Economic freedom gives individuals the ability to pursue self-wants in the most efficient way possible—via the market. Many laws and regulations, in the name of consumer protections or marketplace fairness, take away our fundamental right of economic freedom. This blog post will be part of a series, the first of which describes the basic economics behind the virtues of economic freedom and subsequent posts will describe laws and regulations that hinder economic freedom. From an economist’s point of view, fairness is a subjective question. However, economists do describe markets that benefit the greatest amount of people—given that people have known preferences and act as rational utility maximizers—as markets that have minimal distortions. A market distortion is anything that distorts the true value, or opportunity cost, of a good or service. In this sense, a “fair” market is one that not only accurately represents the true value—or opportunity cost—of a good or service, but also provides a price mechanism that conveys the opportunity cost of scarce resources. In other words, the most efficient market is one in which the value placed on a good or service by society is equivalent to the price of the good, while the cost to producers is equivalent to the societal value placed on the scarce resources used in production.
A transaction cost, in any form, is a distortion of the market. Some transaction costs are natural, i.e. search costs, negotiation costs, information costs, etc. The most efficient markets are those that are “perfectly” competitive— i.e. they have no market distortions (they also have other characteristics I will not bore you with here). Of course, not all markets are perfectly competitive—none are in reality. This does not mean other market structures are “bad” for an economy, but rather they are not as beneficial to society as perfectly competitive ones. Market structures come about naturally as resources are valued among alternative uses. Distorting a market structure usually means a distortion in the true value of a good or service.
Human beings have reached the pinnacle of the food chain because of our ability to minimize transaction costs. We have markets because they decrease the cost associated with trade. We have a price system because of its ability to capture knowledge and economize on its use. Humans did not intentionally create markets and the price system; it has evolved as humans have evolved. Prices compile and convey more knowledge than any single “man-made” system. Distorting the price system subsequently distorts the knowledge and brings about non-optimal decisions.
As humans, we tend to partake in activities that have benefits—pecuniary or non-pecuniary—that are higher than the costs of the next best alternative. When market distortions, or transaction costs, are low we are able to better process what goods and services satisfy our needs.
People innovate when the expected costs of innovation are lower than the expected benefits. Economic freedom allows for proper information to be accessed, via the price system, and for the pursuit of the innovation. Creating an energy efficient car, for example, is lucrative since natural resources used for vehicle fuel becomes scarcer. Toyota estimates that gasoline and diesel sales used for automobile fuel will be approaching zero by 2050. They have, in response, been researching and continuously innovating their product line to better serve the consumer of tomorrow. Many inventions economize on the energy needed to produce a certain good or service. The more scarce the resources needed to produce a good or service, the more likely an innovator will be to innovate. This assumes that prices convey the true cost of a good or service. Unnecessary distortions create a price system that inaccurately conveys the true cost of a good or service. Discoveries and inventions have led to markets with less market distortions, i.e. less transactions costs. The price of the goods and services affected by the continual process of knowledge discovery adjust to better convey the representative good’s true value, and perhaps an augmented value if a discovery has led to goods and services being more or less valuable.
I am not saying that all government involvement in markets is bad or that anarchy is the way to go; however, I am saying that the more economic freedom people have, the more efficiently they can pursue self wants. Economics is all about how people pursue self-interests, given resources are scarce. The creation of artificial scarcity (which ultimately imposes higher costs on consumers) will slowly deteriorate an economy and distort it in such a way that causes resources to be allocated inefficiently. Most laws that promote “fairness” and “protect the consumer” are economically ignorant.