Markets and the Return of the Economic Zombie!

As someone or other once said, generals always plan to fight the next war with the weapons of the last. Much the same seems to be true of economists. In the light (if that is the word) of the last year or two, the idea that market economics is still a contender for the basic model for the economy is quaint to say the least. Even if you take capitalism for granted (which, for the time being, I think we can), markets and market theory are hardly contenders for tools for managing it. The reason I say this is because a) markets don’t really exist, and b) even if they did, standard market theory is at best half-baked and at worst simply false.

Perhaps I should restate the claim that markets don't exist. Markets don't exist as market economists imagine them. The assumptions market economics is based simply do not apply to current economic conditions, and have not been relevant for at least half a century. Market theory has always assumed a number of things (the various perfections of 'perfect competition'), most of which only really exist in minimal, distorted and illusory forms.

For example, 'perfect information' was always nonsense and we have a whole raft of industries - marketing, advertising and lobbying - on hand to keep things that way. The recent history of financial engineering also demonstrates amply how easy it was for markets to be dominated by mechanism that many players plainly did not understand, so that they had little idea what they were doing from day to day. Even George Soros said he had kept clear of derivatives because he did not understand them. Recent developments such as ‘deep pools’ can only worsen this situation by deliberately concealing market information. There are some areas where markets are still quite real, but I doubt that plumbers and fish markets command much of anyone’s GNP.

As for another key condition for markets to be efficient, ease of entry, this ceased to make any sense when economies reached the scale where only major corporations and governments could summon up enough capital to enter any major industry. Conversely, ease of exit was rendered irrelevant with the arrival of large-scale fixed capital as the sine qua non of most industries. Fixed capital is notoriously difficult to dispose of at a decent price even when it is still usable, and if you are keen to exit a market it is probably because it is shrinking, so you won’t find anyone to buy it.

Likewise for all the other key assumptions of market economics. They make a neat, if narrow, theory, but none of them actually applies under modern economic conditions.

As for the idea that market theory is at best half-baked and at worst simply false, market economics claims that markets will always tend towards equilibrium. This is hardly what history would suggest, and it ignores at least two intrinsic features of market economies.

Firstly, the various kinds of market imperfection I have just mentioned all serve to push markets into disequilibrium, because they create special interests (often very widespread or of involving very large players) who are keen to seek, create and exploit disequilibrium.

Secondly, the real tendency of markets is not towards equilibrium but towards bubbles and monopoly. Bubbles arise when it is not the intrinsic value of goods and services that are being invested in but movements in the market itself (i.e., when, as Keynes put it, the speculative froth on the surface of the stream of solid investments is inverted into a maelstrom of speculation that drowns out real investment). This inversion became inevitable as soon markets become a forum for making money by speculation rather than for allocating scarce resources. When this orgy of money-making has reached the point where market players start to notice just how far this process has diverted the formal ownership of resources from any economically plausible use, collapse ensues as inevitably as the original bubble.

Given how market economists like to define the market as an efficient mechanism for distributing scarce resources, inveterate leftists like me find it grimly ironic to note that it capitalism itself, whose sole rationale is to make money, that ensures that markets lead inevitably to bubbles, the misallocation of resources and collapse.

As Oscar Wilde said, a cynic is a man who knows the price or everything and the value of nothing, so it’s nice to see that even in the impersonal world of the market, the inherent cynicism of market theory gets its comeuppance. Pity about the millions of ordinary people whose lives it destroys.

As for monopolies, as we all know, productivity is generally much improved by economies of scale. That in turn generally demands large-scale investment, typically in machinery and rationalisations that are closed to small players. But this reduces the number of businesses that can afford to operate in this market, or for which the size of the market leaves elbow room. And so the spiral starts and continues until only a handful of players is left. Not technically a monopoly, so there is still some limited competition, but even an oligopoly consists of a small number of players whose interests vis à vis their customer are identical – and identically predatory. And certainly any notion of a free market has long since disappeared.

Another nice irony of market capitalism then: as with bubbles, monopolies show how it is the very workings of historic markets that rendered modern market theory irrelevant. Not in this case because they create bubbles that destroy the value even as they generate lots of money, but because they create an economic universe in which, far from a large number of small players buying and selling, a small number of truly vast players distort the entire economy to suit themselves.

Basically, Adam Smith’s enthusiasm for the market was based on an economy of small players with small, easily liquidated investments in a large market. A nice dream of a cosy middle class world. Market theory persists with this dream. But we don’t live there any more.