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What on Earth is a "Natural Market Outcome"?

Last week I heard someone saying crazy things about markets-something like “blah blah blah…but that would be a distortion of the natural market outcome”. This is worth thinking about carefully since many people seem to believe in the existence of an unchanging and essential form of market result.

The trouble is: that’s wrong. Think about it like this: for a “distortion” to exist there must first be some kind of natural outcome from which our observed outcome would depart. This is the direct implication of using the term “the market” outcome in the way it is often done.

Yet is there a “natural market” outcome from which a distortion can be detected?

Absolutely not. There is simply no natural position-no default state-that a market system produces. Every different regulatory superstructure within which a market operates will impact the “market outcome.” If a certain country has very stringent health standards for example, the market outcome (price) of a piece of fruit will be different than if that country had weaker health standards. Which one of these constitutes the market’s essential form? Neither, of course! It depends on how much that society desired strong health standards! A more basic example would be the building of a road. Every time the government builds a road the market outcome-the prices of real estate lots located close to the road-is altered. Is this a distortion of some essential market outcome that existed before the road was built? No. As Amartya Sen, winner of the 1998 Nobel Prize in economics has said, every time a school is built the “market outcome” is altered in some way.

This conclusion holds for many kinds of government regulations. Stronger or weaker enforcement of patent laws will alter the market price of drugs. Which is the “right” price outcome or the “market’s natural answer?” Well it depends on how society thinks the value a medicine creates ought to be divided between the sick people who purchase medicine and the company who takes risks to create it. The answer is not obvious. More patent life means more incentive for pharmaceutical companies to develop new drugs. But more patent life also means that fewer sick people can afford the drug. People may die. Which is the “natural market outcome?” Obviously neither. Human beings must make the decision-presumably through some kind of political process that involves hard decisions, tradeoffs, and compromise.

The claim, therefore, that any regulation or enforcement of law creates a deviation from a “natural” market outcome is simply untrue. For it assumes that the state of affairs that existed before the regulation in question was some kind of natural state of the world. And we know since markets are human creations that no natural state of the world existed.

It is of course proper to speak of such a change as a change-but we can only properly call these outcomes two different market outcomes and not one proper and one improper.

Is there ever at point where a “market outcome” is so significantly altered that it can no longer properly be called a market outcome? Yes. If some kind of new government regulation sufficiently restricted the freedom of individuals to participate in a market, or prevented them from leaving etc.-we might reasonably argue that what ever price outcome the market produced was not in fact a true market outcome since it failed to include participants that were truly free agents.

But it is important to see the other side of this argument as well. Too little government action can be as equally problematic as too much government action. It is well accepted that markets only function in the presence of law and order and a well-understood body of rules. It follows therefore that a market outcome might properly not be called a “market outcome” at all in the absence of these factors. You might imagine a market where all of the participants in the market fear for their own safety or where all of the participants in the market failed to believe that the contracts they sign will be enforced. Could we truly call the price produced by such a market a market outcome? I would argue not.

Political philosophy provides some guidance here. If human beings’ lives are completely controlled by a government or sovereign-surely this represents no meaningful kind of well being (you tend to hear this argument a lot). But total freedom-the absence of any government protection at all-represents no more welfare or happiness than the position of total control (this is what people tend to forget). As Thomas Hobbes argued in “Leviathan”-without the protection of a government, “every man is enemy to every man…and life is…solitary, poor, nasty, brutish, and short”. Here’s the heart of it: Neither absolute freedom nor absolute subjection represents an optimal position.

So between these two extremes the important point to see is: the market takes no essential form. There exists no default or natural state of affairs wherein some kind of “correct” market outcome is produced. There are in fact many market outcomes and we can only describe the movement from one to another-within some reasonable range where we are clearly talking about a real market system-as a change and not as a deviation from some kind of natural market answer. Within this range of truly market-based systems, there will be a different “market outcome” for every different regulatory/government superstructure that a society sees fit to put in place.

February 10, 2003
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