JOIN EHA

DONATE

Published by EH.NET (May 2000)

Michael Perelman, The Natural Instability of Markets: Expectations,

Increasing Returns, and the Collapse of Capitalism. New York: St. Martin’s

Press, 1999. xiv + 188 pp. $39.95 (cloth), ISBN: 0-312-22121-5.

Reviewed for EH.NET by Thomas E. Hall, Department of Economics, Miami

University, Oxford, Ohio.

Economists have long known that competition has some ugly side effects. In

competitive industries, firms go out of business. The competitive process

exhibits Schumpeter’s creative destruction as new technologies come along which

displace existing industries. Workers lose their jobs, and firm owners lose

wealth. This is all very unpleasant for the people who are adversely affected

by these changes, but in the net society is better off by reaping the benefits

of economic efficiency. At least, that is what economists generally believe

about the competitive outcome. This is why most economists argue that (with the

exceptions of a few cases such as public goods and natural monopolies) a policy

of enhancing competition is desirable.

Michael Perelman challenges this conventional economic orthodoxy by arguing

that the economic instability caused by competition may be so large that it

outweighs the beneficial effects of economic efficiency. In fact,

competition is so awful that “the tendency of the competitive process is to

lead to depressions” (p. 62). Perelman does not argue that monopolies are the

solution, instead he contends that society’s welfare is enhanced by having an

industrial structure that is neither too competitive, nor too concentrated. The

optimal structure lies somewhere in between, where the gain in economic

stability resulting from a less than perfectly competitive structure exceeds

the loss to society of lower economic efficiency.

It’s an interesting argument, but one that isn’t well enough documented for

most people to accept. Too much of Perlman’s discussion focuses on what’s wrong

with competitive markets, and too little on the benefits they create.

Yes, the competitive process can cause wrenching changes in society, but what

about the lower prices we pay, the wider variety of goods and services we

choose among, the improved quality of products…? These considerations are

given short shrift compared to the evils of “instability.”

A serious weakness of the book is its lack of a discussion on the role of

demand. For example, Perelman considers economic depressions to be the

intensification of the competitive process. While most of us would agree that

competition among firms is more intense during economic recessions,

would we extend the argument by saying that competition caused the downturn? I

don’t think so. Economic recessions are typically caused by slowdowns in

aggregate demand growth. As spending growth slows, firms have to compete more

intensely for scarcer sales. Thus, we observe more competition during

downturns, but competitive pressures hardly caused the recession.

Perelman also argues that high wages during recessions are good since “high

wages represent a healthy stimulant to the economy . . . because high wages

will encourage productivity” (p. 121). This efficiency wage argument has merit,

but taken to extremes it could cause major problems. After all, if promoting

high wages is such a great idea, during the next recession let’s be sure to

raise the minimum wage to $1 million per hour and see how well that stimulates

recovery!

We often tell students not to get caught looking at the trees when they should

be concentrating on the forest. I think the opposite applies to this book.

Several of Perelman’s trees, i.e., the specific cases he discusses to buttress

his argument, are quite interesting. For example, there is an informative

history of entry and exit in the automobile industry, an excellent discussion

of x-efficiency, and a summary of estimates of the costs of unemployment in

terms of numbers of suicides, homicides, and such that would be useful to

instructors of macroeconomics principles classes.

However, I am considerably less enamored with the forest, the idea that

competition creates more problems than it solves.

Thomas E. Hall is the coauthor (with J.D. Ferguson) of The Great Depression:

An International Disaster of Perverse Economic Policies

(University of Michigan Press, 1998).

Subject: V, W Geographic Area: 7 Country/Region: U.S.

Time Period: 8, 9