Wednesday, November 11, 2009

Free vs. Competitive Markets

Mark Thoma today referred to this old post he did in April 2008, Making Markets Work for Everyone which I think makes a very clear and accurate statement:

"The confusion here is simple, I think. Free markets - where free simply means minimal government involvement - are not necessarily the same as competitive markets. There is nothing that says what many interpret as freeing markets - lifting all government restrictions - will give us competitive markets, not at all. Government regulation (as well as laws, social norms, etc.) is often necessary to help markets approach competitive ideals. Environmental restrictions that force producers to internalize all costs of production make markets work better, not worse. Rules that require full disclosure or that impose accounting standards help to prevent asymmetric information and improve market outcomes. Breaking up firms that are too large prevents exploitation of monopoly power (or prevents them from becoming 'too large to fail') which can distort resource flows and distort the distribution of income. Making sure that labor negotiations between workers and firms are on an equal footing doesn't move markets away from an optimal outcome, just the opposite, it helps to move us toward the efficient, competitive ideal, and it helps to ensure that labor is rewarded according to its productivity (unlike in recent years where real wages have lagged behind). There is example after example where government involvement of some sort helps to ensure markets work better by making sure they are as competitive as possible."

1 comment:

Anonymous said...

A related concept, known as Gresham's dynamic, explains why unethical or illegal financial activities (as allowed in an unregulated free markets) "outproduce" ethical organzations who play by the rules. Gresham's Dynamic posits that organizations which practice unethical, immoral or illegal behaviours will actually drive out of business ethical, moral and law-abiding organizations. Of course, once the illegal or fraudulent behaviour becomes evident, these morally corrupt organizations implode. That is, unless of course, they are bailed-out by the taxpayers of the United States of America.

To quote Professor William Black:

"Accounting control frauds suborn accountants, attorneys, and appraisers and create what is known as a "Gresham’s dynamic" — a system in which bad money drives out good. When this dynamic occurs, honest professionals are pushed out and cheaters are allowed to prosper. Executive compensation has become so massive, so divorced from performance, and so perverse that it, too, creates a Gresham’s dynamic that encourages widespread accounting fraud by both financial firms and firms in the real economy."

In other words, the free market of no regulation, no oversight, true laissez-faire economics, will ultimately lead to the redirection or perversion of capital from useful pursuits like funding infrastructure and pursuing innovation, which benefit society as a whole, to non-productive (perhaps criminal) pursuits that benefit a few powerful and wealthy individuals and organizations, at the expense of all others.

Which one sounds like the recent economic history of the past 10 years?

Perhpas, that is why I, like Diogenes, cannot find an honest company on Wall Street. If there ever were any, they have been long ago driven out of business, or forced to become criminal in order to compete and survive, by Gresham's dynamic.

I wish these experts would stop using terms like "assymetric information", when they really mean lies, more lies, and fraud. It might make their ideas a bit more accessable and meaningful to the average citizen.

TT