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Markets Rely on Accurate and Honest Information — But Governments Want the Opposite

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Tags PricesValue and Exchange

10/03/2019

Have you ever worked with people you couldn’t trust to tell you the truth? It isn’t pretty. Without the ability to rely on what you’ve been told (or that you’ve been told everything relevant), effective cooperation at almost every margin of choice is reduced, because its foundation has been undermined. A new episode of To Tell the Truth must precede every decision.

That problem of effective cooperation is exponentially increased when we expand our horizons to the many margins of choice at which people in society, the vast majority of which do not even know each other, interact. In a modern economy, all of us are dependent on multitudes of strangers not just for our prospering, but our survival.

The reason people don’t always communicate truthfully is that our reason serves our self-interest. Sometimes we perceive a strategic advantage at other people’s expense from intentionally deceiving them. Our words are also often ex post rationalizations to ourselves and others of why whatever we chose or did was a good idea. But that often makes what people say a frail reed to rely upon. And when political power is involved, the incentives for such deception and self-delusion are put on steroids, because the payoffs are far greater when backed by government’s coercive power.

As a consequence, accurate information about the issues most important to our ability to co-operate with others is often among the scarcest and most valuable of goods. Making it worse, the unknowably vast amount of potentially useful information—the infinite permutations of who, what, when, where, why and how--exceeds any individual or group’s ability to comprehend and integrate it. But voluntary market arrangements based on private property rights provide a powerful mechanism of cutting that problem down to manageable size.

Most of the time, we don’t really want to know all the details that might affect our productive interactions with others. We mainly want to know “how much”--what are the tradeoffs others are willing to make between goods, services, current versus future consumption, labor versus leisure, etc. The reason is that, regardless of their specific determinants, others’ willing tradeoffs determine our possibilities and constraints in any society that honors members’ self-ownership.

Expanding the mutually beneficial arrangements that are possible by accurately revealing such information is a central aspect of effective social coordination, as the seminal works of Ludwig von Mises and Friedrich Hayek have made clear. No central planners knows the tradeoffs each individual would make; only the individuals involved know that information. That requires a process to honestly reveal that information to those who will make choices regarding it, or the information will be effectively thrown away, along with the societal wealth creation it would enable.

Markets provide that honest information. While what people say may often be misleading to themselves and others, people reveal the truth about the tradeoffs they are willing to make when they engage in un-coerced exchange. What you do is often far more truthful than what you say.

Regardless of your words, if you actually buy a product for $10 out of your pocket, you reveal that you believe it is worth at least $10 to you; similarly, if you sell a product for $10, you reveal that what the money could purchase was worth more to you than the product. And those choices reveal valuable information about the real alternatives available to those who might choose to deal with you. In contrast, since politics is based on what people say rather than what they actually do, it often short-circuits our central mechanism for discovering the truth to better enable our cooperative potential.

In fact, a vast array of government interference in individuals’ voluntary exchange relationships substitutes lies for the truth that would otherwise be revealed. And in a world where relative scarcities are frequently the primary things we want to know from others, to combine with our more intimate knowledge of ourselves and our situations, the harm is massive.

Consider price ceilings, like rent controls. In their absence, market rents tell you the prices at which you can find apartments, reflecting the opportunity costs landlords face. But rent controls impose a price divorced from landlords’ opportunity costs, and at which many will often be unable to successfully rent an apartment. That is, it misinforms people that the opportunity costs are cheaper than they really are, and in the process makes knowledge of the terms at which apartments can generally be successfully rented largely disappear.

Price floors, like minimum wages, act in a parallel manner. In their absence, market wages tell you the prices at which you can generally find jobs. But a minimum wage dictates a price divorced from prospective workers’ opportunity costs, and at which many will often be unable to successfully get jobs. That is, it misinforms people that unskilled labor’s opportunity costs are higher than they really are, and in the process makes the knowledge of the terms at which jobs can generally successfully be gotten largely disappear.

Taxes, which are the price of the artificial input, “government permission to produce and sell,” reflecting coercively imposed government burdens rather than opportunity costs of inherently scarce goods and services, tell buyers that products are scarcer than they really are. The same is true of import restrictions, like tariffs and quotas, which raise prices above opportunity costs. The burdens of government regulations and mandates also act like taxes. Government barriers to entry and operation in markets similarly raise prices above what relative scarcity would dictate. All of these result in artificially higher prices, underuse and waste, compared to free markets.

Subsidies act in a parallel manner to taxes, but in the opposite direction. They communicate to prospective buyers that products are less scarce than they really are, leading to artificially low prices to consumers, overuse and waste, compared to free markets.

Not only do voluntary market interactions better reveal the truth about relative scarcities through pricing, they allow more accurate evaluation of other aspects of trading, such as product and service quality, than government.

The key (though often ignored) factor is repeat business. The usual scare stories to justify the “need” for government regulation involve one-time interactions, in which others can gain by “cheating” on what they promise. But the relevant question is not whether they can, but whether it is in their interest to do so. We don’t need government protection against things people will choose not to do, even if they could. And since almost everyone we deal with economically wishes to continue in business, effects on future business (directly, as when current customers refuse to deal with such suppliers in the future, and indirectly, through reputation effects on other current and prospective trading partners) act as a performance bond against misbehavior, leading to far better outcomes than the scare stories imply. As students of game theory recognize, repeated games generate very different strategies than one-shot games.

Consider an example. I can cheat you today by providing lower than claimed quality, and doing so would generate $1 million in increased profits for me. If it would leave my future business relationships unchanged, I have an incentive to do so. However, what if I expect the resulting damage to my reputation will lose me more than $1 in future discounted profits? I can cheat you, but I won’t because I have no incentive to. The problem in this case is solved by markets’ reputation mechanisms. Even if the future losses don’t completely eliminate my incentives to cheat, they sharply reduce them, letting much of the air out of the “we need government regulation to protect you” balloon.

This mechanism, while ignored by “nothing can be done if the state doesn’t do it” acolytes, is far from new. For instance, the famous Maghribi traders of Northern Africa relied on reputations to deal with problems in international trade in the 11th century.

A great deal of social coordination is only achievable when based on the truth. But many of the relevant truths behind people’s opportunity costs and values are only known to the individuals involved. That is why voluntary arrangements in markets, in which you tell the truth about the relevant relative scarcities both when you buy and when you sell, are indispensable to all participants’ well-being.

In contrast, when governments displace voluntary arrangements with coercive impositions, lies displace truth in two ways. Not only is the competition to get political power based largely on misrepresentations, but government’s coercive impositions also replace the truth revealed in voluntary market behavior with lies. What is the effect on society? It isn’t pretty. And even though it is an essential aspect of government intrusion into citizens’ affairs, not a single moral or ethical system endorses lying. Lies will not set you free. Not only does the truth set us free, but freedom in our cooperative endeavors reveals truths we have no other way of knowing.

Gary M. Galles is a professor of economics at Pepperdine University. He is the author of The Apostle of Peace: The Radical Mind of Leonard Read.

 

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