To get a glimpse of how a perfect market looks like, consider the film Liar, Liar which tells the story of Fletcher Reede. As a result of his son’s birthday, Fletcher Reede is compelled to tell the truth for twenty-four hours. This is problematic for Fletcher Reede because he is a lawyer—or a liar—as his son understands it—and gaiety predictably ensues as a horrified Fletcher incriminates himself helplessly blurting out truthful answers to every questions asked. Free markets are just like Fletcher Reede’s son—they force you to tell the truth.
Imagine that Fletcher Reede’s son gets his birthday wish, not just for his smooth-talking dad but for the whole world. Let’s buy a hot chocolate in the world of truth. The seller asks:
“How much are you willing to pay for this hot chocolate?”
You’d like to quote the minimum price possible, but the truth just slips out:
“10 dollars.”
With a smirk, the seller prepares to ring up the extortionate sum, but you have a few questions of your own:
“How much did it cost you to prepare this one cup?”
Now it’s the seller’s turn to have a Fletcher Reede moment. Turns out that the hot chocolate costs not $10, but less than one. The seller tries to haggle, but you have one more killer question:
“Are there any other places within a couple kms selling hot chocolate like this?”
“Yes…” the seller moans in abject defeat.
You walk out of the shop with the hot chocolate safely in your possession with a bargain price of 60p.
There’s a basic truth incorporated in the system of prices. The truth comes from the fact that stores and consumers do not have to buy or sell at a given price—they can always opt out. In a free market, people don’t buy things that are worth less to them than the asking price. And people don’t sell things that are worth more to them than the asking price. The reason is simple: nobody is forcing them to, which means that transactions that happen in a free market improve efficiency because they make both parties better off—or at least not worse off—and don’t harm anyone else.
This trivial piece of information that in a free market customers value hot chocolate more than the money they pay for them is not so trivial after all. But we needn’t stop there.
Imagine now that the chocolate market is not only free but extremely competitive, that entrepreneurs are always starting new businesses seeing the potential in this industry. The competition will force the price to go down to the ‘marginal cost’ — which is the cost of the additional hot chocolate that the café incurs, which we remember was just under a dollar. If the prices go lower, firms will opt out until it rose again. If the prices go higher, new firms will enter the market until it fell. Suddenly, the price is not conveying a vague fact (the chocolate is worth 60p or more to the buyer and 60p or less to the seller) , but a precise truth (the cost of the chocolate is exactly 60p).
What if more industries were perfectly competitive? It would mean that for every product, the price equals to the marginal cost. Every product would be linked to every other product through an ultra-complex network of prices, so when something changes somewhere in the economy, everything else would change, maybe unnoticeably, maybe a lot. A frost in Brazil, for example, would damage the coffee crop and reduce the worldwide supply of coffee, thus increasing the price of coffee to a level that discourage coffee drinking, thereby increasing the demand and hence prices of substitute products like tea. Demand for complementary products like coffee creamer would fall a little. Meanwhile, in Kenya, coffee farmers would enjoy huge profits and would invest the money in improvements like aluminium roofing for their houses; which would shoot up the prices for the same and thus some farmers would decide to wait before buying. Eventually, demand for bank accounts and safety deposit boxes would rise, although for the unfortunate farmers in Brazil, the opposite may be happening. The free market supercomputer processes the truth about demands and about costs, and gives people the incentive to respond in astonishingly intricate ways. Even if markets are not perfect, they can convey tremendously complex and vital information.
What is the most important result of a set of perfectly competitive markets interconnected like this? Right things are being made right in the right quantities and given to the people who value them most. It leaves no room for any further gain in efficiency. To put it another way, you can’t get more efficient than a perfectly competitive market. And it all follows perfectly naturally from the truth contained in the price system: prices are true representations of cost to firms, and true representations of value to customers.
The non-market system, however, has some advantages. When you dial 999 nobody asks for your credit card details. The government is supposed to afford the same protection to the rich and poor, although it does not always seem that way. But it also has some demerits. For instance, if the police officer is rude or incompetent, you don’t have the option to shop for a different police force. No, you have to lobby your local politicians and hope they consider your demands. Non-market systems have their advantages, but they also lose something important: information, information about wants, needs and desires and about inconveniences and costs. Sometimes the loss of information is worthwhile because it is offset by gains in equality and stability. But sometimes the loss of information can leave an economy, and a society, floundering in waste and confusion.
EFFICIENCY VERSUS FAIRNESS
While the perfectly competitive market is perfectly efficient, efficiency is not enough to ensure a fair society, or even a society in which we want to live. According to the concept, it is efficient if Elon Musk has all the money and everybody else starves to death… because there is no way to make anybody better off without making Elon Musk worse off. We need something more than efficiency. One very common source of inefficiency is taxes. Why are taxes inefficient? Because it destroys the information carried on by prices in perfectly competitive, efficient markets: price no longer equals cost, so cost no longer equals value. A sales tax of 10% creates a lie. Say the cost of the chocolate is $40. The sales tax increases it to $44. The customer valued it to $42. Thus the sale does not take place. What’s worse is that the tax(the reason why the sale didn’t take place) wasn’t even raised. When the tax is waived off, no one would be worse off, but the buyer would certainly be better off: a clear efficiency gain.
Thus we are faced with a dilemma. We want to avoid inefficiency, because we don’t want to miss the chance of making somebody better off without making anybody worse off. But taxes cause inefficiency, and most of us think that taxes are needed to redistribute income from the rich to the poor. What we need is a way to make our economies both efficient and fair.
Kenneth Arrow, the youngest man ever to win a Nobel Prize for Economics, proved that efficient outcomes can be achieved using a competitive market, by adjusting the starting position. Some people call it the ‘head start theorem’. Let’s take a very simple example: a 100 metre sprint. If you wanted all the sprinters to cross the finish line together, you’d probably ask the fast runners to slow down or ask everyone to hold hands as they crossed the line. A waste of talent. Or you could move some starting blocks forward and some starting blocks back, so that although each sprinter was running as fast as he could, obeying the rules and objectives of sprinting, the fastest had to cover enough extra ground that he would end up breaking the tape neck and neck with the slowest.
Arrow demonstrated that the same approach can be applied to combat the excess of competitive markets: instead the interfering with the markets themselves, the trick is to adjust the starting blocks by making lump-sum payments and levying one-time taxes. Question is, can it be put to practice?
Impractical example: It might seem fair to charge incomes taxes from sports stars. But what if some people did not really enjoy playing the sport and if they are loaded down with heavy taxes, they might give up sports altogether. So although it might seem ‘fair’, there would neither be tax revenue nor the game. So how is it reasonable to call a distribution ‘fair’ when everybody concerned, both fans and player, would prefer the ‘unfair’ outcome?
But we shouldn’t give up on the theorem yet. While we can’t always use lump sum taxation and redistribution, we can sometimes: and when we can, it’s worth considering because it preserves the efficiency and the truth of the competitive market while adding a welcome dose of fairness.
Practical example: how do we prevent the elderly from getting cold in winter, without damaging the environment? Lower taxes? No that would drastically reduce tax revenue. Instead of levying the wrong rate of tax on everyone, better to choose a more sensible rate but give the elderly a head start—because of their poverty and because, being frail, they have an additional need for heating. The simple remedy would be to raise fuel tax but give extra money to the elderly, money they could use to switch their heating on and stay warm. Given the money, pensioners will find their way to the efficient outcome—which may not involve more fuel being burned.
The lesson implied here is that when a problem arises, it’s worth asking whether the problem can be addressed by rearranging the starting blocks rather than interfering with the race.
The ‘world of truth’ is a world where markets are complete, free and competitive. In reality, we’re about as likely to achieve a world with complete, free and competitive markets as hotshot lawyers are to start telling the truth to everyone. ‘Then why should we read about it?’, you might think. This might all sound like a bizarre fantasy, but the fact is that this fantasy helps us deal with real economic problems as and when they arise and helps us move in the right direction.
~Shagun Khetan
Operations Head, Ecofinlysis
©2022 by Ecofinlysis
All rights are reserved.
Комментарии