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Thirty years ago a belief in the superiority of a market organization of economic activity triumphed. Now, the market is coming under serious and sustained attack. What has happened?
A superficial explanation is that the 2008 financial crisis destroyed confidence in the superiority of markets. However, the eclipse of the market is occurring for more fundamental reasons. This blog looks at those reasons.
In the post war world, market liberalism became an ideology; a comprehensive set of cultural beliefs framed in opposition to the contending ideology of Marxism.
It can however be viewed in non-ideological terms. There are two key components – an ethical component and an empirical component.
The ethical component is that we should respect the individual and treat individuals as though, in the first instance, they are best able to define their own wants, needs and goals in life for themselves. A market allows individuals to do so.
The empirical component is the assertion that markets actually perform better than other ways of trying to organize economic activity. The sum total of myriads of individual decisions will result in economically more advantageous outcomes overall, than any form of collective decision taking.
These two propositions do not mean, as sometimes alleged, that liberals regard the individual as detached from a social setting. Nor, do they exclude a role for collective decision taking.
However, these twin foundations do place the individual at the center of liberal thinking about social organization, for both ethical and empirical reasons.
Market liberalism and a rule based order
The placement of the individual at the centre of our way of thinking about social organization is sometimes expressed in terms of the virtues of ‘spontaneous’ order, or the ‘wisdom of crowds’.
However, integral to the mainstream of market liberal thinking is the importance of rules for getting the relationship right between markets and collective decision making.
For example, balanced budget rules restrain public spending and help prevent politicians from undermining the market. They also help to keep politicians from corrupting democratic politics itself, by making deceptive and unsustainable promises.
In addition, the market order is made more secure by placing monetary management outside the hands of politicians and into the hands of independent central bankers. They themselves will observe monetary rules consistent with price stability.
More generally, the rule of law is seen as a key underpinning both for the market and also for politics.
What is leading to the eclipse of liberalism is that this vision of the rules needed to maintain the relationship between markets and collective decision taking has become seriously outdated. Different institutions are needed both for the market and for collective decision taking.
Exit rule based management. Re-enter discretion
From around the mid 1980s, the world entered into what has been a prolonged and continuing period of low, or even negative, inflation sometimes referred to as ‘the great moderation’.
Initially, liberals could claim part of the credit for this change. Monetary rules and independent central banks seemed to be partly responsible. However, since the recession, central banks have been flying blind in a world of ‘unconventional’ monetary policies. They are continuing to fly blind, as central bank debt purchases are wound down, amid fears about over-indebted emerging markets and bursting asset bubbles. We are thus back to the days of discretion rather than rules.
In this evolution, discretion is now in the hands of central bankers rather than politicians. Possibly this shift in favour of experts is for the better in terms of the quality of economic management. Nevertheless, the lack of rules to steer by, undermines one of the key planks of market liberalism.
Fairness and intergenerational inequality
During this period the rich have done well. They were able to protect themselves during the recession. Since then, they have been major beneficiaries of rising equity markets and real estate prices. The losers have been many of those working in manufacturing, those losing jobs in the transformation of retail markets, and those priced out of house ownership. Inequalities in income and wealth have grown.
Fairness is typically seen as an essential ingredient for a democratic society. Yet, the kinds of rule based prescriptions for politics espoused by liberals seem largely irrelevant for addressing unfairness in income and wealth. On the contrary, fiscal rules promoting ‘austerity’ are seen as aggravating inequalities. Liberals therefore seem to be complicit in undermining an essential ingredient of democracies.
Market liberals do not deny that markets, left to themselves, will produce unequal outcomes. They assert however, that the weaknesses of collective judgment are such, that the attempt to impose a collective notion of ‘social justice’, is even more ethically dubious.
This assertion about the weaknesses in collective expressions of social justice remains valid in relation to some traditional forms of welfare provision. However, there are new concerns. They center on questions relating to the lack of inter-generational justice. These focus on the costs of education and reskilling at one end, and the costs of social care, pensions and health provision for aging populations at the other. Reshaping collective assistance seems part of the answer.
From prices to contracts
The assertion that markets lead to better outcomes than other forms of organization rested very heavily on the importance of prices. Prices were key in the efficient allocation of resources, in the transmission of individual preferences and the instrument for market search and discovery.
The emphasis on the role of price discovery led to a neglect of the importance of contracts. Yet in the financial crisis it became apparent that contracts were flawed. They were unclear, deceptive and sometimes fictitious and mendacious. They provided an unreliable platform for pricing.
Models of corporate governance, themselves an expression of a contractual relationship between company managers and its owners and its other stakeholders, were also seen as flawed.
Contracts are not only essential for pricing. They also serve as the foundation for institutional search – the search for institutional forms that best suit market relationships. These relationships may be between businesses, or between businesses and their individual clients, or between business and labour, or between the market and the public sector, or between managers and owners.
If contracts are flawed, so too are the institutions of the market.
The growth of contractual uncertainty has not simply been a problem for professional traders and investors in financial markets. It has also affected labour markets, health and pension provision and housing markets. Flawed contracts are also associated with failures in corporate governance. They are associated too with failed relationships between the public and private sectors – from the Grenfell Tower in the UK, to bridge collapses in Italy.
In liberal market theory, a restructuring of contracts will evolve from the search processes of the market itself. For example, new relationships will emerge in the labour market based around different forms of self-employment. Changes will arise in the housing market as the rental sector expands. There will be new forms of delivery in health and education. There will also emerge new forms of corporate governance.
However, the transition costs seem high. At the least, the case for some kind of collective oversight of the inevitable market frictions seems compelling.
Behavioural: augmented utility, information processing & role strain
In recent decades, market oriented economists have had to absorb important lessons from behavioural theory and social psychology.
Up to a point, the lessons have been taken on board in a way that is consistent with market liberalism. For example, it has been possible to move from depicting the individual as a person who simply ‘maximises’ self- interest, to a person who has a moral and emotional side to their character and who pursues a sense of ‘augmented utility’. The depiction of the individual is thus no longer one dimensional.
At the same time, market economists have also been able to absorb many of the lessons from social psychology that show how our everyday decision-taking relies on short cut methods that are often flawed. The findings seem to point in the direction of the importance of taking decisions that follow rules to counteract our biases. This is consistent with the predisposition of market liberals to look to rules.
However, there are limits. Market oriented economists have underestimated the extent to which people have difficulty in understanding and processing the information provided in markets. The findings about how we actually behave in making informed choices have reinforced what were already growing concerns among economists about the importance of information ‘asymmetries’ in the market. Competition between firms making different offers does not by itself produce fairness in relationships between a seller of goods and the customer or buyer.
Another limitation of the market perspective is that it oversimplifies the context in which people take their everyday decisions. In particular, the importance of what some social psychologists refer to as ‘role strain’ has been underestimated.
Busy people playing different roles in their lives as job-holders, child carers, household budget managers and civic activists often need to rely on benchmarks provided by others for guidance. These benchmarks on schooling, or health services, or consumer products are of growing importance. They help sort information relevant to our different roles and they help us navigate through a world of information overload.
Benchmarks may be provided by the market. They are also often provided by the inspectorates and regulators of the public sector. We rely on both. Their use and misuse has been discussed in a previous blog.
What is left?
The net effect of these changes means that we need to look again at how to express the relationship between markets and collective decision making.
The empirical justification for the superiority of markets seems undermined the need for oversight of changing contractual relationships in the market.
The ethical case also seems undermined by concerns over inter-generational equity, and the need to help ensure fair relationships in the market.
The return of discretionary economic management means that there are no simple rules to steer by.
What conclusions should we draw about how to rebalance relationships?
Despite all its flaws, the market still offers a directness of response to our wants and needs. It offers immediacy and personalization.
Collective decision-taking does not. It offers flawed methods of aggregation of our wants and needs, flawed representatives and flawed decision processes.
Thus, if we are to rebalance relationships between the market and collective decision-taking we have to update collective decision taking too. We need to focus on improving the institutions of democratic politics as much as on improving the institutions of the market.