The advantages of a market economy system and its endangerment by self-interest
An Article in the Compendium of Market-Based Social-Ecological Economics
Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?
Table of Contents
The advantages of the market economy are unsurpassed, because it is the only economic order that evolved »naturally« in societies based on the division of labour. Unfortunately, however, the market economy has been unjustly discredited by the social devastations caused by capitalist excesses of the neoliberal globalisation. The neoliberal crisis demands to demonstrate the unique potential of the market for a sustainable regional and global economic order. And it must be made clear that the market economy is not to be equated with capitalism.
2. The Origin of the Market
The economic activity of mankind begins with production based on the division of labour and the barter building upon it. As the division of labour increases, self-sufficient households supplement and enrich their supply through the exchange of goods and services. Wherever people enter into trade relations with each other, marketplaces for different products are spontaneously formed tied to particular places and times. Places for economic exchange can be evidenced as far back as the Neolithic age. Finally, the encounter in marketplaces is also used for activities other than purely economic exchange, for example as a »marriage market«, thus fulfilling a profound socio-cultural function. The same applies to everyday economic life: Economic activities largely determine the pace of life and relationships within communities, although their primary goal is to secure the individual and collective existence. That is why all economic activity with its formative influence on everyday life is part of human culture.
Given balanced power relations, prehistoric trade within cultural communities is directed towards social welfare and creates a corresponding set of rules consisting of traditions, taboos and unwritten laws (some of which already demand ecological sustainability). Usury, fraud and exploitation are severely punished, so that the market can fulfil its real task: namely to create exchange ratios (prices) in free competition between suppliers and demanders, which provide all players with decisive information for their transactions and, under ideal conditions, direct the resources and products at optimal prices to where they provide the greatest benefit. The exchange of information between market players takes place primarily through bargaining and thus strengthens competition in the sense of a mutual learning process.
In ancient and medieval times, the term »market« stands for a concrete urban marketplace where sellers and buyers, producers and consumers meet at fixed times to haggle about prices and quantities and to trade. Even today, the term is still used for markets that are tied to a certain place and time, such as the weekly market, the auction hall and the trading floor. In its modern economic sense, however, the term primarily stands for an abstract place, which refers to the partly direct, partly anonymous interrelationship between suppliers and demanders of certain products and the free pricing that takes place in competition between all parties involved.
In historical times, the division of labour in production and the regulated trade on marketplaces has been repeatedly abused by excesses such as slavery, feudalism and absolutism. The modern market economy that emerged in the nineteenth century, most of whose markets are no longer tied to a certain place and time, has also been instrumentalized by powerful groups through capitalism and communism (as a state capitalist variant). At present, it is haunted by a modern capitalist neoliberalism that, for the first time in economic history, has created »liberalized global markets« on which barter relationships (prices) are formed that are decoupled from the productive and socio-cultural conditions of production sites and their people.
3. The Market Mechanism
The free formation of prices, also known as market or price mechanism, can be understood as a modern variant of bargaining. In the course of the geographical expansion of markets, free pricing has developed quite »naturally« from the formerly strongly location- and time-dependent trading activities. And so, in contrast to all engineered, mostly centralist systems, the market economy can claim to be an economic order that has developed almost automatically from the human need for exchange and trade. The market economy meets this need particularly well because it enables economic players to make autonomous, decentralized decisions without the necessity for direct central control.
However, it should be noted that markets can only claim the adjective »free« if all market participants are subject to the conditions of a uniform framework including uniform rules and standards. Only under these – seemingly paradoxical – conditions, can equal opportunities be ensured among market participants as well as a balance between both the public and private sector of the economy and between the human access to natural resources and their preservation. And only under these conditions can market participants freely determine their supply and demand and freely negotiate prices without impairing the sustainability of economic processes. Since the consistency of an economic order follows political consistency, the realisation of free markets beyond the borders of autonomous political and economic areas always pose a hazard.
The market is therefore initially a geographically and socio-culturally limited construct. With cross-border freedom, the sensitive balance of productivity, wages, purchasing power and prices in particular is destroyed, so that ultimately equal opportunities and the freedom itself will fall by the wayside. Sustainable economic exchange on free markets therefore primarily requires economic autonomy. Only on the basis of autonomy will economic areas be able to conduct cross-border trade (foreign trade) and benefit from cross-border competition by bilaterally agreeing on the the rules with each trading partner in such a way that both domestic economies benefit from mutual exchange. For further details I recommend the articles Future-Proof Foreign Trade and Comparative Advantage – Upgraded.
The special dangers and conditions of cross-border trade are described below:
Figure 1: Since the emergence of the neoliberal globalization it has become obvious that the natural advantages of the market mechanism can in fact have a detrimental effect if the freedom of market participants is misunderstood as unrestricted access to human and natural resources. In the deregulated global markets that have emerged as a result of this globalization, global economic and financial centres of power have been established that do everything in their power to combat and undermine national and supranational framework conditions, rules and standards for their own benefit. The economic doctrine behind this development aims solely at capital yields – at the expense of human labor and natural resources. The social and ecological devastations and costs thus caused are responsible for the fact that market mechanism and market economy are increasingly equated with capitalism (see also the article Excesses of Capitalism).
4. The Advantages of the Market Mechanism
The basis of the market mechanism is the striving of private enterprises and private households (of suppliers and demanders) for the greatest possible individual benefit and profit. Thereby suppliers and demanders are competing with their objectives both against each other and within each of their groups side by side. The different objectives clash on the market as supply and demand and find their balance in certain product characteristics, conditions, quantities and prices. These qualitative and quantitative variables determined in competition reflect current demand and preferences, values and trends, but also the scarcity of economic resources. In relation to the individual product they provide information about its relative demand and the relative costs of its production in comparison to other products.
The constant feedback of this information from the market enables all market participants to adjust their supply or demand in quantity, quality and price at any time to the current conditions and to optimally meet their objectives. With balanced power structures between market participants, but also between them and public concerns, including the preservation of the natural basics of life, the totality of individual decisions ensures that economic resources are allocated in the most efficient way possible and that optimum supply and satisfaction of demand for goods and services is achieved at optimum prices.
Under the ideal market conditions described each selfish individual decision contributes unconsciously, unselfish and anonymously to the coordination of all economic transactions and to the optimization of the common good
This is also the case because suppliers and demanders are constantly stimulated in competition to innovate and thereby contribute to progress and prosperity and to a diverse, differentiated product range. The market mechanism works all the better (the market is all the more perfect) the larger the number of suppliers and demanders, because the veracity and significance of the prices determined increase with the number of market participants, as does the induced progress and prosperity. The price is therefore the central instrument for coordinating market economy processes.
5. The Risks of the Market Mechanism
As I said, the current neoliberal development clearly shows us the risks and distortions to which the market mechanism is exposed, particularly through unbridled self-interest. In economically deregulated markets, various undesirable developments are triggered, which result in market failure. Two characteristic indications regularly suggest market failure: On the one hand, when social and ecological costs actually incurred are not included in the prices, i.e. costs are externalised by transferring them to uninvolved market participants or the general public. On the other hand, when social needs are not sufficiently satisfied, because tasks of basic public services are privatized allowing private suppliers to neglect tasks that do not generate profits.
In the case of unregulated foreign trade on open markets, undesirable developments intensify and can disrupt entire domestic markets (so-called market disruption). Market disruption occurs mainly when a country imports a large number of products whose prices are below the domestic price level due to unadjusted or deliberately manipulated exchange rates by trading partners (currency war/competitive devaluation), or because trading partners use social dumping, environmental dumping or other forms of dumping to undercut prices. Once domestic markets are disrupted, the dependence on imports imposes increasing risks, ultimately tempting exporting countries to deliver poor quality at excessive prices. For more details I recommend the article Economic Dumping.
In essence, three undesirable developments can be distinguished which, under today’s neoliberal economic doctrine, have taken on extreme proportions and are all caused by a lack of economic policy regulation:
Undesirable development 1: With absolute freedom for market participants – and reinforced by open global markets – concentrations of economic power and capital and cartels arise that use economies of scale and scope to reduce their costs, form monopolistic structures that restrict competition, encourage pricing thats leads to usurious prices and result in de-industrialisation with high social and ecological costs.
As a result of monopolistic structures and externalized costs, economic returns flow to a minority of private capital owners, while the social and environmental costs are, due to the unregulated market mechanism, imposed on the general public and future generations – a typical symptom of capitalist excesses.
Undesirable development 2: With absolute freedom granted to market participants, prices formed for the factor natural resources are too low, rising only shortly before the final exploitation of individual resources, because players on unregulated markets only perceive the scarcity and finiteness of resources if it is already too late.
In contrast, an oversupply of the factor labour arises: The basic increase of capital intensity of production due to technological progress generates more and more unemployment, mainly because the lack of economic policy regulation prevents regular adjustments of wages and working hours to productivity growth, i.e. after an increase in productivity wages are not increased and working hours not reduced, but instead jobs are cut. The job search of the unemployed creates an excess supply on the labour market, with the result that the wages of those still employed fall below the subsistence level in competition with those seeking work, so that unequal distribution and poverty spread among both the employed and unemployed.
Both the ecological and social costs are again externalized due to the unregulated market mechanism – a second symptom of capitalist excesses.
Undesirable development 3: With absolute freedom granted to market participants, a widespread belief in the prosperity and welfare-promoting effect of the unregulated market mechanism arises – promoted by selfish and self-protecting indoctrination of neoliberal protagonists. In this environment the willingness increases to hand over tasks of basic public services such as water supply, local transport, social security, education, health and culture (so-called public or merit goods) to the unregulated market mechanism and private enterprises.
This has further devastating consequences for social cohesion: Companies concentrate their supply of (originally) public goods on selected segments in which they can generate profits and consequently avoid or neglect all other segments, which then are offered only (if at all) in urban agglomerations and at prices that exclude lower income groups from use – this being a third symptom of capitalist excesses.
6. The Market Economy
It follows from the market mechanism described that the market economy is an order in which private enterprises and households make their decisions freely, independently and decentrally. This freedom applies to all market categories described below. Therefore the market mechanism not only works within individual markets, but also across markets. Meaning that markets influence each other because, firstly, products from one market can be replaced (substituted) by products from other markets, and, secondly, because the volume of human labour needed is increasingly reduced by automation and rationalisation, i.e. replaced by physical capital, and, thirdly, because the entire material, immaterial and financial resources available to markets are limited.
Private companies are free to decide on their production and investments in physical capital as well as on jobs and thus on labour demand; private households are free to decide on their labour supply, consumption and savings rate. The economic cycle is complete when a portion of the household income from wages and interest on capital flows back to companies as consumer spending, and when commercial banks make household savings available to companies as loans with a portion of the interest on loans flowing back to households. In addition, the loan volume can be increased in a controlled manner through the creation of money by a central bank and subsequently through the creation of money by commercial banks to promote economic dynamism and technological innovation (see also the article Money Creation and Destruction). The economic cycle illustrates that the price is the central instrument of coordination, not only in the form of the product price, but also in the form of wages (the price of labour) and interest on capital (the price of capital).
7. Adam Smith’s Legacy
The scientific analysis of the market economy begins in the 18th century with the Scottish moral philosopher and national economist Adam Smith, who describes an order of »natural freedom« as a counter model to the existing economic system exploited at the time by political absolutism, the so-called mercantilism. In his main work »An Inquiry into the Nature and Causes of the Wealth of Nations« he lays the foundation for the market economy with the astonishing conclusion: »It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest«. It is Smith’s merit to have given the market economy the place it deserves under the economic orders and to have pointed out that individual self-interests can serve the common good. Today it is our responsibility to further develop Smith’s legacy to meet contemporary needs by working to steer the »natural freedom« of the market economy towards a socially and ecologically compatible regime and, at the same time, make it as profitable as possible, thus protecting it – especially in view of neoliberal conditions – against a false conception of freedom and self-serving appropriation.
8. The Social-Ecological Market Economy
Figure 2: The social-ecologically controlled market economy is the contemporary answer to the experience gained from market and state-directed economy systems since Adam Smith’s times. Since the market economy combines individual economic freedom with binding rules, it ensures that freedom is granted equally to all economic players. In other words, the economic freedom granted to an individual or a group must not lead to restrictions on the freedom of others. Each market participant must be held accountable by the rules vis-à-vis other market participants, society and the environment. Market economy rules are indispensable because only they can ensure a balance of power between economic participants (entrepreneurs, employees, investors and consumers) and, at the same time, protect natural resources from economic overexploitation.
Under this economic imperative, the apparent contradiction between individual economic freedom and governmental regulation dissolves, especially if the regulation is democratically legitimized.
For modern industrial societies, the social-ecologically controlled market economy can almost be described as the ideal order, if it is established in conjunction with a free and democratic order based on the rule of law.
In economic history, attempts have been made time and again to present individual freedom and the governmental control of freedom as incompatible and hence to construe a natural contradiction – usually for selfish reasons. All successful attempts in this regard have resulted in lawless (anarchic) conditions. The current process of the neoliberal globalisation is the most recent example.
9. The Competition under Social-Ecological Regulation
The core of a social-ecological market economy is a competition regime embedded in the overall economic order, whose main function is to compensate for the imbalances in economic power and economic capital, including the tendency to form cartels, that arise between market participants. The »silver bullet« in compensating the imbalances are subsidiary structures. The balance of power thus achieved ensures that the trade-off between supply and demand is placed at the service of the common good. Under these conditions, and only under these, the players’ striving for competitive advantages in price and performance automatically generates social and ecological progress, i.e. qualitative growth (see also the article Economic Subsidiarity).
The practical building of subsidiary economic structures under the conditions of the neoliberal globalization as an entry into a post-neoliberal economic order is dealt with in the article Building Subsidiary Economic Structures.
However, the overall economic and social advantage is always associated with setbacks for individual market participants and individual sectors. Setbacks are caused by external costs. In the case of social-ecological control, however, by conducive external costs serving progress, that is, these costs stimulate learning processes among those affected and repeatedly give them new opportunities to accentuate their own abilities under different conditions or in other sectors, thus bringing about a constant renewal and further development of economic activities and economic diversity.
For example, suppliers (entrepreneurs as well as employees) or entire industries can be elbowed out of the market and their investments devalued without them being finally excluded from participation in economic life, as is the case in neoliberal predatory competition in deregulated global markets. Conducive external costs (conducive externalities) are therefore an indispensable functional condition of a controlled market economy, without which competition could not fulfil its dynamic function directed at progress. These costs should therefore not be confused with distortive external costs (distortive externalities) of an uncontrolled market economy, that distort competition and are imposed on the general public as social and ecological costs. For an in-depth insight into the topic I recommend the article Economic externalities.
10. The Markets under Social-Ecological Regulation
In terms of their economic function, factor and product markets must be distinguished. On the factor markets, the productive factors labour, natural resources (raw materials and land) and capital (monetary and physical capital) are traded and provide the original input for productions. On the product markets, goods and services are traded as end products for consumers (consumer goods markets), but also goods and services for companies, including semi-finished and intermediate products (capital goods markets), which in turn serve as input for production. That is, the capital goods markets have a dual function because they initially produce products as output, that constitute physical capital, and subsequently use these products as direct input to other productions.
The Three Factor Markets
(1) On the labour market the area of tension between supply and demand ensures that workers can demand wages (as a price for work) which secure their livelihood – provided that social regulation and a balance of power between entrepreneurs and employees is established. Wages are then largely returned to businesses as consumer spending and thus keep economic cycles going, but are also partly saved and offered to businesses by commercial banks as loans. At the same time, the area of tension ensures that companies have access to an optimally trained and motivated workforce at reasonable labour costs. For further information see the article Full Employment.
(2) On the raw materials and real estate market the area of tension between supply and demand ensures that natural resources are traded at a price that at least covers the expenses to safeguard their permanent substance preservation – provided that ecological regulation by means of appropriate taxation and legal requirements is established offering entrepreneurs incentives to use resources efficiently. For non-renewable raw materials efficiency is achieved through largely closed material cycles or their substitution by renewable raw materials; for renewable raw materials efficiency means that they are only used within the limits of their natural regenerative capacity.
(3) On the capital market the area of tension between supply and demand ensures that lenders (private households and commercial banks) can demand interest (as the price for capital) for their savings deposits and created money respectively that allows them to reasonably share in the overall productivity growth and at the same time is calculated such that companies as borrowers are able to keep their production capital up-to-date and thus contribute to general progress – provided again that social regulation and a balance of power between entrepreneurs and employees is established.
The presentation of the factor markets shows that the economic functions of »worker« und »investor« are combined in individual persons, above all in dependent employees whose savings balance represents the original monetary capital for entrepreneurial investments, and the resulting interest payments are, at the same time, their second pillar of income. Therefore, no »law of nature« exists that would inevitably force workers and investors to regard each other as opponents belonging to separate social groups or even classes.
The Product Markets
On the product markets, the area of tension between supply and demand under social-ecological regulations ensures that companies can demand prices for their products that secure their competitiveness and existence in the long term and also enable them to pay living wages and appropriate interest on loans. At the same time, consumers and other buyers are in a position to pay prices that offer them modern products and services in line with the level of productivity.
11. Prerequisites of a Social-Ecological Market Economy
The first part of the prerequisites listed below is usually also used for unregulated market economies. In the second part, the necessary regulations are shown in a supplementary or restrictive way, which are suitable to guide the market economy into a socially and ecologically sustainable, non-capitalistic direction and at the same time turning it into a foundation and guarantor for a sustainable economic globalization.
Prerequisites Part 1
Prerequisites Part 2
12. Extract of the Socal-Ecological Market Economy
The overarching goals of a social-ecological market economy are full employment and environmental protection. Full employment is achieved by making production as decentralised and diverse as possible in terms of production technology, with as much balanced participation and economic share of the working population as possible, with as much domestic and foreign economic competition as possible and with as much internal and external knowledge as possible.
Environmental protection is achieved by transferring responsibility for the preservation of the environment as far as possible to local and regional people and by imposing high taxes or legislation on the shifting and export of environmental burdens, by promoting energy- and raw material-efficient production and products, while all others, including scarce resources, are subject to high taxation, and by promoting small-scale economic cycles as the foundation of higher-level and global cycles and by taxing transport services progressively.
For a more detailed introduction to the social-ecologically regulated market economy, I recommend the following articles: Comparative Advantage – Upgraded, Future-Proof Foreign Trade, and also Sustainable Social Welfare.
Click here for the German language version: Markt und Marktwirtschaft
Smith, Adam: An Inquiry into the Nature and Causes of the Wealth of Nations. Modern Library, 1994