The Case for Free Markets
Policymakers focus too much on the perceived benefits of government intervention to notice costs that are difficult to undo
Economists have come under fire of late for a laundry list of transgressions. They are said to have misread economic downturns with outdated frameworks and to be out of touch on big challenges such as climate change. Should economics be renamed Wreckonomics or are the criticisms unfair? This is the first in a series of essays in which economists at Queen’s University weigh in.
Ask 10 people their views on when and how governments should intervene in markets, and you’ll likely get 10 different answers.
Take, for example, the housing market. Some may advocate for stringent regulation to protect tenants from extensive rent increases and enforce required repairs and maintenance of rental units. Others may argue that less regulation is necessary to incentivize investors to increase the supply of housing units.
At the core is the question: Can free markets alone achieve the efficient or socially desired outcome, or is there a need for some form of intervention by the government?
For any free market to function, the government must create and enforce certain rules that establish a framework within which sellers and buyers can exchange goods and services. Some examples: enforcing the protection of intellectual property rights such as copyrights and patents; prosecuting firms and individuals that engage in scams and frauds; and defining and enforcing minimum safety standards to protect consumers from harmful products.
Beyond establishing such rules, however, there is no economic reason for governments to intervene in markets, unless a free market fails to achieve the efficient outcome. In his recent essay, my colleague Henry Schneider carefully explains the different types of market failures that can justify government intervention. These include market power, externalities, the provision of public goods and asymmetric information between sellers and buyers.
Does the presence of one of these market failures always justify direct government intervention? The answer can be complex and requires a careful cost-benefit analysis.
Counting the costs
Any intervention by the government creates direct costs (such as more government bureaucracy) and indirect costs (unintended consequences, among others), and the number of beneficiaries may be small relative to the overall economic cost.
Consider marinas in and around Kingston, Ontario, where I teach. Kingston is a popular spot for boaters, but there are only a few marinas because of the limited number of suitable waterfront properties and the required capital investments. The marinas therefore have substantial market power when renting out boat slips, leading to high seasonal rental fees. Given their market power, is there a strong case for the government to regulate the rental fees for boat slips in the Kingston region? Most people would agree that despite the market being highly concentrated, the issue affects relatively few consumers, so the cost of government interventions would likely exceed the benefit.
Often, governments intervene in markets even when there is no clear economic reason to do so. The case of the Canadian dairy industry is instructive. Ever wonder why dairy products in Canada are significantly more expensive compared to the U.S. and European Union? It is because the market is not “free”. The Canadian Dairy Commission, with permission from the government of Canada (via the Canadian Dairy Commission Act), established a quota system that artificially restricts supply. The result is higher prices.
The dairy industry quota system harms Canadian consumers. So why does the government not eliminate supply management in this industry? The reason is that politicians would face fierce resistance from dairy farmers, as each quota they own is worth a lot of money. In August 2023, the price of one quota in Alberta was $50,515 (the price of a quota in Ontario and Quebec is capped at $24,000). One quota allows a farmer to produce one kilogram of butterfat per day — the average daily production of a single cow. Even for small dairy farms, the value of their dairy quotas is substantial, and eliminating the quota system would essentially make these quotas worthless.
This example also provides a cautionary tale in that government interventions in markets will be very difficult to undo because the benefits are highly concentrated (maintaining the value of the quotas for relatively few dairy farmers) while the costs are dispersed (forcing higher prices on a large number of Canadian consumers).
So when should the government intervene in markets? The consensus among economists is that we should strive to keep markets free from direct government intervention unless there is significant market failure.
I grew up in East Berlin and personally witnessed the adverse effects of excessive government interventions. As with most East European countries and the former Soviet Union until the late 1980s, East Germany had a centralized economic system. The government owned all means of production and determined the production quantity as well as prices for virtually all products. Unlike in West Germany, with its market-based economy, product variety and quality were very poor, and there were severe shortages even for basic items. East Germans needed a lot of patience, as long queues in front of retail stores were common.
Nonetheless, we had one “free” market that functioned exceptionally well: the black market. People would pay more, for example, for a 10-year-old Trabant (the most common car in East Germany) than a new Trabant. For many East Germans, paying excessive prices for old cars — which was illegal — was still more appealing than waiting 10 to 15 years for a new car.
Even in East Germany, the ever-present government could not cancel the basic law of supply and demand.
Veikko Thiele is an associate professor and Distinguished Faculty Fellow of Business Economics at Smith School of Business.