Saturday, July 01, 2006

Markets don't fail, economists do -- just as Plato did

The debate about market failure (below) has beome a philosophical one, although its protagonists may not see it that way. One commenter avers that 'market failure' isn't an anti-concept at all, instead it's an 'ideal' by which economists measure actual markets. Just like "perfectly competitive markets" which he says, "are just a benchmark model that one shouldn't expect to hold in the real world."

An interesting point, but a destructive one -- just like the philosophy from which his contention springs (on that, more a little later). Like the concept of 'market failure,' which has no referents in reality but which is supposed nonetheless to perform a sort of heuristic function, neither does the doctrine of 'perfectly competitive markets' have any refererents in reality. None at all. Explains George Reisman:
No one has ever defined “pure and perfect competition”—the procedure is merely to present a list of conditions which it requires...

To summarize these conditions: uniform products offered by all the sellers in the same industry, perfect knowledge, quantitative insignificance of each seller, no fear of retaliation by competitors in response to one’s actions, constant changes in price, and perfect ease of investment and disinvestment...
Perfect competition, thus defined, probably does not exist, never has existed, and never can exist. . . . Actual competition always departs, to a greater or lesser degree, from the ideal of perfection. Perfect competition is thus a mere concept, a standard by which to measure the varying degrees of imperfection that characterize the actual markets in which goods are bought and sold.
So neither concept actually exists -- neither 'market failure' nor 'perfectly competitive markets' -- yet both concepts are used to damn real markets by those who quite naturally do look for real referents for such terms. That's why they're anti-concepts: their use serves to destroy real concepts which (like all real concepts) do have real referents. As George Reisman expains,
The doctrine of “pure and perfect competition” marks the almost total severance of economic thought from reality. It is the dead end of the attempt to defend capitalism on a collectivist base.
And so it is. It is also fuel for those who seek to shackle and to damn markets. The non-existence of 'market failure' and 'perfectly competitive markets,' which don't exist in the real world, are the anti-matter to real markets and to real businessmen who do.

If markets don't work in the ideal manner prescribed in their heuristic manner by this collectivist variety of economist, then so much the worse for markets say the regulators, who haven't hesitated to regulate, to shackle and to jail businessmen (who resolutely refuse to fit the economists' models and just keep on producing in the real world instead); and who continue to espouse the need for ongoing regulation in order to make the 'imperfect' markets fit the ideal dreamed up for them by ivory tower economists and utopian collectivists.

The doctrine of pure and perfect competion is called by George Reisman "platonic competition," since these destructive 'ideals' are a pure and perfect example of the Platonic "ideal of perfection" which draws from non-existence to serve as the "standard" for judging existence.

Reisman's two-part article on the subject make 'perfect' and very timely reading, and it does help to prove the contention that those who disregard philsophy are destined to be frequently bitten by it.

LINK: Platonic competition, Part I - George Reisman's blog
Platonic Competition, Part II - George Reisman's blog

TAGS: Economics, Philosophy, Objectivism

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7 Comments:

Anonymous Eric Crampton said...

The physical sciences have "perfect fluids", "ideal gases", "perfect conductors" -- all of these are just theoretical constructs that assist in modelling.

The parallel constructs in economics are theoretically useful but unfortunately have been used to justify some rather stupid policies. Seeking to eliminate the concept though is like seeking to eliminate nuclear physics 'cause some folks used it to build bombs.

It would be nice if other terms had been used rather than "failure" or "perfect" as it's awfully tempting in the social sciences to turn those into normative rather than positive descriptors. But those are the terms we're stuck with.

7/01/2006 03:16:00 pm  
Anonymous Paul Walker said...

We asked to believe that

"If markets don't work in the ideal manner prescribed in their heuristic manner by this collectivist variety of economist, then so much the worse for markets say the regulators, who haven't hesitated to regulate, to shackle and to jail businessmen (who resolutely refuse to fit the economists' models and just keep on producing in the real world instead); and who continue to espouse the need for ongoing regulation in order to make
the 'imperfect' markets fit the ideal dreamed up for them by ivory tower economists and utopian collectivists."

But this not how economists would argue. As Coase has pointed out a comparative institutional approach is required.

In one interview Coase noted

"RC: I really don’t know. I don’t reject any policy without considering what its results are. If someone says there’s going to be regulation, I don’t say that regulation will be bad. Let’s see. What we discover is that most
regulation does produce, or has produced in recent times, a worse result. But I wouldn’t like to say that all regulation would have this effect because one can think of circumstances in which it doesn’t."

In other words let us compare the likely results of regulation versus non-regulation, and see which is best.

He then went on to say:

"TH: Can you give us an example of what you consider to be a good regulation and then an example of what you consider to be a not-so-good regulation?

RC: This is a very interesting question because one can’t give an answer to it. When I was editor of The Journal of Law and Economics, we published a whole series of studies of regulation and its effects. Almost all the studies – perhaps all the studies – suggested that the results of regulation had been bad, that the prices were higher, that the product was worse adapted to the needs of consumers, than it otherwise would have been. I was not willing to accept the view that all regulation was bound to produce these results. Therefore, what was my explanation for the results we had? I argued that the most probable explanation was that the government now operates on such a massive scale that it had reached the stage of what economists call negative marginal returns. Anything additional it does, it messes up. But that doesn’t mean that if we reduce the size of government considerably, we wouldn’t
find then that there were some activities it did well. Until we reduce the size of government, we won’t know what they are.

TH: What’s an example of bad regulation?

RC: I can’t remember one that’s good. Regulation of transport, regulation of agriculture – agriculture is a, zoning is z. You know, you go from a to z, they are all bad. There were so many studies, and the result was quite universal: the effects were bad."

7/01/2006 04:07:00 pm  
Blogger Yacap said...

The physical sciences have "perfect fluids", "ideal gases", "perfect conductors" -- all of these are just theoretical constructs that assist in modelling.

"Perfect competition" is not all the same kind of thing. A perfect fluid is, at least conceptually, a kind of fluid. An ideal gas is a gas. A perfect conductor is a conductor. "Perfect competition", on the other hand, is a complete absence of competition.

7/01/2006 05:33:00 pm  
Anonymous Falafulu Fisi said...

Ok, economists, in this thread, I have a question. What is the advantage if it is discovered that there is 'perfect market competition' and what if it is not discovered that it is so? I am not an economist, however I do develop economic mathematical modelings in certain topics.

7/02/2006 02:28:00 pm  
Anonymous Nik said...

What is the advantage if it is discovered that there is 'perfect market competition'?

There can never be perfect competition as no sane businessman would want to compete in a perfectly competitive market as it is impossible to make a profit. I suppose an insane businessman might want to compete, but would soon go broke because of his insanity.

Perfect competition is only defined as a limit. Various markets may be respectively closer or further away from perfect competition. The problem is that this is a Platonic approach where the impossible is considered the ideal.

The equating of the absence of profits with being ideal or perfect stems from the altruistic idea that businesses exist to serve the will of the people. A perfectly competitive market is one where all the benefits are captured by consumers.

Obviously this is a good standard to try to hold businesses to if you are a politician looking to get elected. You can present an impossible standard which will give the most benefit (in the short term) to voters who are consumers and then use the absence of this as a reason to regulate businesses in the public interest.

7/02/2006 10:40:00 pm  
Anonymous paul walker said...

Nik writes

"There can never be perfect competition as no sane businessman would want to compete in a perfectly competitive market as it is impossible to make a profit. I suppose an insane businessman might want to compete, but would soon go broke because of his insanity"

There is no reason at all for a businessman to go broke in a competitive industry. I'm guessing that Nik is confusing accounting profit with economic profit. In a perfectly competitive market economic profits will be zero but this doesn't mean that accounting profits are zero. It just means that the returns to being in this industry are equal to the returns to being in any other industry in the economy.

7/03/2006 10:07:00 am  
Anonymous Eric Crampton said...

Yacap: it depends what you mean by competition. Yes, in the perfectly competitive model there is no innovation because the innovation's already happened and has been adopted by every firm. A firm that comes up with a cost-saving innovation will temporarily earn economic profits as result until such time as the innovation is widely adopted, when we're back again to "perfect competition." So in the equilibrium, firms aren't really innovating -- innovation is a disequilibrating phenomenon. On the other hand, at the equilibrium, all firms are competing heavily in that the second that one of them slacks off in terms of watching costs, it'll be driven out of business immediately.

Falafulu asks what advantages there might be if we find that a market is in perfect competition. I'd first preface by saying that perfect competition isn't a goal to be attained, rather it's a modelling devise. Once we characterise what things would look like at the competitive equilibrium, we can perterb the model to see what things might look like if, for example, competition is limited, or if costs were to change. The "advantage" of perfectly competitive markets is that total surplus is maximised.

7/03/2006 04:26:00 pm  

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