Principles of Market Fundamentalism, No. 3: Rules

No complex socioeconomy can exist without rules, whether explicit or implicit. And rules are human ascriptions. That does not mean that all rules are created equal. It means that economies require a facilitation function for economic actors who will likely never meet and may not even speak the same language. The rules are, in a manner of speaking, a lingua franca.

They have instrumental value. 

Political economists refer specifically to institutional rules. In other words, what is the matrix of rules on which this or that economy operates? How do those rules shape our behavior through the incentives they engender? 

Consider three basic rules upon which advanced economies run: property, prices, and profit and loss: 

Property is a set of rules about who owns what. Without some institution of private property, even if only implicit, there can be no exchange and, therefore, no mutual benefit. Private property also creates strong incentives for resource stewardship, whether in conservation or entrepreneurship. If no one owns some valued resource, people will race to exploit it. We call this situation a tragedy of the commons.Overconsumption is part and parcel of these problems. One rule is to allow common pool resources to pass from an unowned state to an owned state to prevent overconsumption and encourage economic activity. Homesteading, public auctions, and other methods can aid in this transition. On the other hand, some political economists see value in a managed commons. In this scenario, the property remains in the commons but gets stewarded by locals operating according to evolved community rules. According to Nobel laureate Elinor Ostrom, managed commons are notoriously difficult to maintain and scale, so she warns against large-scale or bureaucratic commons management. She also warns that they should be evolved.

Prices. Market actors can set prices through their actions, or authorities can set prices through their edicts. History has shown, however, that the latter creates a series of distortions and difficulties. Because economies are complex and constantly changing, they cannot be known by a single mind or committee of minds. No one can precisely allocate resources among competing wants, needs, and subjective valuations. Prices are thus “knowledge wrapped in an incentive,” according to economists David Prychitko and Alex Tabarrok. If, according to your valuation, the price is too high, you might seek a substitute or do without the good or service. If you find the price is too low, you might be an arbitrageur who buys more of the good or service to resell in scarcer markets. Between supply and demand, market actors tend toward equilibria, referred to as market clearing. It’s not a perfect process, but it is superior to alternatives. Prices coordinate this process in a way that no authorities could.

Profit and loss. All organizations, from co-ops to megacorporations, should exist within a profit-and-loss system. Simply put, if revenues do not flow to the organization in excess of costs, it almost always indicates that the organization is valuable to no one and that its very existence wastes resources.  Interventions, whether bailouts or subsidies, paper over an organization’s value signals. Such value cannot be rationally determined outside a profit and loss system. Whenever authorities stray from such a system, the institutions will attract pirates and predators with promises of paper profits. In other words, not all profit is the same. Paper profits that flow from favor-seeking behavior, such as subsidies, do not reflect market value, which is customer value. Only those organizations that can internalize all costs, including environmental harms, and freely attract customer or investor income over costs ought to exist.

This includes providers of governance services in a Consensual Society.

There are myriad other institutional rules from which to choose. But as innovators experiment with new forms of governance, they must introduce rules that are more likely to benefit any given system member, however unequally. Rules should regularize behavior instead of determining outcomes, just as a traffic rule to drive on the right creates predictable patterns without determining our destinations. And as I suggest, governance systems that don’t satisfy member desires will lose those members. Lost members mean lost revenue. And lost revenue ends in failure. This is the way in healthy economies, just as in healthy ecosystems. We forget this lesson at our peril.