The Competitive Markets Point of View
The Invisible Hand operates in perfectly competitive markets to guarantee that the pursuit of individual profit will lead to economic efficiency, national growth and the distribution of riches according to each person’s (marginal) contribution to creating those riches. However, as nature abhors a vacuum, business abhors competitive markets because competition is the enemy of profit. That is why both Adam Smith and Milton Friedman advocated strong government intervention to maintain competitive markets and roll back the tendency of free markets to concentrate power, collude, conspire and even corrupt (Enron, WorldCom, big tobacco, Three Mile Island…).
Adam Smith and the “freshwater” economists who evangelize “free market” capitalism are actually advocating “perfect competition.” The “free” in “free market” refers to freedom from concentrated market power and from a government menu of prices and outputs levels. It refers to markets where all workers and all businesses face a full and identical range of choices and where none can influence the choices of its competitors. In particular, perfect competition requires:
- infinitesimally small businesses selling things and services that are perfect substitutes for their competitors’ products
- perfect information about what things and services are worth, now and in the future
- prices that reflect all the downstream impacts of products and services
- some mathematical niceties, like rationality and free disposal
Game theory and behavioral economics have added complexities but have not changed Adam Smith’s proposition that perfect competition requires active and robust government intervention. Even if we set aside do-gooder interventions motivated by distributional, environmental, political or other ethical objectives, we are still left with a competition-based case for government interventions such as:
- product labeling and corporate disclosure requirements
- laws against insider trading of securities
- antitrust, anti-predatory practices laws
- product liability laws
- standards setting
- compensatory tariffs
The Free Market Point of View
In contrast, the libertarian meaning of “free market” capitalism is that government should leave workers and businesses alone. It is primarily motivated by the ethical belief that private entities have a right to do whatever they choose unless there is a compelling reason for governments to restrict their choices in order to protect other people’s choices.
Under the libertarian approach to free markets, there is no rigorous theoretical connection between libertarian ideals and economic efficiency except through “natural law” arguments that are sometimes more hortatory than theoretical. Even if Mussolini could make the trains run on time, the argument goes, that wouldn't make it right. Libertarians generally observe that when governments meddle, they make things worse. This observation overlaps with the Invisible Hand economists’ desire to get the government out of setting prices and outputs.
For a long time, examples of inept and ineffectual government interventions, contrasted against steady growth in wealth and income in the private sector, papered over the fundamental incompatibility of the two approaches to free market capitalism and allowed them to coexist in the Republican party.
Two things have changed, recently. One is that the financial crisis has proven once and for all that private entities left to themselves do not reliably make economically optimal or even selfishly smart choices. Unregulated markets are far from perfectly competitive, as market power is highly concentrated, some private entities hide and distort information unless corned like rats, and they daily make decisions with societal impacts far beyond their own bottom lines (“externalities,” in economics-speak).
The second change is that for most of the past decade or so, corporate profits and income among the wealthiest individuals have risen strongly while middle and lower class incomes have fallen in inflation-adjusted dollars. The increasingly stark contrast between the growth in national output and stagnation in worker bee incomes and security has made it harder for the Joe the Plumber argument to stick: that we should help the business class because their success will trickle down, or at least because we are likely to join their ranks one day.
Now, Samuel Joseph Wurzelbacher notwithstanding, the Joe the Plumbers of the Republican party have begun to divide over the choice between the right to be left alone and the right to a fair fight.
Our schoolroom pledge to uphold “liberty and justice for all” takes on new meaning. One persuasive (for some) line of argument is that there is no justice without personal liberty, so we must get government out of our private economic lives. Another persuasive (for others) line of argument is that being stuck at the losing end of an uneven playing field is its own sort of prison, so liberty and justice require government to level that playing field by negating the anticompetitive tendencies of private enterprise.
Both are legitimate Republican points of view, up to now mashed together with faith in the integrity, intelligence and efficiency of private enterprise acting as the glue. But that glue dissolved in the 2008 elections. As free markets appeared to be neither efficient nor benevolent, some of the Republican electorate stuck with free markets as intrinsically just and an end in itself, while others turned to government intervention to restore competitive markets and enable stable and efficient outcomes. The Republican party needs to confront that schism and decide where it stands between free markets and competitive markets.