Exploitation on the Market?

Richard Epstein is surely right in recently observing, contra Democratic Socialists, that “Voluntary contracts—those not tainted by duress or fraud—are exploitation’s opposite. They foster mutual gain for all parties.” Contracts reflect a unanimity principle: unless every party to the contract feels better off than without the contract, the contract will not form. Voilà, everyone’s better off. This raises a puzzle, however: So why would anyone be a Democratic Socialist? Seriously. If exchange only generates win-win outcomes, then why would Democratic Socialism have any appeal? The problem is that experience with the institutional corollary to contract, the competitive market, does not always feel win-win.

Here I’m not talking about market failures (externalities, public goods, asymmetric information, etc.). I’m talking about the actual experience of people in and with competitive markets. We typically are more attuned, at least as a relative matter, to market dynamics in those markets we engage as labor or entrepreneur than as consumer. After all, we buy in hundreds if not thousands of markets. We usually work in only one or a few.

Market competition induces a prisoners’ dilemma among competitors, whether those competitors are entrepreneurs in a given market or workers. This is a good thing socially. Production is higher (there is no “deadweight” loss) and the producers’ surplus gets distributed to the public. But this social good, which market participants enjoy in consumer markets along with everyone else, is largely invisible relative to what they feel they lose through competition in markets in which they produce. The experience of the participants is they are “forced” by competition to lower the price or wage relative to where they would most prefer to sell.

Adam Smith’s famous observation that “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices” provides evidence of this feeling. As among themselves, that is, ignoring society, the win-win outcome for the tradesmen is to fix prices higher than the competitive equilibrium. If the benchmark they use as their guide is the competitive price relative to the fixed price, then they are better off with the fixed price relative to the competitive price, notwithstanding they are better off overall when producing at the market price relative to not producing at all.

This feeling, however, is not limited to Smith’s price-fixing tradesmen. A similar experience drives the desire for labor unions. If workers did not compete against each other on wage, then they could demand a higher wage from their boss. To be sure, this argument cannot not work in equilibrium in a perfectly competitive market given that a higher than competitive wage would mean the business could not offer its product at a competitive price and would have to shut down. Perfect competition, however, is a theoretical abstraction. That markets converge toward competitive equilibrium entails they do not always, or even usually, exist at equilibrium.

Again, the question is one of the benchmark. If workers look at the wage they could command if they did not compete against one another in wages, then they will feel as though they are worse off as a result of the market. And relative to the non-competitive benchmark, they are. And if the competitive wage shifts downward – say because of decreasing transportation costs for importing the same good from abroad where labor is cheaper – then what the worker feels forced to agree to a lower wage, a loss, even assuming the job even remains an option, because elsewise the boss, in pursuit of higher profit, will locate production abroad.

The problem is, if the entire economy were to be cartelized – in capital, land, and labor – we would all be dramatically poorer, relative to a competitive market. The argument is akin to arguments we hear that higher minimum wages don’t cause unemployment: Shoot, if a higher minimum wage doesn’t cause unemployment, then let’s stop nickel and diming the thing. Let’s set it at $100,000 a year and all go home. The observation provides its own answer.

The collective action problem is the rub. As with Adam Smith’s tradesmen, we don’t want a fully cartelized economy. We want to cartelize our part of the economy, keep the surplus for ourselves, but enjoy the fruits of competition in all the other sectors of the economy.

The problem with the market, ironically, is that it harnesses individual interest but socializes the benefits of production through price competition. The benefits are distributed to everyone rather than kept by owner or worker. The irony is that the socialist objection to the market stems mainly from the fact that the market is so good at socializing the benefits of production rather than from the fact that it socializes too poorly. That the market system is best for everyone (again, assuming competitive markets exist) is more complicated than pointing to the essential “win-win” aspect of contract.