11 - Production and the Enforcement of Rationality

Summary

Production rather than preferences should play the leading role in the theory of markets, as in the book’s analysis of volatility and policymaking. Production is not only the fount of social wealth, it is organized by firms whose decisions are guided by a clear ordering principle, their profitability. There is moreover an institution, the market, that can weed out the firms that fail to pursue profits effectively. But the purging of inefficiency by the market confronts policymakers with the dilemmas of Schumpeterian creative destruction. Policies that compensate firms and their owners for any declines in profitability will also dampen the threat of bankruptcy; the enforcement of productive efficiency can require unfettered competition. An application to international trade illustrates some of the challenges: For foreign competition to lead to productive efficiency, domestic prices must be aligned with world prices, which will push some firms into liquidation.