What markets do well

Opponents of the current economic system rail against free-market capitalism without being clear about what it is about markets that’s problematic. Often, they don’t even have a proper understanding of what capitalism is. In this book, we’ve tried to outline the problems with the current order and to suggest what needs to change. It should be clear by now that free markets, and the system which sustains itself by the accumulation and reinvestment of capital, are not themselves the problem. The kind of inclusive, sustainable and just economy we argue for would look quite different from the current setup, but it would still function under the basic principles of free-market capitalism. It would just deliver very different outcomes.

“Markets are here to stay; they just need to be put to work in the service of all citizens.”

Markets are the best way to determine prices. They enable the preferences of consumers and the activities of producers to be reconciled so that the right quantity of a product is created as efficiently as possible. They enable people to exchange their labour for products of the labour of others. Markets are great at pricing real things. They work well when everyone is properly rewarded for his or her labour and so has adequate purchasing power. However, they fail badly when the distribution of income is unequal; and they fail spectacularly when one section of the population enjoys preferential access to economic opportunities and resources, or when they are manipulated by speculators and other rent-seekers. If the market mechanism were removed from the economy, we would have to rely on state bureaucrats to set prices and determine output levels. This would deny essential freedoms and, as the Soviet experiment demonstrated, it would be an economic disaster. Markets are here to stay; they just need to be put to work in the service of all citizens.

In the same way, there is nothing intrinsically wrong with capital accumulation. Our understanding of the role of capital can be helped, once again, by reference to classical economics. Capital is not money. It can be acquired using money but it is something quite different. Capital is the product of previous labour that remains unused and is therefore available for use in the further creation of wealth. It includes things like tools, machines, secret recipes, programming languages, specialist knowledge and experience, and reputation -everything that has been created by others and can be re-used to create new wealth.

“Capital accumulation is problematic only when capital becomes concentrated in too few hands.”

Capital accumulation is crucial to the creation of wealth. With no accumulation of capital, each new generation would have to begin the process of wealth creation from scratch. We would have constantly to rediscover how best to combine our labour with the resources of nature, like our ancient ancestors did when they discovered the possibilities of agriculture. Just as free markets have an essential role to play in a just and inclusive economy, so does ‘capitalism’. Capital accumulation is problematic only when capital becomes concentrated in too few hands. This happens when a minority controls most of the capital, or when a few people have the money to acquire it for their own ends. In a restructured economy offering equal access to opportunities, the distribution of accumulated capital would be much more even.

When capital accumulation becomes concentrated and free markets are prevented from delivering just outcomes, monopolies emerge. A small number of corporations ends up controlling much of the supply in a particular market. The surest way to prevent market domination by a handful of mega-corporations is to effect a better distribution of the factors of production, so markets can deliver efficiency and equity. This tends not to happen because ‘incorporation’ -the most common form of business ownership -encourages the opposite outcome. Incorporation, or the establishment of a joint stock company, creates a ‘legal person’ separate from the owners or shareholders. It also limits shareholders’ liabilities to the amount of their investment. Shareholders in such limited companies are free to sell their stake to others. The advantage of this form of ownership is that it enables firms to raise funds in the stock market from a wide range of investors. The disadvantage is that it makes it much easier for established companies to raise funds compared with smaller firms or new start-ups. Over time, markets come to be dominated by fewer, larger firms who can take advantage of economies of scale to reduce costs and drive down prices, making it even harder for capital-poor new entrants to gain a foothold. This is another aspect of the race-to-the-bottom economy in which more wealth is created to be enjoyed by fewer people.

“The provision of public utilities may not be particularly efficient when managed directly by the state, but the market doesn’t do it very well either.”

There are certain spheres in which free markets are decidedly unhelpful, or simply don’t work. Markets are best at pricing goods and services, and matching supply and demand in a way that encourages moral outcomes, when they are able to mediate between many potential purchasers and many potential producers. While most goods and services are demanded by large numbers of consumers, not all can be produced or provided by many suppliers. The nature of some goods and services makes the management of their supply by the market problematic. Chaos would ensue, for example, if many operators were allowed to compete for fares on the same bus route.

In recent decades, governments have attempted to privatize such natural monopolies as water and energy supply. This has involved the artificial creation of markets by government legislation. It has also meant licensing suppliers who compete on price while buying the use of infrastructure from another government-licensed (but privately owned) firm. Further government intervention is then required -in the shape of a regulatory body -to ensure that these private firms do not engage in profiteering by setting their prices too high in the absence of an effective, market-based pricing mechanism. The provision of public utilities may not be particularly efficient when managed directly by the state, but the market doesn’t do it very well either. Given that energy, water, roads and railways are essential aspects of any society, and used by most citizens, it is counterproductive to use the profit motive and an artificial market to deliver supposed efficiency. This is especially the case when other means of funding and service provision are equally, if not more, viable.