Chapter 13 Making Markets Work

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Ceaseless market vigilance -- How cheap a future -- The myth of free markets -- Skewed markets mean lost capital -- Fiddling with the switches -- An ordered arrangement of wastebaskets -- "Satisficing" -- When regulation fails -- Golden carrots -- Plain vanilla motors -- Making a market in nega-resources -- Alternative annual report

Churchill once remarked that democracy is the worst system of government, except for all the rest. The same might be said of the market economy. Markets are extremely good at what they do, harnessing such potent motives as greed and envy indeed, Lewis Mumford said, all the Seven Deadly Sins except sloth. Markets are so successful that they are often the vehicle for runaway, indiscriminate growth, including the growth that degrades natural capital.

A common response to the misuse, abuse, or misdirection of market forces is to call for a retreat from capitalism and a return to heavy-handed regulation. But in addressing these problems, natural capitalism does not aim to discard market economics, nor reject its valid and important principles or its powerful mechanisms. It does suggest that we should vigorously employ markets for their proper purpose as a tool for solving the problems we face, while better understanding markets' boundaries and limitations.

Democracies require ceaseless political vigilance and informed citizenship to prevent them from being subverted or distorted by those who wish to turn them to other ends. Markets, too, demand a comparable degree of responsible citizenship to keep them functioning properly despite those who would benefit more from having them work improperly. But the success of markets when they do work well is worth the effort. Their ingenuity, their rapid feedback, and their diverse, dispersed, resourceful, highly motivated agents give markets unrivaled effectiveness. Many of the excesses of markets can be compensated for by steering their immense forces in more creative and constructive directions. What is required is diligence to understand when and where markets are dysfunctional or misapplied, and to choose the correct targeted actions to help them to operate better while retaining their vigor and vitality.

This book has often argued that most of the earth's capital, which makes life and economic activity possible, has not been accounted for by conventional economics. The goal of natural capitalism is to extend the sound principles of the market to all sources of material value, not just to those that by accidents of history were first appropriated into the market system. It also seeks to guarantee that all forms of capital are as prudently stewarded as money is by the trustees of financial capital.

The notion that much of the remedy for unsustainable market activities is the adoption of sustainable market activities may offend both those who deny that markets can be unsustainable and those who deny that markets and profits can be moral. Yet worldwide experience confirms an abundance of market-based tools whose outcomes can be environmentally, economically, and ethically superior. These tools include institutional innovations that can create new markets in avoided resource depletion and abated pollution, maximize competition in saving resources, and convert the cost of a sulfur tax or a carbon-trading price into profits realized from the sale and use of efficient technologies.

Ensuring that markets fulfill their promise also requires us to remember their true purpose. They allocate scarce resources efficiently over the short term. That is a critical task, especially as the logic of natural capitalism changes the list of which resources are genuinely scarce. But the continuity of the human experiment depends on more than just success in the short term, and efficiently allocating scarce resources does not embrace everything people want or need to do.

For all their power and vitality, markets are only tools. They make a good servant but a bad master and a worse religion. They can be used to accomplish many important tasks, but they can't do everything, and it's a dangerous delusion to begin to believe that they can, especially when they threaten to replace ethics or politics. America may now be discovering this, and has begun its retreat from the recent flirtation with economic fundamentalism. That theology treats living things as dead, nature as a nuisance, several billion years' design experience as casually discardable, and the future as worthless. (At a 10 percent real discount rate, nothing is worth much for long, and nobody should have children.)

The 1980s extolled a selfish attitude that counted only what was countable, not what really counted. It treated such values as life, liberty, and the pursuit of happiness as if they could be bought, sold, and banked at interest. Because neoclassical economics is concerned only with efficiency, not with equity, it fostered an attitude that treated social justice as a frill, fairness as pass, and the risks of creating a permanent underclass as a market opportunity for security guards and gated "communities." Its obsession with satisfying nonmaterial needs by material means revealed the basic differences, even contradictions, between the creation of wealth, the accumulation of money, and the improvement of human beings.

Economic efficiency is an admirable means only so long as one remembers it is not an end in itself. Markets are meant to be efficient, not sufficient; aggressively competitive, not fair. Markets were never meant to achieve community or integrity, beauty or justice, sustainability or sacredness and, by themselves, they don't. To fulfill the wider purpose of being human, civilizations have invented politics, ethics, and religion. Only they can reveal worthy goals for the tools of the economic process.

Some market theologians promote a fashionable conceit that governments should have no responsibility for overseeing markets, for setting the basic rules by which market actors play. Their attitude is, let's cut budgets for meat inspection and get government off the backs of abattoirs, and anyone who loses loved ones to toxic food can simply sue the offenders. Let's deregulate financial markets, and self-interested firms will police themselves. Let straightforward telephone, cable TV, and airline competition replace obsolete regulatory commissions. Those seduced by the purity of such theories forget that the austere brand of market economics taught by academic theorists is only tenuously related to how markets actually work. The latest illustrations of that principle include the Wild West wreck now looming in Russia, mad-cow disease, savings and loan fraud, phone scams, and crash-by-night airlines. By the time textbook simplifications get filtered into political slogans, their relationship to actual market behavior becomes remote. A dose of empiricism is in order.

Remember the little section toward the beginning of your first-year economics textbook where the authors listed the assumptions on which the theory of a perfect free market depends? Even as abstract theories go, those conditions are pretty unreasonable. The main ones are:
  1. All participants have perfect information about the future.
  2. There is perfect competition.
  3. Prices are absolutely accurate and up-to-date.
  4. Price signals completely reflect every cost to society: There are no externalities.
  5. There is no monopoly (sole seller).
  6. There is no monopsony (sole buyer).
  7. No individual transaction can move the market, affecting wider price patterns.
  8. No resource is unemployed or underemployed.
  9. There's absolutely nothing that can't be readily bought and sold (no unmarketed assets) not even, as science-fiction author Robert Heinlein put it, "a Senator's robes with the Senator inside."
  10. Any deal can be done without "friction" (no transaction costs).
  11. All deals are instantaneous (no transaction lags).
  12. No subsidies or other distortions exist.
  13. No barriers to market entry or exit exist.
  14. There is no regulation.
  15. There is no taxation (or if there is, it does not distort resource allocations in any way).
  16. All investments are completely divisible and fungible, they can be traded and exchanged in sufficiently uniform and standardized chunks.
  17. At the appropriate risk-adjusted interest rate, unlimited capital is available to everyone.
  18. Everyone is motivated solely by maximizing personal "utility," often measured by wealth or income.
Obviously the theoretical market of the textbooks is not the sort of market in which any of us does business. Actually, if there were such a place, it would be pretty dull. No one could make more than routine profits, because all the good ideas would already have been had, all the conceivable opportunities exploited, and all the possible profits extracted or, as the economists put it, "arbitraged out." It's only because actual markets are so imperfect that there are exceptional business opportunities left.

Just how imperfect are the markets in which we all actually live? Let's run a quick check on that list of eighteen theoretical requirements:
  1. Perfect information about the future? If anyone had it, he or she'd be barred from elections and stock markets and probably not given any credence by the rest of us.
  2. Competition is so imperfect that exceptional profits are commonly earned by exploiting either one's own oligopolistic power or others' oversights, omissions, and mistakes.
  3. Markets know everything about prices and nothing about costs.
  4. Most harm to natural capital isn't priced, and the best things in life are priceless.
  5. No monopolies? Microsoft, airlines' fortress hubs, and your managed-health- care provider come close.
  6. No monopsonies? Consider your utility, the Peanut Marketing Board, and the Federal Aviation Administration.
  7. No market-movers? What about Warren Buffet and the Hunt Brothers?
  8. Thirty percent of the world's people have no work or too little work. (Economists justify this by calling them "unemployable", at least at the wages they seek.)
  9. Most of the natural capital on which all life depends can be destroyed but neither bought nor sold; many drugs are bought and sold in a pretty effective free market, but doing either can jail you for life.
  10. The hassle factor is the main reason that many things worth doing don't happen.
  11. Does your insurance company always reimburse your medical bills promptly? Does your credit-card company credit your payments immediately?
  12. Worldwide subsidies exceed $1.5 trillion annually, for example, America's 1872 Mining Act sells mineral-bearing public land for as little as $2.50 an acre and charges no royalties.
  13. It's hard to start up the next Microsoft, Boeing, or GM or to get out of the tobacco business.
  14. The world's regulations, put on a bookshelf, would extend for miles.
  15. The Internal Revenue Code exists.
  16. You can't buy a single grape at the supermarket, nor an old-fashioned front porch in most housing developments.
  17. Many people are redlined, must resort to loan sharks, or have no access to capital at any price.
  18. So why does anyone fall in love, do good, or have kids, and why do three-fifths of Americans attend weekly worship services?
Actually, the market works even less perfectly than the above counter-examples suggest, for two reasons. First, corporations that benefit from subsidies, externalizing their costs, avoiding transparency, and monopolizing markets tend to ignore market realities and lobby for making new rules, or overlooking old ones, that will best achieve their private benefits. Second, people are far too complex to be perfectly rational benefit/cost maximizers. They are often irrational, sometimes devious, and clearly influenced by many things besides price.

For example, suppose you put a group of individuals in hot, muggy apartments with air conditioners and tell them that both the air conditioners and the electricity are free. What would you expect them to do? Won't they just turn it on when they feel hot and set it at a temperature at which they feel comfortable? That's what economic theory would predict; if cooling is a free good, people will use lots of it whenever they want. But only about 25 to 35 percent of individuals actually behave that way. Many others don't turn on the air conditioner at all. Most do run it occasionally, but in ways that are essentially unrelated to comfort. Instead, their usage depends largely on six other factors: household schedules; folk theories about how air conditioners work (many people think the thermostat is a valve that makes the cold come out faster); general strategies for dealing with machines; complex belief systems about health and physiology; noise aversion; and (conversely) wanting white noise to mask outside sounds that might wake the baby.

Theoretical constructs are, after all, just models. The map is not the territory. The economy that can be described in equations is not the real economy. The world that conforms to eye-poppingly unreal assumptions about how every economic transaction works is not the real world. The sorts of economists who lie awake nights wondering whether what works in practice can possibly work in theory are not the sorts who should define your business opportunities.

Previous chapters have documented 100 to 200 percent annual returns on investment in energy efficiency that haven't yet been captured, as market theory presumes they must already have been. Previous chapters documented improvements in U.S. vehicles, buildings, factories, and uses of materials, fiber, and water that could probably save upward of a trillion dollars per year. These efficiency gains are available and highly profitable but haven't yet been captured. Chapter 3 even suggested that waste, in a more broadly defined sense, in the U.S. economy could amount to at least one-fourth of the GDP. Such prominent examples of market failure suggest that the standard question of how to make markets more perfect should be turned around: Are there ways to address the imperfections in the marketplace that would enable people to capture the profit potential inherent in those flaws? It's time to identify the real-world obstacles to buying resource efficiency, and determine how to turn each obstacle into a new business opportunity. The attractive scope for doing this will be illustrated by examples about energy and occasionally water, but most of the implementation methods and opportunities described could be extended to saving any kind of resource.

(End of excerpt)

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