Free market

A free market is a market where the price of each item or service is arranged by the mutual consent of sellers and buyers (see supply and demand); the opposite is a controlled market, where supply and price are set by a government. However, while a free market necessitates that government does not dictate prices, it also requires the traders themselves do not coerce or defraud each other, so that all trades are morally voluntary.

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. Some free market advocates oppose taxation as well, claiming that the market is better at providing all valuable services including defense and law. Anarcho-capitalists, for example, would substitute arbitration agencies and private defense agencies.

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." 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.

Theory

Voluntary Exchange

The key idea of a free market is voluntary exchange. If an exchange takes place under coercion or fraud, then that exchange is not considered a free market exchange. For example, if someone threatens someone with a gun to purchase what he is selling that is a not a free market. Or, if the government legally prevents a merchant from selling his goods at any prices he wishes and that buyers agree upon, that is not a free market. Thus, the operation of supply and demand is not sufficient for a free market if decisions on supply and demand are made under the threat of coercion. If an individual is lied to in order to pursuade him to purchase something, such as when a product or service is misrepresented, this is not considered morally voluntary either. Thus, a free market is one without "force or fraud."

Supply and Demand

Demand for an item (such as goods or services) refers to the market pressure from people trying to buy it. They will "bid" money for the item, while sellers offer the item for money. When the bid matches the offer, a transaction can easily occur (even automatically, as in a typical stock market). When supply exceeds demand, buyers often find that they can lower their bids, and sellers may compete with each other by lowering their offered prices (see buyer's market). Suppliers may choose to respond to the situation by lowering production or going out of business. A street corner with 4 competing hot dog vendors might have so much supply the price falls below the minimum needed for it to be worthwhile for one of the vendors to keep selling hot dogs there. He can easily move to another street corner. Moving a gas station is much harder.

When demand exceeds supply, suppliers can raise the price. Consumers who can afford the higher prices may still buy, but others may forego the purchase altogether, buy a similar item, or shop elsewhere. ("A two-dollar hot dog? I'd rather buy a hamburger at McDonald's!")

As the price rises, suppliers may also choose to increase production. Or more suppliers may enter the business. For example, the gourmet coffee business, pioneered by Starbucks, revealed a demand for three-dollar cups of coffee. Other stores began offering such coffee to satisfy the demand.

Increased demand can result in lower prices, particularly with computers and other electronic devices. Mass production techniques have been steadily reducing prices 20 to 30% per year since the 1960s. The functions of a multi-million dollar mainframe computer in the 1960s could be performed by a $500 dollar computer in the 2000s. The camcorder has been said to place "a television studio in your hand".

Economic equilibrium

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.

This equilibrating behaviour of free markets makes certain assumptions about their agents, for instance that they actffdoing 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.

Distribution of wealth

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.

Laissez-faire economics

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.

Deregulation

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.

Low barriers to entry

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.

Legal tender and taxes

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. 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.

Ethical justification

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. In Smith's time there were no centrally planned economies to the extent they existed in the 20th century 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, 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.

In 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.

Index of economic 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. [1]

History and Ideology

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.

Marxism

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.

Liberalism

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, fascism, 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.

Criticism

Whether the marketplace should be or is free is disputed; many assert that government intervention is necessary to remedy market failure that is held to 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.

Martin J. Whitman

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…

He argues, in particular, for the value of government-provided credit and of carefully crafted tax laws. 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,, although in other respects over-regulated (he is generally opposed to Sarbanes-Oxley).

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. Whitman also states that "Corporate America would not work at all unless many activities continued to be coercive."

"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."

Noam Chomsky

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."

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. He remarked, "the free market is socialism for the rich—[free] markets for the poor and state protection for the rich."

Catholic Church

As explained in Rerum Novarum and The Catechism of the Catholic Church , 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.

See also

• Adam Smith
• Anarcho-capitalism
• An Austrian Perspective on the History of Economic Thought
• Austrian School
• Ayn Rand
• Capitalism
• Economic liberalism
• Economics
• Free-market anarchism
• Free price system
• Free trade
• Friedrich Hayek
• Game theory
• Heritage Foundation
• History of theory of capitalism
• LIEO
• Libertarianism
• Liberalism
• Ludwig von Mises
• Market economy
• Milton Friedman
• Minarchism
• Neoliberalism
• Murray Rothbard
• Neoconservatism in the United States
• Negative liberty
• Night watchman state
• Non-profit organization
• Nash equilibrium
• Objectivist Philosophy
• Open Source Initiative
• Political Economy
• School of Salamanca
• Self-organization
• Transparency (market)
• Underground economy
• Voluntaryism
• Free Market Roads

Contrast

• Communism
• Gift economy
• Inclusive Democracy
• Karl Marx
• Libertarian socialism
• Limited liability
• Market abolitionism
• Market socialism
• Mixed economy
• Participatory economy
• Planned economy
• Quasi-market
• Socialism
• Statism
• Subsistence economy

External links

• Free Market by Murray N. Rothbard
• Free Market Doctors Utilizing the ideals of a free-market economy to revitalize the healthcare industry
• In Defense of the Free Market
• Mises.org is the official website of the Ludwig von Mises Institute for Austrian economics and classical liberalism
• Free Enterprise: The Economics of Cooperation Looks at how communication, coordination and cooperation interact to make free markets work
• Index of Economic Freedom by the Heritage Foundation
• Move Over, Adam Smith: The Visible Hand of Uncle Sam Report concludes that the U.S. government surreptitiously intervenes in the American stock market
• Fair versus Free by Milton Friedman
• Freedom to Work, to Earn, & to Buy by Harry Browne
• The Freedom Library: A collection of Masterpieces of Economics and Philosophy - Free Pdf downloads as well as audios and videos of the free market thinkers.