IUPPSALA PAPERS IN ECONOMIC HISTORY

1997

RESEARCH REPORT NO 43

Scope and Limits of the Market

Bo Gustafsson

Reprinted from Teichova, A. - Mosser, A. - Patek, J. (eds.),Der Markt im Mitteleuropa der Zwischenktiegszeit. Prague:

Universita Karlova, Vydavatelstvi KAROLINUM, 1996.

Depattment of Economic Histoty

DER MARKT IM MIlTELEUROPA DER ZWISCHENKRIEGSZEITKARLS-UNIVERSITÄT - PRAG 1994 S. 19-52

SCOPE AND LIMITS OF THE MARKET

Bo G U S T A F S S O N

(Uppsala)

“It has been said and may be said that this is precisely thebeauty and the greatness of it: this spontaneous interconnection,this material and mental metabolism which is independent of theknowing and willing of individuals, and which presupposes theirreciprocal independence and indifferente. And, certsinly, thisobjective connection is preferable to the lack of any connection,or to a merely lotal connection resting on blood ties, oron prime-val, natural or master-servant relations.”

Karl Marx, Grundfisse (1857; 1973), p. 161

“In principle the study of business relations is the study of themachinery by which men are liberated, over a large area of theirlife, from the limitations which a failure of correspondence bet-ween their faculties and their purposes would otherwise imposeon them. The things they have and can, are not the things theywant and would; but by the machinery of exchange they can betransmuted into them. The economic relation, then, liberatesthem from the limitations imposed by the nature of their owndirect resources. And this liberation comes about by the very attthat brings a corresponding liberation to those with whom theydeal. ‘It is twice bless’d. It blesseth him that gives, and him thattakes.’

Surely the study of such a relation needs no apology, and thereseems to be no room to bring against it the charge of being intrin-sically sordid and degrading. The conditions under which busi-ness is actually conducted (like other conditions under which welive) may be far from ideal, but the business or economic relationas such, does not seem to be open to the faintest suspicion ofa taint, even when regarded from the loftiest aesthetic or ethicalposition.”Philip H. Wicksteed, The Gommon Sense of Politicd Economy 1,

(1933), p. 173

Introduction

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ver sinte Aristotle made his observations on the tontrast bet-ween oikonomike and chrematistike in his Ethics, the propertiesand legitimacy of the market have been hotly contested. TheSchoolmen, following Aristotle and the teaching of The BibZe,

fought a rearguard action against the advancing market ideology inthe late Middle Ages. Weber, Tawney and others have shown how

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important the issue was in earlymodern times. Before Adam Smith, andsome of kis predecessors, entered the scene it was predominantly themoral problem of the legitimacy of the market that was at issue. Byattempting to show that the market, based on self-interest and competi-tion, was not orrly a rational but also a beneficial mechanism promotinghuman welfare, Smith killed two birds with one stone. But he also openedup a main theme in modern social discourse that is still with us. In Britishand French social thought the central teaching of Smith has on the wholeprevailed and become more and more elaborated. The modern theory ofgeneral competitiv,0 equilibrium as suggested by Kenneth Arrow andGerard Debreu may be regarded as the crowning achievement of thistradition even if representatives of Austrian economics from Mengeron would claim a rival interpretation. The situation was, however, differ-ent in Central and Eastern Europe with traditions that were less liberaland more favourable towards regulation. In the wake of the German ZoZZ-verein, Friedrich List emphasized the crucial importante of the stateinpromoting economic growth; and to Karl Marx and his followers theinteraction of competing, autonomous and self-interested individuals inthe market was as likely to produce economic chaos as economic har-mony. In this tradition, shaped in a social environment distinguished bystrong and strongly interventionist govemments, there was also a generaldistrust of the cash-nexus and market mentality, on the one hand, anda strong belief in the possibilities of wholesale social engineering, on theother. This ideologital tontrast between market liberalism and statesocialist thinking is clearly seen in the great interwar debate on the possi-bilities of socialist planning (Hayek, 1935). With the benefit of hindsight itis easy to conclude that the advocates of the market mechanism storeda victory over the advocates of (coercive) economic planning; the first-mentioned representing realism and tommon sense, while their oppo-nents appear idealistic and utopian. However, in the high and palmy daysof seemingly successful Soviet economic planning most Observers hadregarded the 0utcom.e of the debate as inconclusive.

Sinte then the scene has changed dramatically. We are now living in anepoch characterized by the triumphant propagation of the market mecha-nism all over the world. The centrally planned economies of EasternEurope are gone and in Western Europe and the USA publit assets aresold off, industries are deregulated, and some publit economic activitiesare transferred to private firms and the market nexus (Donahue, 1989,chapter 1). But also, parallel to this, mass unemployment is back, and ine-qualities In income and wealth are once again growing. Even if this newtum towards the market has clearly been ushered in by politital changes(the downfall of the Communist regimes in Eastern Europe and thecoming of conservative governments, starting with the governments of

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Thatcher and Reagan in the 1970s in the West), we may still believe thatthese politital changes were conditioned by a growing disbelief in thesuperiority of administrative economic mechanisms.

Markets in history

If we take a very lorigg” viewwe may argue that the market mechanism hashistory on its side. It all started in ancient Greece, where the achievementsof Greek civilization were conditioned or, at least, paralleled by the firstprospering of commerce and markets in the Aegean. Likewise, Roman civi-lization showed at its best during the late Republic and the early Empirewhen the Mediterranean developed into alarge market area. The declineof Rome and the onset of the so-talled Dark Ages of early Europewitnessed, on the other hand, the shrinking and disappearance of mar-kets. When Europe started to expand from the eleventh century, markets,trade, merchants, handicrafts and towns proliferated on the basis of thedivision of labour between agriculture and industry. Similarly, from theearly sixteenth century modem Europe’s development was paralleled bythe new world market economy created in succession by Portuguese,Spanish, Dutch and British traders although, to be sure, trade was alsoeffectively assisted by guns and sails.

Moving forward in history, we may plausibly argue that the industrialrevolution of the late eighteenth century, with its great technological andorganizational innovations, like steam power and the factory system, wastriggered of by an impressive market growth channelling information fromexpanding markets and creating incentives for increasing production. Thefirst industrial revolution was followed by a setond one from the late nine-teenth century, when modern science was integrated with industry and themodern, big torporation emerged. Once again we may connect economicprogress with widening and more efficient markets conditioned by thebuilding of railways and the introduction of steam ships and the telegraph.Thereby, people and countries were brought closer to each other, andinformation about goods, prices and exchange rates were, for the first timein history, rapidly transmitted all over the world. Markets for labour andcapita1 supplied factors of production to industry on a scale unheard of.Admittedly, the first part of the twentieth century was distinguished byshrinking markets, state intervention, extensive regulation of economicactivity and, in Russia and Eastern Europe, even wholesale replacement ofthe market mechanism with a command economy. But by now the markethad regained and extended its earlier prominente.

On the basis of these sweeping observations, one may be inclined tothink that there are no serious problems involved with the market me-chanism sinte, if there were, history would not show us its triumphant

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expansion. Rather, history would have weeded it out and would havegiven rise to other viable mechanisms for resource allocation. But againstsuch a somewhat simplistic view, one may argue: firstly, that it is possibleto find successful alternatives to markets in history; setondly, that marketmechanisms have sometimes been successfully restricted and controlled;and thirdly, that we cannot be absolutely sure that the historital failures ofalternatives to markets have failed because of the inherent characteristicsof those mechanisms rather than their specific historital form and/orbecause of the conditions of their operation.

(1) Economic historians have always felt somewhat uneasy about thetextbook picture of markets found in mainstream economics. In the main,1 do not have in mind the obvious and admitted fatt that the perfectmarket of the textbooks is a construct of a possible, not an actual world(Arrow-Hahn, 1971, p_ vii). 1 refer to the empirital counterpart that thisconstruct implicates. This empirital counterpart presents us with a mar-ket economy made up of myriads of (small) firms operating in anonymousand highly competitive auction markets, with exogenously given pricesand technologies, instantly adjusting mixes ofinputs and outputs accord-ing to relative price changes and with a passive and minimal state in thebackground. In this image of a market economy there is no room fororganizations, sinte firms are only production functions.

This model may have had some empiri& relevante in mid-nineteenthcentury Britain, but it was always difficult to apply it to other periodsand other countries. IModern capitalism has been distinguished by theseemingly contradictory combination of, on the one hand, big and grow-ing business organizations with a considerable capability of influencingtheir environment (prices, preferences, technolo,ay, etc.) and thus able tochange rather than adapt to its constraints, on the other hand, over timeand with improved communications, of increasingly efficient tompetition.lMoreover, it is possible to maintain that this combination of big mono-polistic or oligopolistic business and strong tompetition may be moreefficient than the traditionally postulated combination of many (andtherefore small) firms and strong tompetition; the assumption being thatthe degree of tompetition is a function of the number of firms. In a neglec-ted passage in his book, Capitalism, Sociahm and Democracy, Schum-peter w-rote:

A system - any system, economic or other - that at every given point of time fully utilizesits possibilities to the best-advantage may yet in the lorigg” run be inferior to a system thatdoes so at no given point of time, because the latter’s failure to do so may be a condition forthe leve1 or speed of long-nmperformance (Schumpeter, 1943, p. 83).

Schumpeter did not elaborate on this proposition. Evidently he had inmind two systems, one of which continuously uses its resources optimallyand grows at a rate(r), and another system that does not use its resources

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optimally, but grows at a rate higher than (r). Setondly, that it is the veryfatt of sub-optimal use of resources of the latter system that enables it togrow at a higher rate. The first system may tonsist of a great number ofsmall firms interacting mainly through the market, buying inputs at lowprices and using them efficiently, while the other system may tonsist ofa great many firms that, however, have engaged in a process of verticalintegration. The firms of that system may not be able to buy inputs on themarket at a lower price. But, by integrating vertically, i.e. by transformingtheir environment, they may be able to produce the inputs at lower costbecause of scale economies, increased speed of ‘throughputs’ (flow ofmaterials), lowered transaction costs, etc., resulting in a higher profit rateand a higher rate of growth. Even if in this case the vertical integration offirms may make tompetition and static resource use more imperfect, thisloss is more than counterbalanced by the dynamit gains achieved byvertical integration.

This truly dynamit view of the interaction between firms and marketshas been elaborated (without reference to Schumpeter) by AlfredD. Chandler Jr. in his studies of the rise of the modern torporationreplacing the irrvisible hand of the market with the visible hand of the bigbusiness organization. He summarized his findings thus:

Modern business enterprise took the p!ace of market mechanism in coordinating the acti-vities of the economy and allocating its resources. In many sectors of the economy thevisible hand of the management replaced what Adam Smith referred to as the irrvisiblehand of market fortes. The market remained the generator of demand for goods andservices, but modem business enterprise took over the functions of coordinating flows ofgoods through existing processes of production and distribution, and of allocating fundsand personnel for future production and distribution. As modem business enterpriseacquired functions hitherto carried out by the market, it became the most powerfulinstitution in the American economy and its managers the most influential group ofeconomic decision makers (Chandler, 1977, p. 1).

While, according to Chandler, ‘the market remained the generator ofdemand for goods and services’, markets were replaced because of verticalintegration of independent firms, which before integration had beenrelated through the market nexus. One may add that the same pattern wasrepeated in other countries and even extended, as in the case of the Japa-nese zaibatsu which included also the finantial sector; in this case, more-over, it was aided by the state providing industry with a highly educatedlabour forte and ensuring torporations access to inexpensive financing,while also limiting the number of competing enterprises.

In his recent book, Business Organization and the Myth of fhe MarketEconomy, the US economic historian William Lazonick has made anattempt to generalize these and other findings. This he does by utilizing theMarshallian concepts of internal and external economies respectively.Internal economies are economies internal to the firm, like scale eco-

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nomies or economies due to superior organization, while external econo-mies are economies external to the firm, like lotal access to skilled labour,transportation facilities or a mass market. Before the rise of the modemtorporation in the setond half of the nineteenth century, Lazonick argues,firms were usually single-unit enterprises mainly relying on markets - thatis external economies - for their growth. The modern torporation intema-lized those economies by vertical and horizontal integration and therebycreating internal economies: scale economies, lowered transaction costsand more effective use and coordination of equipment, personnel, andflows of goods and cash (Lazonick, 1991, chapter 2).

The modem torporation, thus, can be viewed as a successful alternativeto the market mechanism. Incidentally, it was precisely by generalizingthis view of the superior efficiency of the conscious, planned and hierar-chical coordinating mechanism of the capitalist firm that led Marx tobelieve that all-round economic planning could do away with the market.However, some caveats are talled for. In the first place, Chandler empha-sizes that for the modern torporation also the market remains the gene-rator of demand for goods and services, which implies that the firm wouldnot be capable of creating demand by itself. Rather, the firm capturesmarkets as when it engages in forward vertical integration into retailing orwhen, thanks to scale economies, it induces buyers to shift their demandfrom higher priced options. Setondly, even if the creation of big businessconglomerates under unified management abolishes the market mecha-nism within the domain of the firm, the firm remains dependent upon themarkets ozrtside the firm as points of reference for calculation of costs andprices. Without a price system external to the firm, the big torporationwould soon run into the same kind of problems that played havoc withbusiness planning in the centrally planned economies. Sinte, moreover,markets over time, as suggested above, probably become more and moreefficient, one may assume that the organizational success of the big corpo-ration to some extent may be related to the market mechanism. Thirdly,there are countervailing tendencies to vertical integration of firms. Whenmarkets grow in size, as they do in the long run with increasing output,economic activities become specialized, due to increasing division oflabour, as emphasized by Adam Smith. To some extent this specializa-tion takes place by creating new firms or by splitting up business conglo-merates, when the specialized activity can be performed at lower cost inindependent business firms, which may or may not be the case. Fourthly, itis interesting to note that the Soviet economy never grew so rapidly asduring the 1920s when the glavki of War Communism with dictatorialpowers were abolished and replaced by more than 400 industrial trustscomprising ninety per cent of all industrial enterprises. These trusts deci-ded independently what to produce and where to sel1 and they were

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supplemented by voluntary syndicates for purchasing and sellingindustrial products, as well as by a competitive banking system and freeagricultural cooperatives (Shmelev-Popov, 1989, chapter 1). The generalorientation of this NEP economic system is consistent with the idea thatbusiness organizations are efficient only to the extent that they operatewithin a market system. Still, it remains a fatt that vertical integration tosome extent does replace the market mechapism.(2) It is also a fatt that market mechanisms sometimes are restrictedand controlled at the matro-leve1 without negative effects on increasedeconomic efficiency, but rather probably contributing to it. An exampleis the temporary use of trade protectionism in a world of unequal partners.England ruthlessly used tariffs and trade restrictions against India tobuild up its own cotton industry during the eighteenth century. Ger-many, Sweden and other countries likewise pursued a protectionistpolicy from the 1870s in order to build up an integrated industrialstructure, while at the same time experiencing accelerated economicgrowth. Even if we cannot rule out the possibility that economic growthwould have been stil! higher in the absente of trade restrictions, it ispossible to link the successful growth retord to protectionism in so far ashigh tariffs temporarily shut out superior competitors, while making itpossible for these newly industrializing countries to reap economies ofscale and coordination behind the tariff Walls. The Japanese growth retordafter World War II may be another instance of the same case.

The labour market is another example of how the market mechanismhas been more or less continuously restricted due to organized labour,social legislation and full employment policies. Full employment policieshave contributed to the utilization of idle capacity and higher levels ofeconomic growth; minimum wage legislation may, at least at low levels,have increased labour productivity more than labour costs (‘the economyof high wages’ or ‘efficiency wages’) and also contributed to the weedingout of sweated industries while, conversely, stimulating efficiency-enhanting mechanization. The rise of organized labour has had the sameeffects while also promoting collective agreements that have reducedtransaction costs and facilitated business planning for employers, not tomention its effects on equalization of earnings and the social stability ofmarket societies. Even if trade unions in their role as labour supply cartelsalso may have had other, less beneficent, influences on struttural changeand market behaviour (clinging to declining industries, increasing quantityfluctuations as a response to wage stickiness, creating insider-outsiderproblems on the labour market, etc.) few would argue that a return toa non-regulated labour market would increase overall economic efficiency.

A third case is the grow-th of the publit sector in modern economieschannelling 30-50 per cent of private gross income as taxes to central and

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lotal government. Part of tax income - transfers and government pur-Chases - retums to tax payers and is spent on private investment andconsumption. But part of the taxes is spent on publit investment andconsuinption and this share reduces the scope of the market. The causes ofthe secular expansion of the publit sector in modern economies areszveral. Some investments in the infrasttucture have been too large, toorisky or promising too small profits to engage private capita1 while stillbeing regarded as necessary for a well-functioning market society. In otherrespects the market tends not to optimize investments as in educationand health, and this has motivated publit intervention. With respect toinsurance, comprehensive social schemes have been superior to privateinsurance (oid age and health) because of lower transaction costs and thespreading ofrisks. Equity considerations have motivated the use of the taxsystem for income redistribution and for income transfers. Even if the pro-portions of the mix in the mixed economies may change over time, it isinconceivable that a modem economy would be all-round efficientwithout a publit sector.(3) We think we know the basic causes of the downfall of the centrallyplanned economies: the vertically structured economic relationship, thatis all hierarchy and no market, and therefore no price system reflecting con-sumer preferences and relative scarcities and no scope for spontaneousmass incentives. In addition, property tights were in practice badly defi-ned and enforced. This explains the lack of tonsumer influence, thewasteful resource exploitation, the technological backwardness andthe massive environmental deterioration. From this we deduce thata modern efficient economy cannot do without the market mechanism,sinte only the market mechanism can channel all important economicinformation and provide people with the necessary incentives to attefficiently in a way that harmonizes private with social welfare tolerablywell. This explanation is probably correct. However, it remains a hypo-thesis. The results of the operation of an economic system do not onlydepend on the structure of the system per se, but also on its environment.The environment of the centrally planned economies was also distin-guished by the absente of democracy and consequently also by theabsente of mass participation, mass legitimacy and a true civil society withits spontaneous organizations and institutions. In brief, the centrallyplanned economies did not only lack the market mechanism, they werealso totalitarian, and this quality may have had as important consequencesfor economic results as the lack of the market mechanism. In addition, thecentrally planned economies did not, as a rule, emerge on the basis ofdeveloped capitalist relations of production but were rather super-imposed by forte on underdeveloped pre-industrial economies. Howwould the centrally planned economies have performed if their politital

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and historital pre-conditions had been different? We do not know, butthey might have performed somewhat better. In asking this question we,however, assume that a centrally planned economy without a marketmechanism would be possible or relevant in a democratic and econo-mically developed society, and this is open to doubt. Even if all marketeconomies certsinly do not imply politital democracy, it seems as if allpolitital democracies imply market economies. This would leave us withother forms of planned economies, like partial central pianning and/orplanned market socialism. But centrally planned economies of the Soviettype would be ruled out. Only for shorter periods or under exceptionalcircumstances (‘war economy’ broadly interpreted) would a centrallyplanned economy of the Soviet type make sense. Such a conclusion maybe warranted by the recent study by Chris Bramal1 of living standardsand economic development in Sichuan sinte 1931 (Bramall, 1993).The problem is, however, that we cannot be certain, sinte historitalsocial experiments cannot be repeated under counter-factual con-diti0ns.l

The upshot of this overview of the market in history seems to be that, onthe one hand, markets appear and develop as a viable mechanism ineconomic development; and, on the other hand, that markets also arerestricted and sometimes replaced by other mechanisms. This observationposes the problem of this paper: what are the scope and the limits of themarket? In order to be able to provide an answer to this question, we needto know what the specific characteristics of the market are, and what isthe market’s relationship to other economic mechanisms; further, whatconditions must be fulfilled fora market to existand work well; and lastly,what markets can and cannot do, that is, the merits and demerits of themarket. Within the scope of this paper the discussion must of necessity begeneral. In the first place we cannot go into the historital and non-econo-mic dimensions of the market as a concrete temporal and spatial phenom-enon. Setondly, we Will leave out of account the important differentesthat are connected with the nature of the objects exchanged (goods,labour, money, capital), the time perspective (present time or future), thenature of the exchange process (flex-price markets like the markets formoney or raw materials or fix-price markets like retail trading) or othercharacteristics (e.g. auctions).

1 In the history of Soviet central planning the experience of the early War Communism isoften cited as a proof of the rationality of central planning under exceptional conditions.This conclusion is unfounded. As shown by Kondratiev already in 1922, and system-atically proven by Medvedev much later, central planning seems to have caused ratherthan eased the economic problems. (Medvedev, 1979, chapter 11)

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Hat is the market?

A market is a mechanism for the allocation and re-allocation ofresources between independent property owners. The mechanism isconstituted by acts of exchange (buying and selling) of goods and services(exchange objects) between buyers and sellers. These bargain on theterms of exchange and, if the exchanging partners agree on these terms(the price), the exchange att can take place. The exchange att takesplace between firms, between households or between firms and house-holds. These exchange partners are furthermore assumed to be guidedin the exchange att mainly by self-interest. The number of exchangepartners is important in the definition of a market. Isolated exchangebetween two exchange partners is not counted as a market. The numberof exchange partners should be large and, the larger the number, the moreperfect the market, ceteris paribus. In addition three other characteristicsof a market are important. Firstly, free entry and e.xit to the market, giventhe accepted rules of exchange. Setondly, tompetition between sellersand between buyers, which makes it possible for buyers and sellers,respectively, to reach the most favourable terms of exchange. Thirdly, freechoice of exchange objects and/or exchange partners, which is a corollaryof free entry and exit and tompetition.

If we situate the market mechanism within the field of an economy asa whole, the market is ‘realizing’ or turning over goods and services, whichalready have been produced by firms or households. While firms andhouseholds produce, i.e. transform inputs into outputs in the process ofproduction, the market allocates and re-allocates inputs and outputsbetween firms and households. In the process of production, economicvalues are created, while in the market values are transferred. When theexchange att is mediated by a generalized means of value and exchange,like money, this transfer of value implies a change in the forn of value(goods to money, money to goods).

Now it is important to note that while exchange presupposes produc-tion, production does not necessarily presuppose exchange. In a comple-tely natural economy - which is a limiting case - production takes placebut there is no market or exchange. Allocation of resources for alternativeuse is effected by other mechanisms, like order (command), explicit orimplicit rules (tradition), by bargaining (as in the case of isolatedexchange), by consensus or by vote (democracy). Sinte there is nomarket there is no price mechanism and, hence, no exogenously giventerms of valuation and exchange. Valuation certsinly takes placebetween agents and between agents and principals in the producingunits, but the nature of this valuation may vary from case to case. Thecentrally planned economy may be regarded as a huge natural economy.

The firm in a market economy is also a producing unit and the decision-making within the firm is nota market. When the firm or the manager ofthe firm wants something done, they do not shop around among theemployees searching for the best offer. Instead the principal orders theagents involved to do it. Therefore the allocation process within firms iscommonly designated as an example of hierarchy, i.e. a vertical relationof command or order, in contradistinction to the market, which is a hori-zontal relation of free and competitive exchange acts. But in contradi-stinction to the firm in a centrally planned economy, the firm in a marketeconomy is embedded in a price system made possible by the market andsignalling opportunity costs and incentives. This has several consequen-tes. Firstly, the firm can use the price system of the market in valuing andailocating the resources of the firm to the most profitable use. Setondly, itcan buy inputs and sel1 outputs in the market on the terms most favourableto it. Thirdly, it can choose between buying a resource on the market orproducing it within the firm depending upon which option is the mostfavourable one. The relationship between the firm and the market ina market economy is thus both one of complementarity and one of substi-tution. The firm cannot exist without markets, i.e. buying inputs andselling outputs. Firms (and households) produce or transform resources(create values), while markets transfer (turn over, realize) value betweenfirms and households. The relationship of complementarity between firmsand markets consists primarily in the fatt that firms are dependent uponmarkets for realizing values and for the valuation and allocation ofresources within firms.‘The relationship of substitution between firms andmarkets consists primarily in the fatt that firms can replace markets andvice versa. The allocation of resources between firms and markets is deter-mined by the opportunity cost - of buying inputs on the market or ofproducing inputs within firms. According to one received explanation, thedelimitation between markets and organizations is decided by the costs oftransacting relative to the costs of producing. (Vore about transactioncosts below.)

Summarizing this we may define an economic system as constituted byorganizations (firms and households) and by markets. Then we may say,ceteris paribus, that the scope of the market sets limits to organization,while the scope of organization sets limits to the market. But it is impor-tant to note that the relationship between markets and organizations isnot only one of substitution or competitiveness, but also one of comple-mentarity as shown above. As an example of this we may look at the conse-quences for the delimitation between organization and market, whena firm becomes more efficient than other firms ‘in processing its inputresources and producing outputs, respectively. If the firm becomes moreefficient in producing its inputs, it gets incentives to expand the firm and

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shrink market activities. But if the firm becomes more efficient thanother firms in producing outputs both firm and market activities wouldexpand.

?Vhy do markets exist?

If we accept that the market is that part of an economic system thattransfers, turns over or realizes values - created by organizations -between firms and households, we may ask which conditions must be ful-filled for a market to exist. 1 have found at least nine such conditions.If they are not fulfilled, markets may not exist. If they are incompletelyfulfilled, markets work also incompletely or imperfectly.

(1) It the first place there must be self-interested agents, who as a conse-quence of their self-interest try to maximize their utility or profit. This con-dition distinguishes markets from other forms of reciprocity like gift--giving or altrustic behaviour. Markets could in fatt exist also if all agentspractised altruism. But the outcome would be inferior to the outcomewhen agents are guided by self-interest, sinte generalized a!truism wouldimply that the outcome of transactions for an agent was always decided bythe preferences of somebody else. Sinte we may assume that 1 have betterinformation about my preferences than you, generalized self-interest givesresults that are superior to generalized altruism. Gift-giving is costless forthe recipient of the gift. In some cases also market transactions can takeplace at zero or even negative prices. This could happen if there are noalternative uses of a resource or when a resource is a disutility, like waste,and we are prepared to pay to get rid of it. These transactions are, however,enforced by circumstances, while gift-giving is voluntary and impliesa transfer of wealth without an equivalent transfer. In archaic societiesgift-giving was imposed on gift-recipients in order to control them, asMaurice Mauss has shown. But this form of gift-giving is distinguishedfrom market transactions by the fatt that the latter are voluntary(Gustafsson, 1989).

(2) Setond, there must be free entry and exit to make it possible foragentsto choose themost profitable options in terms of costs and rewards.If this condition is not met with, markets do not ensure optimal outcomesfor agents. Without free entry and exit tompetition is restricted. This iswhy market monopoly (monopsony) or oligopoly implies market imper-fections.

(3) Third, market exchange presupposes that agents have divergentpreference scales as well as divergent comparative advantage in supply; ifnot, there would be no point in exchanging property right to goods andservices. To quote Wicksteed:

A market is a machinery by which those on whose scales of preference any commodiry isrelatively high are brought into communication with those on whose scales it is re!ativelyLow, in order that exchanpe may take place to mutual satisfaction until equilibrium isestablished. (Wicksteed, 1933, voiume 1, p. 236)

If Jones hasa computer and Robinson an electronic microscope, and ifthe computer stands higher than the microscope on Robinson’s scales,while the microscope stan& higher than the computer on Joness scales,a mutually advantageous exchange can take place.

(4) Fourth, there must exist well-defined and decentralked propertytights, which make it possible for market agents to use and transferresources as well as to receive the rewards from and bear the costs of theiruse. If property rights are badly defined and badly enforced, so that it is notclear who shall bear the costs and receive the benefits of their use, marketsdo not work properly or at all. The reason is that agents expect somereasonable balante between effort and return (see point (1)). If B reapswhere A has sown, A Will loose interest in continuing the activity.A limiting case here is represented by publit goods (see below), whereproperty rights may be difficult or impossible to define and enforte exceptat forbiddingiy high costs (which brings us to the case of high transactioncosts). Badly defined and/or enforced property rights can have negativeexternal effects when some property owners impose unwanted costs onother property owners. This leads to sub-optimal allocations of resources,sinte it encourages the first mentioned set of property owners to expandtheir activity beyond the optimal point of resource use, while it restrittsthe activity of the setond set of property owners. This problem may some-times be solved by recontracting the concerned agents’ scale of activity, ifthe transaction costs of recontracting are not forbiddingly high (inter aliadepending upon the number of agents involved).

In this connection it is important to note that the only conditionimposed on the nature of property rights is that they should be reasonablydecentralized. Private property rights are a subset of decentralizedproperty rights but by no means the only ones, sinte various organiza-tions, institutions and cooperatives are also market agents. Only if there isjust one single property owner, as in the case of the centrally plannedeconomies, are genuine market exchanges excluded. It may be possible todevise a market system w-ith one single property owner on condition thatthe usufruct of property is leased to several lease-holders. But then thecontractual form, e.g. terms and length of contract, becomes important forthe efficiency of the arrangement.

(3) Fifth, market exchange presupposes division of labour or speciali-zation as a necessary although not a sufficient condition. If 1 can produceon my 0w1-1 all the goods and services 1 need, there is no room for marketexchange. As soon as producers specialize and produce only a part oftheir

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needs, they become dependent upon the market nexus. However, therecan be division of labour without markets, sinte a central authorityowning all resources may also institute division of labour by command.This was the case in the centrally planned economies.

(6) Sixth and most important, market exchange presupposes exchda-bility in supply and rivahy in demand. This condition refers to the tech-nital character of goods and services and it is fundamental for the distinc-tian between private and publit goods. If it is possible for a seller totonfine his/her goods and services to a specific buyer and if the purchaseor consumption of these goods and services by the buyer excludes theirpurchase or consumption by other buyers, the goods and services areprivate. The selling and buying of most everyday goods and servicesbelong to this category. But if there is no excludability in supply and thereis no rivahy in demand, the goods and services are publit. Air and naturalscenery may be examples. If 1 as a prospective seller of a publit goods trytosel1 it to A and B, C and D cannot be excluded from appropriating it; and ifthe consumption of it by A does not diminish its availability for B, C and D,neither seller nor buyers have incentives to engage in market exchange.Pure private and pure publit goods are alternatives at the endpoints ofa continuum with semi-private and ,semi-publit goods in-between. Anexample of semi-private goods may be theatre performances, wheretickets can be sold to each visitor but where my consumption of theservice does not exclude the consumption by other persons. An example ofsemi-publit goods, where there is no limitation in supply by rivalry indemand. may be the picking of berries on a tommon, where anybody mayenter the tommon but where simultaneously my picking of berries reducesthe availability of berries to others. This also shows that it is excludabilityin supply that basically defines the distinction between private and publitgoods. Publit goods cannot be marketed and, if they still are necessary forthe reproduction of society, they are either free or tax-financed goods.

(7) Seventh, a well-functioning market presupposes that agents haverelevant information about goods, prices and qualities. If they do notpossess such information, market agents may be unable to find marketpartners, goods or qualities that in fatt exist, buy the right qualities or paythe right prices. The amount of available information depends upon theknowledge of the market agents, the state of communication and mediadevelopment as well as access to relevant advertising.

Information should also be symmettically distributed between buyersand sellers. If information is asymmetricalZy distributed the outcomes ofmarket transactions become inefficient or may cease to exist. If this occursmarkets may be improved by regulation. Sometimes it is buyers who arebetter informed than sellers and therefore may buy the goods below theirmarket price, e.g. on setond-hand markets or markets for rare books, art

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etc. But usually it is the sellers that possess superior information becausethey have produced, owned or used the goods to be traded.

The consequences of asymmetritally distributed information for marketbehaviour have been extensively analyzed by Arr o w and A k e r 1 o f Arrowrefers to the health market, where doctors and patients meet in trans-actions. Doctors are supposed to know more about illnesses and mediealtreatment than patients, while patients may lack information not onlyabout the nature and causes of their illness as well as about proper treat-ment, but also about the qualifications of the doctor who is to deliverdiagnosis and treatment. If the diagnosis and the treatment are wrong theconsequences may be disastrous for the patient. In traditional Chinesemedicine the problem of asymmetritally distributed information aboutthe quality of medieal services was solved by a method which assumed thatthere was a unique causal relation between illness and medieal treatment:the patient paid the price orrly if he/she was tured. In Western healthservice systems other solutions have been used to compensate for theasymmetry of information, primarily by controlling the qualifications ofdoctors (standardized education and authorization of doctors) and bypromoting professional ethics. We meet with similar institutions also inregular goods and service markets, where trade marks are supposed tosignal information about qualities, and publit tonsumer protectionagencies are frequently used to inform buyers (see further Arrow, 1963).

In a seminal contribution, The market for Zemons, George Akerlofhas shown that information asymmetritally distributed between sellersand buyers may cause’markets to shrink, even to disappear, under per-fettly competitive conditions. He takes the market for used cars (‘lemons’)as the standard example. The owners of used cars know the quality of thespecific tar they own but prospective buyers do not. The only thing buyersknow is that there are large quality variations with respect to used cars. Ifthe market for used cars is perfectly competitive, buyers and sellers areprice-takers and decide orrly on quantities offered and demanded. Price istaken as an index of quality. Then interesting consequences may follow.The competitive price for used cars is satisfactory only for those sellerswho supply cars of average or below-average quality. Thus potentialsellers with cars of above-average quality tend to withdraw from themarket, sinte the price offered does not reflect the value of their cars. Ifbuyers are aware of this, they correctly conclude that the average priceestablished does not properly reflect the average quality of the used carseffectively offered on the market. The correct price should not be anaverage of above-average, average and below-average quality of cars, butonly of average and below-average quality, i.e. a lower price. Hence,buyers are prepared to offer only this lower price. But at this lower pricethe owners and sellers of average-quality cars also withdraw from the

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Imarket, sinte the new average price is lower than what corresponds to thequality of their specific cars (the price being an average of average andbelow-average qualities). And on it goes until there are no more used carsoffered on the market.

The Akerlof Zemon-ptincipZe is not so esoteric as one may think.It explains many forms of regulation of the market mechanism. It maycontribute to our understanding of the specific organization of the me-dieval craft guilds with their elaborate control of professional standardsand quality of goods (Gustafsson, 1991).

(8) Eighth, transaction costs may also explain the existence, absente,growth or decline of markets. This cost category has been extensivelyresearched in recent years - although the concept had already been intro-duced in 1937 by Ronald Coase (Coase, 1937). The concept of trans-action costs is not yet satisfactorily delimited. Usually it refers to costsassociated with entering into a contract between transacting agents, likesearch costs, bargaining costs and enforcement costs. Coase was primarilyinterested in defining the essence and limits of the firm relative to themarket as an allocative mechanism. He found that the delimitationbetween firms (organizations) and markets is determined by the costs oftransacting relative to the costs of praducing (see also above pp. 16-18).

Coase and some of his followers seem to suggest that transaction costseven explain the existence of firms. This claim goes too far. Firms e,xistand must exist because they are organizations for producing goods andservices (value creating), while markets exist and must exist for realizingoutputs (value transforming). Firms and markets are basically comple-mentary, not substitutive. An economic system cannot be constituted onlyby markets, i.e. buying and selling, sinte goods and services must be pro-duced before they can be bought and sold. An economic system can, howe-ver, exist without markets (households producing and consuming theirow-n output or centrally planned economies), although the use of marketsmakes an economic system more efficient. Even if transaction costs wouldbe zero, the market is not necessarily used. This is the case, when the pro-ductivity in production of one firm relative to other firms is so high that itoutweighs zero or even negative transaction costs of using the market. Thetheory of transaction costs is thus not a general but a special theory of thechoice between organizations and markets, respectively, for the allocationof resources.

Transaction costs are often important on the margin for the decision toproduce or to buy. Variations in transaction costs sometimes explain theabsente, shrinking or expansion of markets. If bargaining costs are toohigh, e.g. because too many agents on one or either side are involved, notransaction may be possible. Or if enforcement costs, e.g. due to theabsente of a sufficiently efficient legal and policing system, are too high,

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the same consequence may ensue. In the present drive for privatization ofpublit services in the Western world, it is often forpotten that competitivemarket solutions or decentralization within publit agencies, e.g. in healthcare, often turn out to be more costly than centralized publit production,precisely because of the existence of transaction costs, that is search costs,bargaining costs and.enforcement costs, or simply because of duplicationof administrative costs and paper work.

Transaction costs sometimes explain why markets shrink or expand aswell as the emergence of new organizational forms. One importantinstance is the vertical integration of fims, which does away with themarket nexus between the units involved, as when a steelworks integratesbackward to iron mining or forward to steel engineering. The increasingtransaction costs in domestic industries in the early phase of the industrialrevolution help to explain the rise of the factory system, e. g. in cottonindustries. In this case the demand for cotton products started to growrapidly, due to the low costs and superior qualities of these textiles.Merchants and putters-out reacted by adding new, spatially dispersed,domestic producers to their decentralized organization. This increasedbargaining and enforcement costs (because of embezzling of raw mate-rials) as well as carrying costs for distributing raw materials and collectingfinal outputs. Also variations of quality of products increased because ofthe addition of new and less skilled independent producers. Soon thetransaction costs became forbiddingly high. The merchants and putters--out reacted to this by centralizing producers and production in factoriesunder their own supervision. This paved the way for the technologicalchanges associated with the large-scale use of machine techriology andsteam power (Gustafsson, 1987). If however hand transaction costsdecrease substantially, the consequence would be an expansion of mar-kets. This was clearly the case in the commeicial upswing in the West fromthe eleventh century on, when contract law and royal administration(market law) made it possible for traders to trave1 more safely with theirgoods and thus lowered the transaction and enforcement costs ofcontracts. Another instance of the same pattern may be the expandingmarkets of the late nineteenth century, when the telegraph, railways andsteamships lowered search costs as well as bargaining costs.

(9) Ninth, markets exist or are efficient enly if there are institutions,that is, formal and informal rules as well as legally sanctioned andaccepted enforcement mechanisms safeguarding contracts and exchange.(Property rights may be regarded as an instance of institutions, see p. 31above.) If these institutions are lacking it may pay to steal rather than tobuy resources or to cheat or to blackmail market partners. How importantinstitutions are for the e‘xistence of well-functioning markets we are madepainfully aware by observing the tortuous emergence of markets in the

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former Soviet Union. The role of proper institutions for market exchangeis, in this respect, to lower transaction costs. Institutions perform thisfünction by indicating permissible and non-permissible choices, decisionsand acts, respectively, in market behaviour. For this task formal rules, likelaws, may do part of the job. But still more important are informal rules,embedded in ideology and culture, like elementary honesty, goodwill,sound business practices, etc. Without this ‘market culture’ efficient mar-kets cannot existand in the West it took centuries for it to emerge. Formalrules often preceded informal rules, as when medieval laws on commercestipulated that valid exchange necessitated the presence of two witnesses(Gustafsson, 1987). How disastrous the effects of market exchange mightbe for the agents if proper institutions are lacking has been wittilyanalyzed by Amartya Sen (Sen, 1979). One implication for marketbehaviour of the existence and operations of institutions is that the choiceset of agents is not only historitally conditioned but also that it is finite.Consequently institutions also determine the outcome of choices.

These nine conditions for the existence of markets and/or efficientmarkets are of different kinds. But generally speaking they refer to char-acteristics of economic agents (self-interest, optimizing behaviour) andtheir environment (free entry and e.xit, tompetition, comparative advan-tage, property rights, division of labour, private goods, information, trans-action costs and institutions), which have to be fulfilled in order to enableagents to choose but also influencing the outcomes of choice. From thepoint of view of economic history and empirital analysis 1 would suggestthat it is especially important to pay attention to the degree of tompetition,property rights transaction costs and institutions. One should also notethat there are inter-relations between some of the conditions. If goods arepublit ones, property rights cannot be established, economic activityreferring to publit goods gives rise to external effects, and external effectsaffect transaction costs. If property rights are ill-defined and institutionsare undeveloped, negative externalities as well as high transaction costsWill ensue. These interrelations indicate the existence of some more gen-eral underlying conditions than those mentioned. But no high-poweredgeneral theory of the existence of markets has as yet been formulated.

Causes and effects of market growth

The nine conditions discussed above determine the existence but also,as already hinted at, the growth and decline of markets. Historitally weshould probably emphasize four sets of main causes of market growth. Inthe first place government policies with respect to the legal foundations ofmarkets (property rights) and to trade barriers (e.g. tariffs). Setond,division of labour (specialization) that increases markets and vertical

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integration that reduces markets. Given the number of transactions,market size is also determined by the volume of transactions effected.From this point of view, market growth is, third, also influenced by outputgrowth, sinte growing supply essentially implies growing demand. Fourth,and most important, improved communication technology affecting theflow of information is, as Mars hall and others have emphasized, instru-mental in bringing about market growth. Improved communications, ofcourse, also lower costs of distribution which extend markets spatially.A caveat is, however, talled for. When we suggest that increased divisionof labour (specialization) increases markets, we should rather talk aboutthe possibility of increased markets. The reason is that the increaseddivision of labour leads to market extension only in so far as the new spe-cialized activity also implies the establishment of a new firm (a new pro-perty owner). It may well be that the new specialized activity arises withinan already established firm and then no market extension takes place. Ifspecialization leads to lower costs, e.g. thanks to economies of scale, forthe overall activity of the firm, it may even lead to shrinking markets, ifrival firms are destroyed by tompetition.

This observation is also important when we turn to the effects of marketgrowth. Adam Smith enunciated the important principle that the degreeof division of labour or specialization is determined by the extent of themarket: the wider the markets, the more extensive the division of labour(Smith, 1776). Smith made this proposition the foundation of his theory ofthe wealth of nations. In this theory economic growth is determined bytwo factors: the productivity of labour, and the share of productivelyemployed workers in the labour forte. This share, according to Smith, isdetermined by the savings ratio of the capitalists. The more they save, themore workers they can employ in production and vice versa. The product-ivity of labour is, on the other hand, determined by the degree of division oflabour and this, in its turn, by the extent of the market: the wider themarket, the larger the scope for specialization. Ultimately, economicgrow-th, in Smith’s view, is hence determined by the propensity of the capi-talists to save (and accummulate) and by the extent of the market. Fromthis theory, Smith inferred the beneficial effects of free trade and marketextension. Smith’s theory is valid as far as it goes. But two observationsare talled for. In the first place, vertical integration works in the oppositedirection with respect to market size, and there are often strong induce-ments to vertical integration because of scale economies, reduced trans-action costs and/or prospective Capture of rents. Setond, extension of themarket for a commodity may not at all lead to increased specialization.Sometimes the market extension may be too limited to support the activityof a new firm and sometimes it leads, not to increased specialization, butonly to a widening of the on-going activ-ity, especially if market extension

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implies economies of scale and lower costs of production. If this is thecase, market extension may promote the emergence of larger firms. Eco-nomies of scale and lower unit costs of output induce shifts of demand forfinal output because of income as well as of substitution effects. Sintelower costs make price tuts possible, tonsumers’ real income increasesand their demand for the commodity increases. Parallel to this, demandalso increases because tonsumers shift from higher-priced substitutes tothe lower-priced commodity. This is one of the most important causes ofthe emergence of mass markets.

Finally, market extension also tends to increase tompetition if it impliesan increased number of firms in the market. Scale effects as well asincreased tompetition tend to lower costs and prices. The creation oflarger market areas, like the European Gommon Markef, are oftenmotivated by these two effects of market extension.

Peculiarities or market behaviour

On the one hand, markets exist, grow and thrive, and seem to possessunsurpassed qualities in the generation of efficiency and welfare. On theother hand, markets are conditional; are sometimes replaced by othermechanisms for resource allocation and are often, as suggested earlier,more or less imperfect or may not even exist. In the standard version of thetheory of the perfectly competitive market, this mechanism represents anoptimum of efficiency and stability. But in reality this is not always, andperhaps only exceptionally, the case. One reason is that market behaviouris determined not only by the simple aggregation of rational individualdecisions but also by the interaction between individuals, whereby thisinteraction in various ways influences and modifies not only the originaldecisions but also, more importantly, the outcome of them. As a conse-quence, spontaneous individual rationality often produces collective irra-tionality. Akerlof’s theory of the market for Zemons (see above) is just oneexample of a much more general phenomenon (Schelling, 1978). In addi-tion, individuals do not att only on the basis of rational self-interest (maxi-mization of a utility function w-ith known arguments), but also on the basisof ignorance, uncertainty, vanity, and fears; they form expectations thatchange with new information and changing environment; they indulge instrategic behaviour in order to gain advantages and power, or to redistri-bute wealth.

Finally, it is important to note that real markets do not work smoothlyonly on price signals and towards stable equilibria. As everyday expe-rience tells us, quantity signals and rationing also play a role in the marketmechanism and supply and demand do not always balante at given prices.Let us look at some important examples of all this.

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(1) According to the theory of perfectly competitive markets, themarket mechanism guarantees a state of so-talled Pareto efficiency whereno agent can improve his/her utility without making somebody else worseoff. This would, infer alia, exclude involuntary unemployment. But in fattinvohntary unemployment is pervasive in all market economies. Parts ofthe unemployment may be explained by demographic factors, wage rigid-ity or too high unemployment benelits (making unemployment partlyvoluntary). But, sinte unemployment is general, lasting, and even increas-ing, the most probable explanation is that the fundamental cause is inade-quate aggregate demand. Such a state is made possible precisely by themarket mechanism using money as a means of exchange in transactions.In every single transaction, demand and supply balante in the market.But the fatt that 1 have sold a commodity today does not necessarily implythat 1 shah buy another commodity tomorrow for the money received.1 may save the money, depending upon my expectations with respect to myfuture consumption or investment. If 1 think that 1 should postpone con-sumption or investment, my demand disappears from the market. If otheragents also behave in the same way, aggregate demand does not equalaggregate supply at the ruling prices. One consequence would beunemployment. The inference from the theory of perfectly competitivemarkets would be that unemployment is caused by a too high wage leve1and that the labour market would be in balante if wages were lowered tothe equilibrium level. If this took place partially some unemployed wouldprobably be employed at a lower wage rate sinte some employers would beabie to tut their prices and increase their market shares. But if all or mostof the employers acted in the same way, the general price leve1 would alsobe lowered and there would be no incentive to increase employment. Theenly result of the wage tut would be lower output and possibly increasedunemployment, especially if the wage tuts made employers expect furtherwage tuts and therefore they would postpone production and employ-ment decision. The same result would follow if households tried toimprove their situation by increasing savings. If some households tried,they might succeed. But if all or most of the households increased savings,aggregate demand for consumption and investment goods would befurther reduced. Individual rationality would be translated into collectiveirrationality.

One consequence of this (Keynesian) analysis is that the alleged wagerigidity, inferred from the theory of perfectly competitive markets, couldbe explained as an outcome of perfectly rational optimizing choice on thepart of the wage earners without leading one to claim that the unemploy-ment was voluntary. The explanation is either that wage earners have lear-ned from experience that, if they agree to wage tuts, full employment Willstill not be restored; or that it may be worthwhile to pay the price of

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unemployment for a while because it may be difficult to restore the fullemployment wage leve1 after having agreed to a wage tut as a remedy forunemployment. In both cases wage earners’ choice might be regarded asan outcome of superior information (not included in the theory of per-fettly competitive markets).

(2) Market economies are seldom distinguished by stable equilibria.Typically, there are herd-like mouements (S c hump e t er), which inter-mittently prevent full employment of resources or give rise to disequilibriawith or without full employment. The business cycle in the aggregateeconomy is one instance. But cyclical mouements and disequilibria mayalso occur in individual markets. This was discovered long ago, e.g. byArthur Hanau, John Einarsen and others (Hanau, 1928; Einarsen,1938) with reference to the so-talled hogcycle and the shipbuilding cycle,respectively. The causes of disequilibria are, in those cases, that supply anddemand do not react instantly on price signals and vice versa. In a classicalstudy, The Cobweb Theorem, Mordechai Ezekiel concluded:

Classical economic theory rests upon the assumption that price and production, ifdisturbed from their equilibrium, tend to gravitate back towards that normal. The cobwebtheory demonstrates that, even under static conditions, this result Will not necessarily fol-low. On the contrary, prices and productions qf some commodities might tend to fluctuateindefinitely, or even to diverge further and further from equilibrium . . . If many commo-dities are chronically vajing above or below their individual equilibria, then the eco-nomic system Will never organize all its resources for the most effective use, but Willalways be operating below the total installed capacity and with more or less unemploy-ment. Even under the conditions of pure tompetition and static demand and supply, thereis thus ‘no automatic self-regulating mechanism’, which can provide full utilization ofresources. Unemployment, excess capacity, and the wasteful use of resources may occureven when all the competitive conditions are fulfilled (Ezekiel, 1938).The outcome of the fluctuations of prices and the quantities demanded

and supplied in the market may differ, depending upon the price elastici-ties of demand and supply. In happy cases, the range of fluctuations willcontinuously diminish and, after a time, end up in a stable equilibrium.In other cases, the outcome may be stationary fluctuations around anequilibrium. In unfortunate cases, the outcome may be so explosive thatfluctuations increase until the market breaks down.

(3) A peculiar phenomenon in market mechanisms caused by expecta-tions is speculation. Speculation is usually, and rightly so, regarded asa beneficial factor in the market mechanism. Speculators take on the roleofrisk bearers and contribute positively to the equilibrating of supply anddemand. If a speculator in grain buys part of the farmers’ harvest in theautumn, when the supply is large and the price is low, in order to sel1 it inthe following spring, when the supply is scarce and the price is high, hemakes a profit on the price differente reduced by storage and interest costsand the cost ofrisk. But, at the same time, he prevents the price of grain

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falling too low in the autumn, which is beneficial to the producers and,likewise, he prevents the price rising too high in the spring, which is bene-ficial to the tonsumers. Speculators thus take on a specific role in the divi-sion of labour. But this result presupposes that the speculators are not toomany and do not exert too strong an influence on the market mechanism.If they are many, they may, on the contrary, destabilize prices and mar-kets. If many speculators bilieve that the future price Will be much higherthan it is today, they may withhold supply to such an e_xtent and for so longa period that their activity inflicts damage on the physical reproduction ofmarket agents. This occurs, for example, when many market agents arepoor and may become destitute because of speculation. This is an impor-tant reason why grain and bread prices historitally have often beenregulated bylotal and centralgovemment. Amartya Sen has shown howspeculation in underdeveloped countries has caused mass famines andpoverty in India, Bangladesh and Ethiopia, where millions have starved todeath, not primarily because of trop failures, but because supply has beenwithheld from the market and even exported (Sen, 1951).

(4) The fatt that the behaviour of some market agents may damageother market participants directs our attention to the distibution aspectsof the market mechanism. The market does not translate need into welfareif need is not baeked up by entitlements, Le. resource endowments,income and wealth. If market agents have unequal resource endowments,the rich may become richer and the poor may become poorer. To be effi-cient, the market mechanism presupposes that agents att on the basis ofself-interest. This impIies that it promotes virtues like egoistic behaviour,but also smartness and.ruthlessness. If we assume that such virtues aredistributed normally in any population, the outcome of market trans-actions should be that these, on the average, tend to the interests of mostpeople, while they make a minority at the upper end of the scale well-offand another minority at the lower end of the scale poor. The marketmechanism is per se ethically neither good nor bad. It promotes desert,i.e. it gives more to those who have more, and less to those who have less.John Ruskin put the tontrast well:

In the community regulated only by laws of demands and supply, but protected from openviolence, the persons who became rich are, generally speaking, industrious, resolute,proud, covetous, prompt, methodical, sensible, unimaginative, insensitive, and ignorant.The persons who remain poor are the entirely foolish, the entirely wise, the idle, the reck-less, the humble, the thoughtful, the dull, the imaginative, the sensitive, the well-informed,the improvident, the irregularly and impulsively wicked, the clumsy knave, the open thief,and the entirely merciful, just, and Godly person (Ruskin, ed. 1967).

The theory of general competitive equilibrium predicts an optimal out-come for all market agents involved in the sense that no one can be madebetter-off without making somebody else worse-off. This outcome is valid

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for any possible tonfiguration of the distribution of wealth or income. Thisimplies that if, as the result of the competitive market mechanism, somewould have ended up with billions of dollars in income, while otherswould have received only a subsistence income (or less), this optimal out-come would become a suboptimal outcome, if government decided to talteone dollar from one of the billionaires and give it to one of the earners ofa subsistence income. Granted that we base our views on distributionalequity on other considerations than desert, and granted that distributionaloutcomes in reality are occurring in non-perfect markets and, in addition,are influenced by institutions like heritage, it is easy to understand that thedistributional outcome of the market mechanism is corrected by govern-ment intervention in most societies.

(5) As every student of business history is aware, the market is notusually the peaceful Eden which emerges from the theory of the perfectcompetitive market, in which all agents are price-takers and are mainlypreoccupied in making the necessary quantity adjustments to achieveoptimal results. The market is rather LZ theatre of wur characterized bysales promotion, price wars, take-overs, amalgamations, market sharing,cartel agreements and demarcations of spheres of interest. Reading, forexample, the multi-volume study by the Uppsala economic historians ofthe history of the Swedish Match Company is like reading a history ofmore or less permanent warfare (see e.g. Lindgren, 1979). Even in a highlycompetitive market, agents mayuse price as a parameter of action in orderto gain advantages over competitors if they happen to command largerresources than theirs. One instance of this is so-talled predatory pricing.By charging a price for competitive goods that is sufficientlylowfor a suffi-ciently long time, they may drive their competitors out of business andtake over their market shares. Such strategic behaviour is the rule infinantial markets. Nobody can tel1 whether the outcomes are optimal foranybody but the winners.

(6) Competition is one of the aspects of the market mechanism thatmakes it so useful. But sometimes tompetition may be too keen to beefficient. Another way of expressing this fatt is that the market agents insuch cases may be too many. The reasons why they do not withdraw fromthe market may be several. They may lack better alternative occupationsclose at hand, like the coalminers in many regions in Europe or UnitedStates between the wars. Or they may expect a tum for the better in thefuture like the British handloom weavers in the early nineteenth centurywhose downhill struggle against the power-loom became so long drawn-out because the preceding period of ‘prosperity had been so long and sosuccessful. Faced with deteriorating conditions, the glory of the golden age- ‘the men with each a watch in their pocket, and the women dressed totheir own fancy’ (Radcliffe, 1828, p. 67) - made them hope for a turn for

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the better sooner or later. When they had repeatedly adjusted to deterio-rating conditions they had, on the one hand, leamed how to cape with thenew situation and, on the other hand, they had invested too much pride inthe losing strategy to be able to leave the trade. As a result, they were stepby step annihilated economically, and sometimes even physically. Lowbarriers to entry facilitate over-crowding and tut-throat tompetition ina market like the traditional sweafed indusrries (garment sewing, etc.) orin certain service industries (e.g. taxi). As a res&, survival rates of firmsare low and investment in human capita1 and technological innovationsub-optimal. In this regard, we may talk about waste ofcompetition and itmay also appear as duplication of identical services that in fatt enjoy largescale economies, or as cross-hauling of various kinds. Standard cases ofcross-hauling may be found in private railway services and trucking,where horizontal integration sometimes could provide more efficientsolutions. A weli-researched case is garbage collection in the U.S., which isa big and fast growing industry. The organizational forms of garbagecollection in the U.S. vary from publit to private-competitive ones withprivate-contract and private-franchise in-between. The. most efficient formis private-contract, closely followed by publit and private-franchise. By farthe least efficient form is private-competitive. The private firms are pro-bably not too small. But they have higher transaction costs, sinte eachcompetitive firm must bill each tustomer and, while a single contractingfirm can pick up garbage distritt by distritt, the private-competitivesolution leads to cross-hauling and waste, because all firms collect garbagein every neighbourhood with each firm stopping st only a fraction of thehouses (Donahue, p. 66).

(7) 1 have emphasized that efficient market solutions are excludedwhen the required information about goods, qualities, costs and prices isdifficult or impossible to procure. As a result, uncertainty prevails. Whilerisk can be coped with by insurance, genuine uncertainty cannot. The pro-blem of uncertainty is intensified when it refers to indivisibilities andreaches into the future. This is often the case when large investmentprojects or infrastmctural investments are involved. A standard examplefrom industrialization is the following one. A private investor is consider-ing whether to build a large steelworks in a locality with cheap raw mate-rial, but undeveloped transport facilities. The steelworks Will become com-petitive only if a railway is built and can be brought into use when the steelfactory has been constructed. Maybe also the railway Will cover itsexpenses only after the steelworks has been built and uses the transporta-tion services of the railway. There is usually no market for either steel-works or railways and general uncertainty about the profitability of theprojects prevails. This example could be generalized to other cases wherelumpiness of investment, uncertainty about the future and - as in this case -

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also external economies are involved. This is one reason why there isalways some scope for govemment intervention, centralized investmentplanning and long term contracts and cooperation between firms tosupplement the market mechanism.

The case for the market

There are two basic reasons for the efficiency and, therefore, also theviability of the market mechanism. One reason has to do with the dimen-sion of social size and its consequences. The other reason has to do withspontaneous social order and its implications. We have seen thata modern economy is run basically by two mechanisms that are competi-tive as well as complementary: the firm and the market. The firm is a pro-ducing mechanism, the market a transacting mechanism. The firm is basedon consciously planned organization, vertical or hierarchical relationsbetween management and employees and centralized decision-making.The market is a spontaneous mechanism based on horizontal and freelychosen relations between independent and autonomous units and there-fore also distinguished by decentralized decision-making. Between thesetwo basic mechanisms, the vertical authority of the firm to some extentreaches out to and influences the market, while the market influences thefirm via the price system and other signals. To complete the description,we should add that there are also trade associations and governmentagencies that bridge the space between firms and markets and interactwith both.

It is easy to see why markets cannot do without firms sinte, withoutfirms, markets would have no goods and services to transatt. But, as weknow, it is possible to have an economy without markets, although theoutcome is inferior compared to an economy with both firms and markets.How does it come about that it is not advisable to extend the unifieddecision-making and the planning principle which has been so successfulwithin, and to a limited extent also outside, the domain of the firm, to thewhole environment outside the firm, that is including the market? Thisquestion was first raised by Marx who contrasted the consciously andrationally planned order of the capitalist firm with what he talled ‘theanarehy of the market’. He saw no problems involved in treating the wholeeconomic mechanism as one big firm. But he really never gave any goodreason for his conclusion. We cannot go into this problem here. (SeeMoore, 1993 for a historiographic account of Marx Venus Markets.) Onewould have expected that Marx, who was aware of the fatt that the marketmechanism had been used by many pre-capitalist economies, should haveconcluded that the predicted transformation of capitalism to socialismwould not have abolished markets but would have transformed them from

44

capitalist to socialist markets (Gustafsson, 1981). Marx’s intellectualshort circuit on this point was probably conditioned by at least live consi-derations. First, he witnessed the rise of the big torporation and the ‘so-cialized’ capita1 market (share-ownership and the stock exhange) andconcluded by simple induction that this new stage of capitalism was onlythe introduction to full-blown collectivization of capita]. Setond, he (or atleast some of his followers,‘like Kautsky) believed that a socialist marketeconomy sooner or later would degenerate to a capitalist (private pro-perty) market economy, sinte historitally capitalism had been created onthe basis of a generalized market economy, namely when labour powerhad also become a commodity (Gustafsson, 1971). Third, he thought thatthe self-interest and the cash-nexus of the market mechanism could not becombined with a truly communitarian society. Fourth, Marx had unli-mited trust in the possibilities of rationally creating and consciouslyrunning a modern economy, however complex it might be. Fifth, he neversaw a need for creating, or preserving, institutions safeguarding the auton-omy of the individual in society.

Other marxists, like Oskar Lange, saw the problem and suggesteda socialist market economy based on centralized ownership as a solution.In his model, the Central Planning Board would set the prices of industrialgoods, instruct firms to minimize cost, and then adjust prices to equili-brium prices in case of excess demand or excess supply (Lange, 1938).Lange never asked whether the socialist managers would have incentivesto att in such a way that a market equilibrium would ensue. He only sawthat an informational problem was involved, but that would eventually besolved by the computer (Lange, 1967). He did not perceive either theproblem of social size, or that of spontaneous social order.

The problem of social size is related to the role ofinformation as well asof incentives in the economic system. Even in a small-scale social organi-zation like the firm it may sometimes be difficult for the principal to enticesufficient and correct information from his/her agents (employees). And,for this purpose, he/she uses a mixture of payment, reward, and promo-tion systems, as well as supervision and punishment (threat of dismissal).But because the firm is a small-scale organization, information is relativelyeasy to identify, handle, channel to relevant agents, decide on and tocorrect in view of unforeseen results. This, however, is not possible in alar-ge-scale organization involving thousands or hundreds of thousands ofagents and units. The amount ofinformation becomes too large and com-plex, too difficult to interpret and to att on. A principal may specify his/herrequirements, but the list would be forbiddingly large, complex and expen-sive to construct as well as to enforte. To quote Stiglitz:If a price is specified for ‘nails’ made out of any cheap materia1 Will be produced. Ifthe length is specified, but not the thickness, then excessively thin nails Will

45

be madc. If length and thickness are specificd, tbc produccr may still make nails out ofa cheap material, which may be excessively brittle. For more complex commodities,almost no matter how many characteristics are specified, there remains scope fordiscretion - and in particular, cost tutting - which adversely affects how well thecommodity performs the task for which it is intended (Stiglitz, 1993, p. 28).Instead of ordering other agents to do what he/she wants, the principal

tums to the market where independent agents, who possess the necessaryinformation and have incentives to use it, announce the terms on whichalternatives are offered. These terms are precisely the price system ofthe market which conveys an enormous amount of information aboutqualities of goods and services, costs of sellers and preferences of buyers.Incidentally, Marx disclosed an insight into this problem in a paragraphon lists of current prices in his Grundrisse. He noted that:

Institutions emerge whereby each individual can acquire information about the activity ofall others and attempts to adjust his own accordingly, e.g. lists of current prices, rates ofexhange. This means that although the total supply and demand are independent ofthe actions of each individual, everyone attempts to inform himself about them, and thisknowiedge then reacts back in practice on the total supply (Grundrisse; 1857; 1973,p. 161).This does not mean that the price system of the market mechanism pro-

vides agents with all necessary information. A market transaction isexplicitly or implicitly based on a contract between buyer and seller anda contract usually specifies more terms than the price. In both labour andcapita1 markets, bids and offers are screened and the transaction is notalways decided by the highest bid or the lowest offer (e.g. if a borrowercannot offer a satisfactory collateral). As we have already noted, anefficient market mechanism also presupposes institutions for exchangeand enforcement as well as goodwill and reputation. Still, the price systemis the main carrier of information for firms and tonsumers.

The setond problem of social size is related to incentives, which isclosely related to that of information sinte truthful and relevant infor-mation requires appropriate incentives. It was this problem that AdamSmith emphasized when he noted that we should expect our dinner, notfrom the benevolence, but the self-interest of the butcher. In a small-scalesocial organization like the firm, agents’ incentives to perform well aredetermined by rewards, but also by career prospects and group solidarityin a clearly defined tommon project, the success of which depends uponeasily measured and monitored individual efforts. But when socialdistance increases, social interaction and social bonds are diluted andweakened. Eventually, only self-interest becomes really meaningful toatt on:

In general, social pressure and social incentives operate enly in groups of smaller size, inthe groups so small that the members can have face-to-face contact with each other . . .There are perhaps two reasons for this differente in the attitudes of farge and small

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grottps. First, in the large, latent group, each member, by definition, is so small in relationto the total that his actions Will not mattcr much one way or another; so it would seempointiess for one perfect competitor, or a member of some other latent group, to snub orabuse another for selfish, anti-group action, because the recalcitrant’s action would notbe decisive in any event. Setond, in any large group everyone cannot possibiy knoweveryone else, and the group ipso facto not be a friendship group; so a person Will not beordinariiy affected socially if he fails to make sacrifices on behalf of his group’s goals(Olsson, 1965, p. 62).In the small-scale organization, like the firm, the incentive to att on

non-selfish motives is strong because the individual can perceive that hiscontribution makes a differente to the tommon outcome. Likewise, thesocial control is more effective and, due to this, a failure to att unselfishlyis more likely to be punished. In the large scale organization, like themarket, on the other hand, the incentive to att on unselfish motives isweak because the individual cannot perceive that his contribution makesa material differente to the outcome which he may not even be aware of.The social control is weaker and, therefore, self-interested action is notlikely to be punished.

These effects on behaviour of small-scale and large-scale social organi-zations, respectively, may explain why the market, as a species of-large--scale social organization, has to rely mainly on self-interest to performwell. The firm is dependent upon the market. But the market cannot beordered to perform well. Its allegiance has to be bought. Given self-inter-ested action, market agents could be expected to produce efficient out-comes with respect to costs, prices and resource allocation.

If one basic reason for the efficiency of the market has to do with thedimension of social size and its role for information and incentives, thesetond reason is related to the market as a spontaneous order. Thisconcept has been introduced by Friedrich Hayek. With him, themeaning of the concept is not Crystal clear, sinte his contradistinctionbetween ‘made’ and ‘grown’ order is hardly applicable, because ‘grown’orders are also ‘made’. Similar difficulties emerge in Hayek’s attempt totontrast spontaneous social orders with ‘organizations’ or social orderscreated by ‘purpose’ or by ‘design’, because spontaneous orders may alsobe regarded as organizations and as created by purpose (Hayek, 1973,pp. 35-54). For our purpose it is sufficient to characterize the market asa spontaneous order w-ith reference to the meaning of ‘order’ and of ‘spon-taneous’ respectively. The market is a mechanism for allocating resourcesbetween firms and between firms and households. This allocation takesplace for the satisfaction of the needs of tonsumers and producers andthese needs are both physical, economic and cultural (in a capitalisteconomy the prime need of a firm is profit). From this point of view themarket may be regarded as a decentralized mechanism, consisting of inter-related but independent and autonomous agents for need satisfaction.

47

As a viable social mechanism, the market has to allow for both order(structure, stability) and change. Self-interested buyers and sellers withopposite interests as to the terms of exchange meet in the market. Whydoes this meeting not produce chaos rather than order? How is it possiblethat buyers-tonsumers, representing demand, and sellers-producers,representing supply, can agree on the terms of exchange? The answer isprovided by the nature of normal demand and supply functions. Exceptfor so-talled inferior goods (the Giffen paradox, which occurs when verypoor people increase their demand for, for example, bread when the breadprice increases) or conspicuous consumption (increased demand becauseof higher price), demand is inversely proportional to price, while supply,except for the case of increasing returns to scale, is eventually directly pro-portional to price. The underlying conditions are, in the case of demand,that marginal utility is diminishing, while, in the case of supply, the pro-ductive capabilities on the margin are also diminishing (Boland, 1987).Because of. this, a market equilibrium‘ is possible. This equilibriumbecomes efficient if the following six conditions are fulfilled:

1) If the agents are independent decision-markers (safeguarded by effi-cient property rights). 2) If agents att self-interestedly (maximizing beha-viour). 3) If there is free entry and exit, which makes free choice possible.4) If the number of agents is large, which provides buyers as well as sellerswith a large choice set. 5) If there is tompetition, i.e. rival interests bet-ween agents which rewards cost-efficiency, quality improvement, effortand ingenuity. 6) If there is free exchange between agents, which, withgiven resource endowments, implies the possibility of unanimity withrespect to the terms of exchange.

From this we may conclude that the market mechanism representsa possibly stable and efficient static order. But, to be also dynamitallyefficient, the market mechanism must be capable of change and innova-tion. A centralized and hierarchical economic order, lacking a marketenvironment, is also capable of change and innovation. The reason is thatchange and innovation in fatt can be ordered as well as planned. Centrallyordered and planned change and innovation have some inherent positivecharacteristics, like toncentration of effort and planned coordination.These positive characteristics explain the existence and relative success ofresearch and development departments in large torporations. But, sintethese torporations are embedded in amarket mechanism, their innovativeactivity is not only guided by market signals, but also profits from theinnovative activity in other firms, i.e. on the market. Many, perhaps mast,of the important innovations are made in new and small firms and laterpatents, or even firms, are bought or leased by the big torporations. Thedecentralized market mechanism is on the whole superior with respect tochange and innovation when compared with a set of hierarchical firms

48

because it has room for a iarger set of potential inventors, and becausethese inventors are independent and thus have a large scope for freeresearch and development.

In two other respects also, the market mechanism maj be characterizedas a spontaneous order. First, with res’pect to the entrepreneurial function,the entrepreneur is an independent agent with private property rights,who brings about qualitative change in the economic system by introdu-ting new products or new methods. To be able to do this, the entrepreneur,as Robbins points out, ‘must be at liberty to withdraw his capita1 altoge-ther from one tine of production, sel1 his plant and his stocks and go intoother lines. He must be at liberty to break up the administrative unit’. Thisfreedom is not compatible with ‘ownership and control at the center’(quoted in Lavoie, 1985, p. 159). The entrepreneur has incentives tobehave like this because his life and activity are so clcsely linked to his ownfirm. The manager of a firm in a centrally planned economy can be taughtto be an excellent book-keeper. But, sinte creativity implies risk-taking,ability to adapt to market signals, elbow-room for non-planned decisions,and private resources for carrying them out, as well as incentives to att inthat way, the struttural conditions for the entrepreneurial function aresimply missing in the centrally planned economy. The owners of largecapitalist torporations are to some extent confronted with the same prob-lem. They try to overcome the inertia of their managerial bureaucraciesby giving them ownership rights in the torporations. Lavoie puts thetontrast well:

Rival producers under Capitalism may contend with one another about what factorcombination is more likely to promise success. Where capita1 ownership is dispersed, theaccruai of money profits acts as a signal to guide production toward ‘better’ factor combi-nations. Where capita1 ownership is tommon, all decision-makers are part of a jointproject and thus cannot contend with one another in this manner. In such cases there canbe no struggle among decision-makers in their willingness to risk ‘their’ capita1 in variousuncertain avenues, but rather ‘society’s’ capita1 has to be consciousiy allocated in the ‘bet-ter’ ways. Lacking profit and loss signals, these ‘better’ ways would simply be unknown(Lavoie, op. cit., p. 160).The other respect where in the market is an efficient spontaneous order

is in its capability to give tonsumers the freedom to express their needs(preferences) and to choose those goods and services that, given theexisting choice set, best serve these needs. Also, this proper@ - the consum-ers ‘voting w-ith the dollar’ - is made possible by the rivalry of indepen-dent producers guided by self-interest. By exercising their right to votewith their purchasing power, the tonsumers reward some producers andpunish others, and guide the structure of production in a direction thatcorresponds to their needs. The spontaneity of an economic order shouldalso include some properties that allow far the creation and satisfactionof new tonsumer needs. In the centrally-planned economy, those

49

new needs are essentially those experienced, expressed, and catered for inthe production pian by the central planners. Sinte they have no incentivesto introduce new products and services in the plan (especially if theythemselves, due to their power, enjoy a privileged private market) andsinte new products would entail additional administrative costs, it is notsurprising that the centrally-planned economies show a poor retord inthis respect.

We do not need to go into the old discussion of how new needs arecreated in the tontext of the market mechanism. According to one view,widely held among Marxists, new needs are created by production inman’s interaction with nature and society. Thereby, the natural and socialenvironment is changed and this change gives rise to new needs. From thispoint of view, the need for TV-communication arose only when the system ofproduction had supplied the market with TV sets to be bought and enjoyedby the tonsumers. In this view, the market mechanism only passivelyregisters what the system of production has effected. This is true as far as itgoes, but it does not go far enough. In the first place, the market suppliesthe producers with the incentives to produce the new needs. Withoutthose incentives, no new needs would be catered for by the producers.Setondly, the fatt that tonsumers respond positively to a new productsatisfy-ing a new need presupposes in the tonsumers at least a predisposi-tion or a latent need for accepting new products that serve these latentneeds better than existing products, or satisfy a latent need that has notstill been satisfied. The success stories of the tar or the TV may be cases inpoint. In any case, it remgins a fatt that the existence and activity of theentrepreneur as well as the creation of new needs are made possible by theproperties of the market mechanism. From this point of view, the marketcould be characterized as a spontaneous order possessing both stabilityand capability for change and creation.

The market mechanism is not perfect and this quality it shares with allhuman creations. The choice is not between perfect and imperfect, butbetween more or less imperfect creations. Maybe mankind some day Willfind a substitute for the market in allocating resources efficiently. Untilthen, we should use it, regulate it, if possible perfect it, and also supple-ment it with other mechanisms in those domains where it fails to work orto work efficiently. As suggested earlier, it is true that the efficient workingof the market mechanism presupposes the free play of self-interest andthat this poses a problem for the fostering of communitarian ideals of soli-darity and altruism. It is true that a society completely permeated bymarket behaviour would be abominable. But probably a completely com-munitarian society would be so also. ‘If 1 must always make the welfare ofothers my direct intention in acting,’ David Miller has noted, ‘then1 cannot barter and exchange with them even if 1 believe that behaviour of

50

this kind would indirectly maximize the communities’ welfare’ (IMiller,1989). According to Miller, we should approach this problem as one ofrole-playing:

Consider friendship. People can remain close friends even though they find themselvescompeting with one another - say in the market place or on the sportsfield - or onopposite sides in a politital dispute. Multiple role-relations of this kind pose practicaldilemmas - how hard can 1 compete with Jim without jeopardizing our friendship? - butin real life, people are constantly meeting and reso!ving such dilemmas successfully. Whyshould it be any different with community? 1 may identify strongly with a group of peopleand take a deep interest in their welfare, while on some occasions finding myself inconflict or tompetition with particular members. We are sophisticated creatures who donot lind it unduly paradoxical that we should play different roles in relation to oneanother in different aspects of our lives (Miller, op. cit., p. 47).From this approach, it would follow that the main problem with the

market mechanism from a communitarian standpoint would be to keep itworking within its proper domain.

In any case, the market mechanism is not incompatible with democracy.There are non-democratic states that are based on the market mechanism.But, if markets are missing, democracy never exists, while all stateswith politital democracy have market economies. Thus, the market isa necessaxy but nota sufficient condition of democracy. The market has infatt two characteristics in tommon with democracy. In the first place, itgives a ‘voting right’ to the tonsumer in the market place. This propertyhas induced some politital scientiststo suggest a parallel between polititaldemocracy and the market mechanism (Schumpeter and Downs). In anycase, it prevents or makes difficult complete coalitions between economicand politital powers, sinte independent property owners always havesome politital influence. Setond, there is something inherently attractivein an exchange mechanism leading to equilibrium outcomes, i.e. unanim-ity. If the exchanging agents can be made equal with respect to wealthand income, market exchange with equilibrium outcomes is superior evento the majority principle, sinte a state characterized by all individualsbeing satisfied is, of course, superior to a state where a rnajority is satisfiedbut a minority is left unsatisfied.

LITERATURE

Akerlof, G., The Murket for Lenzons, in: An Economic Theorist’s Book of Tales (Cambridge1984).Arrow, K., Uncertainty and the Welfare Economics of Medicnl Cure, Arnerican EconomicReview, 1963, pp. 841-873.Arrow, K. & Hahn, F., Genernl Competifiue Equiilbtium (Cambridge 1971).Boland, L., Methodology for o New Microeconomics. The Critical Foundutions (Boston1987).

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Bramall, C., In Praise of Maoist Economic Planning. Liuing Standards and EconomicDeue-lopment in Sichuan sinte 1931 (Oxford 1993).Chandler, A. D., Jr., The Visible Hand. The Managerial Revolution in American Business(Cambridge, Mass. 1977).Coase, R., The Nature of the Finn, Economica, 1937, pp. 386-405.Donahue, J., The Priuatization Decision. Püblic Ends, Private Means (New York 1989).Einarsen, J., Reinuestment Cycles, Review of Economic Statistics, 1938, pp. 1-10.Ezekiel, M., The Cobweb Theorem, Quarterly Journal of Economics, 1938, pp. 255-280.Gustafsson, B., Lenin och marknadsfrågan, i Lenin V. I., Marknadsfrigan (Stockholm1971).Gustafsson, B., 1 öuermorgon socialism (Stockholm 1981).Gustafsson, B., The Transition from Domestic Industries to Fadories, SCASSS Memo 1987(Forthcoming in print).Gustafsson, B., Frrin gdua till tribut (KVHAA:s &sbok 1989).Gustafsson, B., The Riseand EconomicBehauiourofMedieual Craff Guilds, in: Gustafsson,B. (ed.), Power and Economic Institutions. Reinterpretations in Economic History(Aldershot 1991).Hanau, A., Die Prognose der Schweinepreise, Vierteljahrshefte zur Konjunkturforschung,1928 and 1930.Hayek, F., Law, Legislation and Liberty (London 1982).Lange, O., On the Economic Theory of Socialism (Minneapolis 1938).Lange, O., The Computer and the Market, in: Feinstein, C. H. (ed.), Socialism, Capitalismand Growth. Essays in Honour of M. H. Dobb (Cambridge 1967).Lavoie, D., Riualry and C&traZ PIanning (Cambridge 1985).Lindgren, H., Corporate Growth: the Swedish Match Industry in its Global Setting (Stock-holm 1979).Lazonick, W., Business Organization and the Myth of the Market Economy (Cambridge,ivlass. 1991).Marx, K., Grundrisse. Foundations of the Critique of Politital Economy (1857; Harmonds-worth 1973).Medvedev, R., The October RevoIution (London 1979).Moore, S., Ilfar% uersus Markets (Philadelphia 1993).Miller, D., Why Markets? in: Le Grand, J., & Estrin, S., Market Socialism (Oxford 1989).Olsson, M., The Logit of Collectiue Action (Cambridge, Mass. 1965).Radcliffe, W., Origin of the New System of Manufacture (Stockport 1828; reprini Clifton1974).Schelling, T., Micromotiues and Macrobehauiour (Cambridge, Mass. 1978).Schumpeter, J., Capitalism, Socialism and Democracy (London 1943).Sen, A, Rational Fools in: Hahn, F. & Hollis, M., Philosophy and Economic Theory(Oxford 1981).Sen, A., Pouerty and Famines. An Essay on Entitlement and Deprivation (Oxford 1981).Smith, A., An Inquiry into the Wealth ofNations (Modern Library Edition, New York 1970).Shmelev, N. & Popov, V., The Turning Point. Revitalizing the Soviet Economy (New York1989).Stiglitz, J., Market Socialism and Neoclassical Economics, in: Bardhan P. K. & Roemer,J. E., Market Socialism. The Cunent Debate (Oxford 1993).Wicksteed, P., The Common Sense of Politital Economy, 1 (London 1993).

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Uppsala Papers in Economic History consists of the following series:

RESEARCH REPORTS

1. Bo Gustafsson:

2. Mats Essemyr:

3. Göran Rydén:

4. Alf Johansson:

5. Lena Sonurtestad

6. Li Bennich-Björkman:

7. Håkan Lindgren:

8. Alice Teichova:

9. Lynn Karlsson &Ulla Wikander:

The Causes of the Expansion of thePuhlic Sector in Sweden during the20th Century. 1983.

Food Consumption and Standard ofLiving: Studies on Food Consumptionamong Different Strata of the SwedishPopulation 1686-1933. 1983.

Gammelstilla stångjämssmedja - enmanufakturindustri. 1984.

Market, Nature and Work: The basicsof work organization in a nineteenth-century export sawmill. 1984.

Strukturomvandling och yrkessamman-sättning: Ala sågverk under mellan-krigstiden. 1985.

Nationalekonomi och ekonomisk histo-ria. Inställningen hos national-ekonomer t i l l ämnet ekonomiskhistoria 1929-1947. 1985.

International Finns and the Need for anHistorital Perspective. 1985.

Economic Policies in Interwar EastEurope: Freedom and Constraints ofAction. 1985.

Kvinnoarbete och könssegregering isvensk industri 1870-1950: Treuppsatser. 1985.

10. Bo Gustafsson:

11. Mats Morell:

Det antika slaveriets nedgång: En eko-nomisk teori. 1985.

Eli F. Heckscher, utspisningsstaternaoch den svenska livsmedelskonsumtio-n e n f r å n 1500-talet till 1800~talet.Sammanfattning och komplettering aven lång debatt. 1986.

12. Ragnhild Lundström & Methodological Problems in BusinessKersti Ullenhag: History: Two Papers. 1986.

13. Kersti Ullenhag (editor): Books and Articles from the Depart-ment of Economic History at UppsalaUniversity. 1986.

14. Georg Péteri: The Role of State and Market in theRegulation of Capita1 Imports:Htmgary 1924-1931.1987

15. Hakan Lindgren: Banking G r o u p I n v e s t m e n t s i nSwedish Industry: On the emergence ofb a n k s a n d associated holdingcompanies exercising shareholderinfluence on Swedish industry in thefirst half of the 20th century. 1987.

16. Mats Morell:

17. Juergen Salay:

18. Göran B. Nilsson:

Om mått- och viktsystemens utvecklingi Sverige sedan 1500-talet. Vikt- ochrymdmått kam till metersystemets info-rande. 1988.

The Soviet Union River Diversion Pro-jett. From Plan to Cancellation 1976-1986. 1988.

Kreditens jättekraft. Svenskt bankvä-sende i brytningstid och genom-brottstid vid 1800-talets mitt. 1988.

19. Mattrits Nyström:

20. Lars Magnusson:

21. Hans Sjögren:

22. Eskil Ekstedt:

23. Karl-Gustaf Hildebrand:

24. Gert Nylander:

25. Bo Gustafsson:

26. Gaim Kibreab:

27. Lena Schröder:

28. Ulla Wikander:

29. Anders Floren &Göran Rydén:

30. Maths Isacson:

En spegel av ett sekel. Riksdagensresor i Norrbotten 1880-1988. 1988.

Korruption och borgerlig ordning -naturrätt och ekonomisk diskurs i Sve-rige under Frihetstiden. 1989.

Kreditforbindelser under mellankrigs-tiden. Krediter i svenska affärsbanker1924-1944 fördelade på ekonomiskasektorer och regioner. 1989.

Knowledge Renewal and KnowledgeCompanies. 1989.

Om företagshistoria. 1989.

Företagsarkiv och företagshistoriskforskning. (Forthcoming)

GUMAX Myrdal 1898-1987. Liv ochverk. 1990.

The State of the Art Review of RefugeeStudies in Africa. 199 1.

Från springpojke till fullgod arbetare:Om bakgrunden till 1930~talets ung-domsreservarbete. 199 1.

Delat arbete, delad makt: Om kvinnorsunderordning i och genom arbetet.1991.

Arbete, hushåll och region. Tankar omindustrialiseringsprocesser o c h d e nsvenska jämhanteringen. 1992.

Arbetslivsforskaren i det offentligasamtalet. 1992.

3 1. Gunnar Nordström: Mo och Domsjö och arbetareorganisa-tionerna intill 1940. Frans Kempes per-sonalpolitiska program och Domsjö ar-betareföreningen. 1993.

32. Conny Norling: Byråkrati och makt. Ingenjörer vs eko-nomer. 1993.

33. Anita Göransson: Om teori och historia. Mening, maktoch materialitet. 1993.

34. Bo Härmestrand: Finansieringssätt och attityder. Någraerfarenheter ur ledarhundsarbetetshistoria. 1994.

35. Lars Magnusson: Eli Heckscher and Mercantilism - AnIntroduction. 1994.

36. Torbjörn Lundqvist: Industrialismens kritiker. Utopism, äm-betsmannaideal och samvetspolitik iCarl Lindhagens ideologi. 1995.

37. Olov Åberg & Johan Öster: Efter avslutad färd, en anständig be-gravning. En karaktaristik avundantagsinstitutionen, Nederluleå ochRåneå socken 1790-1895. 1995.

3 8. Lars Magnusson &Klas Nyberg:

39. Lynn Karlsson:

40. Lynn Karlsson:

Konsumtion och industrialisering iSverige 1820-1914. Ett ekonomisk-historiskt forskningsprogram. 1995.

Mothers as Breadwinners. Myth orRealny in Early Swedish Industry?1995.

Women Workers in Figures. A Pictureof Swedish Industry 1863-1912. 1996

4 1. Kersti Ullenhag: Managers, Institutions and Growth.Business History as an Approach toIndustrial History. 1996.

42. Irma Irlinger: Lika lön för lika arbete - Ettnygammalt problem. Uppsala-utredning 1947-1949.1997.

43. Bo Gustafsson Scope and Limits of the Market. 1997.

WORKING PAPERS

1 Alice Teichova: Bivals and Partners. Banking and In-dustry in Europe in the First Decadesof the Twentieth Century. (Reportfromthe Vienna Banking - Industry Sym-posium 1988.) 1988.

2 . FritzKastnerAarsson: Banking and Bank Legislation in Eu-rope 1880-1970. (Report from theVienna Banking - Industry Symposium1988.) 1989.

3. Elizabeth A Boross & Håkan Bank-Industry Connections in Hung-Lindgren: ary and Sweden. Two Studies. (Report

from the Vienna Banking - IndustrySymposium 1988.) 1989.

4. Volker Wellhöner &Harald Wixforth:

Bank-Industry Relations in Theoryand Practise. Two Studies. (Reportfrom the Vienna Banking - IndustrySymposium 1988.) 1989.

5. Ragnhild Lundström &Jan Ottosson:

Bank-Industry Relations in Sweden:Gwnership and Interlocking Director-ates. (Reportsfrom the Vienna Banking- Indus@ Symposium 1988.) 1989.

6. Agnes Pogny &György Kövér:

Banking and Industry In Hungary.(Reports from the Vienna Banking -Zndust~~ Symposium 1988.) 1989.

7, Ulla Wikander (ed.): The Sexual Division of Labour, 19th &20th Centuries. Six essays presented atthe Ninth International Economic His-tory Congress, Beme 1986.1989.

8. Agneta Emanuelsson, Kvinnohistoria i teoretiskt perspektiv.Lynn Karlsson, Konferensrapport från det tredje nor-Ulla Wikander & diska kvirmohistorikermötet. 13 - 16Ingrid Åberg (red.): april 1989. 1990.

9. The Banking Project:

10. Margarita Dritsas:

The Network of Finantial Capital: Es-says i n H o n o u r o f R a g n h i l dLundström. 1990.

Foreign Capital and Greek Develop-ment in a Historital Perspective. 1993.

BASIC READINGS

1. Håkan Lindgren &Kersti Ullenhag (eds.):

Teorier och teoretisk tillämpning iföretagshistorisk forskning. Med bi-drag av Herman Daems, Erik Dahmen,Håkan Lindgren och Kersti Ullenhag.1985.

2. Britta Jonell-Ericsson: Skinnare i Malung. 1987.

3. Håkan Lindgren &Hans Modig:

4. Bo Gustafsson:

5. Bob Engelbertsson & Seminarieuppsatsen. En genomgångLynn Karlsson: av formella krav. 1989.

6. Mats Larsson &Håkan Lindgren:

7.

8.

9.

Paulina De Los Reyes:

Håkan Lindgren (red.):

Juan Bergdahl:

The Swedish Match Company in theInterwar Years. An International Per-spective. 1987.

Den ekonomiska vetenskapens utveck-ling. Del 1: Från Aristoteles till AdamSmith. 1988.

Risktagandets gränser. Utvecklingenav det svenska bankväsendet 1850-1980. 1989.

Bortom Europa. Käll- och litteraturväg-ledning i u-!andsstudier. 1992.

Teori, empiri och metod i ekonomisk-historisk analys. 1992.

Den Europeiska Ekonomiska Gemen-skapen - ursprung och fundament.1994.

UPPSALA PAPERS IN FIIWNCIAL HISTORY

1. Mats Larsson: Aktörer, marknader och regleringar.Sveriges finansiella system under1900-talet. 1993.

2. Alexander Boksjö & Svenska finanskriser - orsaker, for-Mikael Lönnborg- Andersson: lopp, åtgärder och konsekvenser. 1994.

3. Hars Sjögren (red.): Bankinspektör Folke von Krusenstjer-nas vitbok. Anteckningar från bankkri-sen 1922-1923. 1994.

4. Rolf Marquardt: Internationalisering av svenska banker.En process i fem faser. 1994.

5. Mikael Olsson: Corporate Govemance in Economies ofTransition. The case of the SlovakRepublic. 1995.

6. Anders Ögren: Riksbankens penningpolitik. Kreditfor-sörjning och prisstabilitet 1869-188 1.1996.

7. Arne Håfors: En statlig affärsbank i Sverige. Driv-krafter och motiv 1910-1930. 1996.

WORKING PAPERS IN TRANSPORT ANDCOMMUNICATION HISTORY

1. Lena Andersson-Skog &Jan Ottosson:

Institutionell teori och den svenskakommunikationspolitikens utformning- betydelsen av ett historisktperspektiv. 1994.

2. Jan L. östlund: Reglering av kollektivtrafik - stridenpå 191 O-talet om tillkomsten av ABStockholms Spårvägar. 1995:l.

3. Thomas Pettersson:

4. Sven Gerentz:

5. Lars Fälting:

Regionalpolitik och regionalutveckling - med fallstudie forArvidsjaurs flygplats. 1995:2.

Vägverket och företrädarna for bilismoch näringsliv - ett nätverks betydelseför transportpolitik och transportut-veckling efter kriget. 1995:3.

Högtflygande planer i debatten om Ar-landa 1946. 1995: 4

6. Thomas Pettersson: Att kompensera för avstånd - enekonomisk-historisk utvärdering avtransportstädets effekter 1965- 1995.1995: 5.

7. Erik Tömlund: Vägen till försödning. Vägbyggandetsom arbete i Degerfors socken,Västerbotten 1920-1940. 1996:l.

8. Lars Magnusson

9. Lars Magnusson & Transaction Costs and InstitutionalJan Ottosson Change. 1997:2.

Vem och vad formulerar problemen?1997:l.