Table Of ContentHow Markets Work and Fail,
and What to Make of Them
NEW HORIZONS IN INSTITUTIONAL AND EVOLUTIONARY
ECONOMICS
Series Editor: Geoffrey M. Hodgson, Research Professor, University of Hertfordshire
Business School, UK
Economics today is at a crossroads. New ideas and approaches are challenging the
largely static and equilibrium-oriented models that used to dominate mainstream
economics. The study of economic institutions – long neglected in the economics
textbooks – has returned to the forefront of theoretical and empirical investigation.
This challenging and interdisciplinary series publishes leading works at the
forefront of institutional and evolutionary theory and focuses on cutting-edge
analyses of modern socio-economic systems. The aim is to understand both the
institutional structures of modern economies and the processes of economic
evolution and development. Contributions will be from all forms of evolutionary
and institutional economics, as well as from Post-Keynesian, Austrian and other
schools. The overriding aim is to understand the processes of institutional
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Titles in the series include:
Property Rights, Consumption and the Market Process
David Emanuel Andersson
The Evolution of Path Dependence
Edited by Lars Magnusson and Jan Ottosson
Economics, Culture and Social Theory
William A. Jackson
Deep Complexity and the Social Sciences
Experience, Modelling and Operationality
Robert Delorme
Creative Industries and Economic Evolution
Jason Potts
Institutional Variety in East Asia
Formal and Informal Patterns of Coordination
Edited by Werner Pascha, Cornelia Storz and Markus Taube
Capitalism and Democracy
A Fragile Alliance
Theo van de Klundert
Foundations of Economic Evolution
A Treatise on the Natural Philosophy of Economics
Carsten Herrmann-Pillath
How Markets Work and Fail, and What to Make of Them
Bart Nooteboom
How Markets Work
and Fail, and What to
Make of Them
Bart Nooteboom
Professor Emeritus, Tilburg University, the Netherlands
NEW HORIZONS IN INSTITUTIONAL AND EVOLUTIONARY
ECONOMICS
Edward Elgar
Cheltenham, UK • Northampton, MA, USA
© Bart Nooteboom 2014
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Contents
Preface vi
1 Introduction 1
2 Foundations of markets 19
3 How markets work and fail 55
4 Variety of industries 95
5 Hybrids and examples 109
6 Alternatives 137
Notes 167
References 169
Name index 173
Subject index 175
v
Preface
Friends and acquaintances pressed me to write this book. A deeply critical
book on economics and markets was needed, they said, and I was the one
to write it, since I am sufficiently inside economics to know the arguments
and sufficiently outside it to be critical. Once I started, I began to enjoy
writing it. My approach is philosophical in part, and connects with my
lifelong interest in philosophy next to my scientific activities. I also built
on my scientific work on philosophy of science, marketing, innovation and
entrepreneurship, learning, collaboration and alliances, networks, and
trust, in a wide range of publications.
I am grateful to several people who gave advice and read drafts in
different stages of development: Bas Schoorl, Arthur Wassenberg and,
especially, John Groenewegen.
My criticism is radical, but not so radical as to reject the whole of
economics or the operation of markets. Rather, I try to specify the short-
comings of economics and markets, with the aim of transforming theory
and underlying philosophy into a wider notion of markets that includes
perspectives from sociology, social psychology, theory of knowledge and
ethics.
Perhaps the most radical shift that I propose is that from the ruling
utilitarian ethic of economics to a virtue ethic. How can markets become
part of ‘the good life’ that includes more than the satisfaction of desire and
recognizes that human life entails a range of values that cannot be added
and subtracted in utility or caught in the axiomatics of complete and
transitive preferences, and which includes, in particular, the virtue of mod-
eration, in consumption, wealth and egotism? Central is the view that the
human being is fundamentally social, and needs the other to develop itself.
Another basic view is that uncertainty, in the development of knowledge,
preferences, innovation and markets, is often radical, not subject to calcu-
lation of risk. These points jeopardize the central doctrines in economics
of methodological individualism and rational choice.
Evident as my opposing views may seem to most people, for econom-
ics they are radical. One can hardly expect such a radical proposal to be
adopted and implemented any time soon, but I hope to loosen thought and
contribute to a shift of perspective in what I see as the proper direction.
vi
1. Introduction
1.1 IDOLS OF ECONOMICS
In the wake of recent financial and economic crises there is a swelling
debate on the adequacy of economic science. Few economists foresaw the
crises, predictions and recommendations on how to proceed vary greatly,
there is difference of opinion on the root causes of the crises, there is little
perspective of how to prevent similar crises in the future, and established
practices in finance and business appear to simply continue. Apparently
we need to delve deeper. A fundamental re- orientation seems in order.
In this book I criticize fundamental intellectual and moral assumptions
underlying economic science, and I unravel the notion of markets: how
they work and fail, and how they may be redirected to better serve the
good life. However, economics goes beyond markets. It has developed into
a view of behaviour in general, and I will discuss that first.
My criticism of economics is radical and I think that economic thought
is doing much damage. However, I acknowledge that economics has also
made important contributions. In many situations optimal allocation
of scarce resources is in order; laws of supply and demand sometimes
apply. Economics has yielded numerous useful notions, such as economies
of scale, diminishing returns, substitution between labour and capital,
opportunity costs, forms of competition, transaction costs, entry barriers,
and much more. Game theory has yielded important insights into strate-
gic and collective behaviour. My aim is not to abolish economics but to
contribute to its transformation into a wider, more integrative, ethical and
interdisciplinary behavioural science of markets.
The power of economic thought is five- fold. It is simple and parsimoni-
ous; it is amenable to technocratic calculation, satisfying urges towards
rational choice and design; it claims to be universal, applying always and
everywhere; it conveniently avoids difficult ethical questions; and it sup-
posedly promotes freedom. This makes economics virtually invincible,
and its corrosive effects on the good life difficult to dodge.
While economics is based on a utilitarian ethic, I will adopt a virtue
ethic, with a view to multiple dimensions of the good life. This has corre-
sponding weaknesses. It is complicated, discursive rather than calculative,
1
2 How markets work and fail
difficult to universalize, and expensive in the deliberation and debate it
requires. In being normative, it is political, and it can easily be seen as
paternalistic. It pleads for limits to economic growth and less concentra-
tion of wealth. As a result it can expect powerful opposition from an
unholy alliance of the wealthy, established interests of industry and com-
merce, libertarians, technocrats, gluttons and consumption zombies.
I do not expect my views to be implemented any time soon. Fundamental
turns of thought take a long time to take hold, and when they do institutions
are moulded to fit them, they form the cognitive substrate on which society
develops, and then they become self-e vident, beyond scrutiny, absorbed in
the marrow of our cultural bones. I propose that current economic thought
has grown over some 400 years from ideas that arose at the beginning of
modernity, with Descartes, and developed in the Enlightenment in the
emergence of a utilitarian ethic and notions of the rational, autonomous
knowing and acting subject. To make amends, we need to unearth all that,
bringing it back into the open. I do that in this book.
More in particular, we are up against a movement that can be traced
back to the English Renaissance philosopher Francis Bacon, in the six-
teenth to seventeenth centuries, who initiated a ‘no-n onsense’ movement
for experimental science to replace medieval scholasticism and speculative
thought, which step by step conquered Western thought and still domi-
nates it. He attacked idols of misleading but deeply rooted, fundamental
forms of medieval thought, largely tacit and taken for granted.
Here, I attempt a counter- movement, a corrective turn. Ironically, the
idols that Bacon rightly identified and attributed to medieval thought can
be turned around in criticism of modern scientism in general and econom-
ics in particular. For that I will, in retaliation so to speak, specify the idols
of economics.
Bacon identified the following types of idols:
1. Idols of the tribe (here the tribe of economists, policy makers and
politicians seduced by them) arise from the inclination to rest in ideas
that have been received and believed in some community (‘tribe’) and
for the sake of which contradictory phenomena or views are ignored,
neglected or not even perceived. In economics this includes the myths
of rational choice and efficient markets.
2. Idols of the den are private prejudices peculiar to the ‘den’ or ‘cave’
the individual inhabits (Bacon purposely used the Platonic notion of
a cave in which perception is distorted). This varies between people.
Here, it includes the economist’s taste for hard-n osed, no- nonsense
measures, a taste for the analytical force of mathematics, and disdain
of ‘fuzzy’ alternatives.
Introduction 3
3. Idols of the marketplace are illusions of language, of communication
between people, with familiar words that mislead; that are taken to
refer to something in the world that does not in fact exist. In econom-
ics this includes utility or preferences. When those cannot be found in
reality, or in psychology and social psychology, they are nevertheless
assumed to be ‘revealed’ by the fact of choice. Since people make
choices, an ordering of preferences must exist, even if they cannot be
observed, so the argument goes.
4. Idols of the theatre are philosophical systems of the past. In Bacon’s
time those were mediaeval scholasticism, metaphysics and parts of
Aristotelian philosophy.1 In economics it is the very notion of science
that Bacon heralded, with the idols of measurability, objective obser-
vation of facts, rational choice, and mathematics as a precondition for
proper science.
1.2 THE IDOL OF CALCULATIVE NON- MORALITY
The first idol is that of calculative non- morality. Economists claim that
economics is value- free, but this is a myth. Historically, the urge towards
a value- free economics can be understood as a striving for freedom, in
reaction against the coercive, doctrinaire and totalitarian systems of
National Socialism and Communism, and paternalistic religious systems.
The state should in no way interfere with what people think and want.
Understandable and laudable as this is in itself, it has developed into
hypocrisy, a make- believe that serves to mask or excuse the neglect of
difficult normative issues. In fact, economics does not always promote
freedom and often produces injustice, and in its purported abstinence
from morality promotes a tacit, hidden, taken- for- granted and hence
incontrovertible, ideological morality of self-i nterest and compulsive
gratification.
Economic optimization of utility is always maximization subject to
constraints and the constraints are largely normative, dictated by consid-
erations of safety, health, education, justice, environmental protection,
and so on. So, in fact, economics does necessarily deal with normative
constraints. And it is paternalistic in its notions of merit and de- merit
goods.
More fundamentally, economic science is based on a utilitarian ethics
that goes back, notably, to Bentham and J.S. Mill. This entails the
assumption that the good things of life, or constituents of happiness, are
commensurable – can be added, subtracted and traded off in calculation
of utility or in preference orderings that are complete and consistent
4 How markets work and fail
(satisfying certain axioms, such as that of transitivity). That is the crux of
the idol of calculative non- morality.
In Nooteboom (1984) I showed how incommensurable, multiple
dimensions of utility can yield intransitive preferences. I used the
example of shops, with four dimensions of utility: proximity (utility of
place), opening time (utility of time), depth and width of assortment
of products offered (utility of choice), service (including time spent in
queues) and agreeability (utility of experience). The assumption was
that in any comparison between two types of utility consumers can
state a preference, but not between three or more. If shops tend to be
weak on one dimension of utility and strong on another, intransitivity
ensues. Thus a shop with a wide assortment of goods on offer is usually
located at a large average distance to consumers.2
As an alternative to utility ethics there is virtue ethics, going back to
Aristotle. There, the good life consists in multiple dimensions that are not
commensurable and are even often conflicting, such as health, pleasure,
love, friendship, fortitude, security vs. risk, self- interest vs. altruism, chal-
lenge of achievement vs. security, stability vs. change, protection of the
environment, care for ill, elderly and poor, courage (between cowardice
and recklessness), compassion, justice, extrinsic value of work (income)
vs. intrinsic value (satisfaction, self- realization), and so on. For such
an ethics, restraint of gratification and the choice of a middle between
extremes are part of the good life. Not limitless growth and desire but
their limitation is part of it. And note that the choice of one ethics over
another is itself value- laden. In choosing a utilitarian ethics economics is
not value free.
The neglect of incommensurability leads to excesses of planning and
control on the basis of purported measures of quality.
One example is that of scientific publications. Funds and careers for
academic researchers have increasingly been based on a mechanical
count of journal publications (weighted by the impact score of
journals), or of citations. This has evoked several forms of perverse
conduct, such as recycling of publications, plagiarism, excessive self-
citation, mutual citation alliances, or outright fraud with data or
methods. Books are not counted while in some areas (for example
philosophy) they are more important than journal articles. To take into
account incommensurability one needs to also engage in peer review,
in actually reading and then evaluating publications, in debate between
members of the team according to different dimensions of merit
