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What Is A Free Market?

Ian White ’19, Guest Writer

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As an economics major, I spend a lot of time reading about, thinking about, and discussing markets. I have read from Adam Smith’s Wealth of Nations, F. A. Hayek’s The Use of Knowledge in Society, and Milton Friedman’s Capitalism and Freedom. I have studied microeconomic models of perfect competition and macroeconomic models of employment, interest, and money. Having spent so much time analyzing ideas about the market, I get quite frustrated at two words more than almost any others: free markets.

Many politicians, particularly on the right, espouse the “free market” as the ideal economic system. They use this ideal to oppose increased government spending, taxes, and regulation of economic affairs. However, I have never heard any prominent politician actually define a free market. What do those words even mean? Who is free to do what? What is the proper role of government in a free market economy?

The most basic economic argument against government intervention is that of deadweight lost. When a person’s money goes toward taxes, the argument goes, the government deprives that person of whatever they would have spent that money on. The government also spends that money in a less efficient way than the private individual would. The value of all things to society is equal to their market price, and the quantity of all goods sold at market is the ideal quantity to produce and consume.

It is safe to say that no one follows the deadweight loss argument to the extreme conclusion that there should be no taxes. Otherwise, public schools, infrastructure, and courts would not exist. One way to justify taxes is through the idea of externalities. Not all transactions only affect the buyer and the seller. Some things, like factory pollution, negatively affect third parties and increase the real cost of selling a good. Other things, like education, health care, and infrastructure, positively affect third parties and increase the benefit of selling a good. The ideal role of government, then, is to tax goods with negative externalities and subsidize goods with positive externalities. Instead of praising free markets, maybe we should talk about correcting externalities and letting the market take care of what the market is good at.

Speaking of which, what is the market good at? In theory, the beauty of a market economy is its ability to coordinate the production and consumption of goods and services without an all-powerful central authority. Ideally, the market is the ultimate democratizing force, giving everyone a vote on what gets made with their paycheck. You buy what you want, and with each dollar you spend on a good, you vote to continue production of that good by the firm you bought it from.

The mechanism of prices is also, theoretically, a way of distributing limited goods and services to those who want them the most. There are not infinite amounts of anything, so any economy has to have a way to decide who gets the limited quantities of each good. In a market, whoever can and wants to pay the most for a good gets that good. If the government corrects for externalities, then, this would be the perfect economic system.

Does the theory of the market match up with reality? For the market to be democratic, power must be decentralized. No one person has excess market power, or money. No one business has inordinate market share. Each consumer competes against other consumers for goods, and each producer competes against other producers for customers.

This is not how the market works in reality. In reality, large corporations hold large amounts of power on the producer side, and the increasingly wealthy upper class hold large amounts of power on the consumer side. The negative effects of this power concentration are evident. Oligopolies dominate industries across the globe and reap larger and larger profits without making better products. Once a business is large enough, it faces less incentive to innovate and improve its products since there isn’t a serious threat from competition. Meanwhile, there are countless millions of people around the world who cannot afford to feed themselves adequately at the same time that elite bankers can afford multimillion-dollar penthouses and five mansions in the suburbs. If the global marketplace were truly democratic, no one would go hungry because each person would undoubtedly use their market pull to feed themselves.

Instead of praising some abstract free market, we should have discussions about the appropriate scope of government activity to ensure that markets function as they should, for the good of everyone.

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What Is A Free Market?