Free to Choose? Why Free Market Economies Create Happier Populations

Adam Smith

In a previous article I discussed the moral foundations of market institutions and touched upon a subject which will be the focus of this piece. Specifically, whether the concept of the ‘satiability of needs’ is valid? 
If needs are satiable then it could be argued that they could be defined and, there is a valid argument for centralized provision.  If they cannot, then the best solution appears to be to allow market provision. Note that, the former argument does not imply a loss of autonomy, since autonomy is only seen as having a value if it leads to needs being satiated and-according to the theory-these needs can be satiated. 

I want to explore this problem of choices and needs from the perspective of the work of behavioral psychology in consumer choice.


Too Much Choice: People Only Want Jam Tomorrow?

One of the most cited pieces of research on consumer choice is Sheen Iyengar’s ‘When Choice is Demotivating: Can One Desire Too Much of a Good Thing?’ which is most famous for its study of jam selection. The lessons of this study (which is just one part of the work) are oft referred to in the ‘Apprentice’ television series, whereby contestants have actually received challenges which replicate the decision making in this research.

When faced with a large number of jars of jam, consumers appear bewildered by the options and bought less jam. Moreover, they were less satisfied with their purchases. On the contrary, faced with a smaller selection, consumers bought more and were happier with their selections.

Overall, in this work, Iyengar argues…

‘psychological theory and research affirm the positive affective and motivational consequences of having personal choice. These findings have led to the popular notion that more choice is better, that the human ability to desire and manage choice is unlimited. Findings from three studies starkly challenge the implicit assumption that having more choice is necessarily more intrinsically motivating than having fewer options.’

So it seems that consumers do not actually value having unlimited choice over limited choice. So long as that limited choice fulfills their needs. This argument appears to strengthen the idea that needs can be satiated, or at least, that a market with a few suppliers could in fact be better than one with many. An idea, that opens up the possibility of centralized creation of oligopolies, as opposed to completely free markets.


Heuristics in Consumer Choice

Iyengar’s work seems to conform to the principles of the work of Kahneman & Tversky. These two cognitive behavioral psychologists built up a body of research that affirmed the usage of heuristics or ‘short cuts’ in decision making under uncertainty. When faced with many options, humans go through a process of cognitively narrowing the options via using learnt rules or heuristics. If the effort expended in applying this process out cedes the marginal utility in making it, then the process tends to be discarded. In other words, no one can be bothered to decide over what jam to buy.


Free to Choose?

If you put the arguments- in the sections above- together than the case for needs being satiable, appears to be a strong one. However, they appear to go against common preconceptions over the benefit of more choice. Moreover, they also appear to go against the common experience of consumers being offered multiple choices in the marketplace. Supermarkets are full of multiple choices of goods and the internet is booming with long tailed retail. In Chris Anderson's 'The Long Tail' this growing aspect of consumer preferences is discussed in length.

So is this just academic research that falls apart in real world? In addition, is there something intrinsically valuable in having choices that consumers do not necessarily want to use? I suspect so.


Consumers Need Choices That They Don’t Use

It appears that the consumer values having a wide range of options even if it doesn’t appear to be the optimal way for them to make decisions. This perplexing conclusion is only elucidated if one accepts that the value lies in consumers feeling that they are free to make purchasing decisions of their own volition. In a later work, Iyengar expresses this view succinctly in “Knowing What You Like versus Discovering What You Want: The Influence of Choice Making Goals on Decision Satisfaction”

‘Despite the detriments associated with choice overload, consumers want choice and they want a lot of it. The benefits that stem from choice, however, come not from the options themselves, but rather from the process of choosing. By allowing choosers to perceive themselves as volitional agents having successfully constructed their preference and ultimate selection outcomes during the choosing task, the importance of choice is reinstated.’

I am sympathetic to this argument. However, this should not be taken as a validation of the argument that all that need be done is make sure that consumers feel they are making autonomous choices, when in fact they are being manipulated.

The value not only lies in feeling autonomous but also in being part of the epistemic process of the market, whereby tacit knowledge of wants and purchasing desires is expressed through market pricing mechanisms. Consumers want to feel they are part of this process, not only because it is the best way to utilize resources, but people value being free to choose.


Satiability of Needs?

So what does this mean for the satiability of needs? I think that it should be recognized that market mechanisms and freedom to choose should be seen as an end, rather than a means to achieve wants. Whilst needs are not necessarily satiable, consumers are happier when they are presented with choice and the feeling that they are part of the iterative process of defining consumer choice.

In conclusion, being part of the market process appears to be as important as having needs satiated. The implications for social cohesion are clear. Consider two economies which happen to have equal provision of the same type of goods. One has them provided by the market, the latter via centralized control. The one that has it provided via the market mechanism is likely to have a happier population than the latter.  Moreover, it could be the case that the poorer segments of free market economies are happier than those equally poor in a command economy, even though they share the same amount of ‘autonomy’ in terms of being able to enjoy goods.




Source:

Anderson, Chris 'The Long Tail'  Random House Books, 2007

Iyengar, Sheena ‘Knowing What You Like versus Discovering What You Want: The Influence of Choice Making Goals on Decision Satisfaction’

Iyengar, Sheena ‘When Choice is Demotivating: Can One Desire Too Much of a Good Thing?’ Columbia University
 

The Moral Case for the Free Market in the Light of the Financial Crisis (Part II)

In a previous article I outlined the moral basis for the premise that free market economics are the optimal option for economic development. I also argued that -in the light of the financial crisis-the rationale behind these arguments has been significantly challenged. Indeed, the solution to the crisis-that of collectivising risk-not only confirms moral hazard but actively encourages it in future.

 Capitalism doesn't work unless the capitalists and the capital issuers (the banks) are both working under competitive conditions benefitting from Adam Smith's invisible hand but always managing the risk of his slap. Unfortunately one side of the capitalist equation (the banks) has not been working under this premise in recent years.

It's time to look at the scorecard in terms of the arguments outlined earlier and, see how they have fared.


The Argument from Materialism

The strongest moral defence for bailing out the banks was that it would eventually make the environment better for everyone. I think the logic is indisputable, in that as total collapse of the banking system would shave benefitted no one. However, this argument comes with significant caveats. The principle is that all would benefit and that there would not be a significant transfer of wealth and resources from one group to another via collectivisation and redistribution. Unfortunately, this has not happened.

The reality is that significant risk has been transferred to the public from the banking system. Central \banks took on toxic assets. Sovereign Debt Fears have exposed peripheral Europe to significant drags on growth that affect everyone. Furthermore, the actions of the Central Banks have, thus far, ensured that whilst the banking sector has been recapitalised and their staff are enjoying the benefits, they feel the need to hoard cash. In a sense, the banks are doing exactly what they did before the crisis. In other words, taking the benefits and rewards whilst passing on the risk to the taxpayer. They are parlaying the system in a zero sum game that is directly hurting the populace at large.

For example, the UK banks according to the CEBR, they paid their staff £7bn in bonus. Saviles (the upmarket real estate agent) estimate that £1.6bn of this will go into the London housing market. Meanwhile, the UK has loaned the Irish £7bn in order to help out their Sovereign Debt crisis, ostensibly so that it doesn't hit the UK banks.

These actions (by the banks) are the height of irresponsibility. They know full well that the Sovereign Debt on their balance sheets (remember that the risk to public debt increased by taking on banks toxic assets) threatens their capital/asset ratio, so why are they awarding themselves bonuses?

 So, in conclusion, the UK taxpayer has increased risk, higher taxes and now higher house prices to pay thanks to a redistribution of return and risk.

The Epistemic Argument for the Market

Libertarian defenders of this argument will argue that the banks should have been allowed to fail and, that this is part of the process. However, the problem with this argument is that it doesn’t devolve the free market system from the responsibility of creating the financial crisis in the first place. Moreover, allowing the banks to go bust was simply not an option.

The banks and their employees were incentivised, under guiding principles of self interest, in order to maximise profits. Unfortunately, this profit maximisation came at the expense of the taxpayer, the shareholder and the economy at large. The people garnering excessive rewards were not exposing themselves to the risk. In fact, the greater risk was in not complying, because if the employees didn’t take part in the game, then they could have lost their jobs.

The essence of the problem is that the banks were leveraged and all following the same directional strategy. The forces of competition rely upon accountability and also on the fear of failure. It relies upon large companies acting under the same conditions of competition as the smallest entrepreneur is subject to. None of these conditions applied.

Indeed, if we go back to the arguments postulated by the Austrian School over the difficulties of simulating market pricing, we get to a curious irony. Many of the banks were arguing that they didn’t need to engage in mark-to-market pricing of their CDO’s because the market was artificially pricing them lowly and, forced selling would only exacerbate the problem. Similarly, they spent large parts of 2008, trying to justify loss provisions based on their own assumptions of the housing market. In a sense, they repeated the inevitable errors of centralised pricing.

They did so, despite being guided by market competition.

The Argument From Autonomy

As discussed previously, much of this argument is rendered complicated by definitive arguments over positive and negative liberty. Assuming that ‘autonomy’ means needs can be satiated; we see that the question posed here can be defined as, autonomous to do what?

If we accept that we can define satiable needs, and start out to do so, I think that it could be argued that employment, housing and raising a family are all essential aspects of the ‘good life’. It is hard to argue that this autonomy has increased over the last few years. Not only have the redistributive aspects of Government policy (as outlined above) reduced the material prospects for all, but they have also entrenched the vested self interests that actively deny young people the opportunity to do this.

The Government has allowed the banks to game the system and made the conscious decision that, the solution to the problem was ‘more of the same’. They have artificially supported the banking system and the UK housing market. There remains an undersupply of housing in London and South East. 

It need not have happened like this. The opportunity was there to generate growth by relaxing planning restrictions in London. Such action would have produced GDP growth, employment, and made housing more affordable in the areas where people actually want to live. Instead a decision was made to shore up the wealth of a select few in the UK by continuing to artificially rig the London housing market.

It should not be lost on the reader that the beneficiaries of these actions are-in many cases-the self same people that benefitted from the creation of the financial crisis. In 2008, a Savile’s strategist informed me that around 25% of overseas high end (houses £4m and above) where overseas bankers working in the UK.

None of these actions has increased the autonomous options available to most.

The Argument From an Increasing Intellectual Quotient

The desire of the banking industry to ‘intellectualise’ their activities in respect of replacing good ol’ fashioned lending from customer deposits, towards reliance on short term wholesale funding was a serious defect of the system. Similarly, the creation of ‘off-balance’ sheet accounting which enabled the banks to take on significant directional leverage helped create the ensuing crisis.

This ‘intellectualisation’ was anything but intellectually enhancing. In fact, it was a shabby and reckless attempt to maximise short term profits which ultimately ended up in a collectivisation of the losses due to it.

The aftermath of the crisis has brought about an increasing focus by regulators to discourage this kind of financial engineering with derivatives trading. Whether, they will be successful or not is another question.

Creation, Globalisation and the Poor

The last three arguments are best dealt with in one section. Firstly, it is undoubtedly true that free markets engender greater creativity. However, as we have seen, this creativity can sometimes be channelled towards destructive or exploitative purposes which curtail others creativity. The banks gamed the system to the taxpayers’ expense. This is not an act of ‘creativity’ worthy of the name.

Globalisation as actually made the situation worse. It has encouraged greater correlation of markets and therefore amplified the risks when things go wrong. I wonder out loud whether the Asian Financial Crisis (97-98) will be the last major regional crisis not to significantly affect the global economy in a synchronised and coordinated manner.

As for the poor, I fail to see how the redistribution of resources and wealthy that has, knowingly, taken place as a result of bailing out the banks, has in any way contributed to social mobility or advantage to the poor. On the contrary, unemployment is still very high in the States (the US is not a country structured with a welfare system to deal with these problems) and remains persistently high in Europe.

Conclusions

The narrative of this article has been consistently negative. I make no apologies for that. The behaviour of the banks is morally unacceptable. Moreover, regulators are at fault for not upholding the same standards of free market accountability on the banks as they would for anyone else. Whilst the libertarian approach is exposed as a fallacy, it does not mean that the morals and principles of the free market are not the optimal approach. However, they only acquire moral validity by their actions and their results.

The solution to the problems engendered by allowing banks to operate under ‘free markets’, seems to inevitably end up in collectivising and redistributing resources towards them. Therefore, it is better to take collective action before hand, in order to make them directly accountable for their actions. The libertarian approach fails and the moral arguments in favour of it are bankrupt. ‘Too Big To Fail’ is not an option anymore.

The Moral Case for the Free Market in the Light of the Credit Crisis (Part I)

After the demise of the Berlin Wall much ink was spilt outlining the impeding triumph of liberal democracy. The subject of this inquiry is not so the democratic part of the formula but rather the liberal bit. Specifically, I think it is time that intellectual debate focused on the shock that the credit crisis has caused to liberal thinking.

This first article will outline the moral case for the market. In the second I will appraise the 'scorecard' for these arguments in the light of the developments of the last few years. How does the moral case for the market stand up in the light of Moral Hazard?


Too Big to Fail and how it Broke the Libertarian's Case

In short the demise of the capital markets and the collectivist solution that was inevitably enacted has shaken the libertarian's very philosophical foundations. Whereas previously, free market enthusiasts would rely on Adam Smith's 'invisible slap' to, or rather the fear of it, in order to generate a self regulating system that ensured that

1. Economic agents were accountable for the risks they took
2. Risks were graduated into the system via agents having the fear of failure
3. The diversity of agents ensured that when failure occurred the system was maintained

Now, clearly 'Too Big To Fail' and the necessary collectivisation of the problem, dealt a fatal blow to the tacit acceptance of the idea that the libertarian ideal could ever work in practice. Some will argue that the Banks should have been allowed to fail, but I think this is a largely academic argument. However, these issues are covered very well by the likes of Nassim Taleb and also in a speech from Mervyn King, which I wrote about here, and I do not want to go into detail on them now.

Rather, I want to focus on the re-appraisal of what these events have meant for the moral case for free market economy. This matters to me, because I happen to believe in these arguments!

The Moral Foundations of the Free Market do not Depend Upon Weath Creation Alone

It would be easy to draw the conclusion that because, the free market system has demonstrably been more successful in generating material wealth, that the moral case for the free market lies on this ability. Frankly, I think that this utilitarian argument is a weak one because economic growth, in itself, does not contain an ethical dimension. Moreover, this kind of quantitative assessment has never (and can never) get to what the numbers actually mean to an individual's assessment of his life or his ultimate reality.

We can no more accurately find a 'measure' for the sum of each individuals utility in this way, than we can accurately simulate market pricing by via a command economy. Relying solely in GDP growth is not the answer. Indeed, post war Russia was a rapidly developing economy with high GDP growth. It just developed lots of things that nobody actually wanted!

The Moral Case for the Free Market

In John Gray's "The Moral Foundations of Market Institutions" a number of arguments are propagated for the primacy of the market model. Although, for Gray a libertarian position is not adequate.

"a crucial feature of the logic of the ethical defense of the market becomes apparent. This is that the argument which justifies free markets as enabling devices for autonomous choices also, and inexorably, justifies the institution of an enablng welfare state"

He goes on to outline the reasoning and principles behind his model of the social market.

In 'God and the Marketplace', Michael Novak writes a chapter in which he comments on Gray's work and also elucidates a number of moral arguments for the market. Ignoring Novak's critique of Gray, I will outline these arguments and then put them in the context of the current financial crisis.

The Argument from Material Improvement

It could be argued that capitalism is promulgated by the self interest of the individual in making his material condition better. When coached in terms of 'covetousness' this 'moral plus', not only becomes an infringement of Christian Theocracy, but also is seen as a zero sum game. In other words, he who has had his good or material coveted, is set to have it taken from him.

However, material improvement need not be seen as a zero sum game! Indeed, in the act of creation or improvement that an individual sets out to achieve, can be built the edifice of improvements to society that benefit all. These material benefits can clearly be seen. The poorest person eligible to receive medical treatment via public provision today, will receive better treatment than Queen Victoria or George Washington ever would have. Moreover, the act of creation in itself is a positive for the individual involved.

The Epistemic Argument

This argument is forcibly articulated in Gray's work cited earlier. In his book, he summarizes the insights garnered by the Austrian School and their observations over the logical impossibility of being able to rationally replicate the information (pricing etc) produced by market systems. For Ludwig Von Mises, socialist economies are impossible because of the lack of market pricing. Friedrich Hayek argues that the market contains knowledge that is dispersed through the economy and which cannot be known by central planners. However, the market is a device for transmitting this information.

Michael Polanyi argues against central planning in economy as well as scientific planning. He thinks that science (as well as in economy) there is tacit knowledge which cannot be put together by centralised planning. The market is seen as being as the mechanism whereby this information is transcribed and articulated.

Free Markets Create Autonomy

Free Markets are seen as granting greater autonomy to an individual, in order that he can make a wider range of autonomous choices in his life. This is a contentious issue as much debate will centre on the possibility of needs to being satiated. If like Gray, you think they can, then the process can then begin whereby one would set out a pathway to achieving this. However, if you think they can not be, than you might be attracted to adopting the classical liberal position of favouring the aim of negative liberty. Isiaah Berlin is excellent further reading on the subject. However, for the purposes of this enquiry let us assume there is an intrinsic value in the greater creation of autonomy.

The Argument from Increasing Intellectual Quotient

Increasingly, goods are being produced that have a greater portion of their value in intellectual property. This results in a greater amount of human input and less on the material. As the market economy shifts us towards these types of goods the opportunity for human enrichment.

The Argument from Personal Creation

This argument was touched on earlier, but it deserves its own definition. It is, the argument that capitalism encourages personal subjectivity and creation. The individual grows spiritually as he engages in creative acts which force him to make existentialist decisions over his future. Furthermore, economies are growing increasingly reliant on intellectual capital -as expressed in the paragraph above- and this will allow greater spiritual interaction between individuals.

Globalisation is Creating Shared Interests

Given an expanding global market it is likely that interests will become increasingly enmeshed which should produce greater understanding of cultures. Markets can be seen as instruments of integration and discourse within communities and in doing so create a shared community of interests.

Free Markets Create Greater Opportunity for the Poor

It is argued that free markets create greater opportunity for the poor. Social mobility is greater in free market economies and the opportunity for skill and chance to play their role are greater. Moreover, poorer people tend to receive more opportunity given that there is more emphasis upon personal intelligence and creation in these types of economies, than there is in a centralised command economy.


Conclusion

Having articulated the moral case for the market, it is now time to turn to consider how they have fared over the last few years. I believe that the collectivisation of capital markets following the credit crunch is a significant event that raises significant challenges to our understanding of the society we live in.

The second article can be found here

Source:

Berlin, Isiaah "Liberty" Oxford University Press, 2002

Gray, John "The Moral Foundations of Market Institutions" Institute of Economic Affairs Health and Welfare Unit, 1992

Davies, John (Editor) Michael Novak and others "God and the Marketplace" Institute of Economic Affairs Health and Welfare Unit, 1993