Economic Theory

How governments distort and reduce trade


In my recent paper, entitled How Governments Harm Trade, I explain why in most cases the free market works best when governments do not interfere in the prices society engenders by the laws of supply and demand. Those prices, I will argue, reflect human choices played out on a day to day basis, and are the soundest bottom-up basis on which economies are organised, not the top-down organisations that politicians impose on us.

The free market is the aggregation of billions of choices, wants, needs and desires going on in the world at any one time, all in the form of mutually beneficial transactions. Naturally, as you’d expect, such a system is far too complex and dynamical to be mapped to a set of simple ordinances and decrees, and that is the basis on which so many regulations are frequently problematic to the agents involved in trade.

I will show how value is created in every societal transaction for both agents by the combination of consumer surplus and producer surplus. Consumer surplus is the difference between what the consumer pays and what he would have been willing to pay, and producer surplus is the difference between what producers are willing and able to supply a good for and the price they actually receive. I also explain how the mutual value attained by both agents in those free exchanges is much closer to an optimal outcome than when politicians impose their will on the transactions.

As this paper also shows, the main regulations one ought to oppose are ones that artificially interfere with prices and the information-carrying signals they exhibit. Two examples are price floors and price ceilings. I will show how both of these interventions negatively interfere in the market process, and how frequently both parties (buyers and sellers, employers and employees, landlords and tenants) are made worse off by these price controls.

On the issue of when it is good or bad for the state to be involved in the free market, I use quite a simple and obvious formula: the state should only involve itself in our transactions when there is a net benefit to society from this involvement. That is, when the benefits of doing so outweigh the costs.

When stated like that, I would think it is hard to find a sane person who disagrees with that proposition. The odd thing, however, is that there are plenty of people who would find little trouble agreeing with the idea in its above abstract form, but who quite comfortably hold numerous beliefs that depart from the above logic. It is this anomaly that will be unpacked.

 

James Knight is the writer of the blog The Philosophical Muser.


1 thought on “How governments distort and reduce trade”

  1. Posted 22/09/2016 at 12:49 | Permalink

    Most people agree that the free market works well when Governments do not interfere with the laws of supply and demand. If only Governments were to buy into this …..

    The clear message behind the Government’s defence procurement policy is that military equipment for the Armed Forces is to be purchased through fair and open competition.

    This is to be achieved by selecting the preferred Prime Contractor from a choice of industry teams by running a multiple-phase, winner-takes-all competition on the basis of a level playing field, genuinely open to all-comers including non-domiciled suppliers – to ensure it gets the very best value for money for the taxpayer.

    However, the ‘sudden death’ competition (which reduces the field of Bidders from six to one following a one-off release of the invitation to tender) currently used by MoD has been rendered ineffective by Defence Contractors, who are quoting identical bottom-line Selling Prices against the same Requirement – which amounts to price-fixing on a grand scale, with the active connivance of the Secretary of State for Defence. Worse still, MoD’s Project Team Leader at Abbey Wood, Bristol is being denied the opportunity to choose the single Prime Contractor on the basis of price competitiveness, and therefore value for money.

    This has come about because MoD’s long-standing policy of disclosing the total budgeted expenditure figure or associated year-on-year financial funding profile in the ITT has resulted in Defence Contractors quoting identical bottom-line Selling Prices in their ITT responses – an entirely predictable result!

    It is not for MoD to tell the Private Sector what the price of a new equipment programme should be.
    Instead, it is very much the business of Defence Contractors to tell MoD how much each new equipment programme will cost, based upon the prevailing value of goods, services, labour and finance in the free market shaped, not by the interfering hand of people in the pay of the State who always get it wrong, but by competitive market forces.
    @JagPatel3 on twitter

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