What Is the Free Market?

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The Free market is a summary term for an array of exchanges that
take place in society. Each exchange is undertaken as a voluntary
agreement between two people or between groups of people represented
by agents. These two individuals (or agents) exchange two economic
goods, either tangible commodities or nontangible services. Thus,
when I buy a newspaper from a news dealer for fifty cents, the
news dealer and I exchange two commodities: I give up fifty cents,
and the news dealer gives up the newspaper. Or if I work for a
corporation, I exchange my labor services, in a mutually agreed
way, for a monetary salary; here the corporation is represented
by a manager (an agent) with the authority to hire.

Both parties
undertake the exchange because each expects to gain from it. Also,
each will repeat the exchange next time (or refuse to) because
his expectation has proved correct (or incorrect) in the recent
past. Trade, or exchange, is engaged in precisely because both
parties benefit; if they did not expect to gain, they would not
agree to the exchange.

This
simple reasoning refutes the argument against free trade typical
of the "mercantilist" period of sixteenth- to eighteenth-century
Europe, and classically expounded by the famed sixteenth-century
French essayist Montaigne. The mercantilists argued that in any
trade, one party can benefit only at the expense of the other,
that in every transaction there is a winner and a loser, an "exploiter"
and an "exploited." We can immediately see the fallacy
in this still-popular viewpoint: the willingness and even eagerness
to trade means that both parties benefit. In modern game-theory
jargon, trade is a win-win situation, a "positive-sum"
rather than a "zero-sum" or "negative-sum"
game.

How can both
parties benefit from an exchange? Each one values the two goods
or services differently, and these differences set the scene for
an exchange. I, for example, am walking along with money in my
pocket but no newspaper; the news dealer, on the other hand, has
plenty of newspapers but is anxious to acquire money. And so,
finding each other, we strike a deal.

Two factors
determine the terms of any agreement: how much each participant
values each good in question, and each participant’s bargaining
skills. How many cents will exchange for one newspaper, or how
many Mickey Mantle baseball cards will swap for a Babe Ruth, depends
on all the participants in the newspaper market or the baseball
card market – on how much each one values the cards as compared
to the other goods he could buy. These terms of exchange, called
"prices" (of newspapers in terms of money, or of Babe
Ruth cards in terms of Mickey Mantles), are ultimately determined
by how many newspapers, or baseball cards, are available on the
market in relation to how favorably buyers evaluate these goods.
In shorthand, by the interaction of their supply with the demand
for them.

Given the supply of a good, an increase
in its value in the minds of the buyers will raise the demand
for the good, more money will be bid for it, and its price will
rise. The reverse occurs if the value, and therefore the demand,
for the good falls. On the other hand, given the buyers’ evaluation,
or demand, for a good, if the supply increases, each unit of supply
– each baseball card or loaf of bread – will fall in
value, and therefore, the price of the good will fall. The reverse
occurs if the supply of the good decreases.

The market,
then, is not simply an array, but a highly complex, interacting
latticework of exchanges. In primitive societies, exchanges are
all barter or direct exchange. Two people trade two directly useful
goods, such as horses for cows or Mickey Mantles for Babe Ruths.
But as a society develops, a step-by-step process of mutual benefit
creates a situation in which one or two broadly useful and valuable
commodities are chosen on the market as a medium of indirect exchange.
This money-commodity, generally but not always gold or silver,
is then demanded not only for its own sake, but even more to facilitate
a re-exchange for another desired commodity. It is much easier
to pay steelworkers not in steel bars, but in money, with which
the workers can then buy whatever they desire. They are willing
to accept money because they know from experience and insight
that everyone else in the society will also accept that money
in payment.

The modern,
almost infinite latticework of exchanges, the market, is made
possible by the use of money. Each person engages in specialization,
or a division of labor, producing what he or she is best at. Production
begins with natural resources, and then various forms of machines
and capital goods, until finally, goods are sold to the consumer.
At each stage of production from natural resource to consumer
good, money is voluntarily exchanged for capital goods, labor
services, and land resources. At each step of the way, terms of
exchanges, or prices, are determined by the voluntary interactions
of suppliers and demanders. This market is "free" because
choices, at each step, are made freely and voluntarily.

The
free market and the free price system make goods from around the
world available to consumers. The free market also gives the largest
possible scope to entrepreneurs, who risk capital to allocate
resources so as to satisfy the future desires of the mass of consumers
as efficiently as possible. Saving and investment can then develop
capital goods and increase the productivity and wages of workers,
thereby increasing their standard of living. The free competitive
market also rewards and stimulates technological innovation that
allows the innovator to get a head start in satisfying consumer
wants in new and creative ways.

Not only
is investment encouraged, but perhaps more important, the price
system, and the profit-and-loss incentives of the market, guide
capital investment and production into the proper paths. The intricate
latticework can mesh and "clear" all markets so that
there are no sudden, unforeseen, and inexplicable shortages and
surpluses anywhere in the production system.

But exchanges
are not necessarily free. Many are coerced. If a robber threatens
you with "Your money or your life," your payment to
him is coerced and not voluntary, and he benefits at your expense.
It is robbery, not free markets, that actually follows the mercantilist
model: the robber benefits at the expense of the coerced. Exploitation
occurs not in the free market, but where the coercer exploits
his victim. In the long run, coercion is a negative-sum game that
leads to reduced production, saving, and investment, a depleted
stock of capital, and reduced productivity and living standards
for all, perhaps even for the coercers themselves.

Government,
in every society, is the only lawful system of coercion. Taxation
is a coerced exchange, and the heavier the burden of taxation
on production, the more likely it is that economic growth will
falter and decline. Other forms of government coercion (e.g.,
price controls or restrictions that prevent new competitors from
entering a market) hamper and cripple market exchanges, while
others (prohibitions on deceptive practices, enforcement of contracts)
can facilitate voluntary exchanges.

The ultimate
in government coercion is socialism. Under socialist central planning
the socialist planning board lacks a price system for land or
capital goods. As even socialists like Robert Heilbroner now admit,
the socialist planning board therefore has no way to calculate
prices or costs or to invest capital so that the latticework of
production meshes and clears. The current Soviet experience, where
a bumper wheat harvest somehow cannot find its way to retail stores,
is an instructive example of the impossibility of operating a
complex, modern economy in the absence of a free market. There
was neither incentive nor means of calculating prices and costs
for hopper cars to get to the wheat, for the flour mills to receive
and process it, and so on down through the large number of stages
needed to reach the ultimate consumer in Moscow or Sverdlovsk.
The investment in wheat is almost totally wasted.

Market socialism
is, in fact, a contradiction in terms. The fashionable discussion
of market socialism often overlooks one crucial aspect of the
market. When two goods are indeed exchanged, what is really exchanged
is the property titles in those goods. When I buy a newspaper
for fifty cents, the seller and I are exchanging property titles:
I yield the ownership of the fifty cents and grant it to the news
dealer, and he yields the ownership of the newspaper to me. The
exact same process occurs as in buying a house, except that in
the case of the newspaper, matters are much more informal, and
we can all avoid the intricate process of deeds, notarized contracts,
agents, attorneys, mortgage brokers, and so on. But the economic
nature of the two transactions remains the same.

This means
that the key to the existence and flourishing of the free market
is a society in which the rights and titles of private property
are respected, defended, and kept secure. The key to socialism,
on the other hand, is government ownership of the means of production,
land, and capital goods. Thus, there can be no market in land
or capital goods worthy of the name.

Some critics
of the free-market argue that property rights are in conflict
with "human" rights. But the critics fail to realize
that in a free-market system, every person has a property right
over his own person and his own labor, and that he can make free
contracts for those services. Slavery violates the basic property
right of the slave over his own body and person, a right that
is the groundwork for any person’s property rights over nonhuman
material objects. What’s more, all rights are human rights, whether
it is everyone’s right to free speech or one individual’s property
rights in his own home.

A common
charge against the free-market society is that it institutes "the
law of the jungle," of "dog eat dog," that it spurns
human cooperation for competition, and that it exalts material
success as opposed to spiritual values, philosophy, or leisure
activities. On the contrary, the jungle is precisely a society
of coercion, theft, and parasitism, a society that demolishes
lives and living standards. The peaceful market competition of
producers and suppliers is a profoundly cooperative process in
which everyone benefits, and where everyone’s living standard
flourishes (compared to what it would be in an unfree society).
And the undoubted material success of free societies provides
the general affluence that permits us to enjoy an enormous amount
of leisure as compared to other societies, and to pursue matters
of the spirit. It is the coercive countries with little or no
market activity, notably under communism, where the grind of daily
existence not only impoverishes people materially, but deadens
their spirit.

This
article was first published as an entry in The
Fortune Encyclopedia of Economics
(Time Warner, 1993),
David Henderson, ed., pp 636-639.

Murray
N. Rothbard
(1926–1995) was the author of Man,
Economy, and State
, Conceived
in Liberty
, What
Has Government Done to Our Money
, For
a New Liberty
, The
Case Against the Fed
, and many
other books and articles
. He
was also the editor – with Lew Rockwell – of The
Rothbard-Rockwell Report
.

Murray
Rothbard Archives

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