The Weakness of Markets

Are markets capable of meeting our greatest needs?

The courtroom was packed. After a gruelling cross-country chase the notorious killer had finally been captured. The air was thick with tension.

“Do you have anything further to say for yourself?”

The haggard criminal spat, “I regret nothing.”

A gasp filled the room.

“Very well,” declared the judge, “There remains only one thing to do.”

Reaching into his gown, he retrieved a glinting 20-cent piece and tossed it into the air with a flick of his gnarled and bony thumb. It landed again in his palm.

A silent platypus peered up from the face of the coin.

“Not guilty!”

The courtroom erupted.

How to run a country

There’s a basic set of practical questions that every society must answer.

What should we produce? Who should create those products and services? Who should be given access? How much should those people be charged?

On one level, these are logistical problems. On another level they are moral.

Just ask any parent who has experienced dividing a block of chocolate between two or more kids. Breaking the chocolate into pieces is the easy bit. Convincing each kid that they got their fair share is another task entirely.

One popular answer to the practical questions above is simply: let the market decide.

Of course, a market can’t really make decisions. People make decisions. But a market is an ingenious tool that enables a massive number of people to coordinate their decisions.

When buyers and sellers gather together to trade they bring with them a myriad of different needs, preferences, and constraints. The market enables everyone to navigate this complexity and form an agreement about the production, price and distribution of the goods being traded. Instead of developing a highly complex and costly set of rules to determine price and distribution of goods, or the allocation of resources required to produce them, the market finds an answer through competition.

In terms of logistics this is an elegant and powerful mechanism. In terms of morality, it has severe limitations.

Shopping for tomatoes

Imagine a market for tomatoes. A few independent farmers decide to offer their produce for sale at various prices. Customers arrive and begin to negotiate with the farmers to purchase tomatoes. There is no central tomato authority stipulating what the price of a tomato shall be. No government mandate sets the limit on the total number of tomatoes that a farmer may sell or the total number of tomatoes that each customer may buy. Without the need for any regulation, the price for each tomato will emerge as a result of the bargaining process between farmers and customers. This process is sometimes termed, “price discovery”.

Price here is dependent on a range of factors, such as the number of farmers, the number of customers, and the number and quality of tomatoes. The amount of money that the customers bring will also have an impact. If any one of these factors is different there’s a good chance the price of an individual tomato is going to be different too.

With virtually zero overhead we have created a powerful system that assigns value and allocates goods. Yet on closer inspection we begin to see that there are key things which markets do not do. First and foremost, markets do not provide guaranteed outcomes.

A system which allocates resources based on price has little to no regard for the needs of individual market participants or the distribution of resources throughout a population. This is the flip side of the ability of markets to condense a massive amount of information into a price signal. If you can’t match the price, you miss out on the goods.

What’s more, the price of a tomato is not necessarily the same as the value of a tomato. This is where things start to get interesting.

How do you calculate value?

Economists throughout history have argued about the true value of products and services and the correct way to calculate value.

Adam Smith made a clear distinction between the exchange value – or price – of goods and their use value. He puzzled over the contrast between water and diamonds.

“Nothing is more useful than water: but it will purchase scarce any thing; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.”

Writers as far back as Aristotle and Thomas Aquinas had made similar observations.

In the 1800s, David Ricardo and Karl Marx acknowledged the difference between use and price, and argued for a theory of value based on labour. Marx claimed that the exchange value of goods could be calculated by summing up the total labour power required by society to produce the goods. On a farm without complex machinery, the exchange value of a tomato should correspond to the number of hours a farmer must spend tending tomato vines and waiting for tomatoes to grow.

But many later economists disagreed with the labour-theory analysis.

In the 1870s, William Jevons, Carl Menger, and Leon Walras each put forward a marginal theory of value stating that the use value – or utility – of a tomato would depend on how many tomatoes you already own. As it turns out, the process for determining exchange value was based on the same principle. When calculating exchange value, the marginalists claimed that it didn’t matter how many hours a farmer spent growing tomatoes because the amount someone was willing to pay simply reflected the use they expected to get from the purchased item. By showing this connection between utility and price, the line between use value and exchange value began to blur.

Objective and subjective

The argument about theories of value cuts back to the moral dimension of managing and distributing resources in society.

Marx was convinced that the labour theory of value was proof that capitalists were generating profit by underpaying their workers, since the price of goods sold was based on the hours of labour involved in bringing the goods to market. The marginalists showed that no such alarm was necessary since price was based on the subjective preferences and utility expectations of each individual.

Yet the tension between objectivity and subjectivity in the marketplace remains today.

On the one hand we’re confronted by the objective nature of human needs. We all need food. We all need shelter. We all need connection with other humans.

On the other hand, the fact that all humans share the same needs does not mean all people have access to the same resources. And that means the utility we attach to items in the marketplace may be wildly different.

Back in the famers’ market, three customers are competing for a tomato advertised at a fixed price. The first customer wants the tomato for a salad because they’re hosting friends. The second customer wants the tomato for a still-life painting. And the third customer has no access to any other food and will starve to death unless they can purchase the tomato.

Same tomato. Same price. Different utility.

So who gets the tomato?

What markets don’t do

Markets do not allocate resources based on human need but based on price.

There is nothing in the mechanics of a market that is capable of distinguishing between the odds of survival of competing customers. The operation of the market is dependent on abstracting away the important human parts of people and replacing them with prices. It’s not a bad thing – it’s part of the simplifying power that makes markets extremely useful. But we’d be insane not to recognise the immense danger this creates.

The starving man and the still-life artist are exactly equivalent in the eyes of the market as long as they pay the same price for a tomato. If the artist can afford to pay a dollar more than the starving man, the market says that the rational decision is to let the man starve. The problem with the process of market-driven resource allocation is that it can operate without any connection to the intended use of what we buy and sell.

What does a nation need?

When it comes to organising society in a way that promotes order, productivity, and prosperity, what we use resources for turns out to be pretty important. In many circumstances, use value is far more important than price.

Cheap tomatoes? Good for you. You have access to a healthy food source for the week. But if I’m allergic to tomatoes, far from being a health booster, those cheap tomatoes are literally a threat to my life. Use value matters more than price.

Or consider housing markets around the world. Everybody needs a home. Nobody can escape the need for shelter. But an unregulated private property market contains no mechanism to prevent me from accumulating multiple investment properties and leaving them vacant out of preference while you’re left to sleep on the street. Use of housing to accrue capital gains is not equivalent to using it for shelter, or as a stable home for a family. The difference between price and use value matters.

Appropriate distribution of resources according to need has a massive impact on the stability of society. Despite cultural differences, everyone carries an intrinsic sense of right and wrong. Most people don’t like the idea of forcing someone to starve to death simply to enable another person to complete a painting. It feels “wrong” on some deep, instinctive level.

Now imagine that the person starving to death is not a theoretical character from an online post, but your mother. Or your child. The resulting outrage from that primaeval sense of injustice is enough to rip societies apart. This is the kind of raw emotion that fuels revolutions and overturns governments. It all tracks back to individuals and families having access to the actual value that they require to survive and flourish. And as we identified before, markets – while being useful in many ways – are not designed to guarantee access to what people need most.

When considering the interplay between markets and social stability, it is difficult not to think of the murder of UnitedHealthcare CEO, Brian Thompson, in the US. It is imperative that we condemn the unlawful and violent destruction of human life. It is also striking to see such violence superimposed against a healthcare market regarded globally as one of the most ineffective in providing affordable services to meet basic human needs.

Conclusion

A widespread reliance on markets, far from being a recipe for national success, is a path to disaster. Despite a surface-level appearance of promoting equity through encouraging everyone to negotiate using the same, impersonal prices, markets with minimal regulation lead us to ignore utility, prioritise profit over humanity, and leave the door wide open for unjust and ultimately unproductive accumulation of resources.

Flipping a coin is never going to produce a just result when deciding the fate of a criminal. It’s the wrong tool for the job.

Markets on their own are not capable of ensuring that everyone has access to what they need. For that, we require carefully designed regulation, principled leaders, and citizens who are ready to speak up and fight for a fair go.

Photo by Tingey Injury Law Firm on Unsplash.