2
The Market System: Achieving Equity and Material Abundance
Introduction
By the end of the twentieth century, the great ideological clash between capitalism and socialism seemed to have been resolved in favor of capitalism. The nations that embraced the capitalist market system had clearly been more successful in achieving material abundance than those that had adopted the centrally planned economics associated with socialism. Sometimes more rapidly and sometimes more incrementally, nearly all of the economies that had operated under central planning (including the two biggest, Russia and China) began to shift toward a market orientation, eventually reaping the benefits of increasing material bounty. Those few nations that refused to make the shift experienced economic stagnation or worse. Market capitalism had won an unambiguous victory. And that was that.
But a more clear-eyed look at the two economic systems reveals a less clear-cut conclusion. As economic systems, each had its advantages. It turned out that those advantages associated with market capitalism were more important to the accumulation of material wealth than those associated with central planning. This is a very important difference, since the defining function of the economy is to provide material well-being.1 Working under the assumption that people are most strongly motivated by self-interest, a properly functioning market system has enormous advantages in terms of incentives for efficiency, information flows, and responsiveness to shifts in consumer wants and needs – all of which are interconnected. Owners have strong incentives to be efficient because that creates the possibility of higher profits; workers have incentives to be efficient because that creates the possibility of higher pay. The price mechanism is a quick and effective carrier of information about the intensity of demand for each product relative to its availability. And because of the possibility of earning more (profit or pay), producers and their employees have strong incentives to pay attention and respond to price changes that signal shifts in their customers' waxing or waning desire for their particular products and versions of products absolutely and relative to those of their competitors.
Under a properly functioning socialist system, the means of production (the tools, equipment, and facilities people need to do their jobs) are cooperatively owned, workers have more control in their workplace, and therefore there is less of a tendency for workers to be exploited. There is far more job security, and greater access of the whole population to critical basic goods and services such as food, housing, health care, and education because access does not depend on ability to pay. Cooperation, rather than competition, is the order of the day. If it could be assumed that central planners really knew what goods and services people wanted and needed (i.e. if there were no information problem), and were committed to making decisions that maximized the extent to which those products were provided (rather than mainly to narrower and shorter term issues that advanced their own personal careers in the government bureaucracy), socialism would also have considerable potential advantages in coordinating economic activity. But in fact, the information problem alone is enough to give market capitalism the clear advantage in coordination. The system of market-oriented prices determined by the interaction of supply and demand works to efficiently signal information on what goods and services customers really want and need as well as the costs involved in providing them.
It is not particularly something we should celebrate that the economic system which is built on the assumption that people are basically greedy, self-interested, and motivated to outdo each other (the capitalist market system) seems generally to work better for the vast majority of us than the economic system which sees us as more caring, sharing, and cooperative beings (socialism). But it is what it is. If we want to be pragmatic in our quest to understand and perhaps one day to build the good society, we cannot make the success of the project dependent on our ability to change human nature. So it makes sense to take the economic system that seems to work better as our starting point, try to understand its power and limits, and see if we can work out ways to modify the system so as to overcome its most critical limitations without undercutting its key advantages. In doing so, however, we should take care to remember that real humans are complicated, multidimensional beings. We have wants and needs that include but go well beyond material goods and services; and we are motivated by a variety of things that include but go well beyond naked self-interest.
Why Truly Laissez-Faire Capitalism Doesn't Work
Competition
Virtually all the advantages of the capitalist marketplace as a system for generating and distributing material wealth – in a way that raises the standard of living of the vast majority (if not all) of the population – require a high degree of competition among the suppliers of goods and services. It is the economists' theoretical model of extreme competition (called “pure” or “perfect” competition), the logic of which leads inexorably to the conclusion that products will be produced at the lowest possible cost per unit and that the benefits of that efficient production will be passed on to consumers in the form of the lowest possible prices for those products consistent with keeping the producers in business. The pressure of intense competition creates a powerful incentive for each firm to be as efficient as possible and to keep its prices as low as possible lest its competitors take its customers away and drive it out of the market. That same pressure insures that the market will supply the socially optimal amount of each good and be maximally responsive to shifts in what consumers want and are ready and able to buy. In contrast, the economists' polar extreme theoretical market model of “pure monopoly” in which there is no competition at all leads to the conclusion that products will be produced at higher than necessary cost per unit. Further, the penalty this inefficiency imposes on consumers will be compounded by the monopolist's ability to restrict output to drive prices even higher than is required by their high cost of production. In fact, the very essence of monopoly power, granted by the lack of competitors to serve as alternate sources of supply, is the ability to create artificial shortages in the market. Even in the presence of some competition, a company able to significantly reduce the total supply of a product available in the market by its own actions can be reasonably said to have some degree of monopoly power.
The existence of a market system by itself, then, is not enough to deliver the full potential benefits of capitalism. There must also be at least a serious degree of competition. But since each company in a competitive market is always striving to take business away from its rivals in order to maximize its own profits, it has a strong incentive to try to gain a competitive edge with lower product cost and/or higher quality. In practice, some firms will be more successful at this than their competitors, and so will gain market share at the expense of their rivals. Slowly, over time, what was a highly competitive marketplace tends to become more and more dominated by a smaller number of firms that have each become larger and gained a degree of monopoly power. They are now able to earn greater profits because they have been able to lower their costs or improve the quality of their product. That is as it should be. We want the market to reward those companies that have been successful at lowering product prices and increasing product quality. On the other hand, when markets become dominated by a smaller number of large firms, the advantages of a capitalist market system begin to evaporate. A producer that has gained a degree of monopoly power by being efficient and responsive in price and quality may then find that it can more easily and effectively maintain or grow profits by exercising its power to manipulate the market than by continuing to be efficient and responsive. As a result, a market system dominated by a small number of monopolistic firms is neither likely to be efficient nor especially responsive to its customers.
To regain the potential advantages of a market system, something must happen to restore competition. It is possible that, given enough time, new firms will be organized – say around a new breakthrough technological development – and inject new competitive energy into the market, breaking the hold of those companies that have been dominant. How likely that is depends on a number of characteristics of the existing firms, the products, and the market. It certainly can and does happen, as for example in the case of Apple breaking the dominance of IBM in the computer market decades ago, or more recently Facebook breaking the dominance of MySpace. Yet, many firms retain their dominance of markets for many years. And sometimes, as in the case of Facebook, the new entrants are so successful they displace the firms they entered to compete with and become market-dominant themselves.
An active government using antitrust policy to break up concentrations of monopoly power and prohibit anticompetitive practices is one reasonable, and potentially more reliable, alternative way of maintaining or restoring the vibrancy of competition to a market – or a market system – that has drifted toward monopolization. Although it is certainly a form of government intervention, it is not really government interference with the performance of the market because it is focused on restoring and maintaining the conditions under which an undirected free market system operates best.
Just as competition in sports only works if played out within boundaries of the “rules of the game” (upheld by some sort of referees with enforcement powers), competition in the market only works to produce its vaunted economic advantages if it is played out within certain social, political, and ethical boundaries. It requires externally imposed and enforced rules to function properly. For example, it is not permissible to use “any means necessary” to outcompete rivals. It is widely understood that assassinating (or physically threatening) the leaders or employees of rival firms or destroying their facilities and equipment is beyond the pale. That sort of “gangster capitalism”, common to the Chicago underworld during Prohibition in the 1920s, the Russian business mafia during the transition to capitalism in the 1990s, and Latin American drug lords today, is understood to be a corrupting force in the economy and society, not a legitimate or socially beneficial way to run market-oriented business. Similarly, presenting the best face, the rosiest picture, of the company and its products to customers and investors is a perfectly acceptable marketing strategy; committing fraud by lying about the characteristics of the product or the condition of the company is not. Truly fraudulent behavior (as opposed to mere exaggeration) is no minor irritant to the capitalist system; it strikes at the heart of the trust that underlies consumer purchasing decisions and is absolutely crucial to investor confidence. Gross misrepresentation of the company's condition by the leadership of Enron, for example, cost thousands of employees their jobs and their pensions and investors the value of their holdings in the early 2000s. More than this, widespread fraudulent behavior can deal a serious body blow to the entire economy. De facto or intentional fraud in the US financial system played a critical role in triggering the financial crisis of 2007–2008 that brought on the “Great Recession” in the US and abroad, costing many billions of dollars and millions of jobs – an economic downturn from which we had still not fully recovered even after most of a decade had gone by.
In fact, according to Nobel Prize–winning economists, George Akerlof and Robert Shiller,
If business people behave in the purely selfish and self-serving way that economic theory assumes, our free market system tends to spawn manipulation and deception…. [I]nevitably, the competitive pressures for businessmen to practice deception and manipulation in free markets lead us to buy, and pay too much for, products that we do not need; to work at jobs that give us little sense of purpose; and to wonder why our lives have gone amiss…. The economic system is filled with trickery….
We see the basic problem as pressures for less than scrupulous behavior that is incentivized in competitive markets…. Those [managers] who restrain themselves from taking advantage of customers psychological and informational weaknesses… tend to be replaced by others with fewer moral qualms.2
The mortgage market problems that began the financial crisis of 2007–2008 were the result of a kind of conscious or unconscious fraud that began as a result of financial deregulation. It used to be that banks that originated mortgages treated them as valued investments to be held as part of the banks' portfolio of long-term assets. They would therefore take care to evaluate the income, assets, and financial stability of applicants for these loans to be reasonably assured that they would get their money back with interest over the 15–30 year life of the loan. When banks were allowed to sell off mortgages as soon as they made them for an immediate profit, and the purchasers were able to bundle the mortgages into “mortgage-backed securities”3 (securities which made their owners creditors of a package of mortgages), the originators of the mortgages no longer had the same incentive to be careful and do “due diligence”. They began giving mortgages to anybody with a pulse. The people who bought the mortgage-backed securities thought they were low risk because they assumed that the banks were still taking care in making the loans (and the loans were backed by houses whose values were rising – until the housing price bubble burst). Companies whose business it was to rate the riskiness of securities were in on the game. No one told the purchasers of those securities the truth. Ultimately, when it became clear that due diligence was a thing of the past and that many mortgages were in fact very risky, the whole business began to unravel. Financial institutions that had invested heavily in these mortgage-backed securities fell into deep trouble, and because financial markets are so interconnected today, the contagion quickly spread around the world.
The deeper reason behind the crisis was a kind of mindless deregulation of financial institutions that goes back to the early Reagan era and has continued pretty much until today. The walls that segregated the roles of different kinds of financial institutions (built by the Glass–Steagall Act of 1933 to protect the financial system after the Great Depression) were torn down, and regulation and oversight of financial institutions were peeled away. Along with some financial innovations that might have been useful, there was an increasing amount of speculation and other financial gambling and game playing, as we learned how to make a quick buck without making any useful product. The problem is that the financial markets, although they do not directly make any real good or service, have a very important role in the economy. They are the place where those who do produce real goods and services can get access to the money they need to make investments (in machinery, equipment, and structures) that increase their ability to produce (in terms of quantity and quality) and/or make themselves more efficient and competitive. These markets lubricate the gears of the economy by transferring money from those who have more than they want to spend (or hold) and are looking for a good return, to those producers who need it to invest. Now there is always some degree of risk in any investment, so any investment is in some sense a kind of gamble. But turning the financial markets into what amounts to high-risk gambling dens is not a good idea. It throws sand into the gears of the economy. We would all be better off if those who are in the market just to take short-term gambles went to Las Vegas, Atlantic City, or the nearest casino or racetrack instead, and stayed out of these critical markets.
Taxpayers were told that they had to rescue the big financial institutions that found themselves in trouble because of an epidemic of greed, shortsightedness, and poor decision-making because they were “too big to fail”. (The phrase should have been “too big to be allowed to fail” – they were doing a good job of failing on their own.) Their failure could pull down the whole financial system. That is probably true, at least of the biggest institutions. But how did they get too big to be allowed to fail in the first place? Again, the origin of this problem is decades old, going back at least to the beginning of the Reagan Administration and ties into our previous discussion of monopolization. We had taken much too cavalier an attitude, in the executive branch and in the courts, to the enforcement of antitrust laws. Mega-merger after mega-merger was allowed to proceed (in financial institutions and in other key areas such as product manufacturing and the media). Rather than breaking up concentrations of economic power that undo the advantages of competitive market capitalism, we have tacitly encouraged them. Bailing out companies considered to be too big to be allowed to fail as a way of handling this financial crisis encouraged them still more. What we are left with is an economy with much less real competition, and many more firms able to plead successfully for a taxpayer bailout because they have become so big that their failure – the proper fate of badly performing companies in the world of capitalist markets – threatens to pull down the whole economy.
The longer-term solution to the deeper problem exposed by the financial crisis is not a bailout, but the re-establishment of serious antitrust activity, and a reasonable form of government regulation in which the government does not heavy-handedly try to tell each company how to run its business, but rather establishes broad sensible rules within which they must operate, rules that require greater transparency and prevent fast and loose game playing in both financial markets and in markets for real goods and services.
Rules-of-the-Game Regulation
Setting “rules of the game” regulations is not only a more appropriate role for the government than trying to micromanage business decision-making, it is also more likely to be both effective and efficient. For example, prohibiting general anticompetitive practices (such as forming cartels in which firms that are supposed to be competing with each other collude instead, fixing prices at or near monopoly levels) is a better role for government than interfering with the pricing decisions of individual firms. It can foster the competition on which the benefits of the market system depend, without undercutting the price mechanism's key role as an efficient system for signaling changes in customer preferences. Given accurate market price signals, producers can respond appropriately, adjusting the mix of product types and quantities supplied to match those preferences.
Businesses are assumed to be rational actors driven primarily by the profit motive. To the extent that is true, they would logically make decisions among alternative actions based on the relative costs those actions impose and revenues (benefits) they generate, choosing those options that are expected to give them the highest excess of revenues over costs. But even rational actors would not consider all the costs and benefits generated by the alternative choices available to them – only those costs they would have to bear and those benefits they would receive. The costs and benefits that their chosen actions impose on others as a side effect of those choices – the so-called “externalities” that they generate – would not be part of their narrow, rational, short-term calculus. What counts as an “internal” cost or benefit, as opposed to an “external” cost or benefit is largely a matter of legality, tradition, and definition, especially the definition of boundaries.
Think of it this way. We typically think of the “output” of a firm as the good or service it makes that will be sold in the marketplace, the good or service that it was built to produce and deliver. That definition of output sets the boundaries of a firm's necessary concern narrowly around the purchase and use of the inputs (including technology) needed to produce its product and the quantity, quality, and market appeal of whatever good or service it is attempting to sell. But what we could call the “full output” of a firm actually includes everything, beneficial or harmful that it produces, not just its intentional output.4 For example, we count the output of a paper mill as the amount of paper it produces. But that does not include everything that is produced as the result of the firm's operations. It is also producing air and water pollution and solid waste. It may be developing and/or transferring new technologies, training its workforce to a higher skill level, and creating a work environment that dulls or stimulates, sickens or improves the physical and mental health of its workers. In other words, the “full output” of a firm includes everything good or bad that its operations actually do to or for its employees, customers, and the rest of the world, including but not limited to what we usually count as its product.
Looking at the world from the perspective of the “full output” definition of the firm's product, firms logically have the right to claim credit for all the positive effects and the responsibility to bear liability for all the negative effects they generate. The fact that we commonly use the narrower traditional definition of output (the valuable product the firm intentionally produces for sale) means that we do not always give firms the credit for or make them bear the costs of the side effects of what they do. It does not alter the underlying situation. That narrower traditional definition of the firm's output means that there will be some things (good and bad) that result from the firm's operation that are treated as “external”. That in turn means that businesses will not typically take these externalities into account in their decision-making. As a result, where there are significant externalities, there is no necessary reason why the decision-making of firms aimed at maximizing private profits will lead to choices that also maximize net benefits for the wider society. Of course, the wider society is always affected by these so-called externalities, as well as by the direct costs and benefits that the firm's operations generate, whether or not the firm explicitly takes them into account.
Once again, there is a useful role for properly written rules-of-the-game regulation by government. In the case of a business firm, we can think of direct private net benefits as being the excess of revenues the firm collects over the costs it must bear as a result of its actions. Where there is a substantial divergence between choices that maximize narrowly construed private net benefits while ignoring externalities, and those choices that maximize the broader net social benefit taking both externalities and “internalities” (internal costs and benefits) into account, it is the legitimate role of government to help to align private decision-making with public benefit. It is very important to understand that this is not blanket justification for any conceivable level or type of government intrusion into the private sector. Rather, it justifies governmental action to establish rules-of-the-game regulations that align the public and private interest in this particular kind of situation. Where there are strong externalities involved, it is completely appropriate for the government to establish regulations that “internalize” those externalities which result in substantial public benefit or harm, thereby creating strong incentives for business to take them into account. Even with the best of intentions, government attempts to go beyond this to micromanage private sector choice are likely to be inefficient, and sometimes completely counterproductive.
The advantages of a rules-of-the-game approach are not a matter of ideological preference; they are rooted in fundamental matters of information and incentive. Suppose people are being sickened by the emission of excessive levels of toxins from the smokestacks of electric power plants and a variety of other manufacturing facilities. Since the companies involved do not have to bear the costs imposed by dumping these toxins into the air, they have little incentive to go to the trouble and expense of reducing their emissions. Recognizing this as a serious threat to public health, let's say that the government feels compelled to take action to mitigate the danger. But how should they intervene?
They could establish a specific regulation that requires each power plant and each manufacturing facility to burn only fuels whose combustion does not result in the release of excessive amounts of these toxins. If even the cheapest version of such fuels were fairly expensive, this would drive up the producers' costs and therefore potentially increase the prices of what they produce substantially, to the detriment of consumers. Such a regulation might achieve the goal of improving air quality, but the cost of mitigating the problem this way could be unnecessarily high. Worse yet, enforcing a regulation of this kind might not even achieve the public health goal. The companies might find that the only fuels available to them at a reasonable cost that didn't emit too much of the toxins in question also had low energy content – so they had to burn much more fuel per unit of their product. They would be abiding by the regulation (burning low toxic emissions fuel). But the fact that they are burning much more of that fuel would cancel out some, perhaps all, of the gains in reduction of emissions of those toxins that the regulation was intended to achieve.
Alternatively, the government could simply establish a “rules-of-the-game” regulation that put a ceiling on the amount of these toxins that could be emitted by each firm (consistent with public health requirements), impose a heavy fine for exceeding this limit, set up a system for monitoring emissions, and leave the firms free to work out on their own how to stay within the limit. The firms might choose to put filters in their smokestacks to remove the toxins and prevent them from being dumped into the air. They might make their process more energy efficient so that they need to use much less fuel, and thus emit only permissible levels of the toxins in question even as they continue to burn the same type of fuel as before. Or they might choose to burn a different fuel that releases much lower amounts of these toxins. In any case, they have a direct financial incentive to find the cheapest, most cost-effective way to reduce the toxic emissions in their stack gases to allowable levels. They have both a stronger incentive and a greater ability to find that way than some government official who is far removed from their plant because the management of each of the firms knows a lot more about the details of their particular operation than that official. It is a central issue to them that they deal with every day. The result is that the public health is more effectively protected at a lower cost to society. Rules-of-the-game regulations are better than direct government micromanagement for concrete reasons of incentive and information, not merely ideological preference.
Of course, the effectiveness of rules-of-the-game regulations like this depend on the will and ability of the government to monitor the relevant behavior of the firms and enforce the regulations. That is true of any law, regulation, or norm. Voluntary compliance would be nice, but where there are powerful incentives to cheat on or ignore societal rules – as there often are in the environmental arena as well as many others – monitoring and enforcement is unfortunately required. Even those who strongly support a rule that is voluntary may find themselves hard-pressed to continue to obey that rule if their rivals do not, especially if that violation gives their rivals a substantial cost advantage.
The proper economic role of government is thus to set the broader context within which the private sector can flourish. A free market economy is certainly capable of providing abundant opportunities for productive work and generating the level of material well-being that is critical to a good society. To accomplish this, though, firms need the flexibility to do what needs to be done to react to market signals as the dynamic economic world changes around them. They cannot do that if they are put into straitjackets by an overly intrusive government determined to involve itself in the details of their business.
Laws that penalize the arbitrary abrogation of contracts that were freely entered into by all those who are parties to the contract also help create the context within which productive, free market capitalism can flourish. Keeping the trust of investors and customers with penalties against fraudulent reports and doctored financial statements makes sense too. These types of laws are consistent with the idea of a freedom-maximizing legal system. They all are aimed at punishing actions by any individual or firm that substantially interferes with the freedom of action of other individuals. This interference comes in the form of arbitrarily refusing to carry out obligations agreed to under a freely made contract or deliberately misinforming people and purposely manipulating them to distort their understanding of the situation at hand.
To work properly and actually deliver the full potential gains of a “free” market, what we usually refer to as laissez-faire competition actually depends on the active involvement of government to set limits on allowable behavior in the economic arena and enforce them. We can agree that those boundaries certainly include laws against arson, bombing, violent intimidation, and murder that prevent us from descending into a form of gangster capitalism in which anything goes in the struggle against economic rivals. It is also legitimate for the government to intervene in economic affairs through antitrust policy when necessary to maintain the vigorous competition that is critical to the proper functioning of a free market system. And where the existence of “externalities” create a substantial divergence between the calculations of cost and benefit that drive private sector choice of actions and those choices that would result from a “full output” accounting of costs and benefits, it is appropriate for government to introduce “rules-of-the-game” regulations that create incentives for the private sector to take into account the externalities it is generating. But at the same time, government should abstain from heavy-handed and intrusive interference with the details of private sector decision-making.
Truly “laissez-faire” competition – competition without boundaries or any government involvement – does not work. It is license, rather than freedom, and leads to chaos, not efficiency. There must be boundaries, set at least in part by government in the form of laws and regulations. But where they should be set is, in the end, not absolutely clear. What is clear is the criterion by which they should be evaluated. We need to find that sweet spot of minimal government involvement necessary to keep the market game honest and competitive and to keep private decision-making sensitive to the calculation of full societal costs and benefits.
Effective Demand versus Need
One of the greatest advantages of the market system is its ability to impersonally coordinate the activities of those who produce goods and services (the supply side of the market) with what their customers want. If fulfilling everyone's economic wants and needs depends on a small group of people personally making decisions as to what will be produced and how – as it does in a centrally planned economy – that group must gather into their hands and somehow digest enormous amounts of information to do its job well. That is extraordinarily hard to do, if it is even possible. But the impersonal signals that get transmitted chiefly through the price system of a market economy deliver that information directly to the very large number of widely dispersed decision-makers who manage the thousands of firms that make up a diversified, decentralized competitive market economy. To be more precise, what is happening to the prices and sales of the particular products any given firm is making conveys the information that the managers of that firm most need to know to adjust the quantity, characteristics, and quality of their products to match shifting customer preferences. And of course the lure of greater sales and higher profits provides a strong motivation for the firms to make those adjustments. So the market system gathers the deluge of key information that the planning board would require to keep people supplied with what they want and need and distributes each piece of it to those who are directly involved in satisfying that part of the demand. That is all to the good.
It is important to point out, however, that what we have here is not a system entirely driven by consumer sovereignty, with producers taking consumer product preferences as given and seeing their role as having to passively satisfy them in order to succeed. The preferences that determine demand are not formed entirely independently by individual consumers, as is assumed by traditional neoclassical microeconomic theory. We all know that firms spend a great deal of money and effort on advertising campaigns and elaborate marketing strategies to bend and shape, if not create, consumer preferences in favor of whatever new products and versions of existing products they have decided to produce. According to Michael Dawson, big business in America had far surpassed $1 trillion in spending on marketing per year more than a decade ago. This amounted to double US spending on education, both public and private, from kindergarten through graduate school.5 Although they do not always work, marketing and advertising are sometimes quite effective. If they were not, managers would not likely continue to lavish such enormous sums of money on them year after year.
We are assaulted by marketing nearly everywhere we look, as well as on all the communications media we use – radio, TV, smartphones, newspapers, magazines, and of course the Internet. The Internet may be the most intrusive tool of all, since it goes beyond merely marketing to us. It provides a means by which business (and government) can monitor our purchasing habits and through analysis, gain information as to our demographics, economic status, lifestyle, and politics. Among other things (some of which are considerably more nefarious), that information can be and is used to more effectively shape our product preferences through more precisely targeted marketing.
Markets allowed to operate freely tend to efficiently adjust production so that demand is satisfied, although not necessarily immediately and without glitches. That is a powerful advantage of free market capitalism. But there is a problem. In a market system, supply responds not to demand in the sense of any economic want or need, but rather only to “effective demand”. Effective demand is want or need backed up by sufficient purchasing power to pay for the goods or services desired. In most markets that doesn't create much of a problem. The fact that I don't exert any effective influence on the market for private jets, even if I want one (because my income would not support it) may be disappointing to me, but it is hardly worth worrying about. For most goods and services for most people, the market works pretty well. The problem becomes serious though where there is a considerable gap between “demand” in the sense of real need and the “effective demand” that markets respond to. That is especially true where the product involved is a necessity that is relatively expensive to produce. One example is good quality health care. In a good society, every human being, regardless of income or wealth, should be able to access good quality basic health care when they need it. Housing is another example. We all need a decent place to live. No one should involuntarily be without shelter or have to live in rat-infested, disease-ridden squalor. Relying solely on a pure free market system to provide health care or housing will result in an inordinate number of people being shut out. The markets will quite neatly satisfy all effective demand, but at the same time leave too many people out in the cold, perhaps quite literally.
So in markets for critical goods and services where there is a substantial gap between “demand” in the sense of legitimate need and “effective demand”, relying solely on the market system is not a good way to satisfy everyone's basic economic needs (though the markets will “clear” in the sense of balancing supply with “effective demand”). This is a limit of the market system, not a flaw in it. The market will do just what it is supposed to do – satisfy effective demand. For most people and for most goods and services, this works well. But in the case of some fundamental economic needs, it is not enough.
This is not so much a problem of the market system itself as it is a result of the distribution of income and wealth. In a prosperous society with a relatively equal income distribution, there won't be a significant gap between demand and effective demand at least for necessities, and everyone will have sufficient purchasing power to satisfy their basic economic needs through the market. Though it is likely to provoke considerable social stress, even significant income and wealth inequality will not interfere with the effectiveness of the market system in providing critical goods to everyone if there is no absolute poverty. For those who do live in absolute (as opposed to relative) poverty, however, the ability to access goods and services – most importantly, basic goods and services – is severely compromised in a pure market system, even in a prosperous economy.6 And that is not consistent with creating a good society.
There are two fundamental approaches to overcoming this problem. One is to discard the market system in favor of a more directly managed system such as a planned economy. But doing so means that we would lose all of the considerable informational and motivational advantages of market economies, with their proven track record in generating increasing material well-being. The other is to leave the market system alone and intervene after the fact to adjust the distribution of the income and wealth that has been generated so as to eliminate absolute poverty and decrease inequality in general to more acceptable levels. This preserves the informational and motivational advantages of the market system, while assuring that everyone shares in the benefits.
This, in turn, can be achieved in two ways. One way is to directly provide basic goods and services through private charities or through the government to those who cannot afford to buy them in the market. This includes implementing such policies as free or low-cost public housing, national health care, public food pantries, and soup kitchens. In addition to a wide range of federal, state, and local government programs, private groups including a variety of religious organizations, as well as secular nongovernmental organizations such as Habitat for Humanity, Doctors without Borders, and Second Harvest have engaged in this type of activity with varying levels of success. The alternative approach is to take action to increase the flow of money to those in the lower reaches of the income distribution, either by giving it to them directly or providing enhanced opportunities to increase their earning power. Interestingly enough, there are both politically liberal and politically conservative paths within this strategy. For example, in terms of increasing the flow of income to the poor, noted conservative economist Milton Friedman advocated instituting a “negative income tax” to replace existing welfare programs such as food stamps generally favored by political liberals. The core of Friedman's idea was to have everyone in the country file income tax forms each year, whether or not they had income. Those whose income was high enough would pay taxes to the government on a sliding scale, as usual. Those whose income was low enough, rather than paying taxes, would receive money from the government on a sliding scale. Approaches to increasing earning power, on the other hand, cover a very wide range from facilitating entrepreneurship by streamlining regulations and providing special access to capital (including microlending) to small business in general and small business start-ups in particular, to providing free public education through high school and/or increased financial aid to higher education, to minimum wage laws and supporting and encouraging labor unions. Laws that prohibit discrimination on the basis of race, ethnic origins, sexual orientation, sexual identity, and age in hiring, in access to capital, and in admission to public facilities (including schools) also fall within this category.
Building a good society requires building a strong economy, one capable of providing a high enough standard of living to meet the material needs of the whole population. Among other things, that means eliminating absolute poverty, a considerable undertaking. A truly competitive market system, operating within a reasonable set of rules-of-the-game aimed at maintaining a proper competitive environment and helping to align the private and the public interest where they otherwise might substantially diverge, should take us most of the way. Still care must be taken to assure that proper attention is paid to issues of income and wealth distribution if that system is to work well for everyone.
The Real Function of Money
Money has a certain mystique surrounding it, an aura of power and well-being. But to understand what money actually means, it is important to understand what money actually is and what economic functions it performs. To begin with, anything that serves as a generally accepted medium of exchange for goods and services or economic resources is money. It doesn't really matter what it is made out of – pieces of paper, bars of gold, numbers electronically stored in a computer. What is used for money doesn't need to have any inherent value. Money is a wholly artificial social construct. It has value because it is money; you are willing to accept it from others mainly because others will accept it from you in exchange for what you want to buy.
It is perfectly possible to carry out real economic activity – to build things, to provide services, even to exchange goods – without having anything that serves as money. Goods and services can be directly traded for each other. But beyond very limited and primitive economies, this so-called “barter system” is enormously more complex and less efficient than money exchange. As a simple example, consider the problem of buying a shirt in an economy in which there is no such thing as money. You go to a clothing store, look through their stock of shirts and find one that you like. You take it up to the counter and ask the owner of the shop, “What does this shirt cost?” It is a simple question. The owner says, “What have you got to trade?” So you say, “ I've got a load of sheet rock in the truck, or I could bake you some cookies, or give you or any member of your family Spanish lessons.” The owner must then figure out just how much sheet rock, how many cookies or Spanish lessons he is willing to accept in exchange for the shirt. Without anything serving as money, there is not one price for each piece of clothing in the store, there are potentially hundreds, perhaps thousands, of prices in terms of anything that customers might have to trade. And suppose the store owner says, “I have no interest in any of those things. What I'd really like is someone to repair my car or to play music at my son's wedding next month.” If you are not mechanically adept or musically talented and you really want that shirt, you've got to find someone who is mechanically or musically accomplished, and who will accept what you have to trade in exchange for providing those services to the shop owner. Or you've got to find someone who will accept what you have to trade for something that someone else has to trade that is acceptable to someone who will play music or do car repairs for the clothing shop owner, and so on. This is a hopelessly inefficient mess, even in a relatively small economy. In an economy of any size or complexity, it is intolerably complicated.
Having one thing that serves as a medium of exchange that everyone will accept cuts through these problems and makes transactions much easier to carry out. Now every item only needs to have one price. The shop owner states the price in terms of this money. You use the money you earned in exchange for your services as a Spanish teacher to buy the shirt and that's that. You have in effect traded your ability to teach Spanish for the shirt, but no one outside the transaction needs to know what you are trading, i.e. what you did to earn that money. Having something that functions as money greatly simplifies transactions. It also makes it much easier to see the relative expense of (and therefore the tradeoffs between) all the goods and services available, and to determine what you can afford given your money income. Money prices convey a great deal of useful economic information in a simple and concentrated form.
Money can also be used as a store of value, a way to accumulate purchasing power, precisely because it is a generally accepted medium of exchange. This allows money to perform another key economic function, facilitating investment. Some people accumulate more value in the form of money over time than they know how to put to productive use, while others come up with more viable productive business plans than they have the financial wherewithal to implement. Financial markets and institutions (e.g. stock markets, bond markets, the banking system) provide mechanisms for transferring claims against real productive resources in the form of money from the former group (which is not putting those claims into productive use) to the latter group (which will use them productively) – in exchange for a return on their investment, of course. This kind of investment is critical to the health of the economy and the material well-being of the society.
Money is an economic lubricant; it makes the wheels of the economic machine turn more easily; but it is not part of the machine itself. Though it makes carrying out economic activity much more efficient, money by itself cannot directly feed us, shelter us, clothe us, etc. It cannot directly be used to build things or produce services. To accomplish any of those economic objectives, money must first be traded for something else – for food, housing, clothing, and the like – or for labor, machinery, and other productive resources that can be used to produce real goods and services. Money has value only in that it represents a claim on goods, services, and productive resources, and it only does that because of a social decision to artificially give it that value by our willingness to accept it as a medium of exchange. If, for whatever reason, a population in general stops accepting something that they used to accept as a medium of exchange, it ceases to be money – no matter what it is.
It is critical to understand that the real economy – where goods are created, services are provided, and the physical capacity to produce these things is built and activated – is very different from the economy of financial markets and money. The real economy is the part of the social system that provides us with goods and services that add to our material well-being. Money and the other money-valued instruments that flow through financial markets and institutions should always be considered a very useful adjunct that is supportive of but subordinate to the economic activity that helps to satisfy our material needs and wants. The real economy is not fundamentally about money.
Because we so commonly use money to put a value on economic activity, it is easy to confuse money value with real economic value, and the manipulation of money-valued instruments with productive economic activity. Although the real economy and the financial (money) economy are different, because money is an important facilitator of economic activity, what happens in financial markets can have a considerable impact on what happens in the real economy. For example, the mass unemployment during the Great Depression of the 1930s made it difficult for those people thrown out of work to access enough money to buy the goods and services they needed and wanted. Because the people were not able to buy as much as they had been buying, businesses experienced a sharp decline in sales, which led them to lay off even more workers, and so it went in a downward spiral. Those workers who lost their jobs were still willing and able – even eager – to work, and if they could find work, would have been ready to buy goods and services with the income they earned. The equipment in the factories and other workplaces in which they just had been working was still pretty much intact. It had not been destroyed; it had not vanished. It was still capable of producing all the goods and services it had been producing before the crash, but it had been idled by a lack of spending due to a lack of money in the hands of consumers. In other words, the workers and the equipment were just as capable of carrying out the level of economic activity they had been carrying out before the downward spiral took hold, and the people were just as eager to buy the goods and services that would have kept the economy humming. But the shifting of money flows in financial markets created a massive failure of coordination of demand and supply that cast a pall over the economy and kept the bad times going.
The financial crisis of 2007–2008, leading to what has been called the worldwide Great Recession that stubbornly lingered for years, is a more recent example of the capacity of financial markets to wreak havoc in the real economy. It is an example of what happens when we take our eyes off the real economy and turn to short-term financial manipulation, deception, and outright gambling as a means of trying to build wealth.
Money Value and Economic Value
In order to avoid being distracted by financial manipulation and to focus attention on matters key to the economic well-being of a good society, it is important to be clear about the difference between money value and real economic value. That requires taking a step back and asking “What is the economy, anyhow?” Traditionally, economists have looked at the economy as an interconnected system of money-valued transactions, relating to production, consumption, and exchange. With such a definition, there is no distinction between money value and economic value. In fact, the economic value of a good, service, or resource is precisely equal to its money value. But the more practical and functional, alternative definition of the economy discussed earlier is that it is the part of the human social system that provides us with goods and services that add to our material well-being. By this definition, the economic value of a good, service, or resource is determined by the extent to which it contributes to our material well-being, the generation of which is the central purpose of the economy. And that can be very different than its money value.
These two definitions of the economy and therefore of economic value have strikingly different implications. For one thing, the traditional definition does not include as economic activity any goods we produce or services we provide for ourselves, or for our families or friends without pay. This means if you build yourself a bookcase, clean your own home, cook your own meals, take care of your own children or those of your neighbors without anyone paying you money for what you have done, you have created nothing of economic value. But if you pay someone else to do exactly the same things – or even if someone else pays you to do those things for yourself – the same activities would be considered economically valuable. Precisely the same products have been created, the same services have been rendered in both cases, but in the first case there is no economic value generated while in the second case there is considerable economic value produced. By the alternative definition, however, these activities make the same contribution to material well-being and therefore have the same economic value whether or not money changes hands.
In a sense, the traditional definition devalues unpaid activities by saying that they do not contribute to the economy. Since much of the unpaid work within the family in many societies has traditionally been performed by women, it has had the effect of devaluing the economic role of women. It also distorts our view of life in lower income countries, where many more people do more of these activities for themselves or their families, without pay. Yet many of these activities are important, even vital, to the quality of our lives and the proper functioning of all of our societies. These distortions of economic life are avoided by using the alternative definition, since it defines the economic value of an activity in terms of its contribution to our material well-being.
Furthermore, there are some activities which generate considerable money flow but do not add to material well-being. They are included as part of the economy and therefore have economic value by the traditional definition, but not by the alternative definition. The theological activities of religious institutions, much of the functioning of the criminal justice system, and the production of military weapons, for example, involve large flows of money and so are counted as creating substantial economic value. But the alternative definition takes a different view. Recognizing that human beings need and want many things beside material well-being, it sees society as having created other systems to try to satisfy those needs and wants. The network of religious institutions is a system aimed at satisfying the human need for spiritual well-being, moral guidance, and perhaps a sense of community. The criminal justice system, which includes the institutions that make, adjudicate, and enforce laws, is aimed at satisfying the need for an orderly society. The military and its industrial support system is aimed at satisfying the need for security. All of these social systems have their own roles to play in creating a well-running, viable society, and all of them require goods and services to perform their function. But none of these other systems – and accordingly none of the specialized goods and services produced to support them – generate material well-being. They are expensive and create a considerable flow of money (i.e. money value), but no real economic value. That is what the economy does. It is the system whose purpose is to provide goods and services that add to material well-being.
Conceiving of the society as divided into a set of interacting systems oriented to satisfying different types of human needs and therefore generating different kinds of value does not imply a judgment as to which of these systems is more important. Even saying that the main function of religious institutions or military forces has economic cost (by using up economic resources) but no economic value is not to say that they are somehow bad. In fact, even if it were possible, a society in which all economic resources were used only to produce economic value would be a troubling place to live. All of the needs of the people of such a society other than the need for material well-being would be neglected. Although they might have access to a high material standard of living, their lives would be endangered and impoverished in a variety of ways.
It is also important to understand that these different social systems are not entirely independent but instead strongly interact with each other. For example, the economy of a society that has descended into chaos because law and order has broken down, whether for domestic reasons or external military attack, will not be able to function properly. An orderly society is an important part of the context people need to effectively carry out economic activity. As another example, sociologist Max Weber long ago argued that attitudes engendered by religious teachings could have a powerful effect on the functioning of the economy.7 That may well be true and if it is, it means that the spiritual dimension of life forms another part of the context which affects economic performance. Still, saying that producing the money-valued goods and services that support the system of law and order or the system of spiritual belief is part of the context that affects the economy, is very different from arguing that producing those goods and services is itself economic activity and thus is part of the economic system. After all, people who live in cold climates require clothing and shelter to survive. Their biological systems require clothing and shelter to continue to function. Yet we have no trouble understanding that their clothing and shelter are not part of their biological systems. Rather, they are part of the context the biological systems require for their support.
Clearly, money value and economic value are not the same thing. Goods and services that add to material well-being have economic value, whether or not they are paid for with money. Money-valued goods and services that do not add to material well-being may have political value, spiritual value, security value, etc., but they do not have economic value. Why are we willing to spend money – in some cases huge amounts of money – to lay claim to the economic resources necessary to produce goods and services that themselves have no economic value? Sometimes it is precisely because we think they have other types of value that are also important to us. And sometimes, it is because we confuse money value with economic value and mistakenly think such spending, like any other form of money spending, boosts the economy. We fail to see how large a burden (in the form of opportunity cost) such spending causes the economy to bear.
In sum, money has a critical function as a lubricant for the real economy. But money value is not the same as economic value, and money is not what the economy is fundamentally about.8 Neither the size of a nation's money-valued output as typically measured by GDP (Gross Domestic Product) or GNP (Gross National Product) nor the rate of growth of this money-valued measure of output is an accurate indicator of the strength or health of a nation's economic system. And a strong and healthy economy is one important component of a good society because only a strong and healthy economy can be relied upon to reliably provide the people of the society with a high material standard of living over the long run.
Financial Institutions
Financial markets have become so big and so complicated that it is easy to forget that they are not, as I have said, at the center of the economy. The financial organizations that surround them do not make the physical goods and produce the services that provide material well-being to a population. As we saw in the above discussion of the real function of money, their economic role is supportive. These organizations are part of the infrastructure whose function it is to facilitate the transfer of funds between those who have more funds than they are able to productively use and those who have productive uses for that money but are short on the funds needed to implement them. They offer those with funds to invest the opportunity to earn a return on their money, to grow their wealth by providing means through which they can participate, in one form or another, in the wealth-generating activities of those who are productively engaged in the real economy. That is an important economic function, a function that enhances the overall efficiency with which a society turns its available resources into material well-being for the population.
Much of the action in today's financial markets and institutions has little to directly do with this key function, but rather involves various forms of speculation and, worse yet, financial game playing. They have become too much like gambling casinos in which those who are knowledgeable insiders can quickly pile up fortunes of millions or even billions of dollars by one way or another manipulating the game. Some of these manipulations are out and out fraud, such as the infamous Ponzi scheme run by financier Bernard Madoff. Some involve trading on insider information; some involve a variety of machinations by so-called “rogue traders”. But most of the problem is simply a misplaced focus by financial institutions on trying to make a quick buck anyway they can, without regard to the long-term damage they are doing to the economy and to those companies and individuals who find themselves getting the short end of the deal.
There is probably nowhere in the economy that is a better candidate for serious rules-of-the-game regulation than here. A separation must be created between the various functions of financial institutions, in the spirit of the now defunct Glass–Steagall Act of 1933 in the US.9 Banks which hold individual depositors money in checking and time deposit accounts should be focused on lower risk lending and prevented from engaging in more speculative stock and commodities markets activities. Brokerage firms and investment bankers should use funds given to them by investors to operate in stock, bond, and commodities markets, and not provide ordinary banking services. Insurance companies should sell insurance and stay out of the banking and brokerage businesses. With this kind of separation of functions, depositors who are looking to banks as a safe and convenient place to store their money (and the taxpayers who are called upon to bail out defaulting banks) would not run the risk of the bank going out of business because of some high-flying speculative securities market deals the bank decided to try. Those looking for a higher return and willing to bear greater risk to achieve it would not have to be concerned that the attention of their brokers has been diverted elsewhere. Insurance companies would make their money through the premiums they charge based on the risks they insure. This sort of more staid financial system might not be as innovative in developing new types of securities, some of which may be useful, but it would also be far less likely to provoke the kind of financial crisis that shook the world in 2007–2008. This is especially true if it were combined with serious attention to antitrust activity to prevent banks and other corporations from becoming “too big to be allowed to fail”.
What About a Hybrid Economic System?
Since both free market capitalism and socialism have a different set of advantages, it is worth asking if there is some way to create a workable hybrid economic system that has the advantages of both. Can we preserve the informational, incentive-based efficiency, and responsiveness advantages of the market system while maintaining the advantages of socialism in providing greater job security, wider access to critical basic goods and services, and an environment in which ordinary employees (as opposed to top-level managers) are able to capture a larger and more equitable share of the net income generated by firms?
Starting with the market system as its base, one idea that has achieved some currency is to create Employee Stock Ownership Plans (ESOPs) to give the employees of market-oriented firms some degree of ownership in the company.10 Some advocates argue that this will not only increase worker income by giving them direct access to a share of corporate profits, but that companies largely owned by their employees will be less likely to lay workers off, except where such layoffs are vital to the survival of the firm. It seems obvious that employee-owned firms are also less likely to engage in any activities that exploit or are otherwise detrimental to their workforce. But what seems obvious conceptually is not always true in practice. As Seymour Melman argues,
…ESOPs usually involve arrangements whereby the employees assign the management decisions to a trustee group. This group in turn is designated by parties, like the local bank, who allocate the capital used to fund the enterprise. The workers in an ESOP company typically agree to lower wages, which provide additional capital…. Over time the employee owners gain shares of the firm's assets. But this ownership does not entitle workers to immediate access to these assets – in contrast, for example, to the [ordinary] stockholders of a corporation…. Upon an employee's retirement, the stock can be sold and he or she can receive its cash value, but in many cases the stock can only be sold back to the firm…11
Under these arrangements, the board of trustees is designated by managers or bankers, not the workers. This board – not the workers who technically own the stock – has control over the company's decision-making. With only nominal ownership, the workers have the right to share in profits, but they cannot control the decision-making processes that determine the company's behavior, and so cannot decisively influence the company's decisions on wages, benefits, working conditions, and layoffs.
As David Ellerman points out, trusts are typically set up to control assets when the actual owners of the assets in question are considered to be less than fully competent to make sensible decisions as to how to use, disperse, or invest the assets in question. He has written,
Trusts are usually set up when someone is not ‘trusted’ with direct ownership. The trust mechanism interposes a layer of trustees between the indirect ‘beneficial owners’ and the exercise of ownership rights.
Trusts are used, for example, when the beneficial owners are children, or are legally incompetent.12
As the term indicates, “trustees” are trusted to make decisions that are in the best interests of those for whom they have been designated trustees. It would be good if that's what they actually did, but that is not always the case. Ellerman points out, “Trust mechanisms have also been used to separate the control of massive pension funds from the worker beneficiaries. As a result, the pension funds have been used to finance the export of jobs to union-free environments”.13 Furthermore, Ellerman notes that “ESOPs are usually established by corporate managers or owners who are interested in the tax benefits and who are not particularly interested in transferring any power or control to the employees”.14
To the extent that they operate in this way, ESOPs are more an indirect scheme for profit-sharing than a real hybrid form of capitalism. But suppose we go beyond this highly constrained form of expanded employee involvement to conceive of a system in which companies both owned and controlled by their employees contested with each other for customers in an open, competitive marketplace. Since the income of the employees would be greater the more profitable the company was, the motivational advantages of a market system would be preserved. Because the firm was embedded in a competitive marketplace, all the pressures of competition would drive it to be as efficient and responsive to its customers as it could be. The informational advantages of the market system would also be preserved, since prices and sales volume would still be determined in the market, providing the critical signals about changing customer demand. After all, the advantages of the market system depend on the degree of competition between firms, the desire of producers to make profits, and the market-based decentralized determination of prices – not on the structure of ownership within firms.
At the same time, employee ownership and control would logically work against the exploitation of employees and create greater incentives to avoid decisions detrimental to them – such as layoffs, benefit-givebacks, and pay cuts – except in extreme circumstances. But are nonmanagerial employees actually capable of directly and effectively managing firms?
The Mondragon Cooperative Corporation
Having been formed at the urging of a parish priest, the first cooperative enterprise, in what was to become a major network of employee-owned cooperative production organizations, began producing paraffin heaters and cookers in the Basque area of northwest Spain in 1960.15 By 2015, Mondragon Cooperative Corporation (MCC) had grown into one of Spain's biggest business groups, becoming a network of 261 cooperatives and companies with annual revenues of some €12 billion and a workforce of 74,335.16 From the beginning, each of the coops in the Mondragon Group was run by a board of directors democratically elected by the members of the coop in an annual general assembly. “The board meets monthly and names the general manager, who, in turn, works with a management council of functional department heads. Built-in rules assure rotation of offices and avoidance of single candidates for major posts”.17
Decision-making in the MCC was overseen in very important ways by its workforce, but there was still a group designated as managers who made important day-to-day decisions. It is a legitimate example of workplaces in which employees both nominally owned the companies, and also had real and meaningful control of how the companies were run. The workers were the ultimate bosses, yet the managers ran the companies for them day to day. So it is a case of representative workplace democracy, not fully participatory employee decision-making.
Employees did not all receive the same wage. For each worker, wages were based on four criteria: (1) the degree of responsibility associated with the job; (2) job performance; (3) educational achievement; and (4) years of seniority. But there was a maximum allowable salary differential for officials relative to the basic wage of 6:1,18 a remarkably narrow gap compared to the hundreds-to-one differential between chief executive officers (CEOs) and the lowest paid workers in major US corporations today. In addition to their salaries, employees all received payments to the interest-bearing capital account they were required to establish at the Mondragon bank (also a cooperative) upon taking a job at one of the coops. Each year, roughly 70% of the coop's profits were distributed to the members (workers) of that coop as payments to that account. The funds in that account served as one important source of financing for the firm, since the workers were not allowed to draw out that money until retirement.19
It is important to remember that these cooperative firms are competing for customers in a free marketplace. If they do well competing in that marketplace, they can substantially increase their incomes over time. If they do not produce products that are competitive in price and quality with those products produced by their competitors (which may be traditionally organized private firms or other coops), they will lose market share and profits, even to the point of going out of business. The livelihood of their members (the workers) is not guaranteed, but is subject to the vicissitudes of the market, just as it would be in a typical capitalist firm operating in a normal competitive marketplace. Sometimes they do fail. The Economist reported in 2013,
News that Spain's largest appliance-maker [Fagor] is heading for bankruptcy will not come as a complete shock in the crisis-ridden country…. It is part of Mondragon, the world's biggest group of worker-owned cooperatives….Mondragon has won many awards…as a shining alternative to shareholder capitalism and a bastion of workplace democracy during its six decades of history.20
But this vulnerability to the market is what creates the incentive structure that leads to efficient and responsive operations.
The Mondragon Cooperatives produced a wide variety of goods and services, including machine tools and other industrial equipment, electronics, home appliances, auto parts, and consulting services (in engineering and management). And while operating under a thoroughgoing system of democratic workplace decision-making, they earned respectable profits without government subsidy, selling their products in an open competitive marketplace. The MCC network illustrates one potential approach to the creation of a hybrid economic system that combines the motivational, efficiency, and informational advantages of competitive market economies with the equity and security advantages of socialism. It is also an example of the possibility of extending the political virtues of representative democracy into the realm of real-time economic decision-making and so achieving greater control of our working lives.
MCC grew to be a sizable network of companies. But it still leaves open the question as to whether there are diseconomies of scale that would make management less efficient in very large worker-controlled enterprises. It seems obvious that there would be limits to the size of companies that could be effectively run by participatory democratic principles that involved all the firm's workers in making virtually every significant management decision. Beyond a certain workforce size, decision-making would become unduly cumbersome and slow, which can be deadly to a business operating in a competitive capitalist marketplace. It is less clear that the same problem would arise at the same company size where there is a representative workplace democracy. It could be that similar problems would occur, although perhaps at a larger company size.
Then again, diseconomies of scale that kept enterprises smaller than they would tend to become under more traditional management structures might be a good thing, politically as well as economically. By preventing firms from becoming very big, it would help avoid the concentrations of economic power that can be used to manipulate and undermine political democracy. It would also keep any economic market of size from being dominated by one or a few firms that achieve a serious degree of monopoly power. On the one hand, there would be a price to be paid in terms of the potential loss of some advantages of large scale in reducing the costs of production; on the other, there would be benefits from making the size of firms self-limiting and so keeping the economy more competitive without the need for ongoing government intervention.
The Economic System and the Good Society
A market system in which privately held firms, whether profit making managerial enterprises or worker cooperatives, compete in an open marketplace has such considerable potential advantages in information flow, motivation, and responsiveness that it seems the best foundation for organizing economic activity within the good society. It appears to be the economic form most effective at providing the highest material well-being to the broad mass of people of the good society. Achieving that potential requires ongoing attention to propagating and enforcing active antitrust policy to make sure markets remain highly competitive. We have seen that true laissez-faire capitalism doesn't work. The market system requires rules-of-the-game-based government regulation to help align private and public interest in areas such as education, health care, and the environment where many externalities are present. Rules-of-the-game-based regulations are also appropriate to insure that consumers are given accurate information appropriate to the goods and services they are buying, and potential investors are given honest information on the state of the enterprises they are considering investing in. These kinds of government interactions with the private sector are necessary, but there is no justification for government regulation or other government intervention aimed at micromanaging the private sector.
The economy of the good society should also be attentive to matters of income and wealth distribution, not necessarily for the purpose of creating a completely egalitarian economy, but rather to at least eliminate the real deprivation of absolute poverty and perhaps minimize relative poverty as well. There are both sensible politically liberal and conservative policies for accomplishing this.
In developing and implementing economic policy aimed at achieving the level of material well-being the people of a good society consider acceptable, it is important not to confuse the money economy with the real economy– it is the real economy that produces the goods and services we need. The money economy is a useful adjunct to the real economy, but it is not where we need to focus our attention.