Kay on Free Markets (1)

The neo-classical economic model claims that free markets lead to an optimal economic situation. The proof of this claim requires so many restrictive assumptions that the proof is not worth much.

In the Future of Markets, John Kay takes a much less perfectionist approach. He suggests three elements to the triumph of the market economy. He says that economists focus too much the first and not enough on the second and third.

1. Efficient resource allocation
2. Markets as process of discovery
3. Diffusion of political and economic power.

Kay says that a defence of the free markets must include all three elements.

There is one central theme that runs through all three strands in the success of the market economy, a theme which I have called disciplined pluralism. When prices act as signals decentralised enterprises and decentralised information are brought together to create a coherent result. Markets as a process of discovery are based on freedom to experiment, combined with discipline: unsuccessful experiment is acknowledged and terminated. Markets as a means of decentralising power are the determinant of the areas where politics and economics meet.

1. Efficient Resource Allocation
The price mechanism is generally a better guide to resource allocation than central planning. John Kay says,

The model of ‘prices as signals’ describes how self-interested agents – individuals or firms – might, through independent decisions, make consistent and efficient choices about how to organise production and distribution and the allocation of capital, labour and other resources. In a loose formulation, this idea has been around since the beginnings of economics. Many people interpret Adam Smith’s famous remark about ‘the invisible hand’, and his observation that it was not the benevolence of the baker, but his self-love, that furnished our table in this way. In an astonishing demonstration of the power of spontaneous order, decentralised markets manage the process of coordinating complex production systems better than centralised direction.