View source for Does free market theory support free markets?

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[[Category:Romain Brette]]
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In economy, free market theoreticians such as Milton Friedman have shown that under a number of assumptions, free markets are efficient. In particular, they do not have unemployment and resources are well distributed. This is based on conceptual arguments and a fair deal of mathematics, rather than on empirical evidence. The epistemology of economics is a bit peculiar, compared to other sciences. Indeed, economic theories have both an empirical value (you want to account for past and future economic observations) and a prescriptive value (you want to use theoretical principles to recommend economic policies). So in the face of contradicting evidence (there is unemployment in market economies), strong supporters of free market theory argue that, since the theory is valid, then it must be that real markets are not actually free, and so they should be freed of all types of regulations.

First of all, how scientists could get away with such argumentation is puzzling for anyone with an interest in epistemology. If the evidence supports the theory, then the theory is corroborated; if it doesn’t, then the theory is also corroborated. This is precisely the kind of theory that Karl Popper called metaphysical: there is no way you can falsify it (like “there is a God”).

But not all economists, and I would venture only a minority of economists (but perhaps not of politicians and financial executives), would argue on such a dogmatic line. Over the years, leading economists have identified a number of ways in which real markets do not and cannot comply with the assumptions of free market theory. For example, people are not rational in the sense of that theory (which postulates that you can predict all the consequences of your actions, at least in a probabilistic way), there is neither perfect nor symmetrical information between economic agents, competition is not always guaranteed, and there are externalities (consequences of individual decisions that impact agents not involved in the decision process).

All this is well known, at least in the economic field. However what most people do not realize, I believe, is that even at a conceptual level, free market theory does not actually support free markets.

One basic result of free market theory is that, if agents are only motivated by self-interest and there is complete information and fair competition, then profit should be very small in any transaction. Indeed if an economic agent were selling a product with a very large benefit, then soon enough another economic agent would sell the same product at a lower price and still make a sizeable benefit. Free marketeers usually stop here: great, in a free market economy, prices reflect the fair value of products. But let us not stop here and examine the consequences of this result. If agents are motivated by self-interest and the results of fair competition and complete information is to not make a profit, then agents are directly incited to create monopolies and hide or manipulate information, and they will avoid any situation in which they cannot do so. As a consequence, some agents make a large profit at the expense of global economic efficiency. The evidence for such behavior is everywhere, and mostly in legal ways. An obvious example of manipulating information is advertising, which is made by the same companies that make the products. The goal of advertising is precisely to have a biased influence on the decisions of customers. Another one would be selling credit to customers in contradiction with their own interests. Examples of monopoly seeking behavior are many: territorial intellectual property strategies (i.e. patenting so as to own a particular sector rather than for immediate exploitation) and patenting in general, monopolies in operating systems, and of course illegal agreements on prices in certain economic sectors. Creating monopolies is precisely the purpose of marketing, which is to differentiate the company’s products from the rest: to present a product in such a specific way that the company is the only one to produce it. As a result, prices can go up because there is no competition, and no company has any interest in entering the competition since it would make the prices drop and generate no profit. The healthcare system in the US is another example: a system where prices are freely set by a market with captive customers fearing for their life, resulting in the most expensive system in the world by far and yet not at all the most efficient.

Free market theory demonstrates that in a free market economy, economic agents should adopt monopolistic and manipulative strategies that go against global economic efficiency. This is the part of free market theory that has empirical support.
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