hahnel. the case against markets.jei vol41n4 2007

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The author is a Professor of Economics at American University in Washington, D.C. and is currently a visiting

Professor at Lewis and Clark College in Portland, Oregon. His most recent book is Economic Justice and Democracy:

From Competition to Cooperation. Routledge, 2005.

1139

2007, Journal of Economic Issues

JOURNAL OF ECONOMIC ISSUES

Vol. XLI No. 4 December 2007

The Case Against Markets

Robin Hahnel

Markets are an efficient way of producing and distributing a very large

number of mundane items. Market incentives are a dependable way of

getting our bread baked. Markets allow us to make the best use of the

information dispersed throughout a society. Markets give their participants

a certain kind of freedom expanding the range of choices and giving each

person a variety of partners with whom to deal.

David Miller and Saul Estrin (1994)

Rather than efficiency machines, optimal incentive systems, cybernetic

miracles, and human liberators, when we examine markets we find

institutions that generate increasingly inefficient allocations of resources,

unleash socially destructive incentives unnecessarily, bias and obstruct the

flow of essential information for economic self-management, substitute

trivial for meaningful freedoms, and lead to irremediable inequities in the

distribution of goods and power.

Robin Hahnel and Michael Albert (1990)The debate between those who believe that markets are an integral part of a desirable

economy and those who believe we must eventually replace the market system with

some kind of democratic planning is long standing. By the end of the twentieth

century, supporters of markets had the upper hand for obvious reasons. (1) The

demise of central planning not only in the Soviet Union and Eastern Europe, but in

China, Vietnam, and Cuba (to a lesser degree) casts a pall over any talk of

comprehensively planning how best to use productive resources. (2) In Western

Europe and the United States, the free market jubilee began in the 1980s when

Margaret Thatcher and Helmut Kohl defeated social democracy in Europe and


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1140 Robin Hahnel

Ronald Reagan put liberals in the United States on the run. (3) When social

democrats regained power in Germany and Great Britain, and Democrats won back

the White House in the 1990s, instead of reigning in market mania Tony Blair,

Gerhard Schroeder, and Bill Clinton routed progressive forces inside their own

parties, promoted pro-market, third way domestic policies, and directed the IMF

(International Monetary Fund), WTO (World Trade Organization), and World Bank

to force free market medicine down the throat of one third world country after

another. (4) In the aftermath of the East Asian financial crisis even mighty Japan Inc.

and other Asian tigers like South Korea were forced to bow to the market gods they

had long held at bay, and abandon their highly successful Asian model of long-run

international economic planning.

Consequently, by centurys end, to speak ill of markets narrowed ones access

to ears, and progressive economists quickly learned how to reformulate criticisms as

suggestions about improving market performance. Any hint that one considered

markets to be part of the problem rather than the key to the solution to any economic

problem was sure to blow ones cover in the economics profession as well as policy

circles. Proclaiming oneself a market abolitionist at the dawn of the new

millennium was tantamount to a plea of insanity.

But, while it is easy to see why the shrinking circle of progressive economists

with lingering doubts about markets have been cowed into silence, none of the above

reasons have any logical bearing on the positive and negative aspects of either

markets or democratic planning. Market performance is not enhanced by the collapse

of central planning or by an increase in ideological hegemony of those who sing in

praise of markets. Nor does the demise of authoritarian planning mean that

democratic planning is also a bad idea. As a matter of fact, one reading of the

empirical evidence of market performance over the past thirty years is that when

constraints on markets are weakened, the damage to human livelihoods and the

environment increases dramatically. In any case, having no cover left to blow, I take

this opportunity to reiterate the theoretical case against the market system.1

The debate between those who favor the market system and those who favor

democratic planning has always consisted of two parts: (1) How bad are markets? And,

(2) is there a feasible alternative that is any better? I make no attempt to address the

second question in this article having done so elsewhere (Albert and Hahnel 1991a;

1991b; 1992a; 1992b; and 2002; and most recently, Hahnel 2005, where I go to great

lengths to respond to important concerns others have raised about democratic

planning.) In this article, I also make no attempt to explain why markets inevitably

reward people unfairly. I refer readers to Hahnel (2004) for the case against markets

on equity grounds, and why I do not believe correctives would be forthcoming even in

market socialist economies. In this article, I confine myself to arguing that contrary

to both popular and professional opinion, there is every reason to believe that

markets allocate resources very inefficiently and undermine rather than promote

democracy. I also reiterate the case that markets are perhaps the most socially

destructive institution ever devised by the human species.


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The Case Against Markets 1141

Why Markets Are Inefficient

It is well known among professional economists that markets allocate resources

inefficiently when they are out of equilibrium, when they are non-competitive, and

when there are external effects. When the fundamental theorem of welfare economics

is read critically it says as much: Only ifthere are no external effects, only ifall markets

are competitive, and only when all markets are in equilibrium is it true that a market

economy will yield a Pareto optimal outcome. But despite these clear warnings,

market enthusiasts insist that if left alone markets generally allocate resources very

efficiently. This conclusion can only be true if: (1) disequilibrating forces are weak,

(2) non-competitive market structures are uncommon, and (3) externalities are the

exception, rather than the rule. I will offer theoretical reasons to believe exactly the

opposite in all three cases. A second line of defense holds that while free markets may

be plagued by inefficiencies, it is possible to socialize markets through various policy

correctives and thereby render them reasonably efficient. While I generally support

policies to ameliorate market inefficiencies, I will offer practical reasons why it is a

pipe dream to believe that such policies could ever render market systems

reasonably efficient.

Why Externalities Are Likely To Be Pervasive

Markets permit people to interact in ways that are convenient and mutually

beneficial for buyers and sellers. Market exchanges are convenient whenever

transaction costs of exchanges are low which is the case when those others than the

buyer and seller are excluded from the transaction. And, it is a tautology that any

voluntary agreement is mutually beneficial under the assumptions of rationality and

perfect knowledge. While knowledge (which includes foresight) and rationality are

seldom perfect, I am happy to stipulate that both are often good enough so that

market exchanges are frequently beneficial to both buyer and seller. But convenience

and benefits for buyer and seller do not imply social efficiency. Ironically, the veryfactors that render markets convenient and beneficial for buyers and sellers also

render them socially inefficient.

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 asassiduously. Of course the problem is, 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. When

sellers (or buyers) promote their private interests by externalizing costs onto those not

party to the market exchange, or by appropriating benefits from other parties without


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1142 Robin Hahnel

compensation, their behavior introduces inefficiencies that lead to a misallocation of

productive resources, and consequently, a decrease in the value of goods and services

produced in the economy.

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. Two exceptions are Ralph dArge and E.K. Hunt (1971; Hunt and

dArge 1973; and Hunt 1980), who coined the less famous, but equally appropriate

term, invisible foot to describe the socially counter productive 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 ones 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 counter productive

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 small transaction costs 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 little but different 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 either over or under exaggerate? Ronald

Coase (1960) recognized these transaction cost and free rider problems associated

with forming a voluntary coalition of pollution victims when he explicitly stipulated

that his argument for the efficacy of private negotiations between polluters and


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pollution victims applied only to situations where there was a single pollution victim

and not to situations where there were multiple victims. Nor can we solve the free

rider and hold out incentive problems inherent in organizing a coalition of those who

are negatively affected by car production and consumption by awarding them the

property right not to be victimized without their consent. As Coase also

demonstrated convincingly, efficiency or in this case, inefficiency depends solely

on incentives, and is unaffected by whether victims of external effects possess the

property right not to be victimized, or those whose behavior negatively affects others

have the legal right to do so. Who has the property right merely determines who must

approach and bribe whom; it does not change the fact that when there are multiple

victims they face formidable transaction costs, and, free rider and hold out incentive

problems to acting collectively.

It should be noted that the opportunity for buyers and sellers to benefit at

the expense of external parties is not eliminated by making markets perfectly

competitive or entry costless, as is commonly assumed.2 Even if there were countless

perfectly informed sellers and buyers in every market, even if the appearance of the

slightest differences in average profit rates in different industries induced

instantaneous self-correcting entries and exits of firms, even if every buyer were

equally powerful as every seller in other words, even if we embrace the full fantasy of

market enthusiasts as long as there are numerous external parties with small but

unequal interests in market transactions, those external parties will face greatertransaction cost and free rider obstacles to a full and effective representation of their

collective interest than that faced by the buyer and seller in the market exchange.

If we include the free rider and hold out incentive problems faced by

external parties as part of their overall transaction costs, 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 powerfulopponent 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 can be considerable compared

to the interests of the buyer and the seller.3 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 social inefficiencies.In sum, a sufficient condition for buyers and sellers to have the opportunity

to profit in socially counter productive ways by shifting costs onto others is that each

one of us has diffuse interests that make us affected external parties to many

exchanges in which we are neither buyer nor seller. Even if we could make every

market perfectly competitive and thereby eliminate any power imbalance between

buyers and sellers, this source of market inefficiency would persist.


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1144 Robin Hahnel

Why Markets Become Less Competitive

Not every buyer and seller is equally powerful in real world markets. Many

markets are non-competitive, i.e. there are sufficiently few sellers or buyers, so one

party to a market exchange has greater bargaining power than the other. It is well

known that when sellers are few it is in their individual interest to produce an output

that is, collectively, less than is socially optimal.4 Assuming equal cost structures a

rational monopolist will restrict output the most below socially optimal levels.

Rational duopolists will jointly produce more than a rational monopolist, but still less

than the socially optimal level. A three firm oligopoly will produce more than a

duopoly, but less than the socially optimal level nonetheless, etc. 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 to make profits through non-

competitive behavior than socially productive behavior. When a few large powerful

players on one side of a market exchange, face many small powerless players on the

other side, it is often more sensible for large players to pursue socially counter

productive strategies to take advantage of their weaker market opponents than it is for

them to search for ways to increase the size of the economic pie or reduce the time

and discomfort necessary to bake it. In the real world there are consumers with little

information, time, or means to defend their interests against huge, corporate

producers. There are small, capital-poor, innovative firms for giants like IBM and

Microsoft to buy up instead of tackling the hard work of innovation themselves. Non-

competitive market structures give rise to highly profitable, but socially counter

productive behavior.

In The Transformation of American Capitalism, John Munkirs provides

overwhelming evidence to refute the myth that the U.S. market system remotely

resembled the fantasy world of perfect competition prior to 1980. By 1980, most

U.S. GDP was already produced by firms operating in non-competitive markets. Since

then, U.S. business has gone through a prolonged merger mania, which has

dramatically increased what Michael Kalecki called the degree of monopoly in the

economy. Using weighted concentration ratios for the entire economy, Frederick

Pryor argued that industrial concentration decreased in the United States from 1960

to the early 1980s but has increased ever since as merger waves more than offset

counteracting effects from imports and the growth of information technology in

production (Pryor 2001). According to Danaher and Mark (2003, 3) between 1998

and 2000 alone, the U.S. economy witnessed $4 trillion in mergers. According to

Hartmann (2002, 37) the largest 1,000 companies account for about 70% of U.S.

GDP.

In sum, more markets have become non-competitive, and markets that were

already not competitive have become even less so. As anti-trust legal actions declined

and regulation of non-competitive industries diminished, it has become ever easier to

profit by taking advantage of non-competitive market structures in socially counter

productive ways instead of tackling the difficult job of increasing the value of goods

produced or reducing the sacrifices necessary to make them.


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Why Markets Do Not Always 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 questionable, implicit 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. Or, more precisely, standard reasoning assumes that when a market

price rises, buyers and sellers assume that price is just as likely to fall from this new

higher price as it is to rise further. 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 forbuyers 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. This means that 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.

Standard textbook treatments try to salvage the laws of supply and demandin face of these seemingly anomalous outcomes by interpreting them as the result of

changes in the expectations of buyers and sellers that shift the supply and demand

curves. In the standard explanation, both before and after the shift, the supply curve

slopes upward and the demand curve slopes downward, i.e., at all times they obey the

laws of supply and demand. It is the shift that causes the seemingly anomalous

result that the quantity actually demanded responds positively to changes in price

while the quantity actually supplied responds negatively to changes in price. It is

certainly true that the anomalous behavior results from changes in expectations, but

what textbooks invariably fail to point out is that the standard interpretation rendersthe laws of supply and demand unfalsifiable. In any case, however one chooses to

interpret the phenomenon, it is clear that market bubbles and crashes can result from

behavior on the part of individual buyers and sellers that is perfectly rational when

they interpret a change in price as an indication of the direction the price is headed,


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1146 Robin Hahnel

and that this behavior leads to movement away from, rather than toward the market

equilibrium.

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, those who believe 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 this case, it would appear unlikely we would have well ordered markets,

which require actors who engage in arbitrage, without speculative players being

present as well. The view that we have many well ordered markets free from

speculative players and the kind of problems they bring, and only need worry about

problematic disequilibrating forces in a small number of speculative markets may be

difficult to justify upon close examination. What we may have instead are some

markets that suffer from allocative inefficiencies because the same good often sells for

different prices for lack of sufficient players engaged in arbitrage, and other markets

immune from this problem because there are enough players engaged in arbitrage, but

prone to disequilibrating forces because actors engaged in arbitrage are also prone to

price speculation, yielding a different kind of inefficiency. An exciting new area for

theoretical research about market dynamics is to use agent based simulation modeling

techniques to explore outcomes where some market participants interpret price

changes as signals while others assume new prices will remain stable. This research

threatens to call into question what it means to say a market is well-ordered or a

price is consistent with market fundamentals.

Even when equilibrating forces outweigh disequilibrating forces in a single,

isolated market, when equilibration is not instantaneous which it seldom is it is

possible for disequilibrating dynamics to operate between two connected markets.

Keynes greatest insight about self-reinforcing recessionary dynamics can be framed in

these terms.5 Consider a labor market and a goods market. Assume that if either

market is out of equilibrium the excess supply or excess demand in that market will

eventually lead to wage or price adjustments leading that market to its equilibrium.Now assume that while the goods market is initially in equilibrium, the labor market

is not because the wage rate is temporarily higher than the equilibrium wage. While

the excess supply in the labor market will generate equilibrating forces pushing the

wage rate down toward its equilibrium, suppose it does not reach its equilibrium

immediately, and in the meantime labor contracts are struck at a wage rate that is still


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higher than the equilibrium wage. If the labor demand curve is elastic this will result

in lower labor income than would have been the case if the wage rate had reached its

equilibrium. But the demand curve in the goods market was premised on the

(implicit) assumption that the labor market was in equilibrium, and therefore that

labor income was higher than it actually will be. When we reconstruct the demand

curve in the goods market based on the actual outcome in the labor market, where

labor income is lower than it would have been had the labor market been in

equilibrium, we get an actual goods demand curve to the left of the one anticipated.

No matter how quickly or slowly the price in the goods market adjusts to the resulting

excess supply, we will get a drop in sales and revenues in the goods market.

But lower sales and revenues in the goods market will decrease the demand

for labor in the labor market. The demand curve we originally drew in the labor

market was premised on the (implicit) assumption that we had reached the

equilibrium outcome in the goods market. Now that sales and revenues are lower in

the goods market, when we reconstruct the demand for labor curve based on the new,

actual outcome in the goods market, we get a new demand for labor curve to the left

of the initial one. No matter how quickly or slowly the wage rate adjusts to the new

excess supply, employment and labor income will drop, further depressing the actual

demand for goods in the goods market. Instead of remaining in equilibrium in the

goods market and moving toward the higher, equilibrium level of employment in the

labor market, we move out of equilibrium in the goods market and even farther away

from equilibrium levels of employment in the labor market. In general when price

adjustments are not instantaneous, and false trading takes place at non-equilibrium

prices, we can easily get disequilibrating dynamics operating between interconnected

markets.

Sufficient conditions to give rise to this kind of disequilibrating dynamic

between connected markets are: (1) One market must be temporarily out of

equilibrium in the first place. (The second market can begin in equilibrium.) (2) The

price in the market out of equilibrium can adjust, but must not adjust instantaneously

to its equilibrium level so that some contracting takes place at a non-equilibrium

price. (In the second market price adjustment can be instantaneous.) (3) The demand

curve in the market that began out of equilibrium must be elastic. These highly

plausible conditions can give rise to disequilibrating dynamics between markets that

would not have displayed the kind of disequilibrating dynamics on their own

described previously.

In sum, while every economics text book explains how self interested

behavior of buyers and sellers leads to equilibrating price adjustments whenever there

is excess supply or demand in a market, they devote little if any attention to the study

of disequilibrating forces which are also the product of self-interested behavior by

market participants, and which frequently overpower the equilibrating forces Adam

Smith made famous hundreds of years ago.


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1148 Robin Hahnel

Practical Problems with Policy Correctives

When reminded of the important qualifying assumptions that are integral to the

fundamental theorem of welfare economics and when faced with theoretical reasons

to believe that externalities, non-competitive market structures and disequilibrium

dynamics are neither rare nor trivial problems, supporters of the market system

respond in different ways. There is an increasingly 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 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 in fundamental

welfare theorems and the Coase theorem as if they did not exist. Market pragmatists,

on the other hand, concede that we must socialize markets with policies not only to

reduce inequities but to internalize external effects, curb monopolistic practices, and

counter disequilibrating forces as well. Some of these pragmatists are even cognizant

of Karl Polanyis insight that the market system cannot function without institutional

support, which cannot be willed into existence over night, and understand that how

well or badly a market system will function depends to a great extent on the social

institutions that support it. However, I believe those who give qualified support to

socialized markets conveniently ignore a number of practical problems that

inevitably arise whenever we attempt to socialize them.

The job of correcting for external effects is daunting, because they are the rulerather than the exception. As E.K. Hunt explained:

The Achilles heel of welfare economics is its treatment of

externalities. . . . When reference is made to externalities, one

usually takes as a typical example an upwind factory that emits large

quantities of sulfur oxides and particulate matter inducing rising

probabilities of emphysema, lung cancer, and other respiratory

diseases to residents downwind, or a strip-mining operation that

leaves an irreparable aesthetic scar on the countryside. The fact is,

however, that most of the millions of acts of production and

consumption in which we daily engage involve externalities. In a

market economy any action of one individual or enterprise which

induces pleasure or pain to any other individual or enterprise

constitutes an externality. Since the vast majority of productive and

consumptive acts are social, i.e., to some degree they involve more

than one person, it follows that they will involve externalities. Our

table manners in a restaurant, the general appearance of our house,

our yard or our person, our personal hygiene, the route we pick for a

joy ride, the time of day we mow our lawn, or nearly any one of the

thousands of ordinary daily acts, all affect, to some degree, the

pleasures or happiness of others. The fact is externalities are totally

pervasive. (Hunt 1980)


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In the previous section I merely attempted to bolster Hunts claim with theoretical

arguments explaining why competitive pressures that steer market participants toward

the least line of resistance for advancing their personal situations is prone to lead

them to frequently take advantage of easily disenfranchised external parties.

The popular impression that the Coase theorem proves that government

intervention is unnecessary to correct for inefficiencies due to external effects because

once property rights are clear, private negotiations between polluters and pollution

victims will lead to efficient outcomes is completely misinformed. Most importantly,

Coase (1960) himself explicitly stated that he was only considering situations where

there was a single pollution victim. Moreover, Coase recognized that whenever there

were multiple pollution victims there would be transaction cost and free rider

problems for pollution victims that would in all likelihood preclude them from the

kind of negotiation he discussed. Those who cite his theorem to argue against

government intervention conveniently ignore the critical assumption that there is only

a single pollution victim.6 Furthermore, it turns out on careful examination that the

so-called Coase theorem hinges on the highly implausible assumption that both

parties to the negotiations have what game theorists call complete information

i.e., that each party knows not only what her own marginal benefit or marginal

damage curve looks like, but what the curve of her opponent looks like as well.

Whenever this is not the case it turns out that parties have an incentive to deceive

their opponents in ways that will predictably lead to inefficient outcomes. Since it is

seldom the case that a polluter will know how much a victim is damaged, or a victim

will know how much a polluter benefits from pollution, the conclusion that private

negotiations between a polluter and even a single victim will lead to an efficient level

of pollution does not follow in general.7 In other words, when rigorously examined

the Coase theorem provides overwhelming reasons to believe that most external

effects will go uncorrected through private negotiations between affected parties

exactly the opposite of what free market environmentalists insist.

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. Moreover, Pigou also taught us

that the corrective tax or subsidy should be set equal to the magnitude of the external

effect. But how are we to know what the size of the external effect is? It is hard to

calculate accurate corrective, or Pigovian taxes and subsidies because there are no

convenient or reliable procedures in market economies for estimating the magnitudes

of external effects. In this crucial regard, the market offers no assistance whatsoever

forcing us to resort to what are inevitably very imperfect measures. The most commonmethod of estimating the size of external effects in market economies lies with

willingness to pay and willingness to accept damage contingent valuation surveys.

But unfortunately, contingent valuation surveys have well known biases that can be

exploited by special interests, and efforts to reduce hypothetical bias necessarily

increase strategic bias, and attempts to diminish ignorance bias necessarily


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1150 Robin Hahnel

increase imbedded bias. Moreover, estimates derived from willingness to accept

damage surveys are on average four times higher than estimates derived from

willingness to pay surveys, even though, in theory, they should yield roughly similar

results. This hardly breeds confidence in the accuracy of contingent valuation surveys

in general, and provides interested parties with ample opportunities to object to

estimates that disadvantage them and finance alternative studies that give widely

different results. While popular among economists, it is well known that hedonic

regression studies are inherently incapable of capturing two entire categories of

external effects existence value and option value rendering them unsuited to

providing accurate estimates of the full range of external effects. Moreover, these are

only some of the practical problems of estimating external effects. Beneath these

practical problems lurk deeper questions of what is invariably lost when we attempt to

monetize environmental benefits and when we fail to critically evaluate the origins of

the preferences our stop-gap techniques try to estimate. William Kapp and Gregory

Hayden are two who have warned of more fundamental problems with standard

procedures used to account for external effects (Kapp 1950; Hayden 1983; 1988;

2006; and Eberle and Hayden 1991.).

Because they are unevenly dispersed throughout the industrial matrix, the task of

correcting the entire price system for the direct and indirect effects of externalities is

even more daunting. Even if the external effects of producing or consuming a

particular good were estimated accurately, if the external effects of producing or

consuming goods that enter into the production of the good in question are not also

accurate, 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 in most cases, even if

they could be accurately calculated.

A central tenant of evolutionary economics is that peoples preferences do not

fall from the sky but are instead formed and molded by social institutions

including our major economic institutions. Thorstein Veblens famous caricature of

the hedonic calculus was intended to drive this point home. The conviction that

preferences and values are formed by social processes requiring analysis rather thangiven, has played a central role in the contributions of luminaries like Gunnar Myrdal,

John Kenneth Galbraith, and John Dewey to disparate fields of economic study. More

recently, I have argued that if we believe consumer preferences are endogenous, then

we should expect the degree of misallocation that results from predictable under

correction for external effects to increase or snowball over time (Hahnel 2001). To


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the extent that peoples preferences are endogenous, they will 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 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 counter productive and inefficient

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 under

produce. As people have greater opportunities to adjust over longer periods of time,

the degree of inefficiency in the economy will grow or snowball.8 A rigorous

modeling of endogenous preferences helps clarify the mechanism through which

institutional biases affect what preferences people will choose to develop and what

preferences they will not choose to develop, and captures the subtle dynamic of

individually rational self-warping that I believe forms a crucial part of the core of the

evolutionary economics perspective.

In theory, inefficiencies due to non-competitive market structures can be solved

by breaking up large firms, i.e. through anti-trust policy. But sometimes there are good

reasons not to do so. When there are significant technological economies of scale thatsmaller firms cannot take advantage of, the loss of technological efficiency may be

greater than the gain in allocative efficiency from breaking up large firms to increase

market competition.9 But in many cases large firms are not broken up even when

there are no legitimate economic reasons for failing to do so. They are not broken up

simply because large firms are politically powerful and successfully pressure the

political system to permit them to continue their profitable but socially inefficient

practices. Unfortunately, anti-trust policy is in serious decline in the United States as

opponents argue ever more successfully that failure of other national governments to

embrace anti-trust policy limits the ability of the U.S. government to subject our largecorporations to vigorous anti-trust prosecution without crippling the ability of U.S.

corporations to compete against foreign behemoths. An alternative to anti-trust action

is to regulate the behavior of large firms in non-competitive industries. 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 (Munkirs 1985).

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.


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1152 Robin Hahnel

Unfortunately, these policies have all fallen into disfavor over the past two decades

not only among conservatives but among new Democrats in the United States and

among new wave social democrats in Europe as well. Both national economies and

the global economy have experienced huge losses in economic efficiency as a result

(Hahnel 1999).

Why Markets Undermine the Ties that Bind Us

In effect, markets say to us: You humans cannot consciously coordinate your

interrelated economic activities efficiently, so dont even try. You cannot come to

equitable agreements among yourselves, so dont even try. Just thank your lucky stars

that even such a hopelessly socially challenged species such as yourselves can still

benefit from a division of labor, thanks to the miracle of the market system. In effect,

markets are a decision to punt in the game of human economic relations 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 a market abolitionist such as myself

on this matter. Samuel Bowles, who strongly supports a socialized market system,

provides eloquent testimony regarding this failure of markets.

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 Pareto-optimal 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 undemocraticstructure of power or if it rewarded greed, opportunism, political

passivity, and indifference toward others. The central idea here is

that our evaluation of markets and with it the concept of market

failure must be expanded to include the effects of markets on both

the structure of power and the process of human development. . . .


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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 hardheaded adaptation to the

infirmity of human nature may in fact be part of the problem.

(Bowles 1991, 11-13)

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-old MBA (Master of Business Administration)

employees of multinational financial companies trading foreign currencies, bonds,

and stocks in their New York and London offices affect the economic livelihoods ofbillions 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 explains:

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 thesubject 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


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1154 Robin Hahnel

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.(Bowles 1991, 16)

Second, the more wealthy, generally benefit more than the less wealthy from

free market exchanges even when markets are competitive. 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.10

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, and focus instead on less important effects. 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 CEOs (Chief Executive Officers) of multinational

corporations and multinational banks, the new global mandarins at the World Bank

and IMF, and the chairs of adjudication commissions for NAFTA (North American

Free Trade Act) and the WTO, 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.11

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, pre-capitalist obstacles to democratic rule.

The question, however, is not whether markets undermined old structures of

domination which they clearly did 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 democracy has made to

the rise of the market system would take me too far a field and require more historical

knowledge than I pretend to have.


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Commercial Values vs. Equitable Cooperation

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 (quoted in Arrow 1997,

757). Thomas Carlyle (1847, 235) warned: 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. (Marx 1955, Chapter 1, Section 1)

More recently, Robert Kuttner (1997) has bemoaned the fact that the labor market is

becoming even more market like: Most of us recognize work as a central source of

our identity and livelihood, a valued (or resented) affiliation, and sometimes a calling.

But today, downsizing, out-sourcing, leveraged buyouts, relocations, and contingent

employment are reshaping the labor market into a product market where customers employers can buy labor for only as long as they need it. And Margaret Jane Radin

(1996) has argued that treating every activity as a commodity is deeply offensive at

some level to all of us. Her book received sufficient attention to provoke no less than

Kenneth Arrow to respond with a book review in the Journal of Economic Literature

(June 1997) to what he called the oldest critique of economic thinking. As Arrow

presents them, both Radins concern and her recommendation are remarkably mild.

Her target is related to but perhaps a little different from that of the

nineteenth century critics. They were primarily concerned with socialrelations; the market was in theory and practice replacing all social

relations. Radin is somewhat more in the spirit of individualism. Her

concern is that actions which are essential to personal identity fall

under the sway of the market. . . . A basic part of her approach is

the notion of incomplete commodification, recognition that some


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1156 Robin Hahnel

form of purchase and sale is called for but with restrictions of one

kind or another. (Arrow 1997, 758)

Arrows response to her concern and suggestion was blunt: The market is not

something one need enter. A corner equilibrium is a perfectly reasonable outcome

even under conditions of full commensurability and fungibility (Arrow 1997, 761).

However, it is not true that individuals are free to take markets or leave

them. If access to the fruits of economic cooperation are available only through

participation in markets, then while true that anyone can choose to be an outcast, one

does so at great personal cost. How many of us living in a market economy are going

to refuse to buy and sell? What the older, and in my view more important critique of

markets amounts to, is an objection to the organization of economic cooperation in a

way that is not only personally distasteful and demeaning robs us of our

personhood as Radin puts it but 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. In terms Arrow surely understands, markets are a matter of

social, not individual choice, and like all social institutions, markets provide

incentives that promote some kinds of behavior and discourage others. In essence,

what any economic institution does is reduce the transaction costs of engaging in

certain kinds of economic behavior. But as we saw above, while markets reduce

transaction costs for individuals seeking to buy and sell from one another, markets

leave formidable transaction costs for external parties seeking to express their

collective interest. In other words, markets are biased in favor of individual

negotiations between two parties, and biased against collective negotiations among

multiple parties, leading to predictable inefficiencies. Moreover, since the forms of

interaction that are encouraged are mean spirited and hostile, and the forms of

cooperation that are discouraged are respectful and empathetic, the detrimental

effects on human relations are far from trivial.

Conclusion

The degree of allocative inefficiency due to external effects is significant. Hope for

reasonably accurate Pigovian correctives is probably a pipe dream. Market prices

diverge ever more widely from true social opportunity costs as individual consumers,

whose preferences are endogenous to some extent, rationally 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 anti-

trust or regulatory correctives in sight. And, as financial regulation, stabilization

policies, and industrial policies all fall out of vogue, efficiency losses due to marketdisequilibria escalate even further. In sum, 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 anti-social

biases and incentives inherent in the market system continue to tear away at the

tenuous bonds that bind us to one another.


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Notes

1. To sharpen debate I have often described myself as a market abolitionist. By this I do not mean that

I call for the abolition of markets tomorrow. I am fully aware that markets are here to stay for theforeseeable future. What I mean is that I do not believe markets have any role to play in a truly

desirable economy, i.e. that our long run goal should be to replace markets entirely with some kind of

democratic planning.

2. Political economists who developed the conflict theory of the firm had to overcome a similar

misconception about labor markets. Profit maximization requires employers to choose inefficient

technologies if they enhance employer bargaining power sufficiently even if labor markets are perfectly

competitive. In other words, making labor markets perfectly competitive does not eliminate socially

counter productive behavior regarding the selection or rejection of new technologies. See Hahnel and

Albert 1990, chapter 8.

3. Note that the magnitude of the effect on a single external party compared to the effect on the buyer

and seller is not the relevant issue. The effects on individual external parties are almost always smallcompared to the effects on buyers and sellers. But it is the magnitude of the effects on ALL external

parties summed together, compared to the effect on the buyer and seller that determines whether or

not external effects lead to a significant misallocation of resources. In a 1998 report, the Center for

Technology Assessment estimated that when external effects are taken into account the true social

cost of a gallon of gasoline consumed in the United States might have been as high as $15. When the

report was published I was paying $1.50 a gallon in southern Maryland, which already included some

hefty taxes. Obviously they were not hefty enough!

4. Similarly, when buyers are few it is in their interest to demand, collectively, less than is socially

optimal.

5. Axel Leijonhufvud (1967; 1968) was among the first to interpret the insights of Keynes in this

insightful way. He and others went on to develop a Post-Walrasian school of macroeconomic theory

emphasizing the importance of quantity as well as price adjustments and exploring the consequences

of false trading which unfortunately, is not covered in most graduate level macroeconomic

curricula today.

6. I gladly offer those who call themselves free market environmentalists the following deal: I, for my

part, will concede that the government should not bother to get involved in cases where there is only

a single victim of pollution, if they, for their part, will drop their objections to government

intervention whenever there are multiple pollution victims.

7. In competitive market interactions, efficiency does not hinge on buyers knowing anything at all about

the costs of suppliers, or sellers knowing anything about the benefits to buyers because buyers and

sellers are both price takers. However, there is no market in the situation Coase examines, and neither

party is a price taker. There are negotiations between a single polluter and a single victim, and what

each thinks the others marginal benefit or damage curve looks like has a significant impact on likely

outcomes. When the curve of the party with the property right is unknown to the other party, the

party with the property right can benefit greatly by misrepresenting their situation. Moreover, when

they do so the predictable outcome of the negotiations is far from the efficient level of pollution.

Coases implicit assumption that both parties operate with complete information about the

situation of the other greatly exceeds the traditional assumption that those who participate in markets

have perfect self- knowledge regarding their own costs and benefits and the market price, and is far less

plausible (see Hahnel and Sheeran, forthcoming).

8. For a rigorous demonstration that endogenous preferences imply snowballing inefficiency when there

are market externalities see Hahnel and Albert 1990, theorem 6.6 and theorems 7.1 and 7.2.

9. Neither financial nor advertising economies of scale are valid reasons for failing to break up large

firms. Only true technological economies of scale provide efficiency reasons for allowing markets toremain uncompetitive.

10. See chapter 3 in Hahnel 2002; Appendix B in Hahnel 1999; and Hahnel 2006 for simple models that

demonstrate how and why those who are better off in the first place will usually be able to capture the

lions share of efficiency gains that result from exchanges even when markets are competitive.

11. Prior to the arrival of Europeans in the Western hemisphere, some more powerful indigenous tribes

and nations oppressed less powerful ones. While European colonization did remove old obstacles to


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1158 Robin Hahnel

self-determination for some indigenous groups by weakening their native oppressors, I know of no

example where the sovereignty of any indigenous tribe or nation was ultimately advanced by the

European conquest. I think this analogy is apt when considering the supposed liberating effects of

marketization on oppressed sectors in traditional societies.

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