– January 16, 2020
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Fundamentally, there are two different ways to solve what Tyler Cowen and Alex Tabarrok call “the great economic problem” of getting the most out of our resources. Central planning is one way to do it, where a duly constituted authority decides what gets produced and how. This has the problems I explain here. Without private ownership of the means of production and, therefore, free markets for the means of production, the central authority cannot engage in genuinely economic calculation.

Markets solve the knowledge problem, and in that way, they are a marvel: in markets, people who don’t know and may not necessarily care about one another are able to cooperate to mutual advantage. If Kaz has a stick and wants a rock and Neeku has a rock and wants a stick, they can swap. Both will be better off, even if Kaz does not care about Neeku’s well-being and even if Neeku does not care about Kaz’s well-being. 

As we teach in introductory economics classes, free markets create what the economist Tim Harford calls a “world of truth”: We produce the right things. We produce them the right way. We produce them in the right proportions. They go to the right people. In experimental settings, people armed with nothing more than their own interests and knowledge about what they are willing to pay (or willing to accept) will bargain their way to an outcome that maximizes gains from trade. The economist Vernon Smith explored and explained this experimentally.

There’s a potentially huge problem, though, with the equilibrium model. Not everyone has the same information, and self-interested people can use this to take advantage of the poorly informed. 

In a recent discussion with students at my kids’ school, we called this the “Pokemon Problem” because of the problems that emerge when older card collectors take advantage of the inexperience and naivete (and poor math skills) of younger collectors. 

I remember a short cartoon I saw when I was little in which one unscrupulous kid offered to pay his naive “friend” either a dime or a nickel, and the friend picked the nickel because it was bigger. Fortunately, someone with a better-developed ethical compass stepped in and explained the situation. We can probably all tell stories like that.

We read stories like that pretty regularly. You can probably think of a time when you got sick at a restaurant or heard of a product recall or any of a number of other things. It’s a mistake to conclude from this, however, that markets per se are the problem. As Tyler Cowen points out, a lot of the failings people attribute to executives don’t happen because they are executives per se but because they are people (I review his book Big Business here). 

The Bible is pretty clear that all have sinned and fall short of the glory of God; the institutional question, then, concerns finding the arrangements of institutions that do the most to mitigate these problems. It’s a common mistake to think that asymmetric information in markets is a bulletproof case for government regulation. 

After all, governments have their own problems of lousy incentives and asymmetric information. Entrepreneurs, moreover, have come up with a lot of pretty ingenious ways to show that they aren’t going to take advantage of short-term asymmetric information.

I told the students that their integrity and their reputations are among their most valuable assets. We see this pretty readily in the marketplace, where firms hustle to protect their brand names. People talk a lot — and one way to lose a lot of business is to provide lousy products at high prices. Markets help you know you’re not getting ripped off by embedding a lot of information in brand names and reputations. The Bible says a good name is to be preferred to great riches, and in a market economy a good name can be an input into the creation and acquisition of great riches.

In books published in 2011 and 2018, the economist David Rose explains the importance of a society’s moral foundation. Societies of short-sighted opportunists will not prosper, while societies that have inculcated norms of truth-telling and honesty will tend to do better. One might not only want to do the right thing because it is right. One might also want to do the right thing because it is good business. People solve the Pokemon problem and show that they are potential trading partners who won’t take advantage of others by tending to their reputations.

Art Carden

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Art Carden is a Senior Fellow at the American Institute for Economic Research. He is also an Associate Professor of Economics at Samford University in Birmingham, Alabama.
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