An Invincible Hand? The shortcomings of a laissez-faire system for individual economic interests and the necessity of state regulation.

  1. 1.  London School of Economics and Political Science

Abstract

The modern market economy is a complex yet remarkably effective mechanism in which resources are organised and distributed. Historically, an unimpeded system of autonomous individuals acting in accordance to their interests has been shown to be unrivalled in its ability to address the basic economic problem. This begets the following question: Is the invisible hand a benevolent force that has mankind’s best interests at heart? Or is it instead just another fundamental law of nature—impartial and indifferent to the fate of its subjects? The prerogative for individuals to pursue their personal economic interests hinges upon the outcome of very this argument. An absolute stance can only be justified if the market produced the same outcome regardless of the context of transactional agents and the embedded relations.

To capture the nuances within the question, this essay aims to build a case for the necessity of state regulation through the lenses of moral philosophy and psychology in addition to standard economic theory. We draw upon the work of Zelizer (2012) to demonstrate the inherent sociological threads that define economics and how individual economic freedom is conditional upon relative social attitudes. We then focus on Piketty (2014) to illustrate the failure of neoclassical theory in predicting the rise of global inequality and its consequences. This is later strengthened by a critique on the assumption of perfectly rational agents within existing economic models by Sunstein (2014).

The feasibility of absolute economic freedom

Consider first the framework in which the pursuit of economic interests can be allowed to function freely. Has such a system even existed at any given period in mankind’s history? Since time immemorial, economies have had one or more forms of regulation that it is difficult to imagine how a world of absolute economic freedom would look like. The United States has long been associated as the bastion of individual economic liberty and the champion of free markets, yet they are—quite fortunately—anything but. The introduction of the Emancipation Proclamation issued by Abraham Lincoln in 1863 abolished human slaves as a market commodity. This effectively disrupted and rewrote the economic system of plantation owners who managed to accumulate substantial profits through the trade and employment of slave labour.

As such, it can be argued that the freedom of individuals to participate in markets without government intervention is a subjective one heavily dependent on the cultural and social norms of a given time period—in addition to explicit state legislation, regulation also manifests itself implicitly through social solidarity. Zelizer (2012) echoes this sentiment by asserting that economic transactions are essentially social interactions. Even if we were to forcibly remove any form of government within the economy, the asymmetric power relations created by “embeddedness” takes over and creates a precedent for wealthy individuals to restrict the economic freedom of others. Wealth and power often go hand in hand and the onset of inequality brought upon by a purely free market system would lead to the establishment of an economic system dictated by the whims of the affluent. Hence, it is difficult to argue about the effects of absolute economic freedom when such a model could not theoretically exist.

Convergence and divergence in markets

Suppose that such a free market system was defined within the context of minimal state intervention with respect to social norms instead of absolute freedom. The government’s role is then consigned to maintaining law and order necessary to the function of markets. Even so, this creates an outcome that is not only disagreeable with progressive social beliefs but unsustainable as well. Friedman and Friedman (1980) argue that the beauty in free markets is that individuals acting on behalf of their economic interests have incentives that are aligned with that of addressing the economic problem as a whole. However, this failed to account for the fact that the invisible hand is in itself an unrelenting force dead set on maximising economic efficiency—it will stop at nothing to achieve its goal and does so with ruthless disregard to the consequences.

Piketty (2014) examined the effect of capital on convergent and divergent forces that characterise income inequality. He maintains that the forces of convergence are dependent on political influence on economic policies and rarely materialise on their own accord; forces of divergence however are compatible with—and arguably contingent upon—the purity of capital markets. An economy in which individuals have a high degree of economic freedom such as the lack of capital taxes creates favourable conditions for the flow of divergence and restricts the prospects for convergent forces to flourish. On a fundamental level, this paints a dystopian vision of the future reminiscent of late twentieth century cyberpunk works. Political and economic influence will eventually settle upon the desks of the global elite, creating a world where the virtues of humanity are replaced by the pursuits of the rich. More worryingly, inequality increases the prospects of reactionary politics being implemented, such as the recent cases of Brexit and the rise of Donald Trump. Unsurprisingly, the forces of divergence are notoriously hard to quell once they gain a foothold. A return to greater equality is often made possible only through tumultuous periods of violent conflict or warfare in which the redistribution of capital and the diffusion of knowledge is acute enough to overcome the intrinsic dominance of divergent forces. Inequality was never good to begin with, but the prescriptions required to address it are equally dire.

Limitations of the neoclassical framework

Perhaps even more damaging to the case for economic freedom are the assumptions made by the models used to justify it. John Stuart Mill’s Harm Principle, widely used by proponents of individual economic freedom, argues that individuals are in a better position to decide upon the merit of their actions than the government. His argument is centred upon the notion that governments are not omniscient and individuals would be better informed to act upon transactions that benefit themselves. Sunstein (2014) counters this claim by building a case on the fallibility of cognitive judgements. He suggests that individuals often make decisions that tend to discount long term benefits or costs, citing consumer manipulation by businesses that encourage excessive borrowing as an example. This is corroborated by Satz (2010) who mentioned that a majority of Indian kidney sellers later regretted their decision—their financial positions and not understanding the risks involved being contributing factors to their initial commitment. It can be argued that this asymmetry of information and wealth creates a myriad of opportunities for the disadvantaged to be pressured and exploited into making decisions that appear good initially but harm them in the long run, hence justifying the need for restricting individuals’ economic freedom in such cases.

In his book, Thinking, Fast and Slow, psychologist and Nobel prize winner Daniel Kahneman posited that the human brain was wired to utilise cognitive shortcuts in decision making—a characteristic that was crucial to survival for early humans. Unfortunately, biological evolution is an incredibly lengthy process and our cognitive patterns have yet to catch up with civilisation’s progress. This disparity manifests itself in the form of cognitive biases, a systematic and consistent pattern of deviations from the rational behaviour defined by neoclassical economics.  Kahneman argues that our cognitive processes can be broken down into a ‘fast’ heuristic based system and a ‘slow’ rule-based one. The former is the primary mechanism used for evaluating day-to-day economic transactions and is susceptible to lapses in judgement. In a classic example of game theory, exploiting such human errors would be the dominant strategy of a firm seeking to maximise its profits. Therein lies the crux of the argument that an indifferent market mechanism could quickly turn malevolent—the profit driven framework of a free market encourages businesses to exploit its consumers to survive.

A hope for the future

It has been made clear that granting individuals economic freedom has various adverse consequences not just to these individuals themselves but on society as a whole. What about the alternative of a state setting the bounds of acceptable pursuit of economic interests then? Governments are run by humans and hence they cannot possibly be infallible.  Quis custodiet ipsos custodies?”, a Latin phrase meaning “Who will guard the guards?” is the point of contention in the debate for economic liberty. While government failure is indeed possible, I believe that the necessary framework such as the separation of powers practiced by progressive states already exists and mitigates such risks. Political power and the subsequent dictation of economic policies will only persist by winning the popular vote. Hence, it would be in the best interests of a government not to fail. The successful development of East Asia is a prime example of how government intervention in a self-regulating market would not hinder growth but instead promote it.

In conclusion, I believe that restricting individuals in pursuing their economic interests is not only justified—it is essential to the social cohesion and progress of our economies. In both positive and normative perspectives, the arguments presented above concur that the costs of limiting economic freedom are inconsequential relative to the risks associated with a laissez-faire system. Regulation is not perfect—and it will never be—but social science is constantly adapting and evolving in the face of new challenges. The argument for intervention is one of hope—the free market is imperfect, but together we can make it better.

References

Chang, H.-J., 2011. 23 Things They Don't Tell You About Capitalism :Penguin.

C, S., 2014. Why Nudge? The Politics of Libertarian Paternalism, Yale University Press.

Friedman, M. a. F. R., 1980. Free to Choose: A Personal Statement.

Kahneman, D., 2012. Thinking, Fast and Slow. :Penguin.

Piketty, T., 2014. Capital in the Twenty-First Century, Cambridge, Massachusetts: The Belknap Press of Harvard University Press.

Satz, D., 2010. Why Some Things Should Not Be For Sale: The Moral Limits of Markets

Stiglitz, 2001. In: 'Foreword' in K.Polanyi, The Great Transformation. pp. vii-xvii.

Zelizer, V., 2012. How I Became A Relational Economic Sociologist and What Does That Mean. Politics and Society, pp. 145-174.

 

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