You Probably Need Markets and That's Okay

I seem to run into a lot of people who envision a future without markets. And even more people who don’t say so directly, but still talk about markets as if they’re a gross but necessary evil.

I don’t agree. To have a market, two things are necessary (but not necessarily sufficient):

  1. People who have things, where those things usually can’t be taken from them without their consent. That’s called private property.

  2. Pareto-efficient trading opportunities.

A pareto-efficient trade is a trade where nobody is made worse off than before. If I like apples but have oranges, and you have oranges but like apples, we can trade and both be better off than before.

Whether such opportunities exist depend on the allocation. For example, if one person has everything and everyone else has nothing, no pareto-efficient trades are possible. Happier example: if everyone has the thing they like the most, that’s another situation where no pareto-efficient trades are possible. When no trades are possible, the allocation is said to be in equilibrium.

Markets are a way of moving any distribution closer to equilibrium. They’re a particularly good point in the design space because they’re most decentralized and trustless. They probably require some centralization and some trust - for example, they need police and a judicial system to make sure people don’t sign contracts, take payment, then never deliver. But for the most part, any trade transaction requires little trust and is mostly decentralized. (For the most part, nobody except those involved even need to know the trade occurred). So why the antipathy?

I’m reminded of Bryan Caplan’s view of the dichotomy between the american political left and right:

Leftists are anti-market. On an emotional level, they’re critical of market outcomes. No matter how good market outcomes are, they can’t bear to say, “Markets have done a great job, who could ask for more?”

Rightists are anti-leftist. On an emotional level, they’re critical of leftists. No matter how much they agree with leftists on an issue, they can’t bear to say, “The left is totally right, it would be churlish to criticize them.”

Why people don’t like markets

I basically think there’s two main reasons:

  1. Markets seem like they’re often associated with bad things

  2. Market efficiency is unintuitive, so if they’re associated with bad things, why not throw them out?

A good example is Wolff’s tweet. People in rich countries are getting Covid booster shots before people in poor countries are even getting their first dose. That’s obviously inefficient and unjust! Also, vaccines were distributed via a market. Clearly the market is to blame.

I’m not sure. Rich countries have more stuff than poor countries. When new stuff comes out, like vaccines or whatever, then rich countries can trade their existing stuff for more vaccines than the poor countries can. The vaccine distribution was unequal, yes, but only because the initial distribution of stuff in general was unequal too. The root cause is the lopsided initial distribution, not the presence of markets.

Isn’t that a bit unfair? Maybe the cause is the lopsided initial distribution plus the use of a vaccine market. I mean, if vaccines were allocated via a lottery then we wouldn’t have this problem. Surely that would be better, right?

I don’t think this solves the problem. Imagine you’re Richistan, and you’re willing to pay $50 for a vaccine. Meanwhile your neighbor Povertybul is only willing to pay $10 for a vaccine. Using a market, all the vaccines would go to Richistan because they’re willing to pay the most. But let’s say for some reason both countries got the vaccines in equal number - well, what’s stopping Richistan from just buying all the vaccines from Povertybul for $30 a piece? Povertybul was only willing to pay $10 to buy them, so it’d be a little weird if they wouldn’t sell them for $30. The end result is the same: Richistan gets all the vaccines.

Welcome to Coconut Island

There’s another issue with markets: monopolies. The classic demonstration is the “Coconut Island Hypothetical”. You wake up on an island. There’s only one other person there, and he’s already gathered all the coconuts, which you’ll die without. He tells you he’ll be happy to give you some of his coconuts, but you have to suck his dick.

This was designed to be a criticism of the idea of voluntary exchange - are you really voluntarily sucking his dick if you have no other option to survive? It’s a good hypothetical, but it’s not actually making the point it thinks its making.

Let’s mutate the analogy. There’s hundreds of people on the island, and the only way to get coconuts is to make an extremely dangerous jump across a river of lava, grab a coconut, and jump back. Only one coconut can be carried at a time and each one can sustain a person for a week. So most people just make a jump every week to get themselves a coconut and then occupy themselves in other ways the rest of the week.

You’re living on the island, jumping for your own coconuts, but one day you fall down the stairs and break your legs. Now you need to convince someone else to get coconuts for you, but the jump is so dangerous and you have so little to offer that no one is willing to. Nobody… except for one very sexually unsatisfied man, who says he’ll risk his life and do it if you suck his dick every week.

It’s just as coercive as before: suck dick or die of starvation. But it doesn’t seem nearly as ethically wrong as in the first example. In the original hypothetical, the person whose dick you suck loses very little (they have a huge pile of coconuts that weren’t that hard for them to get), but you lose a lot (sucking a stranger’s dick is assumed to be very unpleasant). In the mutated hypothetical, the stranger loses a lot more, because they have to risk their life to get a coconut for you. So the sense of moral wrongness in the original hypothetical, I think, comes from the unfairness of the trade rather than the coercive aspect.

Why is the trade unfair? Simple: the original hypothetical contained a monopolist. That’s actually another problem with markets. They don’t reach a very good equilibrium when someone has a monopoly. In this case, the other islander has a monopoly on coconuts - so the “price” of coconuts (blowjobs) is substantially above the minimum price the coconut vendor would be willing to part with his coconuts for.

This is not the world’s clearest graph, but it’s how an economist would explain the problem. The orange area represents potential mutually-beneficial economic transactions that aren’t happening due to a monopoly. I’ll come up with a better explanation of this later.

Getting back on track: anti-market people are right, markets suck here. There’s actually a very interesting tax which would alleviate this issue that I’ll discuss in a future post. (Put your pants back on Georgists, it’s not a land value tax.)

But also, I’d like to point out again that at least markets didn’t make the situation worse. If you banned trading, you’d just have a guy with a mountain of coconuts and no incentive to give you any. So markets here seem to still be better than no markets?

Fine, I’ll talk about Externalities

Okay, the big one. This one is currently causing global warming and untold other catastrophes. What’s an externality? An externality is when something has a cost, but that cost isn’t paid by the people who choose whether to do that something. For example, emitting carbon has a cost (slightly warming the earth), but typically you can emit carbon basically for free. People will emit carbon when it’s a good deal for them, without caring whether it’s a good deal for society. So if you want to make sure they don’t do that, you need to make emitting carbon cost more, so that people will only do it if it’s a really good deal for them (and in that case maybe society can tolerate the extra carbon).

But like the vaccine example, I will argue that this has nothing to do with markets. Take pooping on the sidewalk - that has an externality too, namely that everyone now has to step around your mess and have their day made slightly worse. But because the one who leaves the waste isn’t the one who has to deal with that problem, you can imagine a person who poops on the sidewalk any time it’s a tiny bit more convenient than using the restroom. That’s obviously a bad deal for society (that is, aggregate welfare would be better off if this guy used the bathroom) and it’s the same problem as before, with no market involved.

If you restate the problem it becomes obvious that it’s unrelated to markets. The problem is that if someone can do something that inconvenience others but benefits themselves, they’ll often do it even if the inconvenience to others is greater than the benefits they receive.

Markets exacerbate the problem by making it much easier to coordinate - with a market you can get thousands of people to work together to make a coal plant and feed it coal, all to benefit themselves while paying no mind to the poison they’re putting in the atmosphere. But they also give us a very elegant solution: institute a Pigovian tax, that is, a tax whose purpose is to discourage people from doing a bad thing rather than to raise revenue. Ideally you make the tax equal to the cost to society. When you do that, you make it so people are only willing to do the bad thing if the benefit to them is bigger than the cost to society.

Other problems

There are more situations where markets fail to reach a good equilibrium that I’ll discuss in a future post. They’re subtle and deserve their own post. They were even missed by economists for a while! (Although of course anything I can say is already common knowledge by now.) Consider subscribing if you want to read it when it’s done!

Market Alternatives

Markets are not all good, but in many cases they can be pretty okay at reaching an equilibrium, and it’s hard to see why you’d want to prevent that from happening. There are other ways of reaching equilibrium, like Henrik Olof Karlsson’s trust networks, or Cockshot's big computer that just figures out the optimal distribution. But there are practical problems to both of those - trust networks don’t scale as well as markets do, and it’s not clear how to get all the information needed for big computer. (Cockshot claims to have a solution to that, he doesn’t.)

Or you can try the USSR method: gulag everyone who tries to trade. But then you’re just stuck with whatever shitty equilibrium you managed to come up with without markets, plus an expensive and totalitarian enforcement system. And what exactly was so bad about people trading again?

Since trust networks and big computer don’t work for a globalized society, markets are all we’ve got. And they’re not so bad - they get the blame for problems whose cause is much farther upstream.

Right now the dominant view of socialism is either “we should raise taxes on the rich to fund social programs“ or “we should have more cooperatives”. I love cooperatives1 and social programs! Call it socialism, I don’t care, the important thing is that anti-market people are kept in their place.


I kind of doubt they will work as a replacement for corporations, but I think there’s a good opportunity for housing cooperatives (I live in one!)