How Does the Market Work? (It doesn’t, at least, not all by itself)

The discussion about how the market works and behaves has been keeping economists busy for a long time. In this post, Dr. Giovanni Siepe takes a systems and complexity-based look at what is going on, and considers a different approach. 

Let’s follow the mainstream reasoning

The contrast between those who think that the market works by itself and those who think (in order to work properly) that the market needs “a little help” is what creates the fracture between two political points of view: “right” and “left”, “liberalists” and “Keynesians”. When supply and demand are balanced, the price of goods is stable. Any decrease in demand, or increase in supply, without an adequate corresponding adjustment causes an “asymmetry”. What producers usually do is to cut prices to stimulate demand.

If prices are lower, the need for money (to buy products) decreases and the interest rates falls. Hence, traditionally, the market for money follows the supply/demand trend.

The above process is supposed to stop when the demand balances the supply again. However, this mechanism is not automatic. In order to make it work we need a political intervention (a monetary policy) that supports the market to keep it working properly.

The Market “out there”

Some people think that the market is an external entity, i.e. something that exists objectively, following its own rules and working independently according to an unspecified “general theory”. They have tried to devise a mechanism with which the above description happens automatically, without any intervention.

However, the market does not work (alone). Just a few considerations will bring us to some different conclusions.

The price alone cannot, and will not, dictate the oscillation in demand. If I really “need” something, I will buy it no matter what.

For example, if I were in the desert and someone offered to sell me an ounce of gold for 50 USD, I probably wouldn’t buy it. On the contrary, for the same price, I would be willing to buy a glass of water.

We should at least agree that its worth re-examining the very starting point of the discussion: The market and prices are created by needs (we have to segment supply and demand). Therefore, the relationship between supply and demand should be reformulated: The idea that no intervention is needed and that simple mechanisms are the foundation for the functioning of the markets are, in my personal opinion, flawed.

The Market “in here”

For almost one hundred years physicists have been debating about how the process of measurement affects the result of the measurement itself. The very short (and not fully explanatory) answer is:

An “objective” reality, totally separated from us, does not exist; interactions create reality, the measurement apparatus is “one” with the experimenter and the subject of the experiment. In other words,  experimenter and the subject of the experiment form one System.

Economics, which is not a “hard” science, might at least consider that there is no such thing as the market as a separate entity; instead, there is the market, the people, the government, there are global interdependencies, and all of these are strictly interconnected.

The Global Network

Markets neither “fail” nor “work”. They are just part of the Global Network (System).

This Global Network represents an extremely complex system in terms of understanding and management. It is highly improbable that we can envisage a simple way to do it. There is not a simple mechanism that can regulate interdependencies.

A possible approach, corresponding to a paradigm shift, would consider:

• agreement between Countries to drive their actions toward a shared common goal;
• defining clear procedures on how operators in the market(s) should behave (define interdependencies);
• continuously monitoring variation at crucial points of the network to avoid the insurgence of chaos.

As a consequence, since the goal of Economists should be to understand how to increase general wealth (which is the goal of the Global Network), a little “help” would always be necessary in order to achieve general wealth and to allow markets to work.

This is not about being a liberal and/or  a Keynesians, this is about sustainability (surviving).