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A free market describes a market without economic intervention and regulation by government except to regulate against force or fraud. The terminology is used by economists and in popular culture. A free market requires protection of property rights, but no regulation, no subsidization, no single monetary system, and no governmental monopolies. It is the opposite of a controlled market, where the government regulates prices or how property is used.
The theory holds that within the ideal free market, property rights are voluntarily exchanged at a price arranged solely by the mutual consent of sellers and buyers. By definition, buyers and sellers do not coerce each other, in the sense that they obtain each other's property rights without the use of physical force, threat of physical force, or fraud, nor are they coerced by a third party (such as by government via transfer payments) and they engage in trade simply because they both consent and believe that what they are getting is worth more than or as much as what they give up. Price is the result of buying and selling decisions en masse as described by the law of supply and demand.
Free markets contrast sharply with controlled markets or regulated markets, in which governments directly or indirectly regulate prices or supplies, which according to free market theory causes markets to be less efficient. Where government intervention exists, the market is a mixed economy.
In the marketplace the price of a good or service helps communicate consumer demand to producers and thus directs the allocation of resources toward consumer, as well as investor, satisfaction. In a free market, price is a result of a plethora of voluntary transactions, rather than political decree as in a controlled market. Through free competition between vendors for the provision of products and services, prices tend to decrease, and quality tends to increase. A free market is not to be confused with a perfect market where individuals have perfect information and there is perfect competition.
Free market economics is closely associated with laissez-faire economic philosophy, which advocates approximating this condition in the real world by mostly confining government intervention in economic matters to regulating against force and fraud among market participants. Some free market advocates oppose taxation as well, claiming that the market is more efficient at providing all valuable services of which defense and law are no exception, that such services can be provided without direct taxation and that consent would be the basis of political legitimacy making it a morally consistent system. Anarcho-capitalists, for example, would substitute arbitration agencies and private defense agencies.
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
Main article: Supply and demandSupply and demand are always equal as they are 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 do not resemble the stock market, and there are significant costs and barriers to "shopping around" (comparison shopping).
When demand exceeds supply, suppliers can raise the price, but when supply exceeds demand, suppliers will have to decrease the price in order to make sales. Consumers who can afford the higher prices may still buy, but others may forgo the purchase altogether, demand a better price, buy a similar item, or shop elsewhere. As the price rises, suppliers may also choose to increase production. Or more suppliers may enter the business.
Gourmet coffee and electronics as examples of market forces in economics
For example, the gourmet coffee business, pioneered in the US by Starbucks, revealed a demand for high quality fresh coffee. Further, the Starbucks sales growth showed that consumers would pay significantly more for this type of coffee. Other food service retailers, such as McDonald's, Sonic, and Burger King, began offering such coffee to help satisfy the demand.
Increased supply 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 $100 computer in the 2000s.
Spontaneous order or "Invisible hand"
Main articles: Invisible hand and Spontaneous orderFriedrich 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 was not 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 frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the good." (Wealth of Nations)
Smith pointed out that one does not 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.
It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages."
Supporters of this view claim that spontaneous order is superior to any order that does not 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
Main article: Economic equilibriumGeneral equilibrium theory has demonstrated, with varying degrees of mathematical rigor over time, that under certain conditions of competition, the law of Supply and Demand predominates in this ideal free and competitive 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 result is described as market efficiency, or more specifically a Pareto optimum.
This equilibrating behavior of free markets requires certain assumptions about their agents, collectively known as Perfect Competition, which therefore cannot be results of the market that they create. Among these assumptions are complete information, interchangeable goods and services, and lack of market power, that obviously cannot be fully achieved. The question then is what approximations of these conditions guarantee approximations of market efficiency, and which failures in competition generate overall market failures. Several Nobel Prizes in Economics have been awarded for analyses of market failures due to asymmetric information.
Some models in econophysics have shown that when agents are allowed to interact locally in a free market (ie. their decisions depend not only on utility and purchasing power, but also on their peers' decisions), prices can become unstable and diverge from the equilibrium, often in an abrupt manner.The behavior of the free market is thus said to be non-linear (a pair of agents bargaining for a purchase will agree on a different price than 100 identical pairs of agents doing the identical purchase). Speculation bubbles and the type of herd behavior often observed in stock markets are quoted as real life examples of non-equilibrium price trends. Laissez-faire free-market advocates, especially Austrian school followers, often dismiss this endogenous theory, and blame external influences, such as weather, commodity prices, technological developments, and government meddling for non-equilibrium prices.
Distribution of wealth
Main article: Distribution of wealthThe distribution of purchasing power in an economy depends to a large extent on the nature of government intervention, social class, labor and financial markets, but also on other, lesser factors such as family relationships, inheritance, gifts and so on. Many theories describing the operation of a free market focus primarily on the markets for consumer products, and their description of the labor market or financial markets tends to be more complicated and controversial. The free market can be seen as facilitating a form of decision-making through what is known as dollar voting, where a purchase of a product is tantamount to casting a vote for a producer to continue producing that product.
The effect of economic freedom on society's and individuals' wealth remains a subject of controversy. Kenneth Arrow and Gerard Debreu have shown that under certain idealized conditions, a system of free trade leads to Pareto efficiency, but the traditional Arrow-Debreu paradigm within economics is now being challenged by the new Greenwald-Stiglitz paradigm (1986). Many advocates of free markets, most notably Milton Friedman, have also argued that there is 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 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 cannot 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.
Laissez-faire economics
Main article: Laissez-faire economicsThe 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
Main article: DeregulationIn an absolutely free-market economy, all capital, goods, services, and money flow transfers are unregulated by the government except to stop collusion or fraud 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 does not 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 is 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 do not define it.
Legal tender and taxes
In a truly free market economy, money would not be monopolized by legal tender laws or by a central bank, 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 is no market without private property, and private property can only exist while there is 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.
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 (especially that of that 19th century) and Mutualism (economic theory) anarchism believe that in a free market competition would cause prices of goods and services to align with the labor embodied in those things. This goes against the contemporary mainstream view, which is held by most contemporary individualist anarchists, that prices would accord to the marginal utility of these things irrespective of the labor embodied in them.
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 do not 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 is a direct relationship between economic growth and economic freedom, but this assertion has not been proven yet, both theoretically and empirically. Continuous debates among scholars on methodological issues in empirical studies of the connection between economic freedom 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 is no consensus about that relationship, especially not about the direction of causality, if any." (AYAL & KARRAS, 1998, p.2)
History and ideology
Some theorists might argue that a free market is a natural form of social organization, and that a free market will arise in any society where it is not 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 is not 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.
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 is 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 is 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, e.g., eliminating the double tax on dividends so that equity financing is not at a disadvantage vis-a-vis debt financing. However, there are some such as anarcho-capitalists who would not even allow for taxation and governments, instead preferring protectors of economic freedom in the form of private contractors.
See also
- Adam Smith
- Anarcho-capitalism
- An Austrian Perspective on the History of Economic Thought
- Austrian School
- Ayn Rand
- Capitalism
- Economic liberalism
- Economics
- Free-market anarchism
- Free-market environmentalism
- Free market healthcare
- Free-market roads
- Free Market Socialism
- Free price system
- Free trade
- Friedrich Hayek
- Game theory
- History of theory of capitalism
- Libertarianism
- Ludwig von Mises
- Market economy
- Milton Friedman
- Minarchism
- Murray Rothbard
- Night watchman state
- Non-profit organization
- Nash equilibrium
- Open Source Initiative
- Political Economy
- School of Salamanca
- Self-organization
- Transparency (market)
- Underground economy
- Voluntaryism
Contrast
- Communism
- Freidrich Engels
- Gift economy
- Inclusive Democracy
- Karl Marx
- Leninism
- Libertarian socialism
- Limited liability
- Maoism
- Market abolitionism
- Market socialism
- Marxism
- Mixed economy
- Participatory economy
- Planned economy
- Quasi-market
- Socialism
- Statism
- Subsistence economy
- Trotskyism
Footnotes
- "Free Market." Rothbard, Murray. The Concise Encyclopedia of Economics
- Dictionary of Finance and Investment Terms. Barrons, 1995
- http://www.donsheelen.org/page14.aspx
- Hayek cited. Petsoulas, Christian. Hayek's Liberalism and Its Origins: His Idea of Spontaneous Order and the Scottish Enlightenment. Routledge. 2001. p. 2
- Smith, Adam. "2". [[Wealth of Nations]]. Retrieved 2007-12-08.
{{cite book}}: External link in|chapterurl=|chapterurl=ignored (|chapter-url=suggested) (help) - , by Eugene Walras
- Theory of Value, by Gerard Debreu
- ^ Critical Mass - Ball, Philip, ISBN 0-09-945786-5
- GREENWALD, Bruce and STIGLITZ, Joseph E. 1986 Externalities in Economies with Imperfect Information and Incomplete Markets, Quarterly Journal of Economics, no. 90.
- ^ COLE, Julio H. and LAWSON, Robert A. Handling Economic Freedom in Growth Regressions: Suggestions for Clarification. Econ Journal Watch, Volume 4, Number 1, January 2007, pp 71–78.
- ^ DE HAAN, Jacob and STURM, Jan-Egbert. How to Handle Economic Freedom: Reply to Lawson. Econ Journal Watch, Volume 3, Number 3, September 2006, pp 407–411.
- ^ DE HAAN, Jacob and STURM, Jan-Egbert. Handling Economic Freedom in Growth Regressions: A Reply to Cole and Lawson. Econ Journal Watch, Volume 4, Number 1, January 2007, pp 79–82.
- ^ AYAL, Eliezer B. and KARRAS, Georgios. Components of Economic Freedom and Growth. Journal of Developing Areas, Vol.32, No.3, Spring 1998, 327-338. Publisher: Western Illinois University.
- BOETTKE, Peter J. What Went Wrong with Economics?, Critical Review Vol. 11, No. 1, P. 35. p. 58
- Biography of Murray N. Rothbard (1926–1995)
- The Machinery of Freedom
References
- AYAL, Eliezer B. and KARRAS, Georgios. Components of Economic Freedom and Growth. Journal of Developing Areas, Vol.32, No.3, Spring 1998, 327-338. Publisher: Western Illinois University.
- BOETTKE, Peter J. What Went Wrong with Economics?, Critical Review Vol. 11, No. 1, P. 35. p. 58
- Stiglitz, Joseph. 1994. Whither Socialism? Cambridge, Mass.: MIT Press.
External links
- Free Market by Murray N. Rothbard
- Mises.org is the official website of the Ludwig von Mises Institute for Austrian economics and classical liberalism
- Foundation for Economic Education one of the oldest organizations promoting classical liberalism and free markets
- Free Enterprise: The Economics of Cooperation Looks at how communication, coordination and cooperation interact to make free markets work
- Fair versus Free by Milton Friedman
- Freedom to Work, to Earn, & to Buy by Harry Browne
- The Tradition of Spontaneous Order,
- U.N. calls for Overthrow of Free Market Ideology by Ambrose Evans-Pritchard, Daily Telegraph, July 16 2009
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