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Love and the Free Market

Unfortunately we live in a world where some of the necessities of life are disparaged and sometimes even criminalised. Carbon is perhaps the life-giving "villain" highest in the public eye right now, but the free market, without which most of us would be living in squalor and misery, or even be dead, cannot be far behind.

In a nutshell, the free market is one of the necessities for wealth and happiness, but in the popular perception two things go very badly wrong:

  1. The free market is confused with laissez-faire economics, deregulation, untrammelled capitalism, and so on;
  2. Admirable ideas about equality, cooperation, friendship, generosity, concern for the weak and powerless, and so on, make the idea of trading—buying and selling, spending one's time making sordid money instead of selflessly giving—seem incompatible with 'being a nice person'.

The former problem means that free markets can be, and perhaps always have been, implemented badly so that a range of corruptions can be indulged in, often perfectly legally but without a shred of morals. The latter problem means that many or most who concern themselves with these issues, and who have the best and finest intentions, turn against the free market and trading in their entirety, and therefore never take part in any discussion to fix the problems with how free markets are actually implemented.

Hayek was one of the key advocates for free markets. His central explanation of why they work is this: for an entire complex society to take, on the whole, the best and most profitable actions (such as to use less resources, create better products, transport goods most efficiently, and so on), the knowledge of millions of individuals is needed. For example, I might know the cheapest way to move things from X to Y; you might know how to make something cheaply at X. Our knowledge combined might make a better product available to a purchaser at Y. So should someone at Y hire me to do shipment, you to make the product, and so on? Maybe other people have a way to make the product at Z and ship it to Y. Which plan optimises the Earth's resources? The answer is that in a free market, prices tell the buyer at Y whose product to buy. If one or the other group of suppliers cannot match the best price, they will get no buyers. If the prices reflect true costs, and if all inputs (including damage to the environment) are costed, then a free market results in the least damaging and most efficient way to obtain the product.

I recall stories on television around the time of the Soviet breakup showing horrifying environmental damage throughout the former Soviet Union, due to badly planned industrial activities in the era of central planning. Hayek's point is that central planners, no matter how clever, how well supplied with supercomputers or you-name-it, cannot compete in making decisions with millions of decision makers informed by prices set in a free market. The point is that prices convey to us information in a distilled form that came from the knowledge of hundreds or thousands (or millions) of other people. Choosing the best price automatically chooses the best set of actions by all those people whose individual knowledge we could never hope to digest and make sense of. Central planners will always fail in comparison to a free market.

So what goes wrong? Why are so many people opposed to free market economies? Are they simply stupid?

I do not believe so. Things definitely can and do go wrong in free markets, things Hayek doesn't account for, and in some cases these things are nearly always allowed to go wrong; so it is an understandable error to blame the basic concept of the free market, rather than the distortions that are in practice almost universal.

Those who are familiar with any system that organises itself according to basic mathematical principles (which is most of them) will know that typically, systems have what might be termed a 'relaxation time'. If you disturb a system, it takes a while to settle down to a new equilibrium point. Alternatively, it might not settle; perhaps it orbits an 'attractor'. An example of this is national economies. The boom and bust cycle of normal economic activity can be shown to cycle around a relatively stable point. When governments intervene to 'stimulate the economy' or 'reign in inflation', all they are really doing is speeding up or slowing down the natural cycle. A good explanation of this is found in Ormerod's book, The Death of Economics. I'll explain this in more detail another time.

Bearing this in mind, one problem with free markets that Hayek misses (or, at least, I cannot find properly discussed in the maybe half dozen of his book I have read) is that prices themselves do not respond instantaneously to the costs that drive them.

For example, say we are making widgets out of zoopers imported from Wijistan. Maybe a hurricane puts the zooper production line in Wijistan out of action for a while, or maybe shipping charges increase. It will take time for these costs to flow through to our production line. Sure, we will try to anticipate problems (and some people are better at this than others) but nevertheless our pricing on widgets will trail by some time the cost changes for zoopers and shipping.

The effect of this is to open a 'market' for forecasters (or guessers) who will try to anticipate our troubles and buy or sell shares, or maybe short sell or something even more complicated, and 'make a killing'. But what are they really doing? They are trying, in a complex way, to trick someone else into selling them something, or buying something from them, at a price at which they would not buy or sell if they knew all the information the forecasters know. Is this a disguised form of fraud? We can argue about that, but for sure this is the kind of thing that is considered mean and nasty, and gives markets a bad name. After all, do nice people really try to trick others into handing over their money?

So here's the problem: the free market tracks costs and informs us of them by way of prices, but the process has an inherent delay. Due to this delay and other problems, a huge market has arisen whose main activity is trying to take advantage of others' relative lack of knowledge; this activity sometimes swamps the activity of investing in enterprises for their productive earning capacity. This is one reason why, rightly so, many consider stock markets and so on to be 'nasty'. It is also one reason why 'economic rationalism' isn't rational.

So where is this taking us? I believe we need, as a society, to take a good hard look at the free market, and introduce rules whose purpose is to make it work properly to reflect costs in the resulting prices, and to discourage all forms of speculation except that about future productivity (that is, investing because of long-term profitability rather than short-term fluctuations).

Here is one idea, which may have many flaws and need big reworking, but which illustrates the kind of thing we need to think about. How about the income tax on stock trade profits depending on the time a stock has been held? If I sell more than a year, say, after I buy, I pay the normal tax rate, but if I sell within a day of buying, I pay 100% tax (making the trade pointless), and so on proportionally for times in between a day and a year. That means that, to get the best return on a profitable trade, I need to predict that a company will do a profitable job a year ahead. That should be far enough out to cover the typical relaxation time for changes in market conditions, and thus minimise the benefit of smart forecasting and maximise benefit from a proper understanding of a business and its potential for producing wealth.

Hayek's insight was the inevitable inefficiencies of any kind of command economy - which everything except a free market ultimately boils down to. Loss of control of the individual's own resources in favour of central planning, however high-minded in intention, however altruistic in conception, ultimately propels the worst of people into the positions of control. How many times must we see the people being expected to 'give up selfishness' and cede their powers to the 'Great Leader' who will never use that power as well as the average of all the many ordinary folk going about leading normal, decent lives?

Hayek's oversight was thinking that the market can run according to perfect rational theory. Give the avaricious half a chance and they will use any system to syphon away the wealth of those who think in terms of making wealth by production rather than manipulation - and yet production (including non-tangible production such as teaching, research, services, etc.) is ultimately where all wealth comes from! Those who typically oppose free markets usually understand this. The way forward must be something that brings these seemingly contrary insights into harmony.

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Re: Love and the Free Market

Today most of the modern developed economies are built on the free market principles.

Re: Love and the Free Market

"His central explanation of why they work is this: for an entire complex society to take, on the whole, the best and most profitable actions (such as to use less resources, create better products, transport goods most efficiently, and so on), the knowledge of millions of individuals is needed."

This is why the US Government is, in my opinion, about to make a colossal mistake in trying to control health care costs by centralizing its administration. I have always advocated tax incentives for creating individual tax-sheltered accounts from which only health care expenses can be made, including catastrophic type insurance policy premiums. Make good preventive health care lifestyle choices, the "profits" of letting your personal medical slush fund grow untaxed year by year. Then, hundreds of millions of cost auditors will rain down onto the medical profession and providers uttering the long unheard phrase: "How much is this going to cost me?"

Costs for anything skyrocket when paid for with other people's money. Costs for everything are brought into line when paid for with our own money. Simple as that.

The aberration and scurrilous (but technically legal) practices carried out within the free market system are often begun by a minority of market predators. Humankind has such characters as part of our spectrum of membership. The problem is, as time goes on, otherwise nice and "moral" participants, must make a hard choice between adopting the same practices or losing to their scurrilous competitors. Survival wins that debate, to no one's surprise. That's why lawmakers must be vigilant in making the rules fair and just, but getting out of the way if played fairly and not allow themselves a stake in who wins or loses. Loss, if done correctly, is a valuable adaptive tool that must not be denied us by well-intentioned legislators.

As a soccer referee, I abhor the occasional "slaughter rule" imposed by some leagues, wherein any team who outscores the other by a given margin will be penalized by the league or otherwise sanctioned. If played fairly by both teams, such games between unequally matched teams and their lopsided scores are the purest lessons in character (for BOTH teams) available to our youth (and adults). Well meaning but fuzzy headed bans on them are sadly short sighted.

Re: Love and the Free Market

Hi Patrick,

I agree. I wasn't aware of that "slaughter rule" rule. What's the idea, some sort of "don't hurt people's self esteem stuff? - that you shouldn't really win, just barely win? You're dead right. I recall reading an investigation of self esteem. The conclusion was that people with very high self esteem end up just as dysfunctional as those with low. The 'right' amount for max. happiness coincides with an accurate appraisal of one's self. But to people with their heads screwed on right, that is scarcely surprising!

I like your ideas about health care. The problem isn't having a god heart, it is wanting to use one's good heart to take control away from others and exercise it one's self - the bureaucratic mindset. Making people pay a certain amount themselves but putting a safety net under their total costs would be much better than the English system. Let people get whatever health care they want - but they should spend their own funds first to prove their bona fides.

Re: Love and the Free Market

Exactly. Otherwise the health care system is like my maternal grandparents' Italian family style dinners. He who eats the fastest and grabs the most is the winner. A big pile in the middle of the table for the taking. If you don't utilize, you are a loser and a chump. The free market in health care would give medical practitioners access to direct pay consumers, and begin an actual provider-customer relationship with the spenders of their own money. The bureaucratic middle-man is eliminated! Cost contained.

The slaughter rules are born of empathy, but result in oppressive social engineering on a community scale. The dominant team is denied the opportunity to discover within themselves magnanimity. The weaker team is denied the opportunity to discover within themselves humility and defiance in the face of overwhelming odds. The parents, coaches and league officials reveal the condescension in their souls. Distasteful, all of it, I say!

Governments and their apparatchiks can be forgiven, I suppose, for their urge to "do something" or "take control" in the face of uncomfortable cycles of the economy. It takes a brave and wise bureaucrat to do nothing when doing nothing is called for.