Free market

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A free market is a market where price is determined by unregulated supply and demand; the opposite is a controlled market, where supply, demand, and price are set by a government.<ref>Dictionary of Finance and Investment Terms. Barrons, 1995 - "market in which price is determined by the free, unregulated interchange of supply and demand. The opposite is a controlled market, where supply, demand, and price are artificially set, resulting in an inefficient market."</ref> According to a more philosophical definition, a "free" market is a market where trades are morally voluntary and therefore free from the interference of force and fraud.<ref>Foldvary, Fred E.. Has Deregulation Failed?, The Progress Report, 2002.</ref>

The notion of a free market 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. Hence, with government force limited to a defensive role, government itself does not initiate force in the marketplace beyond levying taxes in order to fund the maintenance of the free marketplace. A few extreme free market advocates oppose even taxation.

In political economics, the opposite extreme to the free market economy is the command economy, where decisions regarding production, distribution, and pricing are a matter of governmental control. 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."<ref>Free-Market Economy, Microsoft® Encarta® Online Encyclopedia 2006</ref> In social philosophy, a free market economy is a system for allocating goods within a society: supply and demand within the market determine 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.

Along with the concept of a free market is the concept of a perfect market. To have a "perfect market" specific market conditions must be present, generally referred to as: "perfect competition" in where no buyer or seller can unilaterally influence the price; "perfect knowledge" in where all buyers and sellers have the same information; and "perfect mobility" in where all buyers and sellers can move to where they have the greatest competitive advantage.


[edit] Mechanism

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. 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.

[edit] 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 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. 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.

[edit] Theory

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 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 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.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 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.

[edit] 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.

[edit] 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.

[edit] 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.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 to the extent they existed in the 20th century, 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, 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.

[edit] Legal tender and taxes in a pure free market

In a truly free market economy, money would not 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. [citation needed]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 freely, without coercion and violence.

[edit] Criticism of the "free market" concept

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 is 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 today… Government has a necessary role in determining how control persons [management, boards of directors, etc.] are incentivized… <ref>Martin J. Whitman, Third Avenue Value Fund letter to shareholders October 31 2005. p.3.</ref>

He argues, in particular, for the value of government-provided credit and of carefully crafted tax laws.<ref>Ibid., p.4.</ref> 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,<ref>Ibid., p.4.</ref>, although in other respects over-regulated (he is generally opposed to Sarbanes-Oxley).<ref>Martin J. Whitman, Third Avenue Value Fund Letters to our Shareholders July 31, 2004 (PDF), page 2.</ref>

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.<ref>Ibid., p.5.</ref> Whitman also states that "Corporate America would not work at all unless many activities continued to be coercive."<ref>Martin J. Whitman, Third Avenue Value Fund letter to shareholders October 31 2005. p.6.</ref>

"I am one with Professor Friedman that, other things being equal, it is far preferable to conduct economic activities through voluntary exchange relying on free markets rather than through coercion. But Corporate America would not work at all unless many activities continued to be coercive."<ref>Ibid., p.5-6.</ref>

[edit] "Privatized tyranny"

Whether the marketplace should be or is 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. 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.

Noam Chomsky has argued that the asymmetric application of free market principles creates a "privatized tyranny": "The talk about labor mobility doesn't mean the right of people to move anywhere they want, as has been required by free market theory ever since Adam Smith, but rather the right to fire employees at will. And, under the current investor-based version of globalization, capital and corporations must be free to move, but not people, because their rights are secondary, incidental. Further, he emphasizes that it can matter what entities have rights in the market—"Do they inhere in persons of flesh and blood, or only in small sectors of wealth and privilege? Or even in abstract constructions like corporations, or capital, or states?"—and remarks that of what he sees as the three tyrannical systems of the 20th century, Bolshevism, and fascism have "collapsed", but "private corporatism is "alive and flourishing… [a] system of state corporate mercantilism disguised with various mantras like globalization and free trade."<ref>Noam Chomsky, unnamed lecture given February 26 2000 in Albuquerque, New Mexico on the occasion of the 20th anniversary anniversary of the International Relations Center. Accessed 3 September 2006.</ref>

Chomsky argues that the wealthy use free-market rhetoric to justify imposing greater economic risk upon the lower classes, while being insulated from the rigours of the market by the political and economic advantages that such wealth affords.<ref>Takis Michas, "The Other Chomsky", Wall Street Journal, November 4 2005. Reproduced on Chomsky's official site.</ref> He remarked, "the free market is socialism for the rich—[free] markets for the poor and state protection for the rich."<ref>Noam Chomsky, "The Passion for Free Markets", Z Magazine, May 1997. Reproduced on Chomsky's official site.</ref>

[edit] Catholic position

As explained in Rerum Novarum<ref>Rerum Novarum. Accessed 9 August 2006.</ref> and The Catechism of the Catholic Church <ref>The Catechism of the Catholic Church: The Social Doctrine of the Church. Accessed 9 August 2006.</ref>, the Catholic Church upholds the right to private property, requires the employer to pay a decent wage to support the worker, requires the worker to work faithfully and respect the property of his employer, and does not permit "the market" to be used as an excuse to violate moral principles.

[edit] Notes and References


[edit] See also

[edit] Contrast

[edit] External links

es:Libre mercado fr:Marché libre id:Pasar bebas is:Frjáls markaður he:כלכלת שוק lt:Laisvoji rinka mk:Слободен пазар nl:Vrije markt ja:自由市場 pl:Wolny rynek pt:Economia de mercado ro:Piaţă liberă sk:Voľný trh sh:Slobodno tržište fi:Vapaat markkinat sv:Fri marknad th:ตลาดเสรี zh:自由市場

Free market

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