The free market theory expounded by Adam Smith is a brilliant concept. Under the stated assumptions, with no central control, it sets prices and allocates resources in an optimal manner as a result of the independent actions of a multitude of individuals and organizations. The idea is so compelling that some people feel that the free market mechanism, often referred to as the "invisible hand", is adequate for all societal decision making. They oppose, with near religious fervor, all other mechanisms that might affect the marketplace, particularly governmental laws and regulations, on the grounds that these would hinder the invisible hand, thereby leading to less desirable results.
But even some of the most avid advocates of an unfettered free market do make exceptions. For example, Alan Greenspan, a disciple of laissez-faire champion Ayn Rand, has no problem accepting the manipulation of interest rates by the Federal Reserve. (He was the longest serving chairman of the Federal Reserve.) According to this view, government intervention to maintain stock market prices is fine, but protecting the jobs of American factory workers, e.g., by erecting selective trade barriers, is clearly a no-no. There are cases to be made for and against various kinds of restrictions on the free market, but there is no basis for claims that a free market cannot co-exist with any restrictions (unless we define a free market as one operating with no restrictions.)
A fundamental problem with the "purist" approach is that it fails to consider the extent to which the conditions necessary for a free market to operate do not occur naturally in the real world. There are also important problems that cannot be addressed solely by market mechanisms without some form of organized societal intervention--i.e., government action. For example, the unaided invisible hand is not adept at coping with health issues.
How effectively does the invisible hand ward off pharmaceutical products likely to do more harm than good? Think of Vioxx, sold as a pain killer, but also quite effective as simply a killer. Tens of thousands of Vioxx users suffered fatal heart attacks. How could this have happened?
Potentially, Vioxx was worth billions to the manufacturer, Merck. This driving force led company management, two years before it went on the market, to suppress warnings by its own scientists that it posed potential cardiovascular risks. When these warnings were confirmed by the results of a major clinical trial, Merck's principal response was a marketing videotape showing its sales representatives how to evade doctors' concerns about Vioxx's heart risks.
But how did Vioxx get to be on the market in the first place? After all, with respect to the sale of medical products, we do not rely solely on a free market to protect the public. The FDA (Food and Drug Administration) must approve new medications before they can be sold. Such products are supposed to be carefully tested for efficacy and safety before being released for sale. Why did the regulatory process fail in the Vioxx case?
The same free market, profit-maximizing, force that drove Merck to suppress warnings about Vioxx, also influenced the company's long-term behavior with respect to regulation in general. Along with other pharmaceutical companies, it has, over the years, fought, successfully, to weaken government regulation. The big pharmaceutical companies wield enormous political influence thru such means as advertisements and large campaign contributions. While they have not been able to eliminate regulation altogether, they found an almost equally effective strategy. This was to cripple the FDA by gross underfunding. As a result of spartan budgeting, FDA staffing is inadequate, not only to develop better ways to accomplish its missions, but even to test new drugs and to monitor the safety and effectiveness of drugs already in use.
Since the FDA lacks the resources to do drug testing, drug manufacturers seeking approval of new drugs contract with private laboratories to test them. The resulting reports go to the manufacturers, who, only if happy with the conclusions, submit them to the FDA. They are also supposed to report to the FDA adverse effects of drugs already on the market. The Vioxx disaster is an effect of this fox-operated chicken coop. It is not a unique case; in the past decade, ten "FDA approved" drugs were withdrawn because of deadly side effects. (A more recent list of nine, with some overlap, is here.) This approach fits neatly into the ideology of free market worshippers, who relish the idea of pruning government, and who can even point to the resulting disasters as evidence of the failure of government regulation.
One would expect physicians and medical researchers to vociferously protest this deadly sham, and, indeed, a few do. But the profit-driven power of the companies is so great that opposition is largely muted via a massive carrot and stick operation. The carrots are in the form of big bucks used to curry favor with physicians and researchers via means ranging from free dinners to substantial fees for lectures at lavish vacation resorts. University medical departments are co-opted via gifts and research grants. Merck paid The New England Journal of Medicine over $700,000 for reprints of an article saying good things about Vioxx. Influential physicians and researchers are often hired by pharmaceutical companies as consultants.
The stick is in the form of various forms of pressure on those who express concerns about the approval and monitoring processes, or about specific results of these processes. Beneficiaries of corporation largesse are not inclined to be critical of the system, are reluctant to support critics, and, in all too many cases, are willing to endorse, or even to initiate, attacks on critics. An example of such a critic is FDA scientist David Graham, who was prominent in exposing the Vioxx disaster. He was strongly attacked by FDA higher-ups. Fortunately, Senator Charles Grassley (R. Iowa) intervened on his behalf.
The pharmaceutical area is dominated by a few huge companies, and consumers are rarely competent to evaluate efficacy, safety and prices. Under these conditions, there can be no real free market in the classic sense. Sadly, as illustrated above, the effectiveness of drug regulation in the US has deteriorated drastically since the glory days of the early sixties, when, due to timely FDA action, Americans were spared the tragic birth defects inflicted on Europeans as a consequence of using the sleeping pill thalidomide. More material on these issues and on the health care situation in general can be found in the provocative book, Overtreated, by Shannon Brownlee, Bloomsbury, 2007.
A century ago, the key free market requirement for a multiplicity of independent producers was well satisfied in the field of agriculture by large numbers of small farms. However, the free market worked very poorly, as farmers were unable to adjust production in accordance with effective demand. There were too many factors beyond their control. Droughts, storms, insect invasions, frost, all conspired at times to reduce output drastically, so that, even if prices were relatively high due to scarcity, their crops were too small for them to benefit. When conditions were favorable, overall production soared, bringing prices sharply down. It was seldom possible for small farmers to hold produce off the market in anticipation of higher prices to come.
Other problems were of a commercial nature. Midwest wheat farmers, for example, had no real options when it came to getting their crops to market. There was normally a single railroad line and they had to pay whatever the railroad company demanded. This was sometimes a price that left them just enough to survive--i.e., the railroad charged "as much as the traffic would bear". Farmers often had limited options with respect to customers for their crops. They typically had serious problems getting credit from bankers to carry them thru to harvest time.
The effects mentioned above set the stage for the current agricultural scene, which is dominated by large corporate farms, employing poorly paid, often illegal, workers. The family farm is largely history. A serious detrimental by-product of the demise of the family farm is the acceleration of soil erosion, and the depletion and pollution of water resources, resulting from the fact that corporation managers, with an eye on the next quarterly statement, operate more in the spirit of coal mine operators. They have little interest in preserving the land for future generations.
For many decades, we have seen price supports, subsidies, import restrictions operating, not just in the US, but, to varying degrees, in nearly every other country. Nobody would claim that agriculture operates in an unrestricted free market today, and few would argue that it should (I expect to receive such arguments shortly!). In our country, the system now operates to subsidize corporate farms to the detriment of consumers, tax payers, and the few surviving family farmers.
Faced with a choice between releasing untreated products of combustion directly into the atmosphere to pollute the air of states to the East, and spending money on filtering devices, managers of a coal burning power plant in the Midwest would see the former option as the one that clearly maximizes profit. An unregulated free market ignores the social cost of damage to the environment. In fact, where self-interest is not checked by regulations with the force of law, entrepreneurs have every incentive to externalize costs as illustrated in this example.
This is similar to the situation depicted above with respect to pharmaceutical products, and, more generally, covers safety issues for all manner of products. Recall, for example, the battle fought by the auto industry against seat belts.
Defenders of the pure free market claim that unsafe or unreliable products will indeed be filtered out by free market processes, since consumers will simply reject excessively dangerous items, thus making them unprofitable. This, "let the buyer beware" approach makes sense in some simple cases, where hazards are self-evident. Not many people would buy an obviously flimsy 20 foot wooden ladder.
But, even the most capable, aware buyers today cannot be expected to evaluate adequately the hundreds of complex products they purchase annually. How could an individual consumer determine that weaknesses in a particular model tire make the probability of a blowout uncomfortably high after 10,000 miles of use? The problem is further exacerbated if we expect individuals to consider environmental impacts as well as durability, efficacy, and safety.
In many situations people are exposed to hazards that, even in principle, they have no reasonable way to anticipate and thus to avoid. Suppose we were to concede that the purchaser of a tire should somehow carefully evaluate its safety before closing the deal. But what about somebody renting a car at an airport? Or hailing a taxi? Or accepting a ride in a friend's car? What about the danger to people in cars driving on a highway alongside a car equipped with unsafe tires? Free market mechanisms do not seem helpful in such situations.
Nobody has a right to endanger other people recklessly, or to commit acts that seriously damage the environment we all share. But self-interest, the fuel powering the free market, often encourages such behavior and, in many important situations, the unaided invisible hand cannot prevent significant harm. Societal intervention via laws and regulations is needed. As technology amplifies our impact on the earth, and as increasingly complex products are becoming available with greatly enlarged capabilities for both good and ill effects, ranging over larger domains of space and time, the need for regulation is becoming ever more pressing. For some major problems, such as global climate change and the depletion of ocean wildlife, international regulations are badly needed. Unfortunately, at least since the late seventies, a dominant political slogan in the US has been, "get the government off our backs", and we have been moving in the opposite direction, i.e., cutting back on government regulation.
Apart from the drug industry and agriculture, there are several other important arenas in which the free market does not seem to be able to operate successfully without government support. These include housing, transportation, and finance (banks, etc.)
Leaving the setting of wages entirely to unrestricted free market forces is also problematic. In an ideal free market, labor costs would be minimized along with other costs. If, as is usually the case, employers are more powerful than individual workers, wages would be driven down very close to the subsistence level. In practice, this doesn't generally happen because of labor unions, minimum wage laws, and, occasionally, labor shortages.
The idea that any laws or regulations constraining businesses necessarily cripple the invisible hand is just plain wrong. It is not so frail as to be paralyzed by any interference. There is no reason that the existence of constraints that, for example, protect the environment or reduce dangers in the workplace, need deprive us of the principal benefits of a free market. The market reaction to laws and regulations is no different in kind than its reaction to natural laws or events. Of course, the costs and benefits of such constraints must, as for all other proposed laws and regulations, be considered carefully. Some constraints act, not to restrict the invisible hand, but to make it more effective. Examples include general anti-trust laws and specific regulations to prevent excessive concentration of media ownership.
Comments can be sent to me at unger(at)cs(dot)columbia(dot)edu