467. A different view of markets

In view of all the problems of markets as envisaged by economics, discussed in preceding items in his blog, in summary I propose a view of markets that is different, indeed more or less the opposite to the model of perfect competition. My eight basic assumptions, replacing those of that model, presented in item 458, are the following:

1. Actors are limitedly rational. Though rational reflection does have an effect on choice, the latter is largely dictated by unconscious impulse, as recognised in behavioural economics.
2. Knowledge is biased by forms of thought that have developed during life, on the basis of genetic endowments, and vary between people to the extent that they have developed in different environments (cognitive distance).
3. People have no fixed, prior identity. Ideas are pragmatic and preliminary, and develop on the basis of success and opportunities in practice. As a result, preferences are limitedly stable and shift in the process of choice and action.
4. Especially in innovation there is radical uncertainty that precludes prior intelligent design. The development of novelty has the basic characteristics of evolution, with selection from trial and error and transmission of success.
5. People are not autonomous in their knowledge and preferences, which arise from social interaction. Markets are not only about competition but also about collaboration, to utilize complementarities in competence.
6. In markets there are transaction costs of contact, contract and control.
7. Products are differentiated to a greater or lesser extent. As a result, competition is seldom pure price competition and profits routinely exceed costs.
8. By nature, people are self-interested, but they are also oriented towards social legitimation, by which they also have a natural though limited capability to trust. Next to private motives people are entangled in group interests. Collective and individual interest are obstructed by both individual and collective egotism and deadlock (such as prisoner’s dilemmas).
9. Ethics is more than only a consequentialist ethics of utility, to include virtues of justice, moderation, and solidarity. These values are not all commensurable, cannot always be brought together in calculative trade-off, in an objective function.

Clearly, all this leaves much more complexity than the economists’ view of efficient markets. This is a deliberate methodological choice for finesse rather than geometry in human affairs. Given new technologies of computing and software there are novel ways of analysing complexity (e.g. in agent-based simulation). Evolution provides a theoretical framework for modelling such complexity, with markets interpreted as selection mechanisms, together with institutions, as well as sources of variety and discovery, and transmission devices.

The assumptions entail central importance of institutions, descriptively to understand individual and collective behaviour, and prescriptively to enable markets, to constrain perverse effects, to try and prevent their failure, to enable collaboration next to competition, and to ensure minimal standards of justice. But institutions need to be supported and complemented by ethics, which has the advantage of being voluntary and open to personal variety, interpretation, and circumstance.

 As a result of all this, markets can never ‘be left to themselves’, in ‘laisser faire’. It is misleading to speak of ‘market failures’, which suggests that as a rule they do not fail, while as a rule without proper institutions, interventions and ethics they cannot function. Markets always suffer failures to be redressed.