Markets
Peter T. Manicas
University of Hawaii at Manoa

Impersonal markets are, as Adam Smith recognized, the primary mechanism for systems of exchange. There is a huge amount of folklore associated with the idea of a market. Much of this mythology is, in fact, promoted by well established economic theories. This is hardly the place to go into this in much detail, but one or two non-controversial points need to be mentioned.

Markets do function to allocate resources, e.g., factors of production, and to distribute, for example, the wages of workers; the obvious alternative is some sort planning or "command" system. But real markets do not, and never have, satisfied the conditions of modern price theory.

To fix our ideas, consider what may have been the most rudimentary of markets: a place established for vendors who bring products to sell. Perhaps there is a flea market in your town or perhaps you have been to a farmer's market in some city.

At this convenient place in physical space "suppliers" (people with things to sell) come together with "demanders" (people who want to buy). Now if everybody knew the (real) value of commodities, buyers would bargain with sellers until each was satisfied that they were getting their "monies" worth. (A commodity is roughly anything which can have a price attached to it and hence is available to sell.)

But nobody knows the real value of anything and they can not: First, the requisite information is just not available. Each seller does know what it costs her to bring the product to the market and, of course, if the activity is to have a point, she needs to more than this. But she doesn't know what it costs other sellers to bring their products to the market--and they are not likely to tell her. So she fixes a price on her goods which she thinks that she can get. On the other side, buyers do not walk around with a cost/benefit schedule in their heads so that they know what they would be willing to pay for differing amounts of "utility" to be gleaned from the goods available. What happens is pretty simple. The buyers look at the prices of goods offered and decide whether they are willing to pay what is being asked for the particular good. So some things get sold and others don't. Maybe you got a bargain. Maybe you didn't.

Nor does help to say that if there is some other seller of the same good, "competition" will assure that sellers's will get their "monies worth." First, the buyer has to know that there is another seller of the commodity and that his price is lower. People do "shop around," but they do not look everywhere. Indeed, even if in principle, they could the costs of doing so would certainly forbid the effort. This is an example of what are sometimes called "transaction costs."

Second, the two goods may not be identical. The sellar with commodity with the higher price can argue that it is of better quality. And he may not be lying. Put technically, the question of what is "substitutable" cannot be determined in advanced. More generally, exchanges need not satisfy constraints of economic rationality.

There are further implications of this. Theory says that in a "free market," prices will fall until there are buyers for everything: The vendors all go home with money in their pockets but no commodities: the market "clears." But markets do not clear. Buyers go home disappointed (or annoyed); sellers go home with "inventories." That is, there no time at which everything "evens out" as it were. Technically, there is no time when a market is at equilibrium.

Often people speak of a market as being "free," without considering what this could possible mean. It may be assumed that a market is "free" when the government is not "interfering." But this is an odd way to think since without the government and its laws and regulations there could be no market. It is the government which establishes "the rules of the game." It defines, e.g., the bundle of rights which constitute what we think of as private property. It defines contracts, standards, conditions. And one cannot assume that there is only way to do any of these things. Put more generally, because markets are always socially constructed, there is enormous variation in the institutional features, conditions, instruments and legal arrangements which make exchanges possible. Put in other terms, there is enormous variation in the conditions which enable and constrain exchanges. The Japanese stock market, e.g., is very different in critical ways from the New York Stock Exchange. And given Japanese corporate policy not to fire workers, but to put them in alternative jobs, so too their labor market is different than the US labor market (of the German, French, etc.) Currently, we hear a good of talk about "marketization" in China and the former Soviet Union. This is best understood as the effort to bring into existence the rules and regulations and, even more difficult, the agreed-to practices which taken together constitute a market. Some writers have referred to the capitalism which is emerging in Russia as "mafia capitalism" because the key "capitalists" are able to exploit the current situation with extra-legal means, including intimation and violence. A recent essay in the New York Review of Books, was content to say merely that it was "weird capitalism," which is just to say that it is not quite like the system which we take so utterly for granted.

There are other problems with the idea of a "free market." As conventional theory recognizes, where there is no parity of "market power," markets are not free. Giants can (and do) dominate production and sales; they can better control costs, spend millions on advertising, and use other means to restrict competition, for example, by controlling shelf space in a supermarket. Moreover, because of their size and power, new enterprises are unable to enter the markets which big firms dominate. Instead of "market forces" determining organization, organizations determine the nature of markets, or as Chandler put the matter, the "visible hand" replaces the "invisible hand." A host of implications follows from this.

Adam Smith (and all those who followed his line of thought) assumed that because producers are self-interested, the "invisible hand" assures that goods that are wanted will get produced. As he famously said, "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."

We may grant that the primary interest of suppliers is profit, but for consumers to be "sovereign" they need some way to express their wants independently of what is made available to them. This is, of course, sometimes true. It is, to be sure, the whole point of market research and ultimately the best argument in favor of "entrepreneurs," people who can identify some consumer want and who have the means to respond to it. But not only are wants shaped and sometimes created by producers, but, as above, "entrepreneurs" cannot easily enter the market and become serious competitors.

This is good place to introduce what economists call "elasticity." Roughly, the price of a commodity is inelastic if demand for it is not influenced by price changes. People will pay almost anything for bread or rice when there is little else to eat. In a modern economy, however, most prices are relatively inelastic exactly because there is little price competition for a whole range of commodities.

Nor for similar reasons is it the case that a superior product will win out in the marketplace. We now recognize what is called "path dependence." This is the fact that small, random events can establish a choice in technology which become, subsequently, nearly impossible to change. Q-W-E-R-T-Y is the first six letters on the upper left of keyboard that all of us use. It has been the universal standard since the 1890s. But why? It is clear enough that even if there are much better arrangements, once a relatively small number of people had learned that arrangement, it was effectively locked in.

There are more interesting examples, Matsushita's VHS standard over Sony's Betamax, MS-DOS over Macintosh. Indeed, the utter dominance of the gasoline engine cannot be explained by appeal to the idea that only superior products survive in "the competitive marketplace." It is also best explained as a case of path dependence. Historians suggest that solutions to the limits of electric cars where on the immediate horizon around 1915, but that a brief price edge was all that was necessary to lock us all into polluting gas guzzling engines. Some of the same logic is at work as regards the alternative between using cars and mass transportation to commute. The decision to build and sell automobiles, led to decisions to build a massive highway system which, in turn, led to the demise of efficient mass transit. For most people, there is no real choice as regards getting to work: Hit the expressway.

Moreover, there are a host of public goods which private markets have never satisfied. This includes railroads, roads, airports, bus systems, convention centers, and schools.

The "invisible hand" also assured that production would be accomplished "efficiently" where "efficient" simply means that there is no different allocation of resources (inputs) which will improve outputs. But a moment's thought will suggest that an economy could be producing efficiently and wastefully or destructively. Destructive but efficient production, for example, destroys the environment--what is often talked about in terms of "externalities"; wasteful but efficient production generates commodities which fail to serve human needs or wants, or fails to do so as well as it might, e.g., poor quality housing or Star Wars technology, for example.

There is a further problem with "market rationality," often called "the isolation paradox." Acting as individuals, each seeks to make the best of his or her position. But because the predicted outcome of the choices that each considers best is affected by the choices of others, the outcome is unintended by all. When each decides to beat the morning traffic jam by leaving for work earlier, the traffic jam occurs earlier. Nothing is gained and everyone loses out on some sleep. When (as Keynes taught us), everyone holds money in order to cope with uncertainty, uncertainty increases. More generally, market outcomes (the range of commodities, their prices, etc.) are the unintended product of the conscious action of different actors each acting to bring about their goals. Essentially anarchic (unless goverment acts to provide order), this may be generally beneficient, but often is it not, for example, when these actions produce a serious depression. Globalization, as should be clear, increases problems raised by the isolation paradox.

Related are problems for markets are created by goods with what are called "positional" attributes. These include either natural or socially created scarcities and goods subject to crowding problems. Thus beach properties, a Harvard MBA, tourist destinations and automobiles have positional properties. The main idea is caught by noticing that standing on your toes to see better is a good strategy if nobody else follows suit. But when everybody stands on their toes, everybody loses. Because education became more widely available, many jobs formerly available to high school graduates now demand college degrees. Again no one is better off and many are worse off. Automobiles are great on open roads, but they reach their social limits when there are so many that one cannot cross town. The auto confronts natural limits when the pollution becomes unbearable. At this point, the factory which produces automobiles may be efficient, but it is both a waste and is destructive.

In these cases, the rational behavior of isolated firms and individuals each seeking to satisfy their interests produces outcomes which are neither desired nor even economically rational. Markets in themselves cannot solve such problems. Conscious coordination of some sort is required.