Thursday, October 04, 2007

The tyranny of the market

Excellent article by Joel Waldfogel of ( discussing how the free market is not the perfect solution to all problems. Republicans like to lean on arguments of "letting the free market work" to avoid any number of social changes, such as universal health care.

The article discusses how and why the free market doesn't always work. The primary reason, of course, is that a true "free market" only works efficiently when there are no "externalities" affecting the market. In other words, free market theory assumes that all participants have perfect information, at no cost, and that there are no opportunity costs involved to make or change decisions. The Latin phrase is "ceterus parabus" meaning "all else being equal."

I am not familiar with such a world, and I'm not sure you are either. Usually a Republican argument for "free market solutions" is a cover for "our guys are doing well with how things are right now, so let's not change things and cost them money."

A long, but accurate, joke about the fallacy of economics goes like this. A physicist, a chemist, and an economist are stranded on a desert island. A box of canned food washes ashore to save them, but they have no way to open the cans. The physicist uses his talents first to try and open the cans, building a lever out of the tree bark, but fails. The chemist uses his special skills to open the cans by creating an acid from the tree sap to eat the lids off the cans, but fails. They turn to the economist to use his special skills. The economist looks at the box of cans, thinks for a moment, then says ... "OK, assume a can opener ..."

See, that's why economists are generally not invited to parties. But it does explain a lot of the value of free market theories in principal, not so much in practice.


If the Shoe Doesn't Fit
Blame the tyranny of the market.
By Joel Waldfogel
Posted Thursday, Oct. 4, 2007, at 7:27 AM ET

Sam McCracken of Nike shows the new Nike Air Native N7 shoe
Last week, Nike unveiled a shoe designed specifically for American Indians. The sneaker has both a native-theme design and—more importantly—a wider shape to accommodate the distinctly shaped feet of American Indians. With diabetes and related conditions near epidemic levels in some tribes, American Indian leaders were happy to welcome this comfortable product. If anything, what seems odd is that it took so long. After all, free-market economists have told us for decades that we should rely on market decisions, not the government, to meet our needs, because it's the market that satisfies everyone's every desire.

And yet it turns out that it's the Indians' long wait for a good sneaker that's typical. For small groups with preferences outside the norm, the market often fails to deliver, as I argue in my new book, The Tyranny of the Market: Why You Can't Always Get What You Want.

John Stuart Mill pointed out that voting gives rise to a tyranny of the majority. If we vote on what color shirts to make—or whether to make wide or narrow shoes—then the majority gets what it prefers, and the minority does not. The market, on the other hand, is supposed to work differently. As Milton Friedman eloquently put it in 1962, "the characteristic feature of action through political channels is that it tends to require or enforce substantial conformity. The great advantage of the market is that it permits wide diversity. Each man can vote, as it were, for the color of tie he wants and get it; he does not have to see what color the majority wants and then, if he is in the minority, submit." This is a wonderful argument. Except that for many products and for many people, it's wrong.

Two simple conditions that prevail in many markets mean that individual taste alone doesn't determine individual satisfaction. These conditions are 1) big setup costs and 2) preferences that differ across groups; when they're present, an individual's satisfaction is a function of how many people share his or her tastes. In other words, in these cases, markets share some of the objectionable features of government. They give bigger groups more and better options.

In my research, I've discovered that this phenomenon is widespread. Ten years ago, I started studying radio-station listening patterns. I noticed that people listened to the radio more in metro areas of the United States with relatively large populations. This is not terribly surprising. In larger cities, more stations can attract enough listeners and advertising revenue to cover their costs and stay on the air. With more to choose from on the dial, residents tune in more. So, in this situation of high fixed costs (each station needs a following to keep broadcasting), people help one another by making more options viable.

But who benefits whom? When I looked at black and white listeners separately, I noticed something surprising. Blacks listen more in cities with larger black populations, and whites listen more in cities with larger white populations. Black listening does not increase where there's a higher white population, and white listening does not increase with a higher black population. Which means that while overall people help each other by increasing the number of stations on the dial, blacks do not help whites, and whites do not help blacks. Similar patterns arise for Hispanics and non-Hispanics.

A closer look at the data—necessary only because I'm a middle-aged white economist—showed why this was happening. Blacks and whites don't listen to the same radio stations. The black-targeted formats account for about two-thirds of black listening and only 3 percent of white listening. Similarly, the formats that attract the largest white audiences, like country, attract almost no blacks. This means that if you dropped Larry the Cable Guy and a few thousand of his friends from a helicopter (with parachutes) into a metro area, you'd create more demand for country and perhaps album-rock stations, which would be nice for white listeners. But the influx wouldn't help black listeners at all.

In this example, different population groups don't help each other, but they don't hurt each other, either. Sometimes, though, the effect that groups have on each other through the market is actually negative. Industries like daily newspapers offer essentially one product per market. Because the paper can be pitched to appeal to one group or another, the larger one group is, the less the product is tailored to anyone else. This is the tyranny of the majority translated almost literally from politics into markets.

This brings us back to Nike's new shoe. Foot Locker is full of options that fit me and most other Americans. But American Indians make up just 1.5 percent of the U.S. population, and with feet on average three sizes wider, they need different-sized shoes. If we had all voted in a national election on whether the Ministry of Shoes should make wide or typical-width shoes, we surely would have chosen the latter. That's why Friedman condemned government allocation. And yet the market made the same choice. If Nike's announcement looks like a solution to this problem of ignored minority preference, it really isn't. The company took too many years to bring the shoe on line, and according to the Associated Press, the new sneaker "represents less of a financial opportunity than a goodwill and branding effort."

The tyranny of the market arises elsewhere. With drug development costs near $1 billion, if you are going to be sick, hope that your disease is common enough to attract the interest of drug makers. If you want to fly from your town to Chicago, hope that your city is big enough to fill a plane every day.

When you're not so lucky, you benefit when the government steps in on your behalf, with subsidies for research on drugs for rare diseases or for air service to small locales. For a generation, influential economists have argued for letting the market decide a wide array of questions, to protect your freedom to choose whatever you want. This is true—if everyone agrees with you.

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