Market economy

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Template:NPOV-because A market economy is an economic system in which goods and services are traded, with the price at which goods and services are exchanged being determined by trades that occur as a result of sellers' asking prices matching buyers' bid prices.

In a market economy, ask and bid prices are typically understood to be the result of subjective value judgements, with potential buyers bidding up to, but not more, than they are willing to pay for a good or service and potential sellers offering a price down to, but not lower, than that which they are willing to depart with a good or service. When these prices align, a trade is made, and exchange price is determined. Bid prices are influenced by competition among buyers and ask prices are influenced by competition among sellers.

A market economy has no central coordinator guiding its operation, yet theoretically organization emerges amidst the complex interplay of supply and demand and price regarding a multitude of goods and services. Supporters of a market economy generally hold that the pursuit of self-interest is actually in the best interest of society. Adam Smith says:

"By pursuing his own interest frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the good." (Wealth of Nations)

There are a variety of critics of market as an organizing principle of an economy. These critics range from those who reject markets entirely, in favor of a planned economy, such as that advocated by socialism, to those who merely wish to see them regulated to various degrees, and they range from those who believe that greed is inherently immoral to those who raise practical objections. One prominent practical objection is the claim that markets wreak havoc through their externalities (things that the market price does not take into account), for example through environmental pollution. Another is the claim that through the creation of monopolies, markets sow the seeds of their own destruction.

Some proponents of market economies believe that governments should not diminish market freedom because they disagree on what is a market externality and what are government created externalities, and disagree over what the appropriate level of intervention is necessary to solve market created externalities. Others believe that government should intervene to prevent market failure while preserving the general character of a market economy. In the model of a social market economy the state intervenes where the market does not fulfill the needs of the market participants. John Rawls is a prominent proponent of this idea.

The economists' model of a free market is one in which there is no governmental intervention or other coercion. The theoretical model of a large-scale free market economy does not occur legally, however the underground economy may be seen as an actualized free market economy.

Free market economy

Main article: Free market economy

Free market economics is often conflated with capitalism but there is currently no capitalist state that has a free market. Even the United States, which often represents capitalism worldwide, has restrictions upon the freedom of factors in the economy. Free markets are also conflated with anarchy as many people believe that free market implies an absence of government. Only a few free market scholars advocate the elimination of government, most including Adam Smith and Milton Friedman believed government had a role to play, albeit a limited one. Most free market scholars believe that governments should be limited to at least: operating a court system for the settlement of disputes, maintaining stable currency (combating inflation), protecting market competition and consumers, and protecting the country through national defense. These scholars debate and disagree with each other on whether or not governments are necessary to have government funded roads, schools, post offices, libraries, police stations, and fire stations, as some free market scholars believe the market can solve their externalities.

In order for an economy to be considered a true free market, the factors of labor, goods, services, and capital, must be free from government restrictions and trading barriers so they are able to move freely across borders

Adam Smith's theory

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Decisionmaking

The "economy" is usually associated with capitalism.

Generally market economies are bottom up in decisionmaking as consumers input information to producers through prices paid when purchasing products on the market. For a brief time during the 20th century even self described capitalist states engaged in top down market command where the government and or producers attempted to command and direct resources to valued uses. All states today have some form of control over the market that removes the free and unrestricted direction of resources from consumers and prices such as tariffs, and corporate subsidies. Milton Friedman and many other microeconomists, believe that these forms of intervention provide incentives for resources to be sent, and sometimes wasted, producing products society may not value as much as a product that is, as a result of these restrictions, not being produced.

Market externalities

Examples of market failures, or externalities, include negative externalities, monopolies, lack of provision of public goods, and social disparities such as extreme poverty. Market failures are the result of the market not receiving enough or appropriate information through singles such as prices. For example there is currently no way for the market to understand the cost or harm pollution causes to society. These failures are the reason some think have thought that limited government intervention is necessary.

Milton Friedman believes that many market failures can be solved not through government regulation of current information but through information disclosure. Information disclosure would be a requirement of government law but would not actually seriously regulate how buisnesses operate. Instead the disclosure of information would allow the market to react to their behavior by allowing consumers to vote with their dollars given better information about the companies they do business with.

Friedman also argues for pollution permits to solve pollution externalities. By selling permits to the public, the public is now able to demonstrate a price for the harm or benefit caused by pollution. He believes that this type of government "regulation" allows better flowing information rather than the masking of current information to the market. If people really do value clean air, the information will be felt in the market and companies will react more quickly to be environmentally friendly.

Friedman believes governments have a role in fixing market externalities but only if the government is helping solve information transmission problems not masking current information.

Government intervention

It is possible for a market economy to have government intervention in the economy. The key difference between market economies and planned economies lies not with the degree of government influence but whether that influence is used to coercively preclude private decision. In a market economy, if the government wants more steel, it collects taxes and then buys the steel at market prices. In a planned economy, a government which wants more steel simply orders it to be produced and sets the price by decree. An economy where both central planning and market mechanisms of production and distribution are present is known as a mixed economy. Germany's social market economy was one of the better functioning mixed economies, as microeconomists note that it had relativily free prices compared to other more socialist countries like the United Kingdom for much of the later 20th century.

The proper role for government in a market economy remains controversial. Most supporters of a market economy believe that government has a legitimate role in defining and enforcing the basic rules of the market. More controversial is the question of how strong a role the government should have in both guiding the economy and addressing the inequalities the market produces. For example, there is no universal agreement on issues such as protectionist tariffs, federal control of interest rates, and welfare programs.

Milton Friedman, along with many microeconomists, believes that too much government intervention and regulation can result in hampering or stoping the transmission of information necessary to allow the market to operate, what results, he believes, are very serious government externalities that can lead to inflation, deflation, recesions, and depressions. Milton Friedman believes that the Great Depression was the result of a government created externalities and thus was responsible for the causes of the Great Depression.

Market freedom

Friedrich von Hayek and Milton Friedman stated that economic freedom is a necessary condition for the creation and sustainability of civil and political freedoms. They believe that this economic freedom can only be achieved in a market oriented economy, specifically a free market economy. They do believe, however, that sufficient economic freedom can be achieved in economies with functioning markets through prices and private property right]]s. They believe that the more economic freedom that is available the more civil and policical freedoms a society will enjoy.

Friedman states:

"economic freedom is simply a requisite for political freedom. By enabling people to cooperate with one another without coercion or central direction it reduces the area over which political power is exercised." Friedman, Milton and Rose Friedman, Free to Choose: A Personal Statement, Harcort Brace Janovich, 1980, p. 2-3

Studies by the Canadian "conservative" free market oriented Fraser Institute, the American "conservative" free market oriented Heritage Foundation, and the Wall Street Journal state that there is a relationship between economic freedom and political and civil freedoms to the extent claimed by Friedrich von Hayek. They agree with Hayek that those countries which restrict economic freedom ultimately restrict civil and political freedoms.

Criticism of alternatives

There are generalized criticisms of alternatives to market oriented economicswhich are often applied against any alternative to market oriented economic arrangements that seek to reduce or eliminate prices, wages, and private property such as socialism, communism, or anarchism. These points are used to not just argue in favor of markets, especially free markets, but as counter points to criticism of market oriented economics.

Milton Friedman argues that economies need functioning prices and private property in order to function properly and that the more restrictions that are placed on prices and property rights the less well the economy will function. Friedman believes that the elimination of prices, wages, and private property rights will lead to an economy that does not function at all. They believe that without property arrangements, prices, and wages, there is no way to calculate individuals' needs and wants, and hoarding may result. Finally, Friedman believes that any alternative to a market economy and free prices requires coercsion to operate because it requires coercion to eliminate (and maintain an alternative economic arrangement free of) prices, wages, and property. Friedman discusses the role of the market, prices and wages in "Capitalism and Freedom" and "Free to Choose" A condensed and simplified non-academic oriented version by Dr. Robert Reed can be read online here

Prices and wages

Microeconomists and free market scholars such as Milton Friedman have written extensively criticizing alternative economic arrangements to free market economies. Friedman has argued that it is very difficult and inefficient for central planners to guess or approximate values and demand for goods and services and that it is better to let prices float freely by allowing the market to determine them. Friedman also believes that free floating prices and wages help to best approximate the needs and wants of society and that many alternatives to the market oriented economy have no real way of quantifying "needs".

Freidman does believe that workers who take risks deserve more pay than workers who do not, but he also believes that workers are paid based on the utility and skill they provide their company. These microeconomists believe that pay scales based on sacrifice, as well as the elimination of wages or even implementation of maximum wages, are insufficient to provide the necessary incentives toward innovation and efficiency that occurs in a market oriented economy through the unlimited income rewards for innovators, managers, entertainers, chief executive officers or other such pursuits. Friedman believes that an inefficient, non-productive and non-innovative economic society would emerge if these incentives are eliminated.

Markets and cooperation

Friedman also believes that the market, especially the free market, provides appropriate incentives toward promoting cooperation, even among strangers. He believes market oriented economies are the most efficient at transmitting information on supply, demand, and the reallocation of resources, all of which are necessary to bring diverse people together for the common purpose of producing for consumption.

Profits become the motivator for aligning diverse interests and diverse people for a single goal. When included in a competitive economic system where voluntary transactions are the mode of trade, profits become a strong incentive to align capitalists and labor to produce whatever goods or services are demanded by consumers.

International cooperation

Friedman and Hayek both believe that market economies lead to cooperative transactions between people and between states. The more free the market economy the greater incentive for cooperation.

Friedman states, "International free trade fosters harmonious relations among nations that differ in culture and institutions"

Friedrich Hayek discusses the market alternative and its negative effects on cooperation:

"economic planning, conducted independently on a national scale, are bound in the aggregate effect to be harmful even from a purely economic point of view and, in addition to produce serious international friction. That there is little hope of international order or lasting peace so long as every country is free to employ whatever measures it desires in its own immediate interest, however damaging they may be to others…"

The role of private property

Free market critics such as Friedman also argue that private property rights are the staple by which people and society build wealth and that eliminating private property rights eliminates a primary incentive to build and protect wealth. Friedman believes that wealth is not a zero sum game, as is generally believed by advocates of market alternatives, but a positive-sum game as wealth is almost always growing; meaning one person may gain a lot while no one else may actually lose.

Externalities

Milton Friedman does not deny that there are market externalities and offers many solutions to solving problems such as pollution. For example Friedman advocates the selling of pollution rights via permits to any and all legal persons. This allows the transmission of information of how harmful society believes this pollution to be as private citizens may purchase pollution rights and never use them which forces corporations to innovate and pollute less or face a stiff penalty. He notes that without selling pollution rights to all legal citizens there is no way of transmitting information to solve this externality and that simply regulating pollution away does not solve the pollution externality but only hides it temporarily. Friedman also believes that economic externalities occur in all forms of economic arrangements but are most harmful when they are the result of government intervention as it is very difficult to solve government made externalities. He believes that the elimination of private property, wages, and free floating prices will result in serious government externalities such as shortages, inefficient use of resources and waste.

"Participatory" capitalism

Milton Friedman asserts, as would many other microeconomists, that consumers constantly participate in market-oriented capitalism with every purchase they make. By making purchases, they argue, every individual signals to producers in the market what goods are valued, the quantity of such good to produce, of what quality, what it shall be made of, or other properties that are desired. Friedman asserts that prices and money already generate the appropriate level of consumer participation through every purchase within every transaction. Furthermore, they believe market alternatives would not properly transmit this information to the market and would would occur is very little product diversity, thus many people would not get what they really wanted or would otherwise be willing to pay for.

He believes that no other economic arrangement can signal consumer wants to producers and suppliers better than prices in a market economy. He also believes that floating prices are the most efficient as consumers immediatly input information on the value and demand for a product while prices also immediatly reflect the value, demand, and supply of a particular good or service. This information, he argues, will be difficult to guess for any planner, regardless of the size of the planning board, and what will result is a redistrobution of goods away from their highest valued use resulting in a society whose general welfare has been reduced. Thus some low valued goods will be overproduced and some high valued goods will be underproduced or not produced at all.

Markets and poverty

One of the more major complaints of markets and capitalism is a belief that they create exploitation of labor and poverty. These critics cite the 19th century and industrialization as a primary example of how growing markets and capitalism created more poverty. Milton Friedman notes that the 19th century resulted an explosion of wealth for society which created more visible poor not more poor.

Poverty is often conflated with capitalism and with marxist notions of class conflict. Free market economists such as Milton Friedman and Hernando De Soto make compelling arguments on how poverty is often created and sustained by government interference and regulation of the economy. Some ways in which governments can promote poverty is through unequal property rights, high transaction costs to property rights, perverse and complex tax codes which provide no incentive for the poor to save or build capital, tariffs and other trade barriers, and labor laws such as minimum wages and work hour limitations; microeconomists argue that such labor laws increase unemployment.

Many non-market oriented alternatives to market arrangements, and even social-market proponents criticize market economies for their income inequality. Friedman and many other microeconomists note that this can be an irrational response as there is nothing unfair about income inequality in a positive sum relationship where people are engaging in voluntary transactions. Friedman argues that the entertainers or sports atheletes are paid high wages for the same reason chief executive officers, managers, engineers, and doctors are paid high wages: consumers value their service and are willing to pay those wages through multiple voluntary transactions.

Free market solutions to poverty

Free market economists argue that planned economies and welfare will not solve poverty problems but only make them worse. They believe that the only way to solve poverty is not by shuffling and sharing existing wealth through redistributing wealth but by creating new wealth. They believe that this is most efficiently achieved through low levels of government regulation and interference, free trade, equal property rights, money systems, wages, and tax reform and reduction, thus converting even the poor members of society into capitalists. Some further extend this criticism to any alternative to free market economies.

Many neoliberals attribute poverty to insufficient protection or recognition of property rights.

Hernando De Soto argues that poverty is sustained by government overregulation that generates high costs to property ownership through bureaucracy and big government. He argues that many of the poor in the world economy are unable to develop their property or own property because this regulation is too costly to overcome. As a result, they argue they are unable to generate wealth in a legal market that is full of regulation and are forced to resort to operate in an extralegal market that hampers wealth creation, thus hampering their ability to be pulled out of poverty.

Economists such as Milton Friedman argue that tariffs, income taxes, payroll taxes, savings tax and tax on investments all provide perverse incentives toward wealth creation that hurt the poor the most. He further argues that some of these arrangements are also wealth transfers from poor to rich; such as tariffs and social security. He argues that these regressive tax burdons encourage low productivity and little savings and investment that would otherwise lift the poor out of poverty.

Others have argued that welfare] perpetuates poverty by providing incentives counter to wealth creation. Proponents of the FairTax and economists such as Milton Friedman favor eliminating welfare programs that prevent benefits from those earning above a certain income. They believe that these income caps as eligibility to receive benefits provide an incentive for laborers to earn less than they actually could in order to gain free benefits from government programs.

Social market solutions to poverty

Advocates of the third way believe that there is a legimate role the government can play in fighting poverty. They believe this can be achieved through the creation of social safety nets such as wealth redistribution. Examples include welfare, in terms of direct payments to the needy, as well as social security and workers compensation.

Markets and communist states

In the 1980s, most of the planned economies in the world attempted to transform themselves into market economies, for various reasons and with varying degrees of success. In the Soviet Union, this process was known as perestroika while in China the creation of a "socialist market economy" was one element of Chinese economic reform.

Contrary to communist theory proposed by Marx and Engles and later adapted by Lenin, Stalin, Mao the People's Republic of China; the largest country whose ruling party refers to itself as communist, runs Special Economic Zones dedicated to capitalist enterprise, free from central government control. After opening up trade to the world under Deng Xiaoping, the People's Republic of China runs some of the most economically free regions in the world, including Hong Kong, which is regarded by the Hoover Institute and the Wall Street Journal as the world's freest economy .

These Special Economic Zones have few restrictions upon businesses, industries, imports and exports, including the elimination of duties, and a free price system. Since the opening of the Free Trade Zones China has maintained a growth rate of over 8%, and originally saw growth rates around 12%. These Special Economic Zones are different than the State Capitalism, as practiced in the Soviet Union, because the SEZs allow for capitalists to build and expand their industries and private property, free from the control of the central government. SEZ's operate under market economy rather than the state capitalist top down command economy approach.

According to China.org "After opening Shenzhen and other three coastal cities in South China as special economic regions and then dozens of economic and technological development zones in the 1980s, the country introduced free trade zones in the early 1990s in 15 coast cities, including Shanghai, Guangzhou, Shenzhen and Tianjin."

In addition, China has recently declared private property to be a right and as also allowed the opening of foreign capitalist enterprises such as Wal-Mart to operate shopping centers in the Special Economic Zones.

Several other countries ruled by Communist Parties, such as Vietnam, have also made pro-market reforms in the last few decades.

Criticism of market economy