How Markets Fail: The Logic of Economic Calamities By John Cassidy (Farrar, Straus and Giroux, 390 pp., $28
One tried-and-true way to start off a course in elementary economics is to call the studentsâ?? attention to a common object, such as the spiral notebooks in which they are presumably busy taking notes. Somewhere paper is manufactured with the appropriate strength and slickness, somewhere else it is cut into blocks of the right size, the corners rounded, printed with lines about the right distance apart, provided with cardboard covers in the college colors, punched with the right number of holes, bound with those wire spirals that have been manufactured in yet another place, and delivered in reasonable numbers to the college bookstore at the beginning of each term. And all this happens smoothly, without any centralized direction, through the normal operation of a market economy. How does it really work? And how can it go wrong?
My late colleague Evsey Domar, who was, among other things, a student of the Soviet economy, told us how the planning bureau began by setting production quotas for paper factories in tons per year. The result was paper so thick that it could not fit in a Soviet typewriter or anywhere else. So the clever planning bureau changed to setting quotas in terms of square meters per year. The result was paper so thin that even a member of the planning bureau could see right through it. The lesson is that it is so much simpler and more effective to tell paper producers that they have to compete to sell their paper to notebook manufacturers (who are also competing with each other), and live off the proceeds.
If this is how more or less free, more or less competitive markets can deal with something as simple as a spiral notebook, how much more remarkable it is that they can do the same for something as complicated as a computer or a refrigerator. But there seems to be no other practical way to run a modern economy efficiently. That is what Adam Smith understood: a competitive market economy, motivated primarily by individual pecuniary self-interest, can produce coordination where one might expect only chaos.
He invented for that process the memorable image of the Invisible Hand. In the following two centuries and more, an army of economists has spent an enormous amount of time and intellectual effort refining and elaborating Smithâ??s initial insight, teasing out exactly how far that logic can be carried, how the hand operates, investigating when and how it breaks down, and elucidating odd or complex special cases such as professional team sports, or Internet services, or health care. (A recent issue of the highbrow American Economic Review contains highly technical articles aimed at understanding particular aspects of oil prices, gasoline taxes, urban transit, art auctions, and â??two-sided matching marketsâ? like that connecting graduate students and graduate schools.)
In one way it is an interesting intellectual game; in another, it is a deadly serious battle for very high stakes. For in the course of producing and distributing goods and services, market outcomes generate incomes, wealth, status, and power. Any modification of market outcomes modifies the allocation of incomes, wealth, status, and power. So it is no wonder that the discussion has become thickly encrusted with ideology. And one convenient way to turn subtle argument into ideology is to create dichotomies where there are originally fine gradations of more and less. For example: are you for or against â??the free marketâ??
Today, of course, no one is against markets. The only legitimate questions are: What are their limitations? Can they go wrong? If so, how can we distinguish the ones that do from the ones that donâ??t? What can be done to fix the ones that do go wrong? When is some regulation needed, how much, and what kind? More broadly: how to protect the economy and society against specified tendencies to market failure without losing much of either the capacity of a market system to coordinate economic activity efficiently or its ability to stimulate and reward technological and other innovations that lead to economic progress?
The subtitle of John Cassidyâ??s book illustrates the problem. Most market failures--they occur every day--are not even nearly calamities. They start with the existence of partial monopoly power in this or that industry, with the result that the market price is â??too highâ? and the rate of production â??too lowâ? in the precise sense that everyone could be made better off if that error were corrected. They extend to cases where the market does not impose the full costs of their actions on certain producers and consumers, with the result that economic activity is misdirected: the consequences may be minor (a small amount of pollution) or major (fish stocks collapse from overfishing) or potentially catastrophic (climate change from excessive unpenalized emission of greenhouse gases). And what are we to make of the stock-market collapse of October 1987, the largest one-day fall ever on the New York Stock Exchange? It was in one sense a calamity, but it left essentially no trace in the â??realâ? economy of production, employment, consumption, and everyday life. Evidently being for or against â??free marketsâ? does not come close to being an adequate response to the problems that arise in a complex modern economy.
Cassidy, who writes on economics and finance for The New Yorker, yields a bit too easily to the journalistâ??s instinct to set this issue up as a battle of Light against Darkness. The first two parts of his book contrast what he calls â??Utopian Economicsâ? with â??Reality-based Economics.â? In fact he is aware of some of the qualifications and fine distinctions that fact and logic call for, and a careful reader will come away with at least a general feeling for the difficulties facing any serious attempt to understand the working of market economies. The last part of the book is a retelling of the financial meltdown of 2007â??2009, from which the world is only beginning to emerge. Cassidy casts it as a story of Utopian Economics Carried Much Too Far.
Roth's account of this man afraid of living and afraid of dying is given coldly, in an almost clinical spirit. It is hard to be moved by a story that seems not to move its teller.
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