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Friday, October 11, 2013

7 Falsehoods About the Free Market

Just as there are timeless truths, there are also timeless falsehoods. 

Here are a few of the latter that I’ve recently encountered, but there are, of course, plenty more. Some libertarians may not agree with me (at least at first) on all of them.

1) The free market creates scarcity and higher prices. In any economic system—socialist, interventionist, or free market—the quantity of a good will typically not be enough to satisfy demand when the price is zero. In a free market, in which people trade their legitimate claims to those resources, prices will tend to rise or fall to the level where the quantity supplied equals the quantity demanded, and in that way prices help us to cope with scarcity. Not only that, the free market, via a system of profit and loss, gives entrepreneurs an incentive both to supply more of scarce resources and to discover alternatives to them. (But not all “trade” is conducted this way. See No. 4 below.)

2) The free market means the government gives businesses special privileges. This is a very common belief based on the idea that pro-market means pro-business. But the free market is free precisely because it denies special legal privileges to any person or group. People sometimes define “privilege” as any advantage a person or group may have over others. Certainly such advantages exist today and would exist in a free market—you may be born into a wealthy family or have superior drive and resourcefulness—but these advantages are consistent with the absence of privilege in the libertarian sense, as long as you acquired such advantages without fraud or the initiation of physical violence against the person or property of others.

3) The pre-Obamacare healthcare industry was a free market. Actually, it was a highly interventionist market, as John C. Goodman explains. Similarly, the failures of the housing and financial markets were hardly the result of “free-market policies,” and the same could be said for practically every other sector of the American economy. The free market is free of legal privileges and discrimination; it is whatever happens in the absence of aggression and within certain “rules of the game”—for example, private property, freedom of association, and the rule of law. Again, it’s not pro-business, pro-consumer, or pro-anything if that means using political power to intentionally help some and hurt others.

4) The free market requires that all valuable resources be privately owned and traded on markets. Even if this was possible, and I’m not convinced that it is, it’s not always the best way to overcome a “tragedy of the commons.” Sometimes the alternatives to individual ownership just work better. Indeed, Elinor Ostrom, who won the Nobel Prize in economics for her research on commons-type problems, found ways that people around the world and throughout history have avoided conflicts over such things as water usage and forest-cutting by using non-market methods of cooperation (and often without the use of government). Indeed, we typically “exchange” favors with family, acquaintances, and sometimes with strangers without the need for formal markets and market prices. And that’s a good thing.

5) The free market encourages racism, homophobia, and other types of bigotry. Now, it’s true that you can be a racist homophobe in a free market, and refuse to live next to a same-sex, interracial couple, or refuse to hire someone because their looks in some way offend you. The consequences of those actions, however, mean that you will tend to pay a higher price for a house or a higher wage to your employees because you’ve deliberately narrowed the range of your choices.

Some critics of the free market scoff at this explanation and argue that it doesn’t address the underlying racism or sexism. Much can be said in response, but I’ll limit myself to two things. First, paying for prejudice may not eliminate it, but it will tend to reduce it (i.e., the demand curve for prejudice slopes downward). Indulging in prejudice means losing out to the family that is more tolerant or the employer who is more competitive. Second, trying to change a person’s attitude toward homosexuality and racism by the use or threat of aggression is not really an effective method; indeed, it usually does more harm than good and causes enormous complications in the long run. The free market gives you an incentive to profit from associating with and learning from others who might be very different from you, who operate outside your normal social networks. Legal mandates tend to breed resentment and rent-seeking that undermine the tolerance necessary to connect to people who are socially distant from you.

6) The free market is pro-war. It’s true that besides being “the health of the State” and the enemy of liberty, war does benefit some special interests such as businesses that produce the weapons of war. But war undermines the free market in general. War and the government interventions that inevitably accompany it restrict markets (domestically and in the countries against which our government is fighting) and free association, make it more costly for most people to buy and sell, reduce the purchasing power of households and businesses, and disrupt the peace that is necessary for a thriving free market.

7) The free market is always efficient. The real world is populated by real people who don’t have complete information, who may have bad information, and who may just make mistakes. An “ideal” economic system is not one in which no one ever makes a mistake; it is one in which the mistakes that people inevitably make are corrected as effectively as possible. Competition in a free market will tend to let you know if you charge too much or too little, overlook an opportunity to lower your cost or raise your revenue, or utilize a new method of consumption or production. The free market is not ideal because it always operates to perfection, but rather because it does better than any other system that we know of so far in correcting mistakes.

How’s that for a start? I’ll get into a few more falsehoods in a future column, but these are worth keeping in mind for now. They tend to be regarded as conventional wisdom by a lot of people, and they underlie a lot of misunderstandings.

Find a Portuguese translation of this article here.

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.