by Gary North
For now we see through a glass, darkly; but then face to face: now I know in part; but then shall I know even as also I am known. ~ The Apostle Paul (1 Corinthians 13:12).
Beginning in the 1930's, academic economists who were critics of free market economics came up with a new theory. It was sometimes called the theory of monopolistic competition (E. H. Chamberlin). It was also called the theory of imperfect competition (Joan Robinson). Both theories were critical of capitalism because capitalism's actual performance did not match the critics' theory of equilibrium, which in turn relied on the concept of perfect foreknowledge, i.e., human omniscience.
The concept of equilibrium is a mental construct useful at best for teaching about the economic effects of ignorance. Ludwig von Mises used a variation of equilibrium: the evenly rotating economy (ERE). He substituted the imagery of an internal combustion engine for the imagery of liquid dynamics. Mises used the concept of the ERE to demonstrate that there must be a discount for time — time-preference, he called it — in a world without either profit or loss, i.e., a world of perfect foreknowledge. His analytical goal was to distinguish profit (the result of successful forecasting and planning) from interest (an innate aspect of human action). He was always careful to add that the ERE has no application in the real world of imperfect knowledge, i.e., the world of profit and loss, of entrepreneurial forecasting.
The "imperfect competition" economists were not equally forthright. They attributed any deviation from perfect competition, which implies perfect foreknowledge (which they never admitted in print), as a market failure.
One of the most important contributions of the Chicago School economists has been their insistence that knowledge is not a free good. I regard Thomas Sowell's book, Knowledge and Decisions (1981), paragraph for paragraph, as the most insightful economics book I have ever read. Yet all he does in that book is apply the principle that knowledge is not a free good to example after example, in every area of life. (Note: I do not regard Sowell as a Chicago economist, for he writes without graphs, equations, and jargon, and he also never begins his analysis with the phrase, "Let us assume the existence of an economy of two people.")
When an economist criticizes any human institution because it has failed to convey to mankind an incommunicable attribute of God, we can safely dismiss that economist. The trouble is, there remains a market for these economists in academia. I regard this fact as one more piece of evidence for the failure of tax-subsidized education.
ARE THESE EXAMPLES OF MARKET FAILURE?
I don't want to invoke examples of equation-filled criticisms of market failure. My eyes glaze over (MEGO). So do yours. So, let's consider a few real-world examples that I have personally encountered.
Consider the lowly themistor. You probably have never heard of a thermistor. It is a resistor that has a unique attribute. It is made out of a metal oxide that restricts the flow of electricity when it is cold, but then the flow heats it up over time.
Of what practical use is that? In a round chip that is the size of the interior of a light socket, it is of considerable use. First, you stick it into the socket (preferably when the switch is in the "off" position). Then you then screw in the bulb. ("How many Chicago School economists does it take to screw in a light bulb?" Answer: "None. Instead, they assume that two of them do this.") When you flick the switch, the flow of electricity through the thermistor is initially restricted. The bulb begins to glow yellow. Over the next 45 seconds, it reaches full brightness. ("How long does it take for a Chicago School economist to cease being a dim bulb?" Answer: "For as long as it takes him to abandon his equations.")
The bulb never gets hit with a surge of power. As we know from experience, bulbs always burn out (coefficient of point 999) when we flick on the switch. They don't burn out while we are reading. The power surge is what kills them. It is also what weakens their filaments. So, eliminate power surges, and light bulbs last up to four times longer.
The light goes on! You can sell a thermistor chip as a light-bulb extender. But not for long, as the manufacturer learned. For $24 for 12, you could buy a dozen of them in 1985. Once installed, they would cut your light bulb expenses by 75%. It you had a light bulb in a location difficult to get to — under the water level in a swimming pool, for example — a themistor was worth even more.
I used to buy them and recommend them to my subscribers. No more. The company had ceased manufacturing them by 1990. Here was a great product at a low price. Did capitalism fail?
No; an entrepreneur failed. He priced them too low. He planned his sales campaign as if information were free. He also assumed that everyone who heard about the product would buy it. His pricing did not build in enough profit margin for sellers to overcome consumer ignorance and then consumer resistance.
The fact is, consumers are like thermistors. They resist the flow of new information until they brighten up.
Who had an incentive to sell them? Not the local supermarket. Thermistors reduce the sale of light bulbs. There is more profit in selling light bulbs. But an individual could hardly make a living selling them. There were no repeat sales. A thermistor is like a tombstone: you only buy once.
Was this market failure? No. It is another example of the failure of information to be free, and the failure of people to be omniscient.
So, I still own a few dozen light socket thermistors. My wife and I take them with us when we sell a home and move. But you can't buy one. (If you can, please let me know.)
Here's another example: a motor oil filter that ends the necessity of ever changing your engine's oil. It also extends the life of any internal combustion engine by some unknown amount. I figure double, but it may be more. It extends it so long that the bodies of the cars on which I have installed the filter have always worn out before the engine needed an overhaul.
People think, "it's too good to be true." It isn't. They think, "Motor oil wears out." It doesn't, according to the American Petroleum Institute. It just gets dirty or acidic. But this filter removes everything larger than a tenth of a micron, so the oil stays clean. It also removes up to two ounces of water, so acid cannot form.
These filters can also be used on transmissions and fuel lines, but lack of marketing afflicts these applications even more than motor oil filtration.
Why don't car companies install the product? Because people would buy fewer cars. The units would also raise the price of the cars.
Why don't the oil companies promote it? Because people would buy less motor oil.
Then there is secondary sales resistance: the nature of the filter element itself. When the product's salesman tells the prospective buyer that the filter element is highly compact cellulose that stretches 187 feet, the listener may be impressed. He thinks, "Maybe this element really can filter out everything except microscopic particles." Then he learns that the element costs only 60 cents. "Hey, that's great!" Then he learns that his car's conventional filter will never clog up. "What a deal!"
Then the salesman shows the buyer the unique filter element. The sale usually ends right here.
It's a roll of toilet paper.
That's it. "Defensive shields up, Mr. Worf." The prospective buyer thinks, "What is this, a joke? He wants me to believe that I can double my car's engine life with toilet paper changed every six months, plus one quart of replacement oil that the toilet paper absorbs? What does he take me for, a fool?" But he says, "That's simply amazing. I'll get back to you. Let me have your card."
This unconventional use of a cheap, common household product creates enormous suspicion. "This just can't be true. It's too simple." So, the product — a toilet paper canister with clamps and hoses — has come in and out of production since 1955, and its rivals have completely disappeared. (Well, not quite: the main one, Motor Guard, is now used exclusively as a commercial air filter, but it is still not widely known.)
The last full-time manufacturer ran up a huge debt to put it back into production. Then he died a year ago. Some 5,000 units sit in a garage in Idaho. There is also a missing $20 part. There are only 200 of these parts in inventory. So, there are really only 200 units left to sell. Any income from future sales must be used to re-order more of the missing parts.
The man's heir is trying to sell them, but she is a part-time school bus driver. She is not a mechanic, as her father was, nor is she a salesman.
Is this a market failure? No. It's a failure of buyers to believe in the basic concept: the microscopic filtration capability of compressed toilet paper. The cost of re-educating the prospective buyer is higher than the profit margin on the product. But to raise the price high enough to overcome sales resistance increases costs more than the money saved on oil and car replacement. I call this Whipple's conundrum. I am not sure that even John Nash could solve it. Even if he did, most people would think, "John is not taking his medication again." The movie's sequel would have to be called, "A Dirty Mind."
Fabulous offers are usually too good to be true. This common-sense assumption saves people from wasting their money most of the time, but it also keeps them from getting a great deal once in a while.
I have written my personal testimony about this seemingly preposterous product, but this is merely anecdotal: the story of my car's engine that was within factory specifications after 130,000 miles on it, with only three oil changes over the final 103,000 miles. Anecdotes are not proof.
Who will tell the product's story? She can't afford to. I plan to use the story as a free bonus report in a marketing campaign to sign up new subscribers to my free e-mail newsletter. Maybe this will work for me; maybe not. But unless a lot of the new subscribers believe my testimony and buy a unit, once (it, too, is a tombstone product), the product line will disappear, just like Marxist textbooks in 1992. In effect, the product has already disappeared from public view.
THE DIRTY WINDOW FALLACY
Let me offer two more examples of alleged market failure. These are more fundamental examples. They are not related to information failures.
In East Texas, there are rural plots of land, sometimes 100 acres, that sit undeveloped. They will never be developed unless the law is changed.
When the Great War ended in 1865, the slaves were freed. In East Texas, which was on the far Western end of slavery's domain, freed slaves sometimes bought land cheap. These families were large. The patriarchs did not always write last wills and testaments. The families themselves divided up the land. They did not register with the local government as the new owners. Then they died. Pieces of land got smaller and smaller. Now, over a century later, it costs more to find out who owns what piece than each piece is worth. Title is clouded. Also, to sell the entire plot, there would have to be agreement among the heirs, which is rare. Somehow, the families pool enough money to pay property taxes, but that is the limit of their cooperation. If there were no property tax, there would be even less cooperation.
Occasionally, some family builds a shack or brings in an old mobile home, but there will be no subdivisions of these properties. There will be no shopping malls. If the rights of those families are to be honored, the land will remain low-use property. Is this a market failure?
In terms of maximizing the consumers' use of a few properties, yes. In terms of protecting property rights for those same consumers as owners, no.
If we look only at the visible cost — the forfeited use of a few East Texas properties — we might conclude that capitalism has failed. We must look at the larger picture. We must not make "the fallacy of the thing not seen," as Frederic Bastiat identified it in the 1840's. He used the example of a broken window. We see all the employment from repairing the broken window. We do not see all the other things that the money would have bought, including capital goods.
What I call the fallacy of the dirty window rests on the assumption that the State has an obligation either to clean a dirty window by force or break it and install a new one. It is wiser to let a few windows stay dirty.
I regard these undeveloped plots of land as testimonies to the existence of free markets and property rights. They are like barriers on the State — ugly aesthetically, but lovely judicially. We must not make the dirty window fallacy. It's better than smashing it in the name of consumer satisfaction at the expense of the principle of property rights.
THE MINERAL RIGHTS PROBLEM
I used to own 60 acres in East Texas. There was some thought that there might be oil under the land. This is every rural East Texan's dream: to be as rich as a West Texan who has hit oil. Nobody reads Giant these days, but East Texans know the story.
Each time a piece of rural land gets sold, the seller retains half of the mineral rights. By the time I bought the property, I had 1/256th. I decided to be a nice guy when I sold it. I did not retain 1/512th. I let the buyers keep my share. I was moving to Arkansas. I lost my dream of enormous oil wealth. Instead, I now live on a property with a natural gas well on it: a bird in hand. I don't pay to heat my home or cook my food. It would even be suitable for heating a greenhouse in winter for growing hot-house winter vegetables — or, better yet, bananas! (I would then call the farm "Becker Acres.")
Each sale reduces the residual value of the mineral rights by half. By now, it would not pay any land owner to drill for oil. Oil drilling would ruin the aesthetic value of the property, and the pay-off for the owner would be minimal. If not now, then three or four sales from now.
This is an example of what appears to be a true market failure. I may be missing something important in my analysis, but I don't think so. It is conceivable that the legal right of sellers to retain a portion of the mineral rights after the sale could, over time, destroy the ability of society to extract the minerals. The marginal value to the owner of the income stream generated by a tiny fraction of the mineral wealth would prohibit development. It would not be easy to get permission from all of the heirs. This is a variation of the East Texas slave family problem: a wide dispersal of ownership and high costs of gaining joint action.
If this aspect of the free market really could stifle the production of mineral wealth, this would grant an economic monopoly of mineral extraction to societies ruled by civil governments that assert ownership over minerals, as the oil-producing governments both assert and enforce.
This area of property rights should receive attention from free market economists and legal theorists. It is never good in the long run for any ideological group to pretend that conceptual problems do not exist. Reality resists superficial solutions. So do rival groups.
The mark of a serious worldview is the willingness of its defenders to defend. A plan of conquest requires both offense and defense. Libertarianism rests on logic and voluntarism to extend its intellectual and institutional territory. When libertarians encounter a problem with the results of voluntarism, they should seek solutions that do not involve an appeal to State coercion. This is why there is always plenty of work remaining for each generation. The failure of Marxists to maintain an intellectual defense of system after the Soviet Union fell testifies to the high risk of relying on State coercion as the foundation of one's analytic system. Libertarians should learn from the failure of the Marxists.
Most academic examples of market failure are examples of human imperfection, not market imperfection. There may be a few exceptions, and free market defenders should take them seriously and deal with them seriously. But they should not spend much time countering those criticisms of the free market that blame the free market for not transforming mankind into God.
April 30, 2002
© 2002 LewRockwell.com