Markets Are Messy
That's just them at work.
We defenders of free markets often find ourselves responding to two kinds of criticism. One takes the form of pointing out imperfections in real-world markets and using those to argue why markets don’t work and why government intervention is necessary. The other is a sort of frustration that we can’t explain exactly how markets will solve some particular problem. This second criticism says in effect: “If you can’t explain how markets will do something, why should I believe that they will do it?”
I think these two lines of criticism are connected and serve as a reminder about how defenders of free markets should respond. The link is that both overlook the nature of markets as a discovery process — albeit a messy one. Expecting markets to be perfect or for us to know ahead of time how exactly people will solve problems using the market is to misunderstand what markets do, how they do it, and why they are our preferred problem-solving process.
Dispersed, Tacit, Contextual, Imperfect
To understand why markets are discovery processes, we first have to recognize that the fundamental problem facing any attempt at social cooperation is that human knowledge is dispersed, tacit, contextual, and imperfect: Each of us knows different things; we may not be able to articulate what we know; our knowledge might only be relevant in particular contexts; and what we think we know might be wrong. The challenge, as F. A. Hayek put it in his most famous essay, “The Use of Knowledge in Society,” is how to enable other people to use the knowledge we possess so that we can collaborate in order to allocate resources more effectively to improve living standards. The problem of social cooperation and economic growth is a problem of how best to use knowledge.
Thus the role of competition in a free market is to help us discover both what consumers want and how best to produce it by making that dispersed knowledge socially available. The key to doing so is the role prices play as knowledge surrogates. They signal to producers and consumers what people know and what they value, and enable us to coordinate our behavior appropriately. Profits and losses tell us afterward if we made the right choice. The competitive market process is best understood as a way for us learn what we otherwise would not know. Just as we figure out which baseball team is best by playing the game, so do we figure out how best to produce things by letting competition take place.
But let’s face it: Competition is messy. Because it’s a discovery process, entrepreneurs will always be making mistakes. They’ll try new products and consumers won’t want them (the Ford Edsel or New Coke). They’ll try to make existing products in new ways that turn out not to be profitable either because they are too costly or consumers don’t like the change. Entrepreneurs may overlook what in retrospect seems like an obvious opportunity. Failure is just as important to the functioning of the market as success. The result is that at any moment, markets look messy as mistakes are made and entrepreneurs try to figure out how to correct them. Real-world markets, unlike the equilibrium models many economists rely on, can never be perfect since they are always in the process of discovering.
No Advance Notice
The messiness of markets also explains why we cannot know ahead of time exactly how people will solve problems using the market. Expecting a detailed response to that criticism is equivalent to expecting a scientist to tell you what her research will discover before she begins! The justification of scientific freedom is that we can’t know in advance what will be discovered, because if we did, we wouldn’t need science. The same is true of the market: If we knew how markets would solve problems, we wouldn’t need them!
The response to these criticisms then boils down to explaining why we believe markets, as messy as they are, will solve problems better than government intervention. In a number of previous columns, I’ve discussed why the role of profit and loss cannot be duplicated by government and why government cannot access the knowledge generated by the competitive market process.
My point here, however, is that the messiness of the market is not a problem but a sign of its health. It is the discovery process in motion, helping us imperfect human beings to learn what to produce and how to produce it, both of which we could not otherwise know.
Comment by Frank on 10 November 2011:
The future will never be like the past.
Comment by David Coplin on 10 November 2011:
A correct understanding of poverty will elucidate a correct understanding of economics as well as a correct understanding of our current economic situation. Markets could be most democratic
of all our institutions if we were all on a level playing field.
While I am not an Austrian proponent I have made the subjective basis of economics the
foundation of the economic theory laid out in the ebook referenced below. But I come
to very different conclusions regarding monetary policy, credit operations, taxation, and the
definition of individuals and enterprises in any economic system. I also compare communist
economic systems to our current western credit economic system.
I would really appreciate your review of the economic principles proposed in the following ebook
http://www.smashwords.com/profile/view/povertyandthefoundationofeconomics
and your comments on any errors that you find. If you do not have the time to do
this, I would appreciate your assigning the task to your students as an exercise.
As long as we continue to use the western credit system as the primary driver of
economic production the wealthy will continue to control the means of economic
production and poverty will be a guaranteed result. The link above describes an
alternative economic system that will eliminate poverty and maximize economic
production.
Thank you for your time and attention in this matter.
Comment by Ian on 10 November 2011:
Well, I was willing to give your E-book a chance, until I found that I’d have to buy it. Now I’ve no choice but to assume you’re post above is nothing but a commercial.
No thanks, I can read about alternative theories all day for free.
Comment by Freder ick Ford on 10 November 2011:
David: I think you need to check your premises. The wealthy are generally people who have successfully amassed capital by successfully offering products, services to the market, and/or, they have been able to invest wisely. The poor are people who have not been successful and have not amassed wealth; however, they gain tremendously as an indirect consequence of the wealth creators.
The step from poor to wealthy has been accomplished by many Americans. A new economic system will not solve any problem: only a free market system will.
“If concern for human poverty and suffering were one’s primary motive, one would seek to discover their cause. One would not fail to ask: Why did some nations develop, while others did not? Why have some nations achieved material abundance, while others have remained stagnant in subhuman misery? History and, specifically, the unprecedented prosperity-explosion of the nineteenth century, would give an immediate answer: capitalism is the only system that enables men to produce abundance—and the key to capitalism is individual freedom.” Ayn Rand
Comment by James on 10 November 2011:
Fred, the wealthy are people who have succeeded at getting large amounts of money. That is true by definition. But you cannot simply assume that anyone who got large amounts of money must have provided some useful product or service to someone at some point.
What you are saying is, essentially, “well, I’m sure that the rich must have done something to earn their wealth, so I’m not going to look into it any further.”
You cannot just assume, without any serious argument, that we live in a system that gives all people exactly what they deserve. In fact, we do not. Even by your own Randian standards we do not.
Comment by Freder ick Ford on 10 November 2011:
First, I really enjoyed the article.
Second, James, you are putting words in my mouth. While it is true that some wealthy people have not earned their money honestly, we do not define a concept such as wealthy by marginal examples. One of the biggest problems is we do not have a free market but a mixed economy.
I find it strange that you state “we live in a system that gives people exactly what they deserve”? You are completely outside the realm of free market economics. You seem to want a system that guarantees a certain result according to whether they deserve it or not. Is this what you are looking for?
Comment by Levi on 10 November 2011:
Acutally, James, it is true that someone who has amassed wealth (given that they do not steal or operate by gov’t favors) has provided a useful product or service.
The usefulness of a product is determined by those who purchase it. If a person makes a profit on the market, they have done so by combining inputs in such a way that the output is more highly valued than the inputs. Thus, they have added to the wealth of society and thereby obtain wealth for themselves.
Comment by Joker on 12 November 2011:
Horwitz: Great article, as always.
But it appears to me that instead of writing a massive essay (although, that is necessary in some places), a libertarian can simply ask her opponent one question; “Who will win the Superbowl this year?” The various teams all have different information, the games can get messy (no one thought the STL Rams would beat the NO Saints for example), there is imperfection every where (if plays worked how they should work, scores would be in the 70s for both teams, plus injuries mess up everything), etc.
GB Packers are 8-0 so far this season, only undefeated team. Will they win the Superbowl? Impossible to determine, just as many variables as the free market.
Also, I think part of the problem lies in the mindset of many Westerners today. Every one thinks any issue should be able to be solved near instantaneously. Free markets can’t do that, and of course, government ALSO cannot do that. Just look at the past… what is it now, 4… 5… 50? “stimulus” bills.
PS: Yes, the Packers will win, because they are my favorite team, duh.
Comment by wojteksz8 on 14 November 2011:
The market defender should ask socialist how the goverment will solve a problems, if he ask how it will be solve by market.
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[...] Markets are Messy (FEE) [...]
Pingback by Markets Are Messy, Part 2: The Errors of the Economists | The Freeman | Ideas On Liberty on 17 November 2011:
[...] Last week I argued that critics of markets are wrong when they point to imperfections as an ipso facto case for government intervention and when they criticize defenders of markets for being unable to explain exactly how they would solve a particular problem. Markets are inherently messy and imperfect, I argued, because they are processes through which we discover what we otherwise would not know. Asking markets to be perfect or for defenders of them to know what they will do in the future is asking the impossible. The argument for markets has to recognize their imperfections but also note that they are still better than the alternatives. [...]
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Pingback by The Shrubbloggers » The Reign of Fonzie Economics on 10 December 2011:
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