The rise and fall of the 'free market'

by David Hetherington

Ideas, like fashion, move in waves. A big idea will form, expand, dominate, and fade. Along the way it will accrue adherents and opponents, leaving a trailing wake of subsidiary ideas.

The last century has seen the rise and fall of communism, fascism, and socialism. Democracy has proven more enduring, still expanding if not dominating.

Yet the idea closest to the inflection point between domination and fade is the ‘free market’, the most influential concept in political economy over the past 40 years. Outlined in its modern form by the Austrian school of economists and expanded by Milton Friedman, the free market was the bedrock of the Thatcher/Reagan reforms. It defined the political orthodoxy for both right and left until the financial crash of 2008.

The crash showed the limits to which an idea can be stretched. The notion of the 'free market' was suborned by investment banks to justify actions that shattered the global economy. Once the consequences of these actions came to light, these businesses turned to taxpayers to bail them out. But you won’t find "too big to fail" in any free market textbook.

It's worth examining the origins of the free market idea, and its subsequent hijacking. The Austrian economists like Hayek and von Mises started with the notion of individual liberty. They were Central European émigrés, determined that neither fascism nor communism should be allowed to impinge upon personal freedom. Their economic ideas were characterized by a distrust of government, and faith in the ability of markets to deliver optimal outcomes.

Over time, these ideas were challenged on two fronts. Firstly, their supporters pushed further and further the notion that the market was always right. In the face of egregious market failures – monopolies, moral hazard, externalities, poor information – the free marketeers resisted regulation of these failures at every turn, arguing the cure was worse than the disease. To advance their case, they developed elegant concepts like the 'efficient markets hypothesis' and 'rational expectations hypothesis', none of which survived sustained contact with the real world.

More damagingly, the central tenets of the free market arguments – distrust of government and faith in markets - came to be used to defend positions that had little to do with individual liberty. Free-market champions cited Adam Smith's Wealth of Nations but forgot his Theory of Moral Sentiments.

The notion that systemically important banks – those too big to fail – should be more tightly regulated was dismissed consistently in the lead-up to the crash. Three years after the crash, the temerity of governments in seeking to regulate more strictly or control the moral hazards in executive pay – is attacked on the same free market grounds. Why this is so damaging to personal freedom is hard to see.

What place do these arguments have in Australia? Where are the threats to personal liberty such as fascism and communism that motivated the émigrés of the Austrian school? They’re hard to find. Australia has a remarkably high degree of individual freedom by contemporary standards, let alone by historical ones. We have no secret police, no political prisoners, no detention without trial.

Yet according to the free market think tanks, we must be ever vigilant against the pernicious creep of Australian governments, of their 'nanny state', for this is the gravest peril facing the nation.

This nanny state is guilty of such crimes as requiring plain packaging for cigarette packets, offering pre-commitment limits for gamblers, or banning junk food advertising to young kids. According to Patrick Basham, writing in the IPA Review, the danger is that the nanny state descends into the ‘bully state’, with lives ruled by state-sponsored coercion. Sound like Australia to you?

Most powerfully, though, the big government argument is used to resist any increases in tax, whether to price carbon or redistribute super-profits from the mining of publicly owned natural resources. These policy arguments are the real pay-off for the corporate supporters of the free market crowd, despite the fact that they are far removed from the original threats that inspired the first libertarians.

Often, the implicit justification is that the free market is the logical companion of democracy. Democracy reflects personal liberty which requires free markets that deliver prosperity, goes the argument. This equivalence is false; nowhere is this more evident than China. China has created the world's biggest economic growth engine by freeing up market forces, but is patently not a democracy that espouses individual freedom. We hear little about this from the free market think tanks, despite the fact that China's rise is amongst the most important factors affecting Australia's long-term future.

The turmoil of the last three years shows that the contours of next big political idea are yet to take shape. One thing we do know is that the dominance of 'free market' thinking which marked the last 40 years has passed.

David Hetherington is the Executive Director of Per Capita, an independent progressive think tank dedicated to building a new vision for Australia.