Friday, June 26, 2009

The State and the Economy Part 2 of 94, When Markets go Wrong

Alright folks, time for my next thrilling installment of my series "The State and the Economy", last time, I discussed the concept of coordination and the idea of concious and unconcious coordination. What I'd like to concentrate on this time is the concept of unconcious coordination through the market and when it goes wrong.

At it's most basic level, market signals are about supply and demand, an increase in the price indicates an increased need for the good which acts as a signal that supplies should increase. What is often ignored about market signals is that they are tied to a particular time. Take for example a merchant ship travelling to a far off colony, say one that is six months away by ship. On arrival a merchant may learn of the high price of tools due to upcoming building work, by the time that merchant ship reaches home the market signal will be six months old, in addition it is likely that the market signal has been dispersed among a number of merchant's all of whom will attempt to supply these tools. One year later and the various merchant ships return to the colony, but find themselves out of pocket since there is now a vast surplus of tools.

There is the time delay between the price rise indicating an increased demand and the development of capacity to meet that demand often means an excessive development of production capacity which can lead to a coordination failure as too much resource is directed where it is not needed. There is often a serious cost to this kind of coordination failure since there is a cost involved in correcting the failure.

A huge problem with the arguments put forward by those who argue in favour of market forces is that they assume that there is virtually zero cost arising from these coordination failures. They assume that market forces will simply allow the economy to adapt and reallocate resources almost instantaneously. I would suggest that the adaption is not instantaneous and that as a result there would be an opportunity cost and would second ask whether the correction would ever actually result because the of the delay between a demand signal and the resources becoming coordinated appropriately in order to provide the required supply.

It's my belief that the benefits of markets to an economy are decidedly limited, while a market signal may indicate the need for an increased supply of a good, it gives very little information in terms of the acutal quantity needed. While it can certainly be argued that the pricing signals in markets perform a function I would seriously question the need for the market as an institution taking as dominant a role as it has in the modern economy.

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