Dogma Premise # 11

Markets are the most efficient method for an economy to allocate resources and labor.

Markets are the least efficient, and most risky, method for an economy to allocate resources and labor.  That’s why markets are so rarely used for this purpose.

The problems with markets are easy to see.  Imagine the traders in a stock exchange, yelling prices to each other frantically, with the price wandering up or down, based on the changing mood of sellers and buyers.

This is not how we buy a pizza, or a toaster, or a car, and there is a reason for that.  But just because we don’t, doesn’t mean we couldn’t.

Here is how we might use markets to broker all of our purchases.  Imagine that an online auction such as eBay were not only where you bought collectibles and off-beat items, but instead were where you did ALL your shopping: milk, magazines, phone service, gasoline, and shoes.  The prices might change constantly, and there could be a great deal of uncertainty about who you were buying from.  But assuming there were a reliable, efficient method of transporting the goods from seller to buyer, there is nothing unworkable about this system.

It would just be really inefficient, because although this mega-market would constantly balance supply and demand, it would impose significant information costs on the market participants trying to understand their options, and significant uncertainty as to pricing and availability, as supply and demand vary.  Because this uncertainty is undesirable and intrinsic to markets, real markets have developed secondary “futures” markets, where important goods and services can be bargained for in advance at fixed prices.  The potential need for a futures market in a household’s loaves of bread, sugar, or take-out pizza -- or even the potential desirability of paying for an option to buy a snow-thrower next winter at a given price -- illustrates the difficulty of relying on markets for everyday transactions.

This is why it is not accurate to say that in the United States markets are responsible for the efficient allocation of productive resources.

And yet, it is difficult for most people to believe that when they go to a store and purchase a bottle of barbecue sauce that they aren’t somehow participating in a market.  It seems that the purchase must be registered somewhere as an increase in demand, and that increase in demand must motivate suppliers to supply that-much-more barbecue sauce.  It seems that the barbecue sauce industry must become just slightly more profitable as a result of the purchase, which must just slightly increase the likelihood that new suppliers will enter the market, and that innovators will find ways to make better, cheaper barbecue sauce.

It makes perfect sense, but that’s not how it actually works.

What actually happens is that there is a general demand for barbecue sauce, and producers create facilities adequate to meet the demand.  Intermediate distributors -- for example, warehouses and grocery chains -- negotiate with the manufacturers to distribute the barbecue sauce.

One factor that may be considered by the distributors is how well the product will sell, but that is only a small part of the equation.  The profitability of the product looms larger.  The manufacturer may provide pricing discounts to retailers who move a lot of product -- for example by giving it a prominent location in the store.  Or the retailers may provide payments back to the manufacturer in exchange for an exclusive product or guarantied availability, or the chance to test new products.

It all comes down to profitability, which is heavily affected by the price that a consumer is willing to pay for a bottle of barbecue sauce.  Therefore, the manufacturer will typically engage in extensive marketing to make their product seem more valuable.  There may be television ads, signs at stadiums, celebrity testimonials, exotic packaging, and more.  These techniques have been reduced to a science, and are consistently effective.

It may prove most profitable to create six flavors of barbecue sauce from a single factory, and use those six flavors to use up more of the shelf-space that the grocery store allocates to barbecue sauce, thereby reducing competition by forcing a competing brand out of the store.  All that needs to be done to make this trick work is to fragment consumer demand so that six different sets of customers prefer six different types of barbecue sauce.  That puts the grocer in a bad position, because to the extent that she fails to stock all six flavors, her customers may be increasingly dissatisfied and consider shopping elsewhere.

It is a pretty thought that consumers make choices based on their preferences, and the economy responds.  However, that’s mostly not what is happening.  Instead, the producers determine in advance what it would be most profitable way to configure their production and distribution facilities, and then try to manipulate consumer demand to match the supply strategy.  That’s why today's economy is better characterized as a planned economy, and not a market economy.

The allocation of productive resources is driven primarily to maximize profitability, not to meet preexisting customer demand. Sometimes it is more profitable to conform demand to the preferences of the supply chain, and not vice versa. In any event, the final allocation of productive resources -- what gets produced, in what quantities, and by whom -- is not merely a function of markets efficiently meeting demand, but of many different considerations, many of them more closely resembling central planning than market transactions. Because the actual process is quite unlike an efficient market exchange, there is no reason to believe that the resulting allocation is manifests market efficiencies.

Dogma Premise 12

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