When people talk about a “market economy”, what exactly does that mean? You might assume it means a society where all or most economic decisions are made through markets. But this does not describe our own economy, or anything else that gets called a “market economy”. Most economic decisions are made inside particular organizations, which make their internal decisions according to hierarchical structures and individual judgment, taking markets into account as one factor among many. If two workers both want to avoid a Monday morning shift, or two department heads are arguing over hiring policy, or two engineers are debating which design to adopt, no one expects the people involved to start setting prices and bidding against each other like they would in a market. And yet markets are nevertheless crucial to our economic organization, in ways that are notably different from non-“market economies”. How, then, does the market fit in?
What markets make possible is smooth interaction between independent units. Organizations have hierarchical control over their own assets, including very complex social processes like medical schools or aircraft control towers, but they also need to coordinate with other parts of society external to the organization itself, like customers and suppliers. Markets make this easy and reliable. The market is a thin layer of crucial but simple social technology that lets an organization ignore the deep complexity of the people and organizations it interacts with. This is helpful because the market interface an organization presents to the outside world is so much simpler than the non-market-based coordination it uses internally.
In a way, the market is like the docking module between the Apollo and Soyuz rockets. It’s a crucial component, and without it the entire system couldn’t possibly function as a unified whole, but it’s still a relatively small fraction of the system’s mass and complexity. Understanding how it works won’t tell you all that much about how the Soyuz itself works.
Of course organizations don’t always relate to each other according to the rules of the “free market”. Perfect markets don’t and can’t exist, and large swathes of the current economy don’t even approximate markets (see e.g. Patrick McKenzie noting how success in venture capital is determined by “access”). Nevertheless, such exceptions are uncommon. Most of our economy is mostly market-based. This means that organizations and individuals can usually use the market as a reasonably accurate guide to how they should interact with the rest of society—and nothing more.
Ben Landau-Taylor 