Tag: invisible hand

What Money Can’t Buy: The Moral Questions of Market Solutions

Against the backdrop of a society that rarely questions the perceived superiority of “market-based” solutions, Michael Sandel skillfully explores the intersection between markets and morality. In a six-part video series, Sandel teaches viewers a very important lesson: in practice, there is no consensus on what a free market is, and what outcomes are optimal.

The video series “What Money Can’t Buy,” produced by the Institute for New Economic Thinking, takes viewers on a journey which compels them to critically engage with a series of questions that challenge the common perception that untethered markets provide optimal solutions to all problems. While the questions cover a variety of topics, ranging from selling organs to discrimination based on looks, the common thread is to highlight this: in economic terms, what could be seen as an optimal outcome is often not a desirable outcome for society.

By watching the series, one thing becomes evident: there is no clear line that marks where markets should begin or end. Furthermore, each individual has a different understanding of what counts as an optimal outcome. As we come to terms with the lack of clear answers, the perception that unregulated markets always objectively provide a better outcome is shattered.

Economics textbooks teach students that households and firms act as if they are guided by an invisible hand that leads them to desirable market outcomes. As everyone seeks to maximize their own utility, free markets allow individuals and firms to engage in mutually beneficial exchanges, with supply and demand determining ideal price and output levels. Thus, one should simply let markets work their magic — no outside intervention necessary.

However, not even Adam Smith, to whom the “invisible hand” observation is attributed, believed that unregulated markets can lead to the best outcomes for society. As Harvard professor Amartya Sen points out, Smith was aware of the limitation of free markets. He knew resources would be drained and society’s ills would go unaccounted for in the absence of government.

Today, it is largely accepted that governments do need to play some role in setting and enforcing rules that enable markets to operate. For example, it is not controversial that property right and contract enforcement are government actions that enable markets to function, and would not be considered an intervention.

What is less acknowledged by those who oppose regulation under the guise of protecting free markets, is that the boundaries between what is considered a necessary rule and what is labeled as intervention have consistently changed throughout time, along with what our societies have deemed acceptable or not. The idea of what should and should not be sold on the market has constantly evolved.

Cambridge economist Ha-Joon Chang points this out using a simple example: child labor. In our present society, not allowing young children to work is something that seems natural. Yet, in early industrial days, this was a heated debate. Opponents called the ban an intervention in free markets and the infringement on the child’s right to sell its labor.

“What Money Can’t Buy” showcases interviews with a number of prominent academics from across the ideological spectrum, such as Joseph Stiglitz, Larry Summers, Minouche Shafik, and Greg Mankiw, as well as discussions amongst a group of students. Each episode features Sandel asking participants a sequence of questions around a specific theme, leaving it up to each of the respondents draw their own lines on what should or should not be a market good.  

The interviews present a variety of responses and arguments both in favor and against allowing markets to operate in various areas of our lives, and whether allowing markets in those areas would lead to better or worse outcomes for society. There is no consensus on what counts as basic regulation, or when a market is no longer “free”.

There are no right or wrong answers to any of the questions. However, this does not mean that the responses offered by participants are not challenged. Sandel consistently asks for further elaboration on the answers, and explanations for the reasoning behind those responses. What makes the series truly thought provoking is the way in which Sandel then asks respondents if they are comfortable applying the same pro-market argument to a somewhat similar, but instinctively more morally questionable situation.

Throughout the series, it becomes clear that often the arguments in favor of having a market for something, such as kidneys, operate in a vacuum which does not take into account the large inequities and power dynamics of our society. For example, Mankiw defends the need to have a market for kidneys by claiming it would lead to more donors, and more lives saved, thus improving outcomes for society overall. Yet, as Stiglitz points out, in our unequal society, would those selling their kidneys do so as a voluntary transaction, or be coerced by their economic despair? Furthermore, selling kidneys in a market would mean the price would be too high for many people to pay, thus effectively letting poorer people die to save those who are wealthy.

What Money Can’t Buy does not provide any concrete answers to the questions discussed, and does not decide for its viewers what is right, or wrong. That is not its goal. Instead, Sandel encourages viewers to engage with the questions and critically think about the role markets play in our lives, how they are structured, and who they inherently favor. As the series makes clear, there is no objective way to define a free market or what counts as intervention, and thus it encourages us to think about morality and what type of society we wish to live in and incorporate those principles in the way markets influence our lives.

Watch the series here.

Rigged: How Mainstream Economics Failed Us All

Econ 101 operates under the observation that “households and firms interacting in markets act as if they are guided by an invisible hand that leads them to desirable market outcomes.” Thus the role of the economist is “to understand how this invisible hand works its magic,” a role limited to developing and employing models to illustrate the magic workings of this invisible hand. Dean Baker’s latest book, “Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer,” tells a different story. The “invisible hand,” guiding the market, is actually the hand of the financial and political elites, who work to ensure the market works in their favor and to facilitate upwards distribution of income.

In the late 19th century neoclassical economics transformed the subject into “the Calculus of Pain and Pleasure,” by introducing the concept of utility, and creating a theory based on the assumption that each individual aims to maximize their own utility. By introducing a mathematical component, the new theory offers, as Baker states, “a basis for distributing income that is independent of political decisions or moral judgments.” The discussions about class struggle and distribution of wealth, which previously dominated the economics debate, became obsolete. Ever since the mathematical component has become the norm in mainstream economics.

“Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer” very skillfully proves that textbook economics is far removed from the world we actually live in. Baker shows how the distribution of income in our society has little to do with merit and how postulates of neoclassical economics are selectively invoked to prevent any actions that do not benefit elites. Interventions that promote upwards distribution of incomes are never criticized, while inequality and unemployment are left for the invisible hand to fix.     

Head-on the book addresses the myth of the free market: “markets are never just given. Neither God nor nature hands us a worked-out set of rules determining the way property relations are defined, contracts are enforced, or macroeconomic policy is implemented. These matters are determined by policy choices.” It is active policy and not some magical invisible hand that lead to the unequal society in which we live. Baker then goes on to address some of the main policies that actively intervened in the economy to distribute income upwards.

Mainstream economics heavily criticizes government regulation and intervention, yet “almost no proponent of deregulation argued against the bailouts that saved Wall Street in the financial crisis.” Regulation is criticized when it threatens profit opportunities but welcomed in instances where it provides government-backed insurance. The financial sector, which has significantly ballooned in the past decades, has enormously profited from bailouts, yet without suffering any consequences for the harm it caused to the rest of the economy in the aftermath of the financial crisis. The large wages in the financial sector effectively constitute rents for those who manage it and offer no incentive to reform and reduce its size. A “ballooned” financial system where the waste “provides income for some of the highest earners in the economy” that takes government bailouts when it fails is a good example that there is no invisible hand moving things towards optimal outcomes.

Another form of government intervention that is heavily critiqued by mainstream economics is protectionism. The recent debates on trade deals have brought the issue of protecting U.S workers from competition from abroad to the forefront. Many of the people “remarking on the narrow-mindedness and sense of entitlement of manufacturing workers” that are refusing to quietly take a hit on their pay to make goods cheaper for everyone else “earn comfortable six-figure salaries.” And while trade deals open up competition for manufacturing workers, they actually offer protections for those at the top of the income distribution. These deals usually propose strict enforcement of copyright and patent protections that secure monopolies and high incomes for many companies and their top earners.

Furthermore, while manufacturing workers are exposed to competition from abroad, professionals are shielded from it. “Developing countries also have tens of millions of smart and ambitious people willing to work as doctors and lawyers in the United States for a fraction of the pay of the ones we have now.” They are not allowed to do so and there are many restrictions in place that bar those people from working in the United States. Yet, these policies are not being labelled as protectionism. Again, intervention is considered unacceptable to protect those who are vulnerable but acceptable when it benefits those in political power.

At the core of mainstream economics is the idea that pay is related to productivity. This claim is refuted in the chapter that addresses the pay of executives in the United States. It is hard to explain the sharp increase in the pay of top executives based on their actual productivity. Baker points out that in the 1960s, CEO pay was 20-1 compared to their average worker. In 2015 that ratio was 276-1. Significantly, stories like that of Home Depot’s Robert Nardelli, who walked out with a significant payout after leaving the company in worse shape, prove that his pay had little to do with the value added to the company. “The pay of top executives is not determined in anything resembling a normal market” but is decided by corporate boards with little incentive to restrict it. To make matter worse, the high pay of CEOs spills out to other top executives, including those working in the non-profit sector. All this while wages for most other workers have virtually stagnated in the past decades. The story of workers being paid based on their marginal productivity just does not hold.

Perhaps the most important issue in Baker’s book is pointing out the problem of unemployment as a deliberate policy choice. A full-employment economy is clearly beneficial to workers and “the key element in assuring the benefits of growth are shared equally throughout the income distribution.” In a full employment economy, workers have the necessary bargaining power to ensure they also enjoy the gains from growth. Persistent unemployment is proof that the invisible hand is not taking the economy towards full employment.

The financial industry, as well as some powerful business interests, would be the only potential losers in a full employment situation. For financial intermediaries, the risk of inflation is damaging to any lending activities. For business, high bargaining power of workers means more money paid towards wages. The non-interventionist principles of mainstream economics are aggressively used to argue against any type of expansionary policy that promotes full-employment. The same elites that benefit from all the non-market mechanisms that distribute income upwards, selectively invoke the dangers of intervention when it is not in their favor.

Average people are scared into opposing any type of expansionary government policy through predictions of hyperinflation that would destroy the economy. Weimar and Zimbabwe are brought up as examples of what happens when a government decides to print money. However, neither of those stories are appropriate comparisons to the current situation the US finds itself in. For the US government, the purpose of printing money would be stimulating weak demand. Zimbabwe and Weimar simply printed money to pay their bills because they were broke. A policy “that insists on balanced budgets or low deficits is a policy designed to keep unemployment high” but sold as one that is meant to protect everyone from the dangers of inflation.

The policies presented by Baker in his book prove that the society we live in “is not laissez-faire or the free market” but it “is operating the government to benefit a select group.” This group cites the wisdom of neoclassical economics when it aligns with their interests but does not follow the same principles in other circumstances. Clearly, textbook economics is far removed from how the real world works.

Baker proves our economy is rigged in favor of the rich. To ensure economic gains are shared by all, it is essential to deepen our understanding of economics to more than just one failed theory. Mainstream economic models all failed to see the crisis and housing bubble, while Baker and non-mainstream economists, such as Hyman Minsky were able to see it coming. While Minsky’s work, in relation to the financial system, has gained many followers since the crisis, his ideas aimed at addressing poverty and reaching full-employment, are still overlooked. Maybe it is finally time to consider other non-mainstream proposals and make out-of-the-box economic approaches accessible to all, so we can all participate in an informed debate on policy issues.

The book “Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer” is available in PDF form for free. You can also order a hard copy from Amazon.