Rewriting Econ 101: Teaching the Shortcomings of Market Allocation

Forget what you learned about markets in your introductory economics class. In a new book titled, The Tyranny of the Market: Why You Can’t Always Get What You Want, Wharton professor of business and public policy Joel Waldfogel challenges the conventional thinking that markets will provide adequately if left to their own devices.


In the prevailing view, markets allow everyone to get what they want, regardless of what others want — recalling Blockbuster Video’s “Go Home Happy” slogan — while allocation through government imposes what John Stuart Mill called a “tyranny of the majority” — that you get what you want only if the majority wants it. This stark distinction between markets and government, advanced by Milton Friedman in his book Capitalism and Freedom, has been the rationale behind letting markets decide a wide variety of questions for decades. But according to Waldfogel, the tyranny of the majority is also at work in many markets, benefiting some, harming others, and not always ending up promoting efficiency.


The tyranny of the majority — Waldfogel calls it “the tyranny of the market” — arises whenever two conditions hold. First, production entails substantial fixed costs; and second, preferences differ across groups of consumers. High fixed costs limit the number of products that markets can profitably offer, so that only large groups get appealing products. And when preferences differ across groups, then those not targeted — “preference minorities,” in Waldfogel’s words — are unable to go home happy.


The all-virtuous view of free markets is an influential one in contemporary policy making, often paired with a cynical view of government involvement. Waldfogel cites President George W. Bush’s words on the occasion of Friedman’s 90th birthday: “Milton Friedman has shown us that when government attempts to substitute its own judgments for the judgments of free people, the results are usually disastrous. In contrast to the free market’s invisible hand, which improves the lives of people,” Bush continued, “the government’s invisible foot tramples on people’s hopes and destroys their dreams.”


Waldfogel offers a series of detailed empirical and case studies to counter that view. “My goal in this work is not so much to argue that Friedman is wrong,” he writes, but to “demonstrate that Friedman’s dichotomy between markets and collective choice is not right. In many markets, what I get depends on how many others also want it. Market allocation shares many of the features of allocation through collective choice.”


Waldfogel presents evidence suggesting “a more nuanced view on the ‘wonders of markets’ and the ‘evil of government.'” His book makes the case that while markets do a good job of providing products that a majority of people demand, they can fall short in meeting the needs of consumers with less prevalent preferences. Potentially left by the wayside are African Americans, Hispanics, people with unusual medical conditions and residents of remote areas, to name a few groups.


The Misuse of Economics


The Tyranny of the Market is based on academic papers that Waldfogel wrote over the past decade. He says he has repeatedly made the argument to his fellow economists that markets share some messy features of politics and are far from perfect. Now he aims to bring the same ideas “to people outside the narrow world of academic economics,” a goal that meshes with his role over the past 18 months as the Dismal Science columnist at Slate.  


According to Waldfogel, his arguments, though “not revolutionary,” buck the popular wisdom that government involvement in markets is automatically bad. “Economics has allowed itself to be used as a bludgeon in favor of free markets and against a government role, but I don’t think that’s what economics has to say,” he suggests. “Let’s look at how markets actually work and then make our decisions.”


In contrast to the Blockbuster Video conception of markets in which everyone goes home happy, Waldfogel’s research shows many situations in which larger groups get more satisfaction, and smaller groups less, from markets. He first noticed this phenomenon about a decade ago when he was looking at radio-listening data broken down by racial groups. Blacks and whites have sharply different preferences in radio programming. The formats that attract most black listeners get almost no white listeners. A higher share of blacks listens to the radio in U.S. cities with larger black populations. This illustrates that having more people who share your tastes raises the number of products appealing to you, and your group gets more satisfaction from what’s available.


But having more whites in the market does not raise the share of blacks listening to the radio, and having more blacks does not increase the share of whites listening. So while more demand generally helps bring forth more variety and more resulting satisfaction, your satisfaction really only increases when there are more people who share your preferences. This is a far cry, Waldfogel says, from the hypothetical situation where you can get what you want simply because you want it. Instead, you get what you want if enough other people also want it.


Daily newspapers offer an even starker example. While your typical U.S. city has multiple radio stations, it has only one major newspaper. Newspaper preferences differ across groups, so the paper can be pitched to appeal to one group or another. As with radio, in cities with more whites, whites are more likely to read the paper, while blacks are more likely to read the paper in cities with more blacks. What’s striking, Waldfogel says, is that blacks are less likely to subscribe in cities with larger white populations where the paper is pitched more toward white readers’ tastes. Not only do you not get what you want simply because you want it, but you get something even less like what you want because others want something else. This is the tyranny of the majority translated almost literally into the market. Having more people who share your preferences helps you by making the product suit your tastes, and having more who do not actually hurts you by making the product less appealing to you.


Because these problems arise when fixed costs are large in relation to market size, they can be alleviated by increased market size — for example through trade across geographic areas — or through new technologies or managerial approaches that allow cheaper customization of products.


A Preference for Action Movies


The book also explores the liberating effects of trade and the Internet, bringing desirable options to people who lack appealing local options. While trade goes some distance toward solving this group’s problems, it is not a complete solution. “Instead, with products that remain high in fixed costs even relative to the world market, exporting can shift products away from the preferences of the old domestic consumers,” he says, and toward the preferences of the new market. Hollywood, for instance, has begun catering to customers in new-found movie markets, in some cases at the expense of the preferences of moviegoers in this country.


“Hollywood has figured out that Japan and some parts of Europe are markets worth worrying about. And it’s been observed lately that Hollywood has skewed products toward things that will export well, like action movies. If you like what Hollywood used to make — dramatic movies and movies with dialogue — you’ll be less happy.”


Waldfogel says there are some business-to-the-rescue stories, where technology and other advances are addressing the downsides to the market. On-line booksellers and movie purveyors can offer more titles for a wider variety of tastes than your neighborhood book or video store. And pharmaceutical companies, traditionally focused on finding the next blockbuster drug, are envisioning a day when medicines can be specifically “designed” for individuals or smaller groups of people based on their genetic profiles. In restaurants, there is a trend for companies to locate several of their brands under one roof, allowing a family to eat items from Taco Bell and Pizza Hut at the same time.


All this criticism of markets raises the question of whether allocation through government is better or even different. “It’s tough to find an apples-to-apples comparison of market and government allocation,” Waldfogel says, “but one interesting comparison is between municipal public libraries and bookstores.” Markets make bookstores available in rich and populous areas, while governments make libraries available in both populous and less populous areas, and local library availability is about equally sensitive to white and black populations. “It’s clear that a decision to ‘let the market decide’ is good for some and not for others,” he suggests.


According to Waldfogel, there are no pat answers or simplistic formulas to determine the correct balance between free markets and government intervention. “The standard economist view of a subsidy is that it’s venal, and there’s often some truth to that,” he says, adding, however, that the benevolent view of markets is over-stated, too. “While it is true that in a perfectly competitive market, everything that should be done will be done and nothing that should not be done will be done, this expectation does not carry over to realistic, high fixed-cost examples. For people inclined to favor markets because of their efficiency properties, many real-world industries lack an efficiency rationale for a hands-off — or ‘laissez-faire’ — approach.” Society, Waldfogel says, “needs to discuss the shortcomings of market allocation honestly — and with evidence — when choosing whether to let the market decide.” 

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