Market Economy

 Market Economy

This is considered the first formal economic system emerging out of the traditional economic system. Its origin is traced back to the work (An Inquiry into the Nature and Causes of the Wealth of Nations, 1776) of the Scottish philosopher-economist Adam Smith (1723-90). His main ideas can be summed up, in a simplified way, in the following way—

■ It is the self-interest which motivates individuals/firms to do economic activities out of which society gets goods and services supplied with. It means the products society gets is unintended social benefits of someone’s self-interested actions. Adam Smith called this motivating factor the invisible hand (often called as the ‘animal spirit’). This way the questions like ‘who’ will invest in productive assets and ‘why’ seem get answered.

■ To attain higher prosperity there should be increasing division of labour (specialisation of labour force by breaking down large jobs into small components). Specialisation brings in speed, precision and quality in the labour force.

■ For invisible hand to operate properly a suitable environment (i.e., market) determined by the forces of demand and supply (called the market forces) is required. What to produce, how much to produce and at what price to sell (i.e., supply) all such decisions depend on these forces.

■ Such an economic system needs to be regulated by competition prevailing in the market.

■ For efficient operation of the economic activities, government should follow a policy of laissez faire (French word which means ‘leave it alone’ which is generally translated by economists as ‘non-interference’). Lesser the government, better the economic performance. Here, non-interference by government means great many different things such as—government playing no or least economic role (producing none of the goods and services), no economic regulation, no taxes imposed, etc.

Adam Smith himself called such an economic system as ‘the system of natural liberty’. Rather these ideas were the drivers of two major economic systems— ‘capitalism’ and ‘free market economy’. Though, they are based on the same economic environments (demand and supply), there are subtle differences between them:

■ While capitalism is focused on creation of ‘wealth’ and ownership of productive assets, free market economy is focused on ‘exchange’ of wealth (through production and supply of goods and services).

■ In a capitalist system there might be some government regulation but private owner can have monopoly on the market and thus prevents competition. However, a free market economy is solely based on market forces (demand and supply), and there is little or no government regulation. That is why in free market economy free competition is possible without any intervention from outside forces.

Such an economic system got first tried in the USA in 1777 from where capitalism spread across the whole Euro-America (Northern America and Western Europe). These economies enjoyed high prosperity and operated well till got hit with the Great Depression in 1929. By that time great capital was amassed by few (the multi- and trans- national companies) while majority remaining poor—widening inequality in the process over the time. Taxes were imposed but they were very few in number and at very lower rates with state playing negligible welfare role.

Cons of this System Supported by the democratic rights and freedoms, this system had great environment for individual success, innovation and business activities. Though, it looks smoothly operating for over one and half centuries (with subtle changes) it had its own set of limitations which can be summarised precisely in the following way—

■ There was almost no tool to look after those who have lower purchasing power (i.e., the poor).

■ Negligible to total absence of welfare actions from the state.

■ Widening economic inequality even after launching distributive measures such as progressive taxation (in which richer are taxed with higher rates).

The existing set of policy approaches could not help these economies to recover out of the Depression. It was in wake of this crisis that we see the rise of a new branch of economics—the macroeconomics—proposed by the British economist John Maynard Keynes (1883-1949) in his seminal work The General Theory of Employment, Interest and Money, 1936. Together with analysing the causes which might have caused this crisis, Keynes suggested a new set of policy approach also to help economic recovery. In very simple term, Keynes suggested these economies to include certain traits from the other economic system (Non-Market Economy) to correct the crisis faced by them. After including the Keynesian advices these economies recovered out of the Depression and in this process (practically) the mixed economic system evolved.