Managing an economy

I wrote in a previous post that any functioning democracy must run the economy with a blend of the two extremes of socialism and capitalism – that ownership of property must, in some way, be shared between the individual citizen and the whole society. The social part-ownership would manifest as some form of intervention by the government, with a combination of exercising partial control, and collection of partial profits. Even with the stated goal of maximizing productivity, minimizing hardship, and providing long-term stability, this provides little guidance on what a government in actually expected to do. In this post I hope to being to map out how government intervention could be structured, by presenting it as Facilitating Markets.

As discussed at the beginning of this series, an economy realizes value primarily by allowing people to specialize, and then to trade with others to gain goods or services that they don’t specialize in. To this end a market – or a range of markets – is needed to facilitate this trade. The market is the heart of any economy.

The term “free market” is widely used, but I sometimes wonder if it is well understood, or at least uniformly understood. Typically people who use the term freedom, in any particular context but including markets, use it to emphasize the particular aspect of freedom that they value, while ignoring freedoms that might be important to others. To avoid the confusion that will result from such selective interpretation, I think it is worth presenting my understanding of the important freedom for a market. There will undoubtedly be many freedoms that are denied in a well managed market, most obviously the freedom to steal or to cheat. But some freedoms should not be denied. Primarily the freedom to choose whether and where to trade.

In a controlled market I might be forced to purchase from a particular supplier, or to sell all my produce to a specific cartel. For a market to operate at maximum efficiency, such control must be removed. I must have the freedom to buy or sell as a I choose, guided by the values that I choose to focus on, and of course those that my trading partners can work with. I may still be prevented from buying certain goods and services completely, such as drugs or assassinations, but for a market to be free, I must be able to choose with whom I trade, and whether I want to trade at all.

For a market to function with this freedom there must (ironically?) be some control. I would like to suggest that there are three broad areas where a government can and should exert control in a market. They work to ensure Security, Transparency, and Liquidity.

Market Security

For a traditional (medieval?) market, security is a fairly obvious need. Vendors don’t want ruffians to break in and take their goods, and buyers don’t want a cut-purse to wander past and help themselves to their gold. As such activities interfere with the proper function of the market, any serious market operator will employee a security force to patrol the arcades and stalls, to keep an eye out for known felons, and possibly even to frisk people on entry to ensure they aren’t carrying the “Tools of the trade”. Much of this translates directly into modern physical market places, with a good police force, stable rule-of-law, and appropriate standards for barriers, locks, and alarms allowing most traders to operate with reasonable security.

In our modern world we have other sorts of markets, and equally other sorts of threats. We have online markets where deals are made over the Internet, and goods are exchanged using third-party services. We have markets for ideas where theft has a very different form than the theft of a pile of gold or a loaf of bread. Though the markets and threats can be many and varied, the core goal of security is the same: control of third-party interference.

Secure trades require that the two parties to a trade can carry out their business with only clearly predictable interference from any third party. Some interference must be expected, as the market operator might want to impose a tax, verify the goods, record the transaction, or any number of other activities that (it is claimed) enhance the market and make it safer for all. The predictable interferences, while possibly onerous, do not compromise security. They must best seen as part of the cost of doing business. If the traders don’t wish to accept the interference they are free (if it is a free market) not to trade, or possibly to find some other market place for their trade. If it is a productive market (with high liquidity, as I’ll discuss later), the interference will be such that most traders will find the value exceeds the cost, and so will do business under these conditions and benefit.

Market transparency

Where security protects the traders from unpredictable third parties, transparency protects them from each other. Several millennia ago, some Hebrew author (maybe King Solomon) wrote that “The LORD demands accurate scales and balances; he sets the standards for fairness.” Accurate scales and balances are just as important today as they were then for ensuring fairness in trade. It is not the only need, but it is central.

A buyer needs to be sure of what they are getting, so as well as fair weights and measures, accurate and complete labeling are important, as is a warrant that the goods will serve the purpose they claim to be good for. On the flip side, a vendor need certainty that the coin they accept in exchange for their good or service is genuine and will be accepted broadly for other goods and services. These assurances are all things that a government can have a role in providing, through licensing, and compliance testing, stiff penalties, and other means.

Transparency is often a useful path for pursuing economic goals much broader than the safety of individual transactions. One of our over-riding goals is to minimize hardship, and one small aspect of that is to eradicate slavery. Where slavery is used to create cheap produce, it can be easy for bargain hunters to encourage it without realizing. If transparency laws require labeling to be explicit about the conditions of the workers who provided the good, market forces may be enough to make slavery unprofitable, which is one useful strategy for eliminating it.

Market liquidity

Liquidity is, in my mind, the area where there is most room for a government to act to facility and bring value to a market. At its core it means ensuring that trades will happen, without actually forcing them. This means ensuring there are vendors to sell things that people want to buy, purchasers to buy things that are for sale, marketplaces available for the two to meet, and sufficient currency in the hands of the traders that the trades can happen. A government can address the supply side by investing in training, research, manufacturing etc and by modifying the regulatory framework to encourage private investment in the areas identified as needing a boost. The demand side can be strengthened by focused purchasing and by subsidizing cost through any of a number of mechanisms such as giving money to the poor. Markets can be enhanced through building the needed infrastructure and adjusting regulations to encourage trade, and currency can be provided though a credit facility.

This analysis really only scratches the surfaces. It shows a range of possible interventions – each one of which could be explored in more detail, and very probably there are other useful interventions that are not covered even in these broad categories.

My goal, though, it not really to enumerate everything that can be done, but to show a useful way to think about what can be done. I believe the goal should always be to enable the market to function, by providing a mix of freedom and regulation that helps traders to help each other. This is what makes a truly free market, and a market empowered, rather than controlled, by the government will most likely bring the best total value to the society as a whole.