Tuesday, January 10, 2006

The rule of law, "overpriced," market clearing, and information in markets

Update: don't miss the followup, What hath the free market wrought?

My best friend at work and I often talk economics. He considers himself "a capitalist with morals," which is to say that, in wanting things like heavy regulations on business and a progressive tax structure, he's a closet Keynesian and doesn't know it. I love the guy like the big brother I never had, but I have to say, talking to him has given me quite a glimpse into the interventionist mindset.

First, calling for minimal regulation (mainly business, but society in general) is far from believing companies can do whatsoever they can and wish. There is still the rule of law to punish fraud and unlawful force. Minimal regulations and the rule of law are not mutually exclusive, and in fact, the more regulations there are, the more complex and convoluted they are likely to be, and the greater the probability that they violate the rule of law.

I was pleased that my friend brought up that there are (not just the possibility there can be) bad laws, though bad laws exist to a greater extent than he believes. Bad laws are not just ones we deem foolish, but often what a majority of people think are good: especially in the last several decades, Americans support, or at least tolerate, "progressive" laws that purport to help the poor, the sick and the oppressed, and to improve the overall well-being of society. Bastiat defined such laws in The Law as "legal plunder": the use of law to take from one person to give to another (which is against the rule of law). These bad laws come not only in the form of social welfare programs, but in protectionist tariffs and quotas and subsidies for which domestic businesses lobby heavily, and government regulations designed to impede specific companies.

Next, and this is more important, just because the free market doesn't always work the way we want (and what we "want" is not always what is most ideal) doesn't mean it isn't the best system. As my undergraduate microeconomics professor Dr. Ikeda said, paraphrasing Winston Churchill, "The free market is the worst economic system ever tried, except for all the rest." In the free market, some people will assuredly have more than others, because they (or their forefathers) have more valuable abilities and skills. But do we want a heavily regulated society where the forced equality is inevitably one of poverty, because there is no incentive for wealth creation?

Though he doesn't realize it, when my friend talks about "regulation," he really means "central planning." It may not be to the extent of one of Lenin's five-year plans, but it still involves bureaucrats determining what companies and people may or may not do, instead of allowing people the freedom to choose their most efficient preferences. Didn't we learn from the 20th century, which was replete with examples of how, at best, heavy control of an economy prevents it from prospering fully? Indeed, Vladimir Putin today is singing "Those Were the Days" as he leads the Russian economy toward stagnation with his statist policies. At worst, heavy control of an economy leaves it so unproductive that millions starve to death, like in the Ukraine, mainland China and North Korea, not to mention the brutality that central-planning governments tend to use.

At least in a free market system, people are free to work hard and achieve their potential by cooperating with each other voluntarily, not coercing each other. They are also free, like Bill and Melinda Gates, to give away a great deal of the wealth they create. I emphasized that word because it's a common fallacy that "the rich" become rich at everyone else's expense. That is one of the great economic myths espoused today. Almost every "rich" person in the free market accumulates wealth by expanding the economy, because such a system is naturally sustainable symbiosis. When "the rich" do amass wealth at everyone else's expense, which necessitates violating the rule of law, such parasitism never lasts.

As an example, consider the stagnation and eventual downfall of European and Japanese feudalism: property rights barely existed, and principally for just those lords whose land ownership gave them their authority (which is not the rule of law). The West's advancement in the Industrial Revolution and Japan's post-war prosperity would have been impossible were it not for clearly defined property rights. The notion is not just an idealistic one about the rule of law allowing people to own their own property: that they can own their own property is the incentive for them to use it to expand their wealth, which as Adam Smith said, may be for their own individual reasons but still benefits the whole of society.

After my friend and I talked about regulation, where I didn't get into as much detail as I did here, we resurrected an old topic: can something be overpriced? Dr. Ikeda is an Austrian economist's Austrian economist, and he was the greatest influence on me of my economics professors, thus my answer is no, as long as someone is willing to pay that price. What I tried to explain to my friend is that he might consider something overpriced, but that's only for him if someone else is willing to buy the item. Besides, if he felt the piece of apple pie he bought for lunch was overpriced, why did he buy it? As Walter Williams said, "Only an unreasonable person would pay unreasonable prices."

A couple of weeks ago on a Fifth Avenue streetcorner, I heard a woman yell at a street vendor, "You're crazy!" He calmy replied something like, "That's the price." Apparently she wasn't willing to pay the price he asked for whatever it was, but others are willing to pay that, otherwise he wouldn't be charging that. If his prices are indeed too high, then he'd have to come down. But it's Manhattan, where there's a lot of money, and street vendors know what they can charge. If you want to buy a drink from a vendor in Central Park, you can pay a dollar and a bit of change for just a 12-ounce can of soda, and a lot of people (my friend included) think it is worth it at times. We should remember that the NYC government keeps the price artificially high by requiring would-be vendors to buy licenses. There would be many more vendors otherwise, and the greater supply would foster competition and thus lower prices.

Something is not necessarily "overpriced" just because it is above what's called the market clearing price; it's overpriced only if there is no one willing to buy it at the asking price. That brings us to the next part of this entry's title. At what price will a market clear, i.e. at what price will the quantity supplied equal the quantity demanded? In a free market, with items of relatively great value, like cars, companies will invest time so that they can better determine what to charge. With other items, like the price of a Snapple or a hot dog in midtown Manhattan, it sometimes comes down to guessing what buyers are willing to pay, with a dose of experience. And there's nothing wrong with that. Car dealerships do a similar thing when negotiating with customers, as do grocery stores when they try a sale to clear out a certain stock. The alternative is central planning bureaucrats to decide what is a "fair" price, which leaves us in a 1984-like world where we can never produce enough nails, chocolate and razor blades.

Austrian economics doesn't just admit that information can be imperfect: it relies on that for its theory of the entrepreneur. Entrepreneurs in Austrian economics, especially in the work of Israel Kirzner, are far more than Schumpeter's driving forces in an economy. Entrepreneurs as "risk-bearers," and more fundamentally as arbitrageurs of information, are constantly moving markets toward equilibrium. But since information is imperfect, particularly because conditions (like abstract supply and demand curves) are constantly in flux, markets will never quite attain perfect equilibrium. Austrian economics, though, being a very realistic and practical school of thought, doesn't see that as a problem. This surprised my friend, who is used to "neoliberal" (a meaningless term) economics with many bad assumptions like perfect information.

One of my friend's points about imperfect information was that when he bought the piece of pie, he didn't consider it overpriced, but he did later when he discovered it wasn't that good. That still doesn't change the fact that his decision, though later determined to be in error, was made rationally. On the whole, people do tend to act rationally (another core tenet of Austrian thought). I've explained before, using $70 per barrel petroleum to illustrate, that decisions may not turn out to be perfect, but that doesn't mean they weren't rational. This is true even if the information is imperfect, and even if the economic actors involved are cognizant of its imperfection.

2 Comments:

Blogger Mike said...

Folks who breathlessly admire Bill Gates despite unethical (and, in the opinion of pretty much everybody in the industry who has studied it) illegal business practices are part of the problem, not the solution. Gates 'created' wealth for himself by destroying the livelihood and competitiveness of many submarkets in the computer industry - which could have, by now, provided better and more secure products if commercial competition remained.

Wednesday, January 11, 2006 10:24:00 AM  
Blogger Perry Eidelbus said...

Bill Gates didn't destroy anyone. His competitors that fell behind did so because they simply couldn't compete. For the most part, they were either dinosaurs or poor marketers. It's important to remember that competition is not strictly about the product, but about presentation too. OS/2 was superior to Windows at the time, but because IBM screwed up their marketing, people's search costs to discover and use OS/2 were too high.

Microsoft bought out other companies, including one that a friend was working for. Yet at no time were any of these takeovers involuntary: Microsoft made an offer without putting a gun to anyone's head, and the offer was accepted. For better or for worse, but that's how business is done.

You say his practices are illegal. In what way? Are you talking about the anti-trust accusations, which are complete rubbish? Microsoft never had to use true force to do business with a company. If the cost of Windows was so high, if PC manufacturers didn't like the terms, then why did they do business with Bill & Co.?

I admire the man for being a shrewd businessman who, for better or for worse, brought most of the computer industry into a common standard. I myself have a lot of criticisms for Microsoft, mainly with the security flaws, but let's be real here. It's one thing to let the free market work, and convince people to use alternatives. It's another for people, those who cannot compete, to abuse the coercive power of government to break up or shut down a business.

Wednesday, January 11, 2006 12:38:00 PM  

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