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07 October 2014

Is the free market free?

On 2 September when the Senate passed the repeal of the mining tax, the legislation included a considerable slowing of the process to increase superannuation for workers. Senator Lazarus for PUP, and Finance Minister Mathias Cormann, both emphasised that this gave individuals more money in their own pocket. Cormann went so far as to suggest people could now decide what to do with their extra money:

"This is not an adverse, unexpected change as it will leave Australian workers with more of their own money pre-retirement which they can spend on paying down their mortgage, spend on other matters or save for their retirement through superannuation as they see fit," Finance Minister Mathias Cormann told the Senate.

That is a classic liberal, or now neo-liberal, approach to economics: that people should be entirely ‘free’ to decide how they use their money with no government interference. Carried to its logical extreme, there would be no government involvement in health or education services, leaving that to private providers in the market and allowing people to decide how much of their own money they wish to spend on health and education. If you want higher quality health and education services, then you have to choose to pay more for them, or pay less and probably get a lesser service.

A recent issue shows how the market can directly impact health issues. In relation to a female chronic condition called endometriosis, a drug is available specifically to control the condition but it is not yet sold in Australia, although readily available overseas. The manufacturer, Bayer, does not yet believe it would make a profit from selling it in Australia (although it is ‘assessing the feasibility of introducing this product to the Australian market’). Even the AMA said its introduction to Australia was a commercial matter. When the operation of a free market can affect people’s health in this way, one has basis to question the ethics or morality of the whole economic system.

But that is the freedom of a free market, as neo-liberal economists see it.
Economics has drawn on the two basic approaches to freedom discussed in my earlier piece ‘Whose freedom?’: the freedom of the rational person to make their own decisions and choices; and the freedom that comes from there being no interference or coercion in making those decisions and choices.

Classical economics is pinned to ‘rational choice theory’ that assumes individuals always make prudent and logical decisions that provide them with the greatest satisfaction and are in their best self-interest. The pillars of this approach are self-interest, omniscience (‘perfect information’) and conscious deliberation. Adam Smith also created the ‘invisible hand’ whereby this rational self-interest actually creates benefits for others and for society at large, which is the basis of the ‘trickle down’ approach in economics.

The very concept of ‘the market’ is based on the idea that people freely interact, and freely exchange goods and services. In this concept, I exchange my labour for other goods and services and money has become the medium of exchange: it allows my exchange of labour with one person to be used, through the use of money, for exchanges with other people. [Although most economists state that money is not a ‘good’, there is a market for money so it must also have the characteristics of a ‘good’, not just a medium of exchange; in which case, it is the ‘good’ I receive for my labour and then exchange.] But the emphasis is that people freely and rationally make the decision to exchange because each party expects to gain from the exchange, a gain that provides ‘utility’ — or ‘satisfaction’, ‘pleasure’, ‘personal welfare’ (each words that have been used at different times to explain the economic meaning of ‘utility’).

The first glaring fallacy is that in classical economics this is based on a person having ‘perfect knowledge’ of the market, of all goods and prices, and being able to rationally assess that knowledge and make the best decision that meets their needs. ‘Perfect knowledge’ is, however, an impossibility: theoretically, if knowledge was perfect there could only be one rational decision that it would lead to, and that is clearly not the case.

There has been much work in the latter half of the twentieth century, and in the current century, that questions the classical approach, with many works showing that knowledge in the market is imperfect and even that people do not always make rational decisions — decisions can be influenced by emotions, by peers, by previous decisions and experiences, and so on.

Some have argued that it is this less than perfect information that actually leads to distortions in the market and market failures. Hayek and the ‘Austrian school’ recognised imperfect information in the 1940s and argued that each person has only a little information but maintained that it is a free market that efficiently allows each person to use what information they have. On the other hand, firms can raise prices or lower wages because they recognise the greater cost to the consumer or the worker of obtaining the necessary information that may lead them elsewhere: for example, a worker accepts a lower paid local job rather than undertake the effort (‘cost’) to search far and wide and relocate to a higher paid position.

There was also the classical view of ‘perfect competition’ which would produce the best possible outcome for consumers and society. Under perfect competition there would be only one price for equivalent goods because the market demand would be equal to the market supply (an equilibrium). When a good is first produced it may reap super profits for the initial providers but the high price attracts other players into the market, increasing supply, driving down the price, then driving some suppliers from the market, until it moves to equilibrium. This is one reason some economists think that ‘bubbles’ are not a market failure but are self-correcting. (It would also appear to be the underlying economic reasoning for the constant creation of new products, as firms try to obtain that initial advantage, and super profits, in the market.)

In this perfect world of rational buyers and sellers, of ‘perfect information’ and ‘perfect competition’, there is no need for advertising or branded goods. The model doesn’t exist in the real world (although it is argued by some that the money markets, and trading in items like tea and coffee come close) but it is still used as a model against which economic judgments are made. It is at the heart of the argument that unemployment comes about because the labour market is not ‘free’ (being subject to interference by government regulation, like minimum wages, and unions) and that, if it was completely free, wages would settle at a level where there was no unemployment.

All the ‘perfect’ models that make economics work lead to the fact that it is not operating in the real world. Many economic theories use ceteris paribus (‘all things being equal’), meaning they work unless other matters intrude — such as the real world. No doubt that gives rise to the joke that, for economic theory, the real world is an exception. It also means that it takes no account of the real-world social issues that impact freedom and therefore an individual’s capacity to participate or ‘compete’ in the so-called free market.
The neo-liberal economists lay claim to the John Stuart Mill approach to freedom:

The only freedom which deserves the name is that of pursuing our own good in our own way, so long as we do not attempt to deprive others of theirs, or impede their efforts to attain it.

They certainly place a lot of emphasis on the first part of Mill’s statement as an integral part of a free market. They partially cover the second part with their view that their ‘perfect’ free market allows people to enter and leave as they choose without cost (despite the reality that there is usually a ‘cost’). But, to my mind, they pay very little attention to the third part, regarding not impeding the efforts of others to attain freedom. In other words, they basically cherry-pick the concept of freedom and use only those parts that support their ‘free market’.

This is reflected in the approach to private property which is considered essential to a well-functioning free market: a means of managing resources (all forms of resources, whether natural, produced or intellectual). It is, however, actually a constraint and creates a basic anomaly in economic theory. One person’s ownership of a resource obviously limits the extent to which others can access it, but the economists argue that without private ownership there would be constant conflict over resources: in essence, private property provides a peaceful means to make resources available. The extent to which that resource is ‘desired’, or is valued by others, will be reflected in its price.

Private property is also essential to the concept of the market itself. To exchange something in the market, I must own it in the first place and the other party must also own what they are exchanging. The logic of this seems apparent when one considers what a thief may offer for exchange: we undoubtedly consider that not to be a fair exchange because the thief does not actually own the item of exchange — or does he? The thief clearly has ‘possession’, so there must be a logical difference between ‘ownership’ and ‘possession’ in the economic system. When one considers the history of conquest around the globe, it is easy to argue that what in many countries is called ‘ownership’ is in fact only ‘possession’. Take Australia for example: non-indigenous Australians possess the continent but do they own it? That question is, of course, central to the land rights debate.

It goes back to history and C B Macpherson’s argument that political freedom came before economic ‘freedom’ and was first obtained by the property-owning elites who then used it in their own self-interest. And it also goes back to history in the sense that much modern ownership is based on past dispossession of previous owners, and yet the economic system is based on the modern possession not the historic ownership.

So there is an illogicality in the underpinnings of the economic system and it is prefaced not on freedom but an historical loss of freedom imposed on others. It is essentially a system imposed by the ‘winners’.

That loss of freedom continues in the modern economy.

Some economists like to consider that their discipline is a science and, like the natural sciences, ‘value free’, but that ignores they are dealing with social issues which inherently have cultural values driving them; and also ignores that the entire field of economics is culturally derived and culturally driven. And they ignore that their whole economic system relies on the basic social value of trust. The thief is able to exchange the item he has only because we normally trust people to undertake a genuine exchange. The shopkeeper trusts us to pay for an item when it is handed over and/or we trust the shopkeeper to hand the item over when we have paid — otherwise we would either be there all day negotiating who should first begin the exchange, or we would need to have enforcers in every store to oversee the exchange. Without trust the ‘cost’ of exchange would become prohibitive. The economists tend to say that such social issues fall outside their field of study, yet their whole system depends on them.

By ignoring the social implications of the market, they ignore Mill’s dictum that freedom includes not impeding the freedom of others. This actually distorts their view of the ideal that there should be no government interference in the market. Putting those two together they can come up with this:

Consider the case of a black woman who wants to rent an apartment from a white landlord. She is better able to do so when the landlord has the right to set the rent at whatever level he wants. Even if the landlord would prefer a white tenant, the black woman can offset her disadvantage by offering a higher rent. A landlord who takes the white tenant at a lower rent anyway pays for discrimination.

According to this line of thinking, rent controls (in the USA) reduce competition based on monetary exchanges and increase competition based on personal characteristics: because the landlord is restricted in what rent can be charged, he then pays more attention to personal characteristics in selecting a tenant. How can we have any faith in people arguing that it is the lack of a free market that leads to discrimination?

The obvious flaw is that the black woman may not have sufficient money to offer a higher rent. And, if she has to pay a higher rent than a white person might to obtain the same apartment, isn’t that also discrimination? — but that doesn’t seem to exist in the thinking of the neo-liberal economists. They take the view, as explained in the ‘Whose freedom?’ article, that ‘lack of means’ is not a lack of freedom and they completely overlook that it may well be historical circumstances, an historical lack of freedom, that has created the current lack of means. There is no room in economic theory to overcome the economic injustices of the past. If economics can’t address economic injustices, then surely governments should, but not so according to the neo-liberal economists for that would be interference in the market.

‘Lack of means’ overlaps with the whole concept of competition. The economists argue that competition allows the real value of items, to individuals, and through them to society, to be determined (despite the fact that their ‘perfect competition’ actually leads to no competition). Thus, the auction of a house produces a price that reflects the personal value given to that piece of real estate by the individuals at the auction. If, however, I am outbid because another individual has greater means, I have surely had my own freedom to satisfy my self-interested ‘utility’ curtailed. I obviously look elsewhere in the market, so for the economists I still have freedom, but that original competition has impeded my freedom by imposing greater costs (information search) to continue looking for a house and, if those greater costs start exceeding my means, I may give up looking altogether (which is something the government needs to consider in its approach to younger jobseekers). Giving up is still a rational decision because the individual has decided that the cost of gaining more ‘information’ has reached the point of outweighing the benefits. (Note that ‘cost’ here, and in much of economics, is not just monetary but may include physical effort, time and other resources.)

Neo-liberal economists deride the old mercantilist view that any increase in means can only come at the expense of others but there is still an element of that in their ‘competition’. Competition is not necessarily fair when the resources and means are unequally distributed by private property and the historical accidents that led to it. There is, therefore, no real freedom in competition. But what the neo-liberal economists won’t admit is that it is competition, not freedom, that is fundamental to the economy they have created. Although my costs may increase or I lack means, that does not mean I am not free to make other choices, just that I have lost the competition. So it is not really a system about freedom but about protecting the competition’s winners.

In a short piece like this, I obviously cannot do justice to the full range of economic thinking. I have focused on a few key aspects of classical economics partly because that is what the neo-liberal economists returned to when they rejected Keynesian economics.

All is not lost because there are many new economic approaches, including Modern Monetary Theory (see 2353’s post here) and ‘middle out’ economics. There seems to be growing exposure of these ideas and they offer some hope for a new approach to economics but, unless they accept Mill’s dictum on freedom in full, not just in part, and allow a role for government in ameliorating economic injustices, the free market will still not be free.