There are two models of economic development today- there is the American Capitalist model and the Chinese model of economic freedom without political freedoms where the State is totalitarian. Both models have one thing in common. They both allow and follow free markets. China allows the right to own private property and it also allows free markets to operate. But there are some who don’t like free markets who advocate a social market economy which is said to be prevalent in Germany and Sweden which are already developed countries who can afford the luxury of priority for supposed welfare as against economic growth.
Social Market Economy
The social market economy was designed to be a third way between laissez-faire economic liberalism and socialist economics. But unlike Socialists these social democrats do not accept the idea that the capitalist system is inherently antagonistic to social goals or that it is necessarily a political economy characterized by greater economic equality. The social market economy accepts the view that private markets are the most effective allocation mechanism, but that output is maximized through sound State macroeconomic management of the economy. This is not far from the neo-liberal economic point of view although the latter thinks the less regulated the economy the better since regulations tend to distort markets and incur deadweight costs for the administration of the regulations.
Social market economies however promote social or State support for the less affluent. They stress that by decreasing poverty and broadening prosperity to a large middle class, capital market participation is enlarged. Social market economies also say that government regulation, and even sponsorship of markets, can lead to superior economic outcomes, a position not shared by neo-liberals. But the social market economy still contains the central elements of a free market economy such as private property, free foreign trade, free exchange of goods, and free formation of prices. But in contrast to the situation in a free market economy, the State is not passive and actively implements regulative measures.
Free markets in China
Economic reforms introducing market principles began in China in 1978 and were carried out in two stages. The first stage, in the late 1970 and early 1980, involved the de-collectivization of agriculture, the opening up of the country to foreign investment, and permission for entrepreneurs to start businesses. However, most industry remained State-owned. The second stage of reform, in the late 1980 and 1990, involved the privatization and contracting out of much State-owned industry and the lifting of – price controls, protectionist policies, and regulations, although State monopolies in sectors such as banking and petroleum remained. The private sector grew remarkably, accounting for as much as 70% of China gross domestic product by 2005.The State sector is not the dominating contributor to the GDP. It is even less important in the export sector.
We think we have free markets but really, we don’t. The Labour Laws have curtailed the freedom of the enterprise to hire and fire workers. The wages Boards fix wage rates. In addition the government intervenes in fixing wages and even the recent budget wants the private sector to raise wages by a certain amount. It is necessary to allow companies to bargain and fix wages at the company level rather than binding employers to national agreements. The trial period for confirming employees need to be extended to one year at least for small businesses. This budget has increased the employers EPF contribution which will discourage the creation of employment and affect our international competitiveness. 40% of the work force works in the public sector and another large sector in the EStates is covered by separate national wage agreements.
So our Labour market and the wages structure are not determined by market forces. It deprives the economy of the flexibility required for workers to move into new and growing sectors. Wages in a free market economy is based on relative scarcity and the productivity of the workers. But that is possible only if the market for labour is free. So we find wages for the educated are much higher than they need be if supply and demand for such intellectual workers were to operate freely. We find manual workers even skilled workers are not remunerated adequately in our economy. So many skilled workers and manual workers like housemaids go abroad while the country is short of plumbers, fitters, machinists and other grades of skilled and unskilled workers.
We also under-pay for workers who work with their hands instead of their brains and fail to provide incentives for them to acquire these skills. Skills must be rewarded just as knowledge and this can occur in a genuinely free market economy. What if our fore-fathers gave up on rock-carving, painting frescoes, doing metal work, pottery and making furniture, would we be able to have a culture, traditions or history. Our kings rewarded them handsomely. But today, our country gives little chance to the talented. Even our ancient agriculture required blacksmiths to make the blades for ploughs.
There was the need for drummers to drum during the processions; there was the need for fishermen in a society which shunned meat eating. In a market economy the wages if freely determined will compensate for the pleasantness or unpleasantness of the work.. This is possible only if there is a free market for Labour. The State should allow employers to fix wages with freedom and employers must pay the wage that reflects the scarcity value of the Labour. As more people offer their Labour in that market, the equilibrium wage decreases and the equilibrium level of employment increases as the supply curve shifts to the right.
Cheapest rate The opposite happens if fewer people offer their Labour in the market as the supply curve shifts to the left. We do not find these forces operating in our economy because of government regulations. The individual employer doesn’t seek to hire at the cheapest rate but follows the law and the custom. He doesn’t seek to maximize his profits by minimizing his costs. There is inadequate competition to drive him to do so. We expect graduates to be paid more without considering that they are in surplus relative to demand. In a free market, Prices and quantities are allowed to adjust according to economic conditions in order to reach equilibrium and properly allocate resources. Only free markets allow a near optimal allocation of Labour as a factor of production.
A free market contrasts with a controlled market or regulated market, in which government intervenes in supply and demand through non-market methods such as laws creating barriers to market entry or directly setting prices. A free market economy is a market-based economy where prices for goods and services are set freely by the forces of supply and demand and are allowed to reach their point of equilibrium without intervention by government policy, and it typically entails support for highly competitive markets and private ownership of productive enterprises. Although free markets are commonly associated with capitalism in contemporary usage and popular culture, free markets have been advocated even by market socialists, and some proponents of cooperatives and advocates of profit sharing.
The laissez-faire principle underlies the role of government. There should be no non-market pressures on prices and wages, such as those from government taxes, subsidies, tariffs, regulation or government-granted or coercive monopolies. Friedrich Hayek argued in The Pure Theory of Capital that the goal of a free market economy is the preservation of the unique information contained in the price itself.
However, in many countries around the world, governments seek to intervene in the free market in order to achieve certain social or political agendas. Socialists argue that free markets are unfair because of the unequal distribution of incomes. So Governments attempt to create social equality or equality of outcomes by intervening in the market through actions such as imposing a minimum wage or erecting price controls (price ceiling). Governments also interfere with market forces by acting through the supply and demand forces by giving subsidies to add to or reduce production. The USA subsidizes owners of fertile land to not grow crops in order to prevent decreasing the equilibrium price. This is done under the justification of maintaining farmers’ profits.
So in a social market economy market forces are not free to operate since there are government regulations on supplies and prices. But such government intervention also involves costly corrective measures in the form re-distributive taxation and heavy administrative costs to administer them, which weakens the incentive to work, invites dishonesty and increases the likelihood of tax evasion, thus, necessitating more government regulation over markets and ultimately reducing the overall efficiency of the market economy.
Government intervention in the free market can hamper economic growth, entrepreneurship and a healthy economy by disrupting the natural allocation of resources according to supply and demand. Milton Friedman pointed to failures of central planning, price controls and State-owned corporations, particularly in the Soviet Union and Communist China.
A free market does not require the existence of perfect competition. However, it does require a framework that allows new market entrants. If there are no coercive barriers, and the entry cost into the markets is low it is generally understood that competition flourishes in a free-market environment. But about the profit motive. True that the maximization of profit is not always pursued by entrepreneurs but such assumption is not necessary either for a free market.
Courtesy – Author R.M.B Senanayake of Sri Lanka Economic Association