Fundamentals of capitalist economic life

Every time that an unregulated market fails it is another nail in the coffin of the simplistic economic belief that unregulated markets are fundamental to capitalist, economic life. However, the exposed mortality need not herald the end of capitalism but point to the critical need to understand its complexity.

Now then is a good time to examine the corpse to look for a fuller appreciation of the essential nature of a healthy market economy. For that, along with determining the cause of death, is the purpose of post-mortem examination. If we learn from it capitalism will survive otherwise it won’t but either way the fat lady has sung for its under-regulated extreme end.

In my humble view the current world economic woes owe much to the teaching and unchallenged acceptance of an economic theory that is based on a misunderstanding of the nature of the very markets that it promotes. Indeed I believe that the subject of economics should be renamed The Market Theory of Value and that it should be subject to an epistemological review to test the validity of what it contains. (But that is for another day.)

In that context, I submit that the collapse of “extreme capitalism” was inevitable and not just bad management and further that failure of unregulated markets should not be seen as a disaster for capitalism but merely as a regrettable necessity for its survival.

An analysis of the elements of market structure will show that the unchallenged hegemony of The Market Theory of Value over economic analysis poses such a threat to our economic well being and indeed that of the planet itself.

Market structure

Market structure has two fundamental elements. One is the relationship between individual buyers (consumers) and individual sellers (producers). The other is the relationship within and between groups of buyers and sellers.

The former was identified by Adam Smith as what gives markets strength and was later designated “countervailing power” by John Galbraith. The latter, under the general banner of “competition”, gives markets their increasing scope and growth but at the expense of market strength.

There is little doubt that, in the realm of economic orthodoxy, countervailing power barely survives in the shadows of “competition”. I am not sure why; perhaps it is just too difficult to work out, politically, how to apply its principles in practice because it does seem to point to a need for increased government activity. Such an increase would not be generally supported in the current political environment.

But, back to the market analysis. Despite identifying a set of necessary conditions that constitute a perfect market, the orthodoxy simply nominates competition between large numbers of buyers and sellers as a sufficient condition for a deregulated market to flourish and optimise economic health.

Market dynamics

However, immediately more than one buyer enters a market a new dynamic is established that diminishes the effectiveness of countervailing power because each buyer must now take into account the perceived intentions of the other buyer.

As more and more buyers enter a market the strength of the countervailing power is thus progressively weakened. The eventual buyer or buyers will probably pay too much.

Actually, that becomes a certainty when each bidder assumes each other bidder has set an independent value. That would not matter, except for the inflationary implications, if there is continued confidence that the markets will continue to flourish. However, if confidence in markets fall and that confidence is what is driving demand it follows that prices will crash for want of a solid basis of value.

That is why to call increased share prices a “strengthening” of the market is nonsense. Strength is a function of independent judgments. Any “gearing” will of course simply accelerate the process.

Further problems

Three other factors contribute further to problems with our expectations of unregulated markets to deliver “value”.

One is rejection on the significance of “social” costs and benefits. They are the incidental costs and benefits to third parties not directly involved in a sale. The impact of increasing numbers of motor cars on pollution and traffic congestion is a good example. The idea that economic activity occurs in an environmental vacuum is a nonsense - as is the implied belief in “free” market analysis that nature is an abundant, free but saleable resource.

It is likely to become a basic cause of disillusion with market value that will go hand in hand with the destruction of the environment if we expect markets in themselves to place a value of such concerns.

The second is ever-widening gap between buyers and sellers that inevitably decrease knowledge of the quality of goods and how they are produced. That problem will reach its zenith (nadir) in globalisation. For those who see global trade as the ultimate solution it must be pointed out that it is a process of diminishing direct product knowledge.

Third is that quality of a product is likely to be swamped by price considerations, especially if “the ‘homogeneous product” condition for perfect market are accepted. That is most likely to be the case in the “short” run and Keynes of course had the final say about the “long” run.

Thus we need to develop a General Theory of Value that has elements that balance the call for “free markets” with regulated activity if capitalism is to deliver “true” value and survive. For instance in areas where public utility is the required outcome and social benefits are paramount the push for privatisation should be continually questioned.

As a starting point, a General Theory of Value might postulate:

1. Value is the product of the sensible interaction of people with each other and the environment and does not require a sale for it to exist.
2. Market price is often distorted by factors such as unequal power of buyers and sellers, incomplete information, misleading advertising, external consequences and irrational expectations as well as poor knowledge of the quality of goods and services offered.
3. Sustainable economic activity cannot exist at a global level unless it exists within environmental limits at both national and local levels.
4. Economic diversity rather than global specialisation is the better safeguard against vulnerability.

In the mean time capitalism will only flourish if it accepts that the much-flaunted “freedom”, of which it is purportedly the unabashed champion, is understood. It is better if “freedom” is not interpreted as being a denial of limits to behaviour but as an understanding of what those limits are.

We need a General Theory of Value that encompasses social, cultural and environmental worth that weans us from reliance on purely material products for fulfilment.