Hidden risks of our booming free market

Governments must enforce the law of intellectual property across boundaries

THE FALL of the Berlin Wall nearly 10 years ago marked the definitive collapse of central planning as an economic system. Capitalism triumphed, wiping alternative models of political economy off the face of the globe. The US has been enjoying a more or less permanent boom since, riding the crest of a new economic wave of technological innovation and entrepreneurial freedom.

What an awesome irony it would be if the new economy turned out to be making free-market capitalism unsustainable. Yet that is the implication of a paper by two American academics studying the "new economy"*. They say laissez-faire markets will deliver increasingly undesirable results the more the economy depends on weightless knowledge goods such as software or music. What's more, in the age of the Internet, buyers might have too much information for their own good. To reach these counter- intuitive conclusions, they look at the hidden assumptions underlying Adam Smith's case for the superiority of the invisible hand of the free market. As Smith put it: "By pursuing his own interest [every individual] frequently promotes that of society more effectually than when he really intends to promote it."

The unintended efficiency of unco-ordinated decisions taken by countless self-interested individuals arises from the fact that prices send a dual signal. They ration demand and call forth supply. Any interference in the process leads to the wrong amount of consumption and the wrong amount of production.

Price signals do not work ideally in all conditions. Economists have long admitted in certain cases "externalities" mean there is a case for government intervention in the market. A classic example is a public good such as clean air. We all value it but any company that invests in emitting fewer pollutants will be giving a free ride to companies that do not. The free market will lead to little clean air.

The interesting characteristic of public goods, giving rise to the problem of free riders, is that unlike normal goods everybody can consume them at the same time. Many new goods or even pharmaceuticals are non-rival in the sense that the cost of supplying them to one extra consumer after the first is almost zero. For the greatest consumer satisfaction, they should be supplied free to everyone who wants one. But if the price is nil, no producer will have an incentive to create the goods in the first place.

A related problem to non- rivalry is non-excludability. It is hard to stop people who do not have to pay from using such goods. In a sense this is true of all goods because the might of the law is needed to protect private property. But although the legal framework exists to protect intellectual as well as physical property, it is much harder to stop music piracy than to prevent thieves walking off with physical goods. Even worse for the efficient operation of the market, it might be the case that consumers are getting too much of the wrong sort of information and not enough of the right sort.

Think about buying a piece of computer software. The sensible way to buy a standard package is to shop around on the Internet for the lowest price. So obvious is this that ShopBots have been created to do the online bargain-hunting for you. But prices charged reflect not only the intrinsic cost of the good, but also the quality of the service with which it is sold - say, additional information about the software, tips for use or an advice line. Suppliers charging the higher price for better service have every incentive to discourage ShopBots.

So do retailers offering a particular item as a loss-leader to get customers into their virtual store; they do not want to sell goods at a loss to people who will not give them extra business.

But it is impossible to get enough information about many intangible goods because they are a bundle of present and future services. What you want to buy is the ability to make your computer perform certain tasks. You can't know for sure whether it will do what you want until you have tried it. This problem explains why many software companies give away test versions or simpler versions of their products.

One conclusion from this attack on the Invisible Hand is simply that governments need to do what they already do more effectively. They must find ways to enforce the law of intellectual property more vigorously, and across national boundaries. Technology is catching up with the problem, developing "digital watermarks" giving unique identification of a piece of software or dataset or picture. Cryptography offers a way of restoring excludability, requiring consumers to buy a decryption key.

But this does not address the philosophical question posed by the authors: are price signals doomed to be inefficient in the new economy? If the answer is yes, and producers supply too little of something which for economic well-being would be supplied free to all consumers who want it - whether a miracle drug or a Catatonia CD - you could draw a radical conclusion. Anyone for nationalising the pharmaceuticals or music industry? Or how about a form of global common ownership of Microsoft?

* `The Next Economy', by Bradford De Long and Michael Froomkin: http://econ161.berkeley.edu/Econ_Articles/newecon.htm

Hamish McRae is on holiday

Arts & Entertainment
Madonna in her music video for 'Like A Virgin'
music... and other misheard song lyrics
Extras
indybestFake it with 10 best self-tanners
Sport
Peter Moores was criticised for failing to handle top players when he last led the England team
sportFive years after being sacked from the job, Peter Moores to be named a cricket coach
News
Much of the colleges’ land is off-limits to locals in Cambridge, with tight security
educationAnd has the Cambridge I knew turned its back on me?
VIDEO
Sport
Steven Gerrard had to be talked into adopting a deeper role by his manager, Brendan Rodgers
sportThe city’s fight for justice after Hillsborough is embodied in Steven Gerrard, who's poised to lead his club to a remarkable triumph
News
The energy drink MosKa was banned for containing a heavy dose of the popular erectile dysfunction Levitra
news
Environment
People are buying increasing numbers of plants such as lavender to aid the insects
environmentGardeners rally round the endangered bumblebee
News
Ida Beate Loken has been living at the foot of a mountain since May
newsNorwegian gives up home comforts for a cave
Extras
indybest10 best gardening gloves
Sport
Australia's Dylan Tombides competes for the ball with Adal Matar of Kuwait during the AFC U-22 Championship Group C match in January
sportDylan Tombides was diagnosed with testicular cancer in 2011
Arts & Entertainment
tvIt might all be getting a bit much, but this is still the some of the finest TV ever made, says Grace Dent
News
Posted at the end of March, this tweeted photo was a week off the end of their Broadway shows
people
News
peopleStar to remain in hospital for up to 27 days to get over allergic reaction
Arts & Entertainment
The Honesty Policy is a group of anonymous Muslims who believe that the community needs a space to express itself without shame or judgement
music
Have you tried new the Independent Digital Edition iPad app?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

1st Line Helpdesk Engineer Apprentice

£150.00 per week: QA Apprenticeships: This company has been providing on site ...

Telesales & Sales Support Apprentice

£221.25 per week: QA Apprenticeships: This company is a well established Inter...

Client Relationship Manager - SQL, Python

£40000 - £50000 per annum: Harrington Starr: Client Relationship Manager - SQL...

**Financial Services Tax**

£35000 - £50000 per annum: Pro-Recruitment Group: Take your chance to join the...

Day In a Page

How I brokered a peace deal with Robert Mugabe: Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC

How I brokered a peace deal with Robert Mugabe

Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC
Video of British Muslims dancing to Pharrell Williams's hit Happy attacked as 'sinful'

British Muslims's Happy video attacked as 'sinful'

The four-minute clip by Honesty Policy has had more than 300,000 hits on YouTube
Church of England-raised Michael Williams describes the unexpected joys in learning about his family's Jewish faith

Michael Williams: Do as I do, not as I pray

Church of England-raised Williams describes the unexpected joys in learning about his family's Jewish faith
A History of the First World War in 100 moments: A visit to the Front Line by the Prime Minister's wife

A History of the First World War in 100 moments

A visit to the Front Line by the Prime Minister's wife
Comedian Jenny Collier: 'Sexism I experienced on stand-up circuit should be extinct'

Jenny Collier: 'Sexism on stand-up circuit should be extinct'

The comedian's appearance at a show on the eve of International Women's Day was cancelled because they had "too many women" on the bill
Cannes Film Festival: Ken Loach and Mike Leigh to fight it out for the Palme d'Or

Cannes Film Festival

Ken Loach and Mike Leigh to fight it out for the Palme d'Or
The concept album makes surprise top ten return with neolithic opus from Jethro Tull's Ian Anderson

The concept album makes surprise top ten return

Neolithic opus from Jethro Tull's Ian Anderson is unexpected success
Lichen is the surprise new ingredient on fine-dining menus, thanks to our love of Scandinavian and Indian cuisines

Lichen is surprise new ingredient on fine-dining menus

Emily Jupp discovers how it can give a unique, smoky flavour to our cooking
10 best baking books

10 best baking books

Planning a spot of baking this bank holiday weekend? From old favourites to new releases, here’s ten cookbooks for you
Jury still out on Manchester City boss Manuel Pellegrini

Jury still out on Pellegrini

Draw with Sunderland raises questions over Manchester City manager's ability to motivate and unify his players
Ben Stokes: 'Punching lockers isn't way forward'

Ben Stokes: 'Punching lockers isn't way forward'

The all-rounder has been hailed as future star after Ashes debut but incident in Caribbean added to doubts about discipline. Jon Culley meets a man looking to control his emotions
Mark Johnston: First £1 million jackpot spurs him on

Mark Johnston: First £1 million jackpot spurs him on

The most prize money ever at an All-Weather race day is up for grabs at Lingfield on Friday, and the record-breaking trainer tells Jon Freeman how times have changed
Ricky Gervais: 'People are waiting for me to fail. If you think it's awful, then just don't watch it'

Ricky Gervais: 'People are waiting for me to fail'

As the second series of his divisive sitcom 'Derek' hits screens, the comedian tells James Rampton why he'll never bow to the critics who habitually circle his work
Mad Men series 7, TV review: The suits are still sharp, but Don Draper has lost his edge

Mad Men returns for a final fling

The suits are still sharp, but Don Draper has lost his edge
Google finds a lift into space will never get off the ground as there is no material strong enough for a cable from Earth into orbit

Google finds a lift into space will never get off the ground

Technology giant’s scientists say there is no material strong enough for a cable from Earth into orbit