1 The market giveth and the market taketh away

Economic life at the national and increasingly at the international level has become organized along the lines Adam Smith foresaw and Karl Marx criticized. We produce our daily bread (and our daily clothing, shelter, medical care, transportation, information and pretty much everything else we consume) through a complex division of labor largely organized through the exchange of products on markets (which Marx called the “commodity form” of production). Capitalist commodity production is based on money and money capital, and so we also depend on an equally complex set of financial institutions and transactions to finance the production and circulation of goods and services. Thus our economic security and well-being are intimately connected with the functioning and malfunctioning of markets, as the current financial-economic crisis reminds us so forcibly.

As the economic advocates of laissez-faire market organization of production who dominate the economic profession in the U.S. and increasingly in the world (though thankfully not at Barnard College) tirelessly remind us, this capitalist commodity system of organization of production through markets has many good things to offer. Markets, when they are competitive and reasonably transparent, can aggregate information from many dispersed individuals to guide production and investment toward the approximate satisfaction of human needs. The capitalist form of productive organization puts primary control of technological innovation in the hands of successful entrepreneurs, thus encouraging a technologically dynamic and progressive pattern of economic development. We also know from long historical experience that this system has some less attractive features. It tends to distribute the fruits of economic effort very unequally. It also creates a great deal of individual risk and insecurity through the turbulence and instability of market fluctuations.

Economists have spent a great deal of effort understanding the limitations of markets (though they tend as a rule to place the discussion of the advantages of market organization at the beginning and of the disadvantages at the end of the curriculum). Ideally markets work best when the economic decisions of individuals are independent of each other. When the decisions of individuals have consequences for other individuals, or depend on each other in ways that are not completely captured by the market transactions themselves, various market pathologies result. Economists call these extra-market dependencies externalities.

We experience externalities all the time in real life, though we may not always use economic terminology to label them. Traffic congestion, for example, is a vivid constant reminder of external effects, which we can hardly fail to experience as part of modern life. I am just minding my own business, for example, going to work, but at the same time I am getting in your way and slowing down your effort to mind your own business. Some externalities come to our attention indirectly, such as the impact of the burning of fossil fuels on global climate change. In fact, when we examine almost any economic interaction closely, we find that externalities are involved. In some cases they may be relatively small in relation to the market-mediated aspects of commodity transactions, but in other cases they are extremely important, and have impacts on human welfare on the same scale as the gains from commodity production itself.

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Duncan Foley: Department of Economics, New School for Social Research, 6 East 16th Street, New York, NY 10003, and External Professor, Santa Fe Institute. email: foleyd@newschool.edu. This talk was written as the Gildersleeve Lecture at Barnard College, April 17, 2009. I’d like to thank Barnard College, the Gildersleeve Fund, the Barnard Economics Department,
and David Weiman for inviting me as Gildersleeve Lecturer.