We are not smart enough to leave things to the market (Ha-Joon Chang’s Thing 16)

This post is one of an occasional series inspired by Ha-Joon Chang’s iconoclastic and very readable book 23 Things They Don’t Tell You About Capitalism. The quote below is from ‘Thing 16’.

“People do not necessarily know what they are doing, because our ability to comprehend even matters that concern us directly is limited – or, in the jargon, we have ‘bounded rationality’. The world is very complex and our ability to deal with it is severely limited. Therefore, we need to, and usually do, deliberately restrict our freedom of choice in order to reduce the complexity of problems we have to face. Often, government regulation works, especially in complex areas like the modern financial market, not because the government has superior knowledge but because it restricts choices and thus the complexity of the problems at hand, thereby reducing the possibility that things may go wrong.”

Ha-Joon Chang (2012), 23 Things They Don’t Tell You About Capitalism, p.168

The argument that humans have ‘bounded rationality’ and experience uncertainty (as opposed to calculable risk), in which they simply do not know what is going to happen in the future, illustrates the importance of a range of institutions in modern society. These both constrain and enable human activity. The market is an institution, but one of many, even in what is often called a market economy.

For me the term market economy is misleading in that it portrays only part of the economic system in which we live. For example, markets require legal systems under the supervision of states to function at the national level, and we also rely to some extent on global institutions such as the WTO, IMF and World Bank. These may be imperfect, but the answer to that is reform rather than abolition. Those who would undermine the rules-based post-war international order seem woefully ignorant of its benefits. The depression and chaos of the inter-war period of the 1930s were a lesson to post-war policy-makers.

Another term for our modern economic system is capitalism, which draws attention to the accumulation of capital, or investment, which drives expanding wealth and income. For Marx, the key relationship is the conflicting one between the capitalist and working classes in the workplace and his magnum opus was even called Capital. Markets are part of this system, but they have been in existence for far longer than capitalism, so they cannot be used to define it by themselves. They are now widespread in developed nations, but a richer definition of capitalism is necessary, which describes more than simply market exchange.

Private property and the exchange of goods and services on the market may be unavoidable in any large-scale complex economy, as institutional economist Geoffrey Hodgson has argued. He points out that both mainstream neoclassical and Marxist economics argue for ahistorical universals and a ‘pure capitalism’, and deny varieties of capitalism, which is what we observe across the world and in recent history. There is thus a denial of the existence of a variety of institutions, which he argues is a more realistic analysis. He defines an institution as an integrated system of rules that structures our social interactions. Examples are behavioural norms, social conventions and legal rules. These will often evolve as economic development proceeds, and can constrain it if they do not, hence the term ‘institutional sclerosis’.

The modern economy is increasingly complex and depends not just on the accumulation of capital, but also the accumulation of knowledge and skilled labour. Knowledge and skill can be embodied in the individual but also collectively; for example, in firms, industries and states. Their accumulation is thus at least partly dependent on institutional factors.

No one individual or institution can determine the complex outcomes we observe under capitalism, which suggests that collective planning for the economy as a whole, as has been attempted in socialist states, is doomed to failure. Narrow goals such as sending a man into space may be possible under such a regime, but producing a vast and complex range of products requires a range of institutions, including markets and states. Those social functions which necessarily involve market exchange require other such institutions to function well. Capitalism is not just about the market and it is misleading in thought and damaging to policy-making to think so.


3 thoughts on “We are not smart enough to leave things to the market (Ha-Joon Chang’s Thing 16)

  1. To avoid dominance of certain groups and interests in the market or by virtue of the powerful coercive institution called the state, democracy, its system of genuine political competition, deserves protection and dedicated support from us as being an all-important ingredient in the fight against ‘institutional sclerosis’.

    Both the market and the state are intrinsically political phenomena the nature of whose outcomes vitally depend on the quality of the political order in which they are embedded.

    I am worried about the widespread neglect of, even disdain for, democracy to be found both among supporters of “the market” and their “statist” critics.

    • Thanks for your comment. Sometimes support for democracy does seem quite fragile, such as when governments are seen to have been partly to blame for major economic crises, as in recent years. If the dominant political consensus and political class does not deliver the goods materially, alternatives may be sought, which may not always be particularly democratic. The crises of the 1930s and the rise of nationalism must be seen as one example of this, and today’s populism/nationalism as another.

      This kind of thinking is I think influenced by the traditional Marxist emphasis on materialism, with the political and legal ‘superstructure’ as largely determined by economic factors. Others have made the point that politics should be treated as on the same level and equally determinant in social evolution as the economic. If the economic dominates, then severe crises may sometimes undermine democracy in favour of those who offer alternative policies which help to restore prosperity.

      All this can be potentially dangerous to democratic ideals. While I do think that democracy is a good thing, it is no good forcing it on countries which do not have the capabilities to sustain it in terms of the level of economic development and the class structure. After all, democracy is a relatively recent phenomenon historically, and universal suffrage even moreso. These are a fine example of progressive development, but I am under no illusions that history runs in one direction, without opposing tensions from conservative, nationalist and even anti-democratic forces.

  2. Pingback: Trump and the deregulation agenda – a boon for prosperity? | The Political Economy of Development

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