Systems of innovation Book

My review is divided into (two) parts: Abstract and Reaction (e/ part 500-600 words long). Don't let my critique fool you: it is a very well-supported book in the parts that it is strong (he analyzes hundreds of engaging examples). My academic "shit-talking" is due to the fact that this paper was for school, where "critical thinking" is encouraged. In fact, I think it was the book with the strongest case yet for markets and efficiency. I wish that McMillan were still alive today. Anyways, read on.

Abstract:

Establishing how markets are inexorable, McMillan argues that they need to be well-designed in order to promote efficiency and maximum social good. The five elements required for markets to run smoothly are: 1) free flow of information, 2) property rights protection, 3) trust and enforcement of promises, 4) controlling for externalities to third parties, and 5) competition. Markets arise and adapt as needed from the bottom-up - and innovations by participants are their drivers - but often need the the government's help to reach their full potential. However, balance is important, because an economy cannot be planned from above, and central planners can stagnate "distort, and even destroy markets'" ability to raise or maintain living standards.
Markets need support from a set of rules, customs, and institutions that set up mechanisms ensuring full benefits are delivered (13). Market participants' need decision-making autonomy to voluntarily exchange according to their preferences - and competition fosters this autonomy, by restricting disproportionate distribution of market power between participants (6). But choices by themselves do not ensure competition, because people need to be able to compare their choices (44). Search costs weaken competition, e.g. sellers can charge higher, so there are profit and entrepreneurial opportunities in helping information flow (44-6, e.g. Consumer Reports). Thus, the internet age has facilitated trade for both sides (e.g. eBay, Amazon), while also shifting bargaining power toward buyers. Trust and confidence that contracts and property rights will be protected is established through private and public sectors. Trade associations, intermediary firms, and credit bureaus, and "signals" like advertising, brand names, and trademarks, can help by spreading information, or producing collective blacklists of breachers. Thus, market participants can substitute or complement the legal system (or lack thereof) by developing their own self-enforcing mechanisms (61, China agricultural reform 94-101), but the law is often needed for transactions that require large upfront investments and for economic growth. Finally, externalities like pollution or resource depletion need to be collectively-enforced, regulated top-down through appropriately-set taxes or quotas, or through privatization (Marshall Islands fisheries, 125). Even better, quotas can be made tradable to achieve efficient allocation of caps, and alleviate government micromanaging burden (184).
Markets generate value through trade, i.e. participants gain from buying and selling. Thus, markets are resilient and can even form in refugee camps, prisons, and under Communist regimes (16). The decentralization of markets are the source of its dynamism (7), as participants use local knowledge and make adaptations and innovations through trial and error to optimize efficiency. Innovating economic organization can be as productive as technological innovations (21). The internet revolution is an obvious: limited-liability corporations (171), outsourcing (62-64), and the NYSE (22) are but a few other examples.
Markets and government have an uneasy relationship. Patents and intellectual property rights are an example of imperfect solutions maintained by the government at cost to users. Cost-benefit can be weighed to achieve optimum (e.g. Big Pharma v.s. patented AIDS drugs for Africa). Top-down price-setting without the use of market forces, e.g. well-designed auctions, cause market inefficiencies - the market allocates resources to those who value it the most and can use it best. Communism does not work because central planners lack the omniscience of the massive amounts of information from the ground needed to manage every aspect of the economy. However, market-supporting institutions are necessary for markets to be workable. NZ already had them - however, their state price controls caused distortions that required shock therapy, despite the societal pain. Poor countries need to foster markets and minimize inequality to achieve growth, but fail to do so because their markets, even if existent, are underperforming. Further, in both cases, corruption can inhibit growth through lack of investor confidence (Russia) - although self-restrained and strategic corruption, can sometimes help growth (e.g. Suharto's Indonesia, 140). McMillan maintains that market design does not control what happens in the market, but it shapes and supports the process of transacting (9), and that well-designed markets have to protected from both anti-market and free-market ideologues (epilogue Ch).



Reaction:

"In the Price Mechanism We Trust"
This book really beat home for me how (inexorable) markets elicit information on value through the price mechanism, and what it takes to ensure that markets are work most efficiently toward maximizing benefit - but is this necessarily the case? McMillan makes a very strong case for a market economy, as long as it is well-designed. However, the assumption that goods will go to those who "value" it most and to best use, by which he meant to those who would incur the least cost both to self and to society (and benefit all), needs to be examined in more depth. Some additional macroeconomic perspectives on net social benefit may also have strengthened the book.
"Most efficient use" may leave over more resources for more productivity or innovation (or profit). Cutthroat pricing can hardly be good for competition, as it may cause markets to fall into the trap of Gresham's law (51). There can be externalities that aren't always so easily regulatable as his treatment on cap-and-trade may make it seem (e.g. the global overfishing is problematic, but what about contamination with bioaccumulated mercury and millions of other, sometimes yet-tested toxins?). Or it can mean production of lower quality goods - freer information is not a guarantee of quality, as can be apparent by comparing many American products with say, Japanese or German (electronics, auto, home appliances, etc - Demming was a guru in Japan but unfortunately ignored when he came home to the U.S.). It can also mean skimping on labor costs (i.e. lowering wages) or worker health and safety, or otherwise cheating trade partners through disproportionate bargain power (e.g. unfavorable trading terms for third-world producers of raw materials). There was scant mention of worker rights in his entire treatise. This book seems to almost assume that everyone is an entrepreneur, or at least that efficient entrepreneurs or market participants should win most (if not all) of the time. In fact, there is ample validation of markets helping poor people throughout the book (e.g. farmers' markets in Communist Vietnam, p.15, or farmland allocation in Communist China), but class struggle arising from market systems was hardly a feature in this book (there were one-sentence allusions to fisher unions, p.125). Ultimately McMillan, whether in his attempt to maintain his "scientific objectivity" or "neutrality" as an economist, lacks the political and moral courage to take sides on sociopolitical issues, or make any assertions about any redistributive policies, even if their net social "value" may outweigh economic "costs" in the narrower sense (Marylin Waring, 88). The only moment he comes close, is in discussion of compulsory licensing for patented AIDS drugs in low-income countries (36-38), but even then, this is only the result of finding justification through cost-benefit analysis, in the strict financial sense.
Also, his authoritative grasp of microeconomic issues overshadows his perspective on macroeconomics, as evidenced for example by his extremely-superficial treatment of all that is needed to end poverty in developing countries, or further considerations on how so many social investments can indeed, if designed well, lead to economic growth later in many indirect ways. It seems that Keynesian perspectives may be rather foreign to microeconomists' rationales, providing for an incomplete picture on the limits of well-designed markets' abilities to maximize growth and net social benefit. Sometimes it also takes well-designed fiscal policies. For example, information flow may cause students or workers to get training in less-marketable disciplines, but a well-functioning market by itself is very far from solving unemployment. Also, where is there mention taxing other "externalities," like property tax (the wealthy outcompete the majority in bidding for them), on profits, or on excessively-rich individuals? But perhaps these are all macroeconomic issues, and political courage required balancing macroeconomic expertise. This ahistorical account of markets had a little bit of a misnomer for the second half of its title, and may be better called, Reinventing the Bazaar: In Defense of Well-Designed Markets. Hence, the title of this reaction.