AlexSzatmary / Alex Szatmary

Huffduffing since April 15th, 2011 http://sites.google.com/site/alexszatmary/

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  2. Munger on John Locke, Prices, and Hurricane Sandy | EconTalk | Library of Economics and Liberty

    LOCKE MADE A MISTAKE! Two, actually!

    Mr. Locke described a case—which was fleshed out a bit in the podcast—of a wagon about to fall off a cliff but for want of a horse.

    Locke’s concern, according to Mr. Munger, was Justice and Equity. John Locke did not give a definition of Justice (to my knowledge) but seems to have been trying to argue that an agreement reached between individuals in a ideal Free-market met the requirements of Justice whereas an agreement made in a market where one party had monopoly power was Unjust if it deviated from the price that would have been present had the market been equitable to both parties. He did not use terms like “ideal Free-market” but instead described in detail all of the assumptions which define an ideal Free-market—voluntary, informed, and competitive.

    Since no definition of Justice was supplied in this podcast, I will use Adam Smith’s definition from about 100 years later. Adam Smith defined Justice in the “The Theory of Moral Sentiments” as: do not harm strangers, do not deceive strangers, and do not steal from the strangers.

    Justice, therefore, is a set of negative precepts designed to prevent harm between strangers.

    Smith indicated Justice was the moral-minimum for a society to exist.

    Since no definition of Equity was supplied in the podcast, I will infer that by equity he meant “equality of market assumptions”, since that is how the term was used in the podcast.

    With the precepts of Justice, the ideal of Equity, and the assumptions of an ideal Free-market in mind, let us examine Locke’s horse scenario.

    The owner of the horse is in a competitive-informed-voluntary market. (There are others who would buy his horse. He is under no outside coercion and he would not be punished for refusing to sell. He is well informed about the prices for horses and also he has an idea what his own horse is worth to him.) Justice requires only that this horse-owner do nothing to make the cart-owner's position worse and vice verse. Importantly, the horse-owner has no obligation under Justice to make the cart-owner's position better. He has no obligations under Justice to trade at any specific price or to even trade at all. So from the perspective of Justice, there is no moral dilemma.

    On the other hand, the cart-owner's market circumstances are different—ie. not equitable. His market assumptions are voluntary-uninformed-monopolistic. (Fortunately for him, he is under no outside compulsion and he suffers no outside punishment if he does not buy a horse. Unfortunately, he cannot know if there are other people who have horses within the distance of his critical-time-window or what their selling prices might be or if they would sell at all.) Since at least one of the three criteria for an ideal Free-market are false, there is no guarantee that the outcomes he can achieve through trading will be as optimal for him as they would have been in an ideal Free-market.

    Justice is satisfied so long as the cart-owner does not threaten, injure, steal from, or defraud the horse-owner and vice-verse. So from the perspective of Justice, there is no moral dilemma.

    Justice, it appears, does not care about the outcome of the trade between these two individuals or even if any trade occurs at all. I think it is fair to say, therefore, that Locke was incorrect when he suggested that only the prices reached in an ideal Free-market are Just.

    This leaves only Locke's concern about Equity.

    Locke was concerned that the unequal circumstances between these potential trading partners could cause harm to the cart-owner, a violation of Justice.

    He proposed a technique for dealing with this unlevel playing field that is similar to Adam Smith's “outside-and-impartial observer.” Locke proposes—in 1600's language—that the seller (who has the monopoly power) imagine that both he and the buyer were in a voluntary-competitive-informed market, and then act accordingly.

    Locke is a really smart guy. No doubt about it. His understanding of the world is very contemporary. It is not surprising, therefore, that his mistakes are also very modern. Locke made two errors here.

    1st ) It was an error to consider the position of the cart-owner as one of loss. Locke’s scenario guarantees that the cart-owner is going to suffer total loss of the cart and its contents if he does not enter in to a trade for an additional horse. Given that guarantee, this cart-owner's loss is a “sunk cost” and as such is irrelevant to the question of his future decisions.

    That means any consideration of saving his goods from falling off the cliff are questions of future GAIN to the cart-owner. There is really no “moral dilemma” once we realize that this horse-problem is a question of two people trying to maximize their respective gains as apposed to one person trying to maximize gain while the other tried to minimize loss. There is no loss going forward. The loss occurred in the past and cannot be changed. That is why the cart-owner is not harmed by any price offered by the horse owner and that is why Justice is not violated if the horse-owner chose not to sell.

    2nd ) It is an error to suppose that a single person can imagine even a small fraction of the total information that goes in to creating a market-price. Several commenters have already discovered and explored the limits of that thought exercise. Locke's idea of imagining a future ideal market price is a fools-errand. It is impossible. A market price contains input from hundreds, thousands, even millions of people in real time. No person can possibly understand, much less imagine, that much information. [Think of the modern stock market and all the people who pretend they can predict its fluctuations. They can tell you what it is currently or what it was in the past, but future predictions of even seconds are, when considered over time, totally random—except perhaps when you are the Fed Chairman…] No person can even understand fully the amount of information two people contribute when negotiating a single price between them.

    Even though these errors—the sunk-cost fallacy and the impossibility of accurately imaging a future market price—argue against both Locke's perception of injustice and his proposed solution, he was right to note that the cart-owner would have gotten a much better deal had he been in a market which was voluntary, informed, and competitive AND the seller would still have been plenty satisfied receiving a much lower price for his horse—a Pareto efficient solution 200 years before Vilfredo Pareto was born (1848-1923).

    Locke saw the monopoly problem and correctly deduced that an optimal price results for all parties when all parties have large quantities of freedom-information-and competition.

    Further, it is Laudable that the method he proposed for achieving that optimal price when those assumptions are false was voluntary. Perhaps he knew that any attempt by a third party to force the two actors to behave differently than their nature and their environment determined, violates Justice and violates the assumptions necessary for optimal outcomes through trade. What Locke did not see, and what I think we can learn from this scenario, is that the best way to achieve Pareto efficiency is through changing the environment around the actors, not just pretending that they change. By focusing energy on improving market assumptions, the outcomes won’t improve the current case, but will improve all the cases that follow. For example, install some roadside telephones—or a 1600's equivalent—to allow stranded people to access market information faster. Or start a company that provides rapid assistance to horse-buggies in distress that increases competition.

    http://www.econtalk.org/archives/2012/11/munger_on_john.html

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    Tagged with justice cart-owner locke horse price

    —Huffduffed by AlexSzatmary

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