If you hear someone talking about a pure market system or a purely capitalist system, you should know that the person is talking about an ideal or a principle rather than any real economic system. A market economy is generally synonymous with capitalism, as it is in the market that capitalists (the owners of capital) compete for resources, labor and customers to sell their goods and services.
A pure market system can be described as the polar opposite to a pure communist or socialist system, otherwise known as a command system. The government and society work toward empowering the market rather than the market being subservient to the government.
The Ideal of a Pure Market Economy
A pure market system involves the free exchange of goods and services and private ownership of property. Institutions and the government do not obstruct the market, and more importantly, they work to protect and preserve the freedom of the market. The exchange of goods and services is not hindered by factors external to it, such as prices, wages or interest rates. This is the opposite of a pure command economy, in which the government would control the market completely and own all property.
Another way to describe a pure market economic system is pure capitalism. Neither a pure market economy nor a pure command economy exist in any country in the real world. Governments do restrict markets, although from one country to another this is a matter of degree. All economies exist on a spectrum somewhere between these two extremes.
Hallmarks and Caveats of a Market Economy
The two hallmarks of a market economy are a laissez faire approach to the market by the government and the rights of citizens to own property.
Market economies, even those approaching purity, do not necessarily negate the influence of government. Instead of interfering with or limiting the market, the government fosters and protects it. The higher the proportion of goods that are produced due to market processes, the more a country can be said to have a market economy, and the more likely that economic theories based on markets will be able to predict behavior within that country.
It's important to note that full ownership of property in a market economy includes the right to transfer most types of property to others either by selling or trading. This has not been the case for all societies, even those that recognize ownership of property. In the Middle Ages, for example, it was rare for Europeans who owned land to be able to transfer it to sell it to someone else. Even in the United States, it's illegal to sell yourself into slavery or to sell body organs despite the fact that your body is considered by law to be your own property.
The United States Market Economy
While largely free, the U.S. does not have a pure market economy. The federal and state governments often restrict markets. Texas, for example, which could hardly be considered a socialist state by any stretch of the imagination, has a strict law against price gouging. During a state or national emergency, selling food, fuel, medicine, building materials or other necessities at excessive prices is illegal in Texas as it is in most other states.
Even in the freest of markets, public health, safety and security often take precedence. Placing high taxes on the sale of tobacco is another example of the state obstructing the market. In order to reduce smoking and its adverse health effects, governments across the world, including the U.S., have increased taxes on tobacco products, which comes at the expense of the market.
Of course, there are many examples of how the needs of the market have outweighed other needs, like the privatization of prisons, school lunch programs, health care and public utilities. Each of these have been the cause of much debate between those who favor a market-based system and those who prefer more government control.
Markets, Regulators and Government
Bruce R. Scott of the Harvard Business School likens the market economy to organized sports. Just as a league or other sporting authority sets the rules and as referees enforce those rules so that the games can be played fairly, so too does a healthy capitalist society have a three-tier structure.
- The first tier, he explains, is the market itself, where companies compete to secure labor and capital and to serve their customers.
- Above this is a second tier comprised of regulating bodies like the Food and Drug Administration and the Environmental Protection Agency as well as physical infrastructure and systems such as transportation, communications, education, public health and legal.
- The third tier consists of the country's political authority, which in the U.S. includes the executive, legislative and judicial branches that decide on the rules and regulations deemed acceptable by society and hand them to the regulating bodies for enforcement.
Market vs. Nonmarket Economies
Of course, not all countries have market economies. There is no global agreement on what defines a market economy, and the World Trade Organization doesn't define the term at all. Each country has its own definition. The U.S. and the European Union use a multifactor test to discern market economies from nonmarket economies, or NMEs.
The U.S. definition of a nonmarket economy is stated in the Tariff Act of 1930. An NME is any country that "does not operate on market principles of cost and pricing structures, so that sales of merchandise in such country do not reflect the fair value of the merchandise.” Any country that is not designated as an NME is a market economy. According to the same act, a U.S. investigating authority must consider:
- The convertibility of the country's currency
- If wages are determined through free bargaining
- The amount of control the government has over resource allocation, prices and company output
- Any other factor the investigating authority considers appropriate
Some countries, like Cuba and North Korea, are obviously nonmarket or command economies regardless of how loosely you may define an NME. Other countries, like China and some Eastern European countries since the demise of the Soviet Union, are deemed to be market economies by some nations but not others. Furthermore, these designations can change as countries modify their policies from year to year.
Markets, Government and Controversy
Often, the role of governments and institutions in the market are a matter of perspective and the cause of much controversy. What, for example, should be the role of the U.S. Federal Reserve when setting interest rates? On the one hand, higher interest rates reduce borrowing and reduce inflation, which can keep the value of the dollar high with a strong purchasing power. On the other hand, a stronger dollar can harm exports and can slow economic growth.
Another bone of contention among politicians, economists and business owners for much of the past century has been the role of the government when faced with a monopoly in the market. The U.S. government has established antitrust laws to prevent monopolies and to force large companies to give up their control of the market when they become too dominant.
When companies like Standard Oil, Microsoft and Facebook have nearly complete control of a market, is forcing their dissolution making the market stronger, or is it weakening the market by punishing strong competitors while rewarding the weaker companies? It's unlikely these debates will end any time soon.