Why Free Markets are Important

Why I Believe in Free Markets

Photo by Igor Oliyarnik on Unsplash

According to the Collins Dictionary, a free market is an economic system that allows supply and demand to regulate prices, wages, etc, rather than government policy. To be defined as a free market, government must not be involved at any point during the exchange, whether in the form of subsidies, tariffs and quotas, or regulation.

The free market is most efficient when the freedom and rights of the individual are protected. The protection against violence, theft, or other criminal activity are crucial to ensuring that our freedoms are not impacted upon by another. We are therefore free to do as we wish as long as that activity does not negatively impact a third party.

The protection of our freedoms is crucial to ensuring free markets are efficient. If we are in constant fear that we may be mugged when walking the street, we are less likely to walk that street. If we fear that we may exchange money, but not receive anything in return, we will not engage in trade. If we are invaded by a foreign dictatorship, there is nothing to stop them from imposing rules that would restrict existing free markets. In short, such protections create an environment that encourages economic activity. This means the rule of law, policing, the defence of the nation, and most importantly — property rights. There are a number of countries such as South Sudan or the Central African Republic that fail to protect such freedoms and consequently have weak economic activity. Until there is a viable way of ensuring these protections through private means, government becomes a necessary evil.

We Don’t Live In A Free Market

Many will argue how the poor are getting poorer and the rich richer, and it is all the fault of free market capitalism. However, we don’t live in a free market and haven’t for many years. Since the Second World War, government interventionism has increased exponentially. The UK started by introducing the NHS in 1948 and was later joined by the US with the enactment of Medicare and Medicaid in 1965. The US government then introduced the Social Security Pensions Act of 1975, which essentially provides a public pension scheme to citizens. This adds onto the other social programmes such as; food stamps, housing benefit, and the general welfare state. But it also includes the subsidies and tariffs that remain in place, which show we are not a free market. At the same time, government programmes increased in number, so too did regulations, booming from under 20,000 pages in 1950, to over 170,000 today.

The 1980s led to an era of privatisation and de-regulation. Free market capitalism gained popularity and became a viable option again. However, the era of regulation continued to expand to new industries. So whilst industries such as Railway, Airline, and Trucking were deregulated, new regulations were created. Industries such as energy, motor vehicle manufacturing, banking, and pharmaceuticals, have all seen regulation pile up.

Regulation chart
Source: Federal Register Statistics

More Government Spending

Prior to World War Two, federal spending accounted for just 8% of GDP. By 2018, this reached over 20%. More government spending means greater involvement in the economy. It means less resources available for private investment, which distorts the ability of markets to efficiently allocate. As government spending increases, so too does taxation. Not necessarily the rates, but the different number of ways that we can be taxed. Capital gains for example was introduced in 1913 in the US and 1965 in the UK. Sales taxes were also introduced in the 1930s in the US, but not in the UK until 1973. However, perhaps most importantly, is the development of the welfare state. Social security was introduced by Franklyn D Roosevelt in 1935, with employees and employers paying 6.2% each. It has become abundantly apparent that our freedoms are in decline through greater government control of our output.

Free Market Ideology

Free market ideology is based upon the principle that the individual knows best, rather than some unknown government official dictating what can be sold and for what price. When governments tax, regulate, or subsidise, they artificially manipulate the price of the product or service. This subsequently restricts the ability of markets to find the equilibrium price. Markets are stuck in a constant disequilibrium whereby supply and demand are never satisfied. This leads to over-demand and undersupply — particularly noticeable in markets such as healthcare. It can also lead to the opposite — oversupply and under-demand. The dairy sector is a prime example of this. According to a study by Grey et, al., around $22 billion was provided to the dairy sector in direct and indirect subsidies in 2015. At the same time, production is increasing, whilst demand is not. According to the Federal Government, almost 1.4 billion pounds of surplus cheese now sit in refrigerated warehouses around the country. Are such subsidies still necessary when supply is already outstretching demand?

Efficient Allocation

Free markets allow the decisions of millions of individuals to decide the price of a product based on a vote. That vote is the dollar, pound, euro, or yen in their pocket. Each time they spend their money, they are effectively sending a vote of approval to the producer. That vote is an approval that the exchange is mutually beneficial to both parties. The customer is willing to purchase at a said price and is informing the producer of this through the transaction. If the producer is finding that they have received a lot of votes in the form of purchases, they will invariably react by increasing the supply. This enables the supply and demand equilibrium to be met. When supply gets too high, producers cut back on production or reduce prices so that it meets demand. When demand gets too high, production and/or prices are increased to meet supply. This is more efficient than under government intervention as it allows prices and supply to be dictated by demand. When demand is artificially inflated by government as with public healthcare, both supply and prices are put out of place. Government is paying a price that is different to what the customer would be willing to pay. The outcome whether in quality or quantity is therefore inferior to a free market.

Control Over Prices — Rent Controls

When governments control prices, they misallocate resources. Price caps and minimum prices often have the opposite effect to what was originally desired. Rent controls for example have a number of side effects:

    1. Decay of existing rental housing stock – Landlords won’t invest so heavily in maintenance as there is no financial benefit through higher rents.
    2. Rental lock-in – Once a rent-controlled apartment is secured, many will not move even if housing needs change — creating an inefficient allocation of housing stock.
    3. Excessive demand and lowering supply – When prices are below the market rate, there will be higher levels of demand for rental housing. If demand increases, but prices do not, supply with therefore decrease. Landlords will look to sell their properties so they could still earn the market price for their real estate.
    4. Corruption effect – Price controls can be used as a way of gaining political favour rather than actually benefiting the consumer.
    5. Failure to address supply shortage – The point of a rent cap is to make accommodation affordable, but does not address the underlying problem of undersupply which is often caused by government regulation.

When government influences prices, it also effects supply and demand. Demand may in fact outstretch supply and as prices are unable to react, the quality and supply diminishes.

Control Over Prices — Minimum Wages

Governments also control the price that businesses are able to pay their employees. This is only a debatable issue because governments reduce the ability of markets to efficiently compete. By introducing costly and prohibitive regulation, competition is reduced. Businesses therefore only compete against a small number of competitors and have greater negotiating power over consumers and labour. The need for a minimum wage therefore stems from government intervention. Nevertheless, there are a number of reasons why a minimum wage doesn’t work:

  • Increased unemployment – If the minimum wage is higher that the added value the employee provides — unemployment will result.
  • Increase underemployment — Some businesses may look to operate a more efficient ‘just-in-time’ operation whereby employees aren’t on set hours, but rather are called upon when needed.
  • Higher prices — If the minimum wage goes above the added value of the employee, the result will have to be higher prices to compensate. Consequently, demand will also most likely fall, leading to greater unemployment.
  • Decreased investment — For every additional dollar a company pays its employee, it has one less for investment.
  • Kills small business — Small businesses often have tight profit margins. By increasing their costs, it puts many of them at risk.

Government Control

When government interferes in the market – prices, supply, and demand are distorted. Many would argue that government is able to provide all the benefits without any drawbacks. However, this is simply not true. The minimum wage may not create unemployment at a certain level, but it still impacts on business investment. For each action, there is a reaction. Often this is negative and worse than the previous issue. More government is required to resolve the issues caused by government.

Freedom of Choice

Free markets provide the individual with greater freedom of choice and greater competition. This includes domestic competition, but also from abroad. Without restrictions to trade, there is less to hold back new businesses coming through and providing a service at a price the consumer is willing to pay. We only need to see the USSR as an example of the limited choice that happens when free markets are constrained. Free markets allow businesses to operate based on the demand and willingness to pay of millions of individuals. When government interferes, monopolies and oligopolies occur because barriers to entry are created – whether this is in the form of subsidies, tariffs or regulations. One notable example of how government can restrict choice is through occupational licensing. By requiring every individual in a specific practise to go through various forms of training (often unnecessary) and testing, many are left out of the profession. It creates a barrier. A barrier that adds cost and reduces choice.

Further Reading

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