Free market and planned economy

 Free trade theories

Economic Freedom:  Idea, Performance, and Trends

Economic freedom is featured by the absence of government coercion or constraint on the production distribution or consumption of goods and services beyond the extent necessary for citizens to guard and maintain liberty itself. Thus, people are free to work, produce, invest and consume in the ways they choose.  The Economic Freedom Index approximates the extent to which a government intervenes in the areas of free enterprise, free choice and market-driven prices for reasons that go beyond fundamental national needs.  Presently, countries are classified as free, mostly free and mostly unfree and repressed.  Determining factors include:  the fiscal burden of the government, trade policy, the extent and nature of government intervention in the economy, capital flows, monetary policy, and investment, banking and financial activities, property rights, wage and price levels, other government regulation and informal market activities.  In excess of time more and more countries have moved toward greater economic freedom. Countries ranking highest on this index lean to enjoy both the highest standards of living as well as the maximum degree of political freedom.

The instructive power of the theories of absolute and comparative advantage is limited to the exhibition of how economic growth can occur via specialization and trade.  The concept of Free Trade (a positive-sum game) states that nations should neither artificially limit imports nor artificially promote exports.      The invisible hand of the market will decide which competitors survive, as customers buy those products that best serve their needs.  Free trade implies specialization just as individuals and firms resourcefully produce certain products that they then exchange for things they cannot produce proficiently. Nations as a whole specialize in the production of certain products, some of which will be consumed nationally and some of which may be exported; export income can then in turn be used to pay for imported goods and services.         This chapter examines the ethical phase of the market system itself how it is justified and what the merits and demerits of the system are from the point of view of ethics. It starts by discussing the economic conditions in the U.S. at the close of the 20th century, when proponents of industrial policy were influencing the government to help declining industries and their workers to change to new economic conditions. Others urged caution, advising the government to "avoid the pitfalls of protectionism." This dichotomy illustrates the difference between two opposite ideologies, those who believe in the "free market" and those who advocate a "planned" economy.

These two ideologies take different positions on some very basic issues: What is human nature really like? What is the purpose of social institutions? How does society function? What values should it try to protect?

In general, two important ideological camps, the individualistic and communitarian viewpoints, describe modern societies. Individualistic societies promote a limited government whose primary purpose is to protect contract rights, property and open markets. Communitarian societies, in disparity define the needs of the community first and then define the rights and duties of community membership to ensure that those needs are met.

These two camps face the trouble of coordinating the economic activities of their members in two distinct ways. Communitarian systems use a command system, in which a single authority decides what to produce, who will produce it, and who will get it. Free market systems are characteristic of individualistic societies. Incorporating ideas from thinkers like John Locke and Adam Smith, they allow individual firms to make their own decisions about what to produce and how to do so.

Free market systems have two main components: a private property system and a voluntary exchange system. Pure free market systems would have absolutely no constraints on what one can own and what one can do with it. Since such systems would allow things like slavery and prostitution, however, there are no pure market systems.

Free Markets and Rights: John Locke

It is also significant to note that Locke's views on the right to private property have had a significant control on American institutions of property even in today's computer society. First and most important is throughout most of its early history, American law has held to the theory that individuals have an almost complete right to do whatever they want with their property and that government has no right to get in the way with or confiscate an individual's private property even for the benefits of society. Second, underlying many American laws regarding ownership and property is Locke's view that when a person expends his or her labor and effort to create or to get better a thing, he or she acquires property rights over that thing.

Theory of Absolute Advantage

In 1776 Adam Smith asserted that the riches of a nation consisted of the goods and services available to its pupil.  His theory of absolute advantage holds that a country can make best use of its own economic well being by specializing in the production of those goods and services which it can produce more competently than any other nation and enhance global efficiency through its participation in (unrestricted) free trade.  Smith reasoned that: 

(i)                 Workers do not lose time in switching from the production of one kind of product to another.

(ii)                 Long production runs provide greater incentives for the   development of more effective working methods.

(iii)             Workers become more skilled by repeating the same tasks.

Smith also asserted that country-specific benefits can either be natural or acquired.

1.    Acquired Advantage.  An acquired advantage represents a distinct advantage in skills, technology, and/or capital assets that yields differentiated product offerings or competitive homogeneous products. Technology in particular, has created new products, displaced old products, and altered trading- partner relationships.

2.    Natural Advantage.  A country may have a natural advantage in the production of particular products because of given climatic conditions, access to particular resources, the availability of labor, etc.  Variations in natural advantages among countries help to explain where particular products can be produced most efficiently.

3.    Resource Efficiency Example.  Real income depends on the output of products as compared to the resources used to produce them. By defining the cost of production in terms of the resources needed to produce a product, the production possibilities curve shows that through the use of specialization and trade, the output of two countries will be greater, thus optimizing global efficiency.

Comparative Advantage

In 1817 David Ricardo articulate that there would still be gains from trade if  a country specialized in the manufacture of those things it can produce most efficiently even if other countries can produce those same things even more efficiently. Put a different way, Ricardo's theory of comparative advantage states that a country can maximize its own economic well- being by specializing in the production of goods and services it can produce comparatively efficiently and enhance global efficiency through its participation in (unrestricted) free trade.

Locke's critics focus on four weaknesses in his argument:

The clash between natural (negative) rights and positive rights: Why should negative rights such as liberty take precedence over positive rights? Critics argue that we have no reason to believe that the rights to liberty and property are overriding.

The conflict between natural rights and justice: Free markets create unjust inequalities, and people who have no property or who are unable to work will not be able to live. As a result, without government intervention, the gap between the richest and poorest will widen until large disparities of wealth emerge.  Unless government intervenes to adjust the distribution of property that results from free markets, large groups of citizens will remain at a subsistence level while others grow ever wealthier.

The assumption that individuals have natural rights: This assumption is unproven and assumes that the rights to liberty and property should take precedence over all other rights. If humans do not have the overriding rights to liberty and property, then the fact that free markets would preserve the rights does not mean a great deal.

Individualistic assumptions and their conflicts with the ethics of caring: Locke assumes that people are individuals first, independent of their communities. But humans are born dependent on others, and without caring relationships, no human could survive. The degree of liberty a person has depends on what the person can do. The less a person can do, the less he is free to do. But a person's abilities depend on what he learns from those who care for him as well as on what others care to help him to do or allow him to do.

Free Markets and Utility: Adam Smith

Modifying  Locke's  opinions  on  free  markets,  Adam  Smith's  arguments  rest  on  utilitarian arguments that free markets and private property will produce greater benefits than any other system. According to Smith, when personal individuals are left free to seek their own interests  in  free  markets,  they  will  unavoidably  be  led  to  further  the  public  welfare  by  an "invisible hand:"

By channelizing [his] industry in such a manner as its produce may be of the greatest value, [the individual] intends only his own profits  and he is in this, as in many other cases, led by an invisible hand to encourage an end that was no part of his intention. By pursuing his own interest he often promotes that of society more successfully than when he really intends to promote it. Free markets, according to Smith, make sure that buyers will purchase what they need at the lowest prices they can find and business will likewise attempt to satisfy these needs at the lowest prices they can offer. Competition forces sellers to crash their prices as low as they can and to preserve resources while producing what consumers actually want.

According to this view, Supply and demand will help allocate resources efficiently. When the supply of a certain commodity is not adequate to meet the demand, buyers bid the price of the commodity increasing until it rises above what Smith called the natural price (i.e., the price that just includes the costs of producing the commodity, including the going rate of profit obtainable in other markets). Producers of that commodity then harvest profits higher than those accessible to producers of other commodities. The higher profits induce producers of those other products to knob their resources into the production of the more profitable commodity. As a result, the scarcity of that commodity disappears and its price sinks back to its natural level. Conversely, when the supply of a commodity is larger than the quantity demanded, its price falls inducing its  producers  to  toggle  their  resources  into  the  production  of  other more  profitable commodities. The variable prices of commodities in a system of competitive markets then forces producers to assign their resources to those industries where they are most in demand and to take out resources from industries where there is a relative oversupply of commodities. The market, in short, allocates resources so as to most resourcefully meet consumer demand, thereby initiating social utility. The best thing for government to do is nothing the market on its own will advance the public welfare giving people what they want for the lowest possible cost. It is vital to note that, although Adam Smith did not discuss the notion of private property at great length, it is a key supposition of his views. Before individuals can come mutually in markets to sell things to each other, they must have some agreement about what each individual "owns" and what each individual has the right to "sell" to others. Unless a society has a system of private property that allocates its resources to individuals, that society cannot have a free market system.

Smith's utilitarian argument is most generally criticized for making what some call unrealistic arguments. First, Smith assumes that no seller can organize the price of a good. Though this may have been true at one time today many industries are monopolized to some extent. Second, Smith assumes that the producer will pay for all the resources used to produce a product, but when a producer uses water and pollutes it without cleaning it, for example, someone else must pay to do so. Third, Smith assumes that humans are provoked only by a natural, self-interested desire for profit. This, say his critics, is clearly false. Many humans are concerned  for  others  and  act  to  help  others,  constraining  their  own  self-interest.  Market systems, say Smith's critics, make humans self-centered and make us think that the profit motive is natural.