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May 26, 2002
David Warsh, Proprietor


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The Storyteller of Markets

“Markets and governments have an uneasy relationship,” writes John McMillan in his new book, Reinventing The Bazaar. “Markets coordinate the economy better than any centralized alternative; governments sometimes distort and even destroy markets. But help from the government is essential if the economy is to reach its full potential.”

 

That is as succinct a statement of what economists and others have learned these past fifty years as it is possible to imagine. A vast shift in political philosophy has taken place around the world as a result.

Some day, someone will write a political history about our times comparable to, say, R. R. Palmer’s Age of Democratic Revolutions. The twin volumes of that fine book appeared in 1959. They put into historical perspective the transforming egalitarian movement that had swept out of the American colonies and France to the farthest corners of the earth, starting in the last quarter of the 18th century.

The new book would treat the alike the rise of global markets and the fall of communism in the 20th century. Students will study it in schools. It will all seem very long ago.

But in the meantime, for those who want to know how these things work in the 21st century, there is Reinventing the Bazaar. McMillan’s tour of markets has been described as “something akin to a nature walk,” but more often it resembles a city walkabout, since the complexity is man-made.

There definitely is an ecological flavor to his account, however. His overriding point is that markets spontaneously evolve as human institutions. Hence his subtitle: “A natural history.”

People try all the time to explain these things. Some pretty good efforts have emerged over the years. Milton Friedman wrote Capitalism and Freedom in 1962. How the West Grew Rich, by Nathan Rosenberg and L. E. Birdzell, Jr., appeared in 1986.

Reinventing the Bazaar brings the story up to date covering the deeper understandings of how markets work and fail to work that have emerged in recent years. This new knowledge has stemmed both from the rise of new technologies in the industrial democracies and from the failure of the centrally planned-nations to produce comparable results.

A Stanford University economist of considerable distinction, McMillan takes the position of a dispassionate engineer of human institutions. He rejects “quasi-religious views” of markets, both right and left.

The market is not an end in itself, he says, “but an imperfect means to raise living standards.” It is entirely possible to love justice and still appreciate markets’ effectiveness. He quotes F.A. Hayek: a market system is that in which “bad men can do least harm.”

Two dominating ironies characterize the political arguments of the last hundred years, he says. “Those on the far left of the political spectrum, who abhor poverty, espouse policies that would entrench it. The fervent proponents of laissez-faire, who esteem markets, advocate a system that would trigger their collapse.”

For the fact is that markets work only when they are well structured by governments. According to McMillan, this is one of the central lessons of the last fifty years. He describes five necessary features for any well-functioning market.

Information must flow smoothly, property rights must be protected, people can be trusted to live up to their promises, side effects on third parties are curtailed, and competition is fostered.

He makes a nice distinction between a marketplace and the market. A marketplace, physical or cyberspace, is a specific venue where trades take place. The market is an abstraction, an overall system composed of many interdependent markets.

Many — in fact, most — transactions in society have nothing to do with markets, he acknowledges. They occur among members of families, in government activities, within big firms, in churches and all manner of voluntary associations. They are mediated by different rules.

So why do we refer to our system as a market economy? Because, McMillan says, the market provides the context for all the rest. The tradition of individual decision-making and voluntary exchange is the overall key, he says, and shapes the rest.

(Yes, McMillan is a child of his times. There is no chapter in his book on community or duty or tribes. The once-fashionable and still highly descriptive phrase “mixed economy” doesn’t appear. But these are matters yet to come. McMillan’s topic is markets, not society. )

But about markets, he is supremely knowledgeable. A native of New Zealand, a theorist by training, he decided long ago that the best way to learn about foreign lands was to teach in them. There followed stints of various durations in Japan, Australia, Taiwan, India, Germany, the Netherlands, France and Canada.

Three years ago Stanford University’s Graduate School of Business hired him away from the University of California at San Diego.

In 1995, he joined Market Design Inc., a well-known economic consulting firm, as a principal, and now, vice president (http://www.market-design.com). The specialties of the house tell the story: market design, auction design, bidding strategy, spectrum auctions, electricity auctions, package bidding, combinatorial bidding, telecommunications policy, power exchanges, independent system operators, e-commerce, initial public offerings, deregulation, restructuring, divestiture, privatization.

Chapters of Reinventing the Bazaar illustrate each of successful markets’ five crucial struts. Signaling mechanisms are described: reputations are costly to create and must be defended. Patent policy is dissected: intellectual property must be protected, but not rendered too secure. Property rights are discussed from every angle: when Vietnam’s chronically broken trucks are denationalized in the early 1990s, suddenly they work (“When You Work for Yourself.”).

The ill-effects of modern times — pollution, congestion, overfishing and the like — are shown to be capable of mitigation through the use of markets, trading, for example, in permits to add a certain volume of pollution to the air. A chapter on corruption is illuminating, particularly in describing the Dango negotiation system in Japan, whereby companies get together to rig bids

The emphasis on the hand-and-gloveness of markets and government is maintained throughout. An especially illuminating chapter compares the difficulties of “privatization” in Russia with the successes of “growing out of the plan” in China. Incomes plummeted in the former Soviet Union; but China had world record growth for twenty years.

Why the difference? China remained a dictatorship while Russia became democratic. But McMillan says that the real contrast had to do with shock therapy vs. gradualism. Russia tried to create a strong state overnight and failed. China experimented extensively and stuck with the experiments that worked.

The same shrewd sensibility is trained on very nearly every interesting problem. And always there are visits to markets: the great daily Dutch auction of flowers in Alsmeer; the New York Stock Exchange; the Marrakech bazaar; behind the scenes at E-Bay; a baseball draft; the Tsukiji fish market in Tokyo; an electromagnetic spectrum auction in a Washington hotel; the botched deregulation of electricity in Sacramento, California.

Guidebooks don’t get any better than this. Reinventing the Bazaar is the equivalent of a textbook without diagrams, a storybook with just enough numbers to make it really persuasive. If the book has a shortcoming, it is that it is a little sketchy on the details of where the new ideas came from. But then I would think that. Relating these developments is one of the things that my fellow economic journalists and I do.

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