I
UPPSALA PAPERS IN ECONOMIC HISTORY
1997
RESEARCH REPORT NO 43
Scope and Limits of the Market
Bo Gustafsson
Reprinted from Teichova, A. - Mosser, A. - Patek, J. (eds.), Der Markt im Mitteleuropa der Zwischenktiegszeit. Prague:
Universita Karlova, Vydavatelstvi KAROLINUM, 1996.
DER MARKT IM MIlTELEUROPA DER ZWISCHENKRIEGSZEIT
KARLS-UNIVERSITÄT - PRAG 1994 S. 19-52
SCOPE AND LIMITS OF THE MARKET Bo GU S T A F S S O N
(Uppsala)
“It has been said and may be said that this is precisely the beauty and the greatness of it: this spontaneous interconnection, this material and mental metabolism which is independent of the knowing and willing of individuals, and which presupposes their reciprocal independence and indifferente. And, certsinly, this objective connection is preferable to the lack of any connection, or to a merely lotal connection resting on blood ties, oron prime- val, natural or master-servant relations.”
Karl Marx, Grundfisse (1857; 1973), p. 161
“In principle the study of business relations is the study of the machinery by which men are liberated, over a large area of their life, from the limitations which a failure of correspondence bet- ween their faculties and their purposes would otherwise impose on them. The things they have and can, are not the things they want and would; but by the machinery of exchange they can be transmuted into them. The economic relation, then, liberates them from the limitations imposed by the nature of their own direct resources. And this liberation comes about by the very att that brings a corresponding liberation to those with whom they deal. ‘It is twice bless’d. It blesseth him that gives, and him that takes.’
Surely the study of such a relation needs no apology, and there seems to be no room to bring against it the charge of being intrin- sically sordid and degrading. The conditions under which busi- ness is actually conducted (like other conditions under which we live) may be far from ideal, but the business or economic relation as such, does not seem to be open to the faintest suspicion of a taint, even when regarded from the loftiest aesthetic or ethical position.”
Philip H. Wicksteed, The Gommon Sense of Politicd Economy 1, (1933), p. 173
Introduction
r
ver sinte Aristotle made his observations on the tontrast bet- ween oikonomike and chrematistike in his Ethics, the properties and legitimacy of the market have been hotly contested. The Schoolmen, following Aristotle and the teaching of The BibZe, fought a rearguard action against the advancing market ideology in the late Middle Ages. Weber, Tawney and others have shown how
important the issue was in earlymodern times. Before Adam Smith, and some of kis predecessors, entered the scene it was predominantly the moral problem of the legitimacy of the market that was at issue. By attempting to show that the market, based on self-interest and competi- tion, was not orrly a rational but also a beneficial mechanism promoting human welfare, Smith killed two birds with one stone. But he also opened up a main theme in modern social discourse that is still with us. In British and French social thought the central teaching of Smith has on the whole prevailed and become more and more elaborated. The modern theory of general competitiv,0 equilibrium as suggested by Kenneth Arrow and Gerard Debreu may be regarded as the crowning achievement of this tradition even if representatives of Austrian economics from Menger
on would claim a rival interpretation. The situation was, however, differ- ent in Central and Eastern Europe with traditions that were less liberal and more favourable towards regulation. In the wake of the German ZoZZ- verein, Friedrich List emphasized the crucial importante of the statein promoting economic growth; and to Karl Marx and his followers the interaction of competing, autonomous and self-interested individuals in the market was as likely to produce economic chaos as economic har- mony. In this tradition, shaped in a social environment distinguished by strong and strongly interventionist govemments, there was also a general distrust of the cash-nexus and market mentality, on the one hand, and a strong belief in the possibilities of wholesale social engineering, on the other. This ideologital tontrast between market liberalism and state socialist thinking is clearly seen in the great interwar debate on the possi- bilities of socialist planning (Hayek, 1935). With the benefit of hindsight it is easy to conclude that the advocates of the market mechanism stored a victory over the advocates of (coercive) economic planning; the first- mentioned representing realism and tommon sense, while their oppo- nents appear idealistic and utopian. However, in the high and palmy days of seemingly successful Soviet economic planning most Observers had regarded the 0utcom.e of the debate as inconclusive.
Sinte then the scene has changed dramatically. We are now living in an epoch characterized by the triumphant propagation of the market mecha- nism all over the world. The centrally planned economies of Eastern Europe are gone and in Western Europe and the USA publit assets are sold off, industries are deregulated, and some publit economic activities are transferred to private firms and the market nexus (Donahue, 1989, chapter 1). But also, parallel to this, mass unemployment is back, and ine- qualities In income and wealth are once again growing. Even if this new tum towards the market has clearly been ushered in by politital changes (the downfall of the Communist regimes in Eastern Europe and the coming of conservative governments, starting with the governments of 20
Thatcher and Reagan in the 1970s in the West), we may still believe that these politital changes were conditioned by a growing disbelief in the superiority of administrative economic mechanisms.
Markets in history
If we take a very lorigg” viewwe may argue that the market mechanism has history on its side. It all started in ancient Greece, where the achievements of Greek civilization were conditioned or, at least, paralleled by the first prospering of commerce and markets in the Aegean. Likewise, Roman civi- lization showed at its best during the late Republic and the early Empire when the Mediterranean developed into alarge market area. The decline of Rome and the onset of the so-talled Dark Ages of early Europe witnessed, on the other hand, the shrinking and disappearance of mar- kets. When Europe started to expand from the eleventh century, markets, trade, merchants, handicrafts and towns proliferated on the basis of the division of labour between agriculture and industry. Similarly, from the early sixteenth century modem Europe’s development was paralleled by the new world market economy created in succession by Portuguese, Spanish, Dutch and British traders although, to be sure, trade was also effectively assisted by guns and sails.
Moving forward in history, we may plausibly argue that the industrial revolution of the late eighteenth century, with its great technological and organizational innovations, like steam power and the factory system, was triggered of by an impressive market growth channelling information from expanding markets and creating incentives for increasing production. The first industrial revolution was followed by a setond one from the late nine- teenth century, when modern science was integrated with industry and the modern, big torporation emerged. Once again we may connect economic progress with widening and more efficient markets conditioned by the building of railways and the introduction of steam ships and the telegraph.
Thereby, people and countries were brought closer to each other, and information about goods, prices and exchange rates were, for the first time in history, rapidly transmitted all over the world. Markets for labour and capita1 supplied factors of production to industry on a scale unheard of.
Admittedly, the first part of the twentieth century was distinguished by shrinking markets, state intervention, extensive regulation of economic activity and, in Russia and Eastern Europe, even wholesale replacement of the market mechanism with a command economy. But by now the market had regained and extended its earlier prominente.
On the basis of these sweeping observations, one may be inclined to think that there are no serious problems involved with the market me- chanism sinte, if there were, history would not show us its triumphant
expansion. Rather, history would have weeded it out and would have given rise to other viable mechanisms for resource allocation. But against such a somewhat simplistic view, one may argue: firstly, that it is possible to find successful alternatives to markets in history; setondly, that market mechanisms have sometimes been successfully restricted and controlled;
and thirdly, that we cannot be absolutely sure that the historital failures of alternatives to markets have failed because of the inherent characteristics of those mechanisms rather than their specific historital form and/or because of the conditions of their operation.
(1) Economic historians have always felt somewhat uneasy about the textbook picture of markets found in mainstream economics. In the main, 1 do not have in mind the obvious and admitted fatt that the perfect market of the textbooks is a construct of a possible, not an actual world (Arrow-Hahn, 1971, p_ vii). 1 refer to the empirital counterpart that this construct implicates. This empirital counterpart presents us with a mar- ket economy made up of myriads of (small) firms operating in anonymous and highly competitive auction markets, with exogenously given prices and technologies, instantly adjusting mixes ofinputs and outputs accord- ing to relative price changes and with a passive and minimal state in the background. In this image of a market economy there is no room for organizations, sinte firms are only production functions.
This model may have had some empiri& relevante in mid-nineteenth century Britain, but it was always difficult to apply it to other periods and other countries. IModern capitalism has been distinguished by the seemingly contradictory combination of, on the one hand, big and grow- ing business organizations with a considerable capability of influencing their environment (prices, preferences, technolo,ay, etc.) and thus able to change rather than adapt to its constraints, on the other hand, over time and with improved communications, of increasingly efficient tompetition.
lMoreover, it is possible to maintain that this combination of big mono- polistic or oligopolistic business and strong tompetition may be more efficient than the traditionally postulated combination of many (and therefore small) firms and strong tompetition; the assumption being that the degree of tompetition is a function of the number of firms. In a neglec- ted passage in his book, Capitalism, Sociahm and Democracy, Schum- peter w-rote:
A system - any system, economic or other - that at every given point of time fully utilizes its possibilities to the best-advantage may yet in the lorigg” run be inferior to a system that does so at no given point of time, because the latter’s failure to do so may be a condition for the leve1 or speed of long-nmperformance (Schumpeter, 1943, p. 83).
Schumpeter did not elaborate on this proposition. Evidently he had in mind two systems, one of which continuously uses its resources optimally and grows at a rate(r), and another system that does not use its resources 22
optimally, but grows at a rate higher than (r). Setondly, that it is the very fatt of sub-optimal use of resources of the latter system that enables it to grow at a higher rate. The first system may tonsist of a great number of small firms interacting mainly through the market, buying inputs at low prices and using them efficiently, while the other system may tonsist of a great many firms that, however, have engaged in a process of vertical integration. The firms of that system may not be able to buy inputs on the market at a lower price. But, by integrating vertically, i.e. by transforming their environment, they may be able to produce the inputs at lower cost because of scale economies, increased speed of ‘throughputs’ (flow of materials), lowered transaction costs, etc., resulting in a higher profit rate and a higher rate of growth. Even if in this case the vertical integration of firms may make tompetition and static resource use more imperfect, this loss is more than counterbalanced by the dynamit gains achieved by vertical integration.
This truly dynamit view of the interaction between firms and markets has been elaborated (without reference to Schumpeter) by Alfred D. Chandler Jr. in his studies of the rise of the modern torporation replacing the irrvisible hand of the market with the visible hand of the big business organization. He summarized his findings thus:
Modern business enterprise took the p!ace of market mechanism in coordinating the acti- vities of the economy and allocating its resources. In many sectors of the economy the visible hand of the management replaced what Adam Smith referred to as the irrvisible hand of market fortes. The market remained the generator of demand for goods and services, but modem business enterprise took over the functions of coordinating flows of goods through existing processes of production and distribution, and of allocating funds and personnel for future production and distribution. As modem business enterprise acquired functions hitherto carried out by the market, it became the most powerful institution in the American economy and its managers the most influential group of economic decision makers (Chandler, 1977, p. 1).
While, according to Chandler, ‘the market remained the generator of demand for goods and services’, markets were replaced because of vertical integration of independent firms, which before integration had been related through the market nexus. One may add that the same pattern was repeated in other countries and even extended, as in the case of the Japa- nese zaibatsu which included also the finantial sector; in this case, more- over, it was aided by the state providing industry with a highly educated labour forte and ensuring torporations access to inexpensive financing, while also limiting the number of competing enterprises.
In his recent book, Business Organization and the Myth of fhe Market Economy, the US economic historian William Lazonick has made an attempt to generalize these and other findings. This he does by utilizing the Marshallian concepts of internal and external economies respectively.
Internal economies are economies internal to the firm, like scale eco-
nomies or economies due to superior organization, while external econo- mies are economies external to the firm, like lotal access to skilled labour, transportation facilities or a mass market. Before the rise of the modem torporation in the setond half of the nineteenth century, Lazonick argues, firms were usually single-unit enterprises mainly relying on markets - that is external economies - for their growth. The modern torporation intema- lized those economies by vertical and horizontal integration and thereby creating internal economies: scale economies, lowered transaction costs and more effective use and coordination of equipment, personnel, and flows of goods and cash (Lazonick, 1991, chapter 2).
The modem torporation, thus, can be viewed as a successful alternative to the market mechanism. Incidentally, it was precisely by generalizing this view of the superior efficiency of the conscious, planned and hierar- chical coordinating mechanism of the capitalist firm that led Marx to believe that all-round economic planning could do away with the market.
However, some caveats are talled for. In the first place, Chandler empha- sizes that for the modern torporation also the market remains the gene- rator of demand for goods and services, which implies that the firm would not be capable of creating demand by itself. Rather, the firm captures markets as when it engages in forward vertical integration into retailing or when, thanks to scale economies, it induces buyers to shift their demand from higher priced options. Setondly, even if the creation of big business conglomerates under unified management abolishes the market mecha- nism within the domain of the firm, the firm remains dependent upon the markets ozrtside the firm as points of reference for calculation of costs and prices. Without a price system external to the firm, the big torporation would soon run into the same kind of problems that played havoc with business planning in the centrally planned economies. Sinte, moreover, markets over time, as suggested above, probably become more and more efficient, one may assume that the organizational success of the big corpo- ration to some extent may be related to the market mechanism. Thirdly, there are countervailing tendencies to vertical integration of firms. When markets grow in size, as they do in the long run with increasing output, economic activities become specialized, due to increasing division of labour, as emphasized by Adam Smith. To some extent this specializa- tion takes place by creating new firms or by splitting up business conglo- merates, when the specialized activity can be performed at lower cost in independent business firms, which may or may not be the case. Fourthly, it is interesting to note that the Soviet economy never grew so rapidly as during the 1920s when the glavki of War Communism with dictatorial powers were abolished and replaced by more than 400 industrial trusts comprising ninety per cent of all industrial enterprises. These trusts deci- ded independently what to produce and where to sel1 and they were 24
supplemented by voluntary syndicates for purchasing and selling industrial products, as well as by a competitive banking system and free agricultural cooperatives (Shmelev-Popov, 1989, chapter 1). The general orientation of this NEP economic system is consistent with the idea that business organizations are efficient only to the extent that they operate within a market system. Still, it remains a fatt that vertical integration to some extent does replace the market mechapism.
(2) It is also a fatt that market mechanisms sometimes are restricted and controlled at the matro-leve1 without negative effects on increased economic efficiency, but rather probably contributing to it. An example is the temporary use of trade protectionism in a world of unequal partners.
England ruthlessly used tariffs and trade restrictions against India to build up its own cotton industry during the eighteenth century. Ger- many, Sweden and other countries likewise pursued a protectionist policy from the 1870s in order to build up an integrated industrial structure, while at the same time experiencing accelerated economic growth. Even if we cannot rule out the possibility that economic growth would have been stil! higher in the absente of trade restrictions, it is possible to link the successful growth retord to protectionism in so far as high tariffs temporarily shut out superior competitors, while making it possible for these newly industrializing countries to reap economies of scale and coordination behind the tariff Walls. The Japanese growth retord after World War II may be another instance of the same case.
The labour market is another example of how the market mechanism has been more or less continuously restricted due to organized labour, social legislation and full employment policies. Full employment policies have contributed to the utilization of idle capacity and higher levels of economic growth; minimum wage legislation may, at least at low levels, have increased labour productivity more than labour costs (‘the economy of high wages’ or ‘efficiency wages’) and also contributed to the weeding out of sweated industries while, conversely, stimulating efficiency- enhanting mechanization. The rise of organized labour has had the same effects while also promoting collective agreements that have reduced transaction costs and facilitated business planning for employers, not to mention its effects on equalization of earnings and the social stability of market societies. Even if trade unions in their role as labour supply cartels also may have had other, less beneficent, influences on struttural change and market behaviour (clinging to declining industries, increasing quantity fluctuations as a response to wage stickiness, creating insider-outsider problems on the labour market, etc.) few would argue that a return to a non-regulated labour market would increase overall economic efficiency.
A third case is the grow-th of the publit sector in modern economies channelling 30-50 per cent of private gross income as taxes to central and
lotal government. Part of tax income - transfers and government pur- Chases - retums to tax payers and is spent on private investment and consumption. But part of the taxes is spent on publit investment and consuinption and this share reduces the scope of the market. The causes of the secular expansion of the publit sector in modern economies are szveral. Some investments in the infrasttucture have been too large, too risky or promising too small profits to engage private capita1 while still being regarded as necessary for a well-functioning market society. In other respects the market tends not to optimize investments as in education and health, and this has motivated publit intervention. With respect to insurance, comprehensive social schemes have been superior to private insurance (oid age and health) because of lower transaction costs and the spreading ofrisks. Equity considerations have motivated the use of the tax system for income redistribution and for income transfers. Even if the pro- portions of the mix in the mixed economies may change over time, it is inconceivable that a modem economy would be all-round efficient without a publit sector.
(3) We think we know the basic causes of the downfall of the centrally planned economies: the vertically structured economic relationship, that is all hierarchy and no market, and therefore no price system reflecting con- sumer preferences and relative scarcities and no scope for spontaneous mass incentives. In addition, property tights were in practice badly defi- ned and enforced. This explains the lack of tonsumer influence, the wasteful resource exploitation, the technological backwardness and the massive environmental deterioration. From this we deduce that a modern efficient economy cannot do without the market mechanism, sinte only the market mechanism can channel all important economic information and provide people with the necessary incentives to att efficiently in a way that harmonizes private with social welfare tolerably well. This explanation is probably correct. However, it remains a hypo- thesis. The results of the operation of an economic system do not only depend on the structure of the system per se, but also on its environment.
The environment of the centrally planned economies was also distin- guished by the absente of democracy and consequently also by the absente of mass participation, mass legitimacy and a true civil society with its spontaneous organizations and institutions. In brief, the centrally planned economies did not only lack the market mechanism, they were also totalitarian, and this quality may have had as important consequences for economic results as the lack of the market mechanism. In addition, the centrally planned economies did not, as a rule, emerge on the basis of developed capitalist relations of production but were rather super- imposed by forte on underdeveloped pre-industrial economies. How would the centrally planned economies have performed if their politital 26
and historital pre-conditions had been different? We do not know, but they might have performed somewhat better. In asking this question we, however, assume that a centrally planned economy without a market mechanism would be possible or relevant in a democratic and econo- mically developed society, and this is open to doubt. Even if all market economies certsinly do not imply politital democracy, it seems as if all politital democracies imply market economies. This would leave us with other forms of planned economies, like partial central pianning and/or planned market socialism. But centrally planned economies of the Soviet type would be ruled out. Only for shorter periods or under exceptional circumstances (‘war economy’ broadly interpreted) would a centrally planned economy of the Soviet type make sense. Such a conclusion may be warranted by the recent study by Chris Bramal1 of living standards and economic development in Sichuan sinte 1931 (Bramall, 1993).
The problem is, however, that we cannot be certain, sinte historital social experiments cannot be repeated under counter-factual con- diti0ns.l
The upshot of this overview of the market in history seems to be that, on the one hand, markets appear and develop as a viable mechanism in economic development; and, on the other hand, that markets also are restricted and sometimes replaced by other mechanisms. This observation poses the problem of this paper: what are the scope and the limits of the market? In order to be able to provide an answer to this question, we need to know what the specific characteristics of the market are, and what is the market’s relationship to other economic mechanisms; further, what conditions must be fulfilled fora market to existand work well; and lastly, what markets can and cannot do, that is, the merits and demerits of the market. Within the scope of this paper the discussion must of necessity be general. In the first place we cannot go into the historital and non-econo- mic dimensions of the market as a concrete temporal and spatial phenom- enon. Setondly, we Will leave out of account the important differentes that are connected with the nature of the objects exchanged (goods, labour, money, capital), the time perspective (present time or future), the nature of the exchange process (flex-price markets like the markets for money or raw materials or fix-price markets like retail trading) or other characteristics (e.g. auctions).
1 In the history of Soviet central planning the experience of the early War Communism is often cited as a proof of the rationality of central planning under exceptional conditions.
This conclusion is unfounded. As shown by Kondratiev already in 1922, and system- atically proven by Medvedev much later, central planning seems to have caused rather than eased the economic problems. (Medvedev, 1979, chapter 11)
Hat is the market?
A market is a mechanism for the allocation and re-allocation of resources between independent property owners. The mechanism is constituted by acts of exchange (buying and selling) of goods and services (exchange objects) between buyers and sellers. These bargain on the terms of exchange and, if the exchanging partners agree on these terms (the price), the exchange att can take place. The exchange att takes place between firms, between households or between firms and house- holds. These exchange partners are furthermore assumed to be guided in the exchange att mainly by self-interest. The number of exchange partners is important in the definition of a market. Isolated exchange between two exchange partners is not counted as a market. The number of exchange partners should be large and, the larger the number, the more perfect the market, ceteris paribus. In addition three other characteristics of a market are important. Firstly, free entry and e.xit to the market, given the accepted rules of exchange. Setondly, tompetition between sellers and between buyers, which makes it possible for buyers and sellers, respectively, to reach the most favourable terms of exchange. Thirdly, free choice of exchange objects and/or exchange partners, which is a corollary of free entry and exit and tompetition.
If we situate the market mechanism within the field of an economy as a whole, the market is ‘realizing’ or turning over goods and services, which already have been produced by firms or households. While firms and households produce, i.e. transform inputs into outputs in the process of production, the market allocates and re-allocates inputs and outputs between firms and households. In the process of production, economic values are created, while in the market values are transferred. When the exchange att is mediated by a generalized means of value and exchange, like money, this transfer of value implies a change in the forn of value (goods to money, money to goods).
Now it is important to note that while exchange presupposes produc- tion, production does not necessarily presuppose exchange. In a comple- tely natural economy - which is a limiting case - production takes place but there is no market or exchange. Allocation of resources for alternative use is effected by other mechanisms, like order (command), explicit or implicit rules (tradition), by bargaining (as in the case of isolated exchange), by consensus or by vote (democracy). Sinte there is no market there is no price mechanism and, hence, no exogenously given terms of valuation and exchange. Valuation certsinly takes place between agents and between agents and principals in the producing units, but the nature of this valuation may vary from case to case. The centrally planned economy may be regarded as a huge natural economy.
The firm in a market economy is also a producing unit and the decision- making within the firm is nota market. When the firm or the manager of the firm wants something done, they do not shop around among the employees searching for the best offer. Instead the principal orders the agents involved to do it. Therefore the allocation process within firms is commonly designated as an example of hierarchy, i.e. a vertical relation of command or order, in contradistinction to the market, which is a hori- zontal relation of free and competitive exchange acts. But in contradi- stinction to the firm in a centrally planned economy, the firm in a market economy is embedded in a price system made possible by the market and signalling opportunity costs and incentives. This has several consequen- tes. Firstly, the firm can use the price system of the market in valuing and ailocating the resources of the firm to the most profitable use. Setondly, it can buy inputs and sel1 outputs in the market on the terms most favourable to it. Thirdly, it can choose between buying a resource on the market or producing it within the firm depending upon which option is the most favourable one. The relationship between the firm and the market in a market economy is thus both one of complementarity and one of substi- tution. The firm cannot exist without markets, i.e. buying inputs and selling outputs. Firms (and households) produce or transform resources (create values), while markets transfer (turn over, realize) value between firms and households. The relationship of complementarity between firms and markets consists primarily in the fatt that firms are dependent upon markets for realizing values and for the valuation and allocation of resources within firms.‘The relationship of substitution between firms and markets consists primarily in the fatt that firms can replace markets and vice versa. The allocation of resources between firms and markets is deter- mined by the opportunity cost - of buying inputs on the market or of producing inputs within firms. According to one received explanation, the delimitation between markets and organizations is decided by the costs of transacting relative to the costs of producing. (Vore about transaction costs below.)
Summarizing this we may define an economic system as constituted by organizations (firms and households) and by markets. Then we may say, ceteris paribus, that the scope of the market sets limits to organization, while the scope of organization sets limits to the market. But it is impor- tant to note that the relationship between markets and organizations is not only one of substitution or competitiveness, but also one of comple- mentarity as shown above. As an example of this we may look at the conse- quences for the delimitation between organization and market, when a firm becomes more efficient than other firms ‘in processing its input resources and producing outputs, respectively. If the firm becomes more efficient in producing its inputs, it gets incentives to expand the firm and
shrink market activities. But if the firm becomes more efficient than other firms in producing outputs both firm and market activities would expand.
?Vhy do markets exist?
If we accept that the market is that part of an economic system that transfers, turns over or realizes values - created by organizations - between firms and households, we may ask which conditions must be ful- filled for a market to exist. 1 have found at least nine such conditions.
If they are not fulfilled, markets may not exist. If they are incompletely fulfilled, markets work also incompletely or imperfectly.
(1) It the first place there must be self-interested agents, who as a conse- quence of their self-interest try to maximize their utility or profit. This con- dition distinguishes markets from other forms of reciprocity like gift- -giving or altrustic behaviour. Markets could in fatt exist also if all agents practised altruism. But the outcome would be inferior to the outcome when agents are guided by self-interest, sinte generalized a!truism would imply that the outcome of transactions for an agent was always decided by the preferences of somebody else. Sinte we may assume that 1 have better information about my preferences than you, generalized self-interest gives results that are superior to generalized altruism. Gift-giving is costless for the recipient of the gift. In some cases also market transactions can take place at zero or even negative prices. This could happen if there are no alternative uses of a resource or when a resource is a disutility, like waste, and we are prepared to pay to get rid of it. These transactions are, however, enforced by circumstances, while gift-giving is voluntary and implies a transfer of wealth without an equivalent transfer. In archaic societies gift-giving was imposed on gift-recipients in order to control them, as Maurice Mauss has shown. But this form of gift-giving is distinguished from market transactions by the fatt that the latter are voluntary
(Gustafsson, 1989).
(2) Setond, there must be free entry and exit to make it possible for agentsto choose themost profitable options in terms of costs and rewards.
If this condition is not met with, markets do not ensure optimal outcomes for agents. Without free entry and exit tompetition is restricted. This is why market monopoly (monopsony) or oligopoly implies market imper- fections.
(3) Third, market exchange presupposes that agents have divergent preference scales as well as divergent comparative advantage in supply; if not, there would be no point in exchanging property right to goods and services. To quote Wicksteed:
A market is a machinery by which those on whose scales of preference any commodiry is relatively high are brought into communication with those on whose scales it is re!atively Low, in order that exchanpe may take place to mutual satisfaction until equilibrium is established. (Wicksteed, 1933, voiume 1, p. 236)
If Jones hasa computer and Robinson an electronic microscope, and if the computer stands higher than the microscope on Robinson’s scales, while the microscope stan& higher than the computer on Joness scales, a mutually advantageous exchange can take place.
(4) Fourth, there must exist well-defined and decentralked property tights, which make it possible for market agents to use and transfer resources as well as to receive the rewards from and bear the costs of their use. If property rights are badly defined and badly enforced, so that it is not clear who shall bear the costs and receive the benefits of their use, markets do not work properly or at all. The reason is that agents expect some reasonable balante between effort and return (see point (1)). If B reaps where A has sown, A Will loose interest in continuing the activity.
A limiting case here is represented by publit goods (see below), where property rights may be difficult or impossible to define and enforte except at forbiddingiy high costs (which brings us to the case of high transaction costs). Badly defined and/or enforced property rights can have negative external effects when some property owners impose unwanted costs on other property owners. This leads to sub-optimal allocations of resources, sinte it encourages the first mentioned set of property owners to expand their activity beyond the optimal point of resource use, while it restritts the activity of the setond set of property owners. This problem may some- times be solved by recontracting the concerned agents’ scale of activity, if the transaction costs of recontracting are not forbiddingly high (inter alia depending upon the number of agents involved).
In this connection it is important to note that the only condition imposed on the nature of property rights is that they should be reasonably decentralized. Private property rights are a subset of decentralized property rights but by no means the only ones, sinte various organiza- tions, institutions and cooperatives are also market agents. Only if there is just one single property owner, as in the case of the centrally planned economies, are genuine market exchanges excluded. It may be possible to devise a market system w-ith one single property owner on condition that the usufruct of property is leased to several lease-holders. But then the contractual form, e.g. terms and length of contract, becomes important for the efficiency of the arrangement.
(3) Fifth, market exchange presupposes division of labour or speciali- zation as a necessary although not a sufficient condition. If 1 can produce on my 0w1-1 all the goods and services 1 need, there is no room for market exchange. As soon as producers specialize and produce only a part oftheir
needs, they become dependent upon the market nexus. However, there can be division of labour without markets, sinte a central authority owning all resources may also institute division of labour by command.
This was the case in the centrally planned economies.
(6) Sixth and most important, market exchange presupposes exchda- bility in supply and rivahy in demand. This condition refers to the tech- nital character of goods and services and it is fundamental for the distinc- tian between private and publit goods. If it is possible for a seller to tonfine his/her goods and services to a specific buyer and if the purchase or consumption of these goods and services by the buyer excludes their purchase or consumption by other buyers, the goods and services are private. The selling and buying of most everyday goods and services belong to this category. But if there is no excludability in supply and there is no rivahy in demand, the goods and services are publit. Air and natural scenery may be examples. If 1 as a prospective seller of a publit goods tryto sel1 it to A and B, C and D cannot be excluded from appropriating it; and if the consumption of it by A does not diminish its availability for B, C and D, neither seller nor buyers have incentives to engage in market exchange.
Pure private and pure publit goods are alternatives at the endpoints of a continuum with semi-private and ,semi-publit goods in-between. An example of semi-private goods may be theatre performances, where tickets can be sold to each visitor but where my consumption of the service does not exclude the consumption by other persons. An example of semi-publit goods, where there is no limitation in supply by rivalry in demand. may be the picking of berries on a tommon, where anybody may enter the tommon but where simultaneously my picking of berries reduces the availability of berries to others. This also shows that it is excludability in supply that basically defines the distinction between private and publit goods. Publit goods cannot be marketed and, if they still are necessary for the reproduction of society, they are either free or tax-financed goods.
(7) Seventh, a well-functioning market presupposes that agents have relevant information about goods, prices and qualities. If they do not possess such information, market agents may be unable to find market partners, goods or qualities that in fatt exist, buy the right qualities or pay the right prices. The amount of available information depends upon the knowledge of the market agents, the state of communication and media development as well as access to relevant advertising.
Information should also be symmettically distributed between buyers and sellers. If information is asymmetricalZy distributed the outcomes of market transactions become inefficient or may cease to exist. If this occurs markets may be improved by regulation. Sometimes it is buyers who are better informed than sellers and therefore may buy the goods below their market price, e.g. on setond-hand markets or markets for rare books, art 32
etc. But usually it is the sellers that possess superior information because they have produced, owned or used the goods to be traded.
The consequences of asymmetritally distributed information for market behaviour have been extensively analyzed by Arr o w and A k e r 1 o f Arrow refers to the health market, where doctors and patients meet in trans- actions. Doctors are supposed to know more about illnesses and medieal treatment than patients, while patients may lack information not only about the nature and causes of their illness as well as about proper treat- ment, but also about the qualifications of the doctor who is to deliver diagnosis and treatment. If the diagnosis and the treatment are wrong the consequences may be disastrous for the patient. In traditional Chinese medicine the problem of asymmetritally distributed information about the quality of medieal services was solved by a method which assumed that there was a unique causal relation between illness and medieal treatment:
the patient paid the price orrly if he/she was tured. In Western health service systems other solutions have been used to compensate for the asymmetry of information, primarily by controlling the qualifications of doctors (standardized education and authorization of doctors) and by promoting professional ethics. We meet with similar institutions also in regular goods and service markets, where trade marks are supposed to signal information about qualities, and publit tonsumer protection agencies are frequently used to inform buyers (see further Arrow, 1963).
In a seminal contribution, The market for Zemons, George Akerlof has shown that information asymmetritally distributed between sellers and buyers may cause’markets to shrink, even to disappear, under per- fettly competitive conditions. He takes the market for used cars (‘lemons’) as the standard example. The owners of used cars know the quality of the specific tar they own but prospective buyers do not. The only thing buyers know is that there are large quality variations with respect to used cars. If the market for used cars is perfectly competitive, buyers and sellers are price-takers and decide orrly on quantities offered and demanded. Price is taken as an index of quality. Then interesting consequences may follow.
The competitive price for used cars is satisfactory only for those sellers who supply cars of average or below-average quality. Thus potential sellers with cars of above-average quality tend to withdraw from the market, sinte the price offered does not reflect the value of their cars. If buyers are aware of this, they correctly conclude that the average price established does not properly reflect the average quality of the used cars effectively offered on the market. The correct price should not be an average of above-average, average and below-average quality of cars, but only of average and below-average quality, i.e. a lower price. Hence, buyers are prepared to offer only this lower price. But at this lower price the owners and sellers of average-quality cars also withdraw from the
I
market, sinte the new average price is lower than what corresponds to the quality of their specific cars (the price being an average of average and below-average qualities). And on it goes until there are no more used cars offered on the market.
The Akerlof Zemon-ptincipZe is not so esoteric as one may think.
It explains many forms of regulation of the market mechanism. It may contribute to our understanding of the specific organization of the me- dieval craft guilds with their elaborate control of professional standards and quality of goods (Gustafsson, 1991).
(8) Eighth, transaction costs may also explain the existence, absente, growth or decline of markets. This cost category has been extensively researched in recent years - although the concept had already been intro- duced in 1937 by Ronald Coase (Coase, 1937). The concept of trans- action costs is not yet satisfactorily delimited. Usually it refers to costs associated with entering into a contract between transacting agents, like search costs, bargaining costs and enforcement costs. Coase was primarily interested in defining the essence and limits of the firm relative to the market as an allocative mechanism. He found that the delimitation between firms (organizations) and markets is determined by the costs of transacting relative to the costs of praducing (see also above pp. 16-18).
Coase and some of his followers seem to suggest that transaction costs even explain the existence of firms. This claim goes too far. Firms e,xist and must exist because they are organizations for producing goods and services (value creating), while markets exist and must exist for realizing outputs (value transforming). Firms and markets are basically comple- mentary, not substitutive. An economic system cannot be constituted only by markets, i.e. buying and selling, sinte goods and services must be pro- duced before they can be bought and sold. An economic system can, howe- ver, exist without markets (households producing and consuming their ow-n output or centrally planned economies), although the use of markets makes an economic system more efficient. Even if transaction costs would be zero, the market is not necessarily used. This is the case, when the pro- ductivity in production of one firm relative to other firms is so high that it outweighs zero or even negative transaction costs of using the market. The theory of transaction costs is thus not a general but a special theory of the choice between organizations and markets, respectively, for the allocation of resources.
Transaction costs are often important on the margin for the decision to produce or to buy. Variations in transaction costs sometimes explain the absente, shrinking or expansion of markets. If bargaining costs are too high, e.g. because too many agents on one or either side are involved, no transaction may be possible. Or if enforcement costs, e.g. due to the absente of a sufficiently efficient legal and policing system, are too high, 34
the same consequence may ensue. In the present drive for privatization of publit services in the Western world, it is often forpotten that competitive market solutions or decentralization within publit agencies, e.g. in health care, often turn out to be more costly than centralized publit production, precisely because of the existence of transaction costs, that is search costs, bargaining costs and.enforcement costs, or simply because of duplication of administrative costs and paper work.
Transaction costs sometimes explain why markets shrink or expand as well as the emergence of new organizational forms. One important instance is the vertical integration of fims, which does away with the market nexus between the units involved, as when a steelworks integrates backward to iron mining or forward to steel engineering. The increasing transaction costs in domestic industries in the early phase of the industrial revolution help to explain the rise of the factory system, e. g. in cotton industries. In this case the demand for cotton products started to grow rapidly, due to the low costs and superior qualities of these textiles.
Merchants and putters-out reacted by adding new, spatially dispersed, domestic producers to their decentralized organization. This increased bargaining and enforcement costs (because of embezzling of raw mate- rials) as well as carrying costs for distributing raw materials and collecting final outputs. Also variations of quality of products increased because of the addition of new and less skilled independent producers. Soon the transaction costs became forbiddingly high. The merchants and putters- -out reacted to this by centralizing producers and production in factories under their own supervision. This paved the way for the technological changes associated with the large-scale use of machine techriology and steam power (Gustafsson, 1987). If however hand transaction costs decrease substantially, the consequence would be an expansion of mar- kets. This was clearly the case in the commeicial upswing in the West from the eleventh century on, when contract law and royal administration (market law) made it possible for traders to trave1 more safely with their goods and thus lowered the transaction and enforcement costs of contracts. Another instance of the same pattern may be the expanding markets of the late nineteenth century, when the telegraph, railways and steamships lowered search costs as well as bargaining costs.
(9) Ninth, markets exist or are efficient enly if there are institutions, that is, formal and informal rules as well as legally sanctioned and accepted enforcement mechanisms safeguarding contracts and exchange.
(Property rights may be regarded as an instance of institutions, see p. 31 above.) If these institutions are lacking it may pay to steal rather than to buy resources or to cheat or to blackmail market partners. How important institutions are for the e‘xistence of well-functioning markets we are made painfully aware by observing the tortuous emergence of markets in the
former Soviet Union. The role of proper institutions for market exchange is, in this respect, to lower transaction costs. Institutions perform this fünction by indicating permissible and non-permissible choices, decisions and acts, respectively, in market behaviour. For this task formal rules, like laws, may do part of the job. But still more important are informal rules, embedded in ideology and culture, like elementary honesty, goodwill, sound business practices, etc. Without this ‘market culture’ efficient mar- kets cannot existand in the West it took centuries for it to emerge. Formal rules often preceded informal rules, as when medieval laws on commerce stipulated that valid exchange necessitated the presence of two witnesses (Gustafsson, 1987). How disastrous the effects of market exchange might be for the agents if proper institutions are lacking has been wittily analyzed by Amartya Sen (Sen, 1979). One implication for market behaviour of the existence and operations of institutions is that the choice set of agents is not only historitally conditioned but also that it is finite.
Consequently institutions also determine the outcome of choices.
These nine conditions for the existence of markets and/or efficient markets are of different kinds. But generally speaking they refer to char- acteristics of economic agents (self-interest, optimizing behaviour) and their environment (free entry and e.xit, tompetition, comparative advan- tage, property rights, division of labour, private goods, information, trans- action costs and institutions), which have to be fulfilled in order to enable agents to choose but also influencing the outcomes of choice. From the point of view of economic history and empirital analysis 1 would suggest that it is especially important to pay attention to the degree of tompetition, property rights transaction costs and institutions. One should also note that there are inter-relations between some of the conditions. If goods are publit ones, property rights cannot be established, economic activity referring to publit goods gives rise to external effects, and external effects affect transaction costs. If property rights are ill-defined and institutions are undeveloped, negative externalities as well as high transaction costs Will ensue. These interrelations indicate the existence of some more gen- eral underlying conditions than those mentioned. But no high-powered general theory of the existence of markets has as yet been formulated.
Causes and effects of market growth
The nine conditions discussed above determine the existence but also, as already hinted at, the growth and decline of markets. Historitally we should probably emphasize four sets of main causes of market growth. In the first place government policies with respect to the legal foundations of markets (property rights) and to trade barriers (e.g. tariffs). Setond, division of labour (specialization) that increases markets and vertical 36
integration that reduces markets. Given the number of transactions, market size is also determined by the volume of transactions effected.
From this point of view, market growth is, third, also influenced by output growth, sinte growing supply essentially implies growing demand. Fourth, and most important, improved communication technology affecting the flow of information is, as Mars hall and others have emphasized, instru- mental in bringing about market growth. Improved communications, of course, also lower costs of distribution which extend markets spatially.
A caveat is, however, talled for. When we suggest that increased division of labour (specialization) increases markets, we should rather talk about the possibility of increased markets. The reason is that the increased division of labour leads to market extension only in so far as the new spe- cialized activity also implies the establishment of a new firm (a new pro- perty owner). It may well be that the new specialized activity arises within an already established firm and then no market extension takes place. If specialization leads to lower costs, e.g. thanks to economies of scale, for the overall activity of the firm, it may even lead to shrinking markets, if rival firms are destroyed by tompetition.
This observation is also important when we turn to the effects of market growth. Adam Smith enunciated the important principle that the degree of division of labour or specialization is determined by the extent of the market: the wider the markets, the more extensive the division of labour (Smith, 1776). Smith made this proposition the foundation of his theory of the wealth of nations. In this theory economic growth is determined by two factors: the productivity of labour, and the share of productively employed workers in the labour forte. This share, according to Smith, is determined by the savings ratio of the capitalists. The more they save, the more workers they can employ in production and vice versa. The product- ivity of labour is, on the other hand, determined by the degree of division of labour and this, in its turn, by the extent of the market: the wider the market, the larger the scope for specialization. Ultimately, economic grow-th, in Smith’s view, is hence determined by the propensity of the capi- talists to save (and accummulate) and by the extent of the market. From this theory, Smith inferred the beneficial effects of free trade and market extension. Smith’s theory is valid as far as it goes. But two observations are talled for. In the first place, vertical integration works in the opposite direction with respect to market size, and there are often strong induce- ments to vertical integration because of scale economies, reduced trans- action costs and/or prospective Capture of rents. Setond, extension of the market for a commodity may not at all lead to increased specialization.
Sometimes the market extension may be too limited to support the activity of a new firm and sometimes it leads, not to increased specialization, but only to a widening of the on-going activ-ity, especially if market extension
implies economies of scale and lower costs of production. If this is the case, market extension may promote the emergence of larger firms. Eco- nomies of scale and lower unit costs of output induce shifts of demand for final output because of income as well as of substitution effects. Sinte lower costs make price tuts possible, tonsumers’ real income increases and their demand for the commodity increases. Parallel to this, demand also increases because tonsumers shift from higher-priced substitutes to the lower-priced commodity. This is one of the most important causes of the emergence of mass markets.
Finally, market extension also tends to increase tompetition if it implies an increased number of firms in the market. Scale effects as well as increased tompetition tend to lower costs and prices. The creation of larger market areas, like the European Gommon Markef, are often motivated by these two effects of market extension.
Peculiarities or market behaviour
On the one hand, markets exist, grow and thrive, and seem to possess unsurpassed qualities in the generation of efficiency and welfare. On the other hand, markets are conditional; are sometimes replaced by other mechanisms for resource allocation and are often, as suggested earlier, more or less imperfect or may not even exist. In the standard version of the theory of the perfectly competitive market, this mechanism represents an optimum of efficiency and stability. But in reality this is not always, and perhaps only exceptionally, the case. One reason is that market behaviour is determined not only by the simple aggregation of rational individual decisions but also by the interaction between individuals, whereby this interaction in various ways influences and modifies not only the original decisions but also, more importantly, the outcome of them. As a conse- quence, spontaneous individual rationality often produces collective irra- tionality. Akerlof’s theory of the market for Zemons (see above) is just one example of a much more general phenomenon (Schelling, 1978). In addi- tion, individuals do not att only on the basis of rational self-interest (maxi- mization of a utility function w-ith known arguments), but also on the basis of ignorance, uncertainty, vanity, and fears; they form expectations that change with new information and changing environment; they indulge in strategic behaviour in order to gain advantages and power, or to redistri- bute wealth.
Finally, it is important to note that real markets do not work smoothly only on price signals and towards stable equilibria. As everyday expe- rience tells us, quantity signals and rationing also play a role in the market mechanism and supply and demand do not always balante at given prices.
Let us look at some important examples of all this.
38
(1) According to the theory of perfectly competitive markets, the market mechanism guarantees a state of so-talled Pareto efficiency where no agent can improve his/her utility without making somebody else worse off. This would, infer alia, exclude involuntary unemployment. But in fatt invohntary unemployment is pervasive in all market economies. Parts of the unemployment may be explained by demographic factors, wage rigid- ity or too high unemployment benelits (making unemployment partly voluntary). But, sinte unemployment is general, lasting, and even increas- ing, the most probable explanation is that the fundamental cause is inade- quate aggregate demand. Such a state is made possible precisely by the market mechanism using money as a means of exchange in transactions.
In every single transaction, demand and supply balante in the market.
But the fatt that 1 have sold a commodity today does not necessarily imply that 1 shah buy another commodity tomorrow for the money received.
1 may save the money, depending upon my expectations with respect to my future consumption or investment. If 1 think that 1 should postpone con- sumption or investment, my demand disappears from the market. If other agents also behave in the same way, aggregate demand does not equal aggregate supply at the ruling prices. One consequence would be unemployment. The inference from the theory of perfectly competitive markets would be that unemployment is caused by a too high wage leve1 and that the labour market would be in balante if wages were lowered to the equilibrium level. If this took place partially some unemployed would probably be employed at a lower wage rate sinte some employers would be abie to tut their prices and increase their market shares. But if all or most of the employers acted in the same way, the general price leve1 would also be lowered and there would be no incentive to increase employment. The enly result of the wage tut would be lower output and possibly increased unemployment, especially if the wage tuts made employers expect further wage tuts and therefore they would postpone production and employ- ment decision. The same result would follow if households tried to improve their situation by increasing savings. If some households tried, they might succeed. But if all or most of the households increased savings, aggregate demand for consumption and investment goods would be further reduced. Individual rationality would be translated into collective irrationality.
One consequence of this (Keynesian) analysis is that the alleged wage rigidity, inferred from the theory of perfectly competitive markets, could be explained as an outcome of perfectly rational optimizing choice on the part of the wage earners without leading one to claim that the unemploy- ment was voluntary. The explanation is either that wage earners have lear- ned from experience that, if they agree to wage tuts, full employment Will still not be restored; or that it may be worthwhile to pay the price of
unemployment for a while because it may be difficult to restore the full employment wage leve1 after having agreed to a wage tut as a remedy for unemployment. In both cases wage earners’ choice might be regarded as an outcome of superior information (not included in the theory of per- fettly competitive markets).
(2) Market economies are seldom distinguished by stable equilibria.
Typically, there are herd-like mouements (S c hump e t er), which inter- mittently prevent full employment of resources or give rise to disequilibria with or without full employment. The business cycle in the aggregate economy is one instance. But cyclical mouements and disequilibria may also occur in individual markets. This was discovered long ago, e.g. by Arthur Hanau, John Einarsen and others (Hanau, 1928; Einarsen, 1938) with reference to the so-talled hogcycle and the shipbuilding cycle, respectively. The causes of disequilibria are, in those cases, that supply and demand do not react instantly on price signals and vice versa. In a classical study, The Cobweb Theorem, Mordechai Ezekiel concluded:
Classical economic theory rests upon the assumption that price and production, if disturbed from their equilibrium, tend to gravitate back towards that normal. The cobweb theory demonstrates that, even under static conditions, this result Will not necessarily fol- low. On the contrary, prices and productions qf some commodities might tend to fluctuate indefinitely, or even to diverge further and further from equilibrium . . . If many commo- dities are chronically vajing above or below their individual equilibria, then the eco- nomic system Will never organize all its resources for the most effective use, but Will always be operating below the total installed capacity and with more or less unemploy- ment. Even under the conditions of pure tompetition and static demand and supply, there is thus ‘no automatic self-regulating mechanism’, which can provide full utilization of resources. Unemployment, excess capacity, and the wasteful use of resources may occur even when all the competitive conditions are fulfilled (Ezekiel, 1938).
The outcome of the fluctuations of prices and the quantities demanded and supplied in the market may differ, depending upon the price elastici- ties of demand and supply. In happy cases, the range of fluctuations will continuously diminish and, after a time, end up in a stable equilibrium.
In other cases, the outcome may be stationary fluctuations around an equilibrium. In unfortunate cases, the outcome may be so explosive that fluctuations increase until the market breaks down.
(3) A peculiar phenomenon in market mechanisms caused by expecta- tions is speculation. Speculation is usually, and rightly so, regarded as a beneficial factor in the market mechanism. Speculators take on the role ofrisk bearers and contribute positively to the equilibrating of supply and demand. If a speculator in grain buys part of the farmers’ harvest in the autumn, when the supply is large and the price is low, in order to sel1 it in the following spring, when the supply is scarce and the price is high, he makes a profit on the price differente reduced by storage and interest costs and the cost ofrisk. But, at the same time, he prevents the price of grain 40
falling too low in the autumn, which is beneficial to the producers and, likewise, he prevents the price rising too high in the spring, which is bene- ficial to the tonsumers. Speculators thus take on a specific role in the divi- sion of labour. But this result presupposes that the speculators are not too many and do not exert too strong an influence on the market mechanism.
If they are many, they may, on the contrary, destabilize prices and mar- kets. If many speculators bilieve that the future price Will be much higher than it is today, they may withhold supply to such an e_xtent and for so long a period that their activity inflicts damage on the physical reproduction of market agents. This occurs, for example, when many market agents are poor and may become destitute because of speculation. This is an impor- tant reason why grain and bread prices historitally have often been regulated bylotal and centralgovemment. Amartya Sen has shown how speculation in underdeveloped countries has caused mass famines and poverty in India, Bangladesh and Ethiopia, where millions have starved to death, not primarily because of trop failures, but because supply has been withheld from the market and even exported (Sen, 1951).
(4) The fatt that the behaviour of some market agents may damage other market participants directs our attention to the distibution aspects of the market mechanism. The market does not translate need into welfare if need is not baeked up by entitlements, Le. resource endowments, income and wealth. If market agents have unequal resource endowments, the rich may become richer and the poor may become poorer. To be effi- cient, the market mechanism presupposes that agents att on the basis of self-interest. This impIies that it promotes virtues like egoistic behaviour, but also smartness and.ruthlessness. If we assume that such virtues are distributed normally in any population, the outcome of market trans- actions should be that these, on the average, tend to the interests of most people, while they make a minority at the upper end of the scale well-off and another minority at the lower end of the scale poor. The market mechanism is per se ethically neither good nor bad. It promotes desert, i.e. it gives more to those who have more, and less to those who have less.
John Ruskin put the tontrast well:
In the community regulated only by laws of demands and supply, but protected from open violence, the persons who became rich are, generally speaking, industrious, resolute, proud, covetous, prompt, methodical, sensible, unimaginative, insensitive, and ignorant.
The persons who remain poor are the entirely foolish, the entirely wise, the idle, the reck- less, the humble, the thoughtful, the dull, the imaginative, the sensitive, the well-informed, the improvident, the irregularly and impulsively wicked, the clumsy knave, the open thief, and the entirely merciful, just, and Godly person (Ruskin, ed. 1967).
The theory of general competitive equilibrium predicts an optimal out- come for all market agents involved in the sense that no one can be made better-off without making somebody else worse-off. This outcome is valid
for any possible tonfiguration of the distribution of wealth or income. This implies that if, as the result of the competitive market mechanism, some would have ended up with billions of dollars in income, while others would have received only a subsistence income (or less), this optimal out- come would become a suboptimal outcome, if government decided to talte one dollar from one of the billionaires and give it to one of the earners of a subsistence income. Granted that we base our views on distributional equity on other considerations than desert, and granted that distributional outcomes in reality are occurring in non-perfect markets and, in addition, are influenced by institutions like heritage, it is easy to understand that the distributional outcome of the market mechanism is corrected by govern- ment intervention in most societies.
(5) As every student of business history is aware, the market is not usually the peaceful Eden which emerges from the theory of the perfect competitive market, in which all agents are price-takers and are mainly preoccupied in making the necessary quantity adjustments to achieve optimal results. The market is rather LZ theatre of wur characterized by sales promotion, price wars, take-overs, amalgamations, market sharing, cartel agreements and demarcations of spheres of interest. Reading, for example, the multi-volume study by the Uppsala economic historians of the history of the Swedish Match Company is like reading a history of more or less permanent warfare (see e.g. Lindgren, 1979). Even in a highly competitive market, agents mayuse price as a parameter of action in order to gain advantages over competitors if they happen to command larger resources than theirs. One instance of this is so-talled predatory pricing.
By charging a price for competitive goods that is sufficientlylowfor a suffi- ciently long time, they may drive their competitors out of business and take over their market shares. Such strategic behaviour is the rule in finantial markets. Nobody can tel1 whether the outcomes are optimal for anybody but the winners.
(6) Competition is one of the aspects of the market mechanism that makes it so useful. But sometimes tompetition may be too keen to be efficient. Another way of expressing this fatt is that the market agents in such cases may be too many. The reasons why they do not withdraw from the market may be several. They may lack better alternative occupations close at hand, like the coalminers in many regions in Europe or United States between the wars. Or they may expect a tum for the better in the future like the British handloom weavers in the early nineteenth century whose downhill struggle against the power-loom became so long drawn- out because the preceding period of ‘prosperity had been so long and so successful. Faced with deteriorating conditions, the glory of the golden age - ‘the men with each a watch in their pocket, and the women dressed to their own fancy’ (Radcliffe, 1828, p. 67) - made them hope for a turn for 42
