Business & Economy

What Is the Role of Markets?

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Nathan McLellan

This article is the third in a series by Nathan McLellan on a Christian vision for economics. Nathan is completing a Ph.D. in Christian ethics at Southern Methodist University. He holds a master’s degree in economics from Massey University and master’s degree in theology from Regent College. He was formerly the Head of Research at the Marketplace Institute Regent College and an economist at the New Zealand Treasury. He is the author of research on economic growth, productivity, and business cycles. He is also a Research Fellow at the New Zealand Maxim Institute.

In two previous articles, I addressed the questions What is Capitalism? and What is a Christian vision for economic life? This article builds on the latter article by asking whether markets are needed for an economy based on a relational understanding of economic life.    

In the previous article, it was noted that while a Christian must reject the notion that the human person comprises unlimited wants that can never fully be satisfied, it is still the case that the individual person and human societies face scarcity, in that there are limited resources relative to competing ends to which these resources can be devoted.[1] This requires both the individual and entire societies to engage in the task of economic allocation—deciding where to direct scarce resources in order to achieve particular ends.  A person must decide how to allocate her time between work and leisure, a household must decide how much to spend on different items for consumption and how much to save, and a government must decide how it will allocate the tax revenue it has collected between different government programs and debt repayment. 

In large and complex societies, it is easy to see that the task of coordinating the decisions made by various economic actors—persons, households, businesses, financial institutions, and governments—is itself a complex activity.  If households want to purchase a quantity of a certain good, how does that information get transmitted to the businesses that produce the good?  How do businesses communicate that they need more workers and materials in order to produce it?  What about when this good is not produced within a particular society?  How does that get communicated?  These questions suggest that societies need to employ some sort of mechanism to coordinate the allocation of resources by economic actors. 

In general, decentralized markets have proved to be an efficient and effective mechanism for coordinating the allocation decisions of economic actors, compared with other non-market mechanisms, such as centralized planning.[2]  Through the use of markets, economic actors are brought together, and through their interaction in buying and selling goods and services, their allocation decisions are coordinated.  In this, market prices play a crucial role in helping economic actors to allocate their resources.  A change in the price of a good or service, relative to other goods and services, provides information or “price signals” to economic actors that there have been changes in the underlying conditions of demand and supply and, therefore, that resources need to be reallocated.  For example, if the relative price of coffee rises, owing to an increase in demand, then this signals to businesses in the coffee industry that more coffee is required.  Contrast this with the use of central planning as a non-market mechanism for coordinating the resource reallocation that is required in response to an increase in demand for coffee.  In this case, the central planner would need to collect the requisite information from consumers about their change in coffee preferences, communicate this information to businesses in the coffee industry, and then set the price for coffee in order to ensure there is neither excess supply nor excess demand.  This central coordination is itself a costly activity and is likely to lead to situations of excess demand or supply because in the time that it takes to collect and disseminate information about the change in demand for coffee, the underlying demand and supply for coffee are likely to have changed. 

A market economy, then, is “an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services,” where market prices play a crucial role.[3]  Although it is the case that capitalism is a form of a market economy—in that capitalism as an economic system makes extensive use of markets to coordinate economic activity—it would be a conceptual and material mistake to equate a market economy with capitalism.  It is one thing to say that capitalism is a market economy; it is another to say that a market economy is capitalism.  Making this distinction is important because it provides the language necessary to describe market economies that, nevertheless, have a different ideology to that which underpins modern capitalism, and provides a way to imagine and cultivate alternative market economies based on a different conception of the human person and society to that of capitalism. 

Another way of making this point is to recognize that markets are always situated within wider societal frameworks.  These wider societal frameworks determine the areas where markets are allowed to operate.  The prohibition on child labor, the buying and selling of votes, and, until recently, trading on Sunday are all instances where wider societal frameworks have restricted the operation of markets.  These wider societal frameworks also shape how markets function and the ways economic actors participate in markets.  For this reason, Bowles, in discussing differences in capitalism between countries, notes:

Variations in national capitalism, in general, can be attributed to the fact that economies are path-dependent, that is, they have histories which shape the decisions which are made and the institutions which arise, in any particular time period.  These histories include the strength of various classes, the national experiences which countries have been through, and the challenges which they face.  “Markets” do not exist in institutional vacuums but, as sociologist such as Karl Polanyi (1944) have argued, are “embedded” in social structures.  How markets operate depends, therefore, on how national economies have been forged and evolved.[4] 

Even the terminology “free market”, which is used to communicate the idea that “exchange is undertaken as a voluntary agreement between two people or between groups of people represented by agents” evokes a wider ethical framework, namely, that exchange should be voluntary and not coerced.[5]

Capitalism, then, does not have a monopoly on the use of markets, nor does it provide the only rationale for the use of markets in coordinating economic activity.  The use of markets can also be sanctioned based on how they contribute to a relational understanding of economic life.  From this relational perspective, markets can be viewed as essential in coordinating economic activity in large and complex societies, but in a way that contributes to relational flourishing with God, with others, and with the rest of creation, which obviously involves the production of goods and services.  A corollary of this is that the operation of markets must be modified or curtailed whenever the particular operation of markets violates a Christian understanding of the human person and society.  So, for example, in an economy based on a Christian vision for economic life, markets would be used to coordinate the demand that households have for particular goods and the subsequent production of these goods by businesses, but the operation of these markets would be suspended at times so that persons can find time for rest and refreshment.  In practice, reaching policy judgments in particular cases about how to modify, curtail, or expand the operation of markets, in accord with this relational vision, will involve detailed economic analysis, and in this the work of the economist is indispensable.

Finally, it is also important to see that this relational understanding of economic life not only supports a vital place for markets, but also contributes to well-functioning markets through the cultivation of particular virtues, such as prudence, honesty, and trust, based on its alternative conception of the human person and society.  In contrast, an argument can be made, supported by events and trends in the global economy over the last two decades, that contemporary capitalist ideology has actually undermined the performance of markets, once again illustrating the connection between markets and wider societal frameworks.  That argument, however, will have to wait for another occasion. 

Footnotes

  1. In other words, a Christian can still accept Robbins’s classic understanding of the study of economics as “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.” Lionel Robbins, An Essay on the Nature and Significance of Economic Science (Macmillan and Company Limited, 1935), 16.
  2. This is a general statement.  It is recognized that markets will sometimes fail to provide goods and services (e.g., some public goods) and to over or under provide some goods and services (e.g., when externalities are present).
  3. N. Gregory Mankiw, Principles of Economics, 5th ed. (South-Western College Pub, 2008), 9.
  4. Paul Bowles, Capitalism (Longman, 2007), 108–9.  Emphasis added.
  5. Murray N. Rothbard, “Free Market,” The Concise Encyclopedia of Economics (Liberty Fund Inc., 2008), 200–201.  Emphasis added.  Thus, as Rothbard goes on to note, “The market is ‘free’ because choices… are made freely and voluntarily.”  Ibid., 201.

Works Cited

  • Bowles, Paul. Capitalism. Longman, 2007.
  • Mankiw, N. Gregory. Principles of Economics. 5th ed. South-Western College Pub, 2008.
  • Robbins, Lionel. An Essay on the Nature and Significance of Economic Science. Macmillan and Company Limited, 1935.
  • Rothbard, Murray N. “Free Market.” The Concise Encyclopedia of Economics. Liberty Fund Inc., 2008.

Source: Marketplace Institute



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