Earlier in November, I examined some issues relating to the role of markets in art, in particular, assessing the efficiency of their markets. Information and price signals comprise an important element of efficiency in markets. More specifically, price signals (a fancy term for prices) are information — without them, markets would cease to function. When prices reflect arbitrary preferences that do not correspond to supply and demand issues in the market, as when the prices adjust to reflect, say, government purchase of healthcare, then the signals reverberate throughout the system affecting supply and demand of everything even tangentially related with the affected prices. In the case of healthcare, government buying healthcare will distort the market value of doctor’s time (lowering it) as well as the supply of quality doctors (lowering it). Yet, the demand at cheaper prices will be higher than ever. ( The more fundamental point still is that the government expenditures would have been more efficiently spent on other goods because the money, when spent by consumers, would surely have been spent in a different manner because there has been a redistribution of wealth. )
This is all a bit of a helter-skelter analysis of markets, but let us turn to a master, Nobel Prize-winning economist FA Hayek, to make some sense of this issue. This is from his 1945 work The Use of Knowledge in Society and the emphasis is my own.
Fundamentally, in a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan. It is worth contemplating for a moment a very simple and commonplace instance of the action of the price system to see what precisely it accomplishes. Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all his without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. […]
The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information is passed on and passed on only to those concerned. It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement. […]
The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; i.e., they move in the right direction. This is enough of a marvel even if, in a constantly changing world, not all will hit it off so perfectly that their profit rates will always be maintained at the same constant or “normal” level.
And so prices instantaneously reflect supply and demand throughout the entire system. When you see the price of a car, you are therefore gathering information on all its inputs, ranging from the labor to the raw materials that went into its construction. Indeed, if it was an American car, you would know that for the same price you are getting a car with less inputs than a Japanese car, but that’s a story for another day.
As applied to art markets, this suggests no coordination of art sales is necessary to come to an efficient result in the marketplace. Prices of artworks reflect their supply and demand. Although Damien Hirst and Sotheby’s made a killing on Hirst’s work in September, if Hirst issued 1000 indistinguishable copies of every work he sold at auction, the price of all of them would be drastically reduced. The prices go down because the goods are no longer so scarce.
In a recent piece in the Wall Street Journal, Lee Rosenbaum, perhaps better known as CultureGrrl, argues that Sotheby’s, Christie’s, and other major auction houses need to increase the transparency of its sales. Rosenbaum makes an implied argument that the markets would be more efficient if the auction houses changed a misleading sales reporting practice. In summary, the auction houses like to inflate the amount of their sales by reporting the amount the work sold for at auction (called the “hammer price” because that is the highest bid outstanding when the auctioneer slams the hammer down making it a sale) combined with the buyer’s premium. The buyer’s premium is one very important way that the auction houses make money. For every work bought at a Sotheby’s auction, a certain percent, say, 20% of the hammer price, is tacked on to the hammer price. The buyer must pay that whole amount in order to receive the work. For example, if I had a winning bid of $100,000 on Koekkoek’s “Le vieux manoir,” then I would have to pay an additional $20,000 to obtain the painting.
So far, so good?
The catch is that before every auction the auction houses release high and low estimates of where the hammer price ought to come down. They usually have their own experts figure that out, and it’s a real specialty. These people are very good at it, though the appraisals are usually done far ahead of the time of the auction, in order to give time to print in the auction houses’ usually high-quality, glossy-gloss catalogs. Take my word for it, these catalogs are STELLAR. In any event, as Rosenbaum reports, the auction houses will report the hammer price plus the buyer’s premium and then say that the work sold for within the pre-sale estimate. But the estimate was just the hammer price, so they are really talking apples and oranges, as Rosenbaum says, not giving a clear picture of how the sale went.
Rosenbaum says this is a problem (emphasis mine):
This approach serves their interest in reporting a successful sale by producing higher totals and reducing the number of works that appear to have sold below their estimate. Yet it doesn’t serve the interest of the public in getting an accurate understanding of what really took place. Despite the fact that hammer prices of individual lots are announced as they happen during the sale, journalists who ask for them (or for a sale’s hammer total) afterward may need time and persistence to get the information — resources in short supply on a tight deadline.
Rosenbaum probably refers to auction house management, when she writes “their.” The idea is that if the management can make it seem like everything is okay, they stand to gain — by keeping their jobs and possibly more incentives to stay with the firm (higher pay, greater total compensation as with options, etc.). This seems intuitive to me. But what worries me is the discussion of the so-called public interest, along with the odd acknowledgement that journalists are primarily responsible for the silly reporting, not the auction houses.
Whose interest is really marred by the auction house reporting tactic? Is it Joe the Plumber? No, he hates art. Is it the average middle class American person? Well, no, because they’re neither buying art from the auction houses nor owning stock in these firms. No, it seems as though Rosenbaum is merely trying to make the problem sound much grander than it really is. No one is affected by this. How could that be, you say, when you quote Hayek and say that price signals ripple throughout the system?
Lots of reasons. The public is not buying this art. Rich oil barons and investors are. Although some may have read the misleading figures and took them to mean the actual hammer prices, not the hammer prices + buyer’s premium, how that factors into the purchase decisions of other works is a great mystery. If a buyer is willing to pay $1,000,000 for a work by Matisse based in whole or in part on reading that a similar work by Matisse was purchased for $950,000 a week before, then the only question really is: why are we going to make silly regulations to protect her or him? They made a silly value judgment but it is theirs to make. Sotheby’s and Christie’s give disclaimers on their reported figures and depending on how efficient you think the market is, and I think it is increasingly efficient especially in art given the lowering of the costs for transmitting information, then the bidding prices already factor in the bidders’ awareness of these pricing nuances. The glory of the price system, as Hayek pointed out, is that the information could be dispersed amongst so many actors and that they need not have complete information, or anything resembling it. They can make their own appraisals and their own subjective assessments. These art collectors are not going to be spending their money on other things, so where is the distortion and pressing need for intervention?
The real question is: why isn’t Rosenbaum taking the journalists to task for being either a) stupid, b) willfully ignorant, or c) some combination of a) and b)? Let us revisit her sentence:
Despite the fact that hammer prices of individual lots are announced as they happen during the sale, journalists who ask for them (or for a sale’s hammer total) afterward may need time and persistence to get the information — resources in short supply on a tight deadline.
Rosenbaum implicitly argues that meeting deadlines is more important than getting the story right. Even if some editor had a gun to the so-called journalist’s head, the journalist could, and I know this sounds crazy, explain that the figure they are giving is the sum of the hammer price and buyer’s premium. Whoooooa! Revelation! You see, this isn’t about the auction houses, or markets, at all. This whole story, made a mountain out of a the figment of a mole’s imagination of a mole hill, is about journalists. It is about their gross incompetence, their laziness, their lack of standards, or some combination of the above. In any case, it is worrying, but not terribly surprising.
Look for more journalists covering each other’s asses, even in papers as respectable as the Wall Street Journal, and more blame to be unjustifiably placed on the ever-evil and regulation-needy markets. Of course, I do have to confess that Rosenbaum never explicitly says a regulation is necessary, only that the auction houses should come clean. I don’t think it’s a big deal, but I can see the point. Mine is only that no information is hidden, it is probably already already accounted for in other prices, and to the extent any problem exists, journalists are responsible. We need to stop giving them a free pass.