Framing the Market

May 21, 2012 — Poor Richard
Market failure diagram showing deadweight loss

Market failure diagram showing deadweight loss (Photo credit: Wikipedia)

I’m tired of  the market hype from the right and the left. The 1% relentlessly pushes a free market (invisible hand) mythology without defining what they mean by it, all the while lobying for regulations that favor their own interests. And the Left has begun pushing a post-market (new-age invisible hand) mythology. Each form of market/anti-market fundamentalism will fail for the same reason: denial and wishful thinking (two sides of the same coin).

Is the market guilty as charged, or has it been falsely framed by both sides?

MYTH: The Free market.

FACT: There is no such thing as a free lunch or a free market. Every market is manipulated by the strongest players. The private sector cheats, steals, lies, and bullies. The state regulates according to a mixed set of public and private interests. If those interests get out of balance, either the public or private sector (or both) will suffer.

“Markets are not provided by nature. They are constructed — by laws, rules, and institutions. All of these have moral bases of one sort or another. Hence, all markets are moral, according to someone’s sense of morality. The only question is, Whose morality? In contemporary America, it is conservative versus progressive morality that governs forms of economic policy. The systems of morality behind economic policies need to be discussed.”    AlterNet / By George Lakoff and Elisabeth Wehling

MYTH: The Invisible Hand.

FACT: There is no such thing. There are only real, material “hands” that we either cannot or will not look at.

MYTH: Government is the problem, not the solution.

FACT: The solution is maximizing utility through appropriate checks and balances. Government has a role in 1) providing regulatory counter-balance to private concentrations of power which amplify the cheating, stealing, lying, and bullying; and 2) socializing some of the costs of education, R&D, infrastructure, public safety, national defense, etc.

MYTH: Markets are the problem, not the solution.

FACT: Ecosystems behave like economies with markets. Natural markets tolerate large amounts of power asymmetry (aggression) and information asymmetry (deception). What is not found in a natural ecosystem is an externality. They do not exist there. Externality in human economics is an entirely abstract fiction. An externality is where someone gets something for nothing and gets away with it indefinitely. That doesn’t happen in an ecological economy. If it did, all life would probably be extinct.  Instead, nature is stubbornly resisting and postponing its extermination at our hands. It actually doesn’t happen in the real human economy, either. It only happens in human economics, which is riddled with a variety of naive or intentional accounting errors which are generally explained by economists as externalities or market failures. Naturally, externalities and other accounting errors inevitably produce market failures.

Post-market theology

I won’t dwell on the myths of “economics as if only the 1%  mattered,” because they are now fairly well understood by many. We have given the invisible hand a very long trial. It’s had some episodic success but it is now failing badly. But there is lately a “new age” invisible hand that some are appealing to as an alternative.

I recently published a piece with the alternate title of  “Escape from the Planet of the Economists.” In that piece I made a case for “economics as if people mattered” and “economics as if the biosphere mattered.” I drew from writers like E. F. Schumacher who argue that the human economy is part of the ecosystem, not vice versa. This is currently being called sustainable or ecological economics. I completely agree with the particular arguments of the particular authors I cited. But some economic pundits are embracing this general framework without adequate understanding of what the ecosystem is or how it works, and without adequate understanding of what markets are or how they work. They seem fairly sure that you can’t shoehorn nature into a marketplace, and fairly sure that that one idea explains everything.

The premise seems to be that since the market has not historically conserved and enhanced the biosphere, the biosphere must work on non-market principles. The problem is that the second conclusion doesn’t necessarily follow from the first. It is a non sequitur. First, the nebulous thing we often call “THE market” doesn’t exist. Instead, the economy is an aggregate of many markets. Because many (or nearly all) of these markets are distorted or flat-out broken, it appears that markets per se are unworkable. Its as if someone in the middle of a vast junkyard of broken cars concluded that all cars were inoperable. In fact, with the right knowledge and tools, many of those cars could be fixed. But my imaginary character doesn’t have that knowledge. He doesn’t have the right tools, either.

If the first error is a false analysis of the problem, a second error inevitably follows–a false solution. The reason all the old cars (and old markets) in the economic junkyard are broken is that they were not maintained in a responsible fashion because they were only on temporary lease to their operators. Lets say all those irresponsible operators were just following the example, and sometimes the advice, or direction, of their betters, the 1%.

And now this two-faced 1% is getting caught in the act of green-washing their activities. They are pulling the strings of their politician manikins, sending them to international summits on hunger or the environment or global warming, campaigning for austerity or resource management schemes full of tricks and loopholes big enough to drive a fleet of deep-water drilling platforms through.

Many conclude that these amoral capitalists have nothing to offer but more waste, fraud, exploitation and abuse. Which is pretty much the case. So its only natural for a movement to gravitate around respect for the 99% and for the environment, and then go looking for post-market methods for shaping society and finding harmony with nature. They turn to gift economies and sacred economics drawn from mankind’s romanticized past, or imagine societies that function on harmony and good will instead of greed and accounting. They may be inclined to imagine bountiful commons that manage themselves the way nature manages itself. I’m sympathetic to the sentiments and the philosophy, but that doesn’t satisfy me. I want the skills and the tools to get broken markets and broken ecosystems back on the road to thriving.

GB.MEX.10.0143

GB.MEX.10.0143 (Photo credit: balazsgardi)

Of course what goes by the name green often isn’t (including some versions of “green economics“), and the only solution for that  is eternal vigilance against green-washing. “Big Green™” would be dumb not to appropriate certain language from Natural Capitalism, for example–its just so easy.

“When plunder becomes a way of life for a group of men, they create for themselves, in the course of time, a legal system that authorizes it, and a moral code that glorifies it.” – Political economist Frederic Bastiat, The Law [1850]

We are well-advised to be wary of giant green snakes and wolves in green clothing sneaking into the people’s garden; but not to be prejudiced against all applications of  market thinking in ecological economics. Is there any reason the 99% cannot “occupy” and democratize markets?

I can believe that the United Nations Environment Programme (UNEP) and the Reducing Emissions from Deforestation and Forest Degradation (REDD) projects are (or are not) clever tricks to disguise continued exploitation. Either way, the effort to scientifically quantify natural systems, as in  approaches to sustainable or Natural Capitalism, is not in itself a sinister scheme. It is required for good management of any system, whether fishery, forest or farm. No doubt the language of pending high-level agreements may be obfuscating some ulterior motives. I’m very skeptical of trading permission-to-pollute credits. But what is often proposed as the alternative is not exactly transparent, either.

Here is a fairly typical example from a writer who rejects Natural Capitalism and similar approaches because he fears a slippery slope to green-washing. He proposes an economic system based on:
  • peace, harmony and balance among all and with all things;
  • complementarity, solidarity, equality and social and environmental justice;
  • collective well-being and the satisfaction of the basic necessities of all;
  • recognition of human beings for what they are, not what they own;
  • elimination of all forms of colonialism, imperialism and interventionism
There are lots of ambiguities there. Such ambiguities can easily morph into obscurities and obfuscations which can provide cover for abuse and exploitation of people or natural capital or both. Not even the ban on colonialism and interventionism really holds up to analysis unless we go back to being hunter-gatherers and stop colonizing or intervening in nature. As one of my peers pointed out to me recently, appeals to optimality are really arguments that we’re living (or will be)  in the best of all possible worlds; or would be if only we’d regulate or deregulate or something.
Inquisition 2.0?

How will we draw the lines between good-faith green economics and green-washing? No simple answer, but that’s the kind of thing that empirical science, at its best, can be good at. The alternative to science may be a kind of post-market fundamentalism whose dogma demands belief in a new-age invisible hand. I am already seeing omens of an Inquisition 2.0 which will torture disciples of sustainable capitalism until they confess to sins of  green-washing and recant their faith in science.

An ecological moral philosophy is useful, but a new version of the invisible hand (even a spiritual one) is not. A real science of sustainable economics is needed regardless. Such a science won’t be achieved just by good will and wishful thinking. It will require deep observation, painstaking metrics, statistics, and very complex accounting.

Confusion of tongues

The original Green Revolution was guilty of so many sins it may have cast a permanent cloud over the word “green”. Modern corporate and political green-washing darkens that cloud even more.

The battle for the soul of the word green reminds me of the confusion of tongues (confusio linguarum), the fragmentation of human languages described in the Book of Genesis 11:1–9, as a result of the construction of the Tower of Babel.  And George Orwell charicatured the authoritarian appropriation of language with  Newspeak in the novel Nineteen Eighty-Four. In the novel, it refers to the deliberately impoverished language promoted by the state. (Wikipedia)

I’m not convinced that the left is not impoverishing the conversation on sustainability in another way with its glittering generalities about sacred economics and effortless abundance.

In a nutshell, without the rhetoric, the  moral or spiritual approach to economics boils down to:

  • reducing the scale and scope of markets
  • expanding the scale and scope of the commons
  • putting more emphasis on the public sphere

All that really means to me is there is no unitary, all-encompassing market and certain things aren’t on the auction block. Markets shall have circumscribed scope or boundaries, including appropriate regulation and no more archaic, grandfathered externalities. But the notion that everything should evolve from markets toward something else is pure speculation. Well-regulated, democratically-managed markets might be natural and desirable even within many local commons. An agricultural land trust might want a big, bustling produce market, and why not?

What we must add to the moral philosophy is an ability to mimic the balance between steady-state and development in living systems.

We need to start seeing markets, commons, and ecosystems alike as complex adaptive systems requiring appropriate (e.g. transparent, dynamic, and democratic) constraints and regulatory mechanisms both internal and external. We need to see them as layered, overlapping, recursive, and locally differentiated by environemntal niches.

These systems are almost unfathomably complex and I wager that all our current models and subjective interpretations barely begin to scratch the surface of the objective reality. Any notion that we can re-engineer the whole market ecosystem from the top down is the height of hubris. Instead it will take a great deal of inspired trial and error from the bottom up and from the inside out.

In our efforts to upgrade our economic consciousness, plenty of kumbaya will be essential, but it won’t be sufficient. Humanity cannot live on love and peanut butter alone.  I think many of the innovators  who will fertilize the science and technology of sustainable markets may come from the highly experimental (and less theoretical) hacker, re-mix, peer-to-peer (p2p), and open source cultures.

Ecological economics can also be thought of as integral economics, a framework that includes but transcends existing fundamentalist market frameworks, integrating local econo-diversity with global interdependence–i.e. “reinventing economics for people and place.”

Neither markets nor economic anarchy seem to scale well by themselves. But I think they might scale indefinitely in balanced proportions.

Poor Richard

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“They want us to believe the choice is the “free market” or government, when in fact it’s one system because government sets the rules of the market. And the real choice is between a system that works for the many or the few.

They want us to think people are paid what they’re “worth,” when in fact people are paid according to how the moneyed interests have organized the market — to their benefit and against most of the rest of us.

They don’t want us to see the upward pre-distributions hidden inside the market that give them a big chunk of our paychecks, as we pay more than we should for everything from drugs to Internet service to food.

They don’t want us to know how much their pollution is sickening us, their devastation of our lands is imperiling us, their sacking of our communities is ruining us, and their takeover of our democracy is robbing us of our capacity to set things right.” 

~Robert Reich

ADDENDUM

Robert Ryan is a Graduate Student Assistant at the University of Pittsburgh. Class of 2013 · PhD · Structures and Foundations · Business Environment, Ethics, and Public Policy · Strategic Management

This is my online interview with Robert Ryan on 5/22/2012:

Poor Richard: Robert, I’m curious what you think of my very unscholarly take on markets and green economics in “Framing the Market.”

Robert Ryan: The simplest way to summarize this problem is “optimization under constraint”. In the same way that engineers perform constrained optimization problems, it is generally assumed in markets that individuals do the same, each using the same rationale as an engineer of their own personal consumption functions. Markets (here we are referring to idealized, perfect ones) are non-coordinated mechanisms for spot transactions to optimize utility under budget constraint. What this generally means is that the only two important variables are individual level preferences and budgets. As you have mentioned, this doesn’t hold true if you have more important variables like information, time, transaction costs, bargaining power, etc. Simply put, there is no “environment” in traditional market models, period, which is what separates them from evolutionary ecosystems. Ecosystems aren’t just individuals. There are group level dynamics where individuals interact with “BOUNDARIES” of the system. For example, consider how tides in a sandbar ecosystem is a boundary condition for the survival of a population of sandbar-dwelling animals. The very existence of tides shapes behavior. The list of natural system boundaries for markets include, but are not limited to: Rationality (what Herbert Simon called bounded rationality)…environmental entropy and finality (in the sense that some resources tend to be not only scarce, but decaying and non-renewable, and that some resources have critical inflection points where they pass between sustainable in supply and not……power (which is delineated by human institutions, including knowledge, law, etc.)…technology (which is the level of possible combinations of resources to create final goods)….etc…..notice that all of these constraints can be put into the economic system, but economists struggle to do so because of the complexity problem causing indeterminacy (the mathematics of chaos takes over, essentially, when everything ids dependent on everything else recursively). The simplest way to escape the problem of chaos is to hold some things constant over time. So, this is what people do to solve problems- hold things constant that may or may not BE constant. Their biggest error in the modern age occurs when hey hold constant essential SUPPLY SIDE problems, such as pollution externalities being ignored. An externality as you defined it is not quite right. An externality really is when one individual’s action that maximizes THEIR preferences impacts the entire economy negatively. For example, if a polluter pollutes, everyone else picks up the tab. The simple way to deal with externalities is to regulate against them, but that requires common agreement among everyone in the regulation.

Poor Richard: Robert. I appreciate and agree. Could I add your remarks as a comment to my blog post? (I was being a little flip with my definition of externalities. Maybe I should tweak it.)

Robert Ryan: Many people don’t know that economists indeed do solve such problems. The most popular field of economics for dealing with this problem is the economics of contracts. A market is a special case of contracts where all tricky bits are held constant. However, contract economics is generally specified so that you can account for ANYTHING. But, the math is really tricky for even the simplest of contracts. Contract economics presumes a bunch of agents are trying to negotiate a solution to an economic problem, and at least one of them is a principal. This is basically the mathematical representation of social contract problems: “we all get together before birth, or before the veil of ignorance, and devise a social contract to solve problems” – is how my professor Lawrence Ales puts it. For example, there may be some golden ratio of consumption of farmland that if you pass beyond you begin destroying future farm output. In order to prevent this, the principal is granted the ability to distribute to farmland (forming your constraint) and then the agents can auction for their slice of production. In this fashion you cap the use of farmland. Easier said than done, because it is hard to know exactly how this problem works in the real world–the chaotic inter-dependencies of the precise use of farmland and the precise use of other kinds of resources (water, air, etc…what technical combinations are employed in production, etc. ) are hard to know, and the equations of their interdependency are recursive. Carbon caps are an attempt to do exactly this, and the logic for it comes from contract economics, not market economics. To summarize again, you can solve these problems one at a time by holding other problems constant, but you get the “law of unintended consequences” even in contract economics in a complex world. Solving one problem can often pass the problem into another domain. Solving carbon problems can, for example, pass the problem on to other kinds of supply issues, rent-seeking behavior, arbitrage, etc. However, we can still do some of this with economic engineering (combinations of market and contract rules) if we use a kind of Pareto efficiency rule– start with the biggest problems first and work backward– permit the little inefficiencies to exist and simply engineer human solutions to the tough problems. When the problems of the world are explained thusly, then it becomes obvious that ethical solutions to market economic problems are certainly obtainable, and only ignorance or immoral behavior can explain why we don’t engineer problems of public goods of such nature. This means our real problem is NOT economic but political/social. Ironically, everyone keeps blaming economists when the real blame lies in the power structures of political reality.

AS a general rule, one would say that markets should only be the appropriate mechanism where externalities and supply side inter-dependencies are trivial. When they are major problems, markets will inevitably destroy whatever environment you are dealing with. They eat themselves. They are cancerous. However, if you can contain and isolate markets from the ecosystem so that they are in “remission” essentially, then they are optimal. Ecosystems do suffer from cancerous market-like problems, too. The main reason why ecosystems tend to survive in the long run is that the entire system adapts to starve the cancer. Human markets aren’t designed to adapt to starve the cancer efficiently. They will in the long run, but in the long run we’re all dead. A troublesome species like humans can simply write themselves out of existence. Well, if that’s not an acceptable endgame solution, then we have to constrain our own cancers before we eat ourselves. This is why we need social contracts, and if we cannot make adequate ones, we need to break into subspecies (tribes, etc.) and exterminate the cancerous subspecies that are indigenous to the problem in order to save the species. That sounds awful, but true.

Poor Richard: I agree with you about the difficulty of the math. Fortunately massive data collection and pattern detection may soon give us a new way of doing science, and replace a lot of difficult mathematical modeling. I think we should take about 10% of all scientists and mathematicians and put them on that critical path.

Robert Ryan: We are reaching a state of the world that definitely calls for a technocracy in the similar sense that Plato wanted us to have philosopher kings. Truly the smart people of this world could be put to work solving our problems in a fashion far superior than is currently being done, and this is a big part of my political platform I advance. I call it the Pragmatist party (or New Bull Moose).

Poor Richard: I like the sound of the Pragmatist party. How would it handle the 1%?

Robert Ryan: By appealing to the top 20% instead. One of the big fallacies is that the 1% can out-bully the entire middle class. They can’t. No middle class and there is no economy, no military, no institutions to exploit. The middle class has not really shrunk. Its the lower middle, or working class, that has been getting worse off and shrinking as more people are falling to the lower class. The real middle class is really the professionals, intellectuals, entrepreneurs, petite bourgeoisie. There is no political party designed to appeal to them directly. In fact, both American parties preserve power by going around them completely. Most of the real middle class are independent and non-extremists. The pragmatist party basically says: enough is enough. These are the real job creators, the innovators, the creatives of society. Without them there would be no economic growth. So, let’s appeal to them pragmatically and say they can deflate the 1%, and in exchange for gaining more representation, they must take better care of the lower classes than the 1% has. Our target audience is thus the people who truly dominate campaign donations, charity donations, and our communities, but have been so fractionalized and “suburbanized” so as to think of themselves as independent instead of a class. If they were to think of themselves as a class again of sane people of balanced reasoning, then the middle class could save us.

Poor Richard: How can you appeal to such a class without insulting or alienating the rest of the 99%? And isn’t there a good reason that the middle class doesn’t make waves?

Robert Ryan: Yeah– I’ve had this discussion many times before. Well, we are reaching a point where, for the first time in American history, their prospects are not looking to get better, and they all mostly know that their nation is crumbling slowly, and that there is no good reason for this to happen. There are already plenty of instances of these people getting together to get the job done on a smaller scale. Typically you see this in university/business/local govt. cooperation. Various entities have gotten together to plan to save Detroit, for example. And they’re already on the right track. These sorts of cooperative efforts to socially contract new, smarter solutions do happen, and when they do, they tend to be more localized. This is part of the sensibility of the authors out there writing about the urgent need to revitalize our cities– cities are the places where, historically, the top 20% collaborate to make great places to live for everyone. The 1% typically help finance everything and provide resources flowing into these cities. But the very history of the city is the history of the yeoman specialists and master tradespeople getting together and making economies tick. The role of the larger federal system is to provide resources to these self-organizing activities on a more local level– such as infrastructure banking, research grants, development money, etc…but the activities have to be more local and less centrally planned. There seems to be an optimal scale efficiency of central planning, and it is when you have diverse interests willing to throw their hat into a common state interest– in the US, this has never been the federal level because of a lack of common identity. Regions and states are more apropos. Richard Florida is one man who understands this and would be an ideal candidate for such a party.

Richard Florida | Creative Class Group

How Detroit Is Rising

You’ve heard the story of the city’s downfall. This is the story of its comeback.

Multimedia showcase | Creative Class Group

mimicking the balance between steady-state and development in living systems

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