Can Markets Be Designed?

13 June 2007 at 1:26 am 11 comments

| Peter Klein |

A fundamental distinction between organizations and markets is teleological: organizations are established by specific individuals to achieve specific purposes, while markets emerge, organically, from the bottom up. Carl Menger used the terms “organizations” and “orders” to distinguish these two categories of institutions; Hayek preferred the obscure Greek terms taxis and cosmos. Invoking this distinction does not deny, of course, that there are “organic” elements within firms, or that markets are infused with institutions that are at least partly “designed” (civil law codes, for instance).

What, then, is meant by “market design,” as in designing markets for cadaveric organs, education vouchers, or tradeable emissions permits? Do attempts to do so constitute what Hayek called “constructivist rationalism” or “constructivism,” the belief that we can remake social institutions that have emerged incrementally, over long periods of time, to suit our current whims?

Lynne Kiesling and Mike Giberson have been wrestling with this question over at Knowledge Problem (here and here). How, asks a reader, “does one invoke Hayek in one breath and then speak of ‘designing’ a market in the next while keeping a straight face?” Lynne and Mike offer several responses:

1. Some markets, particular energy, utilities, transportation, etc., have long been regulated; what we call “market design” is really just regulatory reform. Trying to improve the existing regulatory regime does not constitute constructivism, nor does it endorse the idea of top-down market creation per se.

2. Market exchange presupposes secure and well-defined property rights. If those rights have not previously been defined — not having emerged as part of the common law, for example — then engaging in a small bit of constructivism to define the relevant property rights is the least bad alternative. Lynne suggests this is an appropriate way to think about carbon trading.

3. More generally, market institutions themselves require some design. Mike gives the example of organized financial exchanges which must begin with some initial ground rules. (See Mulherin, Netter, and Overdahl on this point.)

One could also add that Hayek’s own evolutionary, “organic” account of the emergence of institutions may not be quite right. See Ron Hamowy on Hayek’s view of the common law and former O&M guest blogger David Gordon on Hayek’s view of language.

Entry filed under: - Klein -, Classical Liberalism, Evolutionary Economics, Institutions. Tags: .

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11 Comments Add your own

  • 1. Market Design « Asymmetry  |  13 June 2007 at 3:57 am

    [...] June 13th, 2007 Peter Klein, at Organizations and Markets, just published an interesting post on Market Design. He asks the following question: “Are attempts to design markets examples of what Hayek [...]

  • 2. Joseph Mahoney  |  13 June 2007 at 6:19 am

    Henry Mintzberg poses the question of planning versus emergence at the firm level and its impacts on firm-level performance, while the Hayek question concerns planning versus “spontaneous ordering” for its impacts on the “Wealth of Nations.”

    As Mintzberg often emphasizes there can be emergence (spontaneous ordering) within the firm, and your note suggests that there can be planning decisions concerning markets. As an example, planning can go into markets such as Auction design.

    The upshot is that we need to be careful to not unthinkingly substitute “market” for spontaneous ordering, and “firm-level hierarchy” for planning in the conversation within economics and strategy.

    Thank you, Peter, for continuing to be part of my education.

  • 3. Mike Giberson  |  13 June 2007 at 8:50 am

    Thanks for the Mulherin, Netter, and Overdahl cite, which looks interesting, and actually, more generally, thanks for the comments on our posts. I think I must have read Gordon’s review back when I was in graduate school, but I should refresh my memory.

    My post represents my instinctive opposition to the propensity of some readers of Hayek to instinctively oppose any attempt to mention “Hayek in one breath and then speak of ‘designing’ a market in the next.” There is a big difference between “planning” or “design” or even “economic engineering” in a local, contextual manner, and the kind of constructivist rationalism that Hayek wrote in opposition to.

  • 4. Peter Klein  |  13 June 2007 at 8:58 am

    Joe, my thanks to you as well — when can we begin charging each other tuition?

  • [...] at Organizations and Markets, Peter asks, what is meant by market design?  The concept seems like an oxymoron.  According to the pure [...]

  • 6. REW  |  13 June 2007 at 11:48 am

    Should Peter and Joe design a market between them, i.e. charging each other tuition? In a meeting with the Dean of Business at the Katholieke Universiteit Leuven, I was introduced to the concept of a “closed pocket” exchange program. In an exchange between two institutions, students pay tuition and fees to their home institution, attend the other, and the repatriate their learning. No tawdry exchange of cash between the ivory towers.

    No doubt these arrangements, like the ongoing unpriced exchange between Messers Mahoney and Klein, are socially constructed. Eventually, they are designed (codified in a contract or e memorandum of agreement). But I believe these arose from a long process of experimentation, between dyads over time and across the set of relationships that most universities maintain.

    I vote for Hayekian process for the specific case of inter-university exchange. Do we ascribe the same to Mahoney-Klein or is teleology afoot?

  • 7. Jason Briggeman  |  13 June 2007 at 1:12 pm

    A good comment, Secret Professor W. (You never know, but you just might sell a few more books if you own up to your full identity…) ;)

  • 8. REW  |  13 June 2007 at 9:36 pm

    Mr. Briggeman,

    Anonymity is a vastly undervalued asset! And if you will permit an inept segue, I must note in this thread that many markets are designed for anonymity in transactions. Begin with the development of US commodity markets at the end of the 19th century. The markets for grains were designed overtly so that a large number of anonymous transactions could occur. This led eventually to the design of derivative markets (futures) that work because of the specificity of the design of the commodity markets. Moreover the options markets are derivatives on the derivatives — anonymous sales of options on anonymous sales of futures contracts on anonymous sales of number 2 yellow corn. These markets did not emerge; they were designed and constructed. No Hayekian process. No Blind Watchmaker.

  • [...] they be designed if they are found in nature. This was rehearsed recently in its last iteration at Organizations and Markets, and referenced by Braydenbut occurs quite regularly. I think the idea of the ‘natural’ [...]

  • 10. Vladimir Dzhuvinov  |  18 June 2007 at 7:07 am

    Markets are human creation. There’s always intent behind them.

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