Market economy

The market economy is understood as the organization, allocation of production and consumption of goods and services that arises from the interplay between supply and demand. The characteristic that defines the importance of the market economy is that decisions about investment and the allocation of production goods are made through the individuals who operate in the markets.

The term is equivalent to free market. It is necessary to note, however, that there is no term, especially at a theoretical or general level, about what would be the balance of permissible state intervention without a market economy transforming in command economy: «But there are certain aspects related to the market economy that remain controversial. In the first place, there is some controversy regarding which activities should be left in the hands of the State and which can be awarded to the private initiative.”

There is a very clear difference here, posed by Wilhelm Röpke when classifying State interventions into «compliant» and «non-compliant». The first are those that tend to ensure the operation of market laws. As an example, we can cite antitrust legislation. The second are those that interfere or block that operation. Price and wage controls are among the most common of such interferences. The market economy, as conceived within modern liberalism (see "social market economy"), accepts "conforming interventions" and, furthermore, considers them necessary; but rejects "non-conforming interventions".

Consequently, the market economy is generally understood as the version of the mixed economy, closest to the economic model of the “free market” economy, which has led some to speak of the mixed market economy. However, the "mixed economy" should not be confused with the "Social Market Economy". In the first, certain "non-conforming interventions" that partially block the functioning of the market; while in the second such interventions are rejected, accepting only the so-called "conforming interventions".

The most successful example of the market economy is generally considered to be found in the US in the period from the end of World War II to at least the end of the century XX. In the early part of that period the economic policies (see Political Economy ) of that country were strongly influenced by the so-called classical-Keynesian synthesis or neoclassical synthesis and, later, by the approaches of monetarism and the so-called Chicago School of Economics. Also other successful examples of market economy are the Nordic countries, New Zealand, Germany, Ireland, Hong Kong, Singapore, United Kingdom, Switzerland, the Baltic States, Canada and Australia.

The list of economic freedom reflects that the countries with a market economy are more developed or have a great growth of their economy, as is the case of the Baltic countries, which have increased their GDP three times in only seventeen years.

Origin and general meaning of the term

The term became popular in the US in the context of the Cold War, being used, imprecisely, to designate the economic systems of those countries that, at least theoretically, assign an important role to private property and the free market, but that do not necessarily have a democratic political system or are a rule of law. This allows countries as diverse as those of the Persian Gulf and the Nordic countries to be classified as having "market economies", while at the same time allowing it to be suggested, at times, that a market economy is the same as a market economy. free market and, sometimes, not.

So, and given that there is both some confusion and a tendency to identify the terms market economy, free market and capitalism, It is convenient to make some points.

A market economy is not necessarily equivalent to a free market, since in a market economy the State can intervene not only to guarantee the rights of economic agents, but also to guarantee access to certain goods and services — generally considered to be of absolute necessity for human dignity— as well as to regulate basic prices and to guide production and, therefore, consumption, and more generally, to maintain the stability of economic processes.

The free market supposes the absolute freedom of supply and demand, tolerating state intervention only to guarantee freedom of competition.

That previous point is central to the conception of what a free market really is. Both Friedrich von Hayek and Milton Friedman have declared that Economic Freedom is the sine qua non condition of both a free market and political freedom in general (see Catalaxia).

The above has led to arguments along the lines of: "But the image many people have of the "market economy" is surely already that of a mixed economy, as suggested by the fact that even larger majorities support strong state regulations. That, and substantial minorities strongly against the market, explains why we live in a mixed economy and not in a free economy" based on that general perception that countries that restrict market freedom restrict political and social freedoms.

The relationship with capitalism depends on what is understood by this term. If by this is meant everything that is not communist or that practices “true socialism” —the way it was used during the Cold War and with some bases in usage going back to Marx — the equivalence is correct. However, not everyone understands capitalism that way (see State Capitalism; Libertarian Capitalism; Democratic Capitalism); in which cases, and depending on the criteria, some capitalist countries would not have a market economy —as understood here— or at least some of the countries that show a market economy would not really be capitalist. (see Market Socialism).

Equally, despite the fact that in the popular imagination —especially from a Western perspective— the creation of market economies in the world has only been associated with capitalism since the second half of the century XIX in Europe and more specifically in Great Britain and the United States, that is not the case. For example, in the 18th century, the largest non-capitalist market economy was in China.

The foremost theorist of the market economy model, as implemented in the United States, is generally considered to be Paul Samuelson. Samuelson referred to that system as the “mixed economy”.

Market and intervention

As has been suggested, one of the most important central problems of the market economy is finding the optimal level of state intervention or regulation while maintaining the freedom of economic actors in order to achieve maximum economic efficiency. In the words of Joseph E. Stiglitz:

The real debate today revolves around finding the right balance between the market and the government. Both are necessary. Each can complement the other. This balance will be different depending on the time and place.

In relation to the above, several elements are generally considered.

The acceptance that perfect competition generally does not exist in reality, which implies the validity of the Second Best Theory, that is, that economic efficiency does not necessarily preclude state intervention as the free market proposal assumes.

Furthermore, Greenwald and Stiglitz proved (in the so-called Information Asymmetry Theorem) that in the presence of either imperfect information or non-perfectly competitive markets, the market outcome is not efficient in Pareto terms. It follows that in most real-world economic situations, the effects of such deviations from ideal conditions must be taken into account.

Given the above, Samuelson's condition is relevant; that is, state intervention in the provision of goods and services is justified to the extent that such intervention is more efficient. On the other hand, private production is justified to the extent that it is more efficient than communal or state production. These relationships will change in different places and times. Additionally, these are not matters of theoretical discussion but of practical and technical determination.

However, there are theses that have managed to forcefully question these approaches that, in the opinion of some theorists such as those of the Austrian School, are excessively mathematical or that do not stop hovering around mathematics as a theoretical root, which is why they usually fall into consequences theoretical non-practical and divergent with the nature of human behavior.

As previously stated, perfect competition does not exist and individuals do not know omnisciently the subjective assessments of all other individuals (uncertainty), from this derives the impossibility of economic calculation as detailed by Ludwig Von Mises in his book. Within this theoretical framework developed by the Austrian school of economics, various topics arise that contradict the economic trends of schools, such as the monetarist and neo-Keynesian schools. The main criticisms of the Austrian school about the implications of state intervention begin from the hand of Mises, Von Hayek and Murray Rothbard. The main breaking point with monetarism and Keynesianism is the role of the central bank, the effects of its intervention and monopoly. Which are explained in the theory of the business cycle.

Market process

In a market economy, producers and consumers can interact in the market. It is assumed that both types of economic agents assume the price of the goods as a given (that is, they are “price takers” —“preneurs de prix” in French; “price takers” in English— See Origin and assumptions in "Walras Law".) and, from there, they make their production and consumption decisions, seeking to maximize profit in the case of suppliers and the utility function (satisfaction) in the case of suppliers. consumers. The participation of these actors, offering and demanding quantities of goods and services, in turn alters market conditions, affecting the evolution of prices.

However, in a situation of imperfect competition, either a single agent or a small group of agents can manipulate the condition of the product and can directly affect price formation. Since we live in an age of increasing commerce dominated by international companies and what in the United States are called "corporations" (group of companies in Spanish) it is unrealistic to maintain the claim that market prices are being determined according to the conditions of perfect competition (see, for example: Lerner Index). And trying to return to that perfect competition is not only an "exercise in futility" it would not produce "an economy of great stability, growth and efficiency."

Keep in mind that it is not necessarily the case that imperfect competition has negative effects for the consumer. It is possible that under certain circumstances, the fact that companies compete in these types of "imperfect" (see oligopoly; monopoly; oligopsony and monopsony) can lead to the same prices as perfect competition (see Bertrand competence). This again emphasizes that these are not matters of principle, but practical.

From all of the above it follows that, since perfect competition is not found in reality, state intervention can produce economic results that are superior to those achieved without such intervention.

Even so, there are theories that manage to explain that human beings act individually according to subjective conceptions of value, a theory mainly founded by the Austrian economist Carl Menger and later developed in depth thanks to Ludwig Von Mises. The latter defended that the prices of the goods are the direct expression of the valuations that each individual gives each good in aggregate terms, for which the price is determined by this and even the costs are determined by the prices since they are the consequence directly from the subjective valuations of the group of individuals in a market or economy. Therefore, given that goods are scarce when there is an increase in demand for good 1, prices tend to increase, which act as a signal for the market. This system of signals (prices) works as a mechanism for assigning resources in the economy, so those producers who have the productive capacity to produce good 1 but are producing good 2, will stop producing good 2 (if the opportunity cost is lower) since the prices of good 1 will incentivize its production, consequently the supply of good 1 will increase and the price will tend to stabilize downwards. In a case like this, an intervention in price control would be catastrophic since it would eliminate the incentive to offer, it would produce shortages and black markets with even higher prices.

Laws and interpretations

Classical liberal economic theory, for example with David Ricardo, assumes that, theoretically, in a market economy the rate of interest on capital and corporate profits tend towards zero over time. The third, fifth, or successive units of production cannot yield the same benefits as the first, according to the law of diminishing returns. Similar predictions were made for wages, which must be adjusted to the subsistence minimum, according to the bronze law of wages.

The critique that Marxism makes of classical economics is largely based on the interpretation of these theories, as well as its own formulations, such as the theory of surplus value and alienation; it assumes that the application of a market economy would lead to social polarization between increasingly poorer proletarians and increasingly wealthy capitalists. The fact that both predictions (classical liberal and Marxist) have not been fulfilled (at least not yet) in the historical evolution of the real economy has led to different reinterpretations by the different schools of economic thought that followed: neoclassical economics, marginalism, the monetarism, Keynesianism, economic neoliberalism, the Chicago school, etc.