Markets are powerful and potentially very useful institutions, and the belief in ‘free’ markets is especially strong in the US. But the issue what matters is not whether markets are ‘free’ or not, it is whether they are allowed to perform what they are supposed to do (enabling an efficient allocation of resources and providing incentives to exploit these in the best way). Markets are instruments, means to an end. Those believers in ‘free’ markets (a gross abstraction anyway) are completely blind to this, they are fundamentalists, not unlike the Marxists of the seventies. The issue whether markets are ‘free’ might be interesting in a philosophical sense but it has very little, if any, practical meaning.

There are a host of ‘think-tanks’, especially in the US, which are set up to further the cause of free markets. From time to time, something sensible comes out, but this is more exception than rule, as these are the new Marxist, with their fundamental, unshakable and unbridled belief in ‘free markets’, while everything points to the fact that markets can only function if they are properly regulated, and the present crisis is ‘exhibit A’ in demonstrating what can happen if regulation is bad and/or insufficient.

The question is not whether markets are ‘free’ or not, the question is whether markets (which are very useful institutions, we are no socialists) are allowed to function in such a way as to be socially useful, allocating resources and providing incentives in the most efficient way possible.

As you will see from the article below, the belief (and that’s what it is, just a belief) of these fundamentalists is so strong that they do not even blink in risking the implosion of the whole financial system, rather than having to face some much needed regulation and intervention.

We have made our case why no market can do without regulation, and hence the concept of ‘free’ markets is an abstraction anyway. As we argued in that article, this holds especially true for financial markets. But some of those market fundamentalists just don’t get it. Here is a prime example.

Bailout Could Have Ended Free Markets, Sowell Says
Monday, September 29, 2008 3:55 PM
By: David A. Patten

• The $700 billion Wall Street bailout that the House rejected Monday could have signaled “the end of the free market” as it is structured in the United States, a financial expert said.
• In an exclusive interview with Newsmax before the emergence of the deal’s final details, Thomas Sowell said sacrificing America’s free markets in order to save Wall Street would be “a tragedy of tremendous magnitude.”
• Sowell, the respected Hoover Institution economist, columnist, and author strongly disagrees with those who say an unbridled free market is to blame for Wall Street’s excesses.
• Rather, he attributes the crisis to “very cynical political rules that protected people who went way out on a limb financially, because they knew they had the taxpayer’s money to back them up.”
• Citing the late Nobel prize-winning economist Milton Friedman, Sowell said economic losses are just as important to capitalism as profits, because losses help people learn to make better decisions.
• Bailout plans “don’t take into account that people learn from paying the price for their mistakes,” he said.
• Market interventions inevitably result in unintended consequences, said Sowell, author of “Economic Facts and Fallacies.”
• “The smallest change in a market has reverberations throughout,” he said. “There is no way to predict how the plan will ultimately impact the U.S. economy.”
• A bailout would encourage an entitlement mentality in which people seek to earn profits while being protected from losses. People need to take individual responsibility for their decisions instead of looking for taxpayers to cover the losses, he says.
• Sowell cited Americans’ migration away from unprofitable farms in the 20th century as an example of how people respond to changing economic circumstances. That workforce later fueled the rise of American manufacturing. “Now, we could have kept all those people on the farms, you know, and the standard of living would be a lot lower than it is right now,” he says.
• Sowell conceded that not coming to Wall Street’s rescue also would be dangerous. The nation’s leaders, he said, should try “to restore as much of the free market as possible” and minimize any bailout’s reach.
• “Go to the American people and tell them, ‘There is no Santa Claus, folks. If you want to take risks you are going to pay for it,'” Sowell said, adding, “Compassion should extend to taxpayers as well as everybody else.”

Even the alternative cause for the mess he gives (he attributes the crisis to “very cynical political rules that protected people who went way out on a limb financially, because they knew they had the taxpayer’s money to back them up.”) is a prime example of bad regulation. Would it have been better with no regulation at all?

The fundamentalists are not against any regulation. If you ask them whether the state should not guarantee property rights, they suddenly change their tune. The fundamental question therefore is under what kind of regulation a market functions the most efficient, and this differs from market to market.

A couple of questions for those market fundamentalists:

1. If ‘free’ markets always and everywhere provide the best solution, how come that those unregulated markets for arcane, mortgage related derivative products have frozen up almost completely?
2. Why is it that many financial markets are so prone to bubbles and busts?
3. Don’t we need competition policies (another type of regulation), to prevent that ‘free’ markets come to be dominated by monopolistic companies or practices?
4. Don’t we need at least some safety and environmental standards (also regulation) to prevent disasters like that Chinese milk powder scam

We could go on and on..