WHAT IF MARKETS DON’T WANT TO BE FREE?

17 July 2011

In modern societies the advertised prices of things have become increasingly deceptive – making our markets more imperfect and our economies more problematic.  What does that tell us about “free” markets, and about freedom generally?

Suppose that you’re in a bookstore, and you decide to buy a book. A sticker on its cover shows the figure: $19.99.  Suppose too that your income averages to the round figure of $4,000 monthly (roughly the US median).  In a market with clear and accurate pricing (a feature of what economists call a “perfect market,” which maximizes the welfare of buyers and sellers, i.e., the value to society), the real cost of the book to you – in principle, the increment of extra labor required to obtain it – would be based merely on those two figures, $19.99 and $4,000, both of which would be clear to you.

Now consider some of the factors in a modern market society – such as the US – that destroy the clarity of such an exchange.

The “99” disguise

Your brain is apt to translate “$19.99” into “something in the teens” rather than $20.  Sellers constantly “lie” to you by using this one-cent-below-a-round-number cognitive illusion, and numerous studies have shown that it works as intended.

The plastic effect

You probably have a bank debit/credit card, and often pay with that.  And why shouldn’t you?  It’s more convenient not to have to carry cash around; plus your bank keeps track of your purchases, so you don’t have to.

But the act of taking cash out of your wallet helps you to perceive the real price more accurately. You hold the amount in your hands, and give it to another person. Your card, by contrast, is merely swiped and then replaced in your wallet.  You seem to lose nothing.  So simple!  And yet so deceptive!  Do you really think that such cards were invented solely for your convenience?

And this doesn’t even take into account the additional “free money” feeling of spending borrowed funds – “low introductory interest rate!” – using a credit-card.

Sales taxes

A typical state-plus-local sales tax is 7%.  So, in this case, despite your “somewhere in the teens” price-perception, the amount of money you give up in the transaction will be $21.39.  A minor gotcha but a gotcha nonetheless.

Marginal income taxes

Here is the major distorter of real pricing in most parts of the world.  I wonder what would happen to the global economy were this massive distortion to be removed – since, like the others I am listing here, this one nudges people to underestimate prices or overestimate their income, so that they are more likely to consume beyond their actual means.

In the US, your marginal tax rate on your $4,000/month income, assuming that – as people in the Western world increasingly are – you are a self-employed consultant or freelancer, would be:

25%  – federal income tax

15.3% – self-employment tax (to fund Social Security, Medicare, etc.)

5% – typical state income tax

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45.3% – net marginal income tax

The “marginal” means of course that this is the amount of tax you pay on each extra dollar you earn.  Thus, to have the after-tax money to pay for your $21.39 book, you need to earn not $21.39 but $21.39 ÷ (1 – 0.453) = $39.10!

That’s right!  The actual cost, in terms of your labor, of anything you buy that is not tax-deductible is nearly double the listed price, because of taxes that are not directly advertised.  Cognitive illusions from .99 pricing and the use of bank cards only make the perceptual distortion greater.

There are still more price distorters out there, including the interest and fee components of leases and mortgages, extra fine-print fees such as cellphone companies and airlines routinely charge, tourist taxes on hotel rooms, tips, the costs of driving to do retail shopping, social costs such as pollution, advertising which bundles subconscious promises of sex or glamor with humdrum products to boost their perceived value, and the marketing of substances whose value to consumers is inherently distorted by addiction (cigarettes, alcohol, fast food).  Anyway my broad point should be clear:  There is almost always a huge discrepancy between the perceived price of a good and the true value that you exchange for it.

An even more important point is that these price distortions have been creeping in to the market in the modern era, not creeping out.  In 1880, for example, the average buyer in the US faced no income tax or sales tax, had no bank card or credit card, experienced advertising that was less intrusive and coercive than today’s, and paid for goods that were usually priced in round numbers.  To be fair, merchants even then sought ways to boost consumption, for example by allowing some buyers to have “accounts” at stores, so that they could buy items effectively on short-term credit in advance of getting their paychecks and paying off their balances.  Even so, the forces in favor of overconsumption were certainly much weaker than they are now, and the US savings rate (over 20% in 1880) partly reflected that.

What I think can be inferred from all this is that the freedom of our market system – the freedom of people and companies to sell what they want, to signal prices however they want, to advertise their products using whatever techniques they find most persuasive, and so forth – has not produced a more efficient, more “perfect” market. Instead it has produced a less efficient, more imperfect market that increasingly deceives and disadvantages consumers – even as it loudly congratulates them on their supposed freedoms.  What should be an agora in which buyers and sellers meet on equal terms has become more like a hunting ground on which the cleverer and better-capitalized prey upon the rest.  (Or is it more like a dairy farm on which the consumer-cows are regularly milked?)

Incidentally, the talents of the businesspeople we tend to celebrate in the US – Steve Jobs being a good example – seem to lie chiefly in grasping and exploiting the weak points of human cognition, to make markets less perfect and less efficient, thereby boosting their profits and enriching themselves and their investors (Apple, Inc. enjoys unusually large profit margins) at everyone else’s expense.  That we hold up these selfish mass-exploiters as our heroes, thereby encouraging more and more of the same, is sort of the ultimate evidence of our cognitive weakness as consumers.

Why does this happen?

The creeping inefficiencies of our “free” markets strike me as indicators of a more general phenomenon that afflicts human systems, namely the creeping exploitation of insufficiently-guarded systems by selfish actors.  The Internet is a classic example:  Its inventors set it up, and then watched in dismay as it became infested and exploited – that is, its common users were exploited – by pornographers, e-mail spammers, and of course hackers working for crime gangs, Russia and China.

Another example is the feudal Third World type of society that is “free” in the Wild West sense of having little in the way of effective government, but is essentially controlled by a relatively small number of powerful families, to the detriment of everyone else.

The implication is that the freedoms we do enjoy in modern environments are relatively narrow, and don’t arise spontaneously.  They occur within a space that is established by a larger system of unfreedoms – i.e., culturally and legally enforced ways of doing (and not doing) things.

Consider children playing in a schoolyard at recess.  The schoolyard is their free space.  But it is circumscribed and protected by various unfreedoms: the physical boundaries of the schoolyard, the basic rules, a whistle-bearing schoolyard monitor, the threat of being sent to the school principal, and so forth – all designed not to imprison children but to establish a safe space for them to play (not 100% “freely” but based on the norms of their own child-culture).  Were these unfreedoms to fade away, the children’s euphoria would be short-lived.  Endogenous bullies and exogenous predators would soon corrupt and destroy their neat little world.

A key difference between adults and children, in this respect, is that adults are responsible for setting up their own unfreedoms, i.e., we govern ourselves.  Sometimes we try to disguise our responsibility by attributing our unfreedoms to God, or to some other supposedly unshakeable authority (e.g., the Constitution).  But ultimately, somehow or other, we are the responsible ones – not just in society but in every other grouping in adult life.  And that leaves us with an essential problem, namely, how do we keep the bad among us – or the bad within us – from cheating or killing or somehow crowding out the good?  We can set up systems with rules and restrictions meant to discourage the subversion of that system by selfish actors.  Yet those actors can try to change the rules to their advantage, or find strategies to exploit those rules’ weaknesses.  In such cases, simple static rules to guard against that subversion may prove no more effective than, say, the simple, static Maginot Line was in guarding against the German blitzkrieg in 1940.  And in fact, we see these failures of system-guardianship again and again in modern life.  The banking system and its capture of regulators prior to (and contributing to) the recent recession is another good example.

The broad idea I am getting at here is one that anyone familiar with political philosophy might find trivially true, even naïve.  Nevertheless it seems to get little play in public discourse these days, and in some circles might seem an alien or “socialist” concept.  The idea is that the goal of any human system is not to maximize the freedom of the actors within it, but to provide the minimum necessary constraints to ensure the system’s intended function and defend it from selfish actors.

So the goal of our markets should not be to maximize the freedom of their participants, but to impose the minimum necessary unfreedoms to ensure that they provide adequate social value and don’t creep in inefficient directions.  We already accept that in other realms; we know for example that the goal of our financial system and its regulatory mechanisms should not be to maximize the freedoms of banks or mortgage companies to buy and sell debt; and the goal of the Internet should not be to maximize the freedoms that empower spammers and hackers.  The goal of a human system can never be “freedom,” as in the total absence of restraints on action – first, because any system by definition involves a set of restraints on its actors; and second, because, in human life, freedom is chiefly a means by which positive goals are achieved. On its own, freedom is a virtually meaningless concept.