Market economy
Encyclopedia
A market economy is an economy in which the prices of goods and services are determined in a free price system
. This is often contrasted with a state-directed or planned economy
. Market economies can range from hypothetically pure laissez-faire
variants to an assortment of real-world mixed economies
, where the price system
is under some state control or at least heavily regulated. In mixed economies, state-directed economic planning
is not as extensive as in a planned economy.
In the real world, market economies do not exist in pure form, as societies and governments regulate them to varying degrees rather than allow full self-regulation by market forces. The term free-market economy is sometimes used synonymously with market economy, but, as Ludwig Erhard
once pointed out, this does not preclude an economy from having social attributes
opposed to a laissez-faire
system.
The term used by itself can be somewhat misleading. For example, the United States constitutes a mixed economy (substantial market regulation
, agricultural subsidies
, extensive government-funded research and development
, Medicare
/Medicaid
), yet at the same time it is foundationally rooted in a market economy. Different perspectives exist as to how strong a role the government should have in both guiding the market economy and addressing the inequalities the market produces. This is evidenced by the current lack of consensus on issues such as central bank
ing and welfare.
It is also possible to envision an economic system based on independent producers, cooperative
, democratic worker ownership
and market allocation of final goods and services; the self-managed
market economy is one of several proposed forms of market socialism
.
there are more market economy traits than in the Western Europe
an countries (an exception being the UK, which is considered, even by Greenspan, to be a freer market than the US).
Capitalism has been dominant in the Western world since the end of feudalism
, but most feel that the term "mixed economies" more precisely describes most contemporary economies, due to their containing both private-owned and state-owned enterprises, combining elements of capitalism
and socialism
, or mixing the characteristics of market economies and planned economies.
In capitalism, there is no central planning authority but the prices are decided by the demand-supply scale. For example, higher demand for certain goods and services lead to higher prices and lower demand for certain goods lead to lower prices.
by free market advocates) and no taxes or tariffs other than what is necessary for the government to provide protection from coercion and theft and maintaining peace, and property rights.
Milton Friedman
and Friedrich Hayek
stated that economic freedom
is a necessary condition for the creation and sustainability of civil and political freedoms. They believed that this economic freedom can only be achieved in a market-oriented economy, specifically a free market economy. They do believe, however, that sufficient economic freedom can be achieved in economies with functioning markets through price mechanisms and private property rights. They believe that the more economic freedom that is available, the more civil and political freedoms a society will enjoy.
Friedman states:
Studies by the Canadian libertarian
think tank Fraser Institute
and the American conservative think tank Heritage Foundation
state that there is a relationship between economic freedom and political and civil freedoms to the extent claimed by Friedrich von Hayek. They agree with Hayek that those countries which restrict economic freedom ultimately restrict civil and political freedoms.
Generally market economies are bottom-up in decision-making as consumers convey information to producers through prices paid in market transactions. All states today have some form of control over the market that removes the free and unrestricted direction of resources from consumers and prices such as tariffs and corporate subsidies. Milton Friedman and many other microeconomists believe that these forms of intervention provide incentives for resources to be misused and wasted, producing products society may not value
as much as a product that is valued as a result of these restrictions.
and Ludwig Erhard
after World War II
in West Germany
. The social market economic model is based upon the idea to realise the benefits of a free market economy, especially on economic performance and high supply of goods, while avoiding disadvantages such as market failure
, destructive competition, concentration of economic power and anti-social effects of market processes. The aim of the social market economy is to realize greatest prosperity combined with best possible social security. As a difference to the free market economy the state is not passive, but actively takes regulative
measures. The social policy objectives include employment, housing and education policies, as well as a socio-politically motivated balancing of the distribution of income growth. Characteristics of social market economies are a strong competition policy and a contractionary monetary policy
. The theoretical fundament is build on ordoliberalism
, Catholic social teaching
and Democratic Socialism.
Libertarian socialists and left-anarchists often promote a form of market socialism in which enterprises are owned and managed cooperatively by the workers so that the profits directly remunerate the employee-owners. These cooperative enterprises would compete with each other in the same way private companies compete in a capitalist market. An example would be Mutualism (economic theory)
.
currently has a form of market socialism referred to as the socialist market economy
, in which most of the industry is state-owned through a shareholder system, but prices are set by a largely free-price system. Within this model, the state-owned enterprises are free from excessive micromanagement and function more autonomously in a decentralized fashion than in planned economies. A similar socialist-oriented market system has been implemented in Vietnam
following the Doi Moi reforms.
and Michael Albert
Another practical objection is the claim that markets do not take into account externalities (effects of transactions that affect third parties), such as the negative effects of pollution or the positive effects of education. What exactly constitutes an externality may be up for debate, including the extent to which it changes based upon the political climate. Some proponents of market economies believe that governments should not diminish market freedom because they disagree on what is a market externality and what are government-created externalities, and disagree over what the appropriate level of intervention is necessary to solve market-created externalities. Others believe that government should intervene to prevent market failure
while preserving the general character of a market economy. In the model of a social market economy
the state intervenes where the market does not meet political demands. John Rawls
was a prominent proponent of this idea.
Free price system
A free price system or free price mechanism is an economic system where prices are set by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of...
. This is often contrasted with a state-directed or planned economy
Planned economy
A planned economy is an economic system in which decisions regarding production and investment are embodied in a plan formulated by a central authority, usually by a government agency...
. Market economies can range from hypothetically pure laissez-faire
Laissez-faire
In economics, laissez-faire describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies....
variants to an assortment of real-world mixed economies
Mixed economy
Mixed economy is an economic system in which both the state and private sector direct the economy, reflecting characteristics of both market economies and planned economies. Most mixed economies can be described as market economies with strong regulatory oversight, in addition to having a variety...
, where the price system
Price system
In economics, a price system is any economic system that affects its distribution of goods and services with prices and employing any form of money. Except for possible remote and primitive communities, all modern societies use price systems to allocate resources...
is under some state control or at least heavily regulated. In mixed economies, state-directed economic planning
Economic planning
Economic planning refers to any directing or planning of economic activity outside the mechanisisms of the market, in an attempt to achieve specific economic or social outcomes. Planning is an economic mechanism for resource allocation and decision-making in contrast with the market mechanism...
is not as extensive as in a planned economy.
In the real world, market economies do not exist in pure form, as societies and governments regulate them to varying degrees rather than allow full self-regulation by market forces. The term free-market economy is sometimes used synonymously with market economy, but, as Ludwig Erhard
Ludwig Erhard
Ludwig Wilhelm Erhard was a German politician affiliated with the CDU and Chancellor of West Germany from 1963 until 1966. He is notable for his leading role in German postwar economic reform and economic recovery , particularly in his role as Minister of Economics under Chancellor Konrad Adenauer...
once pointed out, this does not preclude an economy from having social attributes
Social market economy
The social market economy is the main economic model used in West Germany after World War II. It is based on the economic philosophy of Ordoliberalism from the Freiburg School...
opposed to a laissez-faire
Laissez-faire
In economics, laissez-faire describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies....
system.
The term used by itself can be somewhat misleading. For example, the United States constitutes a mixed economy (substantial market regulation
Regulation
Regulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...
, agricultural subsidies
Agricultural subsidy
An agricultural subsidy is a governmental subsidy paid to farmers and agribusinesses to supplement their income, manage the supply of agricultural commodities, and influence the cost and supply of such commodities...
, extensive government-funded research and development
Research and development
The phrase research and development , according to the Organization for Economic Co-operation and Development, refers to "creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society, and the use of this stock of...
, Medicare
Medicare (United States)
Medicare is a social insurance program administered by the United States government, providing health insurance coverage to people who are aged 65 and over; to those who are under 65 and are permanently physically disabled or who have a congenital physical disability; or to those who meet other...
/Medicaid
Medicaid
Medicaid is the United States health program for certain people and families with low incomes and resources. It is a means-tested program that is jointly funded by the state and federal governments, and is managed by the states. People served by Medicaid are U.S. citizens or legal permanent...
), yet at the same time it is foundationally rooted in a market economy. Different perspectives exist as to how strong a role the government should have in both guiding the market economy and addressing the inequalities the market produces. This is evidenced by the current lack of consensus on issues such as central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
ing and welfare.
It is also possible to envision an economic system based on independent producers, cooperative
Cooperative
A cooperative is a business organization owned and operated by a group of individuals for their mutual benefit...
, democratic worker ownership
Worker cooperative
A worker cooperative is a cooperative owned and democratically managed by its worker-owners. This control may be exercised in a number of ways. A cooperative enterprise may mean a firm where every worker-owner participates in decision making in a democratic fashion, or it may refer to one in which...
and market allocation of final goods and services; the self-managed
Self-management
Self-management means different things in different fields:* In business, education, and psychology, self-management refers to methods, skills, and strategies by which individuals can effectively direct their own activities toward the achievement of objectives, and includes goal setting, decision...
market economy is one of several proposed forms of market socialism
Market socialism
Market socialism refers to various economic systems where the means of production are either publicly owned or cooperatively owned and operated for a profit in a market economy. The profit generated by the firms system would be used to directly remunerate employees or would be the source of public...
.
Systems
Although no country has ever had within its border an economy in which all markets were absolutely free, the term typically is not used in an absolute sense. Many states which are said to have a market economy have a high level of market freedom, even if it is less than some parts of the population would prefer. Thus, almost all economies in the world today are mixed economies with varying degrees of free market and planned economy traits. For example, in the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
there are more market economy traits than in the Western Europe
Western Europe
Western Europe is a loose term for the collection of countries in the western most region of the European continents, though this definition is context-dependent and carries cultural and political connotations. One definition describes Western Europe as a geographic entity—the region lying in the...
an countries (an exception being the UK, which is considered, even by Greenspan, to be a freer market than the US).
Capitalism
Capitalism generally refers to an economic system in which the means of production are all or mostly privately owned and operated for profit, and in which investments, distribution, income, and pricing of goods and services are determined through the operation of a market economy. It is usually considered to involve the right of individuals and groups of individuals acting as "legal persons" or corporations to trade capital goods, labor, land and money. Capitalism rarely results in change for the public good, as the market is unable to correct itself in almost all cases.(canada is not a market econ.)Capitalism has been dominant in the Western world since the end of feudalism
Feudalism
Feudalism was a set of legal and military customs in medieval Europe that flourished between the 9th and 15th centuries, which, broadly defined, was a system for ordering society around relationships derived from the holding of land in exchange for service or labour.Although derived from the...
, but most feel that the term "mixed economies" more precisely describes most contemporary economies, due to their containing both private-owned and state-owned enterprises, combining elements of capitalism
Capitalism
Capitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...
and socialism
Socialism
Socialism is an economic system characterized by social ownership of the means of production and cooperative management of the economy; or a political philosophy advocating such a system. "Social ownership" may refer to any one of, or a combination of, the following: cooperative enterprises,...
, or mixing the characteristics of market economies and planned economies.
In capitalism, there is no central planning authority but the prices are decided by the demand-supply scale. For example, higher demand for certain goods and services lead to higher prices and lower demand for certain goods lead to lower prices.
Laissez-faire
Laissez-faire is synonymous with what was referred to as strict capitalist free market economy during the early and mid-19th century as an ideal to achieve. It is generally understood that the necessary components for the functioning of an idealized free market include the complete absence of government regulation, subsidies, artificial price pressures and government-granted monopolies (usually classified as coercive monopolyCoercive monopoly
In economics and business ethics, a coercive monopoly is a business concern that prohibits competitors from entering the field, with the natural result being that the firm is able to make pricing and production decisions independent of competitive forces...
by free market advocates) and no taxes or tariffs other than what is necessary for the government to provide protection from coercion and theft and maintaining peace, and property rights.
Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
and Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...
stated that economic freedom
Economic freedom
Economic freedom is a term used in economic and policy debates. As with freedom generally, there are various definitions, but no universally accepted concept of economic freedom...
is a necessary condition for the creation and sustainability of civil and political freedoms. They believed that this economic freedom can only be achieved in a market-oriented economy, specifically a free market economy. They do believe, however, that sufficient economic freedom can be achieved in economies with functioning markets through price mechanisms and private property rights. They believe that the more economic freedom that is available, the more civil and political freedoms a society will enjoy.
Friedman states:
- "Economic freedom is simply a requisite for political freedom. By enabling people to cooperate with one another without coercion or central direction it reduces the area over which political power is exercised" Friedman, Milton and Rose Friedman, Free to ChooseFree to ChooseFree to Choose is a book and a ten-part television series broadcast on public television by economists Milton and Rose D...
: A Personal Statement, Harcourt Brace Jovanovich, 1980, p. 2-3 - "Capitalism is a necessary condition for political freedom" Capitalism and freedomCapitalism and FreedomCapitalism and Freedom is a book by Milton Friedman originally published in 1962 by the University of Chicago Press which discusses the role of economic capitalism in liberal society. It sold over 400,000 copies in the first 18 years and more than half a million since 1962. It has been translated...
Studies by the Canadian libertarian
Libertarianism
Libertarianism, in the strictest sense, is the political philosophy that holds individual liberty as the basic moral principle of society. In the broadest sense, it is any political philosophy which approximates this view...
think tank Fraser Institute
Fraser Institute
The Fraser Institute is a Canadian think tank. It has been described as politically conservative and right-wing libertarian and espouses free market principles...
and the American conservative think tank Heritage Foundation
Heritage Foundation
The Heritage Foundation is a conservative American think tank based in Washington, D.C. Heritage's stated mission is to "formulate and promote conservative public policies based on the principles of free enterprise, limited government, individual freedom, traditional American values, and a strong...
state that there is a relationship between economic freedom and political and civil freedoms to the extent claimed by Friedrich von Hayek. They agree with Hayek that those countries which restrict economic freedom ultimately restrict civil and political freedoms.
Generally market economies are bottom-up in decision-making as consumers convey information to producers through prices paid in market transactions. All states today have some form of control over the market that removes the free and unrestricted direction of resources from consumers and prices such as tariffs and corporate subsidies. Milton Friedman and many other microeconomists believe that these forms of intervention provide incentives for resources to be misused and wasted, producing products society may not value
Value (economics)
An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...
as much as a product that is valued as a result of these restrictions.
Social market economy
This model was implemented by Alfred Müller-ArmackAlfred Müller-Armack
Alfred Müller-Armack was a German economist and politician.He was professor of economics at University of Münster and University of Cologne. Müller-Armack coined the term "social market economy" in 1946....
and Ludwig Erhard
Ludwig Erhard
Ludwig Wilhelm Erhard was a German politician affiliated with the CDU and Chancellor of West Germany from 1963 until 1966. He is notable for his leading role in German postwar economic reform and economic recovery , particularly in his role as Minister of Economics under Chancellor Konrad Adenauer...
after World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
in West Germany
West Germany
West Germany is the common English, but not official, name for the Federal Republic of Germany or FRG in the period between its creation in May 1949 to German reunification on 3 October 1990....
. The social market economic model is based upon the idea to realise the benefits of a free market economy, especially on economic performance and high supply of goods, while avoiding disadvantages such as market failure
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...
, destructive competition, concentration of economic power and anti-social effects of market processes. The aim of the social market economy is to realize greatest prosperity combined with best possible social security. As a difference to the free market economy the state is not passive, but actively takes regulative
Regulation
Regulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...
measures. The social policy objectives include employment, housing and education policies, as well as a socio-politically motivated balancing of the distribution of income growth. Characteristics of social market economies are a strong competition policy and a contractionary monetary policy
Contractionary monetary policy
Contractionary monetary policy is monetary policy that seeks to reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a finance ministry....
. The theoretical fundament is build on ordoliberalism
Ordoliberalism
Ordoliberalism is a school of liberalism that emphasised the need for the state to ensure that the free market produces results close to its theoretical potential . The theory was developed by German economists and legal scholars such as Walter Eucken, Franz Böhm, Hans Grossmann-Doerth and Leonhard...
, Catholic social teaching
Catholic social teaching
Catholic social teaching is a body of doctrine developed by the Catholic Church on matters of poverty and wealth, economics, social organization and the role of the state...
and Democratic Socialism.
Market socialism
Market socialism refers to various economic systems in which the state owns the economic institutions and major industries but operates them according to the rules of supply and demand. In a traditional market socialist economy, prices would be determined by a government planning ministry, and enterprises would either be state-owned or cooperatively-owned and managed by their employees. The distinguishing feature between non-market socialism and market socialism is the existence of a market for the means of production, and the criteria of profitability for public enterprises; which can either be used to reinvest in production or finance government and social services directly.Libertarian socialists and left-anarchists often promote a form of market socialism in which enterprises are owned and managed cooperatively by the workers so that the profits directly remunerate the employee-owners. These cooperative enterprises would compete with each other in the same way private companies compete in a capitalist market. An example would be Mutualism (economic theory)
Mutualism (economic theory)
Mutualism is an anarchist school of thought that originates in the writings of Pierre-Joseph Proudhon, who envisioned a society where each person might possess a means of production, either individually or collectively, with trade representing equivalent amounts of labor in the free market...
.
Socialist market economy
The People's Republic of ChinaPeople's Republic of China
China , officially the People's Republic of China , is the most populous country in the world, with over 1.3 billion citizens. Located in East Asia, the country covers approximately 9.6 million square kilometres...
currently has a form of market socialism referred to as the socialist market economy
Socialist market economy
The socialist market economy or socialist market economy with Chinese characteristics is the official term used to refer to the economic system of the People's Republic of China after the reforms of Deng Xiaoping. It is also referred to as socialism with Chinese characteristics...
, in which most of the industry is state-owned through a shareholder system, but prices are set by a largely free-price system. Within this model, the state-owned enterprises are free from excessive micromanagement and function more autonomously in a decentralized fashion than in planned economies. A similar socialist-oriented market system has been implemented in Vietnam
Vietnam
Vietnam – sometimes spelled Viet Nam , officially the Socialist Republic of Vietnam – is the easternmost country on the Indochina Peninsula in Southeast Asia. It is bordered by China to the north, Laos to the northwest, Cambodia to the southwest, and the South China Sea –...
following the Doi Moi reforms.
Criticisms
Robin HahnelRobin Hahnel
Robin Hahnel is a Professor of Economics at Portland State University. He is best known for his work on participatory economics with Z Magazine editor Michael Albert. He is currently a visiting professor at Lewis & Clark College....
and Michael Albert
Michael Albert
Michael Albert is an American activist, economist, speaker, and writer. He is co-editor of ZNet, and co-editor and co-founder of Z Magazine. He also co-founded South End Press and has written numerous books and articles...
"(...) claim that markets inherently produce class divisionSocial classSocial classes are economic or cultural arrangements of groups in society. Class is an essential object of analysis for sociologists, political scientists, economists, anthropologists and social historians. In the social sciences, social class is often discussed in terms of 'social stratification'...
" {divisions between conceptual and manual laborers, and ultimately managers and workers, and a de facto labor market for conceptual workers}. Albert says that even if everyone started out with a balanced job complexBalanced job complexA balanced job complex is a way of organizing a workplace or group that is both directly democratic and also creates relative equal empowerment among all people involved....
{doing a mix of roles of varying creativity, responsibility and empowerment} in a market economy, class divisions would arise. Without taking the argument that far, it is evident that in a market system with uneven distribution of empowering work, such as Economic Democracy {the model of market socialism David SchweickartDavid SchweickartDavid Schweickart is an American mathematician and philosopher. He holds a BS in Mathematics from University of Dayton, a PhD in Mathematics from University of Virginia, and a PhD in Philosophy from Ohio State University. He currently is Professor of Philosophy at Loyola University Chicago.He has...
has developed and refers to as "economic democracy"}, some workers will be more able than others to capture the benefits of economic gain. For example if one worker designs cars and another builds them, the designer will use his cognitive skills more frequently than the builder. In the long term, the designer will become more adept at conceptual work than the builder, giving the designer greater bargaining power in a firm over the distribution of income. A conceptual worker who is not satisfied with his income can threaten to work for a company that will pay him more (...)".
Therefore according to this critique class divisions would arise inevitably.
Another practical objection is the claim that markets do not take into account externalities (effects of transactions that affect third parties), such as the negative effects of pollution or the positive effects of education. What exactly constitutes an externality may be up for debate, including the extent to which it changes based upon the political climate. Some proponents of market economies believe that governments should not diminish market freedom because they disagree on what is a market externality and what are government-created externalities, and disagree over what the appropriate level of intervention is necessary to solve market-created externalities. Others believe that government should intervene to prevent market failure
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...
while preserving the general character of a market economy. In the model of a social market economy
Social market economy
The social market economy is the main economic model used in West Germany after World War II. It is based on the economic philosophy of Ordoliberalism from the Freiburg School...
the state intervenes where the market does not meet political demands. John Rawls
John Rawls
John Bordley Rawls was an American philosopher and a leading figure in moral and political philosophy. He held the James Bryant Conant University Professorship at Harvard University....
was a prominent proponent of this idea.
See also
- Free marketFree marketA free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...
- MarketMarketA market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
- Economic freedomEconomic freedomEconomic freedom is a term used in economic and policy debates. As with freedom generally, there are various definitions, but no universally accepted concept of economic freedom...
- Grey marketGrey marketA grey market or gray market also known as parallel market is the trade of a commodity through distribution channels which, while legal, are unofficial, unauthorized, or unintended by the original manufacturer...
- Market socialismMarket socialismMarket socialism refers to various economic systems where the means of production are either publicly owned or cooperatively owned and operated for a profit in a market economy. The profit generated by the firms system would be used to directly remunerate employees or would be the source of public...
- Mixed economyMixed economyMixed economy is an economic system in which both the state and private sector direct the economy, reflecting characteristics of both market economies and planned economies. Most mixed economies can be described as market economies with strong regulatory oversight, in addition to having a variety...
- Planned economyPlanned economyA planned economy is an economic system in which decisions regarding production and investment are embodied in a plan formulated by a central authority, usually by a government agency...
- Regulated marketRegulated marketA regulated market or controlled market, is the provision of goods or services that is regulated by a government appointed body. The regulation may cover the terms and conditions of supplying the goods and services and in particular the price allowed to be charged and/or to whom they are distributed...