5 Reasons Why Free Markets Don't Work

Since the time of Adam Smith, and in spite of all evidence to the contrary, many thinkers and politicians  (not always the same thing) have assumed that the 'invisible hand' of the market would not only balance supply with demand but would produce maximum well-being for all. In recent times this thought has established (ironically) such a monopoly in our political psyche that it has even become confused with morality. It is seen as the moral duty of governments to protect the free market, whatever carnage is caused in people's lives, because market forces are the truth and there is no alternative. 

It turns out that Adam Smith and all his acolytes are wrong, as even the most superficial observation will confirm, mostly because markets are naturally unstable. What we see is not balance but constant and unpredictable volatility, what mathematicians characterise as 'chaos', and certainly not well-being. 

Here are a few reasons why:

1: In spite of the rumours, money doesn't trickle down from the rich to the poor, it naturally flows the other way. Rich people and institutions have more power in markets in a whole variety of ways and therefore take more out of them, reducing poor people to penury and thereby destroying the very market they are exploiting. Without progressive taxes on income and wealth, free markets tend to destroy themselves. The game of Monopoly reaches an end when there is no more market to play and no more players to pay rent.

2: In many areas, such as transport and utilities, large businesses have a natural advantage of scale and there is therefore a natural tendency towards monopolies - another way of destroying the market. The two obvious solutions are nationalisation or a competitive market artificially created and maintained by government regulation.

3: When we are all exploiting the same common resource, such as clean air, clean water or a healthy soil, the logical thing for a competitive player to do is to exploit it as hard and as fast as possible before anyone else has the chance to do so. Of course everyone else is doing the same so the market rapidly destroys the resource on which it depends. This is known as the 'tragedy of the commons'. The only solution is for government to impose a quota system that ensures that the overall rate of exploitation is sustainable - as they have been doing with commoners' rights in forests since Mediaeval times.

4: Markets tend to be focused on the short term. When times are good, everybody wants to invest and make a quick buck. This leads naturally to bubbles that burst rapidly when some trivial incident leads to a cascading loss of confidence and a whole market comes to a screaching and painful halt - the cycle of boom and bust. Logically, governments could smooth the cycle by extracting money during the good times and then investing during the bad times but unfortunately the current fashion is to do the opposite.

5: There is much focus from free-marketeers on the idea that markets will balance themselves (which in many ways, as we have seen, is not true) but much less on how long it takes. If demand for a product or a service suddenly increases, it takes a while to train workers, build facilities, establish a brand and so forth. Equally if demand collapses, it is not a trivial matter to close facilities, lay off workers and find a way to switch into new markets. It obviously varies between market sectors but it can certainly take decades for a market to reestablish equilibrium. If key technologies and business models, not to mention the boom and bust cycle, are moving faster than that then markets will always be out of balance and always struggling to catch up.

Of course the reality of government action does not match the rhetoric; they are intervening and manipulating all the time in any way necessary to protect the illusion of a functioning free market. And in doing so, consciously or unconciously, they protect the rich and powerful from the consequences of their own greed.

Just saying.