Fairy Tales and Perfect Markets
Most modern fairy tales have very misleading endings. There’s a phrase they almost all end with – you can probably already guess what I’m thinking: “And they all lived happily ever after!”
What’s misleading about this? It implies that in life, there’s some kind of end state you can reach called “happily ever after” where the classic pursuit of happiness is, well, completed. Play your cards right, and you will reach the state of “happily ever after” where your continued life satisfaction is locked in. Of course, in the real world, things don’t work that way. The pursuit of happiness is what the philosopher Kieran Setiya calls an atelic activity in his conversation with Russ Roberts on EconTalk. Telic activities are completable and are time-bounded – planning a vacation with friends, for example. An atelic activity is one that is open ended, not time-bounded, and has no defined completion point – friendship would be an example of that. Friendships may end for various reasons, but there really isn’t a sensible point where you can say, “We have fully completed the activity of friendship!” Friendships are ever-ongoing processes. So, too, is happiness.
If happiness were a telic activity, one that was completable once a particular end point was reached, we would cease to actually do much of anything. Ludwig von Mises was right when he argued that all human activity is ultimately driven by some sort of deficiency or dissatisfaction. We act because we anticipate it will create a new set of circumstances we prefer more, to replace our current circumstances we prefer less. A life where total satisfaction was fully and permanently achieved would be a life where nothing actually happens anymore. As fairy tale endings go, that one is pretty grim. (Yes, I did intend that pun, and I am appropriately pleased with myself for it.)
If Mises’s work undercuts the idea of “happily ever after,” there are a couple of other Austrian economists who undercut two other fairy tales in mainstream economics. I’m thinking about F. A. Hayek on “perfect competition,” and Israel Kirzner on “market equilibrium.”
Hayek pointed out that in mainstream models of perfect competition, there is no actual competition occurring. For example, when thinking about how businesses compete with each other, one of the first things that comes to mind is price competition – I try to gain an edge on my competitors by offering lower prices than they do. But in the perfectly competitive model, every business is a “price taker” – that is, they have no options about the price they set, and everyone sets the same price as everyone else. Prices are of course just one way firms can compete with each other, but the larger point is that competition is an active and ongoing process, and that in perfectly competitive models, no such process takes place.
Kirzner makes a parallel point about market equilibrium and market process in his book Competition and Entrepreneurship. Kirzner sets out to describe a theory of market process that stands in contrast to the mainstream idea of market equilibrium. Central to his theory of market process is the entrepreneur and their alertness to opportunities. Entrepreneurs acting on opportunities helps supply the information and competitive pressure that drives economic process forward. But this kind of activity doesn’t exist in equilibrium analysis. As Kirzner notes:
In markets with perfect competition, no competition actually takes place, and in markets that have reached general equilibrium, there is no market process being carried out. Nothing really happens anymore in such a world – everything is stable and static.
Of course, in the real world, markets are never perfectly competitive, nor are they ever in a state of equilibrium. But just as it is a mistake to view life satisfaction through a lens of achieving a state of “happily ever after,” it is also a mistake to judge the economic system by how closely it resembles perfectly competitive markets in a state of general equilibrium. According to much mainstream economic theory, markets falling short of perfect competition, or existing out of an equilibrium state, is a sign that there is a problem with the market itself, perhaps necessitating a solution to be imposed by the state. But wiser minds realize that markets not being perfectly competitive or in a state of perfect equilibrium isn’t a problem to be solved – it’s the whole point of having markets to begin with.