Migrant mother. Dorothea Lang, 1936
Scholars such as Matt Ridley, Michael Shermer and Paul Rubin have been warning us about the dangers posed in trying to understand complex adaptive systems by our evolutionarily inherited folk minds, which tend to see the world in linear and zero‐sum terms.[1] In an environment where the gains of trade were unknown; division of labour and specialization rare and crude; those outside our tiny clan were obstacles to our own clan’s thriving, even surviving; and (even if it was only due to the lack of refrigeration technology) sharing the windfall of big game catches within our clan was the optimum survival strategy; any deviation from general equality was a reliable indicator of cheaters or free riders. It was only in the last hundred thousand years that humans began to trade and probably only in the last 40,000 years or so that such trade started to become a pervasive part of the human landscape.
Those trained in economic thinking have no problem understanding why, once trade got started, there was no going back. Through the circulation of goods, even in a zero‐sum setting, participants are better able to align resources with a more satisfying meeting of marginal utility preferences. Plus, of course, through the virtues of comparative advantage, trade can actually increase productivity, raise the traders into a positive‐sum game, and create even more opportunity for wealth. Yet, amazingly, all these millennia later, notwithstanding the virtues of trade that arguably were the very foundation of human civilization itself[2], and despite the constant long term growth and prosperity, an extraordinary number of people still cling on to the idea that somehow markets create poverty.
In Canada’s squishy social democratic culture, such views are prevalent. I encounter these views among my students every year, but I doubt one needs to be in a university classroom to find such thinking. Certainly, it’s treated as a priori truth in the overwhelmingly amount of discussion on the “public” broadcaster. Oh, certainly, many will concede, markets create wealth, but they also create poverty. The subsequent implication usually being that therefore the state is necessary for a just redistribution. Naturally, a whole line of libertarian critique is called forth by that reasoning, but in these remarks I want to get at the original error: that markets cause poverty. For the reasons cited above, I don’t believe there’s any mystery about why this view is so widely held, but anyone can train themselves to understand how complex adaptive systems, like markets, work – regardless how inorganically such thinking may come to us. So, confronting such confusions gets our foot in the door, as it were, in trying to expand the understanding of the anti‐market thinkers.
To anyone versed in the study of markets, the suggestion that they cause poverty seems immediately peculiar. In fact, quite the contrary, the tendency in markets is to move toward equilibrium. Given the opportunity, investment will move to where wages are low and profits are high; labour will move to where wages are high and working conditions are good; goods will move to places where demand is high and supply is low. In all these cases, though, the very movement to take advantage of the desired conditions tends to transform those conditions. For instance, as investment flees high wage zones for low wage zones, the demand for labour reduces in the former while increasing in the latter. At the same time, labour tends to move from low wage zones to high wages. The combined effect is that both a reduced demand and increased supply of labour in the high wage zones brings down wages, while the increase of demand and decrease of supply of labour in the low wage zone bids wages up. Likewise, areas with a stark scarcity of a particular good – say, subsequent to a natural disaster – will provide high prices for it and tends to draw that good into the area of scarcity from other areas, where prices are lower; yet the more of such goods that take advantage of the high price, the more supply becomes available, the greater the decrease in relative demand, and the further price falls.
Again, these are tendencies; there are always going to be exogenous factors that interfere with perfect equilibrium: environmental changes, shifts in consumer preferences, process or product innovation, natural and man‐made disasters, etc. But the tendency is not to create poverty, but reduce or eliminate it, as is obvious once one thinks through market dynamics. The poverty that we see around the world isn’t due to markets, but states, with their anti‐immigration laws, trade tariffs and investment regulations which constantly hinder these reparative market processes.
One reason for the persistent in this confusion over what markets are and how they work seems to be what we might call the snapshot fallacy. This fallacy operates in some other areas of confusion about markets: for instance, the idea that voluntary markets can generate monopoly. If we use the term literally (or even close to literally), a monopoly is an exclusive right to sell. Only states can use their own monopoly on coercion to provide such privilege to an enterprise. In voluntary markets, where there’s always the opportunity for free entry of new competitors, there is no monopoly – regardless of the size of the market share. The snapshot fallacy though it turns out fuels much of this confusion. One is frequently told about the small number of companies that “dominate” various industries. Of course, one only has to cite the numerous cases of firms that “dominated” their industry at one time that have completely disappeared from the business landscape since. In an interesting little table, Arnold Kling and Nick Schulz illustrate that on the Dow Jones – the listing of the most important stocks in the most important industries – in the century from 1907 (an era of great monopoly anxiety) to 2007 only one single firm has survived. And it, General Electric, did so by largely changing the focus of its business.[3]
So, it’s easy to see how the snapshot fallacy, looking at the market as a frozen moment in time, can create confusion. The same fallacy is seen to be at work when people say, ah, but of course markets create poverty, because they’re based on competition and inevitably some lose in that competition. Consequently, those investors go bankrupt and their workers are thrown into unemployment. Inevitably, poverty ensues and if it weren’t for the redistributive virtues of the state that poverty would be even worse. Again, this is just taking a snapshot at the moment that one or more companies indeed do go out of business. As with the case of “monopoly,” though, if we don’t look at the bigger picture, so to speak, our snapshot constrains our perception of what is really happening in such market processes. So, let’s consider more closely what is involved in such dynamics.
First, when such a business goes down, there is generally one of two reasons: either they were producing something that not enough people wanted or some other(s) outperformed them in producing what people did want. In the former case, the enterprise was unsustainable, not only in that what it was doing was not useful to enough people, but in attempting to pursue that enterprise, the firm was using up investment resources that could have been invested elsewhere, creating other jobs that were more productive and valued by more people and thus more sustainable. So, jobs that are lost in this process lead to a kind of displacement in that the resources can be invested elsewhere to create jobs that couldn’t exist while the resources were being misemployed in a doomed enterprise.
In the case where the firm was outcompeted, the situation is even more transparent. As the successful firm(s) move in to take up the market share of the defunct firm, they require further investment to meet the heightened demand and likewise more labour to employ the resources invested. In this situation, in fact, those working at the defunct firm may very well have the skills to put them at the front of line in applying for the new job openings at the successful firm(s). So, in both these cases, there is not a significant increase of unemployment – and therefore no reason to presume an increase of poverty – rather shifted investment simply allows the employment that does exist to better meet the needs of more people.
However, even that isn’t a sufficient response to the matter. When successful firms out‐compete failed ones, it is generally on the basis of one of two variables. Of course, in real life, there’s often a combination, situated somewhere along a spectrum, between these two. But, for simplicity’s sake, we can just call them the provision of a better product or a less expensive one. The provision of a better product is really just a subset of the earlier example, where the failed firm was producing an inadequately desired good. Here, the firm is producing an inadequately desired version of the same good. Again, the end of this unsatisfactory employment of resources – investment and labour – doesn’t contribute to heightened unemployment and increased poverty; it merely ensures the resources are employed in ways that meet the needs of more people.
The more important example, though, is the case of producing the good less expensively. This benefit, which is likely enhanced by gaining an increase of market share, allowing for benefits from expanded economies of scale (an effect that could also arise from gaining that market share through producing a more desired good), has salutary effects that spread through the entire economy. If the same product can be produced for a lower price, this has the impact of making all purchasers more productive. Just as in the case of comparative advantage, without any increase of effort or time, everyone who would want to buy this product is getting more for their own productivity as the decrease of price, over a period of time, actually allows them to purchase more of other goods than they would have been able to do at the higher price charged by the failed firm. Whether they in fact do buy other goods or simply save the difference, the consequence is a decrease of unemployed resources. If they spend the difference, they increase demand for other products, the producers of whom need to expand to meet the new demand. If they choose to save the difference, they contributed to the increase of supply of savings, lowering interest rates, and enable producers to access resources for expanding productive processes further removed from immediate sales. This too requires further investment and labour.
In this way, the failure of an uneconomical firm does not merely result in a shift of resources to the more economical ones, but actually contributes to an increase of overall production, causing an increase of new resources. New kinds of industries and jobs are created and existing ones expand. This is the virtue that arises from uneconomical firms going out of business. So, while the momentary snapshot gives the impression that this leads to unemployment and poverty, a better understanding of how complex, adaptive systems actually work allows us to recognize that these processes, far from increasing unemployment and poverty, actually work to decrease them.
Again, as with the examples above about the free movement of factors and goods, it is the state’s intervention – through monetary and fiscal policy, bailouts and the creation of monopoly privileges – that distorts these market processes, manipulating interest and the money supply, maintaining uneconomical firms for expedient electoral reasons, and accommodating anti‐competitive rent‐seeking efforts, that prevent the market’s natural anti‐poverty inclinations. It is more than a little ironic that the institutional remedies advocated by the market‐driven‐poverty position are precisely the kinds of anti‐market interventions that create the very poverty that they mistakenly attribute to the natural function of markets. Alas, such is the curse of living in a complex world with a caveman’s brain.
Notes:
- [1] Matt Ridley, The Rational Optimist (New York : Harper, 2010); Michael Shermer, The Mind of the Market (New York : Times Books, 2008); and Paul H. Rubin, Darwinian Politics (London: Rutgers University Press, 2002) ↩
- [2] Richard D. Horan et al. “How Trade Saved Humanity from Biological Exclusion,” Journal of Economic Behavior & Organization, 58 (1), September 2005, pages 1‐29. ↩
- [3] Arnold S. Kling and Nick Schulz, From Poverty to Prosperity (New York: Encounter, 2009) pp. 239, 242‐43. ↩
Tags: Arnold Kling, From Poverty to Prosperity, monopoly, Nick Schulz, Poverty, The Rational Optimist, trade
