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Free Market laisser faire

The economic mechanism by which prices are set according to supply and demand. Thus when demand for a commodity increases the price will rise. The increased price will encourage greater production. As production increases the price will fall again. The result is a cycle or oscillation of prices. For many common commodities the price will remain fairly steady.

However, price can also be influenced by expectations. If people believe the price will rise they may buy in the hope of selling later. In some markets, such as shares in companies, this is the main influence on short term price, even if in the long term the price is influenced by the mathematical utility of the object. There are therefore at least two ways of looking at the free market. One is that it should not be regulated and prices should always be allowed to reach their level. This view has prevailed in the Anglo-Saxon countries during the 1980s (the 18th Century Adam Smith theory also called laisser faire - though Smith also believed in common morality and the social needs of people). The individualist theory may owe more to Thomas Hobbes, who did not believe people could cooperate.

A criticism of the market theory is that people seldom have full or even substantially true information and therefore the market is always distorted by psychology.

Another view is that, like a thermodynamic system, there are oscillations which can be damped in order to produce stable conditions. John Maynard Keynes, whose theories were influential from about 1936 to 1979 advocated government action. His theories greatly influenced British government policy from 1945-1979 and the Roosevelt New Deal. When his theories were rejected in the 1980s (as inflationary because governments seldom reduce borrowing during booms), the booms and slumps which were characteristic of the 19th century resumed. These could be interpreted as the mathematical result of an unregulated system.

Germany and Japan appear to practice modified Keynesianism and suffer fewer slumps.

The British and American versions of the laisser faire system - propagated by Milton Friedman - apparently suffer from chronic diversion of investment into non-productive financial instruments, growing unemployment, deindustrialization and potential mass poverty.

The Soviet Union set prices by central order. Observation shows that the complete absence of the market also leads to economic catastrophe. (But it is not at all clear that the sudden adoption of the market without preparation has done the Russians any good.)

The chief disease of the free market system is persistent inflation by which the value of money continually diminishes as prices rise. It is hard to devise a system in which prices remain stable. All currencies have inflated seriously since 1945, though some have inflated less than others. Of these the Deutschemark (the basis of the euro) has been the most stable. Some economists argue that money inflates because of the interference by politicians who use inflation to engineer election victories by making the voters feel good with a little inflationary boom shortly before elections. But Germany followed consistent policies of investment in productive capacity, which was the real basis of its currency. The euro is controlled by the European Central Bank, in theory insulated from political pressure by individual governments.

Should the market be applied to all human activities? Critics say that it should be used for those which are suitable. But there are those who wish dogmatically to apply to it everything, despite evidence that marketization does not work in all spheres - for example in health care.

Should the system have been introduced in eastern Europe and Russia so suddenly, leading to the collapse of the economy and the dissolution of society into criminality?

In Ireland the 1840s famine was caused partly by the insistence, from dogmatic market theory, on exporting wheat (unaffected by the potato disease). GATT and IMF rules can have the same effect in the modern world. See NAFTA. The World Bank is said to have advised the sale of Zimbabwe's maize reserve on market grounds - just before a drought revealed the need.

World Problem
The most serious defect of the present market system may be that long term signals of predicted resource depletion and pollution do not affect short term decisions. And these "externalities" are not counted in GNP and therefore have no price which would affect the market.

Elliott and Atkinson argue that too much power has been given to the financial sector who enrich themselves at everyone else's expense. It could be argued, and has been, that this is a form of "neo-feudalism".

Niall Ferguson has some useful historical comparisons about the current (2008) financial catastrophe.


The Gods That Failed: How Blind Faith in Markets Has Cost Us Our Future

Guardian extracts from the book - proposals to change policy to curb the super-rich.

Index

See Economic Imbalance


Niall Ferguson - The Ascent of Money, a financial history of the world


Last revised 14/10/09

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