Market Efficiency

Efficient Arrangements

Another group of economists building on Armen Alchian's pioneering article argues that a crucial point in the consideration of efficiency is relative efficiency, one's aggregate position relative to actual competitors, and not some hypothetically perfect competitors. In the real economy, as in a race, success is reached by the relatively fastest, regardless of the quality of his competitors. Hence efficient arrangements can be differentiated from inefficient arrangements over time on the basis of whether firms are making positive economic profits or not.

Douglass North, a Nobel Prize winner, challenges the criterion of survival of efficient arrangements over time, as many obvious inefficient structures have prevailed over very long periods of time. He consequently has come up with a concept of adaptive efficiency—a move of a market toward being more efficient if such an “inefficient” arrangement is dismantled.

[Page 684]Another attempt to rehabilitate the concept of efficiency has been made by James Buchanan, another Nobel Prize winner. His arguments for an alternative concept of efficiency are rooted in subjectivist-contractarian (Austrian-Wicksellian) tradition. From this intellectual background comes his focus on the process through which changes take place and on identification of obstacles to this process. He claims that some constraints to economic development are of an artificial nature, for example, imposed by governmental decree and political authority.

In the presence of such observed artificial constraints, the market can be labeled as “presumably inefficient” because profit-seeking entrepreneurs cannot freely operate to overcome the obstacle. Thus the space opens for a solution to this problem through compensation.

If those harmed by the existence of the barrier to efficiency improvement can compensate those who benefit, the efficiency-inhibiting barrier will be removed. If no such arrangement seems to be possible, the hypothesis of presumed inefficiency is falsified.

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