Consumers play a critical role in a well-functioning market. Consumers consisted of a byproduct of production. Consumers can neither consume nor acquire things to consume without first producing. These facts might lead one to assume that centralized control might make a more efficient market. Before I continue and describe why this cannot work, I would like to explain a concept critical to understanding the fallacy of centralized planning — or market intervention. I will in this post explain the complexity of markets.
Systems thinkers occasionally refer to the Butterfly Effect. The Butterfly Effect provides a hypothetical example of a highly complex system. Small changes in one part of a large system can cause significant changes later in another part of that system. A butterfly could flap its wings in Indonesia, and six months later, through a chain of events, it could cause a hurricane off the coast of Florida.
Such an effect seems highly improbable. But, whether it’s even possible, it provides a good model for understanding the incredible complexity of large systems. Think about the number of connections it would require for a tiny action, like the flapping of a butterfly’s wings, to multiply its effects over time and distance to result in a hurricane thousands of miles away. If you stretch your imagination, the Butterfly Effect can help you consider how small actions in a large system can create sizable effects.
To make this description of complex systems a bit more realistic, I will describe two types of large-scale systems: mechanical systems and living systems.
Mechanical systems consist of those systems that follow the laws of physics. They behave in highly predictable ways. If we know the detailed structure of the system, we can predict with a high level of certainty the behavior of the system’s processes.
The flow of water provides an excellent example of a mechanical system. We can say with almost absolute certainty that water from a small rainstorm on the East slope of the Rocky Mountains will ultimately arrive in the Gulf of Mexico. Even with the mechanical system, however, we cannot predict all the behavior precisely simply because we don’t have the capability of knowing all the details of the systemic structure. No one has mapped out the exact location of every rock and stone in the streams from the Rockies to the Mississippi. It will require that level of detail to predict the system’s behavior in detail.
Complex living systems present an additional set of complications.
Living systems have two characteristics that make them far more unpredictable than mechanical systems: they self-reference and self-adjust. These characteristics mean that living systems can watch their behavior and adjust it to produce different outcomes.
To demonstrate the adaptive behavior of a living system, let me use an example similar to the flow of water. Think of a man (or any mammal) traveling a road that generally slopes downhill. Unlike water, which will always seek a lower level, a man can follow the uphill path to reach his ultimate destination. With many forks in the road, an observer cannot possibly predict the exact route of the man traveling to his destination.
Billions of Decisions
Many individual transactions comprise a living system that we call a market. Predicting the behavior of a single individual in the market can be challenging by itself. You cannot predict impulse purchases or product substitutions even if you have the individual’s shopping list. As markets get larger and larger, they include more and more unpredictable, self-adaptive, humans.
Markets consist of millions of actors —buyers and sellers — making billions of decisions involving one-by-one transactions. No individual, or small group of individuals, can comprehend the structure of large markets. Because of the adaptive nature of the humans in that system, precisely predicting the behavior in markets becomes impossible.
The symbiotic interactions between producers and consumers— who, in the end, are the same people — create markets. Markets require a process that does the best job, somehow or another, allocating resources to produce what consumers desire and have the capacity to acquire.