Markets in mainstream economic theory Mainstream neoclassical economic theory suggests that markets exist in which

Markets in mainstream economic theory Mainstream neoclassical economic theory suggests that markets exist in which

prices arise from the interaction of supply and demand, and that prices thus generated lead to the efficient allocation of resources in the economy as a whole and hence to maximum welfare. However, this happens under a very restrictive set of conditions which are rarely found in reality. For example, markets have to be perfectly competitive, which suggests that no individual agent is able to exert any form of market power over another agent; also, all agents must have complete and perfect information about the goods or services that are being traded. Under these conditions, neoclassical theory can demonstrate that the economy will arrive at an equilibrium set of prices that allows for the efficient allocation of resources, or what is otherwise called ‘Pareto efficiency’. This is a situation where, given the initial allocation of resources, no one can be made any better off through trading without making another worse off.

This theory has been extremely powerful because it suggests that markets

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INSTITUTIONS, MARKETS AND ECONOMIC DEVELOPMENT

are the most efficient way of allocating resources, and it was this theory that underscored the view that ‘getting prices right’ would enable economic development to take place. The assumptions under which the theory arrives at these conclusions never actually exist in the economy. This observation is at the heart of North’s comment quoted above. The idea that markets can bring about a Pareto-efficient solution is therefore very detached from identifying the way markets actually operate in practice. Policies which proposed that markets should be the key mechanism for resource allocation have thus not been based on a real understanding of how markets work but rather on the somewhat naïve belief that the right types of markets could and would emerge if allowed to do so. So why has such a huge gap between reality and the dominant neoclassical economic model been able to survive, persist and even thrive, despite its unrealistic assumptions about the market?

In his book The Great Transformation, Karl Polanyi (1944) offers an explanation and critique of the way the idea of the spontaneously emerging ‘self-regulating’ market came about. He argues that it arose in the 18th century from thinkers of the time – Malthus and Ricardo among them – who related the economy to nature: ‘essentially, economic society was founded on the grim realities of Nature; if man disobeyed the laws that ruled that society, the fell executioner would strangle the offspring of the improvident’ (Polanyi, 2001, p131). Thus, it was necessary to follow the ‘inexorable laws of Nature’ and, as a result, ‘the unshackling of the market [came] to be an ineluctable necessity’ (Polanyi, 2001, p132). This, he argued, was the reason for the reform of the ‘poor laws’ that existed in England at the time and which provided safety-nets for poor people through a system of parish-based welfare. These laws were regarded as inefficient because they stopped people from moving in response to demand for labour in the economy since, if they moved, they would lose their entitlement to support. Polanyi’s argument went further to say that the thinkers of the 18th century took the normative view that ‘natural laws’ were unavoidable and therefore assumed that these laws should form the basis for organizing the economy. Because of this, they set about creating policies which they thought would enable these natural laws to work. But the fact that they had to create ‘self-regulating markets’ suggests that there is nothing ‘natural’ about markets in the first place.

Polanyi’s analysis went on to show that this attempt to construct ‘self- regulating’ markets did not happen without a reaction from society at large. He argued that people resisted these changes in all sorts of ways in order to preserve their preferred ways of doing things, i.e. their rules and norms. He noted that this resistance was varied and specific and not the result solely of specific organizations, such as unions or class-based organizations. Rather, this reaction was what he called a ‘double movement’ in the face of the attempt by policy-makers to transform society through the creation of an economy based on the ‘self-regulating market’. Thus, Polanyi recognized that the idea of a self- regulating market was the product of a school of thought in economics rather than an analysis of the actual ways in which the economy, and markets,

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operated. In practice, he could see that there were a myriad of ways in which social practices affected the way markets actually worked. This he described as the ‘embeddedness’ of the economy in society itself.