The Truth About Markets: Why Some Nations are Rich But Most Remain Poor

"John Kay has written many books but this one feels, to me, like his masterpiece. John is a very, very interesting thinker and an old mentor of mine. I used to work as a research assistant for him in the 1990s. He’s fascinating because he is a brilliant thinker. He has a really sharp grasp of all the classic economic ideas—everything from the economics of trade to the economics of price discrimination, and how markets work. He’s got all of that and he probably had all of that at the age of 19. Then he spent the rest of his life—so far—thinking about the extensions and the complications, and all the messy details. So one of the joys of David Friedman’s book is the way that he strips away all the complications to show you something really powerful about the basic way of reasoning about the economy. John Kay is the antithesis of that. He understands everything in Friedman’s book, but he’s saying, ‘Well, there’s this other consideration. There is this historical consideration. There is this psychological consideration. There is this political consideration or moral consideration.’ All of this stuff needs to be taken into account. Markets are not just a system of equilibrating equations. They have a historical context. They have a political context. They’re a lot messier than they might seem in a textbook. Yes, and whether it’s illuminating or not depends on whether you’re using it in the right context and in the right spirit. The basic idea of a model is to simplify, to strip away detail. That’s really, really powerful. But if you use it in the wrong way, you are going to lead yourself very badly astray. “Markets are not just a system of equilibrating equations. They have a historical context. They have a political context. They’re a lot messier than they might seem” There is this classic idea, in the social sciences, of foxes versus hedgehogs. A fox is going to see everything in all kinds of different ways, a little bit of everything, whereas a hedgehog has one big idea and sees the world through that lens. When the model does not actually apply, you can go incredibly badly astray with that sort of logic. John is a classic fox. That markets are a part of society. They are not this thing that exists in the abstract that either work or don’t work and that’s all there is to it. There is always history. There is always culture. There is always politics, and if you try to diagnose what’s wrong with the market or try to make a market work better and you’re ignoring the history and the politics, and the culture, you’re going to make very bad decisions. The very first column I researched for John would have been, probably, around the time of 1999’s Wimbledon. I said, ‘Oh, Wimbledon’s coming, John. We could write a column about ticket touts and how ticket touts are good for markets.’ He said, ‘Okay. Why don’t you set out your thinking?” This is classic. I’m in my mid-20s and full of the joys of economics. The Economist magazine used to write this sort of column every year, all about how the ticket tout is basically taking a ticket away from someone who doesn’t value it very much—because they pay them enough to persuade them to part with the ticket—and they then turn around and sell the ticket to someone who’s willing to pay more. It’s efficiency-enhancing and everyone’s better off. I sketched all this out for him. He then went and wrote a column about ticket touts, explaining how it all began with Thomas Aquinas and his concept of the just price. Prices are not just market clearing, they embody moral and cultural norms and if you don’t understand that, you don’t really understand anything about markets. I always remembered that. I’m not sure I agreed with him, but I was just astonished that an economist would write this piece that was so equivocal about ticket touts and, also, was talking about Thomas Aquinas. No, no, not at all. He’s a brilliant economist. I think so, yes. He’s an amazing thinker. There is so much stuff out there that is anti-economics, all about how economists get this wrong and don’t understand that, and blah blah blah. Some of it is true or makes good points, but a lot of it is based on no understanding whatsoever of how economists actually think. John really does know, so when he criticises economists he really understands what he is criticizing. If you want somebody to give economics a kicking, it’s got to be somebody who understands how economists think. “The basic idea of a model is to simplify, to strip away detail. That’s really powerful. But if you use it in the wrong way, you are going to lead yourself very badly astray” The great thing about reading John is that he’ll be explaining how an economic idea works with tremendous clarity on one page and the next page he’ll be explaining how economists have made a terrible mistake. And it’s all there together, so he’s well worth the read. I’ve only skimmed it and haven’t studied their resources in great detail, but I’m very much in sympathy with what they’re doing, which is, first of all, to start with the concerns of students who show up interested in economics. What are students interested in economics actually interested in? Apparently, one of the main things they’re interested in is inequality . Well, inequality was not studied much in economics courses—certainly 25 years ago. It was studied, but in a quite theoretical way. So that’s front and centre in this course. It talks about the Industrial Revolution. It talks about the last 200 years of economic history . You’ve got the process of economic growth, you’ve got the process of growing inequality, you’ve got technological aspects of how the economy works, and you’ve got history—all in that opening salvo. They’ve been criticised by some people for not being heterodox enough. Fundamentally, it is all classic economics. They’re not bringing in Marxist or new institutional or feminist perspectives on economics. It is a straightforward economics textbook, just told in a much more human way—which actually is what we’ve been trying to do throughout this interview."

"Yes. I think it’s a very profound book of permanent truths about markets. It’s not just about the dotcom bubble in 2000, which prompted Kay to write it. Reading it 10 years later, it seems incredibly prescient about the bursting of the Lehman bubble, which of course hadn’t even formed when Kay wrote this. The book shows why markets inevitably cause repeated financial crises, and why a pure market system can never avoid disruptive booms and busts. But more profoundly, it’s about whether a market system can become an all-embracing mechanism for all social interactions, largely replacing politics and government, or whether markets can only operate when they are embedded into very specific political structures, which require quite powerful governments. The example that he gives – which is the clincher for the whole book – is that the purest profit-oriented market systems that exist anywhere are in countries like Haiti or Somalia after a complete breakdown of government. Such failed states are pure market systems, in the sense that decisions are driven solely by the economic motivation to acquire wealth. Kay shows, with a brilliant command both of theory and of historical examples, that without a political structure around them, market systems have not just been unsuccessful but catastrophic. Kay is very good on a broad, philosophical level, and even better at illustrating these abstractions with very concrete – and often amusing – examples. For instance, he compares two farm workers, in Switzerland and in India. They both work just as hard, they both have the same access to knowledge through the Internet, and they even use much the same tools. Yet one farmer’s productivity is about 100 times greater than the other. That’s because of the different social structures – politics, education, environment, transport and so on – in which they operate. One of his strongest arguments is that desirable objectives are often achieved not by aiming for them directly but through indirect means. He quotes the ultimate utilitarian, John Stuart Mill, who concluded at the end of his life that the way for humans to achieve happiness is not simply to aim to maximise happiness – as that is hedonism and is not going to make you happy – but by trying to live a more socially useful life. Kay relates this to the shareholder capitalist system, saying that companies which focus on solely maximising profits or earnings per share rarely actually achieve it. The purpose of the market system, he points out, is not to maximise profits but to produce goods and services that satisfy human needs and wants. Profits are a tool for achieving those objectives, a by-product of fulfilling human needs. If you view profits as the main objective, you will ultimately fail to create products and services that satisfy people, and so, because of the very logic of the market system, you will eventually lose your profits. Kay explains particularly clearly two crucial areas where simplistic faith in markets tends to produce perverse results. One is financial markets – they trade predictions about the future but the future is intrinsically uncertain. It is impossible, even in theory, to rely on supposedly “rational” financial trading to produce socially desirable results, because there is no reliable knowledge about the future for market traders to be rational about. The other area of unavoidable market failure, which also relates to the future, is in very long-term investment. Markets on their own are unlikely to make appropriate decisions on very long-term investments, for instance in energy infrastructure or drug development, because the pay-off for these investments is so long term and uncertain that no rational investor managing a portfolio for a pension fund could legitimately allocate vast amounts to bets on possible outcomes that are 40 or 50 years into the future. This is one of the key reasons why markets alone can never be the sole decision-making mechanism in a society that wants to achieve technological progress. Even though most of the economic decisions in a successful capitalist society should be made by markets, there will always be crucial exceptions, often involving uncertainty about the future."