckless and selfish. Markets are short-sighted:

• A direct result of discounting the future due to uncertainty

• Market participants face a constraint on their access to cash.

• Understate future benefits and exclude or understate future costs.

• Underinvestment in long-life infrastructure.

• Degradation of natural ecosystems and

• Underinvestment in public health and education (explains why our hospitals and schools are struggling).

Markets are reckless:

• They create an asymmetry that sees profits accrue to those with private property rights, while costs are left to lie with the general public.

• Limited liability companies limit downside risk and encourage risk-taking. (Limited liability is a hugely significant government intervention that business owners never admit, despite claiming to believe in free markets.)

• Children do not inherit their parents’ debts (but benefit from wealthy parents).

• Irreversible biodiversity loss is unpriced yet deprives future generations of options and choices while exposing them to unknown risks and costs.

• Decisions today without accountability have irreversible consequences, seriously reduce future choices, raise future costs, transfer risks to other members of our society and undermine social cohesion.

Markets are inherently selfish.

• Markets are indifferent as to the distribution of benefits and costs throughout society (This is a massive problem, because the rich get richer, and the poor stay poor).

• Market acolytes argue that the efficiency gains from market-determined resource allocation allow the winners to compensate the losers, leaving society better off (a rising tide lifts all boats), but political obstacles prevent this from happening.

• As it turns out, the winners attribute their winnings to personal attributes, such as hard work, thrift, ability, and are reluctant to pay enough tax or gifts to compensate the losers.

Rod Carr concludes that markets are a tool to achieve strategic, social, political and economic outcomes, not a result to be pursued for its own sake. Markets should be a tool to enable people and not a mantra to enslave us.