Perfect information

[brian0918]

I couldn't find much with the forum search feature, and so wanted to get everyone's opinion on the statement that "the ideal free market and free society assumes that information is perfect, complete and has zero acquisition-cost". What comes with this statement is the implication that because those ideals are not realistically possible, the free market is not possible and could not function of its own accord. The economist Joseph Stiglitz has made this argument, and has referred to those supporting laissez-faire economics as Free market fundamentalists.

What problems are there both with the original statement and with the implication made from this statement?

[KendallJ]

Perfect information is part of the concept of "perfect competition" which Brian Simpson does a nice job of knocking on it's butt in his book Markets Don't Fail! Neither perfect information nor it's larger brother perfect competition exist, NOR does any real free market advocate need or advocate them as ideals.

Markets work just fine without perfect information. Perfect competition is not an ideal state. It is actually the complete lack of competition.

[agrippa1]

The economist Joseph Stiglitz has made this argument, and has referred to those supporting laissez-faire economics as Free market fundamentalists.

"Free Market Fundamentalist" ... I like it. Almost as good as "radical for capitalism."

~FMF

[Galileo Blogs]

A theory should be driven by the facts. The so-called theory of perfect competition is not. The facts are that all information is costly to acquire. It takes time to earn a college degree. An invention takes time to develop. A new production method takes time to perfect. Etc.

The so-called theory of perfect competition dispenses with all that, and it simply asserts a state of affairs where all information can be acquired at no cost. This would be like a building engineer assuming that there is no gravity, and its results are just as disastrous. Imagine if that engineer simply assumed that gravity did not exist, and built his buildings accordingly. They would tumble down.

Modern economics has done the same thing with the unreal theory of perfect competition. It posits a world that does not, can not, and therefore should not, exist. In this fantasy world, all information is free, it can be acquired at no effort and cost. Therefore, all producers are price takers, no one can have "market power," etc.

The spinners of their fantasy, when they are done fantasizing, stop and actually look at the world, and then they discover that businesses behave as if information were... costly! They have pricing power, there are "oligopolies," etc. They decry this fact just as the gravity-denying engineer decries all the extra steel that is required to construct a building in the real world. Just as such an engineer would describe that extra steel as waste, the perfect competition economist rants about lost "consumer surplus" and "deadweight losses."

Then the deadly part of the perfect competition fantasy emerges. It emerges in the demand -- implemented through legislation -- to force the world to conform to this arbitrary, fantasy ideal. There are many ways that is done, but the worst of them is antitrust. Antitrust essentially outlaws all of the manifestations of real-world competition that the standard of perfect competition declares to be destructive of "societal welfare." The result, in practice, is that the most successful companies, those that are actually competing with greatest success, are hamstrung in the name of protecting the consumer and the less successful competitors. The result is egalitarianism enforced by law, and it is justified by a bizarre theory that has nothing to do with reality. Microsoft, Alcoa, Intel, IBM and hundreds of other companies, and the standard of living of all of us, have suffered as a result.

Economics, like every science, must start with the facts of reality. No theory is valid unless it starts with reality as its base and then correctly explains those facts. The theory of perfect competition is a nightmare fantasy made real with devastating consequences here on earth.

An economist (it may have been George Reisman) wrote an article called "Platonic Competition" that explains how antitrust is based on the theory of perfect competition. The title captures the essence of this theory. It is a fantasy, platonic "world of the forms" that has nothing to do with real life.

[agrippa1]

Isn't the theory of "Perfect Information" based on the "information" transmitted by prices? And isn't that information continuously adjusted by individual, objective judgments and comparisons of value?

Since value (and thus price) is subject to objective judgment, the concept of "perfect" information from prices implies a universality of value that does not exist in objective reality. So "perfect" in this sense would tend to denote "most complete" rather than what we would normally consider "perfect" (which is, itself, an objective judgment). Given the fact that government intervention (whether it be artificial demand, supply, price or cost, or inflation due to monetary policy) inevitably adds "noise" to price information, obscuring or hiding entirely the information normally carried by prices, it would seem reasonable to say that free market operations provide the means for "perfect information" which in turn forms the basis for the efficiency of the free market, and that they are, in fact, inextricably linked.

To say that "Perfect" Information can not be realized (as if it could) does not detract from the reality that central control of an economy serves to make information less perfect, and thus the market, less efficient.

[Galileo Blogs]

Yes, government intervention does make the market work less efficiently. However, the meaning of "perfect information" used by the perfect competition theorists also implies that any laissez-faire result is imperfect. It is imperfect because there is market power, oligopolies and the other manifestations of imperfect competition.

The perfect competition theory calls for a standard of judging market performance based on a premise that is inconsistent with reality, and impossible to achieve. That is the premise of perfect information. The specific sense that they mean it is in the sense of both completeness and accuracy. In fact, they explicitly state that they are assuming that all information about consumer preferences and information about manufacturing methods is universally known by everyone, equally, all the time. In an environment of such universal omniscience, no producer can gain a price advantage over another. Therefore, all producers would sell goods at exactly their cost of production, and no more. In this imaginary, "perfect" world, prices would equal costs and consumers would receive the maximum welfare from their purchases.

The entire construct is a fantasy. As an advocate of laissez-faire capitalism and, more fundamentally, as an advocate of reason, I have to reject any attempt to base a theory on a deliberate denial of reality. The fact is, knowledge is costly to achieve. It requires effort, and the acquirer of knowledge has to guard against errors. The costly effort required to attain knowledge means that it is entirely natural that one producer can have an advantage over another producer. If a producer discovers a better production method first , that producer will out-compete the other producers. (For a fictional example, think of Hank Reardan and the years he spent in his lab discovering his metal, or for a real life example think of the countless filaments tested by Thomas Edison before he perfected the light bulb.) To use the terminology of the perfect competition theorists, that producer will be a monopolist or an oligopolist. Moreover, he will be selling his goods at a price higher than his cost of production, which is evidence of market power.

Monopoly, oligopoly and market power are all terms used by modern economists to denounce the efforts of capitalists to produce the things we value. Thus, we come to the realization that such phenomena actually represent perfect competition, but not at all in the sense that the perfect competition theorists say. It is perfect competition by a rational standard. That standard is freedom. If man is free to produce, the result is an economic system perfectly in accord with man's nature as a rational animal. The specific form of business competition that exists in such a society, where entrepreneurs struggle to produce better products and gain advantages over their competitors in doing so (exhibiting monopoly, oligopoly and market power) is perfect competition.

****

The theory of perfect competition denies the nature of man's mind. It states that because acquiring knowledge requires effort and is subject to error, man is imperfect. But, in fact, for man to acquire knowledge does require effort. Therefore, the perfect competition theorists are saying that because man has a mind, he is imperfect. With such a flawed view of man's epistemology, it is not surprising that their economic theory is so warped, and so destructive when it is implemented in law.

Edited March 8, 2008 by Galileo Blogs

[John McVey]

What problems are there both with the original statement and with the implication made from this statement?

Kendall has supplied directions to some of what you should consider, but there's a bit more.

The statement is as much a moral one as it is a practical one. It comes from the efficiency standard (as has been pointed out), which is based on the fallacy of the social ownership of the means of production. Leaving aside the mathematics of it (the marginal-benefit and marginal-cost calculations etc), critics are saying that markets are only justified if they lead to prices being at a point that provides nothing to capital-providers beyond the bare minimum rate of return that leads them to maintain their capital investment in that line of production. Any price that leads to profits being above that bare minimum is seen as theft from society. Those prices above that which create the bare minimum are said to be "monopoly" prices, and since these are the vast majority of prices markets exhibiting the tendency for them are called "monopolisticaly competitive", "oligopolistic" or outright "monopolistic", depending on the number of producers.

The perfect information criteria is one element among a slew of others within the perfect-competition model of what it takes to have prices at that point. The critics of real markets using this standard aren't necessarily saying that markets don't work, they are saying that "imperfect" markets don't give society it's "full due", and that imperfect information is a key element of what stands in the way of society getting its due. This lack of full due, they say, is contrary to the assertions of the older classical economists who said that free markets were the best because competition would make sure society does get its due. The classicals never fully defended the right of producers to keep all their product, and could not because they could not provide a fully rational basis for self-interest. In what defence of property they did make they relied upon the idea of competition to show that it worked out well for society, hence Mandeville's "private vices versus public benefits", Smith's complaints about merchants conspiring together versus his invisible hand, and all that jazz. The critics took the primacy-of-society for granted, concocted the efficiency standard to attempt to quantify how well or otherwise that competition in practice served that end, and then showed that since real markets did not live up to that standard the classicals were wrong about free markets doing the best for society. Therefore, the critics conclude, the classicals were mistaken to advocate laissez-faire and instead there must be intervention to correct that fault.

In industry I don't think the imperfect information criterion plays as big a role in determining the nature of that intervention as does the criterion relating to the number of competitors and the like. Trying to spread more business information at that level is too obviously a direct violation of privacy as the kind of information in question would be industrial processes, marketing campaigns, and so on. Nobody could advocate disclosure of those without being an out-and-out socialist. In finance, however, it plays a very big role indeed, and the laws compelling businesses to reveal an enormous amount about their financial affairs to financial markets are in large part motivated by the imperfect information criterion. Here all manner of people advocate these laws, even those who might otherwise consider themselves quite capitalist, which advocacy itself contributes to the traction that the imperfect information criterion still has.

JJM

Edited March 8, 2008 by John McVey