The Paradox of Free Markets

No individual has had a greater influence on economic policy than Adam Smith. Smith laid the foundations of classical free market theory and most notably conceptualized the idea that profit maximizing firms interacting with rational consumers in competitive markets lead to prosperous societies. [1] For this reason, Smith is frequently celebrated by free market fundamentalists as a champion of Laissez-faire capitalism.

However, despite what his contemporary followers claim, Smith recognized the limitations of the market and the necessity of government:

“According to the system of natural liberty, the sovereign has only three duties to attend to; three duties of great importance, indeed, but plain and intelligible to common understandings: first, the duty of protecting the society from violence and invasion of other independent societies; secondly, the duty of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public works and certain public institutions which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expense to any individual or small number of individuals, though it may frequently do much more than repay it to a great society.”- Adam Smith IV.9.51

Smith believed that it was essential for government to provide certain goods like infrastructure, banking and education because they provided the foundation in which markets could flourish. Nevertheless, Smith recognized the danger of government when their authority was used only to benefit a small number of individuals. Indeed, Smith warned again and again of the collusive nature of business interests, the formation of cabals or monopolies, and the political power this gives to the richest members of society:

“It is in the age of shepherds, in the second period of society, that the inequality of fortune first begins to take place, and introduces among men a degree of authority and subordination which could not possibly exist before. It thereby introduces some degree of that civil government which is indispensably necessary for its own preservation: and it seems to do this naturally, and even independent of the consideration of that necessity. The consideration of that necessity comes no doubt afterwards to contribute very much to maintain and secure that authority and subordination. The rich, in particular, are necessarily interested to support that order of things which can alone secure them in the possession of their own advantages. Men of inferior wealth combine to defend those of superior wealth in the possession of their property, in order that men of superior wealth may combine to defend them in the possession of theirs. All the inferior shepherds and herdsmen feel that the security of their own herds and flocks depends upon the security of those of the great shepherd or herdsman; that the maintenance of their lesser authority depends upon that of his greater authority, and that upon their subordination to him depends his power of keeping their inferiors in subordination to them. They constitute a sort of little nobility, who feel themselves interested to defend the property and to support the authority of their own little sovereign in order that he may be able to defend their property and to support their authority. Civil government, so far as it is instituted for the security of property, is in reality instituted for the defense of the rich against the poor, or of those who have some property against those who have none at all.”Adam Smith V.1.55

What Smith is describing here is the foundation of corporatism. Simply put, corporatism is the control of the state by the richest interest groups. In practice, corporations will lobby the government for things like subsidies and profit reducing regulations. Free market fundamentalists will often call this level of conspiracy “crony capitalism.” They argue that by simply reducing government size that the “free market” will naturally resolve this issue. This, however, is a misguided fantasy with no factual basis in history.

Before we go any further we must identify what a “free market” actually is, or at the very least, try to understand what it implies. Let’s look at some modern dictionary definitions:

“An economic market or system in which prices are based on competition among private businesses and not controlled by a government.” – Merriam Webster

“Business governed by the laws of supply and demand, not restrained by government interference, regulation or subsidy.” – Investor Words

“An economic system in which prices and wages are determined by unrestricted competition between businesses, without government regulation or fear of monopolies.” Dictionary.com

Today, the term “free market” is often defined as a market without government regulation. Implicit in this definition is that buyers and sellers would have “prices based on competition”, markets would follow the “laws of supply and demand”, and economic activity would be “unrestricted.” Immediately we can see contradictions in this concept.

The following excerpt from Understanding Capitalism demonstrates this quite concisely:

“Without government interference there is nothing to prevent interference, restriction, and subsidy by the mafia, an activity for which we have real world examples. Without government interference there is nothing to prevent the erection of barriers to free transaction, used either to extract rents, to marginalize competition, or to punish groups of people based on any number of criteria such as race, religion, gender, etc. Furthermore, there are any number of ways in which non-governmental entities can implement rules and regulations which distort the laws of supply and demand, a classic example being the National Football League’s imposition of salary caps and profit sharing across organizations.” R.G. Price, Understanding Capitalism

So here we have a paradox. Without the government imposing rules on the market, there is nothing to stop the “free market” from restricting itself from the next powerful authority. There are countless examples of the “free market” distorting itself. To name a few:

Coca Cola paying retailers to eliminate competition

Ticketmaster obtaining exclusive contracts with venues

F.W. Woolworth discriminating against black customers

Japanese citizens erecting barriers to trade and charging tolls for the transport of goods

In each of these cases we see private actors take action to subvert the “laws of supply and demand,” distort “prices based on competition” or prevent people from transacting freely in an “unrestricted” market without any coercion from government forces. Indeed, it was the implementation of government regulation that ultimately led to a freer market in these cases.

To conclude, Smiths analysis of free markets provides a solid foundation for creating a prosperous society. However, free markets ≠ no government regulation. A freed market must have limited, but smart regulations towards the highest concentrations of capital. It must also account for externalities. And ideally, the freed market would be one that redistributes its capital to all its citizens, but I’ll save those thoughts for another time.

Redefining the Political Spectrum

I recently came across a fascinating eBook, Understanding the Political Spectrum by R.G. Price. The 92 page book gives insight on what the political terms Left and Right actually mean and how they’ve changed throughout history. It seems as though everyone has their own interpretation of these terms, but are vastly confused what is truly meant by them.

Like many people I’ve long struggled on how to identify myself politically. On any given issue I could give you a straight answer, but I never seemed to fit a predefined ideology. Why should my view on global warming have any relevance on what I think about gun control?

Price explains that one of the major problems in American politics today is the widespread misconception of what the political spectrum actually looks like. He acknowledges that both the Political Compass and Nolan Chart are useful tools to solve this issue, but argues that they are both incomplete. Particularly their use of “authoritarian” and “libertarian” paints a picture that can easily be shown to be contradictory.

Price paints a different picture of the political landscape with his Rational Spectrum:

rational-spectrum

There are a few things on The Rational Spectrum that may raise a few eyebrows. First is the use of Social Right and Social Left for the vertical axis.  Price explains that both the Social Right and the Social Left don’t oppose each other on any given issue, but rather that they are both opposing Liberalism (The inner circle on the spectrum). In America today, liberalism may be more often thought of as “libertarian-ism.”

Liberalism in its classical sense, to put it simply, is anti regulations and anti authoritarianism. Therefore it is always the opposing force when discussing any social issues and economic issues for both the Left and Right. First, let’s look at some examples of specific social issues to give this point more clarity:

Social Right

Anti Gay Marriage vs Liberalism (freedom to marry regardless of sex)

Anti Marijuana Legalization vs Liberalism (freedom to use marijuana)

Anti Abortion vs Liberalism (freedom to terminate a pregnancy)

Social Left

Affirmative Action vs Liberalism (freedom to hire)

Gun Control vs Liberalism (freedom to buy, own and use guns)

Global Warming Regulations vs Liberalism (freedom to pollute)

Price goes onto explain that the Social Right and Social Left may even agree on some issues, but for drastically different reasons. One example he gives is the issue of pornography. The Far Right is against pornography because they believe its immoral- often times for religious reasons. The Far Left on the other hand is against pornography because it represents the objectification of women. For Liberalism, however, pornography is perfectly acceptable because it’s just another form of human expression. Every social issue is a fight for regulation.

rational-spectrum2

Now let’s look at the horizontal axis. Perhaps less surprisingly, this deals with economics and is what is traditionally meant by the terms “Left” and “Right.” However, Price makes a unique distinction in that Laissez-faire Capitalism is a centrist idea rather than a far right one which many other political spectrum’s claim. Price argues that the far right is actually Corporatism which wants regulations to reduce competition and create Oligopolies. The far left or Socialism in contrast, wants regulations on businesses so that their benefits are shared across society.

Similarly, the moderate left advocates for Social Democracy while the moderate right advocates for corporatistic capitalism. Social democracy is a mixed economy where capitalism is retained, but social welfare provisions are in place to make capitalist’s activity tolerable to society at large. I encourage you to read this article to better differentiate this and socialism. Likewise, corporatistic capitalism is in favor of corporate power, but to a lesser extent then the far right.

rational-spectrum-3

I highly encourage everyone to read Price’s work. His clarity will help shine a light on the disarray that is the American political spectrum. Cheers!