Hahnel - The Case Against Markets (2007)

Journal of Economic Issues
ISSN: 0021-3624 (Print) 1946-326X (Online) Journal homepage: http://www.tandfonline.com/loi/mjei20
The Case against Markets
Robin Hahnel
To cite this article: Robin Hahnel (2007) The Case against Markets, Journal of Economic Issues,
41:4, 1139-1159, DOI: 10.1080/00213624.2007.11507090
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The Case Against Markets

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Robin Hahnel
Markets are an efficient way of producing and distributing a very large

number of mundane items. Market incentives are a dependable way of
getting our bread baked. Markets allow us to make the best use of the
information dispersed throughout a society. Markets give their participants
a certain kind of freedom - expanding the range of choices and giving each
person a variety of partners with whom to deaL
- David Miller and Saul Estrin (1994) -
Rather than efficiency machines, optimal incentive systems, cybernetic

miracles, and human liberators, when we examine markets we find
institutions that generate increasingly inefficient allocations of resources,
unleash socially destructive incentives unnecessarily, bias and obstruct the
flow of essential information for economic selfmanagement, substitute
trivial for meaningful freedoms, and lead to irremediable inequities in the
distribution of goods and power.
- Robin Hahnel and Michael Albert (1990) -
The debate between those who believe that markets are an integral part of a desirable
economy and those who believe we must eventually replace the market system with
some kind of democratic planning is long standing. By the end of the twentieth
century, supporters of markets had the upper hand for obvious reasons. (1) The
demise of central planning not only in the Soviet Union and Eastern Europe, but in
China, Vietnam, and Cuba (to a lesser degree) casts a pall over any talk of
comprehensively planning how best to use productive resources. (2) In Western
Europe and the United States, the free market jubilee began in the 1980s when
Margaret Thatcher and Helmut Kohl defeated social democracy in Europe and
The author is a Professor of Economics at American University in Washington, D.C. and is currently a visiting
Professor at Lewis and Clark College in Portland, Oregon. His most recent book is Economic Justice and Democracy:
From Competition to Cooperation. Routledge, 2005.
1139
©2007, Journal of Economic Issues

1140 Robin Hahne!
Ronald Reagan put liberals in the United States on the run. (3) When social
democrats regained power in Germany and Great Britain, and Democrats won back
the White House in the 1990s, instead of reigning in market mania Tony Blair,
Gerhard Schroeder, and Bill Clinton routed progressive forces inside their own
parties, promoted pro-market, "third way" domestic policies, and directed the IMF
(International Monetary Fund), WTO (World Trade Organization), and World Bank
to force free market medicine down the throat of one third world country after
another. (4) In the aftermath of the East Asian financial crisis even mighty Japan Inc.
and other Asian "tigers" like South Korea were forced to bow to the market gods they
had long held at bay, and abandon their highly successful "Asian model" of long-run
international economic planning.
Consequently, by century's end, to speak ill of markets narrowed one's access
to ears, and progressive economists quickly learned how to reformulate criticisms as
suggestions about improving market performance. Any hint that one considered
markets to be part of the problem rather than the key to the solution to any economic
problem was sure to blow one's cover in the economics profession as well as policy
circles. Proclaiming oneself a "market abolitionist" at the dawn of the new
millennium was tantamount to a plea of insanity.
But, while it is easy to see why the shrinking circle of progressive economists
with lingering doubts about markets have been cowed into silence, none of the above
"reasons" have any logical bearing on the positive and negative aspects of either
markets or democratic planning. Market performance is not enhanced by the collapse
of central planning or by an increase in ideological hegemony of those who sing in
praise of markets. Nor does the demise of authoritarian planning mean that
democratic planning is also a bad idea. As a matter of fact, one reading of the
empirical evidence of market performance over the past thirty years is that when
constraints on markets are weakened, the damage to human livelihoods and the
environment increases dramatically. In any case, having no cover left to blow, I take
this opportunity to reiterate the theoretical case against the market system. 1
The debate between those who favor the market system and those who favor
democratic planning has always consisted of two parts: (1) How bad are markets? And,
(2) is there a feasible alternative that is any better? I make no attempt to address the
second question in this article having done so elsewhere (Albert and Hahnel 1991a;
1991b; 1992a; 1992b; and 2002; and most recently, Hahnel2005, where I go to great
lengths to respond to important concerns others have raised about democratic
planning.) In this article, I also make no attempt to explain why markets inevitably
reward people unfairly. I refer readers to Hahnel (2004) for the case against markets
on equity grounds, and why I do not believe correctives would be forthcoming even in
"market socialist" economies. In this article, I confine myself to arguing that contrary
to both popular and professional opinion, there is every reason to believe that
markets allocate resources very inefficiently and undermine rather than promote
democracy. I also reiterate the case that markets are perhaps the most socially
destructive institution ever devised by the human species.
The Case Against Markets 1141
Why Markets Are Inefficient
It is well known among professional economists that markets allocate resources

inefficiently when they are out of equilibrium, when they are non-competitive, and
when there are external effects. When the fundamental theorem of welfare economics
is read critically it says as much: Only if there are no external effects, only if all markets
are competitive, and only when all markets are in equilibrium is it true that a market
economy will yield a Pareto optimal outcome. But despite these clear warnings,
market enthusiasts insist that if left alone markets generally allocate resources very
efficiently. This conclusion can only be true if: (1) disequilibrating forces are weak,
(2) non-competitive market structures are uncommon, and (3) externalities are the
exception, rather than the rule. I will offer theoretical reasons to believe exactly the
opposite in all three cases. A second line of defense holds that while free markets may
be plagued by inefficiencies, it is possible to "socialize" markets through various policy
correctives and thereby render them "reasonably" efficient. While I generally support
policies to ameliorate market inefficiencies, I will offer practical reasons why it is a
pipe dream to believe that such policies could ever render market systems
"reasonably" efficient.
Why Externalities Are Likely To Be Pervasive
Markets permit people to interact in ways that are convenient and mutually
beneficial for buyers and sellers. Market exchanges are convenient whenever
transaction costs of exchanges are low - which is the case when those others than the
buyer and seller are excluded from the transaction. And, it is a tautology that any
voluntary agreement is mutually beneficial under the assumptions of rationality and
perfect knowledge. While knowledge (which includes foresight) and rationality are
seldom perfect, I am happy to stipulate that both are often "good enough" so that
market exchanges are frequently beneficial to both buyer and seller. But convenience
and benefits for buyer and seller do not imply social efficiency. Ironically, the very
factors that render markets convenient and beneficial for buyers and sellers also
render them socially inefficient.
Increasing the value of goods and services produced and decreasing the
unpleasantness of what we have to do to produce them are two ways producers can
increase their profits in a market economy, and competitive pressures will drive
producers to do both. But maneuvering to appropriate a greater share of the goods
and services produced by externalizing costs onto others and internalizing benefits
without compensation are also ways to increase profits. Moreover, competitive
pressu"res will drive producers to pursue this ~oute to greater profitability just as
assiduously. Of course the problem is, while the first kind of behavior serves the social
interest as well as the private interests of producers, the second kind of behavior
serves the private interests of producers at the expense of the social interest. When
sellers (or buyers) promote their private interests by externalizing costs onto those not
party to the market exchange, or by appropriating benefits from other parties without
1142 Robin Hahnel
compensation, their behavior introduces inefficiencies that lead to a misallocation of

productive resources, and consequently, a decrease in the value of goods and services
produced in the economy.
The positive side of market incentives has received great attention and
praise, dating back to Adam Smith who coined the term "invisible' hand" to describe
it. The darker side of market incentives has been relatively neglected and grossly
underestimated. Two exceptions are Ralph d'Arge and E.K. Hunt (1971; Hunt and
d'Arge 1973; and Hunt 1980), who coined the less famous, but equally appropriate
term, "invisible foot" to describe the socially counter productive behavior markets
drive participants to engage in.

Market enthusiasts seldom ask: Where are firms most likely to find the
easiest opportunities to expand their profits? How easy is it usually to increase the size
or quality of the economic pie? How easy is it to reduce the time or discomfort it takes
to bake the pie? Alternatively, how easy is it to enlarge one's slice of the pie by
externalizing a cost, or by appropriating a benefit without payment? Why should we
assume that in market economies it is infinitely easier to expand private benefits
through socially productive behavior than through socially counter productive
behavior? Yet this implicit assumption is what lies behind the view of markets as
guided by a beneficent invisible hand rather than a malevolent invisible foot.
Market admirers fail to notice that the same feature of market exchanges
primarily responsible for small transaction costs - excluding all affected parties other
than the buyer and seller from the transaction - is also a major source of potential
gain for the buyer and seller. When the buyer and seller of an automobile strike their
convenient deal, the size of the benefit they have to divide between them is greatly
enlarged by externalizing the costs onto others of the acid rain produced by car
production, and the costs of urban smog, noise pollution, traffic congestion, and
greenhouse gas emissions caused by car consumption. Those who pay for these costs,
and thereby enlarge automobile manufacturer profits and car consumer benefits, are
easy marks for car sellers and buyers for two reasons. They are dispersed
geographically and chronologically, and, the magnitude of the effect on each
negatively affected, external party is small, yet not equal. Consequently, individually,
external parties have little incentive to insist on being party to the transaction - the
external effect on a single party is seldom large enough to make it worthwhile for one
person to try to insert herself into the negotiations. But there are formidable obstacles
to forming a coalition to represent the collective interests of all external parties as
well.
Organizing a large number of people who may be dispersed geographically
and chronologically, when each has little but different amounts at stake is a difficult
task. Who will bear the transaction costs of approaching members when each has
little to benefit? When approached, who will report truthfully how much they are
affected when it is to their advantage to either over or under exaggerate? Ronald
Coase (1960) recognized these transaction cost and free rider problems associated
with forming a voluntary coalition of pollution victims when he explicitly stipulated
that his argument for the efficacy of private negotiations between polluters and
pollution victims applied only to situations where there was a single pollution victim
and not to situations where there were multiple victims. Nor can we solve the free
rider and hold out incentive problems inherent in organizing a coalition of those who
are negatively affected by car production and consumption by awarding them the
"property right" not to be victimized without their consent. As Coase also
demonstrated convincingly, efficiency - or in this case, inefficiency - depends solely
on incentives, and is unaffected by whether victims of external effects possess the
property right not to be victimized, or those whose behavior negatively affects others
have the legal right to do so. Who has the property right merely determines who must
approach and bribe whom; it does not change the fact that when there are multiple
victims they face formidable transaction costs, and, free rider and hold out incentive
problems to acting collectively.
It should be noted that the opportunity for buyers and sellers to benefit at
the expense of external parties is not eliminated by making markets perfectly
competitive or entry costless, as is commonly assumed. 2 Even if there were countless
perfectly informed sellers and buyers in every market, even if the appearance of the
slightest differences in average profit rates in different industries induced
instantaneous self-correcting entries and exits of firms, even if every buyer were
equally powerful as every seller - in other words, even if we embrace the full fantasy of
market enthusiasts - as long as there are numerous external parties with small but
unequal interests in market transactions, those external parties will face greater
transaction cost and free rider obstacles to a full and effective representation of their
collective interest than that faced by the buyer and seller in the market exchange.
If we include the free rider and hold out incentive problems faced by
external parties as part of their overall transaction costs, one way to see the problem is
that markets reduce the transaction costs for buyers and sellers but do nothing to
reduce the transaction cost of participation in decision making by externally affected
parties. It is this inequality in transaction costs that makes external parti~s easy prey to
rent seeking behavior on the part of buyers and sellers. Even if we could organize a
market economy so that buyers and sellers never face a more or less powerful
opponent in a market exchange, this would not change the fact that each of us has
smaller interests at stake in many transactions in which we are neither buyer nor
seller. Yet the sum total interest of all external parties can be considerable compared
to the interests of the buyer and the seller. 3 It is the transaction cost and free rider
incentive problems of those with lesser interests that create an unavoidable inequality
in power between those who make an exchange and those who are neither buyer nor
seller but are affected by the exchange nonetheless. This is the power imbalance that
allows buyers and sellers to benefit at the expense of disenfranchised external parties
in ways that cause social inefficiencies.
In sum, a sufficient condition for buyers and sellers to have the opportunity
to profit in socially counter productive ways by shifting costs onto others is that each
one of us has diffuse interests that make us affected external parties to many
exchanges in which we are neither buyer nor seller. Even if we could make every
market perfectly competitive and thereby eliminate any power imbalance between
buyers and sellers, this source of market inefficiency would persist.
1144 Robin Hahne!
Why Markets Become Less Competitive
Not every buyer and seller is equally powerful in real world markets. Many
markets are non-competitive, i.e. there are sufficiently few sellers or buyers, so one
party to a market exchange has greater bargaining power than the other. It is well
known that when sellers are few it is in their individual interest to produce an output
that is, collectively, less than is socially optimal. 4 Assuming equal cost structures a
rational monopolist will restrict output the most below socially optimal levels.
Rational duopolists will jointly produce more than a rational monopolist, but still less
than the socially optimal level. A three firm oligopoly will produce more than a
duopoly, but less than the socially optimal level nonetheless, etc. In other words, just
as it is easier to make profits at the expense of disenfranchised external parties than
through socially productive behavior, it is often easier to make profits through non-
competitive behavior than socially productive behavior. When a few large powerful
players on one side of a market exchange, face many small powerless players on the
other side, it is often more sensible for large players to pursue socially counter
productive strategies to take advantage of their weaker market opponents than it is for
them to search for ways to increase the size of the economic pie or reduce the time
and discomfort necessary to bake it. In the real world there are consumers with little
information, time, or means to defend their interests against huge, corporate
producers. There are small, capital-poor, innovative firms for giants like IBM and
Microsoft to buy up instead of tackling the hard work of innovation themselves. Non-
competitive market structures give rise to highly profitable, but socially counter
productive behavior.
In The Transformation of American Capitalism, John Munkirs provides
overwhelming evidence to refute the myth that the U.S. market system remotely
resembled the fantasy world of perfect competition prior to 1980. By 1980, most
U.S. GDP was already produced by firms operating in non-competitive markets. Since
then, U.S. business has gone through a prolonged merger mania, which has
dramatically increased what Michael Kalecki called "the degree of monopoly" in the
economy. Using weighted concentration ratios for the entire economy, Frederick
Pryor argued that industrial concentration decreased in the United States from 1960
to the early 1980s but has increased ever since as merger waves more than offset
counteracting effects from imports and the growth of information technology in
production (Pryor 2001). According to Danaher and Mark (2003, 3) between 1998
and 2000 alone, the U.S. economy witnessed $4 trillion in mergers. According to
Hartmann (2002, 37) the largest 1,000 companies account for about 70% of U.S.
GDP.
In sum, more markets have become non-competitive, and markets that were
already not competitive have become even less so. As anti-trust legal actions declined
and regulation of non-competitive industries diminished, it has become ever easier to
profit by taking advantage of non-competitive market structures in socially counter
productive ways instead of tackling the difficult job of increasing the value of goods
produced or redUcing the sacrifices necessary to make them.
Why Markets 00 Not Always Equilibrate
Real markets do not always equilibrate quickly, much less instantaneously.

The famous "laws" of supply and demand, which predict that when market price rises
quantity supplied will increase and quantity demanded will decrease, leading markets
toward their equilibria, are based on a questionable, implicit assumption about how
market participants interpret price chq.nges. Standard analysis implicitly assumes that
sellers and buyers believe that when the market price rises the new higher price is the
new stable price. Or, more precisely, standard reasoning assumes that when a market
price rises, buyers and sellers assume that price is just as likely to fall from this new
higher price as it is to rise further. If this is truly the case, then it is sensible when
market price rises for sellers to offer to sell more than before and for buyers to offer to
buy less than before - as the "laws" of supply and demand say they will. However,
sometimes buyers and sellers quite sensibly interpret price changes as indications of
further price movements in the same direction.
In this case, it is rational for buyers to respond to an increase in price by
increasing the quantity they demand before the price rises even higher, and for sellers
to reduce the quantity they offer to sell waiting for even higher prices to come. When
buyers and sellers behave in this way they create greater excess demand and drive the
price even higher, leading to a market "bubble." When buyers and sellers interpret a
decrease in price as an indication that the price is headed down, it is rational for
buyers to decrease the quantity they demand, waiting for even lower prices, and for
sellers to increase the quantity they offer to sell before the price goes even lower. In
this case their behavior creates even greater excess supply and drives the price even
lower, leading to a market "crash." This means that if market participants interpret
changes in price as signaLs about the likely direction of further price changes, and if
they behave "rationally," they will not only fail to behave in the way the "laws" of
supply and demand would lead us to expect, they will behave in exactly the opposite
way from what these "laws" predict.
Standard textbook treatments try to salvage the "laws" of supply and demand
in face of these seemingly anomalous outcomes .by interpreting them as the result of
changes in the "expectations" of buyers and sellers that shift the supply and demand
curves. In the standard explanation, both before and after the shift, the supply curve
slopes upward and the demand curve slopes downward, i.e., at all times they obey the
"laws" of supply and demand. It is the shift that causes the seemingly anomalous
result that the quantity actually demanded responds positively to changes in price
while the quantity actually supplied responds negatively to changes in price. It is
certainly true that the anomalous behavior results from changes in expectations, but
what textbooks invariably fail to point out is that the standard interpretation renders
the "laws" of supply and demand unfalsifiable. In any case, however one chooses to
interpret the phenomenon, it is clear that market bubbles and crashes can result from
behavior on the part of individual buyers and sellers that is perfectly rational when
they interpret a change in price as an indication of the direction the price is headed,
1146 Robin Hahnel
and that this behavior leads to movement away from, rather than toward the market
equilibrium.
As the East Asian financial crisis reminded us, financial market bubbles that
burst can generate great efficiency losses in the "real" sector of their economies when
"vicious" dis equilibrating dynamics in financial markets overpower "virtuous"
equilibrating forces. Moreover, those who believe that bubbles and crashes only occur
in a few markets where many players are speculators should remember their own
explanation for why all units of a good tend to sell at a uniform market price. Only
when people are free to engage in arbitrage do we get "well ordered" markets and
uniform prices in the first place. This means mainstream economists must expect and
welcome players who are motivated purely by hopes of profiting from trading rather
than because they have any use for the particular good being bought and sold. Since
those who engage in arbitrage have no interest in the usefulness of the good in
question, it seems likely that they would be particularly sensitive to the implications of
a change in price on the likely direction of further price changes, and therefore on
their profits from trading.
In this case, it would appear unlikely we would have well ordered markets,
which require actors who engage in arbitrage, without speculative players being
present as well. The view that we have many well ordered markets free from
speculative players and the kind of problems they bring, and only need worry about
problematic dis equilibrating forces in a small number of speculative markets may be
difficult to justify upon close examination. What we may have instead are some
markets that suffer from allocative inefficiencies because the same good often sells for
different prices for lack of sufficient players engaged in arbitrage, and other markets
immune from this problem because there are enough players engaged in arbitrage, but
prone to disequilibrating forces because actors engaged in arbitrage are also prone to
price speculation, yielding a different kind of inefficiency. An exciting new area for
theoretical research about market dynamics is to use agent based simulation modeling
techniques to explore outcomes where some market participants interpret price
changes as signals while others assume new prices will remain stable. This research
threatens to call into question what it means to say a market is "well-ordered" or a
price is consistent with "market fundamentals."
Even when equilibrating forces outweigh dis equilibrating forces in a single,
isolated market, when equilibration is not instantaneous - which it seldom is - it is
possible for dis equilibrating dynamics to operate between two connected markets.
Keynes' greatest insight about self-reinforcing recessionary dynamics can be framed in
these terms. 5 Consider a labor market and a goods market. Assume that if either
market is out of equilibrium the excess supply or excess demand in that market will
eventually lead to wage or price adjustments leading that market to its equilibrium.
Now assume that while the goods market is initially in equilibrium, the labor market
is not because the wage rate is temporarily higher than the equilibrium wage. While
the excess supply in the labor market will generate equilibrating forces pushing the
wage rate down toward its eqUilibrium, suppose it does not reach its equilibrium
immediately, and in the meantime labor contracts are struck at a wage rate that is still
higher than the equilibrium wage. If the labor demand curve is elastic this will result
in lower labor income than would have been the case if the wage rate had reached its
equilibrium. But the demand curve in the goods market was premised on the
(implicit) assumption that the labor market was in equilibrium, and therefore that
labor income was higher than it actually will be. When we reconstruct the demand
curve in the goods market based on the actual outcome in the labor market, where
labor income is lower than it would have been had the labor market been in
equilibrium, we get an actual goods demand curve to the left of the one anticipated.
No matter how quickly or slowly the price in the goods market adjusts to the resulting
excess supply, we will get a drop in sales and revenues in the goods market.
But lower sales and revenues in the goods market will decrease the demand
for labor in the labor market. The demand curve we originally drew in the labor
market was premised on the (implicit) assumption that we had reached the
equilibrium outcome in the goods market. Now that sales and revenues are lower in
the goods market, when we reconstruct the demand for labor curve based on the new,
actual outcome in the goods market, we get a new demand for labor curve to the left
of the initial one. No matter how quickly or slowly the wage rate adjusts to the new
excess supply, employment and labor income will drop, further depressing the actual
demand for goods in the goods market. Instead of remaining in equilibrium in the
goods market and moving toward the higher, equilibrium level of employment in the
labor market, we move out of equilibrium in the goods market and even farther away
from equilibrium levels of employment in the labor market. In general when price
adjustments are not instantaneous, and "false trading" takes place at non-equilibrium
prices, we can easily get disequilibrating dynamics operating between interconnected
markets.
Sufficient conditions to give rise to this kind of disequilibrating dynamic
between connected markets are: (1) One market must be temporarily out of.
equilibrium in the first place. (The second market can begin in equilibrium.) (2) The
price in the market out of equilibrium can adjust, but must not adjust instantaneously
to its equilibrium level so that some "contracting" takes place at a non-equilibrium
price. (In the second market price adjustment can be instantaneous.) (3) The demand
curve in the market that began out of equilibrium must be elastic. These highly
plausible conditions can give rise to disequilibrating dynamics between markets that
would not have displayed the kind of disequilibrating dynamics on their own
described previously.
In sum, while every economics text book explains how self interested
behavior of buyers and sellers leads to equilibrating price adjustments whenever there
is excess supply or demand in a market, they devote little if any attention to the study
of disequilibrating forces which are also the product of self-interested behavior by
market participants, and which frequently overpower the equilibrating forces Adam
Smith made famous hundreds of years ago.
1148 Robin Hahne!
Practical Problems with Policy Correctives
When reminded of the important qualifying assumptions that are integral to the
fundamental theorem of welfare economics and when faced with theoretical reasons
to believe that externalities, non-competitive market structures and disequilibrium
dynamics are neither rare nor trivial problems, supporters of the market system
respond in different ways. There is an increasingly clear divide between "free market
fundamentalists" whose influence has grown significantly over the past few decades,
and more pragmatic supporters of the market system who favor what some of them
call "socialized markets." The ideologues' enthusiasm for a laissez-faire market system
literally knows no bounds as they brush aside qualifying assumptions in fundamental
welfare theorems and the Coase theorem as if they did not exist. Market pragmatists,
on the other hand, concede that we must "socialize" markets with policies not only to
reduce inequities but to internalize external effects, curb monopolistic practices, and
counter disequilibrating forces as well. Some of these pragmatists are even cognizant
of Karl Polanyi's insight that the market system cannot function without institutional
support, which cannot be willed into existence over night, and understand that how
well or badly a market system will function depends to a great extent on the social
institutions that support it. However, I believe those who give qualified support to
"socialized markets" conveniently ignore a number of practical problems that
inevitably arise whenever we attempt to "socialize" them.
• The job of correcting for external effects is daunting, because they are the rule
rather than the exception. As E.K. Hunt explained:
The Achilles heel of welfare economics is its treatment of

externalities. . . . When reference is made to externalities, one
usually takes as a typical example an upwind factory that emits large
quantities of sulfur oxides and particulate matter inducing rising
probabilities of emphysema, lung cancer, and other respiratory
diseases to residents downwind, or a strip-mining operation that
leaves an irreparable aesthetic scar on the countryside. The fact is,
however, that most of the millions of acts of production and
consumption in which we daily engage involve externalities. In a
market economy any action of one individual or enterprise which
induces pleasure or pain to any other individual or enterprise
constitutes an externality. Since the vast majority of productive and
consumptive acts are social, i.e., to some degree they involve more
than one person, it follows that they will involve externalities. Our
table manners in a restaurant, the general appearance of our house,
our yard or our person, our personal hygiene, the route we pick for a
joy ride, the time of day we mow our lawn, or nearly anyone of the
thousands of ordinary daily acts, all affect, to some degree, the
pleasures or happiness of others. The fact is externalities are totally
pervasive. (Hunt 1980)
In the previous section I merely attempted to bolster Hunt's claim with theoretical
arguments explaining why competitive pressures that steer market participants toward
the least line of resistance for advancing their personal situations is prone to lead
them to frequently take advantage of easily disenfranchised external parties.
• The popular impression that the Coase theorem "proves" that government
intervention is unnecessary to correct for inefficiencies due to external effects because
once property rights are clear, private negotiations between polluters and pollution
victims will lead to efficient outcomes is completely misinformed. Most importantly,
Coase (1960) himself explicitly stated that he was only considering situations where
there was a single pollution victim. Moreover, Coase recognized that whenever there
were multiple pollution victims there would be transaction cost and free rider
problems for pollution victims that would in all likelihood preclude them from the
kind of negotiation he discussed. Those who cite his "theorem" to argue against
government intervention conveniently ignore the critical assumption that there is only
a single pollution victim. 6 Furthermore, it turns out on careful examination that the
so-called Coase "theorem" hinges on the highly implausible assumption that both
parties to the negotiations have what game theorists call "complete information" -
i.e., that each party knows not only what her own marginal benefit or marginal
damage curve looks like, but what the curve of her opponent looks like as well.
Whenever this is not the case it turns out that parties have an incentive to deceive
their opponents in ways that will predictably lead to inefficient outcomes. Since it is
seldom the case that a polluter will know how much a victim is damaged, or a victim
will know how much a polluter benefits from pollution, the conclusion that private
negotiations between a polluter and even a single victim will lead to an efficient level
of pollution does not follow in general. 7 In other words, when rigorously examined
the Coase "theorem" provides overwhelming reasons to believe that most external
effects will go uncorrected through private negotiations between affected parties -
exactly the opposite of what free market environmentalists insist.
• Alfred Pigou proved long ago that when there are negative external effects in a
market a corrective tax is required to eliminate the inefficiency, and when there are
positive externalities a corrective subsidy is indicated. Moreover, Pigou also taught us
that the corrective tax or subsidy should be set equal to the magnitude of the external
effect. But how are we to know what the size of the external effect is? It is hard to
calculate accurate corrective, or "Pigovian" taxes and subsidies because there are no
convenient or reliable procedures in market economies for estimating the magnitudes
of external effects. In this crucial regard, the market offers no assistance whatsoever
forcing us to resort to what are inevitably very imperfect measures. The most common
method of estimating the size of external effects in market economies lies with
willingness to pay and willingness to accept damage "contingent valuation" surveys.
But unfortunately, contingent valuation surveys have well known biases that can be
exploited by special interests, and efforts to reduce "hypothetical bias" necessarily
increase "strategic bias," and attempts to diminish "ignorance bias" necessarily
1150 Robin Hahnel
increase "imbedded bias." Moreover, estimates derived from willingness to accept

damage surveys are on average four times higher than estimates derived from
willingness to pay surveys, even though, in theory, they should yield roughly similar
results. This hardly breeds confidence in the accuracy of contingent valuation surveys
in general, and provides interested parties with ample opportunities to object to
estimates that disadvantage them and finance alternative studies that give widely
different results. While popular among economists, it is well known that hedonic
regression studies are inherently incapable of capturing two entire categories of
external effects - existence value and option value - rendering them unsuited to
providing accurate estimates of the full range of external effects. Moreover, these are
only some of the practical problems of estimating external effects. Beneath these
practical problems lurk deeper questions of what is invariably lost when we attempt to
monetize environmental benefits and when we fail to critically evaluate the origins of
the preferences our stop-gap techniques try to estimate. William Kapp and Gregory
Hayden are two who have warned of more fundamental problems with standard
procedures used to account for external effects (Kapp 1950; Hayden 1983; 1988;
2006; and Eberle and Hayden 1991.).
• Because they are unevenly dispersed throughout the industrial matrix, the task of
correcti~g the entire price system for the direct and indirect effects of externalities is
even more daunting. Even if the external effects of producing or consuming a
particular good were estimated accurately, if the external effects of producing or
consuming goods that enter into the production of the good in question are not also
accurate, the theory of the second best warns us that the Pigovian tax we place on the
good in question may move us farther away from an efficient use of our productive
resources rather than closer.
• In the real world, where private interests and power take precedence over
economic efficiency, the beneficiaries of accurate corrective taxes are all too often
dispersed and powerless compared to those who would be harmed by an accurate
corrective tax. As Mancur Olsen explained long ago in The Logic of Collective Action,
this makes it very unlikely that full correctives would be enacted in most cases, even if
they could be accurately calculated.
• A central tenant of evolutionary economics is that people's preferences do not

"fall from the sky" but are instead formed and molded by social institutions -
including our major economic institutions. Thorstein Veblen's famous caricature of
the "hedonic calculus" was intended to drive this point home. The conviction that
preferences and values are formed by social processes requiring analysis rather than
given, has played a central role in the contributions of luminaries like Gunnar Myrdal,
John Kenneth Galbraith, and John Dewey to disparate fields of economic study. More
recently, I have argued that if we believe consumer preferences are endogenous, then
we should expect the degree of misallocation that results from predictable under
correction for external effects to increase or "snowball" over time (Hahnel 2001). To
the extent that people's preferences are endogenous, they will learn to adjust to the
biases created by external effects in the market price system. Consumers will increase
their preference and demand for goods whose production and/or consumption
entails negative external effects but whose market prices fail to reflect these costs and
are therefore too low, and will decrease their preference and demand for goods whose
production and/or consumption entails positive external effects but whose market
prices fail to reflect these benefits and are therefore too high. While this reaction, or
adjustment, is individually rational it is socially counter productive and inefficient
since it leads to even greater demand for the goods that market systems already over
produce, and even less demand for the goods that market systems already under
produce. As people have greater opportunities to adjust over longer periods of time,
the degree of inefficiency in the economy will grow or "snowball."s A rigorous
modeling of endogenous preferences helps clarify the mechanism through which
institutional biases affect what preferences people will choose to develop and what
preferences they will not choose to develop, and captures the subtle dynamic of
individually rational self-warping that I believe forms a crucial part of the core of the
evolutionary economics perspective.
• In theory, inefficiencies due to non-competitive market structures can be solved

by breaking up large firms, i.e. through anti-trust policy. But sometimes there are good
reasons not to do so. When there are significant technological economies of scale that
smaller firms cannot take advantage of, the loss of technological efficiency may be
greater than the gain in allocative efficiency from breaking up large firms to increase
market competition. 9 But in many cases large firms are not broken up even when
there are no legitimate economic reasons for failing to do so. They are not broken up
simply because large firms are politically powerful and successfully pressure the
political system to permit them to continue their profitable but socially inefficient
practices. Unfortunately, anti-trust policy is in serious decline in the United States as
opponents argue ever more successfully that failure of other national governments to
embrace anti-trust policy limits the ability of the U.S. government to subject our large
corporations to vigorous anti-trust prosecution without crippling the ability of U.S.
corporations to compete against foreign behemoths. An alternative to anti-trust action
is to regulate the behavior of large firms in non-competitive industries. This practice is
also, regrettably in decline, as regulatory agencies are increasingly "captured" by the
companies they are supposed to regulate and turned into vehicles for promoting
industry objectives (Munkirs 1985).
• There are well known policies to ameliorate inefficiencies due to market

disequilibria. Both fiscal and monetary policies can be used to stabilize business cycles.
Indicative planning and industrial policies can be used to eliminate disequilibria
between sectors of an economy. Regulation of foreign exchange and financial markets
particularly prone to bubbles and crashes are almost always an improvement over ex
post damage control consisting mostly of bailouts for powerful economic interests
most responsible for creating problems in these markets in the first place.
1152 Robin Hahnel
Unfortunately, these policies have all fallen into disfavor over the past two decades
not only among conservatives but among "new Democrats" in the United States and
among "new wave" social democrats in Europe as well. Both national economies and
the global economy have experienced huge losses in economic efficiency as a result
(Hahnel1999).
Why Markets Undermine the Ties that Bind Us
In effect, markets say to us: You humans cannot consciously coordinate your
interrelated economic activities efficiently, so don't even try. You cannot come to
equitable agreements among yourselves, so don't even try. Just thank your lucky stars
that even such a hopelessly socially challenged species such as yourselves can still
benefit from a division of labor, thanks to the miracle of the market system. In effect,
markets are a decision to "punt" in the game of human economic relations - a no-
confidence vote on the social capabilities of the human species. If that daily message
were not sufficient discouragement, markets harness our creative capaCities and
energies by arranging for other people to threaten our livelihoods. Markets bribe us
with the lure of luxury beyond what others can have and beyond what we know we
deserve. Markets reward those who are the most efficient at taking advantage of his or
her fellow man or woman, and penalize those who insist, illogically, on pursuing the
golden rule - do unto others, as you would have them do unto you. Of course, we are
told we can personally benefit in a market system by being of service to others. But we
also know we can often benefit more easily by taking advantage of others. Mutual
concern, empathy, and solidarity are the appendices of human capacities and
emotions in market economies - and like the appendix, they continue to atrophy.
But there is no need to take the word of a market abolitionist such as myself
on this matter. Samuel Bowles, who strongly supports a "socialized" market system,
provides eloquent testimony regarding this failure of markets.
Markets not only allocate resources and distribute income, they also
shape our culture, foster or thwart desirable forms of human
development, and support a well defined structure of power.
Markets are as much political and cultural institutions as they are
economic. For this reason, the standard efficiency analysis is
insufficient to tell us when and where markets should allocate goods
and services and where other institutions should be used. Even if
market allocations did yield Pareto-optimal results, and even if the
resulting income distribution was thought to be fair (two very big
"ifs"), the market would still fail if it supported an undemocratic
structure of power or if it rewarded greed, opportunism, political
passivity, and indifference toward others. The central idea here is
that our evaluation of markets - and with it the concept of market
failure - must be expanded to include the effects of markets on both
the structure of power and the process of human development....
As anthropologists have long stressed, how we regulate our

exchanges and coordinate our disparate economic actlvltles
influences what kind of people we become. Markets may be
considered to be social settings that foster specific types of personal
development and penalize others. The beauty of the market, some
would say, is precisely this: It works well even if people are
indifferent toward one another. And it does not require complex
communication or even trust among its participants. But that is also
the problem. The economy - its markets, workplaces and other sites
- is a gigantic school. Its rewards encourage the development of
particular skills and attitudes while other potentials lay fallow or

atrophy. We learn to function in these environments, and in so
doing become someone we might not have become in a different
setting. By economizing on valuable traits - feelings of solidarity with
others, the ability to empathize, the capacity for complex
communication and collective decision making, for example -
markets are said to cope with the scarcity of these worthy traits. But
in the long run markets contribute to their erosion and even
disappearance. What looks like a hardheaded adaptation to the
infirmity of human nature may in fact be part of the problem.
(Bowles 1991, 11-13)
Why Markets Subvert Democracy
Confusing the cause of free markets with the cause of democracy is astounding given
the overwhelming evidence that the latest free market jubilee has disenfranchised ever
larger segments of the world body politic. The cause of economic democracy is not
being served when thirty year-old MBA (Master of Business Administration)
employees of multinational financial companies trading foreign currencies, bonds,
and stocks in their New York and London offices affect the economic livelihoods of
billions of ordinary people who toil in third world economies more than their own
elected political leaders.
First, markets undermine rather than promote the kinds of human traits
critical to the democratic process. As Bowles explains:
If democratic governance is a value, it seems reasonable to favor

institutions that foster the development of people likely to support
democratic institutions and able to function effectively in a
democratic environment. Among the traits most students of the
subject consider essential are the ability to process and communicate
complex information, to make collective decisions, and the capacity
to feel empathy and solidarity with others. As we have seen, markets
may provide a hostile environment for the cultivation of these traits.
Feelings of solidarity are more likely to flourish where economic
1154 Robin Hahne!
relationships are ongoing and personal, rather than fleeting and

anonymous; and where a concern for the needs of others is an
integral part of the institutions governing economic life. The
complex decision-making and information processing skills required
of the modern democratic citizen are not likely to be fostered in
markets. (Bowles 1991, 16)
Second, the more wealthy, generally benefit more than the less wealthy from
free market exchanges even when markets are competitive. Economic liberalization
breeds concentration of economic wealth, and in political systems where money

confers advantages it leads indirectly to the concentration of political power as well. 10
Those who deceive themselves (and others) that markets nurture democracy ignore
the simple truth that markets tend to aggravate disparities in wealth and economic
power, and focus instead on less important effects. It is true that the spread of
markets can undermine the power of traditional elites, but this does not imply that
markets will cause power to be more equally dispersed and democracy enhanced. If
old obstacles to economic democracy are being replaced by new, more powerful
obstacles in the persons of CEOs (Chief Executive Officers) of multinational
corporations and multinational banks, the new global mandarins at the World Bank
and IMF, and the chairs of adjudication commissions for NAFTA (North American
Free Trade Act) and the WTO, and if these new elites are more effectively insulated
from popular pressure than their predecessors, it is not the cause of democracy that is
served. 11
Support for the theory that markets promote democracy stems from. the
dominant interpretation of modern European history in which the simultaneous
spread of markets and political democracy is assumed to be because the former caused
the latter. It is hardly surprising that perhaps the most intrusive social institution in
human history would have disrupted old, pre-capitalist obstacles to democratic rule.
The question, however, is not whether markets undermined old structures of
domination - which they clearly did - but, if the new patterns of economic power
that markets create are supportive or detrimental to democratic aspirations. I am
skeptical that markets deserve nearly as much credit as mainstream interpretations
award them for the emergence of European political democracy. I suspect this
interpretation robs Europeans who fought against the rule of monarchy and feudal
lord in the seventeenth, eighteenth, and nineteenth centuries, Europeans who fought
for universal popular suffrage in the nineteenth and twentieth centuries, and all who
fought against fascism in the twentieth century of much of the credit they deserve. But
a worthy rebuttal to the thesis that we owe whatever advances democracy has made to
the rise of the market system would take me too far a field and require more historical
knowledge than I pretend to have.
Commercial Values vs. Equitable Cooperation
Disgust with the commercialization of human relationships is as old as commerce

itself. The spread of markets in eighteenth century England led Edmund Burke to
reflect: "The age of chivalry is gone. The age of sophists, economists, and calculators is
upon us; and the glory of Europe is extinguished forever" (quoted in Arrow 1997,
757). Thomas Carlyle (1847,235) warned: "Never on this Earth, was the relation of
man to man long carried on by cash-payment alone. If, at any time, a philosophy of
laissez-faire, competition, and supply-and-demand start up as the exponent of human
relations, expect that it will end soon." And of course running through all his
critiques of capitalism, Karl Marx complained that markets gradually turn everything
into a commodity and, in the process, corrode social values and undermine
community.
[With the spread of markets] there came a time when everything that
people had considered as inalienable became an object of exchange,
of traffic, and could be alienated. This is the time when the very
things which till then had been communicated, but never
exchanged, given, but never sold, acquired, but never bought -
virtue, love, conviction, knowledge, conscience, etc. - when
everything, in short passed into commerce. It is the time of general
corruption, of universal venality.... It has left remaining no other
nexus between man and man other than naked self-interest and
callous cash payment. (Marx 1955, Chapter 1, Section 1)
More recently, Robert Kuttner (1997) has bemoaned the fact that the labor market is
becoming even more market like: "Most of us recognize work as a central source of
our identity and livelihood, a valued (or resented) affiliation, and sometimes a calling.
But today, downsizing, out-sourcing, leveraged buyouts, relocations, and contingent
employment are reshaping the labor market into a product market where customers -
employers - can buy labor for only as long as they need it." And Margaret Jane Radin
(1996) has argued that treating every activity as a commodity is deeply offensive at
some level to all of us. Her book received sufficient attention to provoke no less than
Kenneth Arrow to respond with a book review in the Journal of Economic Literature
Oune 1997) to what he called the "oldest critique of economic thinking." As Arrow
presents them, both Radin's concern and her recommendation are remarkably mild.
Her target is related to but perhaps a little different from that of the
nineteenth century critics. They were primarily concerned with social
relations; the market was in theory and practice replacing all social
relations. Radin is somewhat more in the spirit of individualism. Her
concern is that actions which are essential to personal identity fall
under the sway of the market. . .. A basic part of her approach is
the notion of 'incomplete commodification,' recognition that some
1156 Robin Hahnel
form of purchase and sale is called for but with restrictions of one
kind or another. (Arrow 1997, 758)
Arrow's response to her concern and suggestion was blunt: "The market is not
something one need enter. A corner equilibrium is a perfectly reasonable outcome
even under conditions of full commensurability and fungibility" (Arrow 1997, 761).
However, it is not true that individuals are free to take markets or leave
them. If access to the fruits of economic cooperation are available only through
participation in markets, then while true that anyone can choose to be an outcast, one
does so at great personal cost. How many of us living in a market economy are going
to refuse to buy and sell? What the older, and in my view more important critique of
markets amounts to, is an objection to the organization of economic cooperation in a
way that is not only personally distasteful and demeaning - robs us of our
"personhood" as Radin puts it - but unnecessarily sours human relations. It is a plea
to others to come to their senses and join the search for a different way to organize
economic cooperation. In terms Arrow surely understands, markets are a matter of
social, not individual choice, and like all social institutions, markets provide
incentives that promote some kinds of behavior a~d discourage others. In essence,
what any economic institution does is reduce the transaction costs of engaging in
certain kinds of economic behavior. But as we saw above, while markets reduce
transaction costs for individuals seeking to buy and sell from one another, markets
leave formidable transaction costs for external parties seeking to express their
collective interest. In other words, markets are biased in favor of individual
negotiations between two parties, and biased against collective negotiations among
multiple parties, leading to predi~table inefficiencies. Moreover, since the forms of
interaction that are encouraged are mean spirited and hostile, and the forms of
cooperation that are discouraged are respectful and empathetic, the detrimental
effects on human relations are far from trivial.
Conclusion
The degree of allocative inefficiency due to external effects is significant. Hope for
reasonably accurate Pigovian correctives is probably a pipe dream. Market prices
diverge ever more widely from true social opportunity costs as individual consumers,
whose preferences are endogenous to some extent, rationally adjust their desires to
accommodate significant institutional biases in the market system. Efficiency losses
also mount as real markets become less competitive, with no sign of meaningful anti-
trust or regulatory correctives in sight. And, as financial regulation, stabilization
policies, and industrial policies all fall out of vogue, efficiency losses due to market
disequilibria escalate even further. In sum, at the dawn of the new millennium the
invisible foot is gaining strength on the invisible hand every day. Meanwhile, market
exchanges continue to empower those who are better off relative to those who are
worse off - undermining economic and political democracy - and the anti-social
biases and incentives inherent in the market system continue to tear away at the
tenuous bonds that bind us to one another.
Notes
1. To sharpen debate I have often described myself as a "market abolitionist." By this I do not mean that
I call for the abolition of markets tomorrow. I am fully aware that markets are here to stay for the
foreseeable future. What I mean is that I do not believe markets have any role to play in a truly
desirable economy, i.e. that our long run goal should be to replace markets entirely with some kind of
democratic planning.
2. Political economists who developed the conflict theory of the firm had to overcome a similar
misconception about labor markets. Profit maximization requires employers to choose inefficient
technologies if they enhance employer bargaining power sufficiently even if labor markets are perfectly
competitive. In other words, making labor markets perfectly competitive does not eliminate socially
counter productive behavior regarding the selection or rejection of new technologies. See Hahnel and
Albert 1990, chapter 8.

3. Note that the magnitude of the effect on a single external party compared to the effect on the buyer
and seller is not the relevant issue. The effects on individual external parties are almost always small
compared to the effects on buyers and sellers. But it is the magnitude of the effects on ALL external
parties summed together, compared to the effect on the buyer and seller that determines whether or
not external effects lead to a significant misallocation of resources. In a 1998 report, the Center for
Technology Assessment estimated that when external effects are taken into account the true social
cost of a gallon of gasoline consumed in the United States might have been as high as $15. When the
report was published I was paying $1.50 a gallon in southern Maryland, which already included some
hefty taxes. Obviously they were not hefty enough! .
4. Similarly, when buyers are few it is in their interest to demand, collectively, less than is socially
optimal.
5. Axel Leijonhufvud (1967; 1968) was among the first to interpret the insights of Keynes in this
insightful way. He and others went on to develop a "Post-Walrasian" school of macroeconomic theory
emphasizing the importance of quantity as well as price adjustments and exploring the consequences
of "false trading" - which unfortunately, is not covered in most graduate level macroeconomic
curricula today.
6. I gladly offer those who call themselves free market environmentalists the following deal: I, for my
part, will concede that the government should not bother to get involved in cases where there is only
a single victim of pollution, if they, for their part, will drop their objections to government
intervention whenever there are multiple pollurion victims.
7. In competitive market interactions, efficiency does not hinge on buyers knowing anything at all abour
the costs of suppliers, or sellers knowing anything about the benefits to buyers - because buyers and
sellers are both price takers. However, there is no market in the situation Coase examines, and neither
party is a price taker. There are negotiations between a single pollurer and a single victim, and what
each thinks the other's marginal benefit or damage curve looks like has a significant impact on likely
outcomes. When the curve of the party with the property right is unknown to the other party, the
party with the property right can benefit greatly by misrepresenting their situation. Moreover, when
they do so the predictable outcome of the negotiations is far from the efficient level of pollution.
Coase's implicit assumption that both parties operate with "complete information" about the
situation of the other greatly exceeds the traditional assumption that those who participate in markets
have perfect self- knowledge regarding their own costs and benefits and the market price, and is far less
plausible (see Hahnel and Sheeran, forthcoming).
8. For a rigorous demonstration that endogenous preferences imply snowballing inefficiency when there
are market externalities see Hahnel and Albert 1990, theorem 6.6 and theorems 7.1 and 7.2.
9. Neither financial nor advertising economies of scale are valid reasons for failing to break up large
firms. Only true technological economies of scale provide efficiency reasons for allowing markets to
remain uncompetitive.
10. See chapter 3 in Hahnel2002; Appendix B in Hahnel1999; and Hahnel2006 for simple models that
demonstrate how and why those who are better off in the first place will usually be able to capture the
lion's share of efficiency gains that result from exchanges even when markets are competitive.
11. Prior to the arrival of Europeans in the Western hemisphere, some more powerful indigenous ttibes
and nations oppressed less powerful ones. While European colonization did remove old obstacles to
1158 Robin Hahne!
self-determination for some indigenous groups by weakening their native oppressors, I know of no
example where the sovereignty of any indigenous tribe or nation was ultimately advanced by the
European conquest. I think this analogy is apt when considering the supposed "liberating" effects of
marketization on oppressed sectors in traditional societies.
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The Case against Markets

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The Case Against Markets

Markets are an efficient way of producing and distributing a very large

Rather than efficiency machines, optimal incentive systems, cybernetic

©2007, Journal of Economic Issues

Why Markets Are Inefficient

It is well known among professional economists that markets allocate resources

Why Externalities Are Likely To Be Pervasive

compensation, their behavior introduces inefficiencies that lead to a misallocation of

drive participants to engage in.

Why Markets Become Less Competitive

Real markets do not always equilibrate quickly, much less instantaneously.

Practical Problems with Policy Correctives

The Achilles heel of welfare economics is its treatment of

increase "imbedded bias." Moreover, estimates derived from willingness to accept

• A central tenant of evolutionary economics is that people's preferences do not

• In theory, inefficiencies due to non-competitive market structures can be solved

• There are well known policies to ameliorate inefficiencies due to market

Why Markets Undermine the Ties that Bind Us

As anthropologists have long stressed, how we regulate our

particular skills and attitudes while other potentials lay fallow or

Why Markets Subvert Democracy

If democratic governance is a value, it seems reasonable to favor

relationships are ongoing and personal, rather than fleeting and

breeds concentration of economic wealth, and in political systems where money

Commercial Values vs. Equitable Cooperation

Disgust with the commercialization of human relationships is as old as commerce

Albert 1990, chapter 8.

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