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'Reinventing the Bazaar': Designing Markets
By:
Barry Gewen Here is the perfect book for the Age of John McMillan, a professor of economics at Stanford University's Graduate School of Business, is more than a proponent of free markets. He is a celebrant, an enthusiast. He delights in taking us on an economist's tour of the world -- introducing us to the Dutch flower market in Aalsmeer; the centuries-old camel fair of Rajasthan, India; the brave, persistent vendors of Accra and peddlers of Hanoi, who keep coming back despite the brutal efforts of their governments to suppress them. Markets, McMillan explains, empower people by encouraging autonomous decision making and individual participation; in the jargon of the moment, they are ''proactive.'' Markets generate productivity and efficiency, allowing resources to flow where they can most usefully be employed. They are flexible in ways that no centrally planned system can match. ''For poor countries,'' McMillan writes, ''they offer the most reliable path away from poverty. For affluent countries they are part of what is needed to sustain their living standards.'' Put two people together and it won't be long before one of them is figuring out what he can sell to the other. Markets emerge under the most dire conditions. Rwandans living in refugee camps following their genocidal civil war found ways to set up food exchanges and general stores. British prisoners during World War II swapped their Red Cross rations among themselves, using cigarettes as a form of currency. Rembrandt helped create an art market in 17th-century Holland. Mozart entered the marketplace to escape the domination of patrons and maintain his artistic freedom. So far, so familiar. But McMillan has another shoe to drop. Markets may arise spontaneously as ''the most potent antipoverty engine there is,'' yet as they develop, becoming more complex, they need rules and structures to perform properly. Sometimes the rules will come from the participants, working together in their common interest. The wholesale diamond trade of New York City is regulated by the Diamond Dealers Club, which sees to it that oral agreements are adhered to. The New York Stock Exchange originated at the end of the 18th century in the closed auctions of 24 brokers who had discovered that free riders attending the daily outdoor auctions on Wall Street were distorting the actual prices of stocks (and undercutting commissions). The most important, most necessary regulator, however, is the state. Markets achieve their full potential, McMillan insists, only if the government is providing infrastructure. He identifies five conditions that government must guarantee if markets are to flourish: information has to flow freely; people have to be able to trust one another; competition must be assured; property rights must be protected; and side effects like pollution have to be controlled. Without state intervention, markets can scarcely grow beyond primitive face-to-face transactions. The libertarian utopia of complete laissez-faire does not give you prosperity, it gives you Somalia. In 2000, five years after the United Nations had departed, Somalia was a country without a government. No taxes were being collected, and consequently the number of small businesses exploded. Yet the economy has not been a success, and will not become one. Businesses have to dispose of their own garbage, generate their own electricity, find their own sources of water. In the absence of a police force, protection money has to be paid out. Inefficiencies prevail. McMillan is waging a two-front war here, battling against those who think markets are inherently exploitative and those who think markets can do no wrong. Markets, he writes, are human institutions, with human imperfections. They do not necessarily work well, and they are ''too important to be left to the ideologues.'' Without effective government oversight to assure good corporate market behavior, we can expect two, three, many Enrons. And everyone will suffer as trust declines and investment shrinks. ''Countries with stronger investor protections have bigger capital markets,'' McMillan points out. ''The efficacy of the stock market varies with how activist the government is in setting the platform.'' Ronald Reagan once famously declared, ''Government is not the solution to our problem; government is the problem.'' Ronald Reagan was wrong. He was wrong because, as McMillan shows, there are no easy answers. Economies are complicated, and the interactions between governments and economies are also complicated. Decisions must be made pragmatically, on a case-by-case basis. ''Reinventing the Bazaar'' is full of examples. Why, for instance, did Silicon Valley become the center of the computer industry and not Route 128 in Massachusetts? Experts would have predicted the opposite. But Massachusetts had an intellectual property law that prohibited employees from taking the knowledge they had acquired in their current jobs to new jobs. In California, which had no such law, job-hopping was rampant. Individual companies suffered because knowledge they had developed was widely shared. But the industry as a whole prospered. ''A subtle aspect of market design, in other words, was a crucial element of Silicon Valley's success.'' Market design has also been responsible for the effectiveness of the federal government's acid rain program. In 1990, Washington created tradable emissions allowances, permitting companies to buy and sell the right to pollute. The government continued to set pollution standards, but the market would do the work of determining how much sulfur dioxide each individual company would be allowed to emit. Efficient companies sold their allowances and were rewarded; inefficient companies were penalized. And even environmentalists got into the act by buying allowances and withholding them. Most experts, McMillan reports, say emissions allowances have been more successful than any previous program at reducing acid rain. One of McMillan's most arresting examples concerns AIDS and the pharmaceutical industry. Why shouldn't anti-AIDS medications be dispensed free to third world sufferers too impoverished to pay for them? Moralizers won't like that McMillan performs a cost-benefit analysis while people are dying, but his point is that there are costs no matter which course of action is chosen. Drug companies depend on profits to perform the research that leads to new medication, McMillan observes. No profits, no research, no new drugs. In this case, he concludes, abrogating the companies' patent rights would save lives without greatly affecting profits, since there is such a small market for AIDS drugs in the third world. But, he goes on, there is a grim side to this story. ''Letting the poor nations free-ride is of potential benefit only with diseases that strike the affluent countries and have the U.S. and European markets as an inducement to innovation. With tropical diseases, no patents would mean no research.'' And even with patent protections, unless economists can come up with ways to change the market dynamics of the pharmaceutical industry, the drug companies will spend more on fighting baldness than they do on fighting malaria. As this example shows, markets can function properly and still produce undesirable results. ''The challenge of market design,'' McMillan states, ''is to devise mechanisms, or to allow mechanisms to evolve, that channel the pursuit of profits in a socially productive direction.'' Ultimately, this is a book about tinkering, a technocrat's plea to all of us to recognize that the big ideas are usually wrong, that the truth is not so much in the details as in the adjustments to the details. For a technocrat, McMillan is a surprisingly accessible writer; he deserves a wider readership than he will probably find (though when it comes to his own specialty of constructing public auctions, he can sound like the dinner guest who goes on talking long after you have stopped listening). Still, McMillan's world is not quite the real world. If he had his way, many of the country's most contentious domestic issues and many of the globe's most pressing economic problems would be handled by locking a bunch of economists in a room and letting them hack away at market designs. He may be right. And he may well get the hearing he deserves at institutions like the World Bank and the International Monetary Fund. But pragmatism and rationality have never gotten the crowds out of their seats, cheering. In the marketplace that we call the democratic arena, it will surely be the great simplifiers who continue to set the terms of the debate. 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