Much of the debate around the big issues of our day -- from energy to healthcare -- hinges on whether one is "pro-market" or "pro-government," with Cato and the Wall Street Journal op-ed page lining up on one side and any number of PIRGs on the other.
Unfortunately, neither side appears to understand the pro-market position. Herewith, my attempt to add a bit more rigor to the debate.
So what does a market look like? At the most basic level, a market is defined by its characteristics. There are various definitions out there, but they all come down to the same basic tests:
- No barriers to entry
- No barriers to exit
- Price transparency (e.g., prices reflect costs)
- No participants can independently affect price
Meet these tests and Adam Smith's magic starts to work, whereby the self-interest of each participant leads to social benefit for all in the form of better products and services, at lower prices. Why? Because life in a perfect market sucks! If you're running a firm in a market as defined above, you don't sleep well at night. New entrants keep cropping up. If you can't stay competitive, you're going to lose your money. Tiny changes in raw material costs have big impacts on your profits, which you are completely powerless to change. This causes you to do two things:
One, you strive to produce a better product more cheaply than your competitors. When this happens, the customer wins.
Two, you try like hell to get away from this perfect market nonsense. When this happens, the customer loses.
Indeed, any business that respects the interests of its investors (i.e., every business) works hard to tilt the playing field. They seek to establish barriers to entry (for example, by creating patent-protected intellectual property). They try to get big enough that they can affect price, and drive competition away (think Microsoft). And -- most perniciously -- they seek government intervention to (a) pay for some of their operating costs and (b) erect barriers to exit.
And so the coal industry asks us to pay for their environmental consequences, to make their product appear cheap (and erect barriers to cleaner alternatives). The electric industry gets guaranteed equity returns no matter how economically irresponsible its investments.
We have an easy test of whether your market is truly competitive: when you go bankrupt, who pays? If your shareholders pay, there are no barriers to exit. If the public pays, you've got some nice barriers to exit. The 2000 power crisis is instructive in this regard, when both Calpine and PG&E went bankrupt, both to the tune of about $16 billion. In the case of the former, it was unregulated and shareholders footed the bill. In the case of the latter, the cost was paid for by the good people of California. (Thanks, pals!) Is it any wonder we haven't seen more entrepreneurial joie de vivre find its way into the California power market in those conditions?
So why does this matter? Because policymakers -- and the Catos/WSJs of the world -- frequently forget about competitive markets and instead simply assume that markets = businesses. Ergo, we see governments outsource functions on the rationale that "businesses are more efficient than government." Says who? A no-bid contract to Halliburton to provide food and logistics support to the military is no more competitive than an assignment to an in-house government agency. The mere presence of shareholders and profits does not amount to market magic. (Indeed, absent competitive discipline, profits are just a tax on service. Profits are like happiness in that regard. You ought to have the right to pursue them -- but they shouldn't be guaranteed.)
Recognize that there is no natural constituency for the pro-market position. No business asks to make the world safer for its competitors. Nor should it -- which makes it all the more critical for government to play this role. Yet it is exceptionally rare for government to do so (in no small part because legislators are lobbied hard not to).
Recognize also that this is just as true for "good" businesses as for "bad" ones. What is an RPS, after all, if not artificial price support for a few select industries? And who supports RPS legislation? Solar, wind, and small hydro businesses, of course -- the ones that benefit from the barrier to competition. (They are also the biggest opposition, in my experience, to the shift to a goal-driven structure, since that would level the playing field.) My point here is not to bash an RPS, but simply to point out how pervasive this pro-business/anti-market bias is.
So here's my request. In this political season, prod your elected (or yearning-to-be-elected) officials to get away from the narrow "business is better than government" nonsense, not because government is better, but because markets are better. And look critically at the motivations of anyone who claims otherwise.
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Comments
View as Flat
Jon Rynn Posted 4:08 am
19 Nov 2007
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Biodiversivist Posted 4:32 am
19 Nov 2007
In the end, it all comes down to biodiversity. Poison Darts--Protecting the biodiversity of our world
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GreenEngineer Posted 5:00 am
19 Nov 2007
The more I think about it, the more I'm inclined to say that even "natural" barriers to entry will distort the market from its state of "perfection", even though they are unavoidable in any real world situation. If so, then the "perfect" market not only does not exist, but never can exist, at least for any business producing non-virtual goods.
Thoughts?
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Nucbuddy Posted 5:03 am
19 Nov 2007
RPS stands for Renewable Portfolio Standard.
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Colin Wright Posted 5:37 am
19 Nov 2007
In my understanding, the big fish eat the little fish -- they have to, to survive you have to grow in a competitive market. As they get bigger, they use their power and resources to corner the market (hire lobbyists, engage in massive advertising,...).
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Sean Casten Posted 5:48 am
19 Nov 2007
The other side of that is big dirty stuff that once permitted is a big barrier to someone else coming in. Living in Chicago, I see all those steel mills in northern Indiana that are producing a pure commodity that in many respects is close to an ideal market. But it's expensive to ship it around, and no one wants their town to look like Gary, IN. Ergo, those plants have really nice barriers to entry from their competition, who can't build the facility (even if they had the $) until some town decides that they really want them.
And you're absolutely right that perfection never really exists (although all economic models assume it does, since to admit it doesn't exist is to admit that you can't model reality - subject for another post someday). But that's not to say that regulation can't recognize that and react accordingly - for example, by providing bridges to get over the barriers to entry. More often, regulation takes the opposite tack, raising barriers to entry, as when it extends the life of patents & trademarks or guarantees equity returns of the existing market participants.
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Nucbuddy Posted 5:55 am
19 Nov 2007
There cannot be a perfect market, presently, since a perfect market, presently, would be infinitely hot. We get relatively close to perfect markets when we detonate hydrogen-fusion explosives.
The heat-death of the universe is a perfect market.
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Sam Wells Posted 5:56 am
19 Nov 2007
Onward through the fog
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naturescene Posted 6:13 am
19 Nov 2007
Don't prices in a market reflect supply and demand, rather than costs?
As I was taught, the third bullet should be more along the lines of "information transparency, as reflected by prices." That is to say that there should be few, if any, barriers to obtaining the prices, and the information about the market that is conveyed by those prices.
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Sean Casten Posted 6:30 am
19 Nov 2007
Compare this to the coal industry, where the majority of the costs are related to health impacts, none of which show up in the price of power. So when those costs rise, we see no differential reason to shift resources elsewhere.
This is not incompatible with saying that the relate through supply and demand (since if we paid the health costs for coal in our coal-derived kWh, we'd demand a lot less coal power), but not quite the same thing because it factors in all the costs that are treated external to the system. (And lest someone cry that these externalities are non-monetizeable, I would point out that we make all sorts of decisions about incorporating those externalities into new plants that compete with coal - like all the audits of potential bat fatalities that would accompany a new wind farm - all while assuming that the alternative has no costs that are not already reflected in the price.)
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GreenEngineer Posted 6:42 am
19 Nov 2007
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Nucbuddy Posted 6:47 am
19 Nov 2007
And if we paid the health costs for windpower in our windpower-derived kWh, we'd demand a lot less windpower.
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GreyFlcn Posted 7:03 am
19 Nov 2007
1. Adam Smith wasn't a market fundamentalist either.
(That all comes from Frodrich Hayek, a crank how thought robber barron capitalism was self regulating, but wasn't popular during the great depression. Later his pupil was Milton Friedman)
http://greyfalcon.net/smith.png
2. US Republicans aren't exactly "fiscally responsible". Or atleast haven't been since Regean took office.
http://greyfalcon.net/debt.png
http://greyfalcon.net/debt
http://greyfalcon.net/doonsbury.png
The real question you have to ask is what is the difference between a "competitive" market, and a "free" market.
One perspective of why the market should exist, is to maximize it's benefit to society. Some however believe it should be to maximize the rewards to individuals.
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Delay And Deny Posted 8:47 am
19 Nov 2007
You can try and insulate a market and maybe get away with it for a while, but the strongest enemy of a protected market is the human brain.
As long as there are smart people, they will figure out a better system and eats away at the Cathedral. Their efforts go up the more they are barred.
Government usually steps in when all is said and done. Thus they "break up" AT&T long after MCI establishes that anyone with a bank account can set up a long distance phone company. Microsoft is "fined" long after Linux establishes itself as a cheaper, more powerful competitor.
In energy, the Oil Exchanges are the last gasps of the Old Guard to hold out against hydrogen, and fuel cells. They bid the price up not because of any rational reason, but because they want to make their last dollars before the whole thing collapses.
My Log
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