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Home , Free market, Friedrich Hayek, Market economy, Mixed economy

Laissez-faire and the institutions of the free

Other articles G. R. Steele

The absence of an The apotheosis of the Bolshevik was the temporary phase.A growing concentration of adequate institutional division of in 1945 into market and centrally industrial might would lead ultimately to central structure explains why planned . Its last vestige was covered by direction which would replace the and entrepreneurial the debris of the Berlin Wall in 1989. In between restore the bond between workers and their product. did not automatically follow times, the comparative economic performance of The counter from had been that the collapse of central East and West silenced the socialists, local planning is vital.This would be undertaken planning in the . It is whose aspirations had been sharpened by the Marxist under the impartial direction of the market process, a necessary function of a phalanx in the ‘calculation debate’1 of the 1930s. which no level of sophistication in the liberal state to provide a was shown to be a failed creed, but credit instrumentation of a central plan could possibly framework for the was slow to accrue to the opposing Austrians.That emulate. Since every entrepreneurial decision affects enforcement of private intellectual case against socialism was forgotten in the the configuration of , co-ordination is achieved contractual terms. Beyond era of a ‘mixed ,’‘social ,’ only through a constant feedback of new prices and that basic need, other Keynesian–Beveridge–Butskellite middle-of-the road re-adjustments to ’ plans.With the further regulatory structures tend state.Thereafter, and the point, that a centrally directed economic plan cannot to emerge spontaneously ascendancy of the followed in the wake draw upon knowledge of particular circumstances of through the force of mutual of general dissatisfaction with macroeconomic time and place, had shown that advantage and the test of performance. In the West, the free-market and intellectual aspirations for socialist planning are an social competence. In liberalisation gained an ascendancy. epistemological impossibility. Indeed, the socialist particular, institutions such However, the final collapse of central planning in calculation debate drew from Hayek three important as banking, the , the 1990s presented new for thought. Many arguments against socialism:‘in the real world accountancy, insurance etc. were surprised when laissez-faire did not follow are not easily specified ... costs were not objectively exist to minimise the laissez-aller : the emergence of given ... [and] .... knowledge is uncentralizable.’2 transactions costs which are entrepreneurial capitalism was not automatic.With Yet,the problem of socio-economic co-ordination inherent in a market hindsight, it was always likely that those who had is one which has received scant attention. In ignoring economy. been taught to equate private with theft knowledge acquisition and co-ordination,Walrasian would be troubled by the notion of property . general equilibrium economic theory misrepresents Although thriving black markets in the the ease with which optimal resources allocation had replicated some aspects of the , might be achieved.This allows a case to be made for they had drawn no support from the , nor socialism: given the same information set as is could they provide any basis for taxation. So, apart assumed to exist under theoretical general equilibrium, from the printing-presses, had few Oscar Lange demonstrated that an actual central public revenue sources to draw upon after the sell-off planning board can replicate the competitive of state-owned firms. outcome. So, with this sleight of hand, it was made to appear that the mechanism of competitive market The institutional of a market economy prices adjustment could be replaced by the precise Although the need for positive action is now mathematical calculation of a planning board. apparent, little thought has been given to the institutional infrastructure necessary to support a Austrian versus neoclassical market economy. Stated differently, the long- Because the methodological gulf which exists neglected arguments of the of between Austrian (disequilibrium) economics and Economics are increasingly relevant. Until recently, neoclassical (equilibrium) economics was not the most common – though incorrect – view of the acknowledged, much of the socialist calculation calculation debate was that the thesis of central debate was conducted at cross-purposes.Whereas planning had been matched by the antithesis of Austrian economics perceives the economy as a complete laissez-faire to give a synthesis of market mêlée of competing and contradictory plans, and is socialism. conducted against the (dynamic) criterion of had envisaged the self-destruction of multi-plan co-ordination, neoclassical economic capitalism: specialisation would force individuals into analysis centres upon the (static) criterion of Pareto an ever greater and mutual efficiency.To Austrians, the incentives implicit in the interdependence, the intricacies of which no single margins that exist when trade is undertaken at

G. R. Steele is lecturer in economics would be able to grasp; nor would there disequilibrium prices are an integral part of the at Lancaster University. be any control over its effects. But this would be a process by which markets move towards equilibrium.

47 Laissez-faire and the The entrepreneurial function (which is assumed by no ‘basic rights and ... are immune from the free market to have already taken place) is vagaries of political conflict.’ vital since, by that activity ‘the in one particular market is brought closer to equilibrium, and other Free markets: destroyers of traditions? people are better-informed about the opportunities While Gray acknowledges the ‘original political available.’3 justification and historical rationale of Thatcherite The fundamental lesson to be drawn from the policies,’ which lay in the break-up of corporatist socialist calculation debate of the 1930s – the lesson institutions and policies which created conflict rather that was lost to advocates of the – is than , he sees the free market both as the that economically efficient methods of engine of wealth creation and the destroyer of and become evident only as some traditional institutions and cultural forms.Thus, producers succeed and others fail. Bankruptcies are ‘the communitarian and paternalistic concerns’ of important to processes of discovery in which post-1945 British , where there was a efficiency and ingenuity are tested in open ‘genuine understanding of enduring human needs,’ .To eliminate the possibility of failure is were trampled by ‘the Thatcherite march.’ Even to eliminate initiative. Equally important is Hayek’s though market ‘allowed somewhat message that economics is an integral part of an lower levels of joblessness than our European evolving social order in which cultural history and partners,’ the associated labour mobility brought mores are vital to processes of knowledge acquisition pathologies which include marital breakdown and and dispersion.The importance of a cultural unprecedented levels of crime.6 infrastructure to support free-market processes is Gray does not consider that many (if not all) of central to recent comments by the Chairman of the these trends pre-date . In Britain, the US : 1960s was the most notoriously liberating of recent decades; labour mobility and the decline of the ‘[m]uch of what we took for granted in our free family is more plausibly linked to state system and assumed to be human nature sponsorship of an ever-widening set of ‘rights’ – for was not nature at all, but culture.The example, to adolescent independence, to single- dismantling of the central planning function in parent families, to further , to medical an economy does not, as some had supposed, provision – than to the notion that ‘the free market automatically establish a free market works to transform or overturn all inherited and entrepreneurial system.There is a vast amount traditional social institutions.’ Like many apologists of capitalist culture and infrastructure for dirigiste state control, Gray fundamentally underpinning market economies that has misunderstands (or conveniently forgets) the evolved over generations: , conventions, of free-market exchange: it is because the culture, behaviors, and a wide variety of beliefs and motives of every participant are irrelevant professions and practices that has no important to the functioning of the market that the greatest functions in a centrally .’4 harmony can be achieved. Among other requirements identified by are a free press, an impartial judiciary and Competition, discovery and co-ordination a bill of rights to preclude arbitrary action by The tendency to achieve mutual compatibility across .Although Greenspan is confident of the the decisions of countless economic agencies is a ultimate diffusion of free-market liberal principles – function of an institutional environment founded ‘the face of the continues to edge upon the principles of classical . Market toward free-market-oriented ’ – a recent competition allows knowledge to be discovered and counter-argument has been presented by Professor it provides the mechanisms by which individuals’ of the London School of Economics, who actions are co-ordinated; but the market is cites Hayek, guru of Thatcherism-cum-, unpredictable, and state intervention cannot prevent, as the prime perpetrator of the falsehood that nor could it lessen, the costs arising from that Western modernity is ‘the ultimate fate of all unpredictability. Indeed, the very attempt would be humankind.’5 In furtherance of his belief that the undesirable, for it would retard necessary adjustments. political sphere should have primacy over ‘the Furthermore, it would be absurd to expect the delusive certainty of legal principles,’ Gray asserts that market to reward merit:‘[w]e allow the individual

48 share to be determined partly by luck in order to are low and new supplies lower prices where they make the total to be shared as large as .’7 are high. Instead, the free market serves and Instead of emphasising the importance of that by rewarding those who are lucky enough to be able entrepreneurial function, modern teaching of ECONOMIC to satisfy particular demands arising from rapidly economics has tended towards a general criticism of AFFAIRS changing circumstances. the enterprise system.That criticism is founded upon September 1999 Under competition, it is inevitable that many lose the concept of ‘’ and of a divergence out, and there are always claims for the protection of between private benefits/costs and social vested .While there is an undoubted need to benefits/costs.Yet, many of the phenomena so counter such claims, there are no ready prescriptions: categorised are merely symptoms of the fact that ‘[p]robably nothing has done so much harm to the there are instances where transactions costs are too liberal cause as the wooden insistence of some high to allow a more appropriate allocation of on certain rules of thumb, above all the benefits and costs.Transactions costs are just another principle of laissez-faire.’8 So, it is for to cost of production and exchange.They are not probe the issues which determine the legitimate ‘special.’Where trade does not occur because of high scope for state intervention.‘’ and transactions costs, this is only another case of costs ‘ of ’ do not, in themselves, provide exceeding benefits. High costs do not imply for solutions: inefficiency. If raw materials costs suddenly increased, we would be poorer, but we would not be less ‘[o]ur main problems begin when we ask what efficient.The same applies to transactions costs and so ought to be the contents of property rights, to most examples of ‘market failure.’ Markets allocate what should be enforceable, and how resources most efficiently in that prices will reflect all contracts should be interpreted or, rather, what the costs – including transactions costs – involved in standard forms of contract should be read into producing and trading the outputs which derive from the informal agreements of everyday those resources. transactions.’ 9 As a truism, every institution whose function is to The free economy is not simply mechanistic market facilitate exchange would be superfluous if exchange exchange. Rather, it is a system of local voluntary were costless.Among those institutions which owe planning embodied in the nexus of property, consent their existence to transactions costs are: , , and contract. It is this nexus which comprises the the law, accountancy, insurance, firms, distributors, institutional structure: a coherent set of practices by stores and salesmen. In each case, the institution which individuals are permitted to interact socially exists to reduce transactions costs.To illustrate. and by which they achieve mutual advantages. A bank acts as an intermediary between borrowers Business transactions themselves comprise a sub-set and lenders; if there were no transactions costs to of this social interaction, whereby costs are arranging loans, lenders and borrowers would make determined within the evolving institutional their own arrangements. Financial reporting structures which support an extensive division of standards, principles, insurance and the labour and the realisation of ever greater mutual law generally are an integral part of the contracting gains from trade. process and exist to minimise transactions costs. As another example, firms become The importance of transactions costs when their potential competitors face Yet, even though the existence of most economic impediments to trade; i.e. when entry barriers institutions can be explained as a response to the create insurmountable transactions costs. requirements of socio-economic transactions, the analysis of transactions costs is much neglected The state as enforcer of contracts within economics. It is the existence of transactions The state can also be viewed in these terms, since costs which creates a role for the middleman – the it provides a framework for the enforcement of entrepreneur – who simultaneously takes advantage contractual terms (including the provisions of the of and reduces those costs.Thereby the advantages of criminal law) which obviates the transactions costs © Institute of Economic Affairs 1999 free-market competition are spread as entrepreneurs that would be incurred in private enforcement. Published by Blackwell Publishers, 108 Cowley Road, Oxford, OX4 1JF, ‘buy cheap and sell dear’: the ‘’ More generally, the involvement of the state is UK and 350 Main Street, Malden, ensures that new demands raise prices where they justified to safeguard an agreed basis of exchange MA 02148, USA

49 Laissez-faire and the between two or more parties at minimum and executive functions undermines the impartiality free market cost. of the law and creates (potentially) an instrument of The legal enforcement of individual property rights political repression.A democratically elected is essential both to encourage self-responsibility and government can find itself bound, not by moral to maintain the economic incentives for producers convictions, but by the obligation to satisfy a number to meet consumers’ needs. Moreover, there is a of vested interests. It is for this that symmetry between property rights and the laws government should have no exemption from of liability where contracts between an injured operating according to the fundamental liberal and an injuring party are too costly to negotiate principles of impartiality and universality:‘people or to enforce.The role of the government is to submit to authority not to enable it to do what it lower those costs through the enforcement of law. likes, but because they trust somebody to act in Social cohesion does not just happen.Without conformity with certain common perceptions of there is and conflict; but what is just.’10 It is in this – rather than in regulatory structures tend to emerge spontaneously ‘communitarian and paternalistic concerns’ for through the force of mutual advantage and the test ‘enduring human needs’ – that an individual’s of social competence.The intensive interdependence freedom will remain secure. of an extended socio-economic order relies upon a common moral consciousness which supports rules 1. D. Lavoie (1985) Rivalry and Central Planning. The Socialist Calculation of conduct.These rules fall into different categories: Debate Reconsidered, Cambridge: Cambridge University Press. there are those which everybody follows because of 2. E. W. Streissler (1992) ‘Hayek on Information and Socialism’, Wirtschafts the like manner in which the environment is Politische Blätter, vol. 39, pp. 258–283, cited from M. H. Hagmann and perceived by individual minds; those which are O. Hamouda (eds.) (1994) Money and Business Cycles, The Economics of F. A. Hayek, Volume I, Aldershot: Edward Elgar, pp. 47–75. followed spontaneously because they form part of a 3. B. J. Loasby (1989) The Mind and Method of the , Aldershot: common cultural tradition; and those which must be Edward Elgar. enforced because, though individuals would gain 4. A. Greenspan (1997) ‘The Virtues of Market Economies’, talk delivered at a through non-observance, they would damage the fund-raising dinner to support the Woodrow Wilson Center, 10 June (Woodrow Wilson Center Archive). social order.The latter – the legitimate exercise of 5. J. Gray (1997) Endgames. Questions in Late Modern Political Thought, political power – underpins all such private Cambridge: Polity Press. arrangements. 6. J. Gray (1998) False Dawn. The Delusions of Global Capitalism, London: So, what is legitimate in the exercise of political Granta Books. 7. F. A. Hayek (1978) New Studies in Philosophy, , Economics and the power? Although a democracy enables any majority History of Ideas, London and Henley: & Kegan Paul. to rid itself of a government, it is a dangerous belief 8. F. A. Hayek (1944) The Road to Serfdom, London: George Routledge & Sons. that there is no need for any further institutional 9. F. A. Hayek (1949) and Economic Order, London and Henley: restraint. Even under democracy, the rule of law faces Routledge & Kegan Paul. 10. F. A. Hayek (1979) Law, Legislation and : A New Statement of the the threat of encroachment by government.The Liberal Principles of and , Vol. 3: The Political Order of modern tendency of the state to merge the legislative a Free People, London and Henley: Routledge & Kegan Paul.

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