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Reining markets in

By Geoff Davies - posted Wednesday, 11 December 2013

It's interesting to see even the Coalition Government divided over whether to let the markets take their course, and possibly eliminate Holden and Qantas. The free-market purists see any proposal to prop up a private company as weakness and special pleading. The pragmatists recognise that many jobs are at stake, and there are large economic and social costs to be considered if these companies fail.

The free market mantra is not about to disappear from the Australian political landscape - far from it - but really it's time some logic was brought to bear on this brutal ideology.

It may surprise many to learn that standard free-market theory is so abstract it has nothing relevant to say about real modern economies. The evidence is also clear that free markets have not worked as well as managed markets.


The theoretical basis for the claim that free markets are (usually) best is the neoclassical theory, the theory that underlies the currently dominant neoliberal school of economics and public policy. Unfortunately the neoclassical theory bears no useful resemblance to real economies.

For example, the theory is built on the assumptions that we can all foretell the future, that we all fully inform ourselves before we buy anything, that economies of scale are not important, and that we are not influenced by fashion or advertising. If you make those assumptions, and others equally absurd, you can construct a theory that predicts a market economy will come to a grand equilibrium, with all supplies balancing all demands. Furthermore the equilibrium will be the most efficient conceivable economy, producing the most goods from the least input of goods and effort.

On the other hand if you make more realistic assumptions, you don't get the grand, optimal equilibrium, you get much more erratic behaviour. Technically, you get a far-from-equilibrium self-organising system, probably functioning in the regime of complexity. Their behaviour is actually much more like real, modern economies. It is also more like living organisms. In fact an equilibrium system is a dead system.

Mainstream economists recoil in horror from the possibility of disequilibrium. They prefer the remain in their tidy abstract world, in which market crashes are not even possible. Hence economists' desperate claim that the 2007-8 financial crash was a black swan event, so inconceivable that no-one could possibly have foreseen it. That is really a clear admission they have no understanding of a fundamental feature of modern economies. As it happens, quite a few marginalised economists did foresee the crash.

In real, erratic, far-from-equilibrium economies there is no basis at all for the claim that free markets represent a global optimum. There is not even any reason to suppose a free market will deliver generally beneficial results with reasonable efficiency. The theory simply has nothing to say about such things.

The implication is fundamental to our modern society. A market economy cannot just be set to run on automatic. We have to look at each market segment and see if it is doing what we would like, and doing so reasonably efficiently.


In many real markets producers are able to off-load many costs onto the community, for example by dumping pollutants into the world, by under-paying suppliers and employees, by depleting natural resources too quickly, or by selling shoddy goods. In other markets, inefficient or no-longer-desirable practices, like constructing energy-wasting buildings, continue even though it would be cheaper overall to update practices.

Not only in theory but in practice the claims for free markets do not hold up. The 2007 financial crash not only fundamentally contradicted the neoclassical theory, it caused immense damage to economies and people's lives around the world, and the damage continues still, with much of Europe in depression conditions. Indeed the least regulated modern eras, in the late nineteenth and twentieth centuries, led to the great crashes in 1929 and 2007.

Even aside from the crashes, neither of the laissez-faire eras equalled the post-war boom decades, in which governments were much more involved in economies. From 1953 to 1974 unemployment in Australia averaged only 1.3%. GDP growth was 5.2% and inflation 3.3%. The post-1980 neoliberal era has never come close to matching those figures. Globally, GDP growth averaged 2.5% from 1960 to 1980, but only 1.1% from 1980 to 2005.

Though there is no basis for letting markets fun unfettered, we don't have to turn to socialism. All we have to do is turn a critical eye on our markets. If a market is producing undesirable results, we can adjust the incentives that determine what is profitable, so the market will yield beneficial results. Just eliminating many perverse subsidies, like the $10 billion or so annually supporting fossil fuel burning (around $1 trillion globally), would already greatly improve our society, and save a lot of money at the same time. There are also many unintended perverse incentives operating, incentives that could be reversed with a little creativity and sensible intervention.

In other words, we can recognise the need to manage markets. We do it a lot already, but often for the wrong reasons or incoherently. If we stepped beyond the baseless free-market ideology and set about pragmatically managing our economy, we might find our lives improve with remarkable rapidity.

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About the Author

Dr Geoff Davies is a scientist, commentator and the author most recently of Desperately Seeking the Fair Go (July 2017).
He is a retired Senior Fellow in geophysics at the Australian National University and has authored 100 scientific papers and two scientific books.In 2005 he was awarded the inaugural Augustus Love medal for geodynamics by the European Geosciences Union, and he has been honoured as a Fellow of the American Geophysical Union.

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