(4) A final remark on market mechanisms

[This is a part of a series of entries loosely connected]

There are a number of assumptions rarely made clear when we construct and debate the theory of free markets as a just system for economic interaction (for the workings of it these assumptions are not needed obviously); among them are:

• everyone knows the rules; possibly has even subscribed to them
• everyone has similar starting conditions – an assumption made famous in terms such as the ‘representative agent’, ‘lump sum endowments’ and ‘long-term neutrality of money’.

Still the invisible hand is supposed – like the non-existing Walrasian auctionator – to magically bring about a world in which ‘if everyone thinks of himself everyone is thought of’ prevails and social welfare is only diminished by taxation and government intervention. But there are ‘global public goods’, in anonymous environments the tragedy of the commons does occur, and no, not all are born equal. There is a huge class of problems that individuals and individual rationality and incentive will not solve, exactly because there is no incentive to the individual to contribute to the solution. The only way to solve these problems is to change the game theoretical rules of the games we play each day. One of the most powerful mechanisms to bring about social cooperation for common benefit was doubtless the company. But it was invented some day. Signs are mounting that today its M-C-M mechanism only serves the economy and no longer its creators. The neutrality of money has been ‘empirically proven’ – for a statement by O. Blanchard on the empirical evidence regarding this proposition refer to his entry in the Handbook of monetary economics. You’ll be surprised.

In 2000 appeared a paper widely cited among the econophysics community: “The statistical mechanics of money” by Dragulescu and Yakovenko, which as widely ignored by the economics profession (for a review of the literature from an economists perspective, refer to Prof. Lux from Kiel Institute for the world economy; note also the papers by John Angle starting in 1986 in the journal “Social forces”). In 2005 appeared “The social architecture of capitalism” by Ian Wright, again widely ignored by the economics profession. In 2010 appeared “Universal patterns of inequality” by Yakovenko et al. All of these papers

• could be checked against real world data and fit this data arguably better than any other theory I know of
• showed an exponential distribution of money holdings, energy consumption, income and many other indicators of material well-being over the population. The central point in this is that this high inequality was not brought about by any given social mechanism. It was pure exchange, random. Agents were all the same, they were ‘representative’. The world they lived in was a plain level field. It was not ability, talent or any other means that made people rich, and some poor. It was pure chance.

I will not argue that ability doesn’t matter, shouldn’t matter or any other silly position. I want my readers to start thinking about the privileges they enjoy and what these privileges are founded upon. The income distribution is shaped by the social setup, and the ‘perfectly free’ society makes most people so badly off that their freedom comes at a rather unattractive price.
The paper by Wright (2005) showed that the mechanism of Manchester capitalism – employing people, paying them lump sums and keeping the multiplicative returns for the company owner – did fit US firm size distribution data, replicated the income structure, the rate with which firms went bust and were founded and a number of other statistical data readily available from US authorities.
Finally the paper by Yakovenko (2010) shows that the income distribution consists of two parts (this was already known since 2001 and probably earlier but not explained) which can be explained by different types of income: the big majority of the population lives in the exponential distribution, which can be explained by additive income components. Those in the Pareto tails – the ultra rich – earn multiplicative income generated by those in the exponential distribution.

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