Against free markets

By Lorenzo

The term that is. There seem to be few usages that are a greater barrier to clear thought and debate than free markets. Whether used as a term of sneering abuse to create straw-person arguments or as a slogan of the right and proper, it is ready-made to close minds and abstract away from the issues that do matter; such as the complex questions about the proper lines between private action and public rules.

Liberty and social order

The term economic freedom is distinctly preferable, since it is open to quantification and measurement–with the normal caveats and difficulties than pertain to the compilation of any index. It also connects freedom to constraints on people–either as individuals or associations–rather than to collections of transactions dealing with a particular good or service.


Not that freedom can be equated with lack of constraints on action. On the contrary, security of life, person and property is very much part of any freedom worth the name. Liberty is a value embedded in social order, not independent of it. It is entirely sensible that the most widely used index of economic freedom has security of property as one of its main criteria.

Even more fundamentally, morality is like law in that it constrains and empowers; by limiting our actions towards each other through constraints against and requirements to, morality greatly expands what we can do. If we were amoral rational egoists, we could not build functioning societies. Our ancestors’ development of a moral sense was basic to the rise of human societies.[i] A key building block of our ancestors’ moral sense was the notion of ownership, whose fundamental element is that other people acknowledge something as yours; a cognitive feature that seems to be lacking among other primates.[ii]

hostile acquisition

hostile acquisition

Libertarians often over-estimate how much morality can do in the absence of corruption-through-power while also underestimating the importance of non-state forms of power. Not to mention that even economic freedom has no simple connection to the size of government. As Justice Clarence Thomas pointed out to the Cato Institute when he was Chair of the Equal Opportunity Commission, the notion that American freedoms had been eroding since the American Revolution was not how things seemed to black folk. Nor, for that matter, to women, Jews, Catholics, queer folk … David Boaz says it well:

Has there ever been a golden age of liberty? No, and there never will be. There will always be people who want to live their lives in peace, and there will always be people who want to exploit them or impose their own ideas on others.

Conversely, the classic error of progressivists is to treat regulation and political action as some exogenous feature sitting over the top of the realm of private action. Thereby treating regulation and political action as if its public role and intent shields it from the corrupting effect of private action and motive. Or, as economist Arnold Kling puts it:

(non-classical) liberals and libertarians see the problem of “special interests” differently. Liberals view special interests as exogenous to the policy process. You have to overcome special interests to create good policy. Libertarians see special interests as endogenous. Policy is what creates them.

Putting that point another way:

money in politics are a result of the stakes that we have put on the table — the more power we give to government to reallocate wealth, the more money will be spent to have such decisions made in one’s favor.

Rules versus discretion

One of the real questions in public policy is rules versus discretion. I am generally very much against regulatory discretion [of people’s property and labour]. Not only does it encourage corruption–corruption is the market for regulatory discretion, the more regulatory discretion there is, the higher the level of corruption is likely to be–regulatory discretion will also more or less inevitably favour the wealthy, the well-connected and the articulate, for they have greater ability to gain the favourable attention of regulators. While the evidence is that money (in the form of political donations) has a weak effect on the outcome of elections, even without trying to disentangle whether money follows popularity or vice versa, money most definitely buys access to officials–hence the tendency of highly regulated industries to donate generously to both sides of politics.


Discretionary regulation also elevates the prejudices and preconceptions of regulators where they typically do not have to bear the cost of said prejudices and preconceptions. For example, modern Australian house and building design seems to suffer significant narrowing because the familiar (to regulators) is much easier to get regulatory approval for. (I was memorably regaled by the owner of a herb farm-and-store who was still very bitter at the time and expense it took him to get regulatory approval to build his store whose construction was based on centuries of experience–but not in Australia.)

Discretionary regulation can also generate serious time inconsistency problems. Such as discouraging use of emergency measures, because that will signal how bad things are; or encouraging blanket actions so as to “smother” a crisis, thereby undermining incentives for prudent behaviour. (The former CEO of Wells Fargo is still very angry at being forced to accept TARP money his bank did not need because it had not been imprudent.)

More generally, discretionary regulation raises transaction costs, and usually, as discussed above, in invidious ways. It grants control over attributes of property to people who typically do not bear the costs and consequences of exercising said control. Worse, it is an excellent avenue for privileging some groups over others. The social mercantilism which is the curse of Latin America is directly based on the Iberian model of official discretions. Regulatory discretion also operates invidiously in much of the Middle East (pdf).

Talking about “free markets”, or even just levels of “regulation”, ignores the fundamental differences involved in regulating by rules as distinct from regulating via official discretions. If there was one change I could make to the Australian Constitution, it would be to have an equivalent provision as Article 14 of the Federal German Constitution elevating rules over (pdf) official discretions.

Rules and incentives

What specifically prompted this post was (re)reading this excellent short history of banking (pdf). It makes clear how much the history of banking over the last two centuries has been a history of regulation; particularly history of governance and liability rules. Plus matters such as the tax system favouring debt over equity. Not that it is surprising that the tax system should favour debt over equity–far more voters are in the market for debt than for equity.

The consequence of waves of regulatory change has been to create institutions “too big to fail”, encouraged to go for volatility and debt where benefits were reaped by short-term investors and bank management, risks were dumped on long-term investors and taxpayers while alleged crisis-protections again and again fell prey to time-inconsistency problems.

It is not any sort of simple story about either the “failure” of “free markets” or their absence. Each regulatory change was prompted by previous experience before succumbing to changes in circumstances and/or unintended consequences. Nor does regulation have any sort of simple relationship to transaction costs. Discretionary regulation may raise transaction costs, typically in invidious ways, but rules can lower transaction costs.

Yellow Knights

Comfort from clear inheritance rules

For example, much of the pressure for the Latin Church to get involved in marriage came from the landholding-and-inheriting warrior elite of medieval Europe who wanted a standard set of rules about what marriage involved–who could or could not get married, who was or was not a legitimate offspring–and the Church was the only body operating across the myriad of jurisdictions and coverages of custom law that marked medieval Latin Christendom that could provide such commonality. Libertarian suggestions that the state “get out of marriage” ignore the great advantage in having a standard marriage contract or, at least, a standard contractual form. Clear rules about corporate forms and liabilities can also lower transaction costs.

Lowering transaction costs, thereby expanding possible gains from trade, is a worthy goal. But, as we can see, it does not have any simple connection to the “level” of regulation. Nor to whether a market counts as “free” or not.

Another important characteristic of markets are barriers to entry. Regulation can certainly create such barriers, but so can non-state action. Creating effectively a tort of discrimination may make people less free to discriminate but it can wildly expand the social possibilities for others. Can we really say that banning exclusion on the basis of gender, race, religion, sexuality, etc makes markets “less free”? It is true that commerce has generally been kinder to minority groups than politics; but this is also an effect that operates far more strongly in cities than in small communities, where social cartels are much easier to establish and maintain and repressed groups find it harder to reach the critical mass that encourages targeted commercial responses.

Racial zoning of Birmingham, Alabama, 1926

Racial zoning of Birmingham, Alabama, 1926


Markets are always based on implicit or explicit rules. These rules may be customary, market-generated or imposed by state or non-state action. Imposed action can take the form of rules or discretion. The rules may raise or lower transaction costs. They may create, abolish, lower or raise barriers to entry. They may protect, restrict or undermine property rights. Restrictions on property rights may lower or increase the value of the property. Much of the original pressure for zoning was to protect the value of houses by limiting permitted (pdf) local activities (or permitted local residents [pdf]).

The term free markets is a highly inadequate way of parsing these complexities Which, of course, may be much of its appeal. Barriers to thought can be great support for the simplicities of sloganeering.


[i] Application of experimental economics and game theory suggests strongly that, in a situation of good information about each other (such as in a foraging band), trustworthy cooperation, not rational egoism, is the strategy favoured by evolutionary pressure (pdf).

[ii] There are some signs of a moral sense in other primates and some animals; it appears to be strikingly more highly developed in homo sapiens.


  1. Mel
    Posted April 26, 2013 at 11:56 am | Permalink


    “Conversely, the classic error of progressivists is to treat regulation and political action as some exogenous feature sitting over the top of the realm of private action. Thereby treating regulation and political action as if its public role and intent shields it from the corrupting effect of private action and motive.”

    Talk about strawmen arguments. You might want to have a little think about why this comment is clearly false.

  2. Posted April 26, 2013 at 3:17 pm | Permalink

    [email protected] You might enlighten me.

  3. Posted April 26, 2013 at 3:53 pm | Permalink

    Interesting post. I was with you until I noticed how the rules vs discretion discussion was one sided. There are a number of factors that can count against rules based regulation that you don’t seem to have considered. There’s the potential for unpredictable circumstances to render predetermined rules inadequate or downright harmful. There’s the incentive and capacity for people to find novel ways to exploit a given set of rules to achieve outcomes that are contrary to the spirit of the regulation or otherwise undesirable. There’s the inherent flexibility in discretion that can be useful. Your farm-and-store builder might have complained about the time and expense of getting his designs approved, but what would have had said were the designs rejected outright because they didn’t fit some pre-approved model?

    It grants control over attributes of property to people who typically do not bear the costs and consequences of exercising said control.

    I imagine the whole idea of regulation is to deal with the fact that the owners of property can deal with it in ways which they do not bear the (total) costs and consequences. Hence the need for an independent controller who is supposed to balance the consequences for everyone involved. Increased “transaction costs” may just be a result of curtailing the capacity for people to externalize their costs onto unwilling parties. Where this is the case this would increase the efficiency of the economy (although I’m sure there’s all sorts of regulation out there that doesn’t achieve this ideal optimum).

  4. Mel
    Posted April 26, 2013 at 4:46 pm | Permalink

    L @2:

    [email protected] You might enlighten me.”

    My swami tells me that we must each find our own path ti enlightenment, si I’m afraid I can’t help you 🙂

    But on a more serious note, here is a hegemonic theory from progressive sociologist Mark Bahnisch. Presumably you wouldn’t be convinced by such a theory, but it is certainly stock standard left wing theorising about how democracy works. It isn’t explicitly stated in this particular example, but the point is that democracy in capitalism is to some extent a mirage that legitimates control by the dominant class. See Gramsci for further elaboration.

  5. Mel
    Posted April 26, 2013 at 4:50 pm | Permalink

    And here an Hayek praises Thatcher in a manner that implies an exogenous theory of policy.

    The point being that Kling was engaging in polemic rather than serious analysis.

  6. Posted April 26, 2013 at 5:37 pm | Permalink

    [email protected] Your comments are more difficulties with regulation in general, rather than an argument for discretion. Flexibility and nuance are common arguments for regulatory discretion. Alas, things do not work out that way.

    There are also other ways of dealing with the probability of externalities. Common law, for example has a rich history of dealing with such issues.

  7. Posted April 26, 2013 at 5:42 pm | Permalink

    [email protected] My comment was not directed at that sort of blanket critique, but more the sort of progressivist politics whose first reaction to any economic, and many non-economic, issues is that more regulation is required.

    And, even with the blanket critiques, there is an implication that their sort of politics will avoid such issues. Hence, for example, the persistent disinterest in little issues such as checks and balances because they get in the way of the concentration of power needed to achieve the desired social transformation.

  8. Posted April 26, 2013 at 6:02 pm | Permalink

    things do not always work out that way.

    There are plenty of discretionary systems that work well. For example prosecutorial discretion in pursuing charges against a defendant. Would you argue that prosecutions should rigorously pursue every single technical violation of the law without consideration for the case’s merits or it’s social significance? You cite the common law, but even that is heavily dependant on judicial discretion in many places.

    The common law doesn’t handle all externalization well. It tends to fail at managing risks, particularly where direction causation is difficult to prove, where causes are temporally or jurisdictionally detached from outcomes, or where potential harms are greater than the assets of the tortfeasor.

  9. Posted April 26, 2013 at 7:09 pm | Permalink

    Twice in the last week I’ve encountered the term ‘capitalism’ used – one by a socialist, the other by, I dunno, maybe by an Occupy-sort-of-socialist – in a perjorative but ultimately meaningless sense. And both times I wondered how it came about that the term could be used, not in a descriptive sense (fairly close to the standard definition that an economist might use), but simply to insult and/or to marginalise what they thought of as right-wing economics or politics.

    Did it come from Marx? Or is it simply because economists and economics writers have failed to convey adequately what basic terms, like ‘capitalism’ or ‘free markets’, mean? (There’s something in that last one, I think).

    So I suppose I might be tempted to start using the term ‘economic liberalism’ – but I suspect it would effectively surrendering good, useful terms to the opposition.

  10. Posted April 26, 2013 at 9:10 pm | Permalink

    Lorenzo: from the depths of tax revision, just letting you know that there have been a couple of interesting comments on this post on my FB page.

  11. Mel
    Posted April 26, 2013 at 9:22 pm | Permalink

    Following on from desipsis, police have a great deal of discretion about whether to do anything about a breach of a regulation. On balance, this is a good thing.

  12. Mel
    Posted April 26, 2013 at 9:44 pm | Permalink

    This is baloney too:

    “money in politics are a result of the stakes that we have put on the table — the more power we give to government to reallocate wealth, the more money will be spent to have such decisions made in one’s favor.”

    American politics lacks the party discipline that is more common elsewhere and this encourages vote buying. Conversely, according to the data I’ve seen, much higher taxing continental European countries like Germany, the Nordics etc don’t have anything like the same vote buying culture.

    So your point is falsified.

    But yes, it is true that many left wingers, including probably 90% of those in the social science and humanities departments of our universities have a perverse and overly negative view of markets.

    As I’ve said before, if it was up to me all social science students would be forced to study economics.

  13. Posted April 26, 2013 at 9:54 pm | Permalink

    As I’ve said before, if it was up to me all social science students would be forced to study economics.

    When did two wrongs start making a right?

  14. kvd
    Posted April 27, 2013 at 8:01 am | Permalink

    Well, I took the point of Lorenzo’s post as being more directed towards regulation within economic life, as opposed to a blanket reference to regulatory systems – for instance desipis’ fair point within, say, the courts and policing.

    I agree with him that overuse of discretionary powers, when concentrated in less than transparent officials, ministers, etc. is not conducive to fair and open markets. We’ve had recent quite public examples in NSW of the potential for corruption when one group gains favourable treatment of business plans. And we never seem to learn.

    Discretion per se is probably always necessary – but if there were to be more regulation to curb the excesses or corruption, I’d be in favour of regulation aimed to 1) provide more immediate transparency of the decision process, and 2) the removal from the hands of just one person the ability to exercise that discretion. Corruption will always exist; collusion likewise, but possibly less so?

    As an example of good governance, I’d suggest the deliberations of the RBA board – where results are ‘by committee’ and their thought process is quickly and widely publicised.

    But I could be wrong, and in which case I expect Mel will ride to my rescue 🙂

  15. Mel
    Posted April 27, 2013 at 10:28 am | Permalink

    desipsis @13:

    “When did two wrongs start making a right?”

    I don’t agree that it is a wrong. Currently most social science courses are widely viewed as marshmallow courses that cater for students who lacked the intelligence to get decent year 12 results plus a cohort of brighter students with fluffy ideas about changing the world. I want to see the status and quality of the social sciences improved, in part because my degree is soc sci. I’m a stakeholder in this.

  16. Posted April 27, 2013 at 3:16 pm | Permalink

    [email protected] My comments were specifically directed at regulation of people’s property and use of their labour. I have amended the post slightly to make this clearer.

    Any managerial system (e.g. prosecution) is going to require some discretion. Moreover, such decision-makers typically have “skin in the game” rather more than having building actions require official approval do.

    And yes, judges have discretion for good reason; it is also much easier to have effective judicial oversight for a rule-based system than an official-approval system.

    And managing risks through official-approvals rather than rules generally just adds uncertainty to the mix.

  17. Posted April 27, 2013 at 3:22 pm | Permalink

    [email protected] Marx popularised the term ‘capitalism’ and built a moral perjorative into the definition, so I guess you can blame him.

    Any emotionally charged term tends to suffer content-shift, so we can probably not do any better than currently useful terminology.

  18. Posted April 28, 2013 at 12:08 pm | Permalink

    Mel, I guess I just don’t have all that much respect for the field of economics at the moment. It might be useful for social science students to at least cover the basics of economics, particularly if their areas of study cover public policy issues.

    I was considering it’d be useful to teach them some philosophy and some science so they learn the nature of ideas and how ideas relate to reality, before they get too carried away with ideas that just happen to sound nice.

  19. Posted April 28, 2013 at 12:12 pm | Permalink

    [email protected]:

    Moreover, such decision-makers typically have “skin in the game” rather more than having building actions require official approval do.

    Well yes, there are good and bad ways to do regulatory discretion. There are also good and bad ways to do rules. Look at the outcome from the new mining tax. Would the fact that the mining companies used their financial power to get the rules made in their favour count as ‘corruption’? Is regulatory capture through gaining unfair rules any better than regulatory capture through gaining unfair discretionary decisions?

  20. Posted April 28, 2013 at 12:39 pm | Permalink

    [email protected]

    Is regulatory capture through gaining unfair rules any better than regulatory capture through gaining unfair discretionary decisions?

    Yes, due to lower transaction costs, and greater certainty and accountability.

  21. John H.
    Posted April 29, 2013 at 9:01 am | Permalink

    . Currently most social science courses are widely viewed as marshmallow courses that cater for students who lacked the intelligence to get decent year 12 results plus a cohort of brighter students with fluffy ideas about changing the world.

    Yet that is our biggest weakness and our biggest worry. We can’t do social science the way we do many other areas of science not because social science is just baloney but because it is so often a bridge too far, we simply lack cognitive tools to do it properly and that may always be the case in principle. In practice though there is always the possibility we can learn more, can find better ways of analyzing and hopeless finding fruitful ways to address those challenges. Social science problems are the big challenges for our culture and our turning away from them represents a collective failure.
    6.52 We feel that even when all possible scientific questions have been
    answered, the problems of life remain completely untouched

    So “ünsocial scientists”, and all of us, need to realise that despite the current conceptual paucity of the social sciences, the goal is not to abandon these but try even harder to find those cognitive tools. However the problem remains that at present we are still relying on dubious analytic methods. At heart of all this there is a desperate need to develop a better understanding of behavior. The irony there being that from what I have seen most economists are disdainful of behavioral economics, a platform that starts with building reliable information, the first goal of any decent intellectual domain.

  22. Posted April 29, 2013 at 4:02 pm | Permalink

    [email protected] There is some angst about behavioural economics. On the other hand, Daniel Kahneman‘s Nobel suggests some respectability …

  23. Mel
    Posted May 14, 2013 at 9:28 pm | Permalink

    How soon we forget the failure of markets that was the GFC. Alan Greenspan being grilled by Congress after the GFC:

    For years, a Congressional hearing with Alan Greenspan was a marquee event. Lawmakers doted on him as an economic sage. Markets jumped up or down depending on what he said. Politicians in both parties wanted the maestro on their side.

    But on Thursday, almost three years after stepping down as chairman of the Federal Reserve, a humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.

    “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform.

    Mr. Waxman noted that the Fed chairman had been one of the nation’s leading voices for deregulation, displaying past statements in which Mr. Greenspan had argued that government regulators were no better than markets at imposing discipline.

    “Were you wrong?” Mr. Waxman asked.

    “Partially,” the former Fed chairman reluctantly answered, before trying to parse his concession as thinly as possible.

    Many Republican lawmakers on the oversight committee tried to blame the mortgage meltdown on the unchecked growth of Fannie Mae and Freddie Mac, the giant government-sponsored mortgage-finance companies that were placed in a government conservatorship last month. Republicans have argued that Democratic lawmakers blocked measures to reform the companies.

    But Mr. Greenspan, who was first appointed by President Ronald Reagan, placed far more blame on the Wall Street companies that bundled subprime mortgages into pools and sold them as mortgage-backed securities. Global demand for the securities was so high, he said, that Wall Street companies pressured lenders to lower their standards and produce more “paper.”

    “The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower,” he said.

    We need markets but they must be well regulated and shouldn’t be worshiped.

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