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Some Qualifications
The discussion of market
efficiency rests on many assumptions. Three deserve
special notice.
The first is that people are rational, that they know
what is best for themselves and act accordingly. If people
do not know what is best for themselves or do not act in a
rational way to achieve their goals, the whole normative
basis for economic efficiency is undercut.
Second, the discussion in the previous selections took
place in a static framework in which wants,
resources, and technology were held constant. But the most
distinctive aspect of a market economy is its dynamic
nature. Market economies are constantly changing their
environments. In contrast, other economic systems--such as
tribal-subsistence, feudal, or centrally planned socialist
societies--resist change. Outside forces cause change, not
the internal workings of the economic system. Karl Marx may
have been the first to recognize the dynamic characteristic
of capitalism when he wrote the following in the
Communist Manifesto:
"The bourgeoisie has played a most revolutionary
role in history. The bourgeoisie, whenever it has got the
upper hand, has put to an end all feudal, patriarchal,
idyllic relations...The bourgeoisie cannot exist without
constantly revolutionizing the instruments of production,
and with them the whole relations of society...Constant
revolutionizing of production, uninterrupted disturbances
of all social conditions, everlasting uncertainty and
agitation distinguish the bourgeois epoch from all
earlier ones."
The danger of trying to use conditions of efficiency that
were developed in static models for policy guidance in a
dynamic world concerned Joseph Schumpeter when he wrote the
following:
"A system--any system, economic or other--that
at every point of time fully utilizes its possibilities
to the best advantage may yet in the long run be inferior
to a system that does so at no given point of time,
because the latter's failure to do so may be a condition
for the level or speed of long-run
performance."1
Third, consider Jane and Janet, who are very envious of
each other. Whatever makes one better off makes the other
unhappy. With a system of preferences such as this, the
notion of economic efficiency may lose meaning because there
may be no possible moves that are mutually advantageous.
Economists have generally dealt with this problem by
assuming that preferences of this sort are not legitimate
and should be ignored.
Unfortunately, people do have preferences of this kind.
Most social sciences other than economics consider the quest
for status a powerful motivator. Status, however, is not
like normal goods because it is fixed in amount. If one
person gains status, someone else must lose it. Everyone
cannot be at the top of the social pecking order--someone
must be at the bottom. Efforts to gain status may help the
individual, but must come at someone else's expense. Pursuit
of status leads to a prisoners' dilemma situation.
David Hemenway, in his Prices
and Choices
(Ballinger, 1977) tells a fable of a world in which status
is acquired by being taller than average (not unlike the
world we know) and in which people determine the height of
their children shortly after conception. As people strive to
improve the status of their children, they ask for taller
and taller children. As a result, the average height of
adults shoots up past ten feet. Eventually, the average
height is so high that people need braces just to stand up.
Clearly, the end result is less desirable than the original.
Yet this result comes about through a series of moves that
individuals take to improve their own well-being. Though
Hemenway's story is fiction, there are cases in which quest
for status has resulted in physical mutilation. An important
example was feet binding in China, which crippled women for
centuries.
Though the concept of economic efficiency can survive the
introduction of status, pursuit of status complicates its
use. It adds a large class of situations in which mutually
advantageous exchanges may be socially harmful. Economists
have not studied these situations in depth, but have found
it easier to ignore the pursuit of status and other
interlinked preferences.2
1 Capitalism,
Socialism, and
Democracy,
1946, p 83.
2 An exception is Robert
Frank's Choosing
the Right Pond.
(New York: Oxford University Press, 1985.)
Copyright
Robert Schenk
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