What Is The Market?
A Definition Post
Have you ever been having a conversation with a friend, and slowly start to get the impression that you’re both using a word for which the two of you have vastly different definitions?
When I talk to friends who aren’t familiar with economics or capitalism, I get this impression all the time.
I use words like ‘market’, ‘capitalism’, ‘incentive’. I use them as the backbone of a system that generates wealth and lifts us out of the natural poverty that is the human condition. They use these words as a punchline!
Now, standard rationalist doctrine in such a case is to taboo the word in question - if people can’t agree on a definition, simply forbid use of the word, and make people say what they actually mean. But that’s inconvenient in the middle of a conversation with non-rationalist friends, not to mention it doesn’t necessarily solve the problem.
So today I thought I’d try to set the record straight, and talk about how I define ‘the market’ when I talk about it.
The Definition
The Market is the vast, distributed computational system that assigns monetary values to all goods and services while simultaneously and in real time allocating resources to maximum practical efficiency based on said values.
Conclusion
Great! Now that that’s settled, post over, have a good weekend.
…
…
Okay, I suppose the definition needs a little explaining.
But…we need to back up first.
The Problem At Hand
Civilization has a problem: how many chickens is a cow worth?
How many bushels of wheat is a horse worth?
How many fidget rings is an iPhone worth?
What percentage of the Amazon corporation is worth an hour of a doctor’s time?
Any organization more complicated than a nuclear family, from a co-op to the global economy, has to be able to engage in the exchange of goods and services. People have to be able to trade stuff and time between each other. But knowing how much of one person’s stuff is worth an hour of another person’s time is not a simple question.
It can be resolved simply - just have the two people negotiate an agreement between themselves - but that’s only for that specific case. What about other stuff? Or more time? Or different people?
Any stuff or combination of stuff can, in theory, be traded against any other stuff, combination of stuff, or service.
This is a bewilderingly large amount of questions that need answering.
The Calculation
If there are X things and Y services in the economy, then the total number of calculations we need to make (questions we need to answer) is something like
X^2 + Y^2 + XY
(Each good compared against each good, each service compared against each service, and each good compared against each service.)
That calculation has to be done in parallel, simultaneously and instantaneously, for everything in the economy, all the time.
And if that doesn’t sound difficult enough, it has to take into account all available information as well. Twelve chickens may be worth a cow, but what if the cow is sick? What if it’s old or young or male or female? Every possible scrap of information along every possible axis has to be included in the calculation to arrive at an answer.
This calculation - assigning all these relative values - is not something a human (or any group of humans) can do. It isn’t something any computer on the planet can do, either, because it involves more information than can reasonably be entered into a computer in the given time frame.
And yet it gets done. It happens, it exists, it’s real.
So what gives?
The Solution
There are two pieces to the answer to our conundrum.
The first is currency, a universal medium of exchange that vastly reduces how many calculations we need to make.
The second is the massively distributed analog computation going on all around us as you’re reading these words.
Currency
We can’t compare every permutation of every good to every permutation of every service. It’d take too long, and besides, who really needs to know how many loaves of bread are worth a 1997 Ford Mustang?
So instead of comparing everything against everything, we compare everything against one thing: the value of the dollar (or rupee, or euro, or whatever). We invent a unit of value with no tie to any actual good or service, so it can serve as the metric by which goods and services are measured.
This reduces the number of calculations needed vastly. Instead of
X^2 + Y^2 + XY,
we know only need to do
X + Y
calculations. We just have to determine how many units of our currency each good and each service is worth, and then our currency can be compared against itself trivially.
Analog Computation
Not all computers run on binary. Technically speaking, a computer is a device that performs computations - and computations can be performed by a person, slide rule, abacus, or other piece of equipment that isn’t a computer.
An analog computer is a computer that performs its computations non-digitally, usually by physically simulating whatever math it’s trying to perform.
Certain circuits, for instance, perform mathematics identical to physical systems because both the circuit and the physical system use the same differential equations. This means you can simulate the performance of e.g. a car brake by building a circuit with the same mathematical properties.
The calculations needed to determine the exchange rates of every good and service with the currency of our choice (how many dollars everything is worth) are performed in this analog fashion. Prices are decided based on a combination of what people are willing to pay for things, the results of negotiations, supply and demand considerations, and so on. Every person who buys or sells something is a part of this calculation, performed in real time all over the world.
The market is an analog computation, because while parts of it are done digitally, so much of how prices are set comes from the negotiations between people. From the bottom up, people assign value to goods and services, and those valuations form the basis for the computation to follow.
Distributed Computation
Most computers run serially: they execute one instruction, then the next, then the next, one after the other. While they appear to be doing multiple things at the same time, this is the result of doing one thing at a time very very quickly. Far faster than a human can perceive.
Some computers and algorithms, however, are designed to run in a distributed, or parallel, fashion. They take a problem, break it up into many smaller problems that can all be solved individually, and then send those smaller problems out to a fleet of computers that solve them all at the same time. The answers to the smaller problems are then collected and assembled into the answer to the bigger problem.
The prices of each good and service are computed in a distributed fashion. Whenever a house is bought or sold, the negotiations over the price are part of this calculation. Whenever you pick up some deli meats at the supermarket, you’re part of this calculation. When shipping companies determine freight rates based on the price of fuel and depreciation of capital stock, they’re part of this calculation.
Like pieces of a puzzle, all these individual instances of setting a price - an accepted exchange rate between a good or service and a currency - combine to set the prices of everything.
This is not a calculation that can be done in one central location, no matter how smart the Soviet planners thought they were, because it relies on information that can’t be gathered centrally.
Farmers in Bosnia know the qualities of their own soil and the patterns of the weather, which influences the length of their growing season and the success of their crops. Semiconductor manufacturers in Taiwan understand the environment of a clean room and all the technology that goes into creating microchips better than anyone - how could a central planner factor all of that in when deciding the price of the new iPhone?
The Market is a distributed computation, because it can’t be centralized. It involves information from all over the world, all the time, all contextual and specialized and difficult - if not impossible - to boil down to a list of executable instructions.
Allocating Resources
We’ve covered the analog and distributed portions of the definition, and talked about how The Market is a computational system.
But I also mentioned that The Market allocates resources to maximum practical efficiency - what’s that about?
Economists Tyler Cowen and Alex Tabarrok say:
A price is a signal wrapped in an incentive.
The details on how that works are well worth their own post, but the basics are straightforward.
A high price means that something is valuable. It acts as a signal to everyone that there is money to be made by fulfilling the need (the demand) that created the price. And the money to be made incentivizes people to provide the good or service demanded.
So the results of The Market’s computations are signals telling providers - people who make and/or sell goods and services - what people value, and how said providers can make money providing it. In practice, this results in resources being deployed to maximum practical efficiency, as each resource is deployed for its highest-value use.
(In theory, it may be possible to do better, but in the real world, the market seems to do the best job. Command economies, rent control, anti-price-gouging laws - all these attempt to do a better job than the market, and all either fail or create new problems worse than the problems they were trying to solve.)
Conclusion Redux
The Market is the vast, distributed computational system that assigns monetary values to all goods and services while simultaneously and in real time allocating resources to maximum practical efficiency based on said values.
Hopefully that definition makes a bit more sense now.
I also hope that my anti-market friends might understand, after reading this, why I’m pro-market. The work of assigning prices to everything has to be done, and it cannot be accomplished by experts or politicians in a centralized way. It’s too vast and complicated a problem to be computed by anything but a vast, distributed, analog computer.
The Market isn’t sentient; it doesn’t have feelings. It doesn’t discriminate, nor is it unfair. It just exists, the only realistic solution to a problem all civilizations have.