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Against the Market Economy: Advice to Venezuelan Friends

Robin Hahnel is professor of economics at American University in Washington DC and currently visiting professor at Lewis and Clark College in Portland, Oregon. This article is adapted from a speech the author gave at the Ministry for the Communal Economy in Caracas, Venezuela on July 13, 2007, attended by both their employees and employees from the Ministry of Planning and Economic Development.

Robin Hahnel was a guest of the Centro International Miranda in Caracas for its July 2007 Workshop in Socialism and Human Development. During his stay, we arranged for him to speak at the Ministry for the Communal Economy. This ministry not only oversees and supports the significant Venezuelan cooperative sector and provides training in the principles of cooperation but has also moved recently to develop “socialist enterprises,” which work closely with communal councils. Since one of the principal goals of these organizations is to attempt to avoid the infection of the market, Robin’s talk was oriented toward providing them with important weapons for the battle of ideas. It will be obvious, however, that his demystification of the wonders of the market can be a weapon not only in the Venezuelan struggle but in the movement for liberation globally.

Michael A. Lebowitz (October 31, 2007)

I am here to salute you—because you are attempting to do what nobody has ever succeeded in doing before—help autonomous groups of workers and consumers plan their interrelated activities democratically, equitably, and efficiently themselves. You have already created the elements of what you call the “social economy”—worker-owned cooperatives, communal councils, municipal assemblies, participatory budgeting, subsidized food stores, health care clinics, and nuclei of endogenous development. Now you want the cooperatives and communal councils to display solidarity for one another rather than treat each other as antagonists in commercial exchanges. And sooner rather than later you want the benefits of this kind of participatory, socialist economy to encompass the entire economy and all Venezuelans.

I am also here to warn you—because when the mission you are embarked on proves difficult and problems arise, as they surely will—there are many who will seize the opportunity to insist that you abandon your quest to help autonomous actors plan together in solidarity as quixotic, and demand that you accept markets as the only way to coordinate the activities of autonomous decision makers. I hope my talk today will arm you with sound reasons not to heed the advice of those Fidel Castro once referred to as “brainy economists” when they tell you that markets are the only way to preserve enterprise autonomy and provide consumers freedom of choice.

Early in the twentieth century most socialists thought that after capitalism was overthrown workers in different enterprises and consumers in different communities would begin to plan their activities together with one another with little difficulty. But the history of twentieth-century socialism has taught us that this is most emphatically not the case. Planning by those Marx called the “associated producers” did not occur for many reasons that are important to study carefully. But one reason is that it is not as easy for autonomous groups of workers and consumers to plan together as early socialists naively assumed. Working out procedures so that decision making within a communal council, or inside a worker cooperative, is not only democratic but also inclusive and efficient is difficult enough. But working out procedures that allow communal councils and worker cooperatives to retain an appropriate degree of autonomy while planning their relations fairly and efficiently is much more difficult. In any case, for whatever reasons, instead of planning by the associated producers—and I would add consumers—themselves, what happened in twentieth-century postcapitalist economies was that people’s activities were planned for them by a planning bureaucracy. In some cases the planning bureaucracy was better intentioned and more competent, and in other cases it was more self-serving and bungling. But in all cases people’s economic activities were planned for them not by them.

Besides failing to deliver on the socialist promise of economic self-management, command planning also led to a notable lack of economic initiative and creativity at local levels. But when leaders in twentieth-century postcapitalist economies searched for ways to stimulate local initiative the only solution they came up with was to permit autonomous economic units to interact through markets rather than through planning. In Yugoslavia local autonomy also meant a significant degree of worker self-management through worker councils where every worker had one vote. Unfortunately in most postcapitalist economies that experimented with market reforms it was local managers, not workers, whose decision making power grew as the power of the planning bureaucracy was reduced. But in all cases the price of buying local autonomy was to unleash market forces with all that this entails.

I believe participatory planning by worker cooperatives and communal councils who retain an appropriate degree of autonomy is possible. The fact that it is more difficult than early socialists presumed and has never been done before does not mean you Bolivarian socialists will not succeed in the years ahead. Armed with a clear understanding of the failures of twentieth-century socialism and a clear understanding of the problems you must solve, I believe you can succeed where your forebears did not. But while I have many ideas I hope to share with you on other occasions about how to make planning participatory, that is not my subject today. Today I am here to warn you against the lure of succumbing to the advice of the “brainy economists” who tell you to give up your pipe dream of trying to help workers and consumers plan in solidarity themselves, and to accept the market as the only practical way to coordinate the activities of autonomous actors.

What is wrong with markets? I will discuss four reasons you should reject markets if you want to build a socialist economy—four reasons markets are not the harmless coordinating mechanism that guarantees efficiency some would have us believe, but instead a powerful social institution that undermines everything socialism stands for while generating a great deal of inefficiency as well. I will argue that (1) markets distribute the burdens and benefits of economic cooperation unfairly, (2) markets undermine solidarity and promote egotistical attitudes and behavior, and (3) markets fail to provide economic democracy and subvert political democracy as well. Finally, contrary to what most economists will tell you, I will explain why (4) markets do not allocate scarce productive resources efficiently. There are other valid criticisms of the market system elaborated by a variety of schools of economic thought outside the mainstream. Marxists, institutionalists, feminists, post-Keynesians, and ecological economists have all elaborated important critiques of the market system. Today I limit myself to an “internal critique” in terms that are familiar to economists within the mainstream of the profession. I do this because it is mainstream economists who will advise you to outgrow your naivité and accept markets no matter what reservations you may harbor. I hope to help you explain to them why you have rejected markets in terms even they can understand. I also limit myself to what I think of as the “simple case” against markets because even the simple case is overwhelming.

1. Why Labor Markets are Unfair

When capitalists hire workers, the profits capitalists receive for no work on their part are testimony to the fact that collectively their employees were not paid wages equal to the market value of what their work produced. But beside the fact that capitalist income is unfair because those who do all the work receive too little as a whole, what should we make of differences in wage rates for different categories of workers? And what happens if capitalist enterprises are replaced by worker-owned enterprises that hire members in labor markets where the laws of supply and demand remain free to operate?1

If the last hour of welding labor hired raises output and therefore revenue by more than the last hour of floor sweeping does, when employers compete with one another in labor markets for welders and sweepers they will bid the wage rate for welders up higher than the wage rate for sweepers—whether or not they are capitalist employers trying to maximize enterprise profits, or worker-owned enterprises trying to maximize profits per member.2 This means that when labor is hired in labor markets those who have more human capital, and therefore contribute more to enterprise output and revenues, will receive higher wages than those with less human capital.

Why is this a problem? Suppose our welder and sweeper work equally hard in equally unpleasant circumstances. In a market economy they will not be rewarded equally even though they make what we might call equal “sacrifices.” In a market economy those with more human capital will receive more, even if they make no greater sacrifices, and those with less human capital will receive less, even if they sacrifice just as much.3

Moreover, for all of us who understand this is unfair there is no way to fix the problem in a market system without creating a great deal of inefficiency. If we intervene in the labor market and legislate wage rates we consider to be fair, but allow markets to determine how resources are allocated, not only will different kinds of labor be allocated inefficiently, the entire price structure of the economy will fail to reflect the opportunity costs of producing different goods and services leading to further inefficiencies. There is no getting around the dilemma: In a market economy we must either allow the market system to reward people unfairly, or, if we try to correct for inequities we must tolerate even greater inefficiencies.4

2. Why Markets Undermine the Ties that Bind Us

Disgust with the commercialization of human relationships is as old as commerce itself. The spread of markets in eighteenth-century England led Edmund Burke to reflect: The age of chivalry is gone. The age of sophists, economists, and calculators is upon us; and the glory of Europe is extinguished forever.” Thomas Carlyle prophesized: “Never on this Earth, was the relation of man to man long carried on by cash-payment alone. If, at any time, a philosophy of laissez-faire, competition, and supply-and-demand start up as the exponent of human relations, expect that it will end soon.” And of course running through all his critiques of capitalism, Karl Marx complained that markets gradually turn everything into a commodity and, in the process, corrode social values and undermine community:

[With the spread of markets] there came a time when everything that people had considered as inalienable became an object of exchange, of traffic, and could be alienated. This is the time when the very things which till then had been communicated, but never exchanged, given, but never sold, acquired, but never bought—virtue, love, conviction, knowledge, conscience, etc.—when everything, in short passed into commerce. It is the time of general corruption, of universal venality….It has left remaining no other nexus between man and man other than naked self-interest and callous cash payment. (The Poverty of Philosophy [Progress Publishers, 1955], chapter 1, section 1)

In my view what the oldest critique of markets amounts to is an objection to the organization of economic cooperation in a way that is personally distasteful and demeaning and unnecessarily sours human relations. It is a plea to others to come to their senses and join the search for a different way to organize economic cooperation. The forms of interaction that are encouraged by markets are mean spirited and hostile, the forms of cooperation that markets discourage are respectful and empathetic, and the detrimental effects on human relations are far from trivial.

In effect, markets say to us: You humans cannot consciously coordinate your interrelated economic activities efficiently, so do not even try. You cannot come to equitable agreements among yourselves, so do not even try. Just thank your lucky stars that even such a hopelessly socially challenged species such as yourselves can still benefit from a productive division of labor, thanks to the miracle of the market system. In effect, markets are a no-confidence vote on the social capabilities of the human species.

If that daily message were not sufficient discouragement, markets harness our creative capacities and energies by arranging for other people to threaten our livelihoods. Markets bribe us with the lure of luxury beyond what others can have and beyond what we know we deserve. Markets reward those who are the most efficient at taking advantage of his or her fellow man or woman, and penalize those who insist, illogically, on pursuing the golden rule—do unto others, as you would have them do unto you. Of course, we are told we can personally benefit in a market system by being of service to others. But we also know we can often benefit more easily by taking advantage of others. Mutual concern, empathy, and solidarity are the appendices of human capacities and emotions in market economies—and like the appendix, they continue to atrophy.

But there is no need to take the word of precapitalist romantics like Burke and Carlyle, or the word of the greatest critic of capitalism, Karl Marx, or the word of an avowed market abolitionist such as myself on this matter. Samuel Bowles, an economist who strongly supports a “socialized” market system, provides eloquent testimony regarding this failure of markets in an article titled “What Markets Can and Cannot Do” published in Challenge Magazine in 1991. Bowles said:

Markets not only allocate resources and distribute income, they also shape our culture, foster or thwart desirable forms of human development, and support a well defined structure of power. Markets are as much political and cultural institutions as they are economic. For this reason, the standard efficiency analysis is insufficient to tell us when and where markets should allocate goods and services and where other institutions should be used. Even if market allocations did yield efficient results, and even if the resulting income distribution was thought to be fair (two very big “ifs”), the market would still fail if it supported an undemocratic structure of power or if it rewarded greed, opportunism, political passivity, and indifference toward others….

As anthropologists have long stressed, how we regulate our exchanges and coordinate our disparate economic activities influences what kind of people we become. Markets may be considered to be social settings that foster specific types of personal development and penalize others. The beauty of the market, some would say, is precisely this: It works well even if people are indifferent toward one another. And it does not require complex communication or even trust among its participants. But that is also the problem. The economy—its markets, workplaces and other sites—is a gigantic school. Its rewards encourage the development of particular skills and attitudes while other potentials lay fallow or atrophy. We learn to function in these environments, and in so doing become someone we might not have become in a different setting. By economizing on valuable traits—feelings of solidarity with others, the ability to empathize, the capacity for complex communication and collective decision making, for example—markets are said to cope with the scarcity of these worthy traits. But in the long run markets contribute to their erosion and even disappearance. What looks like a hard headed adaptation to the infirmity of human nature may in fact be part of the problem.

3. Why Markets Subvert Democracy

Confusing the cause of free markets with the cause of democracy is astounding given the overwhelming evidence that the latest free market jubilee has disenfranchised ever larger segments of the world body politic. The cause of economic democracy is not being served when thirty-year-olds with an MBA degree working for multinational financial companies trading foreign currencies, bonds, and stocks in their New York and London offices affect the economic livelihoods of billions of ordinary people who toil in third world economies more than their own elected political leaders.

First, markets undermine rather than promote the kinds of human traits critical to the democratic process. As Bowles explained in the essay quoted previously:

If democratic governance is a value, it seems reasonable to favor institutions that foster the development of people likely to support democratic institutions and able to function effectively in a democratic environment. Among the traits most students of the subject consider essential are the ability to process and communicate complex information, to make collective decisions, and the capacity to feel empathy and solidarity with others. As we have seen, markets may provide a hostile environment for the cultivation of these traits. Feelings of solidarity are more likely to flourish where economic relationships are ongoing and personal, rather than fleeting and anonymous; and where a concern for the needs of others is an integral part of the institutions governing economic life. The complex decision-making and information processing skills required of the modern democratic citizen are not likely to be fostered in markets.

Second, those who are more wealthy generally benefit more than those who are less wealthy from market exchanges. As long as capital is scarce—that is, as long as more capital could make someone’s labor more productive than it is currently—it is predictable that those with more capital will capture the lion’s share of any efficiency gains from exchanges not only in labor and credit markets, but in goods markets as well. Moreover, this is not only true in noncompetitive markets but even when market structures are competitive.5 In other words, economic liberalization breeds concentration of economic wealth, and in political systems where money confers advantages it leads indirectly to the concentration of political power as well. Those who deceive themselves and others that markets nurture democracy ignore the simple truth that markets tend to aggravate disparities in wealth and economic power. It is true that the spread of markets can undermine the power of traditional elites, but this does not imply that markets will cause power to be more equally dispersed and democracy enhanced. If old obstacles to economic democracy are being replaced by new, more powerful obstacles in the persons of chief executive officers of multinational corporations and multinational banks, the new global mandarins at the World Bank and International Monetary Fund, and the chairs of adjudication commissions for the North American Free Trade Association and the World Trade Organization, and if these new elites are more effectively insulated from popular pressure than their predecessors, it is not the cause of democracy that is served.

Support for the theory that markets promote democracy stems from the dominant interpretation of modern European history in which the simultaneous spread of markets and political democracy is assumed to be because the former caused the latter. It is hardly surprising that perhaps the most intrusive social institution in human history would have disrupted old, precapitalist obstacles to democratic rule in precapitalist Europe. The question, however, is not whether markets undermine old structures of domination—which they clearly do—but, if the new patterns of economic power that markets create are supportive or detrimental to democratic aspirations. I am skeptical that markets deserve nearly as much credit as mainstream interpretations award them for the emergence of European political democracy. I suspect this interpretation robs Europeans who fought against the rule of monarchy and feudal lord in the seventeenth, eighteenth, and nineteenth centuries, Europeans who fought for universal popular suffrage in the nineteenth and twentieth centuries, and all who fought against fascism in the twentieth century of much of the credit they deserve. But a worthy rebuttal to the thesis that we owe whatever advances political democracy has made to the rise of the market system would require much more time than we have here today, and require more historical knowledge than I pretend to have.

4. Why Markets Allocate Resources Inefficiently

While those who are not economists can criticize markets because they are unfair, undermine solidarity, promote egotism, and subvert democracy, it is hard for anyone who is not a professional economist to rebut the myth that whatever failings markets may have in other regards, at least they lead to an efficient allocation of productive resources. Professional economists define efficiency in two ways. Their most narrow definition is that an outcome is efficient if there is no possible change that would make at least one person better off without making someone else worse off. Their less narrow definition is that an outcome is efficient if it maximizes net social benefits, i.e., the difference between total social benefits and total social costs. While both conceptions of efficiency can be criticized, for my purposes today they are sufficient because even using these narrow definitions of efficiency we can discover there is every reason to believe that markets generate very inefficient outcomes.

As a well-published, professional economist who has taught theory at the highest levels in economic doctoral programs in the United States for over thirty years I want to testify as an “expert witness” if you will, that the conclusion that markets can be relied on to yield efficient outcomes is completely unwarranted. It is well known among professional economists that markets allocate resources inefficiently when they are out of equilibrium, when they are noncompetitive, and when there are external effects. As a matter of fact, what we call the fundamental theorem of welfare economics says as much when read carefully. But despite clear warnings in our most sacred theorems about what we might call necessary “conditionalities,” market enthusiasts continue to insist that if left alone, or perhaps with a little assistance, markets generally allocate resources very efficiently. This could only be true if disequilibrating forces were weak, if noncompetitive market structures were uncommon, and most importantly, if externalities were the exception, rather than the rule. Unfortunately, there are good reasons to believe that exactly the opposite is true in all three cases, and moreover, that policy correctives will prove very inadequate.

A. Externalities Are Pervasive

At the risk of boring you with more economics than you bargained for when you decided to come here today, I want to take the time to explain this particular failing of markets because it is terribly important and not well understood even among leftists who are critical of markets for other reasons. Markets do permit people to interact in ways that are convenient and mutually beneficial for buyers and sellers. But convenience and benefits for buyer and seller do not imply efficiency. Ironically, the very factors that render markets convenient and beneficial for buyers and sellers also render them inefficient even according to the narrow conception of efficiency used by mainstream economists.

Increasing the value of goods and services produced and decreasing the unpleasantness of what we have to do to produce them are two ways producers can increase their profits in a market economy—and competitive pressures will drive producers to do both. But maneuvering to appropriate a greater share of the goods and services produced by externalizing costs onto others and internalizing benefits without compensation are also ways to increase profits. Moreover, competitive pressures will drive producers to pursue this route to greater profitability just as assiduously. Of course, the problem is that while the first kind of behavior serves the social interest as well as the private interests of producers, the second kind of behavior serves the private interests of producers at the expense of the social interest. All economists agree that when sellers or buyers promote their private interest by externalizing costs onto those not a party to the market exchange, or by appropriating benefits from other parties without compensation, their behavior introduces inefficiencies that lead to a misallocation of productive resources, and consequently, a decrease in welfare.

When car manufacturers fail to take into account the damage their sulphur dioxide emissions impose on those damaged by acid rain, they offer to supply more cars than is efficient from society’s perspective. When consumers of cars have no incentive to take into account the damage their emissions of greenhouse gases inflict on victims of climate change, they offer to buy more cars than is socially efficient. Because negative external effects associated with both car production and consumption go ignored in the market decision making process in which buyers and sellers weigh the consequences of their choices only on themselves, we are led to produce and consume many more cars than is efficient even according to the narrow definition of efficiency used by mainstream economists. In general, it is well known that markets will underprice and overproduce goods and services when there are negative external effects associated with either their production or consumption, and overprice and underproduce goods and services when there are positive external effects associated with either their production or consumption.

The positive side of market incentives has received great attention and praise dating back to Adam Smith who coined the term “invisible hand” to describe it. The darker side of market incentives has been relatively neglected and grossly underestimated. A notable exception is the Marxist economist E. K. Hunt who coined the less famous, but equally appropriate term, “invisible foot” to describe the socially counterproductive behavior markets drive participants to engage in.

Market enthusiasts seldom ask: Where are firms most likely to find the easiest opportunities to expand their profits? How easy is it usually to increase the size or quality of the economic pie? How easy is it to reduce the time or discomfort it takes to bake the pie? Alternatively, how easy is it to enlarge one’s slice of the pie by externalizing a cost, or by appropriating a benefit without payment? Why should we assume that in market economies it is infinitely easier to expand private benefits through socially productive behavior than through socially counterproductive behavior? Yet this implicit assumption is what lies behind the view of markets as guided by a beneficent invisible hand rather than a malevolent invisible foot.

Market admirers fail to notice that the same feature of market exchanges primarily responsible for their convenience—excluding all affected parties other than the buyer and seller from the transaction—is also a major source of potential gain for the buyer and seller. When the buyer and seller of an automobile strike their convenient deal, the size of the benefit they have to divide between them is greatly enlarged by externalizing the costs onto others of the acid rain produced by car production, and the costs of urban smog, noise pollution, traffic congestion, and greenhouse gas emissions caused by car consumption. Those who pay for these costs, and thereby enlarge automobile manufacturer profits and car consumer benefits, are easy marks for car sellers and buyers for two reasons. They are dispersed geographically and chronologically, and the magnitude of the effect on each negatively affected, external party is small, yet not equal. Consequently, individually external parties have little incentive to insist on being party to the transaction. The external effect on a single party is seldom large enough to make it worthwhile for one person to try to insert herself into the negotiations. But there are formidable obstacles to forming a coalition to represent the collective interests of all external parties as well.

Organizing a large number of people who may be dispersed geographically and chronologically, when each has different, small  amounts at stake, is a difficult task. Who will bear the transaction costs of approaching members when each has little to benefit? When approached, who will report truthfully how much they are affected when it is to their advantage to exaggerate? In sum, when there are multiple victims they face formidable transaction costs, and what we economists call free rider and hold out incentive problems to acting collectively.

One way to see the problem is that markets reduce the transaction costs for buyers and sellers but do nothing to reduce the transaction cost of participation in decision making by externally affected parties. It is this inequality in transaction costs that makes external parties easy prey to rent seeking behavior on the part of buyers and sellers. Even if we could organize a market economy so that buyers and sellers never face a more or less powerful opponent in a market exchange, this would not change the fact that each of us has smaller interests at stake in many transactions in which we are neither buyer nor seller. Yet the sum total interest of all external parties is often considerable compared to the interests of the buyer and the seller. It is the transaction cost and free rider incentive problems of those with lesser interests that create an unavoidable inequality in power between those who make an exchange and those who are neither buyer nor seller but are affected by the exchange nonetheless. This is the power imbalance that allows buyers and sellers to benefit at the expense of disenfranchised external parties in ways that cause inefficiencies. Since this opportunity to increase private benefits is readily available in market economies there is every reason to believe those who must maximize profits or be competed out of business will take advantage of it—leading to significant inefficiencies.

B. Markets Are Generally Not Competitive

It is well-known among economists that when markets are not competitive they lead to inefficient allocations of resources. When sellers are few it is in their interest to produce an output that is, collectively, less than the amount that is socially efficient, again, according even to the narrow definition of efficiency used by mainstream economists. In other words, just as it is easier to make profits at the expense of disenfranchised external parties than through socially productive behavior, it is often easier for a small group of sellers to make profits by restricting supply than producing the socially efficient amount of their product. All empirical evidence indicates that most goods are sold in noncompetitive markets and that market structures are growing less, not more competitive. This means that noncompetitive market structures are a serious and growing source of inefficiencies in market economies today.

C. Markets Often Fail to Equilibrate

Real markets do not always equilibrate quickly, much less instantaneously. The famous “laws” of supply and demand, which predict that when market price rises quantity supplied will increase and quantity demanded will decrease, leading markets toward their equilibria, are based on a highly questionable assumption about how market participants interpret price changes. Standard analysis implicitly assumes that sellers and buyers believe that when the market price rises the new higher price is the new stable price. If this is truly the case, then it is sensible when market price rises for sellers to offer to sell more than before and for buyers to offer to buy less than before—as the “laws” of supply and demand say they will. However, sometimes buyers and sellers quite sensibly interpret price changes as indications of further price movements in the same direction. In this case, it is rational for buyers to respond to an increase in price by increasing the quantity they demand before the price rises even higher, and for sellers to reduce the quantity they offer to sell waiting for even higher prices to come.

When buyers and sellers behave in this way they create greater excess demand and drive the price even higher, leading to a market “bubble.” When buyers and sellers interpret a decrease in price as an indication that the price is headed down, it is rational for buyers to decrease the quantity they demand, waiting for even lower prices, and for sellers to increase the quantity they offer to sell before the price goes even lower. In this case their behavior creates even greater excess supply and drives the price even lower, leading to a market “crash.” In other words, if market participants interpret changes in price as signals about the likely direction of further price changes, and if they behave “rationally,” they will not only fail to behave in the way the “laws” of supply and demand would lead us to expect, they will behave in exactly the opposite way from what these “laws” predict. When this occurs and markets move away from not toward their equilibria economic inefficiency increases.

As the East Asian financial crisis reminded us, financial market bubbles that burst can generate great efficiency losses in the “real” sector of their economies when “vicious” disequilibrating dynamics in financial markets overpower “virtuous” equilibrating forces. Moreover, “brainy economists” who argue that bubbles and crashes only occur in a few markets where many players are speculators should remember their own explanation for why all units of a good tend to sell at a uniform market price. Only when people are free to engage in arbitrage do we get “well ordered” markets and uniform prices in the first place. This means mainstream economists must expect and welcome players who are motivated purely by hopes of profiting from trading rather than because they have any use for the particular good being bought and sold. Since those who engage in arbitrage have no interest in the usefulness of the good in question, it seems likely that they would be particularly sensitive to the implications of a change in price on the likely direction of further price changes, and therefore on their profits from trading. In other words, market bubbles and crashes, which all economists agree cause efficiency losses, are generally the result of rational not irrational behavior, and much more likely to occur than mainstream economists would have us believe.

D. Practical Problems with Policy Correctives

When faced with theoretical reasons to believe that externalities, noncompetitive market structures, and disequilibrium dynamics are neither rare nor trivial problems, supporters of the market system respond in different ways. There is a clear divide between “free market fundamentalists” whose influence has grown significantly over the past few decades, and more pragmatic supporters of the market system who favor market interventions to create what some of them call “socialized markets.” The ideologues’ enthusiasm for a laissez-faire market system literally knows no bounds as they brush aside qualifying assumptions as if they did not exist. Market pragmatists, in contrast, concede that we must sometimes intervene in markets with policies to internalize external effects, curb monopolistic practices, and counter disequilibrating forces. However, those who give qualified support to market intervention conveniently ignore practical problems that inevitably arise whenever we attempt to “socialize” markets.

  • The job of correcting for external effects is daunting, because, as I explained, there is every reason to believe they are the rule rather than the exception—as market enthusiasts simply assume without providing any evidence whatsoever.
  • Alfred Pigou proved long ago that when there are negative external effects in a market a corrective tax is required to eliminate the inefficiency, and when there are positive externalities a corrective subsidy is indicated. But how are we to know what the size of the external effect is, and therefore how high to set the tax or subsidy? The market offers no assistance whatsoever in this regard, forcing us to resort to very imperfect measures. Stop-gap procedures for trying to estimate the magnitude of external effects like contingent valuation surveys (where economists survey a random sample of those affected and ask them how much they would be willing to pay not to be damaged) and hedonic regression studies (where economists try to deduce how much people are adversely affected by their purchase of related goods that are sold in markets) are notoriously unreliable and therefore highly subject to manipulation by interested parties.
  • Because they are unevenly dispersed throughout the economic matrix the task of correcting the entire price system for the direct and indirect effects of externalities is even more daunting. Even if the negative external effects of producing or consuming a particular good could be estimated accurately and the corrective tax were applied, if the external effects of producing or consuming goods that enter into the production of the good in question are not also accurately corrected for, the theory of the second best warns us that the Pigovian tax we place on the good in question may move us farther away from an efficient use of our productive resources rather than closer.
  • In the real world, where private interests and power take precedence over economic efficiency, the beneficiaries of accurate corrective taxes are all too often dispersed and powerless compared to those who would be harmed by an accurate corrective tax. As Mancur Olsen explained long ago in The Logic of Collective Action, this makes it very unlikely that full correctives would be enacted even if they could be accurately calculated.
  • People also learn to adjust to the biases created by external effects in the market price system. Consumers will increase their preference and demand for goods whose production and/or consumption entails negative external effects but whose market prices fail to reflect these costs and are therefore too low; and consumers will decrease their preference and demand for goods whose production and/or consumption entails positive external effects but whose market prices fail to reflect these benefits and are therefore too high. While this reaction, or adjustment, is individually rational it is socially counterproductive since it leads to even greater demand for the goods that market systems already over produce, and even less demand for the goods that market systems already underproduce. As people have greater opportunities to adjust over longer periods of time, the degree of inefficiency in the economy will grow or “snowball.”
  • In theory, inefficiencies due to noncompetitive market structures can be solved by breaking up large firms, i.e. through antitrust policy. But true economies of scale provide good reasons for sometimes not doing so, and corporate power provide bad reasons for seldom doing so. Noncompetitive market structures are routinely tolerated simply because large firms are politically powerful and successfully pressure the political system to permit them to continue their profitable but socially inefficient practices. An alternative to antitrust action is to regulate large firms in noncompetitive industries. But this practice is also, regrettably, in decline, as regulatory agencies are increasingly “captured” by the companies they are supposed to regulate and turned into vehicles for promoting industry objectives.
  • There are well known policies to ameliorate inefficiencies due to market disequilibria. Both fiscal and monetary policies can be used to stabilize business cycles. Indicative planning and industrial policies can be used to eliminate disequilibria between sectors of an economy. Regulation of foreign exchange and financial markets particularly prone to bubbles and crashes are almost always an improvement over ex post damage control consisting mostly of bailouts for powerful economic interests most responsible for creating problems in these markets in the first place. Unfortunately, neoliberal ideologues and the corporate interests they serve have waged a relentless campaign against these policies over the past two decades, and both national economies and the global economy have experienced huge losses in economic efficiency as a result.

In sum, contrary to both popular and professional opinion, free markets lead to a very inefficient use of our scarce productive resources, and even when “socialized” by policy correctives, a great deal of inefficiency inevitably remains.

Conclusion

Before concluding, let me thank you for your patience. I have subjected you to a lengthy and tedious diagnosis. I can only hope that the importance of the subject for all of us searching for a socialism for the twenty-first century may have made the price worth paying.

In sum, inefficiency due to external effects is significant. Hope for reasonably accurate Pigovian correctives is a pipe dream. Market prices diverge ever more widely from true social opportunity costs as individuals have every reason to adjust their desires to accommodate significant institutional biases in the market system. Efficiency losses also mount as real markets become less competitive, with no sign of meaningful antitrust or regulatory correctives in sight. And, as financial regulation, stabilization policies, and industrial policies all fall out of vogue, efficiency losses due to market disequilibria escalate even further. At the dawn of the new millennium the invisible foot is gaining strength on the invisible hand every day. Meanwhile, market exchanges continue to empower those who are better off relative to those who are worse off—undermining economic and political democracy—and the antisocial biases and incentives inherent in the market system continue to tear away at the tenuous bonds that bind us to one another.

To avoid all this that inevitably comes with markets you must find an alternative way to coordinate the interrelated economic affairs of worker cooperatives and communal councils here in Venezuela that preserves their legitimate sphere of autonomy. I do not believe it is an exaggeration to say that at this moment the future of twenty-first century socialism rests on your shoulders. Once again, I salute you.
Hasta la victoria siempre!

Notes
1.   The Marxist theory of exploitation focuses on how capitalists exploit their employees as a whole. Here my concern is how labor markets generate unfair wage differentials, and why wage differentials will continue to be unfair in a market system even if there are no longer capitalist employers.
2.   Worker-owned cooperatives may well have goals other than maximizing profits per member, but as long as this is one of their concerns the argument holds.
3.   Most fail to understand how arbitrary differences in what neoclassical economists call the “marginal revenue product” of different categories of labor actually are. Not only do differences in talent, education, and training come into play, differences in the scarcity of different categories of labor are equally important in determining differences in marginal revenue products. Moreover, changes in technology and/or consumer preferences can increase or decrease marginal revenue products of different categories of labor as well. The important point is that all of these influences are largely beyond an individual’s control, and completely independent of the amount of effort an individual puts into his or her work.
4.   I have discussed only the effects of unequal ownership of human capital in a market system. Of course in a capitalist economy unequal ownership of physical capital leads to well-known inequities as well. But even if we replace capitalist enterprises with worker-owned enterprises, inequities from unequal ownership of physical capital will persist. In a market system members of cooperatives with more physical capital per worker will receive higher incomes, on average, than members of cooperatives with less physical capital per worker—even when all workers work equally hard.
5.   See Robin Hahnel, “Exploitation: A Modern Approach,” Review of Radical Political Economics 38, no. 2 (Fall 2006): 175–92, and Panic Rules! Everything You Need to Know About the Global Economy (Boston: South End Press, 1999): appendix B.

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