John Kay – a marvellous economic journalist and commentator

Ever since I read his marvellous The Truth about Markets I’ve been a fan of John Kay – an economist who doesn’t like to get too far away from reality. He’s also not a zealot for any particular view of the world, except that pathetic kind of vagueness and pluralism to which I aspire myself. Perhaps he might even be a Conservative, Liberal Social Democrat after my own heart. In any event, this post is just a marker to suggest that you do yourself a favour as Molly Meldrum used to invoke us to do and get a hold of his recent paper on “The Rationale of the Market Economy” It’s subtitled ‘A European Perspective’ but it’s not entirely clear why since his focus is universal (though judging from some of his columns, Kay thinks that the market life the French have built for themselves is better than the market life the Americans have built for themselves (pause for our red meat eaters to scoff and tell us that that’s just fine while he sips on his champaign and latte.)

Anyway, the key theme of the paper is the importance of pluralism – in civil and market society. Couldn’t agree more.

This passage puts the argument and may get you linking through to the article itself – note it looks like it’s behind a paywall but if you persevere you’ll find it’s just a wailing wall – you just give them a few details and they let you download the document and ask you to lobby your local library to take their journal.

Greed must be constrained, but it is inadequate to describe that constraint simply as the rule of law. The property rights that are critical to the rule of law are not given by nature, but are socially constructed.4 Information asymmetry is endemic in modern economies with complex products, and that asymmetry is handled mainly through the mechanisms of trust relationships and reputation. Market economies operate with far more coordination and cooperation than the model of unrestricted greed allows. The simplistic account of human motivation based on self interest comprehensively fails to recognise the real complexities of human behaviour.

So what are the real strengths of the market economy? There are three components. Prices act as signals; the operation of the price mechanism is a better guide to resource allocation than central planning. Markets function as a process of discovery the chaotic process of experimentation through which a market economy adapts to change. And markets yield benefits from the diffusion of political and economic power. Prosperity and growth require that entrepreneurial energy should be focussed on the creation of wealth rather than the appropriation of other peoples wealth. Decentralisation of authority and deconcentration of activity limit rent seeking.

In what we teach, in what we say, in what we do, in our economic research and, most importantly, in the policies we adopt we put too much emphasis on the first of these elements prices as signals to guide resource allocation. We do this at the expense of the, possibly more important, second and third elements markets as process of discovery, markets as mechanism for the diffusion of political and economic power. In consequence, both supporters and critics of the market economy often confuse policies that are pro-business with policies that are pro-market. This confusion has undermined the social and political legitimacy of the market economy. Serious policy errors have followed from mistaken, or at least incomplete, understanding of how a market economy really works.

One central theme runs through all three strands of argument: that of disciplined pluralism.5 When prices act as signals, decentralised enterprises and decentralised information are brought together to create a coherent result. Markets as a process of discovery are based on freedom to experiment, combined with discipline: unsuccessful experiment is acknowledged and terminated. Markets as a means of decentralising power illustrate how political and economic pluralism are closely associated in the achievement of an open society.

Kay’s understanding of the world gives him a visceral dislike of entrenched interests – and he singles out the entrenched interests in our cultural industries – think music and all those people opposing Google’s digitising the world’s books (the small-mindedness of this strikes me even as I write this) and finance. And here’s the guts of that section of his essay.

Large businesses, or groups of large businesses, use the leverage that power gives to strengthen established positions and enhance the economic and political power still further. Financial services and intellectual property are the most important battlegrounds today. Common to both is the malign consequence of viewing the industry through the eyes of established firms.

The current problems of the financial services sector are too familiar to require much elaboration. Governments of the world have pumped unimaginably large amounts of money into the system. Directly through recapitalisation and purchase or underwriting of so-called toxic assets, and more substantially if indirectly through wide-ranging implicit and explicit guarantees of liabilities. Even if these explicit guarantees expire, a too big to fail doctrine has been established which means that implicit guarantees persist indefinitely. The criteria needed to qualify for these guarantees are, essentially, that the firm is large, well established, and unsuccessful commercially. It is difficult to think of a policy more directly contradictory to the central dynamic of the market economy.

Behind that policy lies the central fact of modern political life that the financial services industry, and particularly its investment banking arm, has become the most powerful political force in the United States and other countries. The reasons are clear enough: the rents available in the financial sector have attracted much of the ablest talent in the two countries and created a generation of financiers who are both smart and wealthy.

Digitisation is transforming all media industries. The change was most immediate in music. The music industry is thriving. The demand for live performances is growing rapidly. As with so many leisure activities, people will pay much more than had traditionally been imagined. Recorded music can be distributed much more cheaply and at higher quality than before. Overall expenditure on music has been increasing, and so has the share of revenue going to artists.

New technology isnt a problem for the music industry, but an opportunity. New technology is a problem for some established firms in the music industry. Music publishers attempted to use legal restrictions to prevent internet distribution in order to preserve their established business model, and failed. Piracy took off, not as an alternative to legal downloading, but as an alternative to no downloading.

The result of this organised resistance to inevitable change was that these businesses marginalised themselves. They ceded market dominance to, bizarrely Apple. But probably such marginalisation would have happened anyway. It is rare for established firms to migrate successfully to new business models in the face of disruptive technologies.

We can already see the beginnings of the same problem in books. The idea of a universal digital library may be the most exciting development in the book business since printing.15 The issue is presented as a problem for authors. It isnt. Not only will authors have expanded opportunities to make their work available, but prospect of a digital library potentially solves the problem that has dogged authors and limited their economic opportunities for centuries: the absence of a trail of record between author and reader. The problem is, once more, what is the role for established publishers in the new era? Their ability to insist that policy makers find one is capable of delaying the application of new technologies for decades.