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On Economic Freedom

An utilitarian, as opposed to ideological, approach to the free market.

Written by johnleemk on 9:04:03 am Dec 17, 2006.

Liberty is often regarded as an ideal - as something to be strove for simply because it is good. Liberty is usually thought to be an end in itself, especially by Western liberals. Libertarianism, which espouses the maximisation of personal and economic freedom, is founded on the thinking of economists like Friedrich Hayek and Milton Friedman - both of whom often spoke of freedom as an end in itself. Hayek's seminal work, The Road to Serfdom, highlights his view that impediments to economic liberty inevitably result in, well, serfdom.

Now, I personally have viewed myself as libertarian for about the past half decade. I believe you have the right to do whatever you please, as long as you don't harm anyone. If you want to watch pornography, go ahead. If you want to stick your penis in another guy's anus, go right ahead. Just don't do it while I'm watching. Similarly, I believe that society should rely on the free market to answer the basic economic questions of what to produce, who to produce it for, how much to produce, how to produce it, etc.

I have always wondered, however, about how to reconcile the free market with the problem of poverty. I do not speak just of the unemployed who just scrape by in life, but of those who die of the easily solved problem of hunger. How can a system that leads to the overproduction of agricultural goods also lead to deaths from starvation? If society can afford to produce life-saving medicines at inexpensive prices, why should there be millions of suffering people unable to get the medication they need? Why should economic freedom be an end in itself?

Like many, I have come to the conclusion that economic freedom is not and should not be an end in itself. (This may seem painfully obvious to a large number of people, but you'd be surprised how many libertarians think of freedom as the ultimate goal society should strive for.) The reason simply is that an economic system exists only to resolve the basic economic problems of production. The ideal economic system is not that which provides the most freedom, but that which can produce the most amount of goods for the lowest cost to society.

Now, most people, after witnessing the insanity of the present state of things, turn into proponents of a highly regulated market, with price controls, nationalisation of key industries, and the like. But a study of orthodox economic theory reveals that the free market is not and should not be the anarchistic market. A free market must operate within a legal framework designed to fight the problems of market failure. (Notice that this is what orthodox economic theory, as espoused by the vast majority of academic economists, suggests. Unconventional economists such as Hayek have argued that a less regulated market than conventional economics would advocate is more efficient.)

I have written in the past of how the ideal market would operate - with strict restrictions on monopoly power, and the incorporation of subsidies and indirect taxes to address externalities. It may be noticed, however, that I have not produced a solution to the problems of hunger and inadequate supplies of lifesaving medication that I mentioned above.

The reason for this is that these problems have not been created by the free market. The main reason we have an excess glut of agricultural goods in developed countries is because developed countries can afford to subsidise the hell out of agricultural production. The European Union, for instance, is known for its mountains of grain and lakes of wine which nobody will buy, because the governments of Europe have encouraged their producers to overproduce by means of subsidising production. And why won't these farmers sell to starving African nations? Because of protectionism - the World Trade Organisation enforces "anti-dumping" regulations, which ban the export of goods at prices deemed excessively low by the WTO. For the same reason, developing countries cannot export their goods to the developed nations. This situation would never occur in a truly free market, because a truly free market does not have ridiculous protectionist measures like anti-dumping regulations.

Similarly, government intervention has created the problem of inflated drug prices, which keep lifesaving pills out of the hands of those who need them most. The reason for this is the government-created monopolies drugmakers have on their inventions. Each drug manufacturer gets a monopoly on its products until a certain date, after which their recipe becomes public. Without the patents, there would be no monopoly, allowing anyone to produce and sell the drug at will - and the ensuing competition would work to drive prices down.

The question of why we do not simply phase out patents is not as simple to answer as why we keep cheap goods out of our countries' borders. The latter is easily answered: local firms and their employees would much rather keep the competition away. The former, however, is not, because without patents, there would be very little incentive for drugmakers to research and develop new drugs. Developing a drug is very costly and time-consuming - it can take as long as a decade to bring a new drug to market. Without patents, there would be nearly no incentive to innovate - not when once you bring the drug to market, competitors copy your product and drive your profit margins down to practically nothing.

If this sounds familiar, it's because the free rider problem has arisen. The pharmaceutical companies' rivals are the free riders, getting the benefits of the new drug for free. There is a positive externality at work here, and so the way to approach it would naturally be to correct it. Governments, however, have chosen to correct this problem by enforcing drug patents - granting pharmaceutical companies a monopoly on their products for a certain length of time. This is not a very desirable solution, however. Replacing one market distortion with another cannot be very helpful.

Alas, this is a problem that remains unsolved. Nobody has cracked this nut yet, and so drug companies continue to reap tremendous profits from their monopolies, while those who cannot afford their expensive medication continue to suffer. Some possible solutions have been proposed, such as a bounty for innovation - the government would pay a lump sum to the inventor of a new drug, with the price set by an auction. (I am not too clear on the specifics.) But still, this proposal has yet to be taken up by any government in the world. If (and hopefully when) a feasible solution is implemented, you can mark my words that its creator will win the Nobel Prize for Economics.

These misattributed problems of the market aside, there also remain some crucial issues that are undeniably caused by the market. I will tackle perhaps the biggest and most controversial one here: the problem of globalisation. In nearly every developed or semi-developed country around the world, there exists a protectionist movement seeking to erect barriers to integration with the global economy. This is especially marked in the United States, with the recent election of several protectionists to Congress such as Senator-elect Sherrod Brown of Ohio and Senator-elect Jim Webb of Virginia, to say nothing of the numerous Representatives-elect in the House.

There are many reasons for protectionism, some less reasonable than others. Often, it is argued that "infant industries" need to be protected so they can build themselves up without worrying about being buffeted by global market forces. This may or may not hold water, but from our experience here in Malaysia, it is extremely difficult to wean these infant industries off the teat of government protection once they get up and running. For example, the national car manufacturer, Proton, remains heavily protected by government import tariffs and the subsidisation of Proton's production lines despite having been in business for two decades.

Another argument in favour of protection is that countries should not render themselves overreliant on imports, in case a key trade partner suddenly pulls the plug. The problem with this line of thought is that you cannot have your cake and eat it. If you want to be truly self-sufficient, you have to produce everything at home. Even if all that is sought is self-sufficiency in a few key goods, it is extremely difficult to attain production levels that will meet domestic demand. Furthermore, it will be nearly impossible to export these goods because they have to be sold at prices above those of other countries who have a natural comparative advantage in their production, and whose goods would have been imported had there been no self-sufficiency policy in place. At the same time, other goods which the country has a comparative advantage in will be underproducing, because they have been neglected at the expense of those self-sufficient policy-targeted industries. The problem can be reduced if we do not seek total self-sufficiency, but in such a case, what is the point? Either you are completely independent of other countries, or you are not. A few extra hundred thousand tonnes of rice won't make much difference if you still need imports to feed your people.

Retaliation is also cited in opposition to globalisation. Many countries, it is noted, impose protectionist tariffs and quotas on our exports, while subsidising their own exports. It is thus only fair and just for us to impose our own protectionist measures to erase this unfair advantage. This argument was popular in the 1980s and early 1990s during Japan's economic ascendancy. The problem with this tit-for-tat approach is that it inevitably results in a worser outcome for everyone. To take the colourful analogy applied by one Cambridge economist, should we block up our harbour because another nation has rocks in their's? Two wrongs don't make a right.

The most-cited argument, however, is that free trade harms workers by destroying local jobs. Protectionists argue that trade pacts result in the loss of jobs to trade partners. The problem here is that this only examines one side of the equation - the job loss is more than offset by the gains made in cheaper imports and the freeing up of resources to allow each country to focus on what it can do best. Protectionism would benefit those workers whose jobs are spared, but harm the whole country by forcing it to continue overpaying for imports and preventing the creation of jobs in industries where the country's comparative advantage lies. This is why legislative bodies, where individual members are accountable to their respective constituencies, tend to be protectionist in nature, while leaders elected by the whole country tend to support free trade.

A corollary to the above argument is the "race to the bottom". Protectionists suggest that all globalisation will result in is a race to the bottom - a race where capital flows to the country with the lowest costs of production, where environmental and labour regulations are most lax, where wages are lowest, leading to a world with very cheap goods and services, but where capitalists exploit and abuse people and nature to the fullest. This argument, if thought through to its logical conclusion, holds no water. For one, there is a finite number of countries in the world. If as wages rise, firms shift their operations to another country with lower costs, eventually there will be nowhere to run. The result will then be that at some indeterminate point in the future, wages everywhere will start to rise. And looking at the up-and-coming developing countries, it's quite clear that the race to the bottom is a myth. Direct investment is not as mobile as one might think; it is impossible to uproot whole manufacturing plants from one country to another. Firms tend to stay put, and living standards everywhere tend to rise. Vietnam, China, India - their economies are growing by leaps and bounds, and living standards (as measured in GDP per capita) are rising in tandem. It is not surprising that this has come about only now, after they have taken down their barriers to trade (Vietnam and China are still communist in name, but not in fact; India was run by socialist governments until the 1980s when the present Prime Minister, economist Manmohan Singh, became Finance Minister and reformed the economy). Eventually, they will rise to a similar level as South Korea and Japan have - there is no such thing as a race to the bottom.

That is not to say that the problems globalisation creates aren't real. Developed economies' firms do take advantage of cheap labour and lax regulations, and meanwhile workers in developed countries whose jobs are eliminated suffer. The former, however, is a problem that will dissipate as economies develop. Implementing policies such as the minimum wage (which, by the way, is controversial among economists for interfering with the labour market) in developing economies would hurt more than they help, possibly stalling development. The time is not yet ripe. As for the problem of workers in developed countries, the problem is that the industry they have specialised in no longer has the comparaitve advantage in the global economy. The solution is retraining. Note that most who have lost their jobs in developed countries due to globalisation are the middle-aged. New entrants to the job market will have had the chance to specialise in an industry where their country has the upper hand, and so will have greater job security.

Many problems people have with economic liberty arise from misunderstanding how markets are supposed to function, and from a failure to examine the fundamentals that have created the issues we struggle with. Often, even the proponents of capitalism fail to grasp that markets are only a means to an end. An economic system is supposed to allocate resources efficiently, not lead to unrestrained freedom. Even Milton Friedman, whose libertarian thinking has been rejected by many economists, was in favour of a negative income tax - redistributing income to the poorest through direct transfer payments. We would all do well to become students of economic thought, because it teaches us invaluable lessons about the world, and how we can never jump to conclusions such as "Globalisation is bad" or "More economic freedom is invariably good" from simple observations such as "Globalisation destroys jobs" or "More personal freedom is invariably good".