15 Things That Markets Must Deal with to Work as the Textbooks Say They Do.

These curses of “pure economics” need to be taken into account if we want to create a healthy economy

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By John Komlos

Markets don’t work the way economics textbooks say they do. While I do believe in the power of markets to cultivate social good, they have many natural limitations that any credible scientific approach must recognize for public policies to be effective. Listed here are fifteen curses—yes, I call them curses—that markets must deal with to work as the textbooks say they do.

Curse 1: Incomplete or asymmetric information poses a huge obstacle to the efficient functioning of markets. Actually, it makes efficiency rarely attainable. Information is costly to acquire and is unequally distributed, and therefore not everyone has access to the same information, given the unequal distribution of wealth.

Curse 2: Opportunistic behavior refers to the problem that free markets open up myriad possibilities for people to take advantage of situations in an immoral, unprincipled, cunning, crafty, or deceptive manner or with guile.

Curse 3: Rationality assumption is a “no starter,” according to Nobel laureate psychologist Daniel Kahneman. In fact, no psychologist today would agree that humans are as rational as armchair economists insist.

Curse 4: Cognitive endowment of people participating in the marketplace is quite heterogeneous. This poses an independent challenge for standard economics insofar as textbooks tacitly assume that the people who participate in the marketplace are homogenous—that is, everyone is equally capable of solving the complex economic problems posed by today’s global system.

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Curse 5: Children are completely disregarded in most of economics. Perhaps economists need to be reminded that we are not born as adults and we do not enter the economy with fully developed tastes as adults.

Curse 6: Time inconsistency refers to the serious problem that our actions today continue to have consequences far into the future, and in the future we might well regret the actions we took in the past. In short, we might change our mind.

Curse 7: Society does not exist in blackboard economics, only individuals who hardly interact with one another. In other words, economists completely neglect the disciplines of sociology and social psychology.

Curse 8: Power imbalances are also neglected by mainstream economics, even though they are enormously important, because they skew economic policies in favor of the wealthy and lead to political power imbalances that further the privileges of the elite while at the same time threatening the basic ideals of democracy.

Curse 9: Uncertainty is a formidable challenge to markets. The human brain has great difficulty processing information with uncertainty involving the calculation of probabilities. The subprime mortgage crisis demonstrated just how much pillaging can result when people misunderstand risk, misprice it, and do not assess it properly.

Curse 10: Financial markets are inherently unstable because of fractional banking and because its assets are long term while its liabilities are short term.  As we have seen hundreds of times since the Industrial Revolution, and most vividly in 2008, financial markets, as a human invention, can go haywire.

Curse 11: Transaction costs put a damper on welfare and hinder efficiency, because they use up resources but do not increase welfare. However, they are not mentioned in Principles of Economics textbooks. There are search, information, policing, and enforcement costs.

Curse 12: Time and space are not firmly integrated into mainstream thinking. This is a serious conceptual shortcoming because both variables are essential to the understanding of why markets are generally inefficient.

Curse 13: Nonexistent markets pose a serious challenge to our welfare and the welfare of future generations. Markets, by themselves, produce too much pollution because no one owns the atmosphere. Consequently, pollution has become our very biggest global challenge.

Curse 14: Setting limits and standards are extremely difficult by decentralized markets. The inability of market to set limits gives us too many different incompatible standards and too much inequality.

Curse 15: Safety is not easily provided by markets inasmuch as it is a difficult-to-ascertain, intangible attribute and there is a psychological bias toward the present on the part of both producers and consumers.

Of course, there are many practicing economists who disagree with the primary thrust of the mainstream view of their discipline and even chide their colleagues for not questioning their own assumptions more seriously. To be sure, conclusions reached by deduction from assumptions practiced by the mainstream are logically valid on the blackboard but often turn out to be toxic at street level.

These curses of “pure economics” need to be taken into account if we want to create market systems that function in a healthy and productive manner while simultaneously promoting societal wellbeing for people and planet.

For further reading see: J. Komlos, What Every Economics Student Needs to Know and Doesn’t Get in the Usual Principles Text (New York: Routledge, 2014).

November 1, 2015

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  • I don’t get the by-line. Surely every econ 101 course would deal with the limitations of the assumptions in economics.

    Much more disgraceful, from my point of view, is the acceptance of naive comparative advantage theory, and the fact that it is the dominant negative influence on the world’s economic health.

    This theory, like so many micro-economic theories, is predicated on the assumption that national economic systems are static. In this case, the theory holds that the maximum benefit for each nation will be achieved by concentrating on those things in which it has comparative advantage.

    Therefore, in Ricardo’s system, UK was encouraged to concentrate on textile manufacture and Portugal on wine production. So far, so good. That is what happened in the 19th century.

    This brings us to the first unintended consequence. The UK developed a machinery manufacturing industry to support its textile industry, whereas Portugal was left behind as a rural “idyll.” It shows that national economic systems are not static, and it is folly (at least for the disadvantaged partner) to assume that they are.

    The second type of unintended consequence has revealed itself in more modern times. This arises from the assumption that as jobs move to nations that can produce goods more cheaply other jobs will arise to fill the gap. Tell that to the 50% of young people in Spain who are unemployed.

    Of course, unemployment in southern Europe will fix itself over time – like the 100 years it took to fix the unemployment that arose out of the enclosure laws in England.

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  • Dr. Lovell,

    I wish your comment on the by-line were true. It surely wasn’t
    when I took econ 101 at MIT (albeit, that was in the 60’s). We started out with
    the conventional supply/ demand curves. The professor mentioned that this was
    an “idealized” concept. HOWEVER, refinements had to wait for ADVANCED CLASSES.
    So we were given problems to work out using the conventional curves.

    I doubt that things have changed much because an “accurate”
    econ theory still remains elusive. What truly scares me is that the theories we
    are currently presented by the so called economics “experts”, produce such
    radically different results over the range we call liberal to conservative. If
    political views have such a strong influence on the economic theories we use to
    guide the fate of humanity, then the concepts of intellectual freedom and
    intellectual excellence at the university level MUST be either severely
    corrupted or without a firm scientific foundation. Please understand my alarm
    about this. This failing applies GLOBALLY. That is the basis for my research at the
    A3 Research Institute – to understand such a massive shortcoming in human intelligence.

  • Robert Wootton

    Curse 3, the idea of the rational actor is why I rejected Economics as a serious subject when reading for my degree in International Studies back in 1982.
    Inequality of Informations. The Rothschilds statted their fortune by arranging to get advance information about the outcome of a battle or a war some where in Europe.

    A fisherman working of the East coast of Africa would use his cell (mobile) phone to contact different ports to find out which market was paying the highest price for fish. He would then land his catch at the port where he could earn the most. I read this in the Economist some years ago.

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  • Punksta

    Incomplete information makes markets work badly. Unlike central planning, which works just fine with incomplete information…?

    Likewise the other supposed problems are something any Econ 101 student could likewise dismiss in one sentence.

    • Kyle Ambrose

      Well said! These very limitations are why politicians should not be trying to manage an economy.

  • Would any of these curses be solved by centralized government mandates? Could they be solved by anyone in some different way? They read to me like human limitations–limitations that are endemic in economic markets, political institutions, cultural institutions, even bird-watching clubs. In short, these curses do not comprise a problem to be solved, but a condition to be faced.

    • Kyle Ambrose

      Exactly right! They are merely the realities of being human. That’s what an economy is–a set of interactions by individual human beings.

  • Jan de Jonge

    This is a typical microeconomic reading. In more sophisticated books many of the “curses” surely are represented (not all; curse 8 and 9 are often missing). But you ignored macroeconomics.

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  • Until economics can get past the hero worshipping of Adam Smith on the right and Thomas Hobbes (the Leviathan) on left, it will never truly evolve. This ‘one way or the other’ thinking which dominates academics and policy making has proven to be increasingly irrelevant in today’s world. Imagine if economics looked past reinforcing ideologies and looked openly at hybrid alternatives or even completely new ways of solution based thought. A good place to start is with the work of Nobel Prize winner, Elinor Ostrom.

  • Bab Bolelli

    “Curse 8: Power imbalances skew economic policies in favor of the wealthy and lead to political power imbalances.” Economics and politics are inseparable, I don’t understand why academia has separated them.

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  • John Larsen

    This is a rebuttal of a strawman, how can you be a professor of economics and write this dribble?

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  • Ray Lopez

    Yawn. Not even controversial. You could also add: “Econ 101 often assumes (except for the chapter on monopoly) perfect competition, which almost never exists in real life”. A more telling list would be: (1) economies are largely non-linear, and cannot be predicted short term, except for the crudest long run, and, (2) monetarism does not work, it only gives, at best, 3.2% to 13.2%, out of 100%, change to real variables (cite: Ben S. Bernanke’s 2002 FAVAR paper).