In my last post, it appeared that my younger self didn’t think too much of money. That would certainly be a minority view, indeed we think an awful lot of money. This put me in mind of the opening of Douglas Adams‘ The Hitchhiker’s Guide to the Galaxy, describing life on Earth:
This planet has – or rather had – a problem, which was this: most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movements of small green pieces of paper, which is odd because on the whole it wasn’t the small green pieces of paper that were unhappy.
The most memorable part of the book is when the Answer to the Ultimate Question of Life, the Universe and Everything is revealed by a supercomputer to be… 42. The trouble is, no one understands the answer. So to make more sense of it, they need to find what the Question of Life, the Universe and Everything is. Unfortunately this is beyond the powers of the supercomputer, who promises to build an even superer-supercomputer:
A computer which can calculate the Question to the Ultimate Answer, a computer of such infinite and subtle complexity that organic life itself shall form part of its operational matrix… Yes! I shall design this computer for you. And I shall name it also unto you. And it shall be called… The Earth.
Now before you starting saying to me, “Well this is all very interesting. But this post is titled Markets and you appear to be babbling about a piece of comic science fiction” I’ll explain. For a market is a bit like a giant computer*, that me and you and every other person on this planet is part of and performing calculations for.
The economic problem is extremely difficult to solve. How would you decide what gets made, how and for whom are they made? How would you decide what each person should do as a job?
Imagine the Prime Minister rang you up and asked you to be Minister of the Economy. Your job was to make sure that every person in the country could walk into a shop and buy exactly what food and clothing and gadgets they want, at exactly the time they want to buy it. You’d need to make sure that all the ingredients and components that are made all over the world are brought together in the final product just in time. You’d need to make sure that people are doing just the right jobs to get these things made.
There’s no person or group of people or supercomputers that could possibly work this all out. It would be beyond Marvin the Paranoid Android, the Heart of Gold or Deep Thought. Indeed, the information needed to work it out is not all in one place to work it out in the first place – but dispersed among many millions of people in many different places. But luckily, all of us, through our voluntary transactions in the marketplace help work out these calculations – the what, how, and for whom.
- What? How we choose to spend our money as consumers, combined with how much it costs businesses to make these things, helps work out what gets made. When we choose to buy something, we are casting our vote for a particular good or service. If consumers spend their money on biscuits, scooters or haircuts – then businesses will want to provide those things. Of course, businesses also have to bear in mind what it costs to provide certain goods and services. They will want to provide things that are profitable, and not those that are not profitable.
- How? The competition between businesses to make things most efficiently helps determine how things are made. Businesses using inefficient production methods would go out of business.
- For whom? Businesses will need land, labour and capital goods to produce their wares. They will pay people for providing these, depending on how productive they are. The amount people get paid for their labour, or use of their land and property, determines their incomes. Those with higher incomes get more votes in the marketplace, and so get more of what is produced.
Now, you may be wondering how all this gets done. If computers send lots of little electronic signals to work things out, what is it that gets sent all around the market place, from buyer to seller, firm to firm?
It is price that co-ordinates all these problems. It is price that matches what people want to buy with what businesses want to sell. It is price that matches what jobs need to be done with who can do them. How it does that will feature in the next chapter of the economics textbook, which will be posted in good time.
I don’t want to give the idea that markets are perfect. They can be very unfair – does anyone think Premiership footballers deserve their huge salaries? Is it right that people spend more on unwanted Christmas gifts than on feeding the starving and clothing the destitute? Markets can also be very unstable, with bouts of high inflation and unemployment. They also fail to take account of many spillovers – bad ones, like pollution and congestion, or good ones like the social benefits of new inventions or an educated and healthy population. But I’ll come back to these spillovers, again, in a subsequent post.
But, markets are able to solve a very difficult co-ordination problem that no central agency could ever solve. They let you walk into a shop at any time of day and buy whatever you need, even if it came from the other side of the globe, without you ever having to plan ahead or give it much thought. For that reason, markets really are remarkable.
* Friedrich Hayek made this point of the market as being a ‘system of telecommunications’ that can solve complex problems that no single person or group could in an excellent essay, The Use of Knowledge in Society.