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Free markets are democratic. mid-2003

by Sanjeev Sabhlok


Buying the tomatoes to sell:

He has to buy his tomatoes (either by growing them himself by buying land, labor, seed, fertilizer, or by buying from a farmer) before he can sell them. The decision to buy is a very local one. It is a function of the past experience of the tomato seller, his expectation of the profits that he will get from selling the tomato he buys, which in turn is determined by his understanding of the nature of the demand for tomatoes in the marketplace. All local knowledge. This illiterate human mind is much better equipped, using our in-built human power of parallel processing and learning paradigms, than the greatest scientists or computers can mimic, to process the local information known only to him.

Selling the tomatoes:

Then he has to price the tomatoes in the marketplace for sale. Over the course of the day, he must try to get at least more than what he has paid for them.

If the seller reaches the marketplace first and he sees a person coming straight for his shining tomatoes, and if he determines that this potential buyer is going to have an ambal party tonight (an Assamese dish made purely of tomatoes), then he will quote a price as high as he thinks the buyer will possibly pay. The next step is called haggling. That is the process of negotiation whereby the optimal price is determined for that particular interaction. Clearly there is a premium to pay for being in a hurry and a premium to be pay for a spurt in demand due to a festival, apart from the fundamental cost driven by the seasonality of the tomatoes.

The situation changes during the day, when other tomato sellers enter the marketplace. Prices fall, determined by loud transmission of local information on prices by various sellers shouting their prices. Note that this is completely unknown to the social planner sitting in the Planning Commission in Delhi.

Finally, at the fag end of the day, people like me emerge from our houses, waiting for the great sale of tomatoes which takes place as the marketplace for tomatoes must close and the remaining - generally rotten - tomatoes, thrown into the trash.

Prices vary instantaneously to reflect ALL available information, physical, local, public, general, or whatever, and factoring all strategy, marketing skill, negotiation technique, etc.

All customers and sellers go back satisfied.

What would socialism do?

Do you remember the huge lines of people waiting for bread in Russia? That is what happens when you try to plan and economy. You even fail to supply bread, despite having 100s of PhDs in statistical techniques, and despite trillions of lines of source code fed into supercomputers.

The attempt of a social planner to plan an economy is like a weather forecaster trying to plan (not simply predict!) the weather. If a metereorologist comes to you and says he has discovered a formula to plan the weather in Calcutta for June 8, 2004, you will call him a nut and lock him up in Agra. Sadly, though, we have not locked up yet, all those pseudo-economists who try to plan an Economy, which is actually far more unpredictable than the weather. Let us open the doors in Agra for our Planning Commission. [PS: there is a great role for planning in many other tasks, such as urban planning, but that is not economic planning which socialists love so much].

Planners create problems by things like socialising or collectivising agriculture (which was done in USSR, and Nehru thought actively about doing it in India). Even the production of tomatoes then becomes an impossibility, since local knowledge and incentives are completely absent in the planners head. All farmers shirk work since they will get no specific reward.

Once production is brought to a standstill, the planner further messes up things by setting fixed prices for everything in the market. If that were to happen in the case of the tomato seller above, everybody in the first lot would buy far more tomatoes than they need at a low price, and tomatoes would sell out in the first two hours. The poor person would get no tomatoes, and lines to buy tomatoes would go for 2 miles! One of my friends asked: in the market system is it not a bad thing that the poor person gets the rotten tomatoes (at a cheap price though)? Step one: he did get his tomatoes, step two: nothing prevents the society through the tax system in providing that poor person with additional resources. And no one needs to spend valuable time standing in lines.

In a socialist economy tomatoes are neither produced nor available to everybody. Even tomatoes can become a luxury good meant only for those who have contacts with the planners. Tomatoes can become like cement which was controlled by our socialists throughout the 60s to 80s and pure cement was then available only in the black market. Socialists create black markets and gangs of mafias. There is no other reason for such black markets.

My friend had a philosophical objection to the market system since it allows for greed and the profit motive. Wasnt the tomato seller being greedy in the morning? Not quite. There is a thing called consumer surplus by which a large number of people get more value out of a good than what they pay for it. In other words, some people are willing to pay much more than what they are asked to pay. Is it not right for the tomato seller to get a bit of that extra willingness to pay? Wont that help his financial status, being an ordinary, poor, tomato seller? By charging what the market can bear he did not hurt anybody, and it was a voluntary decision of the buyer to buy at that price. So long as there is competition, even later in the afternoon, the tomato seller can be as greedy as he wants, but he can only sell at a price that the competition will allow. With everybody required to dispose of their tomatoes at the end of the day, they have to reduce the prices continuously in order to finally go back home.

When my friend, a professor, bargains for the price at which he will teach, is my friend being greedy? Will he agree teach for free for the whole of his life? Is bargaining itself something unethical? The profit motive is the same as the motive to get the best value for ones services. Are we not supposed to get the best value for ones services? Is da Vinci to be paid on par with a roadside poster painter?

Sauvik Chakraverti adds:

When the prophet Muhammad, peace be upon him, was governor of Medina, some good people came to him complaining of the unruly and unfair prices being charged at the marketplace. They pleaded with him to take action to fix prices so that they would be fair and just.

The prophet was an illiterate man (he had divine knowledge, of course) but he had spent his entire life in the marketplace as a trader. His reply: “There is only one way to determine the just price - and that is by hard bargaining!”