Everything about Free Market totally explained
A
free market is a
market in which prices of goods and services are arranged completely by the mutual consent of sellers and buyers. By definition, in a free market environment buyers and sellers don't coerce or mislead each other nor are they coerced by a third party.
In the aggregate, the effect of these decisions
en masse is described by the law of
supply and demand. Free markets contrast sharply with
controlled markets, in which governments directly or indirectly regulate prices or supplies, distorting market signals.
In the marketplace the price of a good or service helps to quantify its value to consumers and thus balance it against other goods and services. In a free market, this relationship between price and value is more clear than in a controlled market . Through competition between vendors for the provision of products and services, prices tend to decrease, and quality tends to increase. A free market isn't to be confused with a
perfect market where individuals have
perfect information and there's
perfect competition.
Free market economics is closely associated with
laissez-faire economic philosophy, which expands this environment by confining government intervention to
market failures. Hence, with government force limited to a defensive role, government itself doesn't initiate force in the marketplace beyond levying taxes in order to fund the maintenance of the free marketplace. Some free market advocates oppose taxation as well, claiming that the market is better at providing all valuable services of which
defense and
law are no exception, and that such services can be provided without direct taxation.
Anarcho-capitalists, for example, would substitute
arbitration agencies and
private defense agencies.
While some economists regard the free market as a useful if simplistic model in developing economic policies to attain social goals, others regard the free market as a
normative rather than descriptive concept, and claim that policies which deviate from the ideal free market solution are 'wrong' even if they're believed to have some immediate social benefit.
Samuelson treated market failure as the exception to the general rule of efficient markets.
In
political economics, one opposite extreme to the
free market economy is the
command economy, where decisions regarding production, distribution, and pricing are a matter of governmental control. Other opposites are the
gift economy and the
subsistence economy. The
mixed economy is intermediate between these positions and is the preferred basis of socioeconomic policy for most countries and political parties.
In other words, a free market economy is "an economic system in which individuals, rather than government, make the majority of decisions regarding economic activities and transactions." In
social philosophy, a
free market economy is a system for
allocating goods within a society:
purchasing power mediated by
supply and demand within the market determines who gets what and what is produced, rather than the state. Early proponents of a free-market economy in 18th century Europe contrasted it with the
medieval,
early modern, and
mercantilist economies which preceded it.
Supply and demand
Supply and demand are always equal as they're the two sides of the same set of transactions, and discussions of "imbalances" are a muddled and indirect way of referring to price. However, in an unmeasurable qualitative sense, demand for an item (such as goods or services) refers to the market pressure from people trying to buy it. They will "bid" money for the item, while sellers offer the item for money. When the bid matches the offer, a transaction can easily occur (even automatically, as in a typical
stock market). In reality, most shops and markets don't resemble the stock market (eg the job market), and there are significant costs and barriers to "shopping around" (comparison shopping).
When demand exceeds supply, suppliers can raise the price. Consumers who can afford the higher prices may still buy, but others may forgo the purchase altogether, buy a similar item, or shop elsewhere. (for example, the consumer might say: "A two-dollar hot dog? I'd rather buy a hamburger at
McDonald's!"). As the price rises, suppliers may also choose to increase production. Or more suppliers may enter the business. For example, the
gourmet coffee business, pioneered by
Starbucks, revealed a demand for three-dollar cups of coffee. Other stores began offering such coffee to satisfy the demand.
Increased supply (meaning volume) can indirectly result in lower prices, particularly with
computers and other electronic devices.
Mass production techniques have been steadily reducing prices 20 to 30% per year since the 1960s. The functions of a multi-million dollar mainframe computer in the 1960s could be performed by a $500 dollar computer in the 2000s. The
camcorder has been said to place "a television studio in your hand".
Spontaneous order or "Invisible hand"
Friedrich Hayek argues for the classical liberal view that market economies allow
spontaneous order; that is, "a more efficient allocation of societal resources than any design could achieve." According to this view, in market economies sophisticated business networks are formed which produce and distribute goods and services throughout the economy. This network wasn't designed, but
emerged as a result of decentralized individual economic decisions. Supporters of the idea of spontaneous order trace their views to the concept of the
invisible hand proposed by
Adam Smith in
The Wealth of Nations who said that the individual who:
"intends only his own gain is led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for society that it was no part of it. By pursuing his own interest [anindividual] frequently promotes that of the society more effectually than when he really intends to promote it. I've never known much good done by those who affected to trade for the [common] good." (Wealth of Nations)
Smith pointed out that one doesn't get one's dinner by appealing to the brother-love of the butcher, the farmer or the baker. Rather one appeals to their self interest, and pays them for their labour.
Supporters of this view claim that spontaneous order is superior to any order that doesn't allow individuals to make their own choices of what to produce, what to buy, what to sell, and at what prices, due to the number and complexity of the factors involved. They further believe that any attempt to implement central planning will result in more disorder, or a less efficient production and distribution of goods and services.
Economic equilibrium
The law of
supply and demand predominates in the ideal free market, influencing prices toward an
equilibrium that balances the demands for the products against the supplies. At these equilibrium prices, the market distributes the products to the purchasers according to each purchaser's preference (or utility) for each product and within the relative limits of each buyer's
purchasing power.
This equilibrating behavior of free markets makes certain assumptions about their agents, for instance that they act independently. Some models in
econophysics . Many advocates of free markets, most notably
Milton Friedman, have also argued that there's a direct relationship between economic growth and economic freedom, though this assertion is much harder to prove empirically, as the continuous debates among scholars on methodological issues in empirical studies of the connection between economic freedom (EF) and economic growth clearly indicate: . "there were a few attempts to study relationship between growth and economic freedom
prior to the very recent availability of the Fraser data. These were useful but had to use incomplete and subjective variables" .
Joshua Epstein and Robert Axtell have attempted to predict the properties of free markets empirically in the agent-based computer simulation "Sugarscape". They came to the conclusion that, again under idealized conditions, free markets lead to a
Pareto distribution of wealth .
On the other hand more recent research, specially the one led by
Joseph Stiglitz seems to contradict
Friedman's conclusions. According to Boettke:
» :Once incomplete and imperfect information are introduced,
Chicago-school defenders of the market system can't sustain descriptive claims of the
Pareto efficiency of the real world. Thus,
Stiglitz's use of rational-expectations equilibrium assumptions to achieve a more realistic understanding of capitalism than is usual among rational-expectations theorists leads, paradoxically, to the conclusion that capitalism deviates from the model in a way that justifies state action--
socialism--as a remedy.
The necessary components for the functioning of an idealized free market include the complete absence of artificial price pressures from taxes, subsidies,
tariffs, or government regulation (other than protection from coercion and theft), and no
government-granted monopolies (usually classified as
coercive monopoly by free market advocates) like the
United States Post Office,
Amtrak, arguably
patents, etc.
Deregulation
In an absolutely
free-market economy, all capital, goods, services, and money flow transfers are unregulated by the government except to stop collusion that may take place among market participants. As this protection must be funded, such a government taxes only to the extent necessary to perform this function, if at all. This state of affairs is also known as
laissez-faire.
Internationally, free markets are advocated by proponents of
economic liberalism; in Europe this is usually simply called
liberalism. In the
United States, support for free market is associated most with
libertarianism. Since the 1970s, promotion of a global free-market economy,
deregulation and
privatization, is often described as
neoliberalism.
The term
free market economy is sometimes used to describe some economies that exist today (such as
Hong Kong), but pro-market groups would only accept that description if the government practices
laissez-faire policies, rather than state intervention in the economy. An economy that contains significant economic interventionism by government, while still retaining some characteristics found in a free market is often called a
mixed economy.
Low barriers to entry
A free market doesn't require the existence of competition, however it does require that there are no barriers to new market entrants. Hence, in the lack of coercive barriers it's generally understood that competition flourishes in a free market environment. It often suggests the presence of the
profit motive, although neither a profit motive or profit itself are necessary for a free market. All modern free markets are understood to include
entrepreneurs, both individuals and
businesses. Typically, a modern free market economy would include other features, such as a
stock exchange and a
financial services sector, but they don't define it.
Legal tender and taxes
In a truly free market economy, money wouldn't be monopolized by
legal tender laws or by a central money maker authority which coerces society to use its own money as the unique medium of exchange in trades, in order to receive
taxes from the transactions or to be able to issue
loans.
Minarchists (advocates of minimal government) contend that the so called "coercion" of taxes is essential for the market's survival, and a market free from taxes may lead to no market at all. By definition, there's no market without private property, and private property can only exist while there's an entity that defines and defends it. Traditionally, the State defends private property and defines it by issuing ownership titles, and also nominates the central authority to print or mint currency. "Free market anarchists" disagree with the above assessment -- they maintain that private property and free markets can be protected by voluntarily-funded services under the concept of
individualist anarchism and
anarcho-capitalism . A free market could be defined alternatively as a tax-free market, independent of any central authority, which uses as medium of exchange such as money, even in the absence of the State. It is disputed, however, whether this hypothetical stateless market could function freely, without coercion and violence.
Ethical justification
The ethical
justification of free markets takes two forms. One appeals to the intrinsic moral superiority of autonomy and freedom (in the market), see
deontology. The other is a form of
consequentialism—a belief that decentralised planning by a multitude of individuals making free economic decisions produces
better results in regard to a more organized, efficient, and productive economy, than does a centrally-planned economy where a central agency decides what is produced, and allocates goods by non-price mechanisms. An older version of this argument is the
metaphor of the
Invisible Hand, familiar from the work of
Adam Smith.
Modern theories of
self-organization say the internal organization of a system can increase automatically without being guided or managed by an outside source. When applied to the market, as an ethical justification, these theories appeal to its
intrinsic value as a self-organising entity. Other philosophies such as some forms of
Individualist anarchism and
Mutualism (economic theory) anarchism believe that a truly "free market" would result in prices paid for goods and services to align with the labor embodied in those things.
In practice
While the free-market is an idealized abstraction, it's useful in understanding real markets whether artificially created and regulated by governments or non-governmental agencies, or phenomena such as the
black market and the
underground economy, which can be remarkably robust in persisting despite attempts to suppress these markets; in fact, many proponents of the free market point to sectors such as the drug trade to prove the phenomenon is both spontaneous and can function without government intervention though some would still prefer the contracts be brought under court protection.
Index of economic freedom
The
Heritage Foundation, a
conservative think tank, tried to identify the key factors which allow to measure the degree of freedom of economy of a particular country. In 1986 they introduced
Index of Economic Freedom, which is based on some fifty variables. This and other similar indices don't
define a free market, but measure the
degree to which a modern economy is free, meaning in most cases free of state intervention. The variables are divided into the following major groups:
- Trade policy,
- Fiscal burden of government,
- Government intervention in the economy,
- Monetary policy,
- Capital flows and foreign investment,
- Banking and finance,
- Wages and prices,
- Property rights,
- Regulation, and
- Informal market activity.
Each group is assigned a numerical value between 1 and 5; IEF is the arithmetical mean of the values, rounded to the hundredth. Initially, countries which were traditionally considered capitalistic received high ratings, but the method improved over time. Some economists, like Milton Friedman and other Laissez-faire economists have argued that there's a direct relationship between economic growth and economic freedom, but this assertion hasn't been proven yet, both theoretically and empirically. Continuous debates among scholars on methodological issues in empirical studies of the connection between economic freedom (EF) and economic growth still try to find out what is the relationship, if any. . .
» :"In recent years a significant amount of work has been devoted to the investigation of a possible connection between the political system and economic growth. For a variety of reasons there's no consensus about that relationship, especially not about the direction of causality, if any."
(AYAL & KARRAS, 1998, p.2)
History and ideology
Some theorists argue that a free market is a natural form of social organization, and that a free market will arise in any society where it isn't obstructed (ie
Ludwig von Mises,
Hayek). The consensus among
economic historians is that the free market economy is a specific historic phenomenon, and that it emerged in late medieval and early-modern Europe. Other economic historians see elements of the free market in the economic systems of
Classical Antiquity, and in some non-western societies.By the 19th century the market certainly had organized political support, in the form of
laissez-faire liberalism. However, it isn't clear if the support preceded the emergence of the market or followed it. Some historians see it as the result of the success of early liberal
ideology, combined with the specific interests of the
entrepreneur.
Marxism
In
Marxist theory, the idea of the free market simply expresses the underlying long-term transition from
feudalism to
capitalism. Note that the views on this issue - emergence or implementation - don't necessarily correspond to pro-market and anti-market positions.
Libertarians would dispute that the market was enforced through government policy, since they believe it's a
spontaneous order and
Marxists agree with them because they as well believe it's evolutionary, although with a different end.
Liberalism
Support for the free market as an ordering principle of society is above all associated with
liberalism, especially during the 19th century. (In Europe, the term 'liberalism' retains its
connotation as the ideology of the free market, but in American and Canadian usage it came to be associated with government intervention, and acquired a
pejorative meaning for supporters of the free market.) Later ideological developments, such as
minarchism,
libertarianism and
objectivism also support the free market, and insist on its pure form. Although the
Western world shares a generally similar form of economy, usage in the United States and Canada is to refer to this as
capitalism, while in Europe 'free market' is the preferred neutral term.
Modern liberalism (American and Canadian usage), and in Europe
social democracy, seek only to mitigate what they see as the problems of an unrestrained free market, and accept its existence as such.
To most
libertarians, there's simply no free market yet, given the degree of state intervention in even the most 'capitalist' of countries. From their perspective, those who say they favor a "free market" are speaking in a relative, rather than an absolute, sense—meaning (in libertarian terms) they wish that
coercion be kept to the minimum that's necessary to maximize economic freedom (such necessary coercion would be taxation, for example) and to maximize market efficiency by lowering trade barriers, making the tax system neutral in its influence on important decisions such as how to raise capital, for example, eliminating the
double tax on dividends so that equity financing isn't at a disadvantage vis-a-vis debt financing. However, there are some such as
anarcho-capitalists who wouldn't even allow for taxation and governments, instead preferring protectors of economic freedom in the form of private contractors.
Criticism
Critics dispute the claim that in practice free markets create
perfect competition, or even increase
market competition over the
long run. Whether the marketplace
should be or
is free is disputed; many assert that government intervention is necessary to remedy
market failure that's held to be an inevitable result of absolute adherence to free market principles. These failures range from
military services to
roads, and some would argue, to health care. This is the central argument of those who argue for a mixed market, free at the base, but with government oversight to control social problems.
Critics of laissez-faire variously see the "free market" as an impractical ideal or as a
rhetorical device that puts the concepts of freedom and anti-
protectionism at the service of vested wealthy interests, allowing them to attack
labor laws and other protections of the
working classes.
Because no national economy in existence fully manifests the ideal of a free market as theorized by economists, some critics of the concept consider it to be a fantasy - outside of the bounds of reality in a complex system with opposing interests and different distributions of wealth.
These critics range from those who reject markets entirely, in favour of a
planned economy or a communal economy, such as that advocated by some types of
socialism, to those who merely wish to see markets regulated to various degrees, and these range from those who associate markets with
greed which they believe to be inherently
immoral to those who raise practical objections.
Externalities
One practical objection is the claim that markets don't take into account
externalities (effects of transactions that affect third parties), such as the negative effects of pollution or the positive effects of education, although this is disputed by those who contend that an externality such as pollution can be and is regularly dealt with by the courts through the principle of protecting
individual liberty and
property rights. What exactly constitutes an externality may be up for debate, including the extent to which it changes based upon the political climate.
Some proponents of market economies believe that governments shouldn't diminish market freedom because they disagree on what is a market externality and what are government-created externalities, and disagree over what the appropriate level of intervention is necessary to solve market-created externalities. Others believe that government should intervene to prevent
market failure while preserving the general character of a market economy. In the model of a
social market economy the state intervenes where the market doesn't meet political demands.
John Rawls was a prominent proponent of this idea.
Martin J. Whitman
Not all advocates of
capitalism consider free markets to be practical. For example,
Martin J. Whitman has written, in a discussion of
Keynes,
Friedman and
Hayek, that these "…great economists…missed a lot of details that are part and parcel of every
value investor's daily life." While calling Hayek "100% right" in his critique of the pure command economy, he writes "However, in no way does it follow, as many Hayek disciples seem to believe, that government is
per se bad and unproductive while the private sector is,
per se good and productive. In well-run industrial economies, there's a marriage between government and the private sector, each benefiting from the other." As illustrations of this, he points at "
Japan after
World War II,
Singapore and the other
Asian Tigers,
Sweden and
China. The notable exception is
Hong Kong which found prosperity on an extremely austere free market concept.
He argues, in particular, for the value of government-provided credit and of carefully crafted tax laws. Further, Whitman argues (explicitly against Hayek) that "a free market situation is probably also doomed to failure if there exist control persons who are not subject to external disciplines imposed by various forces over and above competition." The lack of these disciplines, says Whitman, lead to "1. Very exorbitant levels of
executive compensation… 2. Poorly financed businesses with strong prospects for money defaults on credit instruments… 3. Speculative
bubbles… 4. Tendency for industry competition to evolve into
monopolies and
oligopolies… 5. Corruption." For all of these he provides recent examples from the U.S. economy, which he considers to be in some respects under-regulated, although in other respects over-regulated (he is generally opposed to
Sarbanes-Oxley).
He believes that an apparently "free" relationship—that between a corporation and its investors and creditors—is actually a blend of "voluntary exchanges" and "coercion". For example, there are "voluntary activities, where each individual makes his or her own decision whether to buy, sell, or hold" but there are also what he defines as "[c]oercive activities, where each individual security holder is forced to go along…provided that a requisite majority of other security holders so vote…" His examples of the latter include
proxy voting, most merger and acquisition transactions, certain cash tender offers, and reorganization or liquidation in
bankruptcy. Whitman also states that "
Corporate America wouldn't work at all unless many activities continued to be coercive."
"I am one with Professor Friedman that, other things being equal, it's far preferable to conduct economic activities through voluntary exchange relying on free markets rather than through coercion. But Corporate America wouldn't work at all unless many activities continued to be coercive."
Notes and References
Further Information
Get more info on 'Free Market'.
|
External Link Exchanges
Do you know how hard it is to get a link from a large encyclopaedia? Well we're different and will prove it. To get a link from us just add the following HTML to your site on a relevant page:
<a href="http://free_market.totallyexplained.com">Free market Totally Explained</a>
Then simply click through this link from your web page. Our crawlers will verify your link, extract the title of your web page and instantly add a link back to it. If you like you can remove the words Totally Explained and embed the link in article text.
As long as your link remains in place, we'll keep our link to you right here. Please play fair - our crawlers are watching. Your site must be closely related to this one's topic. Any kind of spamming, dubious practises or removing the link will result in your link from us being dropped and, potentially, your whole site being banned. |
