4.10.2005 kl. 20:18

There is a surprising number of people who believe that an unregulated free market will always produce the most efficient outcome in terms of benefits to the consumer. I think this is completely and utterly wrong -- the free market quite clearly has some serious shortcomings which need to be addressed in order to maximise consumer benefit and I intend to demonstrate my point by way of a few examples.

(Disclaimer: I am not an economist and know only a little about modern economics. That being said, I would welcome any suggestions on how an unregulated market could circumvent these problem)

I. Natural monopolies and exclusive goods

Certain things in life are exclusive. The physical space which I occupy at this moment is one example. As long as I occupy this space at this moment, nobody else can. Thus, insofar as we can speak of occupying this space as a good, it is exclusive. You may, of course, point out that it is possible for me to move and allow someone else to occupy this space, or that standing in the general vicinity will provide much the same value, or even that occupying this space at this moment is not a good which is highly sought after, but this would simply be dodging the issue at hand. The fact of the matter is that a number of goods in the real world are unique and therefore exclusive. If I own the Mona Lisa, nobody else can. The supply of Mona Lisas cannot change -- it will always be limited to that single painting. It is therefore strange to believe that the free-market mechanics of supply and demand apply here. Whoever owns the Mona Lisa has an unchallengeable and absolute monopoly.

Certain natural resources will tend to create natural monopolies as the consequence of unavoidable geographical facts. If someone owns the only oasis in a treacherous desert, with no alternate sources of water nearby, his monopoly on water will be very hard, if not impossible, to break. Any travellers passing through the desert will be compelled to pay the asking price, irrespective of how outrageous it may be, and irrespective of the costs of operating the oasis. The owner of the oasis can thus extort huge sums from the thirsty traveller by way of his natural monopoly. This is not an efficient outcome for the consumer, or for desert-travellers in general.

If we cursorily examine the services necessary to operate a large metropolis, we run into some problems concerning the application of free-market ownership policies. What should we do about roads, electric lines, telephone lines and water pipes? All of these are essential parts of the infrastructure required to maintain developed economies. They are also more or less exclusive, or require drastic inefficiencies in order to become non-exclusive. While it is perfectly possible to have many roads side by side, or several different telephone/electric lines running into people's houses, it can hardly be considered an exemplary use of resources. In this case, I would argue that the inefficiencies involved more than counter any consumer benefits caused by competition, and in the case of roads, I would argue that private ownership would make modern city transportation almost impossible, or at least highly inefficient. The road is a fine example of an exclusive good -- if someone owns a given road, nobody else can compete in providing the service of that road. I would venture to say that privatisation of public roads would lead to monopolies of transportation over large urban areas, followed by massive extortion on behalf of the service-providers.

The laws of a free market operate best when the barriers to entry in a given market are low and the goods can be manufactured in plenty. Given such a basis, the mechanics of supply and demand will more or less ensure that the market in question answers consumer needs efficiently. Neither advantageously placed natural resources nor unique goods meet this criterion. It is therefore folly to assume that the benefits of the market apply to them.

II. Monopolies on non-exclusive goods that create next-to-impossible barriers to entry

Let us imagine that there is only one company, Toothbrush Inc., which manufactures toothbrushes, and that it manufactures toothbrushes of mediocre quality. It sells these toothbrushes at an inflated price which is much higher than the total cost of production. The owners of this toothbrush company make a lot of money off their monopoly. The laws of the market dictate that some entrepreneur will see it to his benefit to invest money in the toothbrush industry, leading to heads-on competition between him and the incumbent monopoly. As a consequence, the price of toothbrushes will fall and their quality will increase, as each vendor tries to outdo his competitor. The monopoly has been abolished and the consumer benefits. Or so goes the theory.

Let us imagine a slightly different scenario. Let us imagine that Toothbrush Inc. owns vast stockpiles of money. Let us imagine that the company could be run with serious losses for a number of years. In this case, a new contender for the market will meet what may very well be called "unfair competition". As soon he starts marketing a cheap new toothbrush, his rival Toothbrush Inc. will start literally giving away toothbrushes. Toothbrush Inc. can afford giving away free toothbrushes for many years -- meanwhile, the competitor will see his revenue dwindle to zero, and unless he has a similar stockpile of funds, he will eventually be forced to withdraw from the market and lick his wounds. As soon as the competitor withdraws, Toothbrush Inc. ceases its "charity" and resumes with a policy of monopolistic extortion. It has taught would-be competitors a lesson -- they now know they cannot challenge the toothbrush monopoly without enormous funds at their disposal, funds which might be more sensibly invested in other ventures.

This example is not, I might add, some fanciful what-if scenarion. We have many actual cases from the past decade. The Netscape vs. Microsoft case springs immediately to mind. The software giant famously crushed the much smaller start-up with an inferior product by choking their cash flow.

III. Vested interest

Not all entrepreneurs have a vested interest in the future. For most, their interests will last only throughout their lifespan, or, if they are foresighted, that of their children. They can thus make perfectly rational decisions that affect future generations adversely, such as ravaging the fishing resources of the seas, hunting a particular species to extinction or dumping radioactive waste in mine shafts to be exposed one day and cause great harm. If doing any of these things is profitable throughout a life-time, the rational profit-seeker will not hesitate. In the long-term, however, these actions are not profitable or rational from a utilitarian standpoint. Rather, the short-term benefits to the entrepreneur is completely cancelled out by the adverse effects on future generations.

IV. Negative externalities

Externalities occur when production or consumption inadvertently affects third parties who are uninvolved in the production or consumption in question. We speak of "negative externalities" when the effects impose costs of some sort on the third party.

An unregulated free market has problems dealing with negative externalities. Let us imagine that two farmers, Jones and Smith, live on small patches of land next to each other. They both own their land and hold *absolute* property rights over it. One day, Jones decides to learn the trombone, and practises far into the night. Understandably, a sleepless Smith soon becomes frustrated with his neighbour. Without regulation, he has nowhere to turn -- Jones is exercising his right to play the trombone on his own private land.

To take a more serious case: Jones opens up a pig farm on his plot of land -- the noise of the pigs is deafening; their feces stinks for miles around, and their urine pollutes a river that runs through both their lands. Yet again, Smith has no recourse under an absolute property-rights system.

Before long Jones decides to buy all the land surrounding Smith's property. Furthermore, he refuses anyone passage through his newly acquired land, and surrounds it with barbed wire and growling guard dogs. It is now effectively impossible for Smith to leave his property -- as a consequence of Jones' unregulated property-rights, he becomes a prisoner and, deprived of his liberty to meet and trade with other men, ultimately starves to death. It is suitably ironic that a system called the free market should allow such a situation to arise.

V. The problem of ownership

Not everything in life can be owned by someone -- or sometimes the ownership cannot be enforced. The air that we breathe is a fine example. It passes in a flux between the many countries of the world, in defiance of all human regulations and laws. It is also an essential good -- for we cannot survive without air. As such, it is natural to raise questions concerning the best method to regulate it. We are presented with the same problem when it comes to other shared goods, such as soundscape, ozone layer, or the water circulating through the ecosystem. Free-market policies cannot regulate these natural commons -- but zero-regulation policies have negative consequences such as pollution and global warming.

A final word on monopolies

If we assume that every entrepreneur wishes to maximise his profits, he will inevitably reach the conclusion that the best way to do so is to establish a monopoly. While competition is desirable from the standpoint of the consumer, it is in direct contrast to the interests of the entrepreneur. Perfect competition will drive prices down to the point where it just barely pays off to remain in the business instead of investing time and effort elsewhere. But ambitious entrepreneurs do not just want to be "barely compensated" for their time and effort -- they want to become rich. As a consequence, it is the logical objective of every businessman to establish a monopoly. I need not, I think, discuss the obvious disadvantages of tolerating a privately run for-profit monopoly. It is thus necessary to have a legal disincentive for the would-be monopolist.

In conclusion

Based on the points I have raised in this article, I believe that a completely unregulated free market would have adverse effects on consumers, natural resources and the general quality of human life wherever it is implemented. The power of a competitive market in meeting supply and demand cannot be denied -- but, as always, it is possible to take a good thing too far.

My solution to the limitations of the free market is orthodox: I propose environmental regulations, dispute mediation, a fair system of compensation, preservation of unique cultural objects, governmental management of essential infrastructure and (most importantly) rigorously enforced, independently organised anti-trust legislation, provided and funded by the state. It is almost no matter how inefficient and wasteful the state is when it comes to these interventions -- they are a better alternative than nothing at all.

5 comments have been posted
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Dolli | 4.10.2005 kl. 22:56

Alveg beint í mark, það er alveg ótrúlegt hvað margir rugla frjálsum markaði og frjálsri samkeppni, þeas að frjáls markaður sé að ríkis stjórnin blandi sér ekki að markaðinum og frjáls samkepnni er að fyrirtæki standi á sem jöfnustu fótum í samkepnni. Hagfræði segir okkur að frjáls samkeppni sé góð en segir ekkert um frjálsan markaði. Það sagt þá er ekki alltaf að segja að ríkis afskipti séu góð þau get oft verið pólitísk og tekið á ósammgjarnlega á einu fyrirtæki gagnvart öðru sem skapar ófrjálsari samkeppni.

Svanur | 5.10.2005 kl. 03:06

Er þetta grein eftir þig eða einhvern annan?

Sveinbjorn | 5.10.2005 kl. 03:53

Þetta er grein eftir mig. Ef þetta væri eftir annan þá hefði ég merkt hana sem slíka.

Aðalsteinn | 6.10.2005 kl. 00:08

"The laws of a free market operate best when the barriers to entry in a given market are low and the goods can be manufactured in plenty. Given such a basis, the mechanics of supply and demand will more or less ensure that the market in question answers consumer needs efficiently. Neither advantageously placed natural resources nor unique goods meet this criterion. It is therefore folly to assume that the benefits of the market apply to them."

Skondið einnig hvernig meðal framleiðenda skapast sátt um að ekki sé sniðugt að gera neytandanum kleyft að velja alltaf ódýrustu lausnina enda virðast þeir allir sjá að það skapar ekki nógan hagnað. Til dæmis farsímar, ég geri í sjálfu sér svipaðar kröfur til gsm síma nú og ég gerði þegar þeir komu fyrst fram. Ég hef ekkert að gera við myndavél og endalaust númeraminni. Líklega eru einfaldir símar ennþá framleiddir en þá virðast smásöluaðilar hér ekki vilja selja þá.

Sveinbjorn | 6.10.2005 kl. 02:19

Reyndar, Alli, þá er ákveðinn botn sem verðið á stafrænum tækjum á borð við farsíma ná áður en það hættir að vera arðbært fyrir framleiðandann að standa í þessu. Það þýðir ekkert að biðja núna í dag um virkilega ódýran Nokia 5110 á þúsundkall -- það er alltaf ákveðinn fórnarkostnaður við framleiðslu á varning -- t.d. mætti nota verksmiðjurnar til að framleiða annað arðbærara. Ég er nokkuð viss um að markaðurinn fyrir farsíma ráðist mjög mikið af framboði og eftirspurn -- og mig grunar að eftirspurnin eftir símum gærdagsins sé ekki nægileg til að réttlæta framleiðslu þeirra.