Market failure is real!

This article is part of a series of short pieces on the theme of what it would be like to live in a Participatory Economy. 

In market economies people are not asked to plan how much of different goods they will want to consume in advance. Therefore, it is not surprising that the most common doubt people express about a participatory economy when they read that consumers are expected to submit requests for how much of different things they think they would like to consume next year is: You want me to do what? But before explaining why asking people to estimate what they may like to consume next year is not as daunting a task as people assume, let’s stop to review how market economies work, and whether the consequences are as felicitous as is commonly assumed.

Failing to plan consumption in market economies comes at a cost!

In market economies consumers do not generally pre-order what they want to buy, and therefore producers are usually left to guess what consumers will eventually demand. Of course, corporations expend considerable resources trying to estimate (and influence!) what people will want to buy. But the important point is that when businesses invariably guess wrong this generates what economists call “market disequilibria” and “false trading” as market prices adjust. Those who want us to believe that markets are God’s gift to the human species seldom remind us that when markets are out of equilibrium inefficiency is the necessary result. Simply reading the necessary assumptions of the fundamental theorems of mainstream welfare economics “high theory” makes this quite clear to any who care to take notice. 

The notion that in market economies the convenience consumers enjoy of not having to pre-plan their consumption with producers comes at no price is based on the grossly unrealistic assumption that market economies instantaneously find what economists call their “general equilibrium.” But clearly this is not what occurs in real world market economies. The convenience for consumers of not having to preorder in market economies is always bought at the expense of a significant amount of economic inefficiency as resources are wasted producing more of some goods and less of others than it turns out people want. Not to speak of the monumental waste and inefficiency during periodic economic slumps like the Great Depression of the 1930s, the Asian Economic Crisis of the 1990s, and the Great Recession of 2008-2009. One way to think about all this is that participatory planning provides a remarkably cheap way to mobilize as much information about what consumers will want as possible to avoid the “macro” inefficiencies which perpetually plague real world market economies.

But is what we ask of consumers in a participatory economy unrealistic?

David Schweickart ridiculed household consumption planning as “nonsense on stilts.” 

Unless requests are made in excruciating detail producers won’t know what to produce. In any event, they have little motivation to find out what people really want.

Seth Ackerman dismissed participatory economics for this reason alone in The Jacobin.

There are more than two million products in Amazon.com’s “kitchen and dining” category alone!

And in Alternatives to Capitalism: Proposals for a Democratic Economy  Erik Olin Wright put it this way:

The problem is that the gross categories provide virtually no useful information for the actual producers of the things I will consume. It does not help shirtmakers very much to know, based on the aggregation of individual household consumption proposals, that consumers plan to spend a certain per cent of their budget on clothing; they need to have some idea of how many shirts of what style and quality to produce since these have very… different opportunity costs.

Since this concern has been so prominent among critics we’ve given it a name.

The size 6 purple women’s high-heeled shoe with a yellow toe problem

The problem is this: Eventually a shoe producer must know to produce a size 6 purple women’s high-heeled shoe with a yellow toe. The producer must know that size 5 will not do, a red toe will not do, and a low heel will not do. However, it is unreasonable to expect the consumer who will eventually discover she wants a size 6 purple women’s high-heeled shoe with a yellow toe to specify this at the beginning of the year as part of her annual consumption request.

But how does a shoe producer in a market economy know to produce a size 6 purple women’s high-heeled shoe with a yellow toe, rather than a slightly different shoe? In a market economy shoe producers guess what shoe consumers will want when they decide to go shoe shopping. They guess based on past sales. They guess based on any consumer research they engage in, perhaps including information culled from focus groups. They guess based on government projections of changes in relevant economic variables such as the distribution of income among households. 

And recently, many large companies have started to use newly available data gathering and processing capabilities to predict what products particular customers will want in the future. When I go to the Amazon website to inquire about some book I’m interested in buying, Amazon now tells me what other books I might be interested in buying as well. Only when I forget and go on the internet from my wife’s email address does Amazon provide me with book suggestions that do not match my preferences. In our brave new market economy producers often know what we will want before we do! In market economies producers also try to influence what I will want to buy through advertising. In other words, a shoe company will decide to produce a certain style of shoe and use advertising to make people want to buy the style they have decided to produce.

In sum: In market economies producers guess what to produce – because most sales are not arranged through pre-orders. And producers use advertising to try to influence consumers to buy what they have produced. New technologies of automated inventory supply management and consumer database mining have made their guess work more accurate, but in the end producers in market economies are still guessing what consumers will want to buy, and when they invariably guess wrong, a great deal of economic inefficiency is the result.