by Rick Wilson

The reality-based community got a little boost recently with the announcement of the 2007 Nobel Prize in economics.

Three Americans, Eric Maskin, Roger Myerson and Leonid Hurwicz, shared the honor for their work in mechanism design theory, which studies under what conditions markets work well or don't. Sneak preview: They do better with private than with public goods.

The very idea that markets are imperfect at some things may come as a shock - or even sacrilege -to true believers in the cult of the market god.

According to this cult, the market is like an all-wise and all-good but jealous god which becomes exceedingly wrathful when interfered with by things like coal mine or workplace safety laws, minimum wage protections, or taxes that pay for health, education or other services. Its ways are not our ways, nor are its thoughts our thoughts. And if it demands an occasional human sacrifice, we just have to deal with it.

In the real world, however, markets work better for some things than others. They are at their best when they distribute private goods in a situation which isn't dominated by any one or few industries and where sellers and buyers have adequate information. They have problems in cases of monopolies or oligopolies, imperfectly informed consumers, or where exchanges create public costs and social problems.

As the Royal Swedish Academy of Sciences put it, "Adam Smith's classical metaphor of the invisible hand refers to how the market, under ideal conditions, ensures an efficient allocation of scarce resources. But in practice conditions are usually not ideal; for example, competition is not completely free, consumers are not perfectly informed and privately desirable production and consumption may generate social costs and benefits."

Many transactions, according to the Academy, don't take place in open markets but occur within firms, under special arrangements, or under the influence of political or other powerful interest groups. Think Halliburton or Blackwater.

Maskin, Hurwicz, and Myerson's mechanism design theory studies what kinds of arrangements make for an optimal allocation of resources. Here's the short version of a key finding: Markets work well with what economists call private goods, like refrigerators or cars, but not for public goods, such as a clean environment or public health.

According to Maskin in an article in Bloomberg.com, "There are some things we want that are never going to be attainable by markets," he said in a telephone interview. "If we are going to get them at all we have to find alternative ways of delivering them. That's where mechanism design comes in."

A Reuters report on the prize noted, "Societies should not rely on market forces to protect the environment or provide quality health care for all citizens ..."

In such cases, public investments and policies should promote and protect public goods.

None of this would have come as a surprise to Adam Smith, who wrote in 1776 that there was a need of government support for "public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay the expense to any individual or small number of individuals, and which it therefore cannot be expected that any individual or small number of individuals should erect or maintain."

If some people want to worship the market god, that's fine with me, as long as they don't try to make it the state religion.

In reality, markets are goods, not gods. What we need to do is figure out how to let them do what they do well, while also protecting the very important things they don't.

Wilson is director of the American Friends Service Committee WV Economic Justice Project and publishes The Goat Rope, a daily public affairs blog: www.goatrope.blogspot.com.
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