Thursday, February 11, 2016

Are Free Markets "Natural"? What Does That Even Mean?

The term “free market” has always made me feel very strange.  I suppose the reason is that, for many people, the word “free” implies a lack of regulation.  And yet without regulations, a good market cannot even exist.

There is this idea that a free market is something natural and that rules encumber the natural “invisible hand” of that market.   While I think there is some truth to the law of supply and demand, I would argue that what is “natural” encompasses a wide range of behaviors that we do not associate with desirable markets.

Stealing is a natural behavior, unfortunately.  Creating monopolies by using power to crush competition is natural.  Working together in symbiotic ways is also natural.

Most of us find monopolies and theft as unacceptable types of markets.   And they are markets.  If a person threatens my life unless I give him my car, then I have just made an exchange.  We don’t have to see it as legitimate, but it is a market exchange.  If Wal-Mart can undercut every other business because of their preexisting infrastructure advantages, this is still certainly a type of market even if we find it undesirable.

Most of us have decided that outlawing theft and outlawing monopolistic business practices are parts of a healthy market.  A market is, by definition, a system of exchange, and we choose what type of market we want to have by the rules we choose.

So what market rules are good and what rules are not?  Why do we choose to create certain markets?

I would argue that a desirable market is based on merit, morality and economic benefit. The merit comes from rules that reward creativity and hard work.  The morality comes from a safety net that provides basic human rights for folks regardless of their situation and makes sure economic rewards are not too lop-sided.  And the economic benefit comes from rules which stimulate economic growth and technological advancement.

Patents are a great example of a rule which forms a part of a desirable market.  First of all, they are complete fiction.  There is nothing inherently “natural” about saying that only a certain person can use an invention of some type for several years. Perhaps it would be more natural for everyone to market a new invention as quickly as possible in order to make money.  So why do we have patents?  Because we think the inventor deserves a reward for her invention (merit), and we think that those rewards will stimulate others to invent, creating economic growth  (economic benefit).

How about rules breaking up monopolies?  Once again, complete fiction.  But we have decided that competition is good for economic benefit and morality, so we break up big companies.

What about compound interest?  Talk about fiction!  There is nothing natural about increasing someone’s money when it sits around in a savings account of some kind.   Yet we use those returns in various ways to stimulate the allocation of resources (economic benefit.)

And of course the biggest fiction of all - capital.  There is nothing natural about someone giving someone else a piece of paper, or blips on a computer screen, having other people do the work, and then the original person receiving more money (while possibly doing very little).   And yet it tends to make our investment of real resources (materials, labor, planning, etc.) fairly efficient throughout the economy (economic benefit).

So a good market is something that is created through rules.  By its nature, that’s what it is.  Even on a simple level of bartering, there are invented rules which make it work to satisfy the conditions of merit, morality and economic benefit.

So what about the word “free” often placed in front of market?   Personally, I think it’s somewhat irrelevant, perhaps even a bit of an oxymoron.  “Free” implies choice and “market” implies rules which often restrict choices - at least in the short-term.  However a quality market, with rules to support merit, morality and economic viability, can create greater personal freedom, a greater amount of choice in the long-term, for people.

 Most people agree that patents, however “natural” they are, are a good idea for our economy.  However sometimes people will argue that a minimum wage or a progressive income tax is unnatural, encumbering the “free market.”   The truth is that these ideas are no more or less natural than a patent.  They should be judged according to merit, morality and economic benefit as we create desirable markets.

Here is one argument for a minimum wage, progressive taxation and other associated policies being an essential part of a good market:

Capitalism is designed to isolate financial wealth into fewer and fewer hands. That's what happens when it is working properly. If I have excess capital, then I either hide it under the mattress (which hurts the economy - I am not re-spending the money so I am depressing trade) or I invest it. Sure, that investment is sometimes spent elsewhere creating income elsewhere in the short-term, but I expect a return on my investment. So eventually more financial resources are isolated into my hands as I make a profit. In the aggregate economy this has a depressing effect on economic transactions, because financial assets begin to drift away from those who spend the most quickly - the working and middle classes - and they accumulate in the hands of the rich.

So there is an upward gravity of capital in our system that is destructive to the velocity of money. We can mitigate for this by keeping a decent tax rate on hoarded wealth (particularly the estate tax, keeping investment income taxed at the same rate as earned income and a progressive tax rate), maintaining a healthy minimum wage, planning quality deficit spending from the federal government to maintain a decent level of income, infrastructure, and inflation (which devalues hoarded financial wealth) and a variety of other ways etc.

And yet, once again, these rules are often called “anti-free market”.  But these rules seek to serve the same purpose as patents and antitrust legislation - to enhance merit, morality and economic benefit - so they are not inherently any different.

So “free market” is an unhelpful term.  The real question is - what rules best enhance merit, morality and economic viability?  That’s the standard by which we have created invented rules such as patents, compound interest, antitrust rules, laws preventing theft, etc. etc.  And other rules, such as minimum wages, environmental standards, progressive taxation, etc. have the same goals and should be judged along the same lines. Let’s not pretend that certain rules are “free” or “natural” and others are not.  These terms are poorly defined in the context of markets.  Rather, let’s judge all rules according to merit, morality and economic benefit.