On Philosophy

September 17, 2007

The Assumptions Behind Free Markets

Filed under: Society — Peter @ 12:00 am

Free markets produce the most efficient allocation of resources, or at least that’s the claim. Of course the question then is: efficient by what standard? At least in their pure form free markets are most efficient at satisfying the wants of people in proportion to their ability to help satisfy the wants of other people. Whether this is good or bad depends on several assumptions, which I will discuss below. However, as I see it, this set-up has the potential to create what I see as a treadmills of pointless consumption: someone works to produce junk to satisfy the desires of people to own junk in order to go out and buy junk themselves. And that seems like a massive waste of effort, wouldn’t the world be a better place without that cycle and the associated desires for junk that fuel it?

But let us put that aside for the moment and return to the assumptions that must hold true if the efficiency that is created by free markets is to be a good thing. Free markets are only desirable is the satisfaction of wants is a good thing, if the strength of the want corresponds to the value of satisfying it, if consumers know what will satisfy their wants, and if consumers are wise spenders. We will consider each in turn.

The satisfaction of wants is good
Of the four assumptions this is probably the best. Certainly we can argue about whether all wants are good or how to evaluate wants in comparison to each other, but it is fairly clear that it simply isn’t worth doing something if it doesn’t satisfy someone’s wants or contribute towards satisfying them. To do otherwise, to act in ways that no one endorses, is simply ridiculous.

The perceived importance of the want corresponds to value of satisfying it
But while few will argue against the idea that at least some wants should be satisfied, and are in some way the basis of all action, it isn’t as clear that every want is worth satisfying, or if the perceived strength of the want has any bearing on whether it should be satisfied. To endorse this assumption is effectively to say that people are always right when it comes to their wants, and I can’t agree with that. The problem with the assumption is that people are not perfect reasoning machines. Their wants may fluctuate unpredictably and they may have inconsistent desires. Consider someone who suddenly wants something very strongly, but only for a brief moment. Does it make sense to satisfy that want at its period of higher strength, even if the person may later regret satisfying it? Similarly we must consider the possibility that some wants are more central or fundamental than others to who the person is, and that even if they aren’t always perceived as most important they might still be the best wants to satisfy. Since I have discussed these topics, and more, in my writings about the good life I won’t spend any more time on them here, except to point out that these considerations give us good reason to think that satisfying wants based on their perceived importance is a bad strategy, or at least a sub-optimal strategy.

Consumers know what will satisfy their wants
In some ways this assumption is problematic for the same reasons that the previous one is: people are often poor reasoners when it comes to their wants. And in this case the problem is usually aggravated by advertising, which is promoted by the free market system. Or, in other words, not only is the assumption bad, but the free market makes reality diverge even farther from the assumption. Consider someone who wants to be popular with the ladies. If they don’t think about the matter very hard (or don’t have the faculties to mentally ignore advertising) they might believe that they can satisfy this want by buying the right goods, fashionable clothing, and so on. But this probably won’t help them satisfy their want. And similar situations can arise with many modern products, which are simply too complicated for most consumers to make an informed choice about (most electronic devices spring to mind).

Consumers know how to best allocate their money to satisfy their wants
Yet again, an assumption that rests on a mistaken faith in the rationality of consumers. In an ideal world consumers would spend their money on the basis of the want satisfying power per dollar of their purchases. However, at least in my observations, people tend to buy things on the basis of how much they want them alone. Price does seem to factor in to some extent, but only when something is simply too expensive to buy or when by foregoing that purchase they can a huge number of other wants in return. Of course not everyone spends their money in this way, but what we are dealing with is generally different varieties of irrational spending habits. For example, I am an over-saver, if there were only people like me nothing would ever be produced in the first place, because I am unwilling to buy anything new that could possibly be gotten used for cheaper (and if there aren’t any used items yet, well then I’m willing to wait).

Thus, as I see it, three of the four assumptions behind free markets fail to hold to some extent. Which doesn’t mean that free markets are bad, just that they aren’t maximally efficient, to a degree that depends on how far reality diverges from the assumptions. And this means that we could improve the efficiency of free markets by changing the rest of the world so that the assumptions do hold. One way to do that would be via education, making individuals better able to judge which wants they should satisfy and to rationally evaluate ways to satisfy those wants. But of course that is not a feasible or sustainable solution, education is hard, people are stupid, and every corporation has an interest in making people bad consumers while there are no entities with an opposite interest. A better possibility is collective consumption. Collective consumption would be a situation in which individuals give up their ability to buy things on their own and instead join groups who are aimed at satisfying certain wants. The groups then decide collectively what to buy (individuals pay dues and get goods in return, but exactly which goods are determined collectively). Of course there are a number of details involved in making such a system workable, but there is no need to get into all the specifics here. It suffices to point out that collective consumption is likely to be efficient for the same reason that the supply side of the equation works so well in free markets; corporations, being collective entities, are excellent rational deliberators and evaluators of what they need. Thus when corporations deal with each other free markets work much more effectively. Given the three possibilities I see for improvement: abandoning free markets for something else, wiser consumers, or collective consumption, I think collective consumption is the most likely to move the free market closer to maximum efficiency.

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