What markets should and shouldn’t do

We often face the impressive and efficient balancing forces of perfect competitive markets and try to convince others (or ourselves) of their efficacy in contentious area of policy, which are usually imperfect or uncompetitive markets. Before the armchair politicians we all can be shoot from the hip, let’s cover some basics, like: what are the perfect competitive markets the model is built on?

Competitive Markets
Competitive markets assume demanders and suppliers can easily enter or leave the market, as a result of which there are many demanders and suppliers in the market. Also, the product is assumed to be a homogenous product, about which factors like the prices and quality are well known (perfect information). We can apply economic theory if all these prerequisites are present, and the results are impressive-no one can argue how well the market models aid and predict say the organisation of production of potato, its distribution and pricing, and how badly centrally planned economies fared when removed the market forces and imposed controls on production, distribution and pricing. But these glowing results will cause us to try to apply the same models in other areas, like nature, medicine, education, media, etc. and forget the assumptions on which they are based. So, let’s ask the policy technocrat that tries to apply straightforward economic modelling in medicine: which of the assumptions are true?
Market forces in non-competitive markets
Let’s take medicine for an example. Suppliers of medicinal services cannot easily enter the market-apart from the cost and time involved in training, their number are artificially restricted by medical boards. Indeed the existence of powerful medical boards makes medicine a de facto monopoly, the antithesis of “many suppliers free to enter the market”, which fact alone should alert any free-market proselytisers. Medical information, even the “hardest” sort like clinical trials about efficacy of treatments is highly distorted by factors like the limited scope of investigation, evaluation of results over limited time horizon and partiality to the backers of research (drug companies). Investment depends on the potential profitability of the drug: longsuffering patients (say, high cholesterol sufferers) are the premium clients benefiting from the majority of research, but one-shot lifesaving drugs (antibiotics) aren’t (remember: to profit driven companies human life has no price tag, of only interest is the ability to pay for saving one). For ease of management administrators do their best to standardise the services provided (now even hospital funding is provided on the case-mix basis: one wound treatment is $X, one broken arm $Y), but everyday people can all recognise that every patient is different, and the easy cases will be cash cows, and there won’t be incentive to treat the difficult ones or to prevent problems from occurring in the first place.
We must realise that hard-nosed, profit-driven private interest relying on economic models developed with theoretical perfect competitive markets in mind, do not work and have no place in higher echelons of complex areas like medicine because of three types of problems: markets models are not applicable to complex products, the market is stuffed up by the interventions of special interest, and lastly, diametrically opposed un-reconcilable interests of entrepreneurs on one hand, and society as a whole on other.

“Un-Priceable” outcomes
Another factor that makes market models useless is the narrowness of criteria by which outcomes are judged. Human intelligence simply isn’t capable of pricing all possible outcomes to accurately reflect the utility they provide to our society in general and on a very long time scale-that would require omniscience. If we don’t know what is foregone, how do we know we are making the right choice? Since we tend to imagine ourselves as highly intelligent (and we tend to equate that to mean rational), we tend to assume that our rational decisions are “pretty close to the money”, but often the commonsense/obvious and rationally measured value are diametrically opposed. When we call something “priceless”, we identify that experience as, despite being free, having the highest value, above all material goods and services. For example we might go to a lake region to experience the serenity and awe witnessing nature’s beauty gives us, and later enthuse about the weekend spent as “priceless”. However, what the economist or commercial operator hears when listening to the same story is: “worthless”. A true entrepreneur is likely to decide to cut down the forest and start a jet-ski business on the lake. Sure, the lake and its surrounds will no longer be the source of priceless experiences to all that are drawn to it, but in economic terms, what has been given up? Nothing. The jet-ski business is producing utility where there was “none” before, therefore is a roaring success, literally and business wise alike. The GDP has further grown, and everyone applauds. The narrowness of criteria is exacerbated by the ruthless efficiency of the market model. Anyone that fails to jump to exploit any opening or gift of nature is eliminated and a more ruthless person will take the opportunity to price short term private profits above long term public benefit.
Of course, in the case of nature, governments around the world recognise this problem and wisely have created national parks, and other restrictions to stop the dismal science of economics from eliminating all un-priced utility, and reaching its predictable, joyless, homogenous end game. After all, we are used to seeing land as important, strategic resource. But we are much more tolerant of the same territory grabbing trick in other areas, like the media scene. Are ideas less worthy of protection than physical land? Should we create public areas for the varied ideas can flourish, free from being pressed into service and being exploited, like nature is allowed to thrive in national parks? I suspect so, but that message is a harder sell and under harder attack from interest group. Information and ideas, not land, give effective control in the 21st century.

Loss of diversity
Another outcome of ignoring un-priced and long-term outcomes is that commercial products have to be similar and mediocre, lacking foresight, originality and innovation. Media is a good example of this dynamic as well. Commercial movies, radio and TV stations take minimum risks, repeat what worked in the past or focus groups tells them work now, narrowly aim at the lowest common denominator and don’t invest in un-priceable aspects such as public taste or understanding. Copying and repetition are passed as innovation. As markets mercilessly eliminate anyone but the shows giving the highest returns this season, the formulas on how and what to produce become more cut-and-dry. As commercial media hones in ever more accurately on their narrowing and calculated demography, public broadcasters fill an ever more important role in identifying talent, new ideas, serving niche markets, innovation and satisfying those yearning for high quality exchange of un-priceables: ideas, taste, understanding, independence, diversity, etc.
Sadly, democratically elected politicians are a good analogy of commercial products. My problem is finding an analogy for public broadcasters in the political arena.

Social norms
There are psychological weak points unaccounted for in the market theory. Classical theory assumes rational demanders, who pay in proportion to the utility the goods provide. But there is another motivation factor: identity utility, derived by performing actions that conform to social norms (Akerlof & Kranton, 2010). This force explains phenomena like the rationally unexplainable concentrations of men and women in different job profiles. This is how (and not through some rational thought) the practice of paying thousands of times the value for bottled water is perpetuated. Companies with big market power realise this, and establish the norms that suit them by artefacts that obviously add no value for the society at large like advertisements. We could see how an overpowering social change like the Second World War could wipe the established irrational norms in job distribution: when there were no men to do the “manly” jobs, women filled the void, and thus created a new social norm. The end result is a more equitable and efficient labour force. Of course, we don’t need to create war to present a unified, overpowering force (central social planning?) to get rid of outdated norms inherited from different times, or inefficient and exploitative norms imposed by special interest. Hysterical slogans like “nanny state”, “big brother” will inevitably arise in the wake of such action. These slogans have their place, but not if a benevolent public representative with foresight exerts efforts to change what the market is never going to do on its own-another wrong application of a powerful idea, but that is another topic for another day.

Reference List:
Akerlof, G & Kranton, R, Identity Economics, 2010

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