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Charles Wheelan, Ph.D. The Naked Economist

Markets Make Sense, Except When They Don't

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Posted on Tuesday, February 13, 2007, 12:00AM

Do you believe in markets? Of course you do -- unless you're a communist.

Even the communists managed some pretty impressive black markets. I traveled for several weeks in the U.S.S.R. in 1988, and spent much of the time behind my hotel trading things out of my suitcase to Soviet teens for rabbit fur hats and Lenin pins.

Cornering the Market

Presumably, the 20th century proved that the market solution is usually the right solution. The theory is simple and elegant: Individuals and firms make themselves better off by entering into voluntary transactions, which collectively make up markets. By definition, all involved parties expect a transaction to make them better off, or else they wouldn't do it.

True, things may turn out badly, such as the hot stock you bought last year that fell 78 percent when the CEO revealed that all earnings since 1983 would have to be restated. But that's not what you expected. Nobody intentionally tries to lose money or to make their life worse. Instead, all parties to a transaction expect good things, or at least better than the alternatives.

That turns out to be pretty powerful stuff when you add it all up. If we leave people and firms alone, they naturally do things that make all of us richer -- they innovate, they work hard, they put resources to their most efficient use. Who can be against that?

Trapped by Progress

Just about everyone, it turns out, depending on the market in question. I would venture that economists like markets a lot more than the rest of the population, regardless of their political views.

Left-wingers aren't fond of sweatshops, for example. Why do we pay Vietnamese workers 75 cents an hour to sew shoes? Because we can. That's a pathetic reality; on the other hand, how exactly would closing the sweatshop make those workers better off? In all likelihood, if they had better options than sewing shoes for 75 cents an hour they wouldn't be working in a sweatshop in the first place.

Some liberal opposition to market outcomes is much more justifiable. We too often forget that every time someone builds a better (or cheaper) mousetrap, it's bad news for whoever made the old mousetrap. I don't advocate banning new mousetraps (or curtailing cheap imports from China), but there's nothing wrong with showing some empathy when markets create losers, as they always do.

Free and Easy Trade

What about conservatives? They talk the market talk, but don't always walk the walk. Try this experiment: Find a large Republican rally and take a turn at the microphone. Get the crowd warmed up with some general remarks about the elegance of markets and the evils of government. Then, when the applause lines are coming fast and furious, ask where you can buy some really good sex.

During the stunned silence, admonish these conservative market enthusiasts to fight against the oppressive zoning regulations that make it impossible for you to buy private property and build apartment buildings in most ritzy suburbs.

Why shouldn't you be able to do a tear down a single-family home on a five-acre lot in Greenwich if you can make a profit by replacing it with lots of cheap apartments? After all, don't they call it the housing "market"?

A Free-Market Self-Test

The reality is that most people -- from one end of the political spectrum to the other -- find some market outcomes objectionable.

Markets don't elicit any kind of consensus. The most interesting public policy questions often involve market outcomes that people decide they don't like -- whether it's sweatshops, prostitution, cheap imports from China, or something else.

So how do you feel about markets? Take this quick quiz. I've included my own (short) answers.

Should we legalize the sale and possession of drugs like marijuana, cocaine, and heroin?
My answer: I don't know. Certainly there's a market for these drugs -- lots of eager buyers and sellers. Society spends a lot of money trying to disrupt that market, seemingly to no avail.
Yes, drug use harms innocent third parties, but so do alcohol and tobacco. In those cases, we use taxes to raise the cost of smoking and drinking, and we regulate the specific behaviors that affect third parties, such as smoking at the office or driving drunk.
So why not do the same with drugs? Our current approach is both ineffective and expensive. Nonviolent drug offenders are clogging the courts and prisons. All the while, demand seems unabated and the illegal drug trade is empowering and enriching gangs and violent criminals, just as Prohibition did for organized crime.
Milton Friedman famously noted that everything wrong with drugs stems from the fact that they're illegal. I don't know about "everything" -- these are addictive substances that harm people and their families -- but I take his point.
And yet I'm not prepared to turn the sale of crack over to a Fortune 500 company that can maximize profits by finding new ways to get 18 year olds to sample their product. Nor do I want the government in the business of selling and distributing heroin. I don't have a moral objection to legalizing drug use and punishing only the behavior that affects the rest of us -- the drug equivalent of drunk driving. I just can't figure out how to do it.
Should we liberalize labor markets, so that workers can more freely cross international boundaries?
My answer: Yes. I find it hard to justify criminalizing anything that I would do myself. If I were poor and trying to raise a family in Mexico, I would do anything to get to the U.S. -- legally or otherwise. Capitalism is all about rewarding those who are willing to work harder or cheaper. Why is labor that crosses an international border any different?
When we buy a cheap stereo from China, that's globalization. When we give the kitchen remodeling job to the lowest bidder, that's competition. When some guy from El Salvador offers to cut the lawn cheaply, that's illegal. To an economist, it's just another voluntary transaction that makes both parties better off.
Yes, we need to police the borders -- for terrorists, not cheap poultry workers. You can reasonably disagree with me, but you must concede that I'm the one advocating the "free market" outcome in this case and you're not.
Should we implement a federal carbon tax and/or significantly raise the gas tax?
My answer: Absolutely. If you believe in markets when they work well, then you have to understand how they need to be tweaked when they don't. If page 10 of any introductory economics text explains the wonders of supply and demand, page 12 usually explains that markets don't deliver an efficient outcome when eager buyers and sellers impose some harm, or negative externality, on a third party.
If I can change the oil in your car more cheaply than the competition by dumping the old oil in Lake Michigan, that's not the kind of market transaction that got Milton Friedman so excited. Yes, I make profits and you save money -- a mutually beneficial, voluntary exchange -- but anybody who cares about Lake Michigan is not happy at all, and they aren't represented in our little transaction.
When the price of some activity is artificially cheap because society is picking up part of the tab, people do too much of it. That's not the economically efficient outcome that markets usually deliver. One standard economic fix is to impose a tax on whatever private activity imposes the social cost; when the price of the activity goes up, people do less of it.
That's exactly what a carbon tax or a higher gas tax would do. There's nothing voluntary about me breathing your tailpipe emissions. If we raise the private cost of driving, people will be less likely to commute 60 miles alone in a Chevy Tahoe.
The optimal market outcome isn't always synonymous with doing nothing; in this case, the market works best when the government does something. That something happens to be a tax, or anything else that raises the cost of the polluting behavior.

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97 Comments

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KoalaBear33 - Tuesday, April 17, 2007, 2:17PM ET Report Abuse
- Overall: 5/5
Your articles are excellent, regardless of whether one agrees with them or not (I'm actually a liberal-libertarian so I'm more extremist than you (yes, legalize drugs for example)). Your writing is also excellent.
Thomas - Tuesday, March 20, 2007, 2:21PM ET Report Abuse
- Overall: 2/5
I was agreeing with much in the article until he got to the part about the "carbon tax" that ruined his premise. You cannot compare carbon dioxide emissions to pouring toxic waste into a lake. Carbon dioxide is an essential nutrient for plants that they need for photosynthesis, it is not a pollutant. All that a carobn tax would do is create a government bureaucracy, put undue burdens on the economy, and siphon tax money from private hands to an already bloated government. The carbon tax is a "solution" looking for a problem that does not exist. It is part of the socialist agenda against free enterprise and capitalism in their unholy alliance with the environmental extremists that come up with myths like "Global Warming".
freakyz - Thursday, March 8, 2007, 5:48PM ET Report Abuse
- Overall: 5/5
Unlike some writers for Yahoo (Robert Kiosaki), Dr. Wheelan actually knows what he's talking about. His wit and wisdom are top notch.
Yahoo! Finance User - Tuesday, March 6, 2007, 4:43PM ET Report Abuse
- Overall: 3/5
The gasoline 'Carbon Tax' serves to put a bigger pinch on the American consumer than is already being felt. It is liberal political fluff and self-flagration. We have an active technological and political incentive to reduce carbon emissions that needs support and funding. lLet's concentrate on reality shall we?
AlG - Tuesday, March 6, 2007, 12:54PM ET Report Abuse
- Overall: 3/5
Good writing, although I have heard most of these ideas before. Helpful, though, to expose them to folks who haven't, so good job. As a father of two boys, I do not want to have drugs legalized. We could have a nice debate back and forth, but I would simply state this. Any politician who tried to legalize drugs would create a fanatical opponent in me as I would see it as a direct assault on my boys. NOTHING, NOTHING, NOTHING anyone would say will change this. I think politicians understand this reality, and that is why you don't see such stupid ideas floated around by them, only by tenured profs who don't have to worry about the real world. Simply put, making drugs illegal means a non-trivial segment of the population that will avoid them solely for this reason. Also, society signals that drugs are bad by making them illegal. What signal does it send if they were legalized? As a parent, I need to have this argument as one of my weapons in my own personal war on drugs. Sure, sure, booze and butts, blaah, blaah, blaah. So if I have cancer, I should go out and get heart disease too? Same stupid argument is made by comparing booze and butts to smack, coke, and weed.
Yahoo! Finance User - Sunday, March 4, 2007, 6:48PM ET Report Abuse
- Overall: 5/5
I'm hooked and will need continuing doses of your excellent output. And as for who should supply drugs; between a private company or the government, I'd choose government for exactly the reason you mention. Why would you maximize sales through profit motive? I certainly have serious problems with the gov't doing it but even more serious problems with the fact that there is no real control now. If gov't captures distributive control then further control becomes possible.
SteveA - Wednesday, February 28, 2007, 10:43AM ET Report Abuse
- Overall: 5/5
Wit, wisdom and philosophy all rolled into one without the preaching professor after-taste. How refreshing!
Doron - Wednesday, February 28, 2007, 12:47AM ET Report Abuse
- Overall: 5/5
I have my degree in economics and I can't find a single economists that hits the nail on the head like Charles Wheelan. Funny, accurate, and well recommended.
Yahoo! Finance User - Monday, February 26, 2007, 2:12PM ET Report Abuse
- Overall: 5/5
I think that this article makes more sense than anything I have read in a long time. It states both fact and opinion in a clear and straightforward manner. Also, I am Democrat; I don't now how this article plays with the neocons passing themselves off as Republicans these days.
Yahoo! Finance User - Monday, February 26, 2007, 1:08PM ET Report Abuse
- Overall: 3/5
I do not understand how tariffs (taxes) fit into free market.
R. J - Friday, February 23, 2007, 7:19PM ET Report Abuse
- Overall: 5/5
Nicely written. I like your philosophy.
Chris - Friday, February 23, 2007, 6:03PM ET Report Abuse
- Overall: 5/5
As always - great column. Just stating what everyone else normally would not in this PC world.
Yahoo! Finance User - Friday, February 23, 2007, 1:08AM ET Report Abuse
- Overall: 4/5
Not his best, but always lucid and worthwhile. As far as the 2/21/07, 1:15 AM ET post, odd assumptions, even odder conclusions. Lots of words, little substance. I guess 4000 characters isn't enough.
Yahoo! Finance User - Thursday, February 22, 2007, 12:53PM ET Report Abuse
- Overall: 5/5
I would point out to the goober that said that the economist was ignoring the COST to society on illegal immigration, that the net present value to the country of those workers overall is a positive number.
April - Wednesday, February 21, 2007, 5:47PM ET Report Abuse
- Overall: 3/5
Overall good...on the illegal immigration, it's ignoring the other half of the issue, which is the COST to society (hospital bills, welfare for citizen children born of illegals, schooling, roads and infrastructure, etc). Believe me, if it were JUST the transaction of cutting grass, I'd be all for it, but it's not.
Moira Noiseux - Wednesday, February 21, 2007, 2:41PM ET Report Abuse
- Overall: 5/5
lots of guts to write this
Yahoo! Finance User - Wednesday, February 21, 2007, 2:34PM ET Report Abuse
- Overall: 4/5
It's a good article- not great, but good. There are no easy fixes in this world. There are no easy answers. People need to learn to keep an open mind otherwise we'll end up with a dirty country made up of indigent people.
Yahoo! Finance User - Wednesday, February 21, 2007, 1:15AM ET Report Abuse
- Overall: 1/5
Sorry. This person does not know what he is talking about. 1) There is a big difference between having a free-market economy and having a free-market society. When we restrict our understanding of economics to its traditional use as a tool to achieve certain material ends, then we are talking about a free-market economy. When, however, we start extending it beyond its traditonal use, then we are using econo-mysticism to remake society into something people don't want. So, yeah, it's real funny to create "gotcha" moments like asking conservatives where you can buy some sex, but this simply reflects the poor understanding that their are distinctions between economies and societies. 2) Legalizing drugs is not the answer. This would cause a massive decrease in the price of drugs which would lead to a massive increase in the number of drug addicts. Legalization would only work if the demand for drugs is highly inelastic so that any movement along the demand curve will be smaller relative to the price movement. Few products face this kind of demand inelasticity, meaning drug legalization is out of the question. 3) The real way to get rid of drugs is to impose a death penalty on drug dealing. This would be very effective since a dealer must rely on, well, dealing. He has to identify himself as a dealer and offer his wares to users...any one of which could be undercover cops. By imposing such an enormous penalty and utilizing the transactional nature of the drug dealing, the problem would go away in a year. 4) Immigrant labor is not free-market. The government allows them here, gives them welfare benefits, sends their kids to school, and provides all manner of services to immigrants. These are nothing but subsidies paid to big corporations in an effort to destroy the livelihoods of average Americans. This notion that moving people is the same as moving goods is silly, since widgets don't march in the streets yellling "Si, se pueda." This immigration fetish seems to be the one exception to clear-headed economic thinking. 5) Obviously, this guy does not understand that the decision to internalize an externality is itself based on the cost-benefit approach. To understand this, one needs to remember that internalizing an externality can itself create other externalities. What happens if carbon taxes create their own externalities, like greatly increasing the costs of food, energy, and other requirements needed to survive. Sure, I'll "breathe" better but then I will starve to death. What sort of tradeoff is that? This guy exemplifies the way "externality fetishism" creates mischief in public policy.
Yahoo! Finance User - Tuesday, February 20, 2007, 8:52PM ET Report Abuse
- Overall: 2/5
Your view is interesting, but really your decisions to support illegal immigrant migration and carbon and gas tax really have nothing to do with being in support of a free market. For a free market to be successful, there must also be laws that govern the free market, or it will not succeed. For instance, if you just let the free market go wild without any laws, people would write bad checks and commit credit fraud and businesses would not tell us of potentially lethal flaws in their products and the market would not work. (Just as in Russia, where crime is so rampant, the economy has difficulty growing) Immigration law is something that helps our free market work. If we chose to completely disregard the law, we would have illegal aliens setting up businesses only to pick up and leave every time they caused serious problems, ie. building a house incorrectly, so it is worth nothing or actions that cause someone to get hurt or die. Also, when we have to pay for their healthcare, babies, children in school, and even have them and their families jump on social security and welfare, it is not an even playing field for those of us who follow the laws. There have to be legal standards or the products and services we receive would be worthless. Your answer to carbon taxes and gas taxes smells of communism. You are making assumptions that you know better than a good portion of scientists who have studied volcanic eruptions, sun spots, ice cores and history confirming the earth has been through warming stages just like this before. The funny thing is liberals that believe like you do on the environment actually make it worse than better, because going along with the belief that we are killing the environment is the fact that we should force everyone in to mass transit and not build roads, which in the end causes more cars to sit in traffic jambs and pollute much more than they would of, if they could just drive efficiently. Instead let's have reasonable emission standards, such as cleaner diesel fuel, which is rolling out and we all can look forward to.
Joe S - Tuesday, February 20, 2007, 5:46PM ET Report Abuse
- Overall: 1/5
Let me suggest a framework that goes to the heart of the issues. It is never okay to initiate violence to attain your ends. Violence is only appropriate as a means of defending your self or your property. Question 1: I think that using drugs is stupid and self-destructive. However, as long as you bear those costs yourself and do no harm to others, I don't believe it is right for me to use violence to infringe on your liberty to do as you wish with your body. Question 2: A person crossing an arbitrary border to engage in a voluntary transaction is not only peaceful but potentially advantageous to me. I do complain that illegal immigrants consume a great deal of government largess without paying taxes. However, this largesse itself is immorally extracted from us in the form of taxes enforced by the threat of violence (imprisonment, confiscation of property, etc). Don't blame the immigrants for the prior crime. Question 3: This one is most interesting. Another commentator equated being forced to breathe carbon emissions to being punched in the nose. I believe that this would be a complex question for a truly free market to handle. How do you protect one person from something that another person does not consider an injury? I leave this question unanswered except to insist that violence in the form taxation is not a suitable answer.
Patrick - Monday, February 19, 2007, 2:33PM ET Report Abuse
- Overall: 1/5
The test is entitled "Free Market Self Test" - The word free implies an absence of regulation. All questions take the format should government regulate X, where X is either drugs, the movement of labor, or the price of gasoline, if you want to use the word "free" as in market, then your answer is no, if you mean something else, feel free to use another word.
Yahoo! Finance User - Monday, February 19, 2007, 10:34AM ET Report Abuse
- Overall: 5/5
I enjoyed the column-- and the comments. People forget that Milton Friedman was a conservative (many so-called conservatives today don't agree with him). Adam Smith envisioned an important role for government in markets when the necessary outcome couldn't be obrtained by the market. Infrastructure and education are two examples. Yet to hear today's politicans talk both of these conservative economists were leftists. I too am of a libertarian persuasion. But if long commutes in large vehicles are made possible by avoiding the true cost on the market system, that's not a legitimate free market. If government has to come in later and pay someone to clean up the mess with someone else's [tax] money, then the true cost of the original transaction was sluffed off on the taxpayers, Unfortunately, the money saved by avoidance does not go for alternative energy research, unless those with long commutes in large vehicles are investing their savings in alternative energy stocks, instead of buying more consumer goods, or better food, or education for their kids. Besides, it would seem to me that the person driving a Tahoe 60 miles every day is on average unlikely to be interested in investing in alternative energy.
Yahoo! Finance User - Sunday, February 18, 2007, 9:21PM ET Report Abuse
- Overall: 5/5
Great article! =)
big - Sunday, February 18, 2007, 8:22PM ET Report Abuse
- Overall: 3/5
On the "illegal" labor question, yes to letting anyone come across to work. No to providing benefits to them and their extended families that inevitably follow, such as medical care, free schooling, welfare, ADC, subsidized housing, unemployment payments, etc. They are here to work cheaply, nothing else.
Jacob T - Sunday, February 18, 2007, 6:40PM ET Report Abuse
- Overall: 4/5
Yes to legalizing drugs (instantly robs the underground economy of its legs, sales tax funds addiction programs), yes to freeing up the labor mkt. (we need the labor help - Americans aren't willing to work these jobs, if immigrants are here to do it, either consumer prices will rise or the industries will move to the labor - lose/lose to US residents), yes to gas tax (use proceeds to fund energy independence and no longer have to bed non-Democratic oil producers or fight ill-conceived wars to maintain access). These are all no-brainers, and I have yet to hear good arguments to the contrary.
Douglas M - Sunday, February 18, 2007, 11:02AM ET Report Abuse
- Overall: 4/5
Still missing the snapshot of political economy, I'll settle for a lucid MOR like this.
Stephen - Sunday, February 18, 2007, 9:37AM ET Report Abuse
- Overall: 1/5
"Should we implement a federal carbon tax and/or significantly raise the gas tax? Absolutely." That externality strawman doesn't hold up under closer scrutiny. The problem is tragedy of the commons, not pollution. (Wheelan, what's to stop someone from dumping used oil, or used corn oil, in Lake Michigan after a carbon tax?) The cost of a carbon tax far outweighs its benefit. I want the freedom to drive my Tahoe 60 miles alone, and if the free-market says I can do it, I do it. The carbon tax is money that could be used on technological improvements in the private sector, which is much more efficient, and not handed to the government to be be spent on yesterday's technology and today's political allies. The cost of the carbon tax isn't what you see, it's what you don't see. It's the opportunity cost, which would be extraordinarily high with a carbon tax. Just look at the Europeans.
Carla - Saturday, February 17, 2007, 11:13PM ET Report Abuse
- Overall: 1/5
Only a liberal or socialist mind could be so wrong.
tommyv - Saturday, February 17, 2007, 6:12PM ET Report Abuse
- Overall: 1/5
Very poor set of conclusions. Markets work, no question. This is not a test of markets; it is a test of politics.
Donald F - Saturday, February 17, 2007, 10:16AM ET Report Abuse
- Overall: 3/5
I enjoy reading Wheelan's pieces because I like hearing how the left leaning economists attempt to explain their positions when they generally contrast with the way the real world works. Watching (or in this case reading) the mental gymnastics required to try to make their views make sense is both amusing and entertaining simultaneously. On question 1, I just advise anyone really interested to find the Rand study showing just how much attempting to police this behavior really costs. If you can't find the study, try Neil Boortz website. He talks at length about it periodically and probably has links or at least a summary. On question 2, Wheelan can't have it both ways. On one hand, when he sees a cost to society he doesn't agree with (as in question 3) he advocates government action because society is picking up some of the bill but on this issue he is silent about government action when the societal costs from these "illegal" immigrants are HUGE and going to get worse. The government's only truly unlimited Constitutional authority is to defend this country. I don't care if it's an army of a million people invading at one time or whether it's a million people aiming to steal our social service program dollars coming one at a time. Defend this country! On question 3, more of the pump price of a gallon of gas is going to the government than the oil companies that actually refine and sell the product. If you truly wanted governmental action, how about something other than yet more taxes? Incentives, public sector/private sector partnerships, and research into efficiency and/or alternatives are all non-punitive and non-regulatory government actions. But Wheelan has to recommend a tax. How about the government stop using money to police auto emissions and use that money to builld thousands of strategically located giant air cleaning devices instead. Mexico City (a far more liberal place than here) had so much pollution from the mountains trapping the smog that you could practically chew the air. They realized that their citizens couldn't handle a tax to deal with their smog problem and it would have crippled their economy to attempt to disincent transportation anyway. So they installed giant fans around the city to disperse the smog. And the best thing about the fans is that they are cheap to operate, require no policing, and are therefore not an ongoing societal cost burden. That's good "outside the box" thinking. Government should do less in general but when they do more, it shouldn't be only to tax.

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