by Girish Menon
Suma, you have asked a
really fundamental question and I will try to answer it in two parts viz;
-
What is a market
economy?
And
-
What does free mean in
the context of free market economy?
So let’s start with the
first aspect – What is a market economy?
The activity of buying or
selling a good is called a market transaction or a market activity. Thus a
market is a set of arrangements where goods are exchanged for money.
Today most countries in the
world adopt the market model for the production and consumption of goods and
services. They believe in the Adam Smith quote, ‘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 interest.’
Google Dictionary defines
self interest (own interest) as ‘one's
personal interest or advantage, especially when pursued without regard for
others.’ Some economics texts assume that the self interest of a goods producer
is to earn profits whereas the self interest of a consumer is to maximise her
happiness by paying for goods she requires.
Adam Smith’s theory expects citizens in an economy to be both producers
and consumers of goods. As a producer you are expected to generate a profit
from your toils. You, as a consumer, are expected to use the profits to buy other
goods to live your life.
Based on the above logic, market theory predicts that if all the
citizens of an economy are left to pursue their self interest then it will
result in the automatic production of all goods and services that citizens require
in order to be happy.
Though Adam Smith preferred the word ‘invisible hand’, I have used the
term automatic. Google dictionary defines automatic as ‘working by itself with
little or no direct human control’. In other words producers make and sell
goods which they think will be demanded and hope to profit from it. There is no
authority other than their anticipation of consumer needs that guide their
decision to produce and sell goods. Similarly, consumers pay for a good because
they think it will make them happier and there is nobody telling them what to
buy and consume.
Thus, a market economy would be an economy where the production and
consumption of all/most goods and services is determined by the self interest
of its producers and consumers. This system is also known as capitalism.
So, what is a free market economy?
These days it’s not only the UK , USA etc. but many other
countries who call themselves free market economies. But are they truly free
market economies where the production and consumption of all goods are
determined automatically with its citizens unabashedly following their self
interest?
I notice that you seem to be shaking your head. Especially in this Covid
climate you will have noticed the role that the UK government has played in your
life and the way it has affected your pursuit of self interest and happiness.
So what I will now do is list the conditions necessary for Adam Smith’s theory
of the invisible hand to work:
- There are
many buyers for a good in the market and no buyer is large enough to get a
discount on the price.
- There are
many small sellers of a good in the market and no seller is large enough
to set its own price.
- The goods
produced and consumed are identical or homogeneous. In other words a
consumer cannot recognise the producer of the good.
- There must
be freedom of entry to the market – or no barriers that prevent a
potential producer from entering the market.
- There must
be freedom of exit from a market – if a producer wishes to quit a market
then s/he should be able to do so freely and without any sunk costs.
- There must
be perfect knowledge. Producers must have full knowledge of the
technologies used by its rivals and consumer preferences. Consumers must
be aware of the short and long term benefits and costs from consuming a
good.
- The factors
of production must be mobile. It means that the land, workers, machines
used for producing a good should be easily redeployed to producing any
other good when demand changes,
- There must be
no transport costs.
- There must
be independence in decision making. No external forces affect the decision
making ability of producers and sellers.
- No
externalities. The act of production and consumption based on self
interest should not result in benefits or costs to third parties.
I am sure that after you have read the above conditions you will agree
that neither the UK
economy nor for that matter the Indian economy is anywhere close to being a
free market economy. I don't think there is a single economy in the whole world that satisfies most of the conditions of a free market.
I will now let Ha Joon Chang have the final word on free markets:
“The free market
(economy) does not exist. Every market has some rules and boundaries (by
governments) that restrict freedom of choice. A market looks free only because
we so unconditionally accept its underlying restrictions that we fail to see
them. How ‘free’ a market is cannot be objectively defined. It is a political
definition. The usual claim by free market economists that they are trying to
defend the market from politically motivated interference by the government is
false. Government is always involved and those free-marketeers are as
politically motivated as anyone. Overcoming the myth that there is such a thing
as an objectively defined ‘free market’ is the first step towards understanding
capitalism.’
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- When I presented this article to Suma she said, 'Girish, you have not understood my question. I meant where can I find the free goods that should by definition be there in a free market?'