Free market

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Template:Liberalism A free market is one in which buyers and sellers make mutually voluntary exchanges at a price agreed upon by both (see market economy). In economics and political economy, it is the polar opposite of a command economy.

A free market is a concept in both ethics and economics treated as an abstract model by many economists and some ethicists. In its idealized sense, it is a market where all transfers of money, goods, and services are devoid of coercion and theft.

Since no country fully manifests the ideal of a free market, the term free market economy is used for a nation state's economy that approximates the ideal by virtue of having a government that engages in little or no interventionist economic regulation. If such a government intervenes in private affairs, it only does so to stop coercion that may take place among market participants. As this protection must be funded, government taxes to only as much as is necessary to perform this function. This state of affairs is also known as laissez-faire.

A "market economy" that has very substantial regulation is not a "free market economy." Whether any particular economy is free enough of coercion to reasonably be called a free market economy is often a matter of political dispute: libertarians typically say that western economies are not free, and are at best mixed economies, due to what they believe constitutes very significant interference by government in what would otherwise by a free market.

Whether the marketplace should be free is also disputed; many assert that government intervention is necessary to remedy market failure that is held be an inevitable result of absolute adherence to free market principles.

Internationally, free markets are advocated by proponents of economic liberalism, in Europe usually simply called liberalism. In the United States, support for free market economic structures is a key tenet of U.S. conservatism and libertarianism. Since the 1970's, promotion of a global free-market economy, deregulation and privatisation, is often described as neoliberalism.

The term free market economy is generally used to describe western economies, but pro-market groups would only accept that description if the government practices laissez-faire policies, rather than state intervention in the economy. Since the emergence of a distinct economic system in the Soviet Union, the free market is usually contrasted to a command economy and a centrally planned economy. However, early proponents of a market economy in 18th-century Europe contrasted it with the mediaeval and early-modern economies which preceded it.

For social philosophy, a free market is a system for allocating goods within a society: supply and demand within the market determine who gets what, and what is produced. The market does this without prior external decisions or values, and this is seen as its great advantage by its supporters. The allocation function is usually called "the market mechanism", or again simply "the market".

A free market economy is generally understood to be different from pre-modern economic systems. Some were monetarised but that is not seen as sufficient to define a free market. Market transactions are understood to be economic in nature, and personal gift-giving is not generally considered a market transaction. Neither are coerced transfers such as tribute. Lack of economic transactions, for instance in a society of pure subsistence farming, also rules out a free market.

A free market implies the presence of competition, although monopolies that are not maintained through coercion can be present. It often connotates the presence of the profit motive, although neither a profit motive or profit itself 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.

Origins

Some theories assume 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. The consensus among economic historians is that the free market economy is a specific historic phenomenon, and that it emerged in late mediaeval and early-modern Europe. Some 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. In Marxist theory, the ideology simply expresses the underlying long-term transition from feudalism to capitalism. Note that the views on this issue - emergence or implementation - do not necessarily correspond to pro-market and anti-market positions. Libertarians would dispute that the market was enforced through government policy, since that has a connotation of repression, and Marxists agree with them, for different reasons.

Theory

If a government is present, its use of force in the marketplace is ideally limited to protecting the market participants from coercion, including protection of property rights and enforcement of contracts. The essence of a free market can be understood as a game in which the players compete according to a common set of rules that prevent coercion (including theft); the enforcement of these rules may be carried out by a neutral referee (government). Players in this game may have different skills, knowledge, and wealth, which may conflict with social norms of fairness, so a free market may not accord with what some would consider a fair market. Or, some may see the equal application of the rules to all participants as the essence of fairness. [1] This conception of a market as a pure economic system based on freedom from coercion among market participants as well as from government is in fundamental contrast to a command economy.

The law of supply and demand predominates in the idealized 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 use (or utility) for each product and within the relative limits of each buyer's purchasing power. 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.

This equilibrating behaviour of free markets makes certain assumptions about their agents, for instance that they act independently. 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 behaviour 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 behaviour often observed in stock markets are quoted as real life examples of non-equilibrium price trends. 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 on non-equilibrium prices.

The distribution of purchasing power in an economy depends to a large extent on the labor and financial markets, but also on other 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, which is almost certainly never true in a command economy, not least because a government is likely make mistakes in distributing resources, since the information to its disposal is far less than perfect. Many advocates of free makets, 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 both theoretically and empirically. Joshua Epstein and Robert Axtell have attempted to predict the properties of free markets in an agent-based computer simulation called sugarscape. They came to the conclusion that, again under idealized conditions, free markets lead to a Pareto distribution of wealth. This finding confirms the ideas of Vilfredo Pareto himself, who believed that the "natural" tenedency of society is towards a power law distribution of wealth, power, or influence.

Practice

While the free-market is an idealized abstraction, it is 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. Taxes and government regulation bias the equilibrium points of every large government-sanctioned economy in existence today, so that these economies are only relatively free or unfree. Monopolistic practices, cartels, externalities (like pollution), and asymmetrically distributed information are often cited as potential problems that may exist in a free-market economy. Knowledge bias can lead to what many may see as evils of such an economy, like insider trading, price fixing, price gouging, adverse selection, moral hazard, and the principal-agent problem which they claim justify government intervention to remedy. Some believe that the notion of a free market is inherently unachievable because it operation depends on a class system, Commodity fetishism and they hold that governments create property rights and are fundamentally involved in markets through the enforcement of such rights. Others argue that the concept of property comes from natural law and therefore it is incorrect to see governments as creating markets.

The degree of market 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. Today one can see a vivid correlation between EOF value and country's GDP. [[2]]

Ideology and ethics

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 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 and libertarianism 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 is to refer to this as capitalism, while in Europe 'free market' is the preferred neutral term. Use of the term ‘capitalism’ in Europe usually implies a Marxist, or at least critical, approach, unless it is being used to describe the 19th century.

Marxism, communism, and socialism are usually seen as the main ideological opponents of the free market. Modern liberalism (American 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.

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, although it is older. In Smith's time there were no centrally planned economies to serve as a comparison, he was simply arguing that the market benefits the common good. 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, they are appealing primarily to its intrinsic value as a self-organising entity. Intense admiration for these abilities of the market became a characteristic of some pro-market argument in the 1990's, especially among those who saw the internet as a form of perfect market.

See also

Contrast

External links


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