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No Log(ic)o

Perhaps the most sophisticated argument that markets “fail” is that two parties to a transaction are rarely privy to the same information (you can write down a problem where total ignorance is better than partial ignorance for market outcomes). In the presence of information asymmetries you would expect certain parties to be driven from the market. The “failure” in this case would be that there would be buyers and sellers whom would gladly exchange with one another in a full information setting, but the information constraints prevent this from happening in many situations.

Now, regular readers know I disapprove of the term “market failure” on the grounds that such problems are neither unique to markets and that calling them a failure is rather arbitrary. On the former, is it reasonable to think that one party to a transaction in a marriage, religious encounter, athletic competition, political action, family decision, etc. is not endowed with different information than other parties? Or course not. So calling information problems a market failure is as arbitrary as calling them marriage failures. On the latter, the sense that they are “failures” is in respect to a perfect market outcome. I find this ironic since isn’t it the anti-market folks who claim that when markets are working well (i.e. with no failures present) that they are leading to undesirable results? Why then would movements away from something that is undesirable be labeled a failure? Take the extremists who for example hate fossil fuels and any development that depends on using anything other than man or animal power. Don’t they argue that markets lead to “too much” externality producing activity? Wouldn’t they be happy that information asymmetries prevent certain parties from transacting? Furthermore, every potential opportunity to make an improvement in the world would be viewed as an existing “failure” in this lens. The lack of existence of the World Wide Web would, in 1945, have to be viewed as a market failure, a technology failure, a government failure. Something tells me that is not right.

But that is not the illogic I’d like to point out today. Folks who don’t like what I’ve said above would usually argue with me that I demand too much of people. That folks simply cannot think through the inconsistencies in the various positions they hold. Fine. We’ve pointed the above out before in many previous posts. Consider today instead the cadre of people who argue that capitalism promotes waste and destruction because of the extensive use of advertising. And ignore these non-examples of advertising that never occur outside of market settings.

Why do we have advertising? The easy answer is that it is used to overcome imperfections in the market. Market actors know that they would like to know more about the goods and services that are being bought and sold, and if information asymmetries make it hard for transactions to happen, there is a great big fat pile of cash on the table waiting for people who can overcome these information constraints. Hence not only do entrepreneurial organizations like Kelly Blue Book and Consumer Reports thrive to overcome these problems, but so too do various forms of advertising, which serve as signals to potential market participants about the reliability and quality of various products. Yes, it is likely that we have “too much” advertising, for reasons we will not discuss here. But there is a cadre of people who don’t merely argue that point, which we could reasonably agree upon. No. There is a cadre of people who argue that all advertising is unnecessary and in fact is ipso facto bad.

Fine. Let’s go with that. Because on net if we saw an end to all advertising, especially in politics, I think the tradeoff would be worth it. I have enough understanding of market forces to know that actors will find a way around that problem in the private sector. In the government sector, I don’t see how it would last. But think about the nature of anti-capitalist arguments now. If you want to go hard with the idea that advertising is totally wasteful and unnecessary, it has to be the case that you are also arguing, “Information Asymmetries are totally irrelevant in the market.” Now I suppose you can weasel out of this conclusion by arguing that they have in mind some other solution to the information problem, but then that takes me to the first point I made way at the top of this post. In other words, one of the strongest anti-market sentiments (really, a sentiment is all it is, it is not based on an actual developed literature of empirical evidence for it) is based on a faulty premise. Either market transactions are prone to crippling information asymmetries and therefore advertising is a necessary but regrettable way to overcome some of them; or, market transactions are not prone to cripplung asymmetries and therefore advertising is a complete unnecessary waste.

Which is it going to be? Of course, for the anti-market cadre, that question is that same as asking them, “if you had 7.27 pints of beer (organic of course) and you multiplied it by pi puppy yelps, would the light flicker or would the concave side of the emotions turn underground?

3 Responses to “No Log(ic)o”

  1. RIT_Rich says:

    This was an interesting post. The “issue” of information asymmetry isn’t necessarily an anti-market position, it’s just that it has been co-opted by every anti-market type as an argument for some “other” form of “control” (they don’t typically outright call for government, but they often talk about the necessity of “social norms” or some sort of sociological concept which baffles me, especially since it becomes painfully obvious that none of those people have ever read even the basic texts of econ, like Adam Smith).

    Personally I think the concept of information asymmetry is blown out of proportion, and is often misunderstood. It is blown out of proportion because of what you point out; there’s a lot of money to be made for information specialists. The history of the 20th century is essentially a history of the reduction in information asymmetries. But it is also misunderstood; Simon for example in explicitly identifying this problem, also identified that the firm itself was a mechanism for reducing information asymmetry; i.e. information asymmetry can be “crippling” at the individual level, but as we get more individuals who specialize within organizations, this problem becomes alleviated considerably. In my opinion it is misunderstood because it is applied across different levels of analysis under the original assumptions which were at the individual level of analysis (perhaps this error is not done as much in econ, but it is constantly done in management, for example).

  2. Alex Y says:

    Especially salient to a guy working in marketing. I have many discussions in a week and this voices many of my points perfectly.

  3. Tom Davis says:

    I think you’ve missed “their” point and so created straw-men. You are in fact defining market-failures according to a pro-market viewpoint, which is reasonable except when defending the market system itself. Which is what you are purporting to do.

    You give the “burning oil” example which clearly, for any of us who actually read journalistic publications about this issue, is termed a market-failure for the single reason that a market in oil for burning exists. Those so-called greens believe that any system which promotes or even allows such burning to occur is a failure for “the Earth”.

    Additionally, the anti-market extremists are not arguing that it’s information asymmetry that is the problem. Rather they do say that it is the artifacts of the market system — including selfishness, power mongering, and consumerism — that are the problems.

    The problem with our anti-market co-sojourners isn’t that they are particularly irrational (some certainly are just as some of us free-marketers are), but that they are ignorant. They don’t understand economics, which they think is about paper currency. And they don’t even keep a smattering of history in their brains. They don’t know that 100 years ago, people in this country still starved to death in the winter because of a bad harvest or torrential rains at harvest time. They don’t know that 100 years ago 90 percent of people in this country (as well as throughout the world) cooked over open wood fires (talk about inefficient carbon-dioxide producing heat sources).

    It doesn’t help anyone to refute arguments that no one has made.

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