Friday, April 18, 2014

Are Markets Better Described as Robust than Efficient?

Something that I think all of us with private sector jobs experience in our day to day lives is just how incompetent a large number of private businesses are. These may be our customers, suppliers, or another division. Yet, somehow, these businesses thrive despite not really having a good grasp of basic administrative procedures, financing, or sometimes even customer service.

Despite this, we often write and speak of private sector actors as if they are brilliant and efficient individually, despite the experiences of our everyday lives.* We simply assume as a result of mere market success that a business or individual has ability and competence. This isn't surprising, the just world hypothesis is a powerful cognitive bias which leads us to believe that the system as a whole must be more just than what our individual experiences would lead us to conclude. However, there is no property of the market system which should lead to this belief.

What's more notable is how little this impacts how we think about the market system as a whole. After all, given an immortal, perfectly rational, and omniscient central planner even the worst designed communist system would work beautifully. What's remarkable about the market system is that it should lead to ever increasing levels of productivity and efficiency even if the individual actors are all completely incompetent. Competition and creative destruction should lead businesses to be ever better even if they only differ due to random variation alone.

Yet, somehow this doesn't seem to impact how we think and write about markets and how they reward people much at all. Instead we often read in the popular press views about how market success means that an individual or business possesses unusual ability or competence despite the dearth of well established causal links between market success and any particular ability or trait. Creative destruction works as more of an evolutionary system, simple selection will lead to new forms to suit the environment they're in without the need for any conscious planning.**

An example may help illustrate this. The need for a common computing platform caused the market to require that a single operating system would predominate. In the early years of innovation in the personal computer market a wide variety of operating systems developed, all with a business plan that was more or less plausible. It was inevitable, however, that only one of these would dominate the industry due to the structure of the market. Someone was going to make billions, and did, but the need for a common platform meant that this would have happened whether or not any of the competing platforms exhibited even the barest level of competence. In addition, once established the need for interoperability mean that structural factors dominate any actual characteristics of the competition.***

This makes me think that markets might be better described as robust rather than efficient. The incredible thing about markets is that even if all the individual actors are morons the systemic factors will still lead to good outcomes, unlike other forms of human organization. But somehow this doesn't break into popular discussions of markets at all, much less into discussions about how our market system is distributing the fruits of our labors. I'm not sufficiently well versed in economic literature to know whether or not someone has done work on this, but I'm very curious if anyone has tried.

*I don't mean to imply that all, or even many, private sector actors are incompetent. While there certainly are many extremely well run firms the striking thing is how many obviously incompetent ones there are at every level; though admittedly they become rather rare among the largest firms.

** Not that being able to foresee market shifts doesn't help a great deal, but someone will turn out a winner even if there is no possibility of judging which plan will be successful from information beforehand; in other words the success of an individual strategy in no way implies that this strategy was better than the ones that failed.

***I don't mean to say anything negative about Microsoft. But there is no way to judge from its success whether it had a better business plan than its rivals or if its success was simply the result of network effects among users. Determining causes would require a more fine grained analysis that takes into account what was knowable before the market drifted to favor it rather than working backwards from its present success.

1 comment:

  1. The whole purpose of bureaucracy, whether in government or in a company, is this. Tightly defined processes and procedures allow an organization to function, even when many of the individual components are barely marginally competent. And in most (I would go so far as to say virtually all) organizations, that is the case. Certainly nobody who has worked in a large organization would characterize it as efficient.

    Markets, I suspect, are similar. They are a method for reaching generally good economic results, even though many of those involved are not particularly competent. Or efficient.