Home > Anarchism and Voluntaryism, Democracy, Law, Markets, Taxation > Don’t fear the free market, part 1: What it is and what it isn’t

Don’t fear the free market, part 1: What it is and what it isn’t

Many people are certain of what crashed the economy in 2008. They call this culprit “the free market”. But what do they think the free market is? How do they think it made the economy collapse? Well, these people will tell you, it’s deregulation. If they say that, ask them to point to specific instances of deregulation of the financial sector. In fact, the banking sector was and is highly regulated. They may not be very good regulations, and of course big banks are largely to blame for the meltdown, but there was no free market. Given actions like the pressure from the 1990s from the federal government to expand mortgage loans to people of lower income, which contributed to the crash and the massive US household debt, what do they think the government should do? Did these same anti-free market people applaud the trillion-dollar bailouts and stimulus packages because they though the government would rescue them and make everything better? Do they think the government will ever rescue them and make everything better? These are people who need to learn what the free market is.

The free market is when there is no force in the economy. Laws and taxes are force: things you must do if you want to avoid violence. A free market might be likened to a bazaar: people trading for what they want however they decide, going by uncomplicated rules that everyone already agrees on.

A truly free market would have no regulations that threaten violence against people who do not comply with rules. It would have no licenses that could be denied without fees or bribes to bureaucrats. It would have no minimum wages that prevent unskilled workers from finding employment. It means no laws protecting corporations, so that business operators could not hide behind legal shields. And it means no backing up of patents or intellectual property by courts. Many statists find the idea of a free market frightening. They see it as a ticket to monopolies, crashes, the concentration of wealth and the spread of poverty. This section explains why the free market works better than government intervention to help the poor and create a more equal society, why it eliminates monopolies and minimises crashes, and why believing a government can fix an economy, or even make a decent pencil, is mistaken.

Walter Block describes the free market as “the concatenation of all voluntary acts in the economy.” In the words of the Centre for a Stateless Society’s David D’Amato, free markets

divide and moderate market power by denying special protection and privilege and opening competition to a wide assortment of both entrants and methods. Only where potential threats to corporate monopolization are precluded by force of law — through, among other impediments, ‘safety’ and ‘consumer protection’ standards — can today’s ‘captains of industry’ ascend to market dominance.

Speaking on high food prices, he continues,

It is too often assumed that the behemoth conglomerates populating the landscape of corporate capitalism wince at regulations supposedly aimed at health and safety. These rules, however, routinely function to outlaw the farm stand down the street, the small, local producer who can’t afford to jump through the arbitrary and unjustified hoops put up by the political class.

Why does it work? Here is Professor Edward Wayne Younkins:

Progress requires the use of information that exists only as widely dispersed knowledge that each person has with respect to his own circumstances, conditions, and preferences. Such tacit, locationally specific knowledge is only useful if people are free to act upon it. A free market permits prices to emerge from the use of people’s localized knowledge. These prices contain more and better information and result in better decisions than what can be achieved under a regime of central planners. Limited government and decentralized markets permit more freedom and foster more prosperity than do state-dominated and centralized bureaucracies.

The free market is superior to central planning regarding the uses of localized information and in combining those uses into an efficient system of production and consumption. Markets spread ideas, encourage the constant search for improvements, and evolve through trial and error, experimentation, and feedback. Markets produce a positive, emergent order.

And why is it better than government intervention? Adam Smith’s invisible hand is about the virtue of human action not to design a better world, not to make the poor better off, not to solve environmental problems, but action that is selfish, but produces outcomes that do build a better world and make the poor better off and solve environmental problems. Harry Browne, former leader of the Libertarian Party of the US, said “the free market will give the best minds in the world an incentive to devise profitable methods (that we can’t even imagine today) by which the free market can perform functions we might think now can be performed only by government. That isn’t a ‘vague anarchism’; it’s a reasonable belief that free human beings are much more creative, productive, and efficient than government.”

Let us take this time to address some of the myths about the free market. Critics say that the free market leads to monopolies. The fact is, however, that a free market abhors monopolies. In 1879, when John D. Rockefeller’s Standard Oil controlled 90% of the US’s refineries (all purchased through more or less ethical means), the remaining oil producers attempted to avoid working with Standard Oil by constructing the first long-distance pipeline. Rockefeller’s dream of controlling oil supplies by controlling the railroads did not work, and gave birth to a useful, monopoly-busting innovation. Admittedly, Standard Oil bought a small stake in the pipeline and continued to control most oil transport in the region. Customers did not complain much, however, as Standard Oil kept prices low and quality high. If it had not, oil would not have been the cheap, alternative fuel of its day that it was. After all, another rule of the free market is that overcharging by any firm gives rise to competitors or substitutes. (Perhaps that is why international competitors soon emerged and began to ship oil more economically to Russian and European markets.) The antitrust suit against Standard Oil was not brought by its customers or a concerned public but by its competitors. (Read more here.) The rhetoric that alleged a criminal conspiracy worked in the end, but the unethical business practices did not take place on the free market but when competitors demanded the state strongarm a successful business.

Competition from other parts of the world (and other parts of the US) arose when oil was discovered outside Pennsylvania. To break Standard Oil’s stranglehold, the new oil men, bankrolled by financiers who knew the venture could be profitable, developed a new, safer type of oil tanker. Because of the risk of spills and explosions, the Suez Canal had been closed to oil tankers. However, with this new innovation, oil could be safely transported around the world, and prices could remain low.

Alternatives to oil exist. We just need more time to understand better how to exploit them. Take the electric car, another great example of a monopoly-breaking innovation that promised to end (well, reduce) dependence on oil, but which was ended by a powerful lobby group and a pliable government. Monopolies are made possible when government steps in to protect business. If business is left to itself, anyone else can and will enter the market. Look at Microsoft. It was charged with attempting to monopolise the software industry. Such charges seem irrelevant (and hilarious) today: no one could monopolise the software industry. (Find more on monoplies here.)

If new entrants can provide something cheaper, or something better, or just something different, the company might get established and might undercut the larger corporations and might thrive in doing so. As far as I know, it has always worked that way in the past when there have been no government-imposed barriers to entry and one firm has tried to monopolise.

Government subsidies are more protection and are unnecessary to those with good business sense. James J. Hill grew up in poverty but used his entrepreneurial skill to make the Great Northern Railroad. In 1893, when the government-subsidized railroads went bankrupt, Hill’s line was able both to cut rates and turn a substantial profit.

After the government of New York had granted Robert Livingston and Robert Fulton a monopoly on steamboat traffic for thirty years in 1798, Cornelius Vanderbilt ran a steamboat between New Jersey and Manhattan in defiance of that monopoly, undercutting the monopolists by charging only one-quarter the fare. After the steamboat monopoly law was overturned, fares dropped across the board. (See here.)

During the early days of capitalism, big business and government were comfortably in bed with one another. Laws favoured privately-owned monopolies. Obviously, this was not a free market. But Marx and others began to complain about what they called a free market anyway. I don’t know why they thought state coercion made markets free, but that was their mistake. Activists began to argue that government should be used to curb the power of corporations. Let’s have more laws, they said, laws that give governments a greater hand in the economy. But the marriage of big business and government did not end. New regulations continued to be written by corporate elites. In 1935, economist and later United States senator Paul Douglas observed, “Public regulation has proved most ineffective. Instead of the regulatory commissions controlling the private utilities, the utilities have largely controlled the regulatory commissions.” (Find references to the large amount of research on the subject here.)

Let us jump forward in time. What are the causes of the more recent crisis? Risk taking? Speculation? Greed? Do these explanations actually explain anything? We can be a bit more specific. The Federal Reserve is hardly ever mentioned as a cause of the crisis. Artificially low interest rates (1%) encouraged artifically high risk taking for certain sectors, including construction and lending to people who could not afford to buy homes. Fed policy increased the supply of money (look out for inflation) with the result that more dollars were created between 2000 and 2007 than had been created in the rest of the history of the United States. House prices rose. Fannie Mae and Freddie Mac, government-backed corporations that would be bailed out if necessary (a formula for moral hazard if ever there was one) also pushed to expand mortgage loans to people with bad credit under Bill Clinton. Democratic congresspeople were reluctant to demand any oversight of Fannie, a campaign contributor.

-They rose the most in California, where various laws made it impossible to develop the land, creating artificial scarcity and driving up home prices. But they rose in other localities too, in most cases because of similar restrictive building laws. 90% of the land in Nevada is owned by the federal government, so instead of a free market, the availability of land for building depends on the government’s approval of each use of it. Less than 10% of the land in the US is actually developed, but under the guise of preserving nature (a handout to environmental protesters), the government protected the land and thus raised the price of it. As a result, many places saw a housing boom artificially brought on by government, whereas other places saw no boom at all. Thomas Sowell explains.

A fundamental misconception of the housing market existed both during the boom and after the bust. That misconception was that the free market failed to produce affordable housing, and that government intervention was therefore necessary in order to enable ordinary people to find a place to live that was within their means. Yet, the hard evidence points in the opposite direction. It has been precisely where there was massive government intervention, in the form of severe building restrictions, that housing prices skyrocketed. Where the market was more or less left alone, places like Houston and Dallas, for example, housing prices took a smaller share of family income than in the past. (Thomas Sowell, The Housing Boom and Bust.)

The booms that did result, however, were, like many local problems, misperceived by an officious federal government as a national problem, requiring national-level intervention.

Here are some more reasons for the recent financial crisis. The Community Reinvestment Act was meant to eliminate racial inequality in availability of credit. If banks did not lend to minorities in high enough numbers to satisfy the authorities, they could be crushed by lawsuits. Lending standards loosened.

Bear Stearns said the mortgages were sound. Government-approved rating agencies, you remember, the ones that said the mortgage-backed securities were great when they were garbage, were protected from competition by government regulations, and they served to reinforce the popular lending-to-everyone policies alive. Tax codes encouraged overinvestment in housing. To blame lack of government oversight for the crash is to get things backwards. The banks did what the government wanted them to do: hand out more and riskier loans.

One study finds that federal outlays for banking regulation—the laws big banks supposedly fear so much—increased from $190m in 1960 to $1.9b in 2000 and $2.3b in 2008. The US has 115 regulatory agencies. Funding to the Securities and Exchange Commission under George W. increased sizeably, with the result that its staff increased by one quarter. The number of rules businesses need to follow rose. There may be an ideal regulatory agency or system, but it has nothing to do with what what the agencies actually do. These ones did what the politicians wanted: encouraged banks to make home loans to people who could not afford them, and solved a problem that did not exist, namely a nationwide lack of affordable housing. The result was disaster. Either government cannot be trusted to oversee corporations because it has been corrupted by them, or else it cannot be trusted because it is so incompetent. Either the fox is guarding the henhouse or the headless rooster is. More regulations are not likely to help the public.

Moreover, it may be a mistake to call the crash a failure of regulation. Again, the corporations did what the government told them to, and people responded to incentives that monetary and lending policies created. Whenever we consider a policy a failure, we need to question whether it is indeed a failure or whether the goals and eventual outcomes went just as planned. After all, the crisis has ended up further enriching the rich, through bailouts and stimulus.

(I am not an economist, but I do suggest the book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas E. Woods. Obviously, one book is not definitive, and all books I have read on this subject make good points. This one simply argues very cogently the government’s role in the debacle was enormous. Either way, it is obvious that “the free market” and lack of regulation did not exist to cause this crisis.)

The securities and investment industry contributed $53m to congressional and presidential campaigns in 2008. (They have not slowed down since then.) Then, they stood back with their hands out and received more than a trillion dollars for their generosity. The bailout bill was defeated at first, and legislators, in their inimitable way, searched for a new way to pass the bill. They got more congresspeople on board by sprinkling horsetraded favours in with the bailout money. Special interests got what they wanted, legislators got what they wanted—win-win!

The argument the government made at the time was that these firms were “too big to fail”. In other words, their failure would mean the collapse of many more firms and the economy itself. But the fate of Lehman Brothers, with more than $600b in assets, is instructive. It seemed too big to fail; yet, when it did fail, its assets that were worth preserving were bought by other firms. Keeping firms on life support discourages investment, encourages wild risk taking and drains money from those firms who are, in fact, productive and allocates it to those who have proven they are not.

Along came an enormous (more than 400-page) bailout bill, that anyone who opposed or even wanted to debate would be labeled as wanting the economy to fail. The government now owned hundreds of billions in bad debt, which means that, instead of letting the companies pay for their own foolish bets, the taxpayers would. Thank you, our wise protectors. The case of the 2008 crisis and the recession that followed has nothing to do with a free market. There was no free market. There was only socialism for the rich. And democrats, who think that they have choices, were presented with two presidential candidates who agreed on the bailout and stimulus bills.

So why would we think the free market brought on all these troubles? How could anyone think we live in a free market? Mainly because everyone says we do. It is the same reason we believe the government represents the collective will of the people: because they say they do.

The free market boogeyman is always blamed for economic ills, when, as Austrian school economists (most of whom predicted the 1929 stock market crash, the bursting of the dotcom bubble and the subprime mortgage meltdown) can tell you, crashes become more likely when government meddling in the economy runs wild. The free market should be given a chance before it can be blamed for anything. When something goes wrong, like a stockmarket crash, the people, who do not understand its causes, make the following equation. Something happened. Something must be done. The government understands what happened. The government will do what needs to be done. After all, they work for us. This thinking is obviously riddled with logical fallacies. Take the Sarbanes-Oxley Act, passed in the wake of the Enron accounting scandal and failure. The Act made accounting more complicated. Implementing it costs a firm millions of dollars. Millions of dollars is pocket change for a big corporation, but prohibitively expensive for new and small businesses that could otherwise rival them. As a result, fewer businesses are created, and wealth and power are concentrated in the larger firms. Government regulation almost always favours the big players because the big players have the government in their back pocket. Like voters, small businesses have no leverage over governments.

(Find more myths about the free market crushed here, here and here.)

There are also many myths around deregulation. When libertarians talk about deregulation, they do not mean what I have heard the Skeptical Libertarian call “the Republican method of rearranging the chairs on the Titanic.” Deregulation should mean ending government monopolies, including on the making and enforcement of rules, because it tends to concentrate wealth rather than redistribute it, which in turn creates elites that can control the government. It is sad that so many people view regulations as largely good when they usually prevent healthy competition, block people’s freedom to trade with each other and raise prices. The airlines are but one example. Until 1978, the Civil Aeronautics Board controlled entry, exit and prices in the airline industry. Prices were high, and flights were less efficient in the sense that fewer seats were being filled. Now that airlines can compete on price, and new airlines can enter the market, fares are much lower and more seats are filled on each flight. (Find more here.) That is true deregulation: taking the power away from a few big corporations and giving it to the market. There are still many regulations standing in the way of a free market for air travel, such as barriers to foreign competition, protection of Boeing and Airbus and laws that govern how much airports can charge. But the process that began in the late 1970s has made it possible for the rigid and inefficient controlled market to give way to improvements in several areas of the industry, with consumers benefiting most.

Then there is market failure. Market failure is basically when the free market produces inefficiencies in the allocation of goods and services. Market failure is usually followed by public overreaction and a call for government to intervene, again, to “do something”. Politicians see every such incidence as a way to win votes by appearing to do something big, while not necessarily addressing the root of the problem, and provide a handout to a special interest group or two. Because government responses are usually far more inefficient than market failures, they are government failures (though they are frequently disguised as market failures). But even when government could do something about a problem, it is wrong to assume that the private sector could not. In fact, a lot of market failure is government failure, as many supposed market failures such as externalities and non-competitive markets could be solved by a reduction in government regulation. Many economists see market failure as an untapped market. Plastic bags are bad for the environment? How could you make money off that? The potential is usually there with a little imagination and a less realistic ceding of government power.

There is still no free market. Like before the crash, the government is interfering with the economy in all kinds of ways, and is of course not bringing about the recovery it promises to. I do not know if constant intervention into every area of economic life is simply a way to reward the big players who contribute the most money to political campaigns, or if it is based on delusions that people like Ben Bernanke have that they can somehow save the economy. There is no evidence they can.

Political risk holds back investment. The term was once used only for places like Africa and Latin America where it was feared that a wayward government would nationalise or seize the assets of foreign investors, or just arbitrarily raise corporate taxes by 50%. But with its enormous debt, its trillion-dollar handouts to giant corporations and its seemingly arbitrary regulations, the US has become a political risk. Lee Doren of How the World Works suggests that the reason why businesses are not investing and hiring right now is that “they are scared. They have no idea what politicians in Washington are going to do. They are treating the economy like a little kid’s chemistry set.” (Here is an example of a small business owner holding back because of uncertainty—a little sentimental, but telling nonetheless.)  Most businesses benefit most from stable political climates where the government’s moves are predictable.

-But politicians love to make themselves feel important while finding a way to please a special interest. That is why, instead of surrounding themselves with Austrian or even Chicagoan economists, they find people like Paul Krugman and Joseph Stiglitz, people who ignore the enormous government hand in the financial crisis and have the nerve to fault the free market. Such people, like government scientists, are essential to the modern state, because they clothe the actions of the state in jargon about multiplier effects and quantitative easing, making economic growth seem more complicated than it is, and concealing the truth from the average person.

These are the experts who tell politicians to stimulate the economy through massive spending, so that politicians can decide whom, across the whole country, to give hundreds of billions of dollars to. I question the thinking behind that, not only because I do not trust a politician to fix the economy, not only since every time they give money to well-connected interest groups they make the playing field less level, but mainly because governments at the moment are so far in debt they are beginning to collapse under its weight.

They suggest controling interest rates, instead of letting the market do so. Then, they tinker with the rules of the economy by introducing all kinds of new laws to make it more competitive or more equal or smarter or whatever promises central planners think they can fulfill toward an economy that no small group of elites could possibly run. They might make things more complicated or more expensive, which could be fatal to a new business. If they want to help small businesses, lawmakers should reduce  the size of the tax code and eliminate operating licenses and license fees. (See some of the more ridiculous ones here.) They are a government’s way of retaining the power to deny a business, any business, from operating without a fee, or as it is called in a dictatorship, a bribe. More importantly, though, they keep small businesses out of markets where they could pose a threat to the big businesses that provide generous retirement funds for politicians, bureaucrats and lobbyists.

There is no such thing as “too big to fail”. The trillion-dollar bank and insurance bailouts of 2008 and onward indefinitely are justified by the excuse that, if the banks fail, credit markets freeze and no one will be able to borrow to invest. That is unlikely. Banks are merely intermediaries between those who have money to lend and those who want to borrow. There is always some other way to get money if you need it, such as venture capitalists and angel investors. And letting big companies fail does not send markets into turmoil: Enron’s collapse sent barely a ripple through the stockmarket.

The legal corporation is itself a product of government, a legal fiction, like government itself. One of the greatest threats to a free market is the legal treating of a corporation as a person. It is not a person; it is made up of people. If a CEO orders a person that works for him to dump chemicals into a river, the people harmed by that dumping should have the right to defend themselves against the person who made the order. Law does not have to end without a state; it can be made better. People like the idea of putting sanctions on people who commit crimes, so there is no reason to believe it would not happen without a state. As it stands, they cannot stop the behaviour. They can only hope the government will make the corporation pay. But when corporations pay, whose pocket is lighter? The employees might be forced to accept lower salaries, the customers higher prices. The CEO barely feels a thing. The legal corporation is thus a shield, a way for people to avoid responsibility for their crimes. Corporate personhood protects people who should not be protected. It should end.

We can also safely abolish the Federal Reserve System. Not only has it contributed to most of the bubbles and financial crises of the past century, it is the basic cause of inflation. Its origins should tip us off as to whom benefits from its existence. The Fed was created in 1913 behind closed doors by bankers and their political sponsors. It has, ever since, served to enrich bankers and impoverish the people. How does it impoverish the people? A central bank cannot create value, or goods that are worth buying, but it can print paper, which goes first to bankers. The bankers now have more money to spend. When they spend it, the wider economy gradually adjusts to the greater supply of dollars and inflation sets in. Inflation eats away at savings. Now that your dollars are worth less than they were, you feel forced to spend. Some people say that is good because spending keeps the economy going. I say you should be allowed to decide when to spend your own money.

We are so afraid of deflation that we are willing to put up with inflation as a lesser evil. And yet, falling prices can just as easily be a sign of prosperity. Prices fell in the US between its independence from Britain and the Federal Reserve Act of 1913, for instance, when the economy went from agrarian to the greatest industrial power in the world.

Laws and regulations are not usually good for the economy or for consumers. Most of them benefit the few at the cost of the many. We have seen how above. In extreme cases, government intervention kills. What are the effects of laws on the free market? Well, what is the difference between a legal business and a criminal organisation? Just one law. Both are filling a demand. But one is forced into the violent underground, and reaps big profits, because what they supply is illegal. For some reason, be it a naïve belief that prohibiting something means ending demand for it, or a favour to an interested party such as a rival producer, lawmakers have created an enormous black market comprising 15 to 20% of world GDP no one can control without a huge number of guns. And the more they try to fight suppliers, if demand does not change, they will spend more public money and kill more people. Find more on black markets on my other blog.

We need to stop being afraid of profit. Profit is the incentive that starts and grows businesses. When people profit, they create goods and services we like, they create jobs, they bring themselves out of poverty and into wealth. People who make their money, however many billions, by giving us what we want do not have an obligation to “give back”, as they have already given. There is nothing greedy or immoral about profit. It is only immoral if you take it without the consent of the other party (like taxes). Starting a business is hard, hard work, and the risk of failure is high. And yet, the wonderful people who succeed are the people who have given us all the wonderful things we take for granted. Entrepreneurs are vastly unappreciated and overpunished in our world.

Furthermore, it is because businesses need to profit that the most powerful check against corporations is the power of the dollar. If you believe that a corporation is bad, you do not have to buy from it. When enough people stop buying from a business, either it changes or it goes bankrupt. The government, on the other hand, is a monopoly you are forced to obey. It cannot go out of business because it does not rely on market forces but violent forces. If government were a business operating in a free market, it would have been hurled out of business long ago by firms that do what their customers want (security, jobs, environmental protection, you name it) more effectively and efficiently.

I laugh when I hear someone say that, of the largest “economies” in the world, half or more are corporations. Corporate power is very different from those of government. Corporations cannot take your money; they can only ask for it. Corporations are often blamed for suckering you out of your money, but one might argue that anyone who gladly pays taxes has been suckered; and at least with a business, you are allowed to resist. What could big business do without the power of government behind it? The reason big business is problematic is because it can corrupt the state and lobby to use laws to force unethical behaviour.

Some people fear that corporations, as they too have lots of money, would develop their own weapons. But why would they? There is no instance in history of a corporation whose product is legal growing in size and taking on the coercive properties of a state, only ones where it has used existing state apparatus of violence to coerce. Business cannot use force. It can only persuade. And of course, no organisation or social system could ever completely do away with fraud, trickery and stealing. But the government not only allows those things to continue, it engages in them on a massive scale. I think we are better off without its protection.

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  1. Sky
    May 6, 2015 at 6:08 am

    I really loved this article, a great case for the free market. However, I’m also curious to know what your thoughts are on the industrial revolution. After farms became corporately owned factories began producing goods. People left the farms to move to cities where they were essentially slaves to the factories. Long hours, poor conditions, money that could only be spent at company stores, women who went on dates had to be accompanied by a company escort, and people lived in company houses. Labor unions were created and government laws were enacted to prevent these kinds of human rights violations. It could be compared to the cheap exploited labor that make my clothes today.

    • May 8, 2015 at 11:45 pm

      Hi Sky,

      Yes, the Industrial Revolution was a very hard time for most people and in fact it is not over yet. I didn’t know that much about the violence of its origins until I read the part of Marx’s Capital on primitive accumulation. I really recommend it, and I also recommend this talk on the subject. It deals with everything you mention. –>https://www.youtube.com/watch?v=L3N3uPviEYc

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