How markets make us more rational

Ilya Somin has some thoughts about how markets make us more rational. He quotes Hayek:

Competition . . . is the method by which we have all been led to acquire much of the knowledge and skills we do possess. This is not understood by those who maintain that the argument for competition rests on the assumption of rational behavior of those who take part in it.... [R]ational behavior is not a premise of economic theory, though it is often presented as such. The basic contention of theory is rather that competition will make it necessary for people to act rationally in order to maintain themselves. It is based not on the assumption that most or all the participants in the market process are rational, but, on the contrary, on the assumption that it will in general be through competition that a few relatively more rational individuals will make it necessary for the rest to emulate them in order to prevail. In a society in which rational behavior confers an advantage on the individual, rational methods will progressively be developed and be spread by imitation. It is no use being more rational than the rest if one is not allowed to derive benefits from being so.

In short, the market doesn't assume that individuals act rationally. It does, however, reward those that do and, therefore, encourages the rest of us to act rationally to stay competitive.

Also, while it's tempting to turn everything over to the experts, the net result is worse, since the experts pay no price for their poor policy decisions. The experts may know more, but they have little incentive to abandon their biases; individuals in a market pay a high-stakes, personal price, and therefore have a strong incentive to set aside biases and get things right. As Somin puts it:

Ultimately, there is little doubt that market participants are sometimes irrational. The problem is that government decision-makers are likely to be more so.

Thomas Sowell puts it even more bluntly:

It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong.

Yep, exactly.

And finally, Somin explains why market dynamics to do not result in voter rationality:

Hayek’s point is particularly relevant to the comparison between voters and regulators on the one hand and market participants on the other. There is little benefit to being a well-informed, rational voter, since the chance of any one such voter affecting electoral outcomes is remote; if a government with better policies does somehow get elected, irrational voters who voted for the other side will benefit just as much as their better-informed compatriots. Voters are therefore almost a paradigmatic example of Hayek’s category of people for whom “[i]t is no use being more rational than the rest.”