The Reality of Markets
By Russell Roberts
“There is a third category of experience—phenomena that are the product of human action but not of human design.”
Or suppose you’re heading out to run some errands and when you open the door, it’s raining. There’s no switch to turn to off, no dial to set to “dry.” You go back inside and grab a raincoat or an umbrella.
It’s easy to divide the world we experience into these two types of phenomena—things like the temperature in your house that are the result of human activity and human intention and things like the rain outside that are not the result of human activity or human intention.
This third category is discussed by Friedrich A. Hayek in The Fatal Conceit and was first coined by Adam Ferguson in 1767 in An Essay on the History of Civil Science, discussing the evolution of institutions: “Every step and every movement of the multitude, even in what are termed enlightened ages, are made with equal blindness to the future; and nations stumble upon establishments, which are indeed the result of human action, but not the execution of any human design.” [Part Third. Section II, p. 122 of the Duncan Forbes edition, Edinburgh University Press, 1966. An online edition is at McMaster’s.]
But there is a third category of experience—phenomena that are the product of human action but not of human design.
Language is one example. No one designs or controls the English language. There are self-appointed experts who try and influence the way English evolves but they have no real control anymore than the French government can stop the French people from calling Saturday and Sunday “le weekend” rather than the government-approved “fin de semaine.”
Who invented the verb “to google?” Or the nouns “cyberspace” or “blog?” More crucially, who decided that these words could be used in common parlance without explanation? No one. Because no one is in charge, we might expect language to be chaotic and random. But words don’t fall like rain. Which words live and which words die, which words delight the mind and which words get ignored, isn’t a random phenomenon. Human beings and their choices make these words (and not others) part of the English language because they are useful. But no one person is the arbiter. We all are, in some sense. But not in the usual sense that we use the word “we,” the sense of a collective decision. There is no collective decision, merely the result of a sufficient number of individuals using particular words that spread by word of mouth. Language emerges from the complex interaction of those who speak, read and write it.
Ironically, we don’t have a vocabulary to describe this peculiar form of group influence. There’s no vote and no delegation of power to experts or a committee by the group. The speakers of English “decide” which words live and die but not in the way we usually mean the word “decide” which implies a conscious decision. There is no group consciousness.
Commuting time in major American cities is another example. Why does it take so long to get around during rush hour? Whose fault is that? No one’s. But it’s not a random or a natural phenomenon. Traffic is the result of human activity but not the result of human design. The time it takes to get from here to there emerges from the complex interaction of the decisions made by those who drive. It has a predictability despite the fact that no one is intending it to be that way. Traffic is slower in rush hour than during the middle of the day. Traffic is slower in big cities relative to small ones.
This doesn’t mean there aren’t ways to affect commuting time or emergent phenomena. Traffic congestion isn’t like the rain. But the obvious ways, the ways that are akin to turning a dial don’t work the way people anticipate. Widening the freeways and adding public transit options fail to reduce rush hour traffic for anything other than the very short term. These “solutions” treat the outcomes of an emergent process as if they were the temperature on the thermostat. They inevitably fail.
We have no trouble wrapping our minds around the concept that no one individual is in charge of how long it takes to get from here to there during rush hour in a major American city. No one would argue that just because I drove the car and it took an extra half hour for my trip during rush hour that it was my intention that the trip would take that long. Even though I drove the car, even though I was at the wheel, we all understand that it wasn’t my intention to take an extra half hour. We understand that the extra half hour was due to the individual choices of all the other drivers. We also understand that it would be absurd to suggest that “we,” all of the drivers combined, have a collective intention that the drive at rush hour takes longer than outside of rush hour. It’s no individual’s intention. And it isn’t the result of a collective intention, either. That concept has no meaning.
Similarly, if you move from St. Louis to Washington D.C. as I did two years ago, you’ll find that a house in Washington D.C. is more expensive than a comparable house in St. Louis. When I bought my house in Washington, I wasn’t angry at the seller for charging such a high price. I didn’t blame him for the price discrepancy between his house and a similar one in St. Louis. I didn’t express outrage that he was charging almost ten times what he had paid for the house when it was new in 1969. Most people understand that the price of a house isn’t really set in any real sense by the seller or by any one person or by any collective will. No one intended that the price of housing in Washington DC double over the past five years as it has.
Economics is the study of such emergent phenomena, particularly when prices, monetary or non-monetary are involved. We call these phenomena “markets.” It’s an unfortunate term, but one of course, that I have no control over. It’s the term that has been used for a century or more and is likely to endure. But I say unfortunate, because in the mind of the public, the term “markets,” conjures up either the New York Stock Exchange or a farmer’s market, highly organized, centralized interactions between buyers and sellers. Most of what we study in economics called markets are decentralizednon-organized interactions between buyers and sellers.
Yet these decentralized, non-organized interactions result in prices, either monetary in the case of houses or non-monetary in the case of traffic, that have an orderliness to them in spite of their not being organized by any individual or even a group. That orderliness, that predictability, runs through our lives in ways we rarely appreciate.
For more on specialization, the dispersion of knowledge and the role of prices in allowing dispersed knowledge to be used effectively and producing order, see, Hayek’s “The Use of Knowledge in Society,” Leonard Read’s “I, Pencil,” Adam Smith’s discussion of the division of labor in Chapter 1 and Book 1 of the Wealth of Nations and my earlier Econlib essay, “A Marvel of Cooperation.”
To take one very important example, the orderliness of prices and the resulting lack of shortages allows knowledge to be widely dispersed via specialization. Such specialization sustains our standard of living. The level of specialization emerges alongside the prices, but the prices make it all possible. A pencil company never worries about there being a graphite shortage or a cedar shortage or a shortage of yellow lacquer. That lets the pencil factory outsource these materials and avoid the accumulation of knowledge necessary to master all of the processes involved in pencil making. The emergence of prices allows a world to emerge where no one knows how to make a pencil. That world is a pleasant one because it is a world where pencils are inexpensive, abundant and always available.
Understanding the emergent phenomena economists call a market is the essence of the economic way of thinking. In contrast, the human brain seems more accustomed to what might be called the engineering way of thinking where human action and human design work together. If I’m dissatisfied with the size of my kitchen, I make a plan and by following the plan, if it’s a good plan, the result is a bigger kitchen. A person who sits around hoping for a new kitchen without design or action is going to be disappointed. Or if I notice the leaves falling from the trees, I don’t hope that they’re going to clean themselves up. I have to plan to rake them and then do the actual raking. Changing my thermostat to alter the temperature inside my house is another such example.
But the engineering way of thinking doesn’t work with emergent phenomena. Trying to change emergent results is inherently more complex than building a bridge or expanding your kitchen or even putting a man on the moon. Understanding the challenge involved is to begin to answer the old question that asks why we can put a man on the moon but we can’t eliminate poverty. Putting a man on the moon is an engineering problem. It yields to a sufficient application of reason and resources. Eliminating poverty is an economic problem (and by the word “economic” I do not mean financial or related to money), a challenge that involves emergent results. In such a setting, money alone—in the amounts that a non-economic approach might suggest, one that ignores the impact of incentives and markets—is unlikely to be successful.
Thomas Sowell likes to say that reality is not optional. But we oh so want it to be. We want to change outcomes without consequences with the ease of adjusting the thermostat on the wall of our house. We want to dial incomes upward and gasoline prices downward. We want to blame Wal-Mart for the fact that its employees earn below the national average. We want to blame China (or Mexico or Japan or India) for our trade deficit. We want to blame or honor the occupant of the White House for whether new jobs are high-paying or low-paying. This worldview that flies in the face of reality and that ignores the inherent complexity of the real world is the bread-and-butter of journalism and the breeding ground for unintended consequences.
Consider the average employee at Wal-Mart who earns less than the average and has no health care benefits. If the seller doesn’t set the price of the house why do people blame Wal-Mart for paying low wages or offering inadequate health care benefits? It seems obvious that Wal-Mart sets its wages, but that is as naïve is thinking that the seller of the house determines its price.
My income, for example, is higher than the average Wal-Mart employee. That might fool you into thinking that my employer, George Mason is compassionate while greedy Wal-Mart only cares about the bottom line.
But the real reason I make more than the average employee at Wal-Mart has nothing to do with the compassion of George Mason University compared to the greediness of Wal-Mart. It has everything to do with my alternatives outside of George Mason compared to the alternatives of the average Wal-Mart employee, just as the price of my house depends on the prices of alternative houses of similar quality. If we want the Wal-Marts of the world to pay higher wages, low-skill workers have to acquire more skills, more education, more higher-paying alternatives.
When I made this point to a student he countered by asking why Wal-Mart has a right to exploit low-skilled workers who have such limited alternatives.
It would be tempting to answer that question with a similar question—what right does the seller of houses in Washington, DC have to exploit the prospective buyer by charging a higher price than people pay in St. Louis. But that answer misses two deeper points. The first is that Wal-Mart isn’t exploiting people by hiring them. In fact, the opposite is the case. By creating a business model that allows low-skill workers to serve customers hungry for low-price goods, Wal-Mart increases the alternatives available to low-skill workers and raises their wages above what they would otherwise receive in a world without Wal-Mart.
The second point is that viewing Wal-Mart as the cause of low wages can lead to destructive policies like banning Wal-Mart from opening a store in your city. When Wal-Mart opens a new store, workers eagerly line up for the opportunity to work there. How can it help them to reduce their opportunities?
It is unfortunate that well-meaning people often join in concert with self-interested competitors of Wal-Mart to hamper Wal-Mart and other employers from expanding. It is tragic when a lack of economic understanding pushes a nation to the edge of economic chaos.
As I write these words, New Orleans is in chaos. A number of oil refineries have been knocked out of commission by Hurricane Katrina. Gas prices have spiked upward. Politicians are threatening suppliers with legal action for “price gouging,” raising prices at a time of crisis. Politicians from President Bush on down are asking drivers to drive less or “only when necessary” as if that phrase had meaning. These politicians evidently believe that begging and lecturing citizens can perform the role that prices do in creating and sustaining order, an order where I never have to think twice or even once about whether gasoline will be available at the corner for my vacation or drive to work or to take an emergency trip to the hospital.
But reality is not optional. You cannot have a sudden reduction is gasoline available to the market and low prices at the same time. There is no dial for gasoline prices. The result of these threats is easily predicted—suppliers are already rationing. Drivers are worried about shortages and in the face of threats to punish ‘gougers’ they are right to worry. As a result, lines are forming in some cities, and gasoline retailers are closing early in the day, out of gasoline, the same results we saw when explicit rather than implicit price controls were put in place in the 1970s.
Friedrich A. Hayek, in The Fatal Conceit, wrote that “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” Unfortunately, when politicians try to dial down prices to preserve order, they only worsen the problem. We would do well to remember the emergent nature of prices, especially in times of crisis.