Free markets don’t really work for everything

My Bloomberg View colleague Tyler Cowen has a running series of blog posts bearing the title “Markets in Everything.” Plenty of other economists and writers have picked up the phrase, and with good reason—it’s evocative of a powerful idea that defined much of Western political economy in the later part of the 20th century. The idea is that markets—systems of property rights with free buying and selling—are the best way to organize a vast array of human interactions.
Decades after the Beatles sang “Can’t Buy Me Love,” a whole generation of libertarian thinkers were wondering how much better the world would be if people could buy and sell everything. Some, like authors Jason Brennan and Peter Jaworski, took this idea to radical extremes, arguing that everything from body parts to school grades should be up for sale. Though few would go that far, the idea certainly seemed to fit with a political era of privatization and deregulation. Economists tended to like the idea for a more prosaic reason—mathematical models with so-called complete markets are a lot easier to solve.
In the US, marketism is still making inroads. The Trump administration is considering a plan to replace many military functions with private contractors in Afghanistan. Donald Trump also cancelled an Obama-era proposal for a rule against getting paid for donating bone marrow. The Internal Revenue Service is experimenting with using private debt collectors. Efforts to reduce the use of corporate prisons have stalled.
For the most part, this isn’t a good thing. Like every ideology, marketism has its limits, and like every movement it eventually overreached. There are plenty of reasons that a vast array of human interaction should be carried out without money or any kind of quid pro quo. And unsurprisingly, these problems crop up in many of the areas of human life into which people are now trying to push markets.
The problems with markets mainly fall into a broad category that economists like to call “transaction costs.” That term refers to any cost people pay when they engage in arms-length market transactions. It’s not just sales taxes or swipe fees for credit cards. Market exchanges require time and effort to match a buyer with a seller, to verify that counterparties are trustworthy, to negotiate prices and to verify whether the counterparty delivered the desired results.
Economist Ronald Coase realized that this is why companies exist in the first place. Companies are like little miniature governments—instead of negotiating a monetary payment each time you file a report or write some code or do an hour of work, your boss simply tells you to do it, and you do it. The long-term, implicit, unstated economic relationships within a company cut down on time and effort. It’s no great stretch to think that many human social institutions—communities, governments, even groups of friends—accomplish a similar function.
Transaction costs can also arise from natural human emotions. Imagine if someone offered you money to be their friend. If you’re a normal human being, the idea of boiling friendship down to a cold, self-interested exchange would probably feel repellent to you.
Within companies, people often prize loyalty to coworkers or to an organization. That may explain the surprising yet common finding that direct monetary incentives often reduce work performance rather than increase it. Privatizing the army, tax collectors and prisons is a bad idea, because it ignores the crucial function that loyalty, dedication, idealism and commitment play among combat troops, bureaucrats and prison guards.
Transaction costs can also arise from other people’s market decisions. This is called an externality. When people let their houses fall into decay, they’re making a market decision not to pay for upkeep, but it imposes a cost on neighbors who now have to live in a run-down area. Governments often try to manage these externalities with markets—for example, cap-and-trade exchanges for pollution permits. But when left to its own devices, society often deals with externalities through non-market mechanisms—neighborhood associations, for example.
Taken to its ludicrous extreme, marketism would incur far too many transaction costs. Imagine having to pay a fee for the air you breathe, or to walk down the street where you live. Such a free-market paradise would feel more like a prison.
The late 20th century saw an expansion in the scope of human relations that take place in markets. But the early 21st century should be a time for rethinking this trend. The idea of markets in everything is bumping up against its natural limits.
—Bloomberg