The free-market myth that wouldn’t die

[First posted to Chelseagreen.com. Go to that version for links.]

Proponents of the “free market” have a tendency to ignore one inconvenient fact: there is no such thing as a free market in reality. Never has been one. Never will be one. The “free market” is a myth, a fairy tale told over and over by newspaper columnists and TV pundits and quite a few professional economists. I’ve come across a few declarations of this myth lately that irked me (for example this infuriatingly ignorant and ignorizing dreck), and so I’d like to rant for a moment.

This is not to say that markets, as a system for organizing economic activity, are no good. There are some good things about markets, flawed as they always are. There are also bad things about them. Sometimes, the flaws are their saving grace! That’s because some “flaws” in what might otherwise be a fully “free” market (theoretically, that is, but only in theory since it simply cannot exist in reality) make the results of the market activity more socially beneficial. The opposite is also true: some flaws lead to worse social results, relative to what might happen if the markets were to be fully “free.” But again, that’s all pie-in-the-sky philosophizing, because markets are never, ever fully free.

Here’s photographic proof!

One result of a free market, proven beyond any doubt in multitudes of Econ 101 courses for the past century, is the so-called “law of one price.” As Wikipedia states,

The law of one price is an economic law stated as: “In an efficient market all identical goods must have only one price.”

(Where “efficient” is econo-speak for what laymen call “free.”)

Now even in the Econ 101 courses, the professors will mention some nuances to this blanket statement, for example to account for the difference in shipping costs to deliver an otherwise identical product from different locations. Similarly, as Wikipedia notes

The law also need not apply if buyers have less than perfect information about where to find the lowest price.

Yet here we are in the brave new 21st century, equipped with the world’s greatest information tools in history, and even still, prices for identical products differ by enormous magnitudes. An example: this Samsung 32-inch flat-panel TV, as shown through Google shopping.

prices-tv.jpg

Check it out”¦ the lowest price shown is $382 and the highest price shown is 149% higher at $950. The screenshot doesn’t capture all the offers that the Google search unearthed, but obviously prices vary widely within those two outliers.

How can this be? How can there be so much difference in prices for an identical product? Well, economists and business analysts can probably offer quite a few explanations, but they all boil down to this: the market is not free. It is not efficient.

So keep that in mind next time someone says that all we need to do to solve some problem is to “set the market free,” “get rid of government interference,” or “blah blah blah.” As I implied above, sometimes it will make sense to reduce the government’s influence on a particular aspect of some particular market, but too many people have adopted a blindered ideology that the “free/efficient/unfettered” market represents an ideal that we should be always and everywhere be pursuing. Not only is that doubtful that the ideal is actually ideal, but it simply cannot be achieved, nunca. And as the “theory of the second best” teaches us, that means there is no good reason whatsoever to think that the best alternative is to move as close as possible to this unachievable so-called ideal.

Class dismissed!

3 comments

  • Cross-reply:
    An “efficient” market does NOT equal a “free” market!

    Wikipedia:
    “A free market is a market in which prices of goods and services are arranged completely by the mutual consent of sellers and buyers.”

    From Investopedia:
    “How Does a Market Become Efficient?
    In order for a market to become efficient, investors must perceive that a market is inefficient and possible to beat. Ironically, investment strategies intended to take advantage of inefficiencies are actually the fuel that keeps a market efficient.

    A market has to be large and liquid. Information has to be widely available in terms of accessibility and cost and released to investors at more or less the same time. Transaction costs have to be cheaper than the expected profits of an investment strategy. Investors must also have enough funds to take advantage of inefficiency until, according to the EMH, it disappears again. Most importantly, an investor has to believe that she or he can outperform the market.”

    The market in 32″ TVs is large, but it is not liquid. The transaction costs make it impossible for me to buy a TV at the lowest price and then turn around and sell it at the higher price.

    Also, the products show on the google shopping page are not identical– the reputation of the seller, shipping costs, shipping time, product availability, shopping experience convenience, the seller’s desire to attract new customers (who they hope will become repeat buyers…) all affect prices, and all of that stuff has to be considered to be “the product” that you’re buying, not just the item that shows up at your front door.

  • Gavin, your final paragraph is further evidence of what I was saying. Though the physical units of the TVs are identical, there are scads and scads of other factors that muck of the market and prevent it from being efficient. But isn’t it striking that, even accepting seller reputation, shipping costs (which don’t differ all that much in this example since these sellers are all shipping from within the U.S.), etc., the price difference would be so extreme from one seller to another? That it could more than double from one seller to another?

    And while you may be right that in a technical sense, “free” is not precisely synonymous with “efficient” in relation to markets, in common usage by politicians, pundits, and even casual usage by academically trained economists, the terms are treated fairly interchangeably.

    Actually, you do raise a good point in noting that they are not actually synonymous. In fact, the failure of the two to be true synonyms is one reason to be wary of political calls to “free” the markets in order to solve all social problems. That’s because most of those making such calls believe”“or pretend to believe”“that allowing a market to be “free” (from government influence) will necessarily lead it to become efficient. Efficient markets are, in theory, socially optimal. But merely taking the government’s hands off a market does not mean that that market will magically become efficient. Among many other things, there are other interfering forces that inhibit the “freedom” of a market, and other factors”“such as those that you list”“that prevent even an otherwise “free” market from being efficient.

    A private monopoly or monopsony is possible in a free market, but obviously inhibits efficiency. Irrationality on the part of people engaged in the market”“a universal fact of human existence”“inhibits efficiency. Lack of perfect information about products”“a universal fact of human existence”“inhibits efficiency. Emotional entanglements between buyers and sellers and seemingly unrelated third-parties”“a universal fact of human existence”“inhibits efficiency. Lack of liquidity in secondary markets, which you point out for these TVs, inhibits efficiency. And so on.

    All in all, I think my main argument in the original post still stands. (Or maybe you were agreeing with me all along and I just misinterpreted your comment as being a critique? Or maybe I didn’t understand your critique and my argument is lying in tatters on the floor and I just don’t realize it?)

  • Jon, The main problem with your argument is that it attempts to influence, through facts and logic, people whose whole philosophy of the universe is based on believing the opposite of your argument.
    Arguing against the optimality of the free-market is like arguing against people’s religion. You can’t use facts to convince people that evolution happens if they are dead set agaist believing it, and you can’t convince most Americans that free-market capitalism is not the ideal we should be striving for. Even if they see the need for some government intervention now, they see this as a necessary evil that should be avoided in future, like quadruple bipass surgery.
    Blind faith in the idea that free markets=efficient markets=optimal markets is right up there with democracy and childhood obesity as emblems of Americanism.
    My point, if I have one, is that one will never diminish American’s belief in optimal free markets through logic or facts. You need a more emotionally based appeal. Maybe a free-market bogey man to set up as the symbol of free-markets, then slander until no one wants to be associated with him. I suggest W, as both the association and the slandering should be fairly easy.
    -Dan