Trust the market

たまご屋／egg store2
Originally uploaded by motocchio.

Markets are a good thing. Whether you are buying or selling, you can be sure that you will get a good price for what you are selling and will not pay too much for what you want. And producers quickly get to know what people want to buy, and the right goods become available to those who want them.

It is a much better system than having bureaucrats in offices decide what people want. Usually, they haven't a clue, and then they have to force people to produce what is not wanted, and you end up with Gulags, concentration camps, secret police, corruption and all the other apparatus of a totalitarian state.

Post-1945 economists especially, recognised this and became advocates of the free market, in preference to the directed economics that was favoured in both communist and social democratic countries.

But the concept is flawed. Free markets assume prior equities, and when not everyone has equal access to land, those who do are in a privileged position, since the two sides to many transactions are not entering into the deal on equal terms. For instance, if the choice is "work or starve", employers can drive down wages.

Taking the notion of markets beyond where it is appropriate has also had strange results. Economists like to borrow concepts from other disciplines, especially the physical sciences. One such, promoted by the late Milton Friedman, amongst others, was that markets are a "signalling system", informing entrepreneurs where to direct their energies. It is a nice idea and a good way of describing what is happening in the Barcelona market in the picture. Unfortunately it has come to dominate economic policy almost world wide. This is the model on which reforms of services like the NHS and the railways have been predicated. After nearly 25 years of this kind of thing, it is obvious that it is not working.

First, it assumes perfect knowledge and intelligence on the part of the entrepreneurs - again, it works if you are keeping a few chickens and selling the eggs. But in complex enterprises, people tend to get things wrong. The main way to stop this from happening is to have a means of allowing a variety of inputs. Where the provision of services falls into monopolies or oligopolies, there is no room for proper questioning, and they all follow each other over the cliff together.

As for the economic signals that come from the market - these have no intrinsic meaning, as they are shaped by market circumstances some of which are natural and changing, others of which are cultural and others of which are an artificial construction, such as the fiscal and legal framework in which transactions take place. There is nothing "natural" about them, so that following market signals is not automatically going to produce the optimum outputs.

One consequence is that it is not possible to argue that any tax modifies the economic signals more than any other does - they are all modifiers. What matters is whether they modify in the direction of causing people to things that are desirable or whether they discourage desirable activity. This is an important function of government and one they are not getting right.