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CHARACTERISTICS OF FREE MARKETS - CONT'D

Competition

Competition is important but it is not critical for the free markets. Free markets were created before competition, operated without competition, in some instances they operate without competition and can continue to operate without it. This is a fact. The reasons are complex and lengthy deserving of their own lesson, and so, we will talk about competition in the next one.

Government intervention

Market efficiency effectively produces choices in goods and services. These choices produce lower prices and so we are gifted with a system that provides us with the solutions we need at the lowest prices. This is what standards of living are all about. Giving us affordable choices to make our lives better. It is quite simple, really.

However, there is problem. It is called government and its masters, the politicians, who must be seen as adding meaningful value to it. They do so in order to maximize their votes. However, in this process, the only thing they manage to do is to de-optimize free markets. Consequence? Our standards of living drop.

It is helpful to see a graph depicting what happens with a free market in terms of standards of living.

Let’s begin with standards of living over time. The plot below shows how our living gets better and better all the time, thanks to markets. You may also notice that this improvement is not a straight line, but a curve that accelerates the further one moves into the future. This is yet another benefit of free markets since invested capital begets capital in a self-sustainable and self-accelerating cycle (engineers would call it “positive-feedback”).

 

Standards of Living

 

Now let’s take a look at a plot showing what governments do to our standards of living when they mess around with the free market.

 

Government Intervention In Markets

 

Market activity is represented by a blue line. This line has a maximum (point A). This is the maximum standard of living we can obtain in a given market; it is also the point at which a free market operates. It is the optimum point.

If we move to the left (point B), we can see that the standards of living decrease. This is what happens when government intervenes by either regulating or prohibiting market activities. The reason for this drop is quite obvious. Regulations and prohibitions are simply restrictions on market operations. In other words, markets do less than under a free market. Less market activity means less goods and services, which in turn means lower standards of living.

If we move to the right (point C), we can see that standards of living also decrease. This is what happens when the government intervenes by subsidizing market activities. This drop may seem strange because the government wishes to increase certain market activities. How is this possible? Because there is no free lunch. If a specific market activity must be increased above and beyond its natural level, it will require extra resources. These resources must come from somewhere and as resources are not infinite, they must simply be taken from some other business activity.

There are several problems with this.

The first is that this shifting of resources is disturbing a finely tuned system. If we take from industry X and give it to Y, industry X cannot adequately fulfill its role in the productive cycle. This affects many other industries in a snowballing effect. Less production means lower standards of living.

The second is that the amount produced by Y was tailored to satisfy an existing demand. If we push Y to produce beyond demand, there will be manufacturing excesses which won’t be purchased. This means that either they will go to waste or their price will have to drop significantly. If they go to waste, those resources are… well… wasted. If they drop the price other competing industries will be affected having lower sales and therefore producing less which will decrease our standards of living

The third is that subsidies are not based on real needs (which are already properly satisfied by the free market) but by politicians’ perceived needs. In other words, subsidies are simply vote purchases. As such, they do not help citizens in general and at the same time they disrupt the free market, which then produces less which leads to lower standards of living.

The fourth is that subsidies are in effect money given by a small market segment. This money either comes from taxes, borrowing or printing. In any case, it is money that belongs to you or will be taken from you through inflation. In other words: theft.

Of course, governments typically intervene in both ways at the same time, which have devastating effects.

Let’s now take a look at both graphics superimposed over time.

 

Government Ruining Markets

 

The vertical axis shows our standards of living. The horizontal axis shows time. For each point in time, we have an inverted blue “U” curve. These represent all possible market activities with all possible government interactions. In addition, we have three curves (Green, Yellow and Red) representing different degrees of government interaction. Green represents a free market where government interaction is zero. Yellow represents our current, average standard of living with governments interacting heavily with the economy. Red represents a dictatorship, with governments giving orders to the economy. Finally, a Red Dashed line represents communism (government’s total and complete planning and directing of all economic activities).

This shows not only what happens when governments interact with markets (our standard of living drop) but it also depicts the fact that the drop is not equal. The more interaction there is, the less powerful the market becomes to correct those problems. This is only common sense. The more elements are removed from a productive cycle, the more damage is inflicted on other productive processes that were not directly affected. Think of it in these terms. If a government nationalizes nail manufacturing and makes it inefficient, all manners of carpentry will suffer. Carpentry was not targeted for nationalization, but it was a victim nevertheless.

All these graphs emphasize a very simple idea: free markets are already optimized. Any tampering only decreases our standards of living.

 

CONCLUSION

In the end, Mr Free Market is the one that give us constantly higher standards of living. Mr Free Market is a group effort, not a government design. Mr Free Market is not perfect, but it is the best we have. Mr Free Market is the apex of freedom.

All these ideas emphasize a very simple truth: free markets are already optimized. Any tampering only decreases our standards of living.

You now have a decision to make. You can continue tolerating increasingly lower standards of living or you can oppose the system by spreading the truth. It’s your choice, as usual

Note: please see the Glossary if you are unfamiliar with certain words.

 

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