What's needed for a 'free market'?

In the ‘Adam’s Fallacy’ post, there was a long stream of discussion in the comments, where some interesting issues were raised.

Perhaps it’s not Adam Smith’s fallacy or fault, but there is a conception that in a free market, the ‘invisible hand’ converts the self-interested actions of the participants in the market into a result that is to everyone’s benefit.  Sounds pretty easy!  But I think there’s a lot of necessary ‘foundations’ that are often left unspecified.

What factors are prerequisites for the working of ‘free markets’?  Here’s my a starting point of a list, with brief notes on each point.  I’d be happy to have any of these disputed or new ones added.

1. Strong notions of private property and ownership.  Things that aren’t privately owned, such as air and the seas, don’t make for good markets.  Some things seem to run toward natural monopolies, and these can also not work so well as markets.

2. Legal system of contracts and ability to press for damages in case of breach.  Also mechanisms for addressing externality problems (one party’s fruitful activities having a negative impact on unrelated parties).

3. Strong sense of cooperation and trust in the population.  It’s a very good question where this comes from and how it’s sustained…  We often take this for granted, but it’s not always present – here’s a funny but scary bit from Tony Horwitz’s book “A Voyage Long and Strange” where a person is speaking of the driving ‘rules’ in the Dominican Republic:

“Rule number one, defensive driving,” he said, accelerating as we approached a busy intersection. “Never stop at a red light, because the guy behind you won’t, and he’ll rear-end you.”
“What about drivers coming the other way?” I asked.
“Their light’s green, so they know to stop and then go very cautiously.  Yellow’s the easiest. You step on the gas.” He paused. “of course, a lot of the time the stoplights aren’t working. Then the rule doesn’t apply.”

Granted, this is a kind of cooperation & trust, but not one most Americans could feel comfortable with!

4. Common rules and a ‘level-playing field’.  In general it should not be the case that one company gets special privileges that its competitors do not – company success should be through superior performance, not superior connections.  Likewise it must be clear to new entrants what the rules are.  People must abide by the rules or face legal consequences.

5. A certain level of transparency – what does a product consist of? has it been shown to be effective in some sense?  This relates to creating a sense of trust.

6.  Institutions to help out where markets don’t really apply – charities for example.

7.  An educated populace with a variety of skills & ability to learn.  Along with this a certain willingness to give up old traditions and habits in order to adapt to market changes.

8.  A certain level of common infrastructure that is maintained – for example, transport systems, electricity and water and sewage.

9. A certain kind of ‘enlightened’ self-interest.   For a person, we might say that an ‘enlightened self-interest’ takes into consideration the ‘common good’ – if a person simply tries to maximize short term personal gain at the expense of all his neighbors, he may find that his narrow self-interest leads to a negative outcome.  Note however that for a corporation, by law the self-interest is in creating shareholder value, or in other words making a profit (can this be reconciled with an ‘enlightened’ self-interest?).

The bottom line of all this, I believe, is that where we see the most pure expression of ‘free markets’, we also see large government involvement to help achieve and maintain many of these pre-conditions.

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