A Simple Rule for a Complex World

by Don Boudreaux on March 17, 2006

in Complexity & Emergence, Seen and Unseen, The Economy

“‘Let the market handle it! Let the market handle it!’ Don’t you tire of muttering this simplistic formula?” So ended an e-mail that I received from a reader.

It’s true that all of us sometimes are tempted to avoid thinking hard about complex issues and, instead, to fall back lazily upon simplistic mantras. We should guard against this weakness, in ourselves and in others.

At the same time, though, we shouldn’t confuse consistency with simplicity. The two are different. Just because I instruct my eight-year-old son to be always truthful does not mean that I’m a simpleton offering simplistic advice; it means, instead, that truthfulness is a virtue that should be pursued consistently — even if in a handful of instances my son might be made better off by telling a lie.

I admit that my proposed solution for many public-policy problems is to say “Let the market handle it.” But this response is neither naive nor lazy. It’s realistic. It reflects my understanding that almost any problem you name — rebuilding the Katrina-ravaged Gulf Coast, providing excellent education for children, reducing traffic congestion on highways — is most likely to be dealt with efficiently, fairly and effectively by the market rather than by government.

Saying “Let the market handle it” is to reject a one-size-fits-all, centralized rule of experts. It is to endorse an unfathomably complex arrangement for dealing with the issue at hand. Recommending the market over government intervention is to recognize that neither he who recommends the market nor anyone else possesses sufficient information and knowledge to determine, or even to foresee, what particular methods are best for dealing with the problem.

To recommend the market, in fact, is to recommend letting millions of creative people, each with different perspectives and different bits of knowledge and insights, each voluntarily contribute his own ideas and efforts toward dealing with the problem. It is to recommend not a single solution but, instead, a decentralized process that calls forth many competing experiments and, then, discovers the solutions that work best under the circumstances.

To recommend the market is to understand, or at least to cooperate with, the wisdom of James Buchanan’s important insight that “order is defined in the process of its emergence.”  It is to understand, at some level, Vernon Smith’s awareness that “ecological rationality” is greater than individual or “constructivist” rationality.

This process is flexible and it encourages creativity. It also denies to anyone the power to unilaterally impose his own vision on others.

In brief, to advise “Let the market handle it” is a shorthand way of saying, “I have no simplistic plan for dealing with this problem; indeed, I reject all simplistic plans. Only a competitive, decentralized institution interlaced with dependable feedback loops — the market — can be relied upon to discover and implement a sufficiently detailed way to handle the problem in question.”

None of this is to say that getting the government out of the way is sufficient to create peace and prosperity. Markets require a rule of law to ensure that, among other blessings, property rights are secure and exchangeable. At their best, governments can help to protect our rights. Markets also require a culture in which commerce flourishes.

Unfortunately, no recipe exists to create the legal institutions and commercial culture required by capitalism. If these prerequisites are absent, there can be no market to handle any problem. So saying “Let the market handle it” is not the same as saying “All will be just dandy if only the government gets out of the way.”

But when these prerequisite institutions are mostly in place, as they are in the United States and other developed countries, markets are amazingly creative and reliable. Calling on markets to deal with problems is then the wisest course.

Alas, though, foolishness frequently triumphs over wisdom. People too often suppose that large social problems can be solved only by deciding ahead of time which particular group of people and procedures hold the key to the solution.

While declaring “Let the government handle it” comes across as a solution, it’s no such thing. Instead, it is merely a sign of a simple and baseless faith — a simple and baseless faith that people invested with power will not abuse that power; that political appointees possess or will find better answers than will millions of people pursuing solutions in their own ways, and staking their own resources and reputations on their efforts; that only those ‘solutions’ that are spelled out in statutes and regulations and that have officials paid to implement them are true solutions.

So yes, show me a problem and I’ll likely respond “Let the market handle it.” I’ll respond this way because I know that not only is my own meager knowledge and effort never up to the task of solving big problems but that not even the Einsteins or Krugmans or Bushes amongst us can know the best solution to any social problem.

Solutions to complex social problems require as many creative minds as possible — and this is precisely what the market delivers.

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{ 29 comments }

Norman March 17, 2006 at 4:47 pm

"Let the market handle it?" "But it requires rule of law?"

Why? Why not let the market handle contract enforcement and property rights enforcement and capital market regulations and national defense and so on and so on and so on?

"Well that's just crazy talk; markets require some government."

O.K., then how much government? Why is your conception of the proper amount and role of government any more valid than your email writer's conception of the proper amount and role of government? Do advocates of laissez-faire market capitalism have some monopoly on absolute truth? If so, then out the window goes the Austrian notion of knowledge problem.

Don Boudreaux March 17, 2006 at 4:51 pm

Nothing in what I said suggests that markets cannot handle the creation and enforcement of a rule of law. In fact, I believe that markets are the best source of a rule of law.

ben March 17, 2006 at 5:04 pm

> Why is your conception of the proper amount and role of government any more valid than your email writer's conception of the proper amount and role of government?

Because the assumptions as listed by Don of those promoting govt as a superior allocator of resources are testable and false.

ben March 17, 2006 at 5:14 pm

Norman,

In my experience it is always those who misunderstand what they are arguing against that resort to the claim that their opponents argue from authority or some self-proclaimed but unjustified "truth". Creationists use this tactic ad nauseam.

Don's position has a claim to truth only because his central tenets are testable. Given this, your only credible comeback is that when tested, the results conflict wih Don's position. Simply claiming Don is unjustifiably laying claim to truth is pathetic and lazy.

The Individualist March 17, 2006 at 6:47 pm

The answer, at least from a Hayekian perspective, is that government activity in certain areas IS a market solution. In other words, market forces have granted government a limited role.

Government exceeds its bounds when it attempts to impose ORDERS (a set of fixed ends) rather than simply respond to market needs by enforcing RULES (to resolve conflicting aims) or providing services that the market cannot efficiently or cheaply provide (e.g., the military). Whether all existing rules or organizations are necessary for the preservation and enhancement of competition, choice, life, and liberty–or will continue to be necessary–is a matter that the market sorts through over time.

wex zqed March 17, 2006 at 7:28 pm

for the sake of argument let's grant that what you say about the greater effectiveness of the market over most other ways of getting things done is true (indeed, I believe it is). What do you say to the person who says, 'but that is irrelevant, since inequality of outcome is immoral and the market requires inequality of outcome in order to function. It would be better to be poorer and equal than wealthy with the inevitable inequality, and if the only way to achieve that is to have the government run everything, then that is what must be despite it's inefficiency, just because anything else is immoral.'?

Norman will find answers to his questions in the early chapters of Nozick Anarchy, state and utopia.

Steve March 17, 2006 at 8:39 pm

pcs,

You ask, "Why is it that military or law enforcement needs of a society cannot be solved by market forces and health and educational needs can?"

Free market economists have an answer to that question. Law enforcement and the military are public goods, meaning that they are non-rivalrous and non-excludable. Markets cannot efficiently provide public goods because of the problem of "free-riders". Click here for an explanation of the problem. There is a reason for those exceptions.

Steve

Steve March 17, 2006 at 8:43 pm

That link on free-riders didn't post. Here is the URL: http://plato.stanford.edu/archives/sum2003/entries/free-rider/

Steve

Steve March 17, 2006 at 8:46 pm
johngaltline March 17, 2006 at 9:09 pm

The Market: Letting people participate voluntarily, in a system where aggregate values reward the most effective solutions to a problem.

Government: Delegating the problem to power-hungry people with guns.

I just thought it needed to be explained in a way that shows who's really taking the easy way out…

ben March 18, 2006 at 3:14 am

Wex

>What do you say to the person who says, 'but that is irrelevant, since inequality of outcome is immoral and the market requires inequality of outcome in order to function. It would be better to be poorer and equal than wealthy with the inevitable inequality

Here is what I would say:

1. Government intervention, and the necessary concentration of power that goes with that intervention, is no guarantee of reduced inequality. As Don has said, inequality is not like a thermostat – it is emergent, and there is a law of unintended consequences. Governments are less capable of achieving their goals than they make out, especially something as nebulous as reducing inequality.

2. Inequality as a prime or sole objective is, at best, a poor one, because there are trade-offs between inequality and prosperity, and therefore, indirectly, health care and education and personal consumption.

3. Reducing inequality, expressed as the elimination of class distinction, killed 85 million people last century. Regimes targeting inequality, and the concentration of political and economic power that goes with addresing that objective, are deadly.

Gavin Kennedy March 18, 2006 at 5:24 am

Don
I agree with your statements about 'the' market, except for a small, but I think important, 'quibble'.

The consistent advice should be: 'let markets handle it'.

Slipping into talking of 'The market' undermines the power of markets – there is not one single, monolithic market, but there are numerous markets, as many as there are transactions almost, because markets are not fixed in time and place.

Two transactors conclude a deal for X, and moments later, other markets for X assemble, separated in time and place.

Conceiving of markets as a singular entity, 'The Market', drains markets of their dynamism.

cb March 18, 2006 at 8:23 am

Don,

I enjoy your blog, and I am in favor of free markets however, the question that keeps crossing my mind is whether a free market can be defeated by a machiavellian nation-state?

Consider a country that wants global market domination in some area.
Is it possible for a government to set up domestic policies that allow it's national corporations to crush global competitors?
By significantly reducing costs by:
1) subsidizing corporate expenses: health care, education, energy costs, transportion costs, labor costs, housing costs, etc. etc.
2) maintaining favorable currency exchange rates for export
3) reducing regulatory rules, polution controls, safety standards, labor laws, zoning, etc.

What prevents this and do you think this is a plausible scenerio?
Where should a government intervene to save critical industries?

Laurent GUERBY March 18, 2006 at 9:38 am

What about the "market for ideas" that is the notion of "intellectual property"? Is that a market in your sense, or just the usual inefficient bloated-government-lawyers-big-firms awful intervention in the really "free" markets?

Kevin Feasel March 18, 2006 at 11:57 am

Here's my take on that, cb: in the short run, it is possible; in the long run, I do not believe it is.

If we freeze all technology changes (or assume that everybody gets these changes at the same time), there is a current group of competitors, including a new one run by this country in question. This last company has some combination of government subsidies and weaker regulations, as well as a regional monopoly (because otherwise, other firms could potentially come in and take advantage of the same subsidies and regulations). At this point, the firm could produce at a cost lower than some number of other firms. This could drive out marginal firms, potentially all other firms, in the short run. However, there are three consequences to this, once we start talking longer-run and more realistic situations:
1) Citizens of that country have large penalties to pay. Their tax dollars are subsidizing this firm's success, and in some of those regulation changes, externalities are introduced which harm certain groups. The upshot of this is that the success of some firms must come at a cost to other people (and companies), so a government could not use interventionist techniques to help all–or a substantial majority–of firms simultaneously.
2) These firms, by now receiving large subsidies, are insulated from market competition. The firms are not working off of market profit and loss. This reduces the firm's dynamic capabilities, as a corporate jet beats research and development when somebody else is footing the bill.
3) Although current firms have been eliminated, this does not remove the capacity for entrepreneurial alertness. As long as the firm is charging less than any other firm, this basically acts as a subsidy between nations (with the Machiavellian nation on the giving side) because people are paying a lower cost than they would otherwise pay at that moment in time. However, once the firm tries to raise prices again, there are entreprenuerial profits to be grabbed. In addition, even if the prices remain lower, this does not protect the firm from technological, organizational, or capital structure changes. New firms that come in with different technological or organizational methods, or which take advantage of changes in the capital structure by applying longer production chains, will gain an advantage here and cause the government-subsidized firm to either need even more government funding or just capitulate.

There is one more aspect to this: most businesses fail. A lot of them fail quickly, some fail more slowly, but only a relatively small number last for a long time. When a government chooses one business (in this case, because its owners are of the same nationality), the government is now betting against the field, basically saying that this one firm is going to be an exception. But the government can do little to ensure the success of one particular firm. It can prevent failure (through bailouts) and jigger the rules to give short-term advantages, but a government cannot guarantee success, and I would say that the empirical side shows almost the opposite to be true.

Because this is so long, I don't have a chance to get into the unforeseen consequences of such government subsidies on other industries and the misallocation of resources which follows. But hopefully the above is a clear and reasonable enough explanation of my argument, as it goes.

cb March 18, 2006 at 2:01 pm

Kevin,

Nice post, here is how the Machiavellian nation might address your points.

1) You are correct the citizens will pay the costs for corporate subsidies, historically the nation must satisfy the majority and suppress the minority. If the population is starting off from a very low wage base and poverty is wide spread then simply providing small improvements a more promising future might satisfy the masses.

2) I agree that monopolies often lose their competitive edge.
To maintain this edge "free market" competition could take place between companies within the nation, allowing individual companies to fail, thereby maintaining the dynamism of free enterprise.

3) I also agree that "alert entrepreneurs" can jump back into the market once price pressure rise. The nation would select markets that have very high barriers to entry and that require a substantial technical knowledge base. The key to dominating an industry would be to erode both the infrastructure and the technical knowledge base in other nations making reentry difficult and unwise for the entrepreneur whose substantial investments could easily be crushed by a sudden drop in pricing.

The development of new technology seems to be the best counter argument, since technical changes can alter the entire business landscape. So the machiavellian nation state would want to invest heavily in technical education and R & D to subsidize new development and maintain technical dominance.

Russell Nelson March 19, 2006 at 1:19 am

Laurent– "Intellectual Property" covers too many different fields to be a useful term. For example, a trademark never expires, need only be unique, not creative, and the same text can be separate trademarks in different fields, e.g. Apple Records and Apple Computers. Apple != Apple.

Also note that there are different types of trademarks: the trademark ™ and the trademark (R). The first is a common-law trademark, and the second is registered. So clearly you could have private parties providing conflicting trademarks which are distinguishable because one uses (R) and the other uses (G) (for example).

Copyrights, trade secrets, and patents all have completely different characteristics from trademarks; I'm too sleepy to go into the details. But private law could deal with them just as it could deal with obvious things like preventing murder, and subtle things like allowing/preventing abortion.

Maurice Sonnenwirth March 19, 2006 at 3:51 am

Tonight as we were driving on the highway home from a weekend visiting relatives, we saw a truck of one of our local supermarket chains at a truck stop. This prompted my 14 year old daughter to ask how all the products came to the supermarket we do most of our shopping in.

I thought about it…I know some of the details, but I started thinking about markets and Hayekian notions…this, prior to reading Don's entry when I got home…and it's a true miracle that the hundreds or thousands of different products, including fruits and vegetables from foreign countries, can end up in our supermarket one mile from our us.

Contrast that with the quies in the Soviet Union, when it tried to run the markets…cheap bread, as I understand, but not much of anything else, and what was there was poor quality, and nothing like the variety we now take for granted.

We can discuss all kinds of things about markets vs. government, but out of the mouth of babes…there was no clearer picture to me of how markets..literally in this case, a food market…'miraculously' draws thousands upon thousands of disparate workers and companies to put food and other goods on the shelves at the store and in my house.

Kevin Feasel March 19, 2006 at 4:59 am

Here is my rebuttal to the Machiavellian's response:

For #1, there are still major wealth transfers. However, there is another aspect I admit I had not thought of until now: this analysis is going by the notion that prices are driven by costs, when it is the opposite (prices are determined by individual transactors and costs are imputed from prices). The upshot to this is that there is a major principal-agent dilemma involved. The principals (government officials) want to, effectively, control the production of a good, and they use an agent (the firm) to do this. The idea is that the principals would give money to the agents, the agents would subsequently cut prices, and then this flow would hold prices down below the point that any other firm could compete.

However, the agent does not need to do that. Instead, an agent would, according to public choice theory (or at least my reading of it), charge the same price that captures the marginal consumer from before and then pocket the subsidies. The principals don't know the costs (they can make estimates, but those would be estimates based on the status quo or believed deviations), so the only way to combat this would be price fixing schemes. Then, it becomes a game where the firm owners maximize their budgets and try to convince the government officials to let them raise prices because they're "running losses" (those modified 777s with cushy leather seats aren't cheap, you know) and you end up with a highly inefficient industry that lives off of wealth transfers.

The upshot is that, in order to dominate foreign markets by using subsidies, this would entail massive handouts to foreign citizens and to workers in the particular firm(s) in question. If prices were legislatively forced down to the point where it would push out of business all other firms, this means that I, as a foreign citizen, could buy the product for a smaller amount than I would otherwise pay. So a taxpayer in the Machiavellian country is effectively giving me something for nothing (in return, he gets nothing for something). The taxpayer, on top of just giving me something for nothing, also has to foot any transportation costs or other costs between markets for this good. Then, this taxpayer must further pay to cover the costs of the firm. That firm is no longer working on a profit and loss scale, but instead is working as a bureaucracy of sorts, and so has an incentive to maximize its budget.

So I think this gets us right back to before: in the short run, it is possible to do this. However, in the long run, it is not sustainable. There is only so much that you can get from citizens–especially if, as you said, this is a poor country–and the heavy taxes and subsidies required for this will also distort the long-run capital structure within the country, affecting its future growth.

Because you brought up the point of having a number of firms compete, in this principal-agent situation, having multiple agents does not mean competition. Rather, you end up with multiple bureaucracies which feed off of one another. After all, if BigCo says they need a 5% subsidy increase and OtherCo says they need a 7% increase, ThirdCo can claim an increase in the 5-7% range and everybody wins (well, except taxpayers).

I know that this has been tried many a time (though without the additional part you brought up: that all other firms are in a postion where there are no subsidies or taxes affecting them), but I cannot think of anything right off-hand that is an almost-perfect example. Google might provide some form of example, though I've not quite the time to think it through. It is warm and sunny here and thus I must take a walk…

Kevin Feasel March 19, 2006 at 5:06 am

One last thing: in the above post, I'm assuming that there would be no shortages. Instead, the firm would produce just as much as there is demand at the price, or that, as posited, there were a number of firms (all of which are run by citizens of that same country) which would do this. I doubt the realism of this claim, but if it were the case, those taxpayers would have to pay additional amounts for two reasons. First, there is potential diseconomies of scale. Second, though, is the bigger reason: because demand would increase. If demand is X at price P, pushing price down to P2 would increase demand to X2, as there are now additional people who would buy this good (or people who would purchase additional units of it; same difference). So not only are taxpayers subsidizing all the old consumers, but they're paying for new consumers as well. As it stands, I wouldn't want to be one of those taxpayers…

Laurent GUERBY March 19, 2006 at 11:55 am

Russell, nice way to avoid the question!

All you say is true, but most or all of intellectual property law all rely on government-enforced monopolies on immaterial things (non rivals in economics term).

Exceptions: trade secret is more about contract between employer and employee than any other thing. And trademarks are in theory about government protecting consumers information (in practice protecting big corporations – that's another story), but could also be done away with basic contract law.

This is my test question to distinguish real liberals & free market guyes (who usually answer quickly and without detour, citing the opinion of Hayek himself on the subject) from the pro-big-corporation-seeking-liberal-image crowd.

Looks like Cafe Hayek crowd is less liberal than I thought…

liberty March 19, 2006 at 7:49 pm

Laurent,
nice way to try to smear people who don't pipe up with the "right" opinion right away.

I think you misunderstand patent and copy law. It isn't about government subsidized monopoly, its about property rights.

If I create something – be it a solar powered car or a piece of software or a new medicine, I want to protect it, either in a safe or with a patent (or both). If I want to manufacture more of them, I require the latter. Whether it is provided by a private patent company or a government one, it is the "safe" I need for my prototype so that it cannot be stolen and used to create imitations. In the old west, I might have simply kept my prototype in a safe and made as many copies as I could before someone found out and then I would have taken it out of the safe after I sold the copies – since by then people could copy the copies.

Many companies still use this tactic – keep trade secrets to hide the idea until it gets sold. But we also use patents and copy law. The patent (again, it could be provided by a private company) is required in order to use property law – you need to prove that it was your idea first.

None of this is in conflict with the free market and is at least as good for the entrepreneur as for the big corporation.

As to the second question, whether the patent should be run by government or by a private company – I don't think it matters much. What cannot be run by government is anything that aims to help the poor – because it automatically dismisses the free market of supply and demand, incentives and efficiency because it is aiming to help the inefficient and hide them from competition and basic market forces. Small agencies related to property law are totally constitutional and not at all in conflict with the free market.

Randy March 20, 2006 at 11:22 am

Individualist,

Re; "…government activity in certain areas IS a market solution. In other words, market forces have granted government a limited role."

Exactly. I wanted to put it down again because I think that it is a very important point. Government, when done well, is part of the free market.

IR March 20, 2006 at 3:10 pm

In response to CB about "machiavellian nation-state".

You do not need to imagine hypothetical situation. Soviet Union fitted the three criteria you described perfectly. And we all know how that story turned out.

Laurent GUERBY March 20, 2006 at 5:16 pm

liberty: thanks for your post. Here are Hayek views for the amusement of readers, again he probably doesn't undestand "copy law".

"Just to illustrate how great out ignorance of the optimum forms of
delimitation of various rights remains – despite our confidence in the
indispensability of the general institution of several property – a few
remarks about one particuilar form of property may be made. [...]

"The difference between these and other kinds of property rights is
this: while ownership of material goods guides the user of scarce means
to their most important uses, in the case of immaterial goods such as
literary productions and technological inventions the ability to produce
them is also limited, yet once they have come into existence, they can
be indefinitely multiplied and can be made scarce only by law in order
to create an inducement to produce such ideas. Yet it is not obvious
that such forced scarcity is the most effective way to stimulate the
human creative process. I doubt whether there exists a single great work
of literature which we would not possess had the author been unable to
obtain an exclusive copyright for it; it seems to me that the case for
copyright must rest almost entirely on the circumstance that such
exceedingly useful works as encyclopaedias, dictionaries, textbooks and
other works of reference could not be produced if, once they existed,
they could freely be reproduced.

"Similarly, recurrent re-examinations of the problem have not
demonstrated that the obtainability of patents of invention actually
enhances the flow of new technical knowledge rather than leading to
wasteful concentration of research on problems whose solution in the
near future can be foreseen and where, in consequence of the law, anyone
who hits upon a solution a moment before the next gains the right to its
exclusive use for a prolonged period."

The Fatal Conceit: The Errors of Socialism, 1988 (p. 35)

Note: for encyclopedias, we now have wikipedia as an element of proof.

liberty March 20, 2006 at 6:50 pm

Yes, I have come across that before. I disagree. The argument does not prove that it is anti-free-market, just that he opines that they are unnecessary. I do not treat him as a God, we all make mistakes, Hayek can be wrong about something.

cb March 20, 2006 at 10:30 pm

Randy

I disagree that the Soviet union was a Machiavellian state. It was very inefficient since the government dictated the actions of the producers. The Macheivellian state must be efficient. To do this it needs to develop a free market internally. The US oil companies used to epitomize this in the early twentieth century, all within single country and fiercely competitive with one another and any outsider trying to get in.

This internal competition would eliminate what Maurice mentioned "highly inefficient industry that lives off of wealth transfers"

I agree with Maurice that "this would entail massive handouts to foreign citizens". The nations citizens would sacrifice initially to reap the reward of dominance in a particular industry later on.

I disagree with Maurice that the benefits would specfically go "to workers in the particular firm(s) in question"

I think this is due to the way I think of corporate subsidies. The job of government is to provide safety and laws for its citizens. This has a cost, therefore taxes on the citizens to pay for this subsidize the corporations at tax payer expense. You can further subsidize corporations by providing solid transportation, utilities, networking, education, healthcare, retirement benefits, etc. You can make their export cheaper by fixing exchange rates, and restricting investments by private citizens.

These forms of corporate subsidies are more or less evenly divided among all the companies in the nation giving no company any particular advantage.

All these measures raise the costs in taxes and prices for the nations consumers while removing various head aches for the nations corporation.

Not much fun to be the citizen in this country. But remember the Machiavellian nation works only for the prince and world domination.

Bruce Hall May 11, 2006 at 2:40 pm

I'd be interested in your view of recent Federal Reserve actions in both lowering interest rates during a perceived economic crisis and then raising them in a perceived inflationary trend.

Should the Fed try to smooth out the bumps or let the market take care of it?

molly July 25, 2008 at 8:19 pm

why can't I see the handbag pics??

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