Market economy
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A market economy (also called a free market economy, free enterprise economy) is an economic system in which the production and distribution of goods and services takes place through the mechanism of free markets guided by a free price system rather than by the state in a planned economy.[1] [2] In a market economy businesses and consumers decide what they will produce and purchase, as a opposed to a planned economy where the government decides what is to be produced and in what quantities.[3]
A market economy has no central coordinator guiding its operation, yet theoretically self-organization emerges amidst the complex interplay of supply and demand and price regarding a multitude of goods and services. Supporters of a market economy generally hold that individuals pursuing their self-interest through trade has the incidental effect of bringing about a spontaneous order that is effective in supplying the greatest abundance of goods for society and in the most efficient manner. Adam Smith says 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 [an individual] 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 [common] good." (Wealth of Nations)
The economists' model of a free market is one in which there is no governmental intervention or other coercion. The theoretical model of a large-scale free market economy does not occur legally, however the underground economy may be seen as an actualized free market economy.
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[edit] Free market economy
In order for an economy to be considered a true free market, the factors of labor, goods, services, and capital, must be free from government restrictions and trading barriers so they are able to move freely across borders.
The United States has restrictions on the attainment of monopoly, but also grants monopoly rights in some cases. Less market restrictions are found in other countries, such as in Hong Kong, according to the Index of Economic Freedom.
Free markets are also conflated with anarchy as many people believe that free market implies an absence of government. Only a few free market scholars advocate the elimination of government; most have believed government had a role to play, albeit a limited one (notably Adam Smith and Milton Friedman). Even anarcho-capitalists believe in the rule of law (either natural or contract) being defended by voluntarily-funded institutions.
Most free market scholars believe that governments should be limited to at least: operating a court system for the settlement of disputes, maintaining stable currency (combating inflation), protecting market competition and consumers, and protecting the country through national defense. These scholars debate and disagree with each other on whether or not governments are necessary to have government funded roads, schools, post offices, libraries, police stations, and fire stations, as some free market scholars believe the market can solve their externalities.
Although no country has ever had within its border an economy in which all markets were absolutely free, the term is typically not used in an absolute sense. Many states which are said to have a capitalist system have a high level of market freedom, even if it is less than some would prefer.
[edit] Decision making
The "economy" is usually associated with capitalism.
Generally market economies are bottom up in decisionmaking as consumers input information to producers through prices paid when purchasing products on the market. For a brief time during the 20th century even self described capitalist states engaged in top down market command where the government and or producers attempted to command and direct resources to valued uses. All states today have some form of control over the market that removes the free and unrestricted direction of resources from consumers and prices such as tariffs, and corporate subsidies. Milton Friedman and many other microeconomists, believe that these forms of intervention provide incentives for resources to be sent, and sometimes wasted, producing products society may not value as much as a product that is, as a result of these restrictions, not being produced in many ways.
[edit] Market externalities
Examples of market failures, or externalities, include negative externalities, monopolies, lack of provision of public goods, and social disparities such as extreme poverty. Market failures are the result of the market not receiving enough or appropriate information through singles such as prices. For example there is currently no way for the market to understand the cost or harm pollution causes to society. These failures are the reason some have thought that limited government intervention is necessary.
Milton Friedman believes that many market failures can be solved not through government regulation of current information but through information disclosure. Information disclosure would be a requirement of government law but would not actually seriously regulate how businesses operate. Instead the disclosure of information would allow the market to react to their behavior by allowing consumers to vote with their dollars given better information about the companies they do business with.
Friedman also argues for pollution permits to solve pollution externalities. By selling permits to the public, the public is now able to demonstrate a price for the harm or benefit caused by pollution. He believes that this type of government "regulation" allows better flowing information rather than the masking of current information to the market. If people really do value clean air, the information will be felt in the market and companies will react more quickly to be environmentally friendly.
Friedman believes governments may have a role in fixing market externalities but only if the government is helping solve information transmission problems not masking current information.
[edit] Government intervention
It is possible for a market economy to have government intervention in the economy. The key difference between market economies and planned economies lies not with the degree of government influence but whether that influence is used to coercively preclude private decision. In a market economy, if the government wants more steel, it collects taxes and then buys the steel at market prices. In a planned economy, a government which wants more steel simply orders it to be produced and sets the price by decree. An economy where both central planning and market mechanisms of production and distribution are present is known as a mixed economy. Germany's social market economy was one of the better functioning mixed economies, as microeconomists note that it had relativily free prices compared to other more socialist countries like the United Kingdom for much of the later 20th century.[citation needed]
The proper role for government in a market economy remains controversial. Most supporters of a market economy believe that government has a legitimate role in defining and enforcing the basic rules of the market. More controversial is the question of how strong a role the government should have in both guiding the economy and addressing the inequalities the market produces. For example, there is no universal agreement on issues such as protectionist tariffs, federal control of interest rates, and welfare programs.
Milton Friedman, along with many microeconomists, believes that too much government intervention and regulation can result in hampering or stopping the transmission of information necessary to allow the market to operate, what results, he believes, are very serious government externalities that can lead to inflation, deflation, recesions, and depressions. Milton Friedman believes that the Great Depression was the result of a government created externalities and thus was responsible for the causes of the Great Depression.
[edit] Market freedom
Friedrich von Hayek and Milton Friedman stated that economic freedom is a necessary condition for the creation and sustainability of civil and political freedoms. They believe that this economic freedom can only be achieved in a market oriented economy, specifically a free market economy. They do believe, however, that sufficient economic freedom can be achieved in economies with functioning markets through prices and private property rights. They believe that the more economic freedom that is available the more civil and political freedoms a society will enjoy.
Friedman states:
"economic freedom is simply a requisite for political freedom. By enabling people to cooperate with one another without coercion or central direction it reduces the area over which political power is exercised." Friedman, Milton and Rose Friedman, Free to Choose: A Personal Statement, Harcort Brace Janovich, 1980, p. 2-3
Studies by the Canadian "conservative" free market oriented Fraser Institute, the American "conservative" free market oriented Heritage Foundation, and the Wall Street Journal state that there is a relationship between economic freedom and political and civil freedoms to the extent claimed by Friedrich von Hayek. They agree with Hayek that those countries which restrict economic freedom ultimately restrict civil and political freedoms.[1] [2]
[edit] Markets and communist states
In the 1980s, most of the planned economies in the world attempted to transform themselves into market economies, for various reasons and with varying degrees of success. In the Soviet Union, this process was known as perestroika while in China the creation of a "socialist market economy" was one element of Chinese economic reform.
Despite being the largest country whose ruling party refers to itself as communist, the People's Republic of China runs Special Economic Zones dedicated to capitalist enterprise, which are free from central government control. This is contrary to the communist theory proposed by Marx and Engels and later adapted by Lenin, Stalin, and Mao. After opening up trade to the world under Deng Xiaoping, the People's Republic of China runs some of the most economically free regions in the world, including Hong Kong, which is regarded by the Hoover Institute and the Wall Street Journal as the world's freest economy [3].
These Special Economic Zones have few restrictions upon businesses, industries, imports and exports, including the elimination of duties, and a free price system. Since the opening of the Free Trade Zones China has maintained a growth rate of over 8%, and originally saw growth rates around 12%. These Special Economic Zones are different from the State Capitalism, as practiced in the Soviet Union, because the SEZs allow for capitalists to build and expand their industries and private property, free from the control of the central government. SEZ's operate under market economy rather than the state capitalist top down command economy approach.
According to China.org "After opening Shenzhen and other three coastal cities in South China as special economic regions and then dozens of economic and technological development zones in the 1980s, the country introduced free trade zones in the early 1990s in 15 coast cities, including Shanghai, Guangzhou, Shenzhen and Tianjin." [4]
In addition, China has recently declared private property to be a right and as also allowed the opening of foreign capitalist enterprises such as Wal-Mart to operate shopping centers in the Special Economic Zones.
Several other countries ruled by Communist Parties, such as Vietnam, have also made pro-market reforms in the last few decades.
The government is not in charge in this kind of economy.
[edit] Criticism of market economy
There are a variety of critics of market as an organizing principle of an economy. These critics range from those who reject markets entirely, in favor of a planned economy, such as that advocated by socialism, to those who merely wish to see them regulated to various degrees, and they range from those who believe that greed is inherently immoral to those who raise practical objections. One prominent practical objection is the claim that markets wreak havoc through their externalities (things that the market price does not take into account), for example through environmental pollution. Another is the claim that through the creation of monopolies, markets sow the seeds of their own destruction.
Some proponents of market economies believe that governments should not diminish market freedom because they disagree on what is a market externality and what are government created externalities, and disagree over what the appropriate level of intervention is necessary to solve market created externalities. Others believe that government should intervene to prevent market failure while preserving the general character of a market economy. In the model of a social market economy the state intervenes where the market does not fulfill the demands of political demands. John Rawls is a prominent proponent of this idea.
[edit] Notes and References
- ^ "market economy", The New Dictionary of Cultural Literacy, Third Edition. 2002.
- ^ "market economy", Merriam-Webster Unabridged Dictionary
- ^ Gorman, Tom. The Complete Idiots Guide to Economics, Alpha Books (2003), p. 9
[edit] Further reading
- 2005 Index of Economic Freedom, Heritage Foundation and the Wall Street Journal
- De Soto, Hernando. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere else, Basic Books, 2000.
- Economic Freedom of the World Report, The Frasier Institute
- Friedman, Milton. Capitalism and Freedom, University of Chicago Press, 1962.
- Friedman, Milton and Rose Friedman. Free to Choose: A Personal Statement, Harcort Brace Janovich, 1980.
- Hayek, F.A., The Road to Serfdom, University of Chicago Press, 1944.
- Hayek, F.A. The Constitution of Liberty, University of Chicago Press, 1960.
- Lindsey, Brink. Against the Dead Hand: The Uncertain Struggle for Global Capitalism, Wiley, 2001.
- Przeworski, Adam. Democracy and the Market (New York: Cambridge University Press, 1991.
- Reed, Robert, Max Schanzenbach, "Prices and Information: A Simple Framework for Understanding Economics"
- Schumpeter, Joseph. Capitalism, Socialism and Democracy. Harper Perennial, 1962.
- Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations, 1776.
- Yergin, Daniel, and Joseph Stanislaw. The Commanding Heights: the Battle for the World Economy, Simon and Schuster, 1998
