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The three myths about free markets

A trader works ahead of the closing bell on the floor of the New York Stock Exchange (Getty Images)

A trader works ahead of the closing bell on the floor of the New York Stock Exchange (Getty Images)

June 25, 2019   6 mins

Freely trading markets are the greatest tool of economic development, social advancement, and wealth creation ever known.

They helped to lift almost a billion people out of extreme poverty between 1990 and 2010. And they drove the so-called ‘Great Enrichment’ – the period since the late 18th century in which real per capita income has risen by 3,000%.

In general, then, open markets are a boon. And the modern rhetoric of ‘free markets’ has had huge value: in the fight against communism in the 1970s and 1980s, in highlighting the dangers of modern socialism in states such as Venezuela, and in making the case for the modern international trading order.

But like all rhetoric, free market rhetoric is better used for put-downs than for policy. It often misses the complexities of modern tech-enabled markets, and underplays the role of the state in creating and sustaining markets. Moreover, it smuggles in a host of mistaken assumptions and ideas, with potentially dire longer-term consequences. Markets are not merely mathematical constructs; they have social and cultural functions as well as economic ones. And they are all different – some very different indeed, from others.

In my recent book on Adam Smith, and in a new essay in Britain beyond Brexit by the 2020 Conservatives, I address these issues directly. What matters is not the rhetoric of free markets, but what that rhetoric often, paradoxically, impedes: the reality of effective competition. More effective competition requires better ways to think about markets, and new means to tackle the lurking monopolies of the tech giants.

It also means we need to bust the myths.

Myth 1: the truth is that in the modern world there are very few, if any, entirely free markets – markets that do not rely on any external rules or regulations at all. Even the most devout free-market theorists recognise that property rights need to be clear, public and enforceable, and that generally means law, police, courts and other institutions of the state. Some will actively argue for patent, copyright and other laws protecting intellectual property, but these are themselves significant infringements on market freedoms.

This catalogue merely scratches the surface. In fact, there are many things that generally cannot be legally bought and sold at all: people, body parts, hard drugs, votes, court decisions, public qualifications, the outcome of sporting contests. Then there are items that in many countries can only be sold under licence: guns, alcohol, and many medicines.

There are regulations on who is allowed to work: on child labour, on immigration, on the professions and the qualifications needed to enter them. There are regulations on organisational form: companies, associations, partnerships, mutuals, cooperatives, employee-owned firms, charities. There are entry requirements for some industries, such as tests on ownership, capital and track record in banking.

And then there are rules on product safety, on weights and measures and on conditions of trade, such as the right to a refund. The global foreign exchange markets are often thought of as the nearest thing to a perfectly free market. It is true that they are astonishingly large and astonishingly liquid. The Bank for International Settlements estimated, for example, that trading averaged $5.1 trillion a day in April 2016. Yet they are also very closely bound by rules and regulations.

Myth 2 concerns how markets function. Markets are far from identical to each other, and do not all operate to a single equilibrating mechanism. Markets for food products are very different from asset markets; financial markets differ radically from labour markets; markets in primary goods are different from secondary or resale markets in those goods.

To take a few examples: in product markets, buyers know fairly precisely what they are getting in advance. This is not the case in labour markets, despite the best efforts of recruitment consultants. In financial markets, the edge for participants generally lies not in serving some need in the real economy, but in knowing what their competitors are doing and second-guessing them.

The British housing market has evolved into a form of proxy savings vehicle in which price inflation, far from being despised, is actively welcomed by owners keen to see their properties increase in value. The owners’ reliance on mortgage finance makes them preternaturally sensitive to interest-rate changes, conditioning both domestic politics and central bank monetary policy. The German housing market, by contrast, is dominated by rental and leasehold properties, reducing both political tolerance of and economic exposure to house price inflation.

Myth 3 is about culture. Markets shape our lives, our homes, our possessions – even the music we listen to. And yet, they do much more that this. They shape our expectations of others, our manners and our capacity to trust, and those things in turn shape them.

Markets are not merely antiseptic objects of expert study, or neutral tools of public policy. The people who trade in them are not economic automata operating purely in accordance with financial incentives. On the contrary, markets are subject to ‘animal spirits’. These are the human passions of confidence or pessimism in the face of the unknown, as well as the human instinct to be moved by stories and narratives, and to react to unfairness or corruption.

In sum, markets constitute a created, constructed order. Of course, foolish government interventions can undermine or even destroy markets. But far from being intrinsically opposed, states and markets rely on and benefit from each other. Indeed, they rely on each other more and more today, as competition increases pressure on public resources, private property rights become more contested, and globalisation drives the need for enforceable international standards.

The old bromide that “the private sector makes the money and the public sector spends it” misses a deeper and more interesting truth: that both require each other to function effectively. To take a recent example: the Space Industry Act 2018 sets out law to enable a person or company to put a private satellite in space from a UK launch site, and to cap their liability. The result is expected to be a new era of British space entrepreneurship — all made possible by an Act of Parliament.

What does this mean? As an ideology, neoliberalism is dead. Meanwhile, the debate we as a society need to have – the debate about what markets are and should be for, about the limitations of the idea of ‘market failure’ and the role of the state – has been left by the wayside.

Modern technology has brought with it rapidly increasing complexity in markets, as choices proliferate for consumers. Public attention has rightly focused so far on the use of intra-company transfer pricing and other devices to reduce tax payments to a minimum, and on escalating concerns about privacy and the manipulation of public opinion. But we also need to think again about competition policy.

Companies such as Google, Apple and Facebook enjoy gigantic and increasing asymmetries of power and information versus the individual consumer. These asymmetries allow them the scope to exploit their consumers, both in specific segments, in groups, or individually in ways that run counter to established norms of fair dealing and justice.

These businesses are modern titans which bestride their markets as completely as did the old oil and railway trusts. They are hard for government or regulators to scrutinise, because they are closed systems. But at the same time their status as networks means the normal armoury of regulatory tools against market monopoly or oligopoly is far less effective.

In due course, the world will need to have a deep debate about the astonishing power, and the astonishing absence of accountability, of the technology platforms. But in the meantime, we can look at competition policy. More transparency and disclosure are a prerequisite in this regard, yet markets all being different from one another, different levers will be needed to achieve it.

The Standard Oil Company was broken up after 1911 under the Sherman Act into a host of smaller (but still enormous) oil and gas companies, including what would become Exxon, Chevron, Conoco, Mobil, Amoco and Sohio (the latter two later bought by BP).

Few if any people seriously believe that Google could be effectively broken up into different regional or business units, or that to do so would generate economic value. But that approach might work better for Amazon, with a split between its marketplace and product provider functions, and national or regional services working from a common back office but competing against each other in the marketplace.

As for Google and Facebook, we can lift an idea developed by the father of economics and social psychology, Adam Smith. Human shoppers can be supported by new algorithmic consumers – that is, by pieces of software able to compare and contrast different offers in the digital marketplace and make choices on the human’s behalf.

Imagine trying to choose the best home insurance in such a world, instead of poring for hours over dozens of sites and hundreds of products, or using potentially costly price-comparison sites. You could have your personal online assistant do it for you, in its own time and using networked computational power.

Over time, such online assistants are likely to become commonplace; still more so if data comes to be seen as a public good created by individuals, rather than simply accumulated by companies. These digital agents could, in principle, make automatic purchases subject to individual guidelines, negotiate transactions, and even build coalitions with other digital consumers automatically in order to get keener prices or elicit new products.

There is no reason why an array of new businesses should not emerge to enable this levelling of the playing field to take place. They will require coordinated regulatory intervention, but there is no reason to think that any of this is technically, economically or politically impossible.

These ideas come from recognising the limitations of free-market rhetoric, grasping the possibilities offered by a really deep understanding of markets, and pushing hard for more, and more effective, competition. They can potentially set the new trading and trust-busting standards of the digital future.

Jesse Norman is a British Conservative party politician and has served as Paymaster General and Financial Secretary to the Treasury since 2019. His latest book, Adam Smith: What He Thought, and Why it Matters, is published by Penguin


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