The Failure of Markets

I very much enjoyed John Cassidy’s How Markets Fail. It is an ambitious piece in which he tries to describe how economic thought has impacted real-world markets. He has a special focus on the collapse of the financial markets in 2007/8 and the economic thought behind the failure to regulate the markets properly.

He outlines many of the problems that he sees with conventional economic theory, which he calls “Utopian economics”. He contrasts the Utopian approach with what he describes as “reality-based” economics. This reality based form includes behavioural economics but goes much wider. Reality-based economics includes considering tricky issues around the institutional details of markets. We shouldn’t just examine demand and supply but consider how the buyers and sellers can actually get together to form the market?

I appreciate Cassidy’s viewpoint on market details despite the fact that I think theory is important. I wouldn’t want to see reality-based economics as atheoretical. I see the problem with the Utopian based economic models not as their use of theory but as a problem of assumptions. If you assume people will behave in a certain way despite the fact that they never behave that way, then it isn’t really surprising if your predictions are poor. This will happen even if your theoretical model is internally consistent and its math beautiful.

Seeing the need for reality-based economics, especially the need for accurate assumptions about people and institutional details, allows one to consider some key questions about the simplistic views of markets we often see. That markets can work marvellously is not a guarantee that markets will always work perfectly. This is not even a guarantee that markets will work better than any given alternative. In healthcare there are many challenges with single payer systems but it is important to understand that advocating for “free” markets often doesn’t solve these problems and indeed often create new issues. As such the key question isn’t “do markets in general work or fail?”; but “in what circumstances do markets work or fail?” We need to figure this out to better understand whether markets are likely to fail or not to set public policy informed by reasonable assumptions.

Clearly this is a massive task but a dose of reality-based thinking as Cassidy advocates seems necessary to avoid simply repeating past mistakes.

Read: John Cassidy (2010) How Markets Fail: The Logic of Economic Calamities, Picador