The imperfection of perfect competition

The conditions for perfect competition seem impossible to achieve. 

• Many firms 
• This is in conflict with economy of scale. If their are too many firms, the economy of scale will never happen. In fact the best economy of scale happens when we have a monopoly.  What that means is that the prices are not lowest possible.
• Little barrier to entry 
• Many industries have big barriers to entry. Be it money, time, patents. Only handful of industries participate in natural resource extraction, because barrier to entry is very high. Phrama requires years of research. Telecommunications need huge investments in infrastructure. It is sort of illogical to try to get into a business which is not defensible.  
• Homogeneous products
• Marketing and advertising have only one function, create differentiation.  
• Complete Information 
• This is in conflict with "many firms". It is not possible to have complete information about infinite firms. This is also in conflict with division of labor. If everyone needs to know everything about what he needs from another, he might as well build it himself. 

Perfect competition looks like a myth which only exists in theoretical models, except may be for unskilled labor. There are many. No barrier to entry, by default everyone is an unskilled laborer. They have nothing to differentiate by definition and because the only information required is do they have functioning limbs, it is easy to see by inspection.

Economic Equilibrium Without Perfect Competition

I propose here a very simple solution to the problem of achieving and keeping economy in equilibrium. It can easily be called capitalistic communism. It doesn't requires ANY changes to way democratic capitalism currently works. It works within the constraints of the capitalism. No state ownership of capital assets is necessary. No redistribution of capital assets is required. The crux of the proposition is that not just greed of one person is good for all (capitalistic principle), sometimes greed of set of people is good for each one in that set (communism). To deal with impossibility of defining what is preferred by all based on individual preferences, I propose partition of the set based on these preferences. These partitions are dynamic in the sense that individuals might shift from one set to another as their preferences change. The prices are decided by the relative economic power of these sets of individuals and their interdependence on each other for their own welfare.

Consumer Corporation
The goal of a consumer corporation is demand aggregation and taking collective decisions on behalf of its members. Because of its size, it can negotiate better prices (Groupon) or create new alternatives for handling that demand (Kickstarter). It could be based on location (where) or time (when) or products (what) or kind of consumers (who) or any combination of them.  The consumer corporation causes discrete fluctuations in demand, making prices stick for a longer time. A small increase in price might cause large swing in demand, making the company unable to survive. Home loans can be negotiated. School bus can be arranged without asking schools to have one. May be not everyone needs to have a washing machine. The economy of scale can happen at demand side of the equation too and not just at the supply side. Examples could be people living in an apartment or whose children study in same school or owners of mobile phones or customers of Airtel. The only real power of consumer corporation is that it can cause significant change in demand that can be used to keep prices stable.

Labor Corporation
The goal of labor corporation is skill aggregation and taking collective decisions on behalf of its members. It is different from employee union because union is restricted to a company. Labor corporation can span multiple companies, multiple skill sets, multiple regions, etc or may be a small subset of labor in a company. Basically any organisation of labor that increases its collective bargain power. This make labor as a product or service which can only be purchased from Labor Corporations. Labor corporation can for example decide to reduce the supply of labor to the market if it can bump up the wages to a point that increase in wages makes up or increases the total income of the labor corporation. It also acts as an insurance agent against unemployment. We don't need any specific labor laws because labor corporation can handle that as part of price of its product, the labor and kind of contract it signs with the company. The same kind of competition that exists between normal corporations can exist in labor corporations. Such corporations can arrange education/training to convert "one kind of labor" to "another kind of labor" if that is what will maximize the total income of the labor corporation. It can even help fund education of children which will ultimately join these corporations. Their main purpose is to fiddle with "labor supply" to keep wages relevant. Because all that the employer gets is labor, it can be effectively shared. Everyone works but may be only once a week and half a day or at multiple companies. Companies don't own the person, just labor time and that time can come from multiple persons. The core job of labor corporation is keeping labor prices relevant by controlling the supply of labor to maximize returns for corporation as a whole.

What we get because of this arrangement is three kind of organizations. Capital, Consumer and Labor. All of them depend of each other to make the economy work. Without Labor consumers don't gets the product they want and Capital is wasted. Without capital, labor don't get jobs and consumers don't get any products. Without consumers capital is wasted and labor don't get jobs.  You could even call it economic cold war. Note that the core assumption here is interdependence. Any set that achieves interdependence from the rest is essentially not part of the economy anymore as it can survive on it own.

What we get because of this is balance or equilibrium in the economy in spite of perfect competition, because each set needs the other two to achieve survival. Even monopoly can be made to work if consumer and labor also make a monopoly. They make is easy to study economy because instead of 7 billion participants, we can may be talk about 7 million or 7 thousand or may be even 7 consumer or labor corporations with different labor power or buying requirements. They can be broken up if they are not in the interest of its occupants, creating more diversity or combined to fetch more benefits. Labor and consumer corporation can be a single entity with same members. In this special case, they operate with the same premise that other corporations exist, namely profit.

Somehow both these "concepts" are handled by government. All consumers and all labor somehow depends on government to interfere to make life work for them. Sadly governments are too busy preparing for the next elections. This dependence on government is artificial, not required. People can organize as labor and/or as consumers and work/consume at their own terms without government intervention. Political systems organizes people according to political buckets (religion, region, ideology, gender, age) to create power delegated to government. The same can be done via economic buckets to create buckets of economic and labor power and solve the economic problems or at least giving them a fair chance. May be Adam Smith was actually right. We don't need governments and its intervention. Just like capitalism creates pockets of capital power, we just need similar organization of labor and consumers to keep the economy in balance.

It is very simple to create, given the communication systems that connect people instantly across the globe. We don't need to change government or create new policies or anything else. Capitalism itself provides the solution to the economic problems we face today. All we need is greedy employees and greedy consumers, using the inverse principal - good for "my corporation" is good for me, reducing competition among themselves to counter the increasing power of producers. And that probably is the best way for "communism" to exist side by side with "capitalism" without needing any violence or revolution.

May be we have been evaluating the best of the two approaches for a long time. The answer probably is both. 

Capitalism - The missing piece

Capitalism always reminds me of Darwin's theory of natural selection. Companies that don't make profit, die. Nothing emotional about it, that is supposed to be good for the economy and people. What about labor, specifically unemployed labor? If we assume the capitalism's answer is "they die",  capitalism starts to make complete sense. Death of poor unemployed labor lowers the labor supply, results in better wages for those alive.  That could be the capitalistic way of creating equilibrium. In countries without any welfare policies, with no access to land to cultivate or forests to hunt, the only choice capitalism leaves for unemployed labor is death and for a good reason. It creates equilibrium and better wages.

I understand the horror of what I said above, but if you accept it for a moment, you will see the beauty of capitalistic equilibrium equation. Nothing else is required. It will be a well functioning system, killing or producing people in relation to demand is all that it asks for, to be in perpetual balance. The more people are rendered useless because they contribute negatively to the equation of maximization of profit, more people need to die to maintain the economic balance. I guess that is what Atlas Shrugged was all about. Using the term "division of labor"  somehow presumes that their exists labor opportunity for everyone. Unemployment is logically absurd if capitalism is about division of labor.

The problem then is not that government is doing less, the problem is government is meddling around too much in this laissez faire economy. Left to its own design, it would solve the unemployment, poverty and other stupid social problems faced by society.  The invisible hand does seem to believe in removal of poor as a way of removal of poverty. Except for the issues of the morality of killing people and the biological problem of 16-21 years of waiting period before those born can be made into labor, the capitalism indeed works as described.

Of course this is not at all true. It is just a commentary on a mental walk on the roads of capitalism with "poor die" goggles. The good part is, it makes sense. The bad part is it is horrible. The reality on the other hand doesn't makes sense and is horrible too.

 Here is an alternative way of achieving Economic Equilibrium which doesn't requires killing poor.       

Louis Kelso - The Binary Economics

In one of my over the whiskey discussions, we explored the idea of consumers investing in the stock of the companies from whom they buy products.  The basic idea was that if company is making profit from me, it will probably reflect in the stock price of the company some day. Google search for any precedence lead me to Louis Kelso and his theory of binary economics. He was the inventor of the ESOP.

I don't think I buy the whole argument, but the intentions feel solid. The core premise is that any increase in production should happen with equivalent increase in purchasing power for the economy to function properly. This I think is a gem of a observation.

Consider an economy in perfect equilibrium. Lets say someone invents a new thing and everyone wants it. This would require people to buy less of the other stuff so that they can buy this new thing. Which means less prices for everything else to save money for the new product. The introduction of new thing causes prices of rest of things to be recalculated so that economy is in balance again. What is required here is that either magically everyone has enough money to buy the new thing or price of everything else is "adjusted" so that everyone has enough money for the new thing. That is not what usually happens. Multiple things can happen at this point. Some people might reduce the use of other things to save for the new thing. Some might use their savings. Some take debt. Some don't care. Unlikely, but some may increase prices to get more margins. And some may invent new ways to reduce costs to get more margins. If most people reduce the use of things, demand goes down, some other people make less money. That would be a start of slowdown. If most people use their savings, the cost of money goes up, interest rates are increased. This might cause defaults, as wages were untouched. This might make some businesses suffer, whose margins are less than the interest rates. What we really need here is a perfect kind of transformation. Some people save, some use the savings, some take debt and somehow everything cancels out, without impacting money supply or margins for existing businesses. The point is economy doesn't seems to tend towards equilibrium, when moved away from it.

If some of the people make most of the money then most of the people will not have much money. Compound it with money makes money, you end up with lots and lots of poor than you started with. The end result would be decrease in market size. Some of the people just can't afford some of the things anymore.  This can be offset by technological advancements to decrease the cost of production but only up to a point. All businesses need consumers, but if businesses are run for maximization of profit alone, they may end up destroying the very thing namely consumer which is the main source of profit. One way to make things affordable in short term is debt, but sooner or later the things will collapse if consumer cannot even pay the debt. Seems like this is true even for countries. Historically, the only way to deal with such situation (inability to pay debt) was handled using slavery.  So maybe that is really the end goal of obsession with money.

The funny thing is I heard one gentleman saying he is looking forward to depression because he knows how he can make money from it.  That I think is very sad state of affairs. If the only way to deal with correction of the economy is depression, then something is fundamentally wrong about the system. We use vote to decide who will run the country. We might as well start killing each other to show who is more powerful. That would be absurd, except that is how I think we deal with financial systems.

One of the ways to deal with this could be use of communication on the demand side of things. What Groupon did was something which was not possible for long time. Unknown buyers joining to bargain product prices. Kickstarter is doing the same, except for funding new products. What should I call it - consumer union?  Just like labor unions used to stop work and cause financial loss to company, may be consumer unions can stop purchasing the products of the company to bring it to halt. That is what Gandhi did to British clothes. This was not possible earlier because consumers never knew each other because of physical distances. It was not possible to discuss, but given the communication systems of today, this is very likely.

If the consumers own the company stock, we still have a fair arrangement, except it is much cleaner.  The margins flow back to the consumer automatically.  This could even be used by governments when they give natural resources to companies. The current best practice is auction. What if government could use half of the money from auction to buy the stock of the company to which it is selling the contract for natural resource like coal mine. What it does is that it insulates government from any bad deal it got while selling the resource. If the company got less, its stock price will not rise much. If the company got more, its profits will reflect in its stock prices, giving more value to the government. 

Thoughts on traffic jams

One of my favorite joke of all times is carry bread while driving, you never know when you will find (traffic) jam. We have all crossed intersections. I am talking specifically about the no traffic lights, no traffic police kind. Sometimes they are so smooth that we don't even notice. But sometimes when everyone wants to go first, no one ends up moving. For a long time my take would oscillate between two point of views:

• People don't have driving sense (They don't know what they are doing) 
• People are mean (They are doing with intention)

Lately I have been thinking may be something else it as play here. And that something is "lack of information".  What I mean by that is that we only know what is "going on" for a distance of 20-30 meters in light traffic and may be next 3-5 meters in bumper to bumper traffic. That is all we know. That is all the information that we have at our disposal to judge "driving behavior" of other people. This is too less to be correct. 

Here is a simple hypothetical test case. Stand at any intersection and wait for other to stop before you cross the intersection. Ensure that it is always possible for the others to cross without bothering about you. My understanding is that you can wait for hours without getting to cross. And I guess the reason is the other drivers just get few seconds to "see" you waiting. They don't know how long you have been waiting. And if later you try to cross the intersection, I am sure you will still get honks, people trying to squeeze in, so that they can cross first. Hopefully you will cross without being cussed, but nevertheless being judged as not having driving sense and being mean. As social animals, we learn correct behavior by imitating what we see.  But if what we "see" is skewed, we will judge that skewed behavior to be correct. At least that is what I feel what I have been doing for most of my driving life.

If somehow it was possible to communicate and let everyone see the correct facts, may be the way we react and judge would change. One of things that comes to mind is a simple "wait counter" installed above the car which counts the time you have been waiting and displays it for others to see.  Not that this would magically cause deadlocks to go away, but at least everyone will know if what they and others are doing is fair or not.  At least instead of always learning people are mean or people don't have driving sense, we will possibly learn most people are not mean and most people have driving sense or vice-a-verse.

It gives people a fair chance to be fair.