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Myth of the Free Markets: A Catholic Perspective

By Dr. Hassan M. Shirvani

The importance of economic education in fostering higher levels of social welfare and political stability is widely acknowledged.  However, judging by the poor quality of most public economic debates, the level of economic literacy, even in major industrial countries, seems to be still awfully low.  This is particularly evidenced by the increasing tendency of many debaters to refute the views of their opponents, not through sound economic arguments, but rather through disparagements and even name-callings.  A good example of this tendency is provided by the constant chastising of the Catholic Church for her periodic warnings about the dangers of unbridled free market economies.  In these warnings, issued in a series of papal encyclicals dating back at least to 1891, the Church, while supportive of these economies, has also raised serious concerns about the rising levels of economic concentration, environmental degradation, and inequality that have been associated with them.  In addition, the Church has also offered strong support for the rights of the workers in these economies to unionize, to earn living wages, and to enjoy safe working conditions.  In response, some of the papal authors of these encyclicals have been criticized as being economically illiterate and even branded as “radical leftists, if not worse.  In addition, the Church has been frequently advised to leave all economic matters to economists and instead to concentrate solely on the issues of faith and morality.  Apart from the fact that economics is primarily a moral science, this dismissive attitude of the critics ignores the fact that modern economic theory is far more supportive of the economic positions of the Church than those of her detractors.   

The Myth of the Free Markets

One reason for the unsatisfactory state of economic conversation in many industrialized countries is the fact that, unlike most professions, economics can be seemingly practiced without a license.  Thus, without any prior economic training, many individuals consider themselves to be competent economists and, thus, highly qualified to express opinions on the most important economic issues of the day.  Even for those professionals who have taken some introductory economics courses, there still remains the problem of the limited scope of those courses.  Thus, while many of those courses pay lip service to a variety of market structures, the standard model of the economy that they eventually single out for special treatment, and the one that most students take away with them, is the perfectly competitive model of the markets.  In such markets, characterized by their popular demand and supply curves, many small buyers and sellers regularly meet to freely exchange their goods and services at mutually agreed prices.  These flexible prices will in turn ensure that all markets are continuously cleared, that all scarce resources are efficiently allocated, and that all economies will be always at full employment.  What is less emphasized, however, is that for the perfectly competitive markets to work, it is also necessary to make some additional unrealistic assumptions.  According to the most important of these assumptions, the individual economic units should have no significant economic power, should be fully informed, should be willing to pay for all public goods, and should respect the well-defined property rights of others.  Needless to add, in the absence of these stringent conditions, the idea of the free markets as an economic nirvana will simply be a myth.     

The Market Failures

The foregoing should make it clear that, given its reliance on too many restrictive assumptions, the competitive model of the free markets can hardly provide a realistic description of how modern economies operate.  These economies are almost universally characterized by the presence of vast concentrations of economic power, the prevalence of uncertainty and asymmetric information between many buyers and sellers, the existence of free riders for many public goods, and the absence of clarity about the nature of many existing property rights.  As a consequence, most modern economies suffer from the so-called market failures, in which many large corporations routinely manipulate the markets, pollute the environment, ignore the interests of their stakeholders, destabilize the financial markets, and facilitate the growth of the extreme forms of economic inequality.  Under these conditions, it is therefore incumbent upon governments to address these market failures through a host of antitrust, environmental, financial, and labor regulations.  In addition, governments also need to periodically apply appropriate demand management and redistribution policies to maintain both economic and political stability in their economies.  

Abusing the Free Markets Model

Notwithstanding its mythical nature, however, the free markets model is still widely used to uphold a host of unwarranted economic positions and policies.  This can be illustrated by a few examples.  First, consider the argument that the imposition of a minimum wage will push the price of the low-skilled workers above its economically justifiable level, thus resulting in higher unemployment among these workers. While this conclusion is valid under perfect competition, it fails to hold if employers enjoy considerable economic power either in the product or in the labor market.  Under both of these conditions, it is easy to show that firms will tend to both underpay and under-hire workers.  Thus, the minimum wage legislation can indeed result in both higher wages and higher employment.  To this should be added the positive effects of higher wages on consumer spending and, hence, on the level of employment.  Indeed, there is considerable evidence that a gradual minimum wage increase will entail minimal loss of jobs, while at the same time providing millions of low-paid workers with rising incomes.  In addition, even when some small businesses are adversely affected by their higher labor costs, governments can always cover some of these costs through appropriate tax breaks and direct subsidies to these businesses.

Second, consider the assertion that individuals always earn what they deserve, that is, what they contribute to national output.  Again, this assertion, which is aimed at justifying the existing inequalities and undermining any attempt at income redistribution, is based on the perfect competition model.  In reality, economic power, together with artificial barriers to entry, can significantly influence the distribution of personal incomes.  This explains the absurd disparity between the compensations of many CEOs and their average employees.  This also accounts for the fact that many modern professionals, such as musicians and medical specialists, who enjoy either copyright or licensing protections, make much more money than their predecessors in earlier times, who did not.  In addition, while many entrepreneurs and managers deserve financial rewards for their efforts and risk-takings, this can hardly be said for the passive owners of wealth.  Put differently, the ownership of capital per se should not be deemed a productive activity and should not be rewarded.   

Third, consider the assertion, proven wrong again and again, that the severely depressed market economies, if left alone, can speedily recover on their own.  As the experiences of both the Great Recession of 2007-2009 and the current coronavirus crisis indicate, adherence to such a view would in general be a prescription for disaster.  Indeed, and despite massive government interventions during the current pandemic, the global economy is still in the throes of unprecedentedly high rates of unemployment, mass poverty, and business failures.  

Finally, there is the assertion that financial markets are informationally so efficient that security prices can be relied on to constantly reflect their true values.  Again, as evidenced by the repeated cycles of boom and bust on Wall Street, the idea that financial markets know best and can largely self-regulate turns out to have been badly mistaken.

Conclusion

The fictitious model of the free markets, assumed to be free from all forms of market failure, is often used by the proponents of private initiative to deny any legitimate economic role for governments.  Like most modern economists, the Catholic Church has always had issues with the relevance of this simple model.  In particular, the Church has found little evidence that many corporations, in the absence of government regulations, will voluntarily respect the interests of their diverse stakeholders, from the welfare of their employees to the environmental safety of the communities in which they operate.  In addition, the Church has consistently rejected the assertion that private charity would largely obviate the need for any systematic governmental support of the needy.  Instead, the Church has called for an inclusive and responsible capitalism, in which both businesses and governments can work together to ensure the highest possible levels of welfare for all their citizens, regardless of their economic, political, and social standings. 

About the Author — Hassan Shirvani

AvatarDr. Hassan Shirvani is the Cullen Endowed Chair of Economics. His research areas include macroeconomics, investments and international finance.

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