Consider a word one hears often in discussions of economics and the economy – “the market”. Markets, meaning a physical place where sellers and buyers congregate and transact, have been around for millennia. Virtually every town of any consequence has had a market for livestock, grain, fresh produce, wool, whatever was produced or trafficked in the area. These are the kinds of markets Adam Smith had in mind in his Wealth of Nations.
As economic activity and economic thinking evolved, the word “market” has become applied to more abstract “products”. The first “stock market” started out beneath a tree in Amsterdam. Lloyds of London was originally a coffee house where those interested in buying and selling insurance contracts congregated. In some respects, these nascent markets resemble the boys playing football in the park I mentioned in an earlier blog (#3). People gathered at the tree or in the coffee shop because they were interested in what happened there and they also wanted to “play”. However, and like the boys, they were not strangers to each other; they lived within the same society, probably went to the same churches and schools, knew each other’s family background and friends etc. In addition, they understood the same technical language of joint stock companies or of insurance. And, as with the boys, it is easy to underestimate how important this social fabric is for their market to function smoothly.
A market needs more than just willing buyers and sellers. It needs a shared ethic, some kind of collective code of conduct. It needs a language to give precision and mutual understanding about what exactly is being bought and sold and what precisely are the terms of the transaction. The market needs a means to identify and qualify would-be participants, so that different trading parties know with some confidence whom they are negotiating with. Finally, and perhaps most tendentious, every market needs an effective enforcement mechanism, to demand respect for the code of conduct, to clarify and settle differences over terms and conditions, to require specific performance, to verify the bona-fides of the participants: in short, to keep the market running smoothly.
This is what a market economy is about – smoothly functioning, transparent and open markets, with sensible and reasonable regulations firmly and consistently imposed. But this is often not what we hear in the public dialogue. Under ideological banners of “Free Markets” and “Free Enterprise” we hear calls for what is really de-regulation, which is something rather different and deserves its own analysis.
As a concluding point, it seems worthwhile clarifying just what a market is supposed to do for the society, as distinct from what it does for its participants. One often hears that markets “allocate resources”. In fact, this is not correct. The function of a market is to “clear”, to bring supply and demand into harmony. When all the various markets of a society are “cleared” then the society itself (or at least its economic aspects) are “in equilibrium”. Whether or not this “equilibrium” is also the “most efficient allocation of resources” is, like de-regulation, also another question deserving its own examination.