Economic Regulation and the Myth of Free Markets

For all practical purposes, free markets don’t exist in our economic system, they were virtually eliminated by governments acting at the behest of capitalists well over 100 years ago, and their loss rightly goes unnoticed.  Those who champion unregulated markets and laissez-faire capitalism either don’t have the slightest idea what they are talking about, or they are attempting to control one or more markets for their personal advantage. The leadership of AIG, Merrill Lynch, Citicorp, Microsoft, Alan Greenspan and members of both political parties are just a few recent examples of both kinds of people. These are strong assertions, but allow me to provide some support for them.

Regulation is required to make any system’s performance predictable; the economic system is no exception. The two possible regulatory mechanisms for any system are hierarchical controls and homeostatic adaption. Hierarchical controls are centralized and specific with decision making bottlenecks at the top of each hierarchy, homeostatic adaptations are distributed and average results produced from large numbers of local peer to peer influences. Some systems are exclusively regulated by one or the other mechanism, many employ combinations of both mechanisms. For example, an oven’s temperature is controlled hierarchically: a person, at the top of the hierarchy, sets the desired temperature on the oven’s thermostat and then the thermostat controls the heat source in response to signals from a thermometer in the oven. However, the temperature of the human body is determined by homeostatic mechanisms; trillions of cells interact locally in a biological soup, each doing its thing, but in the process generating some waste heat which permeates the soup and slightly alters the average temperature which in turn slightly influences the average rates at which many of the individual cells do their things in ways that produce a reasonably stable average temperature. Businesses are primarily controlled by hierarchies with CEOs forming decision making bottlenecks at the top, but many decisions in the field are based on the culture of the company and the local conditions rather than on specific instructions from the top.

Free markets, where they exist, form a homeostatic economic environment in which sellers, buyers and prices are continually adapting to immediate local conditions. A free market’s principle benefit is local autonomy and its principle drawback is wildly fluctuating local conditions. Small farmers with perishable products adapt to what they find when they go to market. Individual buyers must adapt to what’s available.

In a truly free market, no supplier or buyer can represent or influence more than 5% of the transactions. At a roughly 5% market share (for either seller or buyer) it becomes attractive to reduce the need to adapt by either developing cohesive alliances or fragmenting the market to develop a 25% market share or more; a farmer takes produce to small local markets, a business locates in a neighborhood with few competitors, another business attempts to distinguish its product from the greater market with advertizing.  This is an economic case of a more general rule that the only viable strategy for small groups (<5%) in large communities is to adapt to the norms of the larger community. Christians in Iraq, less than 5% of the population, survived for centuries by adapting.

Once a cohesive group represents 25% or more of a market or a cultural community, the most profitable strategy for that group is to attempt to control the environment rather than to adapt to it. Markets in which one or more participants have control or cohesive influence over 25% or more of the transactions begin to migrate towards a managed market where those who survive, buyers or sellers, are able to influence or set prices that favor them to the relative detriment of other market participants. That is what the vast majority of markets are today, and they reached this point long ago through the systematic intervention of governments, primarily at the behest of the larger players in the markets. When a small farmer sells corn to Cargill or ADM, that farmer must accept the prices these corporate behemoths set. When we buy software from Microsoft, we must accept the price it sets. The Sunnis of Iraq were less than 30% of the population, but were able to control the country for decades; to their benefit and to the detriment of everyone else.             

The Industrial Revolution, began in England with surpluses of products, property and energy. After the late 17^th century, and well into the 19th century, Parliament ruled the economic and political life of England and 1200 propertied families controlled Parliament. They established a process of enclosure to transfer common lands into their hands to improve their economic productivity, entailment to keep it in their hands, trade barriers and monopolies to safeguard the surpluses they controlled, corporate and bank charters to enable cohesive management of large blocks of trade goods, cohesive development of natural resources under a limited number of entities, and cohesive management of large pools of credit. Property rights were established and codified including intellectual property rights in the forms of patents and copyrights. Through the rule of law, enforced by governments, the sellers and their surpluses were granted opportunities to cohesively manage and profitably sell their surpluses in markets skewed to favor large suppliers who exercised partial or complete control.

The rapid growth that ensued by unclogging the decision making bottleneck of royal rule and distributing it to a rapidly growing community of propertied hierarchies, successfully muted the dark side of the still extensive participation of government in the marketplace.  The dark side included the beggaring of previously successful craftsmen and the exploitation of a labor market which was inhibited from forming similar cohesive groupings and whose rebellions were put down by force. Eventually, governments made adjustments to improve the balance of their participation by regulating health and safety, minimum wages and working conditions, by enabling labor unions to form and by limiting some monopolies.

To say that “free markets” have brought about the plenty that we have today is to ignore the realities of history. Governments have always regulated markets, in many cases for the good of the propertied and in some cases for the common good. So the question is not should government stay out of the market regulation business, rather how much should the government participate in regulating markets for goods and credit, and how even handed should its regulations be?