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first, let me draw a distinction between "free markets" and "capitalism".
"capitalism" provides for basic freedom of economic transactions while maintaining a degree of (government) oversight to ensure that certain rules of fairness are followed.
"free markets" is economic anarchy, where people and corporations are permitted to engage in any kind of economic activity they can get away with.
obviously these definitions are both simplistic and extreme, but they serve to illustrate the problem. government regulation is a key aspect of capitalism and one consistently dismissed, dismantled, corrupted, and ignored by republicans and right-wingers.
one of the major problems with economic transactions is that for everything to work as nicely as your econ 102 professor said it should, all participants in economic transactions must participate willingly, fully informed, and pay or be paid appropriately for the advantages or disadvantages they incur from that transaction.
that is, if two people trade something and it affects absolutely no one else, then there's no problem. but as soon as you realize that there's a third party, or perhaps many third parties who benefit or are harmed by that trade, the whole deal's off. someone's getting ripped off and the results are never pretty.
let's say it costs me $9 to produce a widget that is worth $11 to you. we trade for $10 and we each have improved our lot by $1. wonderful. now let's say that produce and consuming that widget, including pollution and garbage and so on, costs nearby non-participants $3 of damage that they were never compensated for. now society as whole is net minus $1 rather than plus $2. this is the sort of economic activity that harms a community and should be discouraged, but unless there's a way to prevent that pollution or at least to make the economic participants pay for the clean up or compensate the non-participants who were harmed, such activity will continue, to the detriment of society.
externalities can work the other way as well. if my neighbor fixes up his eyesore of a house, that increases my own property value. i've leached off my neighbor if i profit and don't pay him for it. that's not ideal, either. because an individual homeowner bears all the cost even though the benefits are shared, at least somewhat, among the entire neighborhood, that means that some home improvements that should be getting done aren't, because there's no practical way to get the neighbors to chip in. thus the neighborhood fails to profit when it should.
government regulation and oversight is necessary to at least try to internalize such externalities. government can ban pollution or permit civil suits for affected people to recover damages. you know, all the stuff republicans hate. red tape and tort suits.
is this just an academic thought exercise? hardly. the reality is that we're all intertwined as a community and there are VIRTUALLY NO economic transactions that don't have SOME externality to them.
one of the biggies in the news these last few years is offshoring. similar to the pollution problem, a corporation might cut costs a bit, and the foreign workers might get better jobs than they're used to. but these small gains are dwarfed by the economic harm done to the workers who lost their jobs, their families, and all the ancillary businesses that were built around supporting the mothballed plant like the lunch suppliers and the parking garages and the utilities and the construction workers and so on. similarly, people in the foreign country profit even if they're not direct participants because the increase and jobs and wealth there has many benefits, this time going to the ancillary businesses who support the new foreign plant.
republicans can cry "protectionism" is they like, as if any suggestion that the government do its job was a bad thing. heaven forbid we try actual capitalism for a change instead of this free market anarchy where big corporate bullies are treated as geniuses because they're able to crush competitors, not by having a better product, but simply by being more effective bullies.
it's time we stopped lauding "free markets" as if the mere fact that something happened means it's necessarily a good thing. just because a transaction was entered into freely by two parties does NOT make it an overall society good, it does NOT make it an efficient allocation of resources, and it does NOT make it right.
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