Understanding the market Europe and Liberty Bakuriani, July 2008

The market (or markets?)

What is economics? « Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses » Lionel Robbins, 1932

The classical approach of the market Q pdemand supply Alfred Marshall ( )

Economic analysis of minimum wage regulation Quantity of labor Wage wHwH wLwL w* unemployment

Economics = Social engineering ? 1920s = Socialist calculation debate What do we need the market (and private property) for? Centralized decision making is more efficient (Barone, Neurath, A. Lerner, O. Lange, …) Economics system should be compared according to their use of knowledge (Hayek). Without property rights (and prices) economic calculation is impossible or extremely poor (Mises)

The knowledge problem  Knowledge is dispersed  Knowledge is partly “tacit”  Knowledge is changing N.B. The quality of our solution to the scarcity problem depends entirely on the quality of the solution to the knowledge problem Scarcity problem Knowledge problem

The challenge Finding the “system” that best deals with the knowledge problem. We are not so much interested in allocating scarce resources with alternative uses than to increase our knowledge (in particular, knowledge about resources) and make sure that this knowledge will be used. e.g.: leaving individuals decide for themselves boosts the use of tacit knowledge

The market  A meeting point for traders  A way to save time and money  A place for learning  A place for discovery  A place of wonder!  A place where some rules prevail (pieds poudrés)  Transactions to be taxed…  A spontaneous order!

Greeks’ understanding  Physei = natural order  Seasons, life cycles, biological evolution, etc.  Nomos = (unnatural) order resulting from human action  Language, money, markets, Law  Thesei = (unnatural) order resulting from human design  Firms, associations, governments, contract

From the Greeks to Smith… Tradition of the nomosDenying of the nomos (Aquinas, B. de Sienne) Late scolastic (Molina) Püfendorf, Grotius Mandeville, Hume, Ferguson Smith Hobbes (social contract) Bentham (utilitarianism), Rousseau (new social contract) Descartes, Voltaire

French v. Scottish Enlightment  Descartes: One must only hold as true that which one can deduce logically from clear and distinct premises  Voltaire: “If you wish to have good laws, burn those you have and make new ones”  Ferguson: Nations stumble upon establishments, which are indeed the result of human action, but not of the execution of any human design (quoted in LLL, I, 150) = spontaneous order  Montesquieu: “Intelligent beings may have laws of their own making; but they also have some which they never made” De l’Esprit des Lois, I, p.i

From Smith to present days… Tradition of the nomosDenying of the nomos Say, Bastiat, M.Villey Von Humboldt, von Savigny, Spencer H. Maine, C. Menger Most 20th century economists Welfare and New welfare economics, Kelsen Stuart and James Stuart Mill Auguste Comte Hayek, Popper, M. Polanyi, B. Leoni Most 21st century Law and economics

Organization v. order (taxis v. kosmos) purposefulnature degree of complexity type of rules spontaneous order noabstracthigh general (negative) organization yesconcretelow commend

Market as a process A spontaneous process of interactions framed by property rules and whose outcome at each point in time is somehow orderly and desirable. “Paris gets fed” says Bastiat equilibrium prices?! Carl Menger

The “invisible hand” of Adam Smith “by directing (his) industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention ” Essay on the Nature and Causes of the Wealth of Nations (1776)

The fingers of the invisible hand “Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” (A. Smith)

The price system and the entrepreneur  The entrepeneur perceives a profit opportunity  Some directly benefit from its action, others loses  Some actors receive better knowledge (of what is possible and what preferences are)  There is convergence towards a unique price  Nature of profit sell 140 buy 110 Profit = 30-costs

A closer look at the market process  It gives strong incentives to the use of tacit knowledge  It does not waste “scientific” knowledge thanks to the price system  It generates new knowledge  It is unpredictable  It leads to extremely complex social phenomena

Market and progress The dynamics (progress) of societies (and economies) is due to “true” learning, that is, entrepreneurial discovery “Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge.” Carl Menger, Principles of economics, 1871, page 73

Worries about market competition  It is a waste of energy (may be the oldest argument)  Economic power can threaten democracy (Sherman)  People will not undertake what is not profitable (public goods)  Producers will collude and block competition (cartels) or use “unfair” strategies to win the competition  Some market participants will do poorly and therefore the market is unjust