What Do Markets Do? - WHY SOME THINGS SHOULD NOT BE FOR SALE

Economists have written surprisingly little about the nature of a market, assuming perhaps that it is a simple concept with a clear or obvious referent. There is, for example, no deﬁ nition of a market in many of the most widely used economic textbooks. ¹ Yet in reality a market is a complex institution. As we will see in subsequent chapters, my view of markets is that they are even more complex than the basic account I give here suggests.

To begin, markets are institutions in which exchanges take place between parties who voluntarily undertake them. ² Because all human action takes place within limits—I can’t use my arms to ﬂ y simply by wishing it so—“voluntary” cannot mean the same thing as “unconstrained.” All human action is constrained, by external and internal factors. There is a rich and subtle philosophical literature on the nature of voluntary actions, attempting to distinguish them from actions that are unjustly constrained. ³ For present purposes I will simply assume that in market exchanges both buyer and seller are entitled to the resources with which they transact, have the freedom to accept or refuse an offer of exchange, and can attempt to make another offer or strike a better deal with someone else. ⁴

Additionally a market is not a single exchange between two individ-uals; indeed an exchange can be noxious without there being a noxious market. ⁵ Markets coordinate behavior through price signals, and to do this there have to be enough exchanges so that people are able to adjust their behavior in response to the actions and anticipated actions of others. If there are only two goods in the world, then you and I might exchange those goods with each other, but unless there is the possibility of coordination on future exchanges we don’t really have a market, at least as I am using the term here.

The New Shorter Oxford English Dictionary deﬁ nes a market as “a meeting or gathering place of people for the purchase and sale of

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provisions or livestock” and as “the action or business or buying and selling.” ⁶ But markets are not merely meeting places or a series of indi-vidual transactions: they are social institutions that must be built up and maintained. ⁷ Initially markets may be thrown up spontaneously, but in the end they are socially sustained; all markets depend for their operation on background property rules and a complex of social, cultural, and legal institutions. For exchanges to constitute the structure of a market many elements have to be in place: property rights need to be deﬁ ned and protected, rules for making contracts and agreements need to be speciﬁ ed and enforced, information needs to ﬂ ow smoothly, people need to be induced through internal and external mechanisms to behave in a trustworthy manner, and monopolies need to be curtailed.

In all developed market economies governments play a large role in securing these elements.

For this reason it is mistaken to consider state and market to be oppo-site terms; the state necessarily shapes and supports the process of mar-ket transacting. In Lewis Kornhauser and Robert Mnookin’s memorable phrase, all (market) bargaining occurs in the shadow of the law. ⁸ Trans-acting individuals depend on the state for their basic security when they walk to the corner store to purchase food for their meals; they expect the state to enforce health and safety requirements concerning food pro-duction and handling; and they expect the shop owner to be sanctioned if he fails to keep up his end of the transaction. The fact that laws and institutions underwrite market transactions also means that such trans-actions are, at least in principle, not private capitalist acts between con-senting adults, as the libertarian philosopher Robert Nozick famously claimed, but instead a public concern of all citizens whether or not they directly participate in them.

In addition to speciﬁ c markets, such as markets in land, labor, or luxury goods like a yacht, there is what is sometimes referred to as “the market system” or the market economy. This further abstraction is usu-ally taken to refer to a “society wide coordination of human activities”

through mutual transactions. ⁹ Some people also use the term to refer to the integration of markets with “private property in the means of production.” ¹⁰ But markets can coordinate behavior under very different property rules. I will use the term market in the context of discussing speciﬁ c types of exchange transactions and market system as the abstrac-tion that is supposed to link the set of all such markets. One important

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argument of this book is that in order to understand and fully appre-ciate the diverse moral dimensions of markets, we need to focus on the speciﬁ c nature of particular markets and not on the market system.

M A R K E T V I RT U E S

It is difﬁ cult to understand how a market system or any particular mar-ket works. Like ants in a colony, individuals cooperating in a marmar-ket

“have no dictators, no generals, no evil masterminds. In fact, there are no leaders at all.” ¹¹ The participants in a market are not obligated to follow another’s orders with respect to what they buy and sell. Through markets individuals coordinate and mutually adjust their behaviors without relying on a conscious organizer to bring about the coordina-tion. Somehow a market order arises out of millions of independent individual decisions, although such decisions are supported, as I stressed earlier, by an array of government and nongovernment institutions.

Nevertheless the fact that coordination occurs largely through indi-vidual decisions and not through a central command and control struc-ture explains and supports two particular virtues associated with markets, at least when they are working well: their link to efﬁ ciency and their link to liberty. Let us consider each of these virtues in turn.

E F F I C I E N C Y

Market transactions link multiple chains of trades and involve coopera-tive behaviors spanning the globe. To give an example, workers in India whom I will never meet assembled my cell phone using materials imported from Africa and ordered on the Internet from suppliers, and the phone was transported to me by the employees of a transnational shipping com-pany. Through the use of prices, markets signal what millions of goods are worth to sellers and buyers and intermediaries who will never meet each other. In doing so they function to mete out resources efﬁ ciently, indicating to sellers what and how much to produce, to consumers what price to pay, and to investors where to lay down their capital. Because rational individuals will exchange with one another only when they have

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something to gain, markets will (ideally) purge the economy of less desirable goods and move the trading parties to their most preferred positions, given their resources. The continual adjustment of supply and demand, registered in changing prices, allows markets to “clear” what has been produced. When inventory is cleared, there is no excess demand or excess supply: supply equals demand at some price.

A set of remarkable theorems formalizes the link between markets and efﬁ ciency. The ﬁ rst is the so-called fundamental theorem of welfare economics, according to which the result of any market equilibrium under perfect competition is Pareto optimal. ¹² A social state is described as Pareto optimal if and only if no one’s position (measured in terms of their preference satisfaction) can be improved without reducing the position of someone else. The intuitive idea behind the theorem is that people will engage in mutually beneﬁ cial exchanges and continue doing so until they cannot improve their positions by exchanging further.

When all exchanges cease it is because an optimal allocation has been reached. Once that point is reached any deviation will make at least one person worse off.

A second formal result proves the converse proposition, that every Pareto optimal social state is a perfectly competitive equilibrium for some initial distribution of resources. It is worth keeping in mind that there is typically more than one Pareto optimum for any economy; in addition, given different starting distributions market competition will yield different results. This theorem allows that radical change from the status quo can still be efﬁ cient; it suggests that we can always ﬁ nd some initial distribution of resources that, along with the use of a market, will support a given Pareto optimal (efﬁ cient) social state.

These two results have intuitive ethical appeal. With respect to the ﬁ rst theorem, it seems obvious that it is better to make people better off and that if one of two prospects is better for someone than the other, and at least as good for everyone else, then it is better. ¹³ Yet although these efﬁ ciency results may be powerful in certain respects, they are actually of limited signiﬁ cance from a normative (ethical) point of view.

Paretian efﬁ ciency does not give us overriding reasons for using markets or overriding reasons against interfering in them. As Amartya Sen notes,

“A state can be Pareto optimal with some people in extreme misery and others rolling in luxury, so long as the miserable cannot be made better off without cutting into the luxury of the rich.” ¹⁴

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We have good reasons to care about more than Paretian efﬁ ciency in our assessment of markets. For example, we have reasons to care that the initial distribution of resources in society is fair . Indeed if you think that individuals are entitled to certain property rights—by considerations of justice—then the fact that a certain social state is efﬁ cient relative to a different distribution of property rights has no normative force for you whatsoever. This is why objections to slavery are not undermined if it turns out that a slave system is Pareto efﬁ cient (insofar as any change in distributive allocations would make the slave owners worse off).

The second theorem might seem to help here since it allows for the incorporation of the distributive justice objection. If a critic doesn’t like a particular Pareto equilibrium she can always redistribute initial resources the way she wants—abolish slave ownership, for example—

and then allow competitive markets to produce another Pareto optimal result. Of course arranging for the redistribution is another matter.

In practice it is very difﬁ cult to ﬁ nd policy interventions that do not make at least one person worse off. Consider policies to promote the building of roads, hospitals, bridges, or schools. Somebody almost always prefers that these tasks not be undertaken; for example, a new highway beneﬁ ts some businesses but hurts others located along the route of the older road. Nonetheless there may be good reasons to build the road.

For this reason many economists prefer to think about efﬁ ciency in ways that allow the costs to some to be compensated by the extra gains to others. We can deﬁ ne a social state R as a potential Pareto improvement over a social state S if the winners in R could compensate the losers in R and still retain something over and above what they would have had in S. This idea of efﬁ ciency is sometimes referred to as KaldorHicks efﬁ -ciency, and it is effectively a form of cost-beneﬁ t analysis. Cost-beneﬁ t analysis tells us to adopt the policy (e.g., to build or not build the new road) that has the largest net beneﬁ t, other things being equal. However, we should bear in mind that a policy with the greatest net beneﬁ t may in reality fail to distribute some of that beneﬁ t to the losers, and thus this form of efﬁ ciency (unlike Pareto efﬁ ciency) can wind up endorsing pol-icies that actually make some people worse off!

Although Kaldor-Hicks efﬁ ciency is a more useful concept than Pareto efﬁ ciency to use in evaluating economic policies, given that so many exchanges produce both winners and losers both concepts are still normatively narrow ways of assessing economic achievements. Both

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employ criteria that omit consideration of such issues as what is a fair distributive outcome. Indeed the development of these concepts of efﬁ -ciency was partly motivated by the desire to separate the study of what economists saw as uncontroversial economic improvements from the more controversial questions of ethics and distributive justice.

I believe that such a complete separation is in fact impossible.

For example, the acceptance of the Pareto criterion as the measure of economic improvement depends on a key normative assumption: that improvement is to be measured in the space of individual preferences.

That is, on this view of efﬁ ciency, people are considered better off the more that their own (consistent) preferences are satisﬁ ed. Additionally this criterion was formulated to bypass interpersonal comparisons with respect to different individuals’ preference satisfaction since such com-parisons are considered meaningless because there are “no means whereby such comparisons can be accomplished.” ¹⁵

But surely not all preferences are equally worthy of satisfaction. First, some preferences are really urgent needs, whereas others are altogether frivolous. It is surely more important to satisfy the needs of those in extreme misery in Sen’s example than to add more to the coffers of those already rolling in luxury. The fact that income transfers to the poor would make the wealthy worse off does not settle the case against such transfers.

Second, some preferences, such as the preference for hurting others, would be accorded no weight at all from a moral point of view. Is it really an improvement if, all things being equal, the slaveholder’s preference for more slaves is satisﬁ ed or the sadist’s preference for inﬂ icting pain?

For these reasons most political and moral philosophers (indeed most people) use criteria for assessing social policies that go beyond Paretian and even Kaldor-Hicks efﬁ ciency. They appeal to fairness as well as to con-ceptions of human well-being that allow us to compare the beneﬁ ts and costs of different policies to different individuals. In comparing people’s well-being we might be led to decrease the preference satisfaction of the millionaire to satisfy the urgent needs of the desperately poor. Indeed we might be led to reject preference satisfaction as the right metric for making and assessing interpersonal comparisons and for evaluating economic states of affairs. (Later in this book I discuss in more detail the limitations of focusing on preference satisfaction as a standard for assessing markets).

Nevertheless the efﬁ ciency theorems do give us some insight into the individualistic basis for the mutually advantageous nature of trade.

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Individual decisions function, in the context of markets and prices, as signals for coordinating action to satisfy maximally agents’ wants under given sets of constraints. In a market’s best-case scenario, where informa-tion ﬂ ows, there are no third-party effects of exchanges, no monopoly power, and the parties are completely trustworthy, the network of indi-vidual trade serves to generate improvements in getting people what they want. It thus produces efﬁ ciency relative to those wants; it limits waste and uses human and nonhuman resources efﬁ ciently. However, in real-world scenarios we cannot automatically conclude that the market is more efﬁ cient than alternatives. In almost all actual market contexts there are problems with information and enforcement that mean that intervention can improve on efﬁ ciency, a point to which I will shortly return.

F R E E D O M

From a normative point of view, one of the key attractions of markets is their relationship to individual choice and decision. Markets:

• Present agents with the opportunity to choose between a set of alternatives (partly by providing individuals with incentives to create the material wealth which is a precondition of having an extensive array of choices)

• Provide incentives for agents to anticipate the results of their choices and thus foster a kind of instrumental (means-ends) rationality • Decentralize decision making, giving an agent alone the power to

buy and sell things without requiring him or her to ask any one else’s permission or take anyone else’s values into account • Place limits on the viability of coercive social relationships by

providing (at least formally) avenues for exit

• Decentralize information, thereby making abuses of power by authorities less likely

• Allow people to experiment, to try new commodities, to develop new tastes, to opt out of traditional ways of life

• Contribute to the undermining of racial, ethnic, and religious discrimination by appealing to the reciprocal self-interest of individuals in exchanging goods with one another and by fostering anonymous exchange

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Liberal theories that assign substantial weight to individual freedom thus tend to allot a central role for market allocation, pointing to the market realm as a place where the capacities for individual choice, indeed where the liberal individual herself is developed. Markets call up our powers as individual decision makers who can veto as well as sign on to exchanges, and they give scope for the exercise of these powers. In this sense markets can be instruments for promoting freedom: they develop our capacities to choose. Additionally markets can be compo-nents of freedom. As Amartya Sen has noted, the freedom to engage in transactions with others, to decide on where to work, what to produce, and what to consume, are important parts of a person’s overall free-dom. ¹⁶ Choosing often has an intrinsic value; many of our actions have a special meaning for us precisely because we chose them. Think about buying a birthday gift for a devoted friend. Even if I could hire someone to make the choice and purchase for me, I may want to do it myself as a way of expressing and communicating my own feelings. Even if a well-designed computer program allotted people into careers that matched their talents, this would be quite different from allowing people to choose (perhaps with less happy outcomes) their own occupations.

Many of us want our own values and judgments to be reﬂ ected in what work we do, what we consume, and which of (what Max Weber termed) the warring gods we serve in how we live.

Many political and social theorists have valued markets precisely because they believed that markets assist in the development and exer-cise of our capacities as individual decision makers. For even if, as Locke and Rousseau thought, we are born to a state of freedom, it is widely recognized that to develop and realize various freedoms requires educa-tion, planning, practice, and cooperation with others. The development of the free individual is in fact a tremendous social achievement.

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