Markets Make Sense, Except When They Don't
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by Charles Wheelan, Ph.D.
(Originally posted at:
http://finance.yahoo.com/expert/article/economist/24259)
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Posted on Tuesday, February 13, 2007, 3:00AM
Do you believe in markets? Of course you do -- unless you're a communist.
Even the communists managed some pretty impressive black markets. I traveled for several weeks in the U.S.S.R. in 1988, and spent much of the time behind my hotel trading things out of my suitcase to Soviet teens for rabbit fur hats and Lenin pins.
Cornering the Market
Presumably, the 20th century proved that the market solution is usually the right solution. The theory is simple and elegant: Individuals and firms make themselves better off by entering into voluntary transactions, which collectively make up markets. By definition, all involved parties expect a transaction to make them better off, or else they wouldn't do it.
True, things may turn out badly, such as the hot stock you bought last year that fell 78 percent when the CEO revealed that all earnings since 1983 would have to be restated. But that's not what you expected. Nobody intentionally tries to lose money or to make their life worse. Instead, all parties to a transaction expect good things, or at least better than the alternatives.
That turns out to be pretty powerful stuff when you add it all up. If we leave people and firms alone, they naturally do things that make all of us richer -- they innovate, they work hard, they put resources to their most efficient use. Who can be against that?
Trapped by Progress
Just about everyone, it turns out, depending on the market in question. I would venture that economists like markets a lot more than the rest of the population, regardless of their political views.
Left-wingers aren't fond of sweatshops, for example. Why do we pay Vietnamese workers 75 cents an hour to sew shoes? Because we can. That's a pathetic reality; on the other hand, how exactly would closing the sweatshop make those workers better off? In all likelihood, if they had better options than sewing shoes for 75 cents an hour they wouldn't be working in a sweatshop in the first place.
Some liberal opposition to market outcomes is much more justifiable. We too often forget that every time someone builds a better (or cheaper) mousetrap, it's bad news for whoever made the old mousetrap. I don't advocate banning new mousetraps (or curtailing cheap imports from China), but there's nothing wrong with showing some empathy when markets create losers, as they always do.
Free and Easy Trade
What about conservatives? They talk the market talk, but don't always walk the walk. Try this experiment: Find a large Republican rally and take a turn at the microphone. Get the crowd warmed up with some general remarks about the elegance of markets and the evils of government. Then, when the applause lines are coming fast and furious, ask where you can buy some really good sex.
During the stunned silence, admonish these conservative market enthusiasts to fight against the oppressive zoning regulations that make it impossible for you to buy private property and build apartment buildings in most ritzy suburbs.
Why shouldn't you be able to do a tear down a single-family home on a five-acre lot in Greenwich if you can make a profit by replacing it with lots of cheap apartments? After all, don't they call it the housing "market"?
A Free-Market Self-Test
The reality is that most people -- from one end of the political spectrum to the other -- find some market outcomes objectionable.
Markets don't elicit any kind of consensus. The most interesting public policy questions often involve market outcomes that people decide they don't like -- whether it's sweatshops, prostitution, cheap imports from China, or something else.
So how do you feel about markets? Take this quick quiz. I've included my own (short) answers.
1. Should we legalize the sale and possession of drugs like marijuana, cocaine, and heroin?
My answer: I don't know. Certainly there's a market for these drugs -- lots of eager buyers and sellers. Society spends a lot of money trying to disrupt that market, seemingly to no avail.
Yes, drug use harms innocent third parties, but so do alcohol and tobacco. In those cases, we use taxes to raise the cost of smoking and drinking, and we regulate the specific behaviors that affect third parties, such as smoking at the office or driving drunk.
So why not do the same with drugs? Our current approach is both ineffective and expensive. Nonviolent drug offenders are clogging the courts and prisons. All the while, demand seems unabated and the illegal drug trade is empowering and enriching gangs and violent criminals, just as Prohibition did for organized crime.
Milton Friedman famously noted that everything wrong with drugs stems from the fact that they're illegal. I don't know about "everything" -- these are addictive substances that harm people and their families -- but I take his point.
And yet I'm not prepared to turn the sale of crack over to a Fortune 500 company that can maximize profits by finding new ways to get 18 year olds to sample their product. Nor do I want the government in the business of selling and distributing heroin. I don't have a moral objection to legalizing drug use and punishing only the behavior that affects the rest of us -- the drug equivalent of drunk driving. I just can't figure out how to do it.
2. Should we liberalize labor markets, so that workers can more freely cross international boundaries?
My answer: Yes. I find it hard to justify criminalizing anything that I would do myself. If I were poor and trying to raise a family in Mexico, I would do anything to get to the U.S. -- legally or otherwise. Capitalism is all about rewarding those who are willing to work harder or cheaper. Why is labor that crosses an international border any different?
When we buy a cheap stereo from China, that's globalization. When we give the kitchen remodeling job to the lowest bidder, that's competition. When some guy from El Salvador offers to cut the lawn cheaply, that's illegal. To an economist, it's just another voluntary transaction that makes both parties better off.
Yes, we need to police the borders -- for terrorists, not cheap poultry workers. You can reasonably disagree with me, but you must concede that I'm the one advocating the "free market" outcome in this case and you're not.
3. Should we implement a federal carbon tax and/or significantly raise the gas tax?
My answer: Absolutely. If you believe in markets when they work well, then you have to understand how they need to be tweaked when they don't. If page 10 of any introductory economics text explains the wonders of supply and demand, page 12 usually explains that markets don't deliver an efficient outcome when eager buyers and sellers impose some harm, or negative externality, on a third party.
If I can change the oil in your car more cheaply than the competition by dumping the old oil in Lake Michigan, that's not the kind of market transaction that got Milton Friedman so excited. Yes, I make profits and you save money -- a mutually beneficial, voluntary exchange -- but anybody who cares about Lake Michigan is not happy at all, and they aren't represented in our little transaction.
When the price of some activity is artificially cheap because society is picking up part of the tab, people do too much of it. That's not the economically efficient outcome that markets usually deliver. One standard economic fix is to impose a tax on whatever private activity imposes the social cost; when the price of the activity goes up, people do less of it.
That's exactly what a carbon tax or a higher gas tax would do. There's nothing voluntary about me breathing your tailpipe emissions. If we raise the private cost of driving, people will be less likely to commute 60 miles alone in a Chevy Tahoe.
The optimal market outcome isn't always synonymous with doing nothing; in this case, the market works best when the government does something. That something happens to be a tax, or anything else that raises the cost of the polluting behavior.
