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Published by EH.NET (May 2000) 
 
Michael Perelman, _The Natural Instability of Markets:  
Expectations, Increasing Returns, and the Collapse of Capitalism_.  
New York: St. Martin's Press, 1999. xiv + 188 pp. $39.95 (cloth),  
ISBN: 0-312-22121-5.   
 
Reviewed for EH.NET by Thomas E. Hall, Department of  
Economics, Miami University, Oxford, Ohio.  
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Economists have long known that competition has some ugly side  
effects. In competitive industries, firms go out of business. The  
competitive process exhibits Schumpeter's creative destruction as  
new technologies come along which displace existing industries.  
Workers lose their jobs, and firm owners lose wealth. This is all  
very unpleasant for the people who are adversely affected by these  
changes, but in the net society is better off by reaping the benefits  
of economic efficiency. At least, that is what economists generally  
believe about the competitive outcome. This is why most  
economists argue that (with the exceptions of a few cases such as  
public goods and natural monopolies) a policy of enhancing  
competition is desirable.   
 
Michael Perelman challenges this conventional economic  
orthodoxy by arguing that the economic instability caused by  
competition may be so large that it outweighs the beneficial effects  
of economic efficiency. In fact, competition is so awful that "the  
tendency of the competitive process is to lead to depressions" (p.  
62). Perelman does not argue that monopolies are the solution,  
instead he contends that society's welfare is enhanced by having  
an industrial structure that is neither too competitive, nor too  
concentrated. The optimal structure lies somewhere in between,  
where the gain in economic stability resulting from a less than  
perfectly competitive structure exceeds the loss to society of lower  
economic efficiency.   
 
It's an interesting argument, but one that isn't well enough  
documented for most people to accept. Too much of Perlman's  
discussion focuses on what's wrong with competitive markets, and  
too little on the benefits they create. Yes, the competitive process  
can cause wrenching changes in society, but what about the lower  
prices we pay, the wider variety of goods and services we choose  
among, the improved quality of products...? These considerations  
are given short shrift compared to the evils of "instability."   
 
A serious weakness of the book is its lack of a discussion on the  
role of demand. For example, Perelman considers economic  
depressions to be the intensification of the competitive process.  
While most of us would agree that competition among firms is  
more intense during economic recessions, would we extend the  
argument by saying that competition caused the downturn? I don't  
think so. Economic recessions are typically caused by slowdowns  
in aggregate demand growth. As spending growth slows, firms have  
to compete more intensely for scarcer sales. Thus, we observe  
more competition during downturns, but competitive pressures  
hardly caused the recession.   
 
Perelman also argues that high wages during recessions are good  
since "high wages represent a healthy stimulant to the economy . .  
. because high wages will encourage productivity" (p. 121). This  
efficiency wage argument has merit, but taken to extremes it could  
cause major problems. After all, if promoting high wages is such a  
great idea, during the next recession let's be sure to raise the  
minimum wage to $1 million per hour and see how well that  
stimulates recovery!   
 
We often tell students not to get caught looking at the trees when  
they should be concentrating on the forest. I think the opposite  
applies to this book. Several of Perelman's trees, i.e., the specific  
cases he discusses to buttress his argument, are quite interesting.  
For example, there is an informative history of entry and exit in the  
automobile industry, an excellent discussion of x-efficiency, and a  
summary of estimates of the costs of unemployment in terms of  
numbers of suicides, homicides, and such that would be useful to  
instructors of macroeconomics principles classes. However, I am  
considerably less enamored with the forest, the idea that  
competition creates more problems than it solves.   
 
 
Thomas E. Hall is the coauthor (with J.D. Ferguson) of _The Great  
Depression: An International Disaster of Perverse Economic  
Policies_ (University of Michigan Press, 1998).   
 
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