Free markets are ruthless regulators
Markets have a marketing problem. Much of the problem is the widespread belief that markets enable selfish, even selfish behavior. Today, more and more conservatives, such as Senators Marco Rubio and Josh Hawley and others, are joining the traditional leftist criticism of the market to encourage individual selfishness. As a result, many see markets as a matter of regulation only: markets need to be regulated in order to limit the harmful effects of human selfishness. The irony is that this brings the central feature of the markets exactly backwards. Far from giving in to self-interest, the markets exploit selfish behavior. Markets actually thwart selfish behavior, even when used to serve the common good. Markets are not opposites, but a form of regulation of superlatives. A false dichotomy between markets and regulation invites one to overlook this central feature of markets. The means by which markets regulate economic activity are hardly new. Even Adam Smith, in his case law lectures, discussed the markets in the subsection on the powers of the government police.
Markets have profound regulatory implications because their central feature is the prisoner’s dilemma incentive structure. The reason the incentive structure is referred to as a “dilemma” is because, while pursuing self-interest in the game, the players are getting a sub-optimal “lose-lose” result for themselves by pursuing the incentive structure.
It is important, however, that the prisoners’ (PD) dilemma can improve society in the broader sense, even though the result for the players in the game is “lose-lose”. (Though, of course, sometimes the prisoners’ dilemma can make society worse off, depending on the context of the game.)
An example of how PD games can make society better when the players are worse off is the canonical story that gave the “Prisoner’s Dilemma” its name. In the story, a public prosecutor constructs a business case for each of two criminal partners. The incentive structure that the prosecutor develops in the context of the plea is such that each partner exterminates the other partner. (The canonical story is described here for those who do not yet know it.) The result of the game – the result of “balance” – is that both criminals are worse off than if they did not exterminate the other. Due to the incentive structure developed by the prosecutor, every criminal is individually better off than not to rat. Individually rational behavior of every criminal leads to a suboptimal result for him.
While both criminals are doing worse because of the prisoner’s dilemma, society as a whole is doing better. The criminals rat out each other and give the prosecutor the testimony necessary to convict each of the worst crimes they have committed. The incentive structure of the prisoner’s dilemma enables the prosecutor (and society) to exploit the self-interest of each individual criminal for the good of society. (It must be reiterated that the dilemmas of some prisoners can also be suboptimal for society, as can negative externalities like pollution. The only point here is that the dilemma situations of some prisoners are for the common good, even though the players are worse off as a result Playing game.)
The crazy genius of markets is that they democratize or socialize the benefits of production rather than socialize the means of production.
Competition in the market creates a prisoner’s dilemma for businesses. Of course, the owners pursue their own interests. But like the canon prisoner dilemma, in creating a competitive marketplace, society uses the self-interest of entrepreneurs to advance the common good. This insight is not new. Because markets frustrate and take advantage of self-interest, Adam Smith noted, “People of the same trade seldom meet, even for pleasure and distraction, but the conversation ends in a conspiracy against the public or an invention to raise prices. “Companies want to limit or stop competition in the marketplace if the incentive structure of the prisoner’s dilemma allows it.
Of course, using markets to regulate business is not about creating frustration, but about promoting the common good. In order to understand why markets are often a superlative means of regulating business behavior, we have to compare them with alternatives. The main alternatives to today’s markets are socialism and cartelism.
Socialism – social ownership of the means of production – is a well-known alternative to markets. What is less well known, however, is that socialist economists admitted decades ago that an efficient socialist economy would replicate market outcomes. The likelihood that a system of centralized planning could replicate market outcomes is, of course, a completely different question. The debate is long and well-known; Here you hardly have to warm it up again.
While there are indeed examples of socialism in the United States, the government owns the means of production (public schools, roads, some hospitals, and by 2001 a cement plant in South Dakota) what today’s American “socialists” are “Mainly advocating improved social security and for companies a form of cartelism or increased regulation that would have the same effect. “
Government-run “cartels” exist when corporate ownership remains in private hands, but production and price decisions are made by government-created planning boards. Cartelization was at the core of the economic program of the FDR’s National Industrial Recovery Act during the Great Depression. Government-run cartels, particularly in agriculture, still exist in some US markets today, and there is increasing interest in establishing some form of “managed agricultural supply” such as in Canada. There are some demands that the government expand cartels widely across the economy. In his book The New Class War, Michael Lind explicitly advocates New Deal-like cartels as part of the solution to America’s current economic problems.
Government-run cartels are all about suppressing the prisoner’s dilemma that is detrimental to the common good in markets. The irony of cartelization, however, is that it inherently less broadly distributes benefits than markets, and cartels impose “deadweight” losses on society compared to markets.
First, the crazy genius of markets is that they democratize or socialize the benefits of production rather than socialize the means of production. This is easiest to see in price competition, but also in quality competition. The incentive structure of the prisoner’s dilemma created by the markets causes business owners to derive their profits (via the minimal profits required to remain in business) through lower prices. Everyone in society has access to these lower prices. As profits are democratized by the market in the form of price cuts, every dollar goes on. The same nominal wage for a worker will buy more goods and services as those profits are eroded by price competition. The standard of living is rising, although nominal wages may not.
The economic case for cartels usually revolves around protecting companies from “ruinous competition” (ie, the market’s prisoner’s dilemma) in order to provide workers with higher wages. (While the stated aim is usually to raise wages, to be honest, cartels seldom hurt owners’ profits as well.) But those profits – though real to workers in the cartelized industry – are becoming far less democratically distributed as the market distributes the same profits. The profits are limited to the workers in the cartelized market and are not distributed to everyone in society.
Like other regulatory tools, the markets are not always optimal, just as taxes or subsidies or civil or criminal sanctions are not always the right regulatory tool for every situation.
The effects of cartelization are not just a matter of redistributing the profits of everyone in society as a whole to a privileged group of owners and workers in cartelized industries. In addition to redistributing the profits from everyone to some, cartels also reduce the size of the economic pie that is distributed.
The problem with cartelization relative to the regulatory impact of market competition is that cartels increase prices and decrease supply. The reduction in supply and price increase, which is the real purpose of cartels, leads to a deadweight loss that market pricing does not cause. In essence, the economic pie is smaller with cartels than with markets, as cartels hamper the markets’ prisoner dilemma. In principle, the democratic price systems that arise through the regulation of market competition offer more advantages for people than the prices within the framework of a cartel system.
The point is not that markets are a panacea for all economic problems. Like other regulatory tools, the markets are not always optimal, just as taxes or subsidies or civil or criminal sanctions are not always the right regulatory tool for every situation. And market failure can be caused by externalities, asymmetrical information, nonexistent or incomplete markets, and more. (Although not all market failures result in a government response. It depends. After all, there are both “government failures” and “market failures”.)
Rather, it is about the fact that markets for both the left and the right, who want to promote the common good, should not only be viewed as objects of regulation. The markets themselves are powerful regulatory tools. In fact, they are so powerful that those exposed to the prisoner’s dilemma such as incentive structures withdraw from them and want to be protected from them. The regulatory effects of the markets are not strong because they give in to self-interest, but because their incentive structures exploit the same self-interest for the benefit of the public.