Capitalism distorted by three free markets myths

Matthew Holliday

The confluence of the 2012 presidential election, high unemployment, the Occupy Wall Street movement and high gas prices has led to an intensifying debate over the economic future of the U.S. In turn this has lead to many misunderstandings and mischaracterizations of how free markets work. This column seeks to dispel just three of the more common myths surrounding free markets.

First, the U.S. has a free market economy. This is one of the most pervasive myths concerning capitalism. The refutation of this myth is probably the most important prerequisite to any serious discussion on economic policy.

A true free market is simply a dynamic matrix of voluntary transactions coordinated by price and predicated on private property. This state of affairs hardly exists in the U.S. –– a nation where individuals are subjected to over 150,000 pages of federal regulations and government spending is nearly 40 percent of GDP.

It is extremely important to absorb this point since the plethora of national ailments that are often blamed on free markets is rather the fault of a corporate-government hybrid. Perhaps the best example is our ongoing financial crisis. It resulted from state monetary mismanagement and misguided housing subsidies and was aggravated by the infusion of trillions of taxpayer dollars into unstable lending institutions.

Second, a free market rewards greed. In reality, a free market doesn’t make people any more or less greedy than they actually are.

Rather, a market rewards the provision of socially desirable goods and eliminates waste by rewarding or punishing individual economic agents, regardless of their motivations. In a word: markets emphasize results over intentions.

Entrepreneurs can succeed whether they are saintly or avaricious, so long as they produce something of value. In the words of economist Mike Munger, “Capitalism takes greed as a given and celebrates consumer sovereignty. So, anything that starts with ‘greed is good’ is wrong. It’s a mischaracterization of capitalism. No one has ever believed that. What capitalism does is try to harness greed and use it for the good of consumers.”

Third, free market proponents ignore market failure. While it may sound politically charged, market failure is in fact just a technical economic term for a condition such as asymmetric information or an externality wherein a market’s allocation of goods and services is not efficient.

A common anti-capitalist trope is that market proponents ignore these issues and blindly assume that models of perfect competition always sufficiently approximate the real world. In reality, free market proponents advocate capitalism precisely because there is such a compelling case that voluntary institutions handle these situations better than the state.

The economist Joseph Stiglitz is a prominent proponent of government intervention. He even conceded in a 1976 paper that even though markets are not perfect aggregators of information, it does not follow that governments should intervene in the economy since they may be even less efficient. Market supporters argue that voluntary actions/arrangements such as assurance contracts, signaling, screening, etc. are usually more efficient than top-down, bureaucratic meddling. The idea of market failure, therefore, is not the end of the debate over free markets but just the beginning.

Of course, this list of misconceptions about capitalism could go on indefinitely; economic misinformation is omnipresent in hard times. Therefore, it is more important now than ever to reaffirm the foundations of free market economics.