Markets and Pseudo Markets; D. Boudreaux

421 Markets and Pseudo-Markets by Donald J. Boudreaux T he 1980s will be remembered as the dec ade in which "the market" gained a de gree of respect worldwide that it never had or that it had only many decades ago. Most obviously, the overthrow of Communist regimes throughout Eastern Europe during the final months of 1989 holds promise for significant eco nomic reforms that will introduce market mecha nisms into those economies. Recent election results in Nicaragua, and current political maneu verings in the Soviet Union, also suggest that a continuation down the path toward freer markets is likely. Obviously, classical liberals should be pleased by these developments. More time-tested reforms have taken place in the English-speaking world. In Great Britain, Margaret Thatcher's program is an attempt to restore the market in that nation. And, of course, the United States in the 1980s was the Reagan era-a period in which "the free market" lost its vulgar connotation in the popular mind.

Although Thatcher's and Reagan's efforts de serve praise (especially when compared with the possibility of a continuation in the 19808of 19708 type policies), that praise should be only mild. The changes brought about were neither as extensive as those promised in the late 1970s and early 19808, nor as permanent. Of course, Thatcher and Reagan faced political realities that made it extremely dif ficult to do more than bruise government on its lit tle toe; any attempt to cut off an arm or leg of gov ernment almost certainly would have resulted in the loss of Thatcher's or Reagan's political head. It is a common theme that opponents of government intervention seldom win in battles with politically Dr. Boudreauxis studyinglawatthe Universitya/Virginia. entrenched specialinterest groups. It is also a com mon theme among classical liberals that ideas do matter and that long-run victory for the market is possible only with a fundamental change in the way people think about the role of government as com pared with the role of the market.

I accept the claim that ideas matter. Therefore, I believe that the ideas marshalled in support of the market should be correct, promising neither too little nor too much. I argue here that a signifi cant portion of the intellectual arguments under girding the Thatcher-Reagan efforts were mis guided. (Being a United States citizen, I confine my essay to the U.S. experience.) In brief, my the sis is that arguments in favor of "the market" are not necessarily arguments in support of classical liberal values. Restoration of "the market" is not an ultimate goal of classicalliberalism. By focusing too much on "the market," classical liberals and their friends can undermine the case for the ulti mate classical liberal values of peace, prosperity, and liberty. Arguments in support of these classical liberal values should focus, not on "the market," but on the protection of private property and freedom of contract. It is these latter two institutions that are absolutely necessary for peace, prosperity, and lib erty. Although private property and freedom of contract inevitably giverise to markets-defined as the interactions of buyers and sellers for the pur pose of exchanging ownership titles-markets as such are secondary phenomena in a classicalliberal society. That is, classical liberals should aim their arguments at supporting private property and free dom of contract rather than directly at supporting "the market." By doing so, free mutually beneficial 422 THE FREEMAN • NOVEMBER 1990 exchange willbe protected. More important, what I call "bastard markets" or pseudo-markets willbe avoided. Pseudo-markets are markets that arise, not via the interplay of private property and con tractual freedom, but via the suppressionof these vital classicalliberal institutions.

Pseudo-Marketsversus RealMarkets An example of what I mean by pseudo-markets may be useful. Consider a manufacturing firm that has been purchasing its inputs from indepen dently owned suppliers. Now suppose that a tech nological change occurs that allows this firm to increase the efficiency of its operation by merging with one of its suppliers. The institutions of pri vate property and freedom of contract insure that this merger may take place. After the completion of the merger, no formal exchange occurs between the input-supply branch of the firm and the manufacturing branch. In a literal sense, a market relationship has been terminated. Sup pose now that a court or an administrative gov ernment agency orders this merger dissolved. By forcing the manufacturing firm to sell its input supply branch to an independent owner, a "mar ket" relationship is (re)established: the manufac turing firm now engages in a greater number of formal exchanges than before because now it must purchase its supplies of this particular input from a separately owned firm.

But the market relationship created here by the court did not grow out of the institutions of private property and contractual freedom. Instead, it resulted from the attenuation of these institutions. This is a pseudo-market; it is illegitimate from the perspective of classical liberalism. Compare this pseudo-market relationship with the market rela tionship that exits when the manufacturer and its input supplier voluntarily choose not to merge. In the latter case, the market grows out of the institu tions of private property and freedom of contract. For this reason I call such a marketin this case for inputs-a "real market." A danger arises when people fail to account for the fact that protection of private property and freedom of contract is not synonymous with pro tection of markets. The danger is that the protective walls around private property and con tractual freedom begin to crumble. The path is then opened for private property and contractual freedom to be violated by government. Few classi cal liberals will disagree with the claim that mar kets erected out of the material gathered from the dismantling of private property and contractual freedom promise neither lasting peace nor pros perity.And it can hardly be argued that these pseu do-markets are consistent with liberty.

When government has the power to use markets without respecting the private property and con tractual freedom of its citizens, it can design and employ markets to achieve goals that have little to do with the individual goals of the people. As incongruous as it may seem, markets become a tool in the central planner's kit of instruments for attempting to engineer society into some precon ceived mold. One problem with the use of pseudo-markets, of course, is that the central planner may desire a set of social outcomes that is different from that which contributes most to the welfare of the people. More fundamentally, political support for pseudo markets can be purchased in democratic societies only when voters are promised specific benefits that the market supposedly will bring them. This support requires an explicit listing of what the pseudo-markets promise to do (e.g., reduce prices, increase employment opportunities, and so on).

But such political support is tenuous because, by their nature, markets are simply a forum for ex change-markets can expedite the exchange only of that which already has been produced. Al though the signals sent out by market exchanges are crucial in the determination of what goods are produced and how, these signals emerge only in the actual process of market exchange. Thus, spe cific accurate predictions about the benefits and costs of a·system of market exchange can seldom, if ever, be made. Market signals-which relate relative intensities of consumer wants and relative scarcities of alter nativeinpu~--eannotbepredictedindependently of the process that generates them because mar kets synthesize a vast amalgam of information "bits." The signalssent out on the basis of this syn thesis result in specific outcomes, the details of which no one ever could have hoped to predict. Markets, therefore, are a poor tool to use in·at tempting to attain specific results. Thus, political support for markets based only on the promise of specificoutcomes too often, if not invariably,leads MARKETS AND PSEUDO-MARKETS 423 to disappointment among those who lent their support to the market. In the face of such disap pointment over the specific performance of the market, the political coalition built up to support the market dissolves.Support for the market even tually evaporates, and this "experiment" with the market is abandoned because of the popular belief that the market failed.

Consider, for example, the Reagan tax cut in 1981. The promised result was that government revenue would increase because of the "Laffer Curve" effect. Although debate still goes on about the actual revenue effects of this tax cut, the consensus seems to be that government tax revenues did not increase as a result of the 1981 tax-rate cut. That is, the specific market outcome that was anticipated did not happen. Reagan's market experiment with lower tax rates was widely viewed as having failed, and the stage was set for 1982's tax hike. In contrast, had the 1981 tax cut been based upon arguments in support of private property, the observed outcome of the tax cut would have occa sioned far less criticism. No one could have argued that the tax cut didn't fulfill its goal. Under these circumstances, we very well might have avoided the 1982 tax increase. Whenever pseudo-markets are created, they are usually intended to serve the interests of a politi cally well-organized group. But even when such markets fulfilltheir intended purpose, they seldom make a net positive contribution to the welfare of society.

An example of this recently occurred in the air line industry. United Airlines spent a great deal of resources developing its Apollo computerized reservation system. When United bought the rights to Pan Am's Pacific routes, the court refused to allow the purchase unless United agreed to make its reservation system available for use by its competitors on terms that did not discriminate against its competitors and in favor of United. By requiring United to deal with its rivals on terms that it would not have otherwise agreed to, the court, strictly speaking, created a market. But notice that United's right to dispose of its property as it sees fit has been pushed aside by the court. Exchanges willbe made that would not have taken place in the absence of the court's decision. Clearly,the airlines who now have the right to pur chase use of the Apollo reservation system from United are benefited by the court's ruling; the court's creation of this market helps these airlines.

However, consumers won't benefit. Because the incentive to invest in the development of such reservation systems is reduced by the precedent set in the United-Pan Am case, fewer such systems will be developed in the future. In its attempt to protect the market for United's rivals, the court found it necessary to modify United's freedom of contract and private property rights. The result willbe that airlines, on the whole and in the future, will be less efficient than they otherwise would be, and consumers will ultimately bear the cost of the forgone improvements in efficiency. The Role of ClassicalLiberalism Classicalliberals should focus on the explication and defense of private property and freedom of contract, pointing out how these institutions are indispensable for well-functioning markets and for free and prosperous societies. The role of classical liberal principles is to restore private property and contractual freedom to their place of primacy in Western civilizationand to continue to introduce these principles to non-Western nations.

Classical liberals have the responsibility of op posing those who seek to engineer society through selective introduction of market mechanisms. The classicalliberal must work to persuade others that markets that emerge out of the interplay of private property and contractual freedom are the only markets that promise genuine net benefits to soci ety.The classicalliberal must further remind others that markets created by the suppression of these institutions are not the type or form of economic organization that classicalliberalism champions. As we begin the new decade, the risk of disen chantment with the market is high. By failing to recognize the distinction between pseudo-markets and real markets, voters may well decide that the market is not all that it was claimed to be at the beginning of the 1980s. What the classical liberal must do is, to be sure, defend markets, but defend them only insofar as they are a natural and healthy result of private property and freedom of contract.

It is the intellectual and moral foundations of these latter institutions that must be supported by sound classicalliberal argument. If classicalliberals meet this challenge, restoration of the market-the real, not pseudo, market-will follow. D 424 The Myth of PubliclPrivate "CooperativeEnterprises" by Barbara R. Hunter A popular term today for schemes that transfer money from the taxpayer's pocketeitherto a privateindividualor to aprivateorganizationis "cooperation."According to this notion, the government (which may be municipal,county,state,or federal)hasthe rightto extractfromthetaxpayeranysumforanypurpose, as long as those doing the extractinghave deter minedthat the takingis for a "goodpurpose." Strangely,once the money has been taken, it is no longerrecognizedas belongingto the taxpayer. Now it is instead "governmentfunds," and these funds are portrayed as a source of benevolence fromthatparticulargovernmentto therecipient.A multiplicityof terminologymay be used to mask the actual source of the alleged benevolence "cooperative effort," "synergy," "assistance,"