Where did the idea that free markets are "efficient" come from?

I’ve been reading an article about starvation in Malawi in the current issue of the New York Times Magazine. Describing the changes in attitudes during the 1990s of the entities most responsible for international aid, the article said this:

(you can read it online at www.nytimes.com - requires free registration)

I am emphatically NOT an economist, but I can’t quite fathom how it was deemed logical that free markets were somehow more “efficient” or would better serve the poor. The one overriding principle of a truly free market is that everything – prices, quality, etc. – is “whatever the market will bear.” Therefore, money = power. How could anyone think the poor would have a chance in a system like this, where they are disadvantaged from the very beginning?
From my layman’s viewpoint. capitalistic democracy only seems to really work well when the a) there is a modern infrastructure that allows development, and b) there is actually a market for any products poduced.
Malawi, and apparently much of Africa, has neither of these things. In the article I quoted, a person says their sister was very smart because “she went to school up to the second grade.” (!)
No country where people are so uneducated is going to develop a modern infrastructure; where would the brainpower to design and build it come from?
As for African access to markets, I don’t really know enough to comment on it. But the point of this thread was: How did aid organizations like the IMF and World Bank get their ideas, and why do they keep clinging to them, when all signs point to their being mistaken? Are international eonomics really a zero-sum game?

> >How did aid organizations like the IMF and World Bank get their ideas, and why do they keep clinging to them, when all signs point to their being mistaken?

No, all signs do not point to what you say. You admit you do not know the first thing about economics so why do you feel you are at the same level as economists and the international organizations? You might want to read up a bit and I suggest “the road to serfdom” by Hayek as well as The Use of Knowledge in Society also by Freidrich Hayek

>> Are international eonomics really a zero-sum game?


Since this is GD, do you mind if I add some random tidbits I’ve grasped here and there? Others more knowledgeable than I will be able to correct or fill in the details.

  • The idea that free markets are the most efficient derives AFAIK to the beginning of economic theory, Adam Smith and Mandeville.

  • There is rising and significant criticism against the assumptions of the policies of the IMF and World Bank, precisely against the kind of things you mention. A well-known economics professor who used to work for one of those organisations springs to mind (I read about this; unfortunately I don’t recall his name :().

  • There is also a growing recognition (or if you will, support for the standpoint) that a market economy needs a proper civil society, democratic government and rule of law to function properly. The assumptions that aided the rise of a market economy in the Western world need not apply to Africa today.

  • Furthermore even the rise of the free market in the Western world was accompanied by lots of human misery. You can read up on the appalling conditions in British industry for example in Engels’ The Condition of the Working Class in England in 1844. We tend to forget that, since reading about misery doesn’t make a nice history lesson. It is easy to say as an economic theorist, remote from actual hardship, that this is necessary for the common good in the long run. But as has been remarked (by Keynes?): in the long run we’re all dead.

So, your OP does find support with other’s opinions.

It’s called the law of comparitive advantage, it allows the person, company or nation most suited to a particular task to specialize in that function and through trade live better than if they had to produce everything on their own.

That’s the basic idea, and “free markets” more or less echo it writ large. The simple fact that you tend to end up with more by specializing in your strengths under the auspices of free trade is exactly why international economics is not a zero-sum game. (Though that is somewhat arguable in the shorter term)

You seem quite confused so far, I suggest you read up on economics and reconsider your questions.

“Whatever eventual benefit there might be in such reforms, the immediate impact on Malawian farmers – paupers during the best of times – was distress.”

THIS is the crux of your question, I believe- free markets are inefficient in the short term.

In the long term, they allow rapid economic growth and in general provide the best means for allocation of scarce resources- the central effort in any economic system.

However, markets are slow to respond to change.

Say a village bicycle maker works alone. Now, suppose the village demand for bicycles increases enough that the maker needs an additional employee to take the load. He can’t hire someone instantly- he needs to observe a trend in his business. What if all those extra bicycles are being purchased before a mass exodus? (Unlikely, but I’m illustrating a point).

Thus, for a short time, he will continue to work alone and overburdened, and thus will be charging extra- he can, because he’s the only bicycle maker. Eventually, he will hire an assistant bicycle maker, and the market will return to its previous state, but larger. Otherwise, someone else will see his big profits, and get into the bicycle making business too.

The lag between increase in demand and increase in supply is what makes market economies inefficient in the short term- imagine, say, Toyota facing the same problem, only having to decide how many thousands of additional workers to hire (and how many factories they’ll need to house them, and support staff, and tooling, etc.)

HOWEVER- every economic system suffers from this same lag. The production bosses couldn’t just go and ask the Central Committee for eight extra workers because Yevgeny, Yuri, and Jeff all called in sick one day. Non-capitalist systems suffer from other inefficiencies too- price ceilings and floors (which is what your economy basically consists of in a command system) create all kinds of additional inefficiencies- such as having to collect extra taxes to pay farmers to produce extra wheat to keep prices down, which means you have to hire a bunch of extra tax collectors, and so on.

The ‘free market’ such as can be said to exist, since no economy is truly “free” (beyond perhaps black market systems), only has one major inefficiency. It doesn’t account for “externalities”- in other words, problems market industries create which don’t affect the public’s spending habits, like pollution. To deal with these things, you need heavy government regulation, which creates inefficiency, because new laws are always being passed and businesses must (or in certain administrations, mentioning no names, are asked to if they feel like it) buy new technology to deal with them, and thus consumers pay more for their final goods, creating inefficiency because, in effect, a price floor has been created.

I know I kinda rambled here but dammit, I’m trying to explain a pretty freaking complex set of ideas.

About your last two points:

There is no “growing recognition” that you need a proper civil society, democratic government and rule of law to function properly. Everyone (short of Capitalioanarchists) believe this. There has never been any argument about this. In fact most, if not all, Libertarians and economists will argue that the primary thing holding back most third-world countries is that they do not have any sort of legal framework needed for a free-market to run. How the hell can you have an economy when no one really owns any land, and does not have any way to go about it (no such thing as deeds, etc.). If a person can’t even legally own the land he lives on, why would any foreigner invest their, etc.
Hernando De Soto is a famous Peruvian Economist who has written on this subject. He also heads the Institute For Liberty And Democracy.

Point the second:

The rise of capitalism was accompanied by the end of much of those miseries. The horrible conditions you talk about are nothing compared to the disease and death that was human existence before the industrial revolution. Don’t forget, those people left the country side for the English factories, they had good reason to do so and the prosperity since generated has made their plight only a terrible memory.

If you want to get a good grounding on the differences between free markets and other systems, watch this. If you have broadband you can watch the entire show online. It is a documentry that was made by PBS last year, it is the best one that they have ever done.

If the assumptions that a market economy “needs a proper civil society, democratic government and rule of law to function properly” have found growing recognition, what assumptions would you suggest economists believe allowed the Western economies to develop thus? Are you seriously suggesting that western economies grew strong because none of these things existed?

Another important hindrance to the development of economies in Third World countries, which the IMF and World Bank have totally failed to address, is the fact that most Third World countries are kleptocracies. When you pump money in from an outside source to develop infrastructure or markets or whatever, almost all of it it stolen by the ruling elite, who use it to finance an affluent First World lifestyle for themselves and their families and cronies, mostly by importing what’s necessary for that lifestyle. (Frex, Saddam Hussein’s many palaces in his poverty-stricken country, though admittedly that came from oil money rather than loans).

There is very little that the IMF or the World Bank can do to help a kleptocracy until such problems are cleared up, and I’m not sure anyone has come up with an effective way to clear them up.

For more info, Google 'John Kenneth Galbraith" and kleptocracy.

Well, “democratic government” may be a subjective part of it (how democratic by modern standards were the 19th-Century Great Powers?), but a proper civil society and rule of law are essential.

That some did not consciously realize this until after-the-fact, probably due to having believed that this was the natural state of things, and therefore grew to believe that “free market” in and of itself was some sort of magic incantation to prosperity and well-being, even if imposed on a semifeudal society, a miserable populace, or a government where individual rights are based on the Crown Prince’s degree of boredom, is a different thing.

IANAE (economist), so i’m sorry if I screwed up things in my post.

  • I did not suggest that free markets didn’t develop without a proper civil society etc., but I got the impression that certain policy makers seemed to forget about those requirements. When the Soviet Union collapsed, I heard a lot of people cheer the advent of capitalism. Cue to lots of years later, and people are beginning to realize that the basic structure of Russia had some things lacking, which leads to lots of misery at the present time for the common people. Similarly with many African countries, AFAIK. If I was wrong about what economists in general (as Muad’ Dib pointed out) or policy makers in general think or thought, I apologize. I’m glad to hear that this is communis opinio.

  • With respect to the situation during the advent of capitalism (I’m assuming that we’re speaking of 19th century Britain in particular), I’ve been given to understand that there were more factors into play. The farmers were pushed off their land by landowners who appropriate lands that beforehand were considered to be common good. As a result they become poor and were forced to work in factories. Wasn’t this what’s called ‘The tragedy of the commons’? If I’m wrong about this, I’d love to have my ignorance corrected. :slight_smile:

FTR, Muad’ Dib, dutchboy, I find your posts very interesting. I hope you don’t mind my dilletantesque ramblings.

And again FTR: I’m not against capitalism per se; I think the Soviet experience is strong evidence that a free market society does work better than a completely planned economy.* I’m just wary to recommending it as the immediate solution for each society at the present moment. I find support for this in what Evil Captor said, with which I agree.

  • With the proviso that there are lots of different free market societies; the US is quite different from most European countries.

I was under the impression that “the tragedy of the commons” was more a lesson in ecology; because the commons belonged to “everyone”, and everyone had a vested interest in maximizing their own profit and to hell with the others, the common became overgrazed and eventually became a wasteland, to everyone’s loss. The current state of the world’s oceans and fish stocks might be another example.

Actually, this is often cited as an example of needing more privitization, rather than less: instead of some authority doling out “fair shares” to everyone, placing a market value on something that was previously “free” forces the owners of that property to make economically sound decisions, such as limiting the exploitation of their investment to a sustainable level.

When I and my wife visted New Orleans a few years ago, we were told an interesting tale. Alligators were once endangered, so the state instituted a system where you could get permission to harvest so many alligators per year- from bayou you owned. This has largely been a success, preserving the alligator population, providing a steady flow of meat and hide, and benefiting the people who actually live and work in the bayous.

Anyway, I had a comment about the “free market”: in one glaring way, the global economy is NOT free- in the mobility of labor.

Imagine if the states were not obligated to allow citizens from anywhere in the US to relocate- if people from the “Rust Belt” cities like Detroit had been unable to move to the developing southern and western states- if Texas could say that Michigan’s unemployment was Michigan’s problem. The poverty problem in the US would be unthinkable.

If there truly were a totally free global market economy, with some world government guaranteeing uniform economic laws, what we would see would be the immediate emigration of hundred of millions, or even billions, of impoverished Third World people to North America and Western Europe. People who would happily work 16 hour days in terrible conditions for minimum wage and live in slums, because that would still be better than what they came from.

The problem of course is that this would “import” much of the Third World’s poverty into the West, and would swamp the ethnic and social cultures of the receiving nations. This has been recognized by the US and other industrialized nations since at least the end of the nineteenth century, when immigration laws were first instituted.

It would be going too far to cynically suggest that the West’s prosperity is based directly on the Third World’s poverty. But it is true that the developed nations have their own vested interests, including their own prosperity, even if this means continuing patterns of trade that are probably not helpful to undeveloped nations. So the best we’re left with is the conviction (almost an ideology), that eventually water will find it’s own level and the undeveloped nations will eventually “catch up” to the West. This of course is of little consolation to the millions of literally starving people around the world.

I’d say its a little too soon to give up. Many, if not most of these nations were not really free until 1950 (essentially all of Africa and much of Asia) and they have experienced insane population growth from better water and food. Ironically, much of the world’s starvation comes from the population growth caused by clean water.

Plus, most of what people think are terrible work conditions are not bad in the third world. The pay may seem low by our standards, but a very small amount can keep people going for a very long time.

The OP is more than a little confused, which is fair enough because it is a confusing subject.

But to answer the question put in the title: it depends what you mean by “efficient”. Markets can be “Weak Form efficient”, “Semi-Strong Form efficient” or “Strong FOrm efficient” and it’s all dependent on how they reflect information.

[li] A weakly efficient market reflects past public information[/li][li] A Semi-strong form efficient market reflects ALL past and current public information.[/li][li] A Strong form efficient market already reflects all past and current information, whether public or private[/li]
Now weak efficiency is pretty clear, so long as there are reasonable mechanisms for diseminating that past public information. Most western markets will be weakly efficient pretty trivially. Where it is not so, various regulations are in place to protect the weaker parties in transactions - for example where there is an information disparity due to the difficiulties in processing information.

Insider trading laws should prevent strong-form efficiency.

So the question is whether markets are semi-strong efficient. This is actually a matter of some debate, but certainly experimentation suggests that markets are semi-strong form efficient.

Either way, you can see that even the question of what you mean by “efficient” isn’t clear cut, let alone the answer to that question!


Well I am an economist, and the short answer is that The Bank has been very slow to recognise the importance of institutions and The Fund still doesn’t seem to get it. As I understand it, the notion that “corruption is bad” has only recently found universal acceptance in the Washington institutions.

Are you trying to be darkly humorous? :wink:

This subject is turning out to be a bigger morass than I even imagined. I suppose I should’ve focused the OP more specifically on Africa, since that is what I was thinking about.
The article I quoted just underlined for me what most people already know, although few stop to think about it much: things are really, really bad in Africa. The reason I start threads like this is an attempt to understand what seperates Us from Them socially. Obviously, just adhering to Free Markets alone will not transform a Malawi into a United States, or even a Mexico. To what do we owe our low levels of corruption, law and order, etc.? Why are these things (or lack thereof) such persistent problems in the Third World? Is there any remedy in sight, short of social revolution?
I’ve been wrestling with this issue for a long time, and haven’t even come CLOSE to finding an answer.

Lizard, your last post contains a number of highly intriguing questions (which may or may not have been debated here before), but they would each require a separate thread on their own. Do you want us to go into them here? Just asking for clarification.

The name you are looking for is Joseph Stiglitz, who published Globalization and its Discontents.

To answer your first question, all economic systems are the most efficient in the world – the only question is, efficient for whom? Undoubtedly, Western corproations working in sympathetic dictatorships find them remarkably efficient. No human rights, no minimum wages, few taxes.

But is efficiency the only aim? If one is looking for a system that offers the best benefit for the largest number, unregulated, laissez-faire capitalism is one of the worst choices.

How did this system become popular again? It was largely discredited by the middle of the 20th century. But an economist named Milton Friedman resurrected it like a necromancer with a zombie, and put it to work. It wasn’t long before those twin towers of Keynsianism – the World Bank and the IMF – were transformed as well, become economic Typhoid Marys, spreading economic disaster wherever they went.

A business journalist named Linda McQuaig has spent much of her life chronicling the rise of marketism and presenting the alternatives. Her exposé on the IMF and the Bank – All You Can Eat: Greed, Lust, and the New Capitalism – is a fascinating read. She quotes several of the Bank’s own analysts. One (William Easterly) presented a report to the IMF revealing that the poor in countries that ignore the IMF’s advice fare better than those in countries that take it. An independent report by the Centre for Economic and Policy Research found that per capita income in the poorest parts of sub-Saharan Africa grew by 36% while the Bank was pursuing Keynsian policies, and dropped by 15% in the last two decades, while the Bank has been following Friedman’s lead.

It would be wrong to paint all Bank and IMF as horned Mammon-devils with a lust for gold in their eye. Many sincerely believe in what they do. But a belief so profound that it is impervious to evidence – that relies on simple truths rather than complex realities – such a belief can only be called a religion. Nations who refuse the Bank’s ideas are threatened with economic damnation, while economic salvation for the poor is always in some hazy future.

Keynsianism worked better, but Keynisanism relies on complex balances and context. Friedmanism, with it simple wipe-the-slate-clean philosophy is a lot sexier.

The FREE MARKET is a pre-1900 idea. Planned obsolescence wasn’t going on then.

34 years after the moon landing our economists still haven’t noticed.

So free market means everyone is free to hide information as it serves their purposes.

I think THE SCREWING OF THE AVERAGE MAN by David Hapgood is the best economics book I’ve seen so far. It won’t give you the usual pseudointellectual garbage you get from economists tho.

do a search on “depreciation of durable consumers goods”

Dal Timgar