Market Theory

Markets are central to economic theory, and none more than to Neoliberalism, which holds that free markets, free trade, and the free flow of capital create the greatest social, political, and economic good. The discipline of the market should rule everything, from the production of armaments to the privatisation of health and the opening of economies to foreign competition. It is a view proselytised in business studies textbooks and reflected in mainstream news outlets like Businessweek, the Financial Times, Wall Street Journal and the Economist. {1}

Proponents point to its stunningly successes in countries like China and India, for all that detractors argue that benefits go largely to the already wealthy, widening social divisions and contributing to the unemployment woes of middle-class America and Europe and the destitution of rural communities in India and elsewhere. Benefits will come to everyone in due course, they say — a view contested by Marxist academics who point to an unending pool of impoverished labour. The matter is complicated — development in China and India is still largely state controlled, and many rules were broken to create the European Economic Union — but a strong case can be made for contending that: {2}

Market operations are abstractions devised by economists, whose concepts and procedures are open to question.

The pre-eminence of the market evades obvious social and moral concerns: simplistic ideas are elevated to an impersonal science imposed to serve sectional interests. Other, less market-dominated, models give a truer picture of economic reality.

Markets are in practice rigged, by governments and wealthy investors.

Dictates of the marketplace often serve as a fig-leaf for political realities.

Even the economics profession has been corrupted by money concerns.

To its critics, economics is a self-perpetuating priesthood, divorced from reality, ignorant of how business really works, and therefore dealing with hypothetical situations through concepts plucked from the air. {3}

Market Operations

Economists call their discipline a science: the study of the allocation of scarce resources. It is unlike other sciences in deducing effects from models, however, rather than inducing laws from observation. Economics still sees itself as objective, however, allowing practitioners with the same procedures to draw the same conclusions from evidence agreed to be relevant. Politics and national interests may well guide business practice, but market economics regards these as unimportant, or deviations from fundamental and unchanging relationships. The market — a simplified abstraction of conditions that only partially hold in the real world — is the controlling factor, and prices are set by supply and demand in everything: labour, commodities, land, intellectual property, etc. The market is efficient, rational, fair, not affected by historical factors and works best when unhindered by social or political constraints. Both workers and industrialists are better off under market economies, and governments should simply set, interpret and enforce the rules. Indeed all resources are optimally allocated by the market, which is self-correcting: slumps and unemployment occur rarely, and only because the market is being kept from its proper functions.

Most economic concepts originated in a pre-industrial, mercantile society — and were indeed a self-justification of laisser-faire capitalism against the medieval condemnation of usury. The greatest originator was Sir William Petty (1623-87), but his ideas were codified by Adam Smith (1723-90) whose 'invisible hand' nonetheless stressed the need for banking regulations and progressive taxation. Much was subsequently a campaign against a socialist view that workers should partly own the product of their labour. William Stanley Jevons (1835-82) introduced marginal costs, and John Maynard Keynes (1883-1946) tried to adapt the concepts to deal with widespread unemployment.

Much is unfortunately built on sand. Both economics and law are branches of ethics, but motive, so central to law, is missing from economics. Man is a social, emotional and spiritual animal — aspects entirely overlooked by practical economics. The enlightened self-interest of economic man is too often assumed than demonstrated: in a complex, interrelated society men rarely know where their best interests lie, particularly in a world saturated with advertising and stage-managed politics. Economic laws reflect relationships between groups of people and so vary with societies and their history: again all ignored by classical economics. The attraction, and probably the success of market economies, lies in the freedom afforded societies from officialdom and subsistence living, though neither is guaranteed. In 1900, for example, when the British Empire ruled one person in five of the world's population, one third of London's population lived in direst poverty: a situation accepted as natural by mainstream economics and the ruling classes. Neoclassicism has culminated in globalisation, which has ostensibly brought astonishing growth to China, India and other countries previously languishing under centrally-planned economies. {4}

Neoclassicism is simple in principle, but uses statistics to collect representative data, and often a good deal of advanced mathematical concepts in its analyses. The basic principles of neoclassical economics are well set out in textbooks and Internet sites — such matters as supply and demand, output, growth and capital, inflation and unemployment, money supply, trade, taxation, trade unions, competition, government spending: there is hardly an aspect of modern life in which economics has not something to say. {5}

Neoclassical economics is still the lingua franca of the business press, but critics allege that economic forecasting has been ineffective: few economists predicted the current crisis, or previous ones. Reliance on economic theory, particularly market efficiency, has played a large part in the financial disasters of the last few years. Globalisation and the free market have created unemployment in western countries, and widening inequalities in the third world. Money has become an abstract, quantifiable thing, and economists argue the best societies are those that aggregate money most effectively, at whatever cost, to whatever ends, whether productive or not. Companies that buy back their shares and enhance their value to shareholders are therefore behaving responsibly, for example, even though investment in R&D and new facilities suffers, and the long-term health and competitiveness of the companies are endangered. Even the basic tenets of economics are shaky or demonstrably false. Economic models are remote from business realities, many models being 'blackboard diagrams' or 'armchair theorizing', sometimes more obscured than illuminated by mathematical treatment. The world simply isn't as economics supposes.{6}

The Power of Markets

Economic theories generally see human beings are rational creatures propelled by narrow self-interest who nonetheless have sufficient knowledge and ability to make consistently sensible judgments toward their subjectively defined ends. 'Homo economicus' attempts to maximize utility as a consumer, and economic profit as a producer. {7}

Much of economic theory is through modelling of diagrams, which is basically a calculus of nineteenth-century utilitarianism. Human beings are not rational, however, do not have a clear view of opportunities and their consequences, and are not always self-seeking in the manner supposed. No company would survive if its workforce were so constituted, and indeed most try to inculcate a sense of loyalty, common purpose and service to their customers. {8}

But why has economics, and neoclassical economics in particular, become so influential? Because, critics argue, it allows companies to sidestep ethical considerations and need for social change by claiming they are simply following market dictates. Some think this is socially unwise, and that maximizing profits to shareholders leads to short-sighted policies, where the need to watch the share price and prevent takeovers inhibits long-term investment. {9}

Only a minority suppose that economics is worthless. Economists are continually compiling the statistics of matters vital to economic life, and trying to understand them. Without access to detailed international statistics and reports, no government can indeed maintain a viable economic policy. Criticism is levelled at sterile arguments over models that have little currency outside academic journals, and/or which justify wrong-headed business practices. {10}

Blackboard Modelling

Steve Keen provides a detailed critique, summarizing the assumptions as: 'Economic behaviour can be modelled by a single consumer, endowed with rational expectations, who aims to maximize his utility from consumption and leisure. His income derives from the profits of a single firm in the economy, of which he is sole owner and in which he is sole worker. The profits he receives are the marginal product of capital times the amount of capital employed by the firm. The wages he receives are the marginal product of labour times the hours he works in the firm. The output of the firm determines output today, and today's investment (minus depreciation) determines tomorrow's capital stock. The single consumer/owner/worker decides how much of current output to devote to investment, and how many hours to work, so that the discounted expected future value of his consumption plus leisure plan is maximized. Technology facilitates the expansion of production, the expansion growing at constant rates but subject to random shocks The shocks may alter the equilibrium levels chosen for labour and investment, but the system will gravitate to equilibrium conditions.' {11}

Scarcity may well put up prices, but only because society sanctions such practices. Distributive communities do not, and Imperial China indeed outlawed merchant profiteering. In fact, even that neat concept of the clearing price, established by the intersection of the demand and supply curves, is a fiction. Products don't suddenly sell themselves at a certain price, nor unaided. Heavy marketing costs are involved, and these can exceed the costs of manufacture, R&D, and distribution. Business is increasing controlled by corporate and multinational companies, and such companies do not compete with each other, but more collaborate in setting standards and codes of conduct. Price wars are disastrous to all parties, as is negative advertising. Grouped under product differentiation and selective marketing, the selling policies of large companies are complex and diverse — in no way resembling the clearing price concept. {12}

Even the concepts are hypothetical, and their mathematics flawed. Mainstream models generally assume that a. individual preferences can be quantified, and b. they remain unchanged even though income rises. Models then reduce a complex society to an idealized citizen whose needs can be measured in units of satisfaction or 'utils'. Cook an adequate meal at home or go out to dinner? The choices could be measured and compared in terms of 'utils', and be extended to heating, clothing, freedom of action, and so on. Individuals would rationally aim to maximize their amount of 'utils'. Curves linking the same totals of 'utils' were curves of the same satisfaction, and are therefore called 'indifference curves'.

The indifference curve can be quantified if know the value of x and y utils — i.e. the prices of x and y — and the income of the individual concerned. By a. holding the income fixed, b. reducing the price of one of the utils (say x) and c. keeping the price of the other for the other util (y) constant, a demand curve is constructed for x. It is downward sloping and applies only for the one individual. Substitution is likely if income increases (the individual buys ground coffee in place of instant), but the substitution effect can be neutralized by retaining the shape of the indifference curve while shifting its position (the Hicksian compensated demand curve). In this way — without reference to empirical data — the demand curve receives its characteristic shape. {13}

Unfortunately, once the single individual is replaced by a society of interacting individuals (i.e. a more realistic picture, though still hampered by hypothetical 'utils') the demand curve can adopt almost any shape. Indeed, since individuals differ in their preferences and earning abilities, the Law of Demand will only apply if there is just the one consumer, a highly unrealistic scenario that is nonetheless employed to argue against redistributive economic policies.

Even without these hypothetical entities, the marginalism that sees prices rising to the point at which no extra profit can be made from the manufacture of one extra unit blithely overlooks how companies act in the real world. Economies of scale operate. Prices at which companies offer their products are not fixed and independent of output. Output is generally limited by demand, which is itself a combination of employment and wage levels. Labour is not always flexible, moreover, and if new staff are taken on they have to be trained, which is an expensive and lengthy process. In short, companies do not price their products as market theory says they should, but employ advertising and sophisticated business models to stimulate demand. {14}

Equally damaging is the internal inconsistency of economics: the discipline can be logically disproved in its own terms. The supply curve doesn't exist, for example, because the concept of marginal cost of production on which the supply curve is built (the additional expense incurred in producing just one more item of production) rests on the error of supposing that a small figure equates to zero. Correct that error, and a competitive market will set a price above the marginal cost, which makes it impossible to draw a supply curve independent of the demand curve. {15}

Other suppositions fare equally badly. The distribution of income is not based on merit, nor determined by the market, but reflects the power of various classes and professions. Money traders, bank and managerial staff do not have their high wages because they are more productive and/or contribute more to the marginal product of labour and capital, but because their high wages are part of an accepted socio-economic structure, a circular argument for the status quo. In the high debt situations of today, increasing wages for the many (i.e. contrary to austerity programs) may indeed create the necessary inflation better than printing money. {16}

Static versus Dynamic Scenarios

Situations are always changing, and to assume that actual situations are merely transient states on their way to equilibrium conditions shuts the door to more helpful treatments. Keynes' work addressed the persisting unemployment of the 1930s, though his policies did not become orthodoxy until much later. Minsky's modelling of bank share, wage share and unemployment disclosed a 'death spiral' of debt that would not exist in a static world. The well-known Phillips relationship between inflation and unemployment was only one result of adding a time factor to economic modelling. {17}

Are Markets Efficient?

Are markets efficient? Yes, said Paul Samuelson and host of brilliant economists from Yale, MIT and the University of Chicago in the 1950s and 1960s. A decade later appeared the work of Scholes, Merton and Black on the pricing of options, which won their authors a Nobel prize, and opened the door to the explosive growth of financial futures and derivatives. Intrinsic to these is the normal distribution of risk, that familiar bell curve that pushed severe events so far to the extremes of the curve that major disasters could happen hardly at all. On this was built the value at risk (VaR) concept and the Long-Term Capital Management (LTCM) hedge fund with assets totalling $126 billion. {18}

But stock markets events are not independent of each other but retain some 'memory' of the past, and the better model is one of complexity, where disasters are far more frequent, indeed to be expected. VaR was used to manage risk in the decade that led up to the financial crash of 2008, and contributed to its $60 tn loss. LTCM had to be bailed out. {19}

Efficient Market Hypothesis

The efficient market hypothesis argues that all relevant information is already incorporated into the market price, and that stock prices move randomly and therefore unpredictably. Fundamental analysis is therefore pointless since no one can see the future. Most economists hold to this hypothesis in one form or another, and it is regularly taught to business studies students.

In its 'strong' form, the EMH asserts:

Collective expectations of stock market investors are accurate predictions of the future prospects of companies.

Share prices fully reflect all information relevant to the prospects of traded companies.

Changes in share prices are entirely due to changes in information concerning future prospects, that information arriving in an unpredictable and random fashion.

Stock prices follow a Brownian movement or 'random walk’, where past movements give no indication of what future movements will be. The hypothesis was built on elegant economic models in the sixties, and gained support from studies that showed investment managers do not consistently beat the market, but is now being modified by behavioural market theories. {20}

Investors argue that markets may be efficient some 85-90% of the time, but not always because: {21}

Some investors do consistently make money. Indeed, by simply holding stocks in the top ten Fortune 500 companies over the period 1976 to 2006, investors would have outperformed the S&P 500 index by some 4.85 times.

Investors can wildly overvalue stock during stock market bubbles, as they did in the 1997-2000 bubble. How did those stock prices incorporate relevant information and not market hype?

Stock prices fell immediately after 9/11. In what sense were mining companies, makers of cars and semiconductors, and service industries suddenly worth 5-15% less?

The EMH has collected a large literature. A review of the evidence by Malkiel in 2003 concluded that markets were more efficient but less predictable than commonly believed. Efficient markets can make valuation errors, accept irrational behaviour from investors, but do not allow investors to continually earn above-average returns without accepting above-average risks. Markets in the short run may be a voting mechanism, but act as a weighing mechanism in the long run: true value is disclosed eventually. Many stock market anomalies appear on analysis, but the transaction costs involved still argue against consistently profiting from such anomalies, though a buy and hold policy with 'value' stocks may still be possible. {22}

Efficiency and predictability are not necessary bedfellows, however. It is possible for markets to be efficient — or sufficiently so to prevent trading strategies being consistently profitable — but still be somewhat unpredictable. If investors watch other investors — i.e. the previous day's prices enter into their buy or sell calculations, for which there's good evidence — then stock markets are not static systems tending to equilibrium, but time-dependent complex systems which will inevitably throw up bizarre results from time to time. The standard deviation of daily movements on the Dow Jones Industrial Average is roughly 1%, but over 60 daily movements of 5% were recorded in the twentieth century: the very odds against that happening shows that movement isn't random. Moreover, since stock markets are complexly interlinked, bizarre movements can trigger worldwide disturbances, which is possibly an explanation for foreign currency crises sometimes laid at the door of hedge fund manipulation. {23}

Attention has also shifted to intermediaries — fund managers, banks, fund managers, brokers and other specialists — who have better information than lay investors but may be driven more by commissions than service to clients. Market momentum distortions may also be increased by investors transferring from under-performing to over-performing fund managers. {24}

Strategic Management

Another nail in the coffin of market theory is strategic management, what managers actually practise to get the best from their workforce. It has nothing to do with economics, but evolves in response to new studies, perceived opportunities and threats, and apparent excesses or oversights of previous strategies. Not all theories have been progressive, universally accepted or even helpful. One decade has sometimes had to undo the harm the planning of the previous one inflicted. Managements can be found embracing mixtures of theories, some not contemporary or mutually compatible. Charismatic CEOs leave; new competitors appear on the horizon; the world suddenly looks different. Reorientations take time to filter down and be implemented.

Several overlapping and sometimes blending phases of strategy formulation can be recognized. {25}

Planning in Large Multi-product Companies: 1950s-60s

Aimed to produce large, multi-product firms, although accompanied by decentralization and diversification into attractive but often unrelated businesses.

Planning in Large Multi-product Companies: 1965-75s

Adopted the Boston Consulting Group's (BCG) micro-economic approach, concentrating on areas where market leadership was possibly, and divesting in others. In detail:

Focus on cash rather than profits.

Aim for cost advantage over competitors.

Force competitors to withdraw from the company's main profit segments.

Use debt to finance growth.

Reinforce market leadership.

Raise returns for stockholders.

Avoid overextending the product line or building in too much complexity or overhead.

Use excess cash flow to diversify into new areas.

Though not central to BCG's world-view, companies also tended to build large central planning departments in conglomerates, and diversify excessively: both caused problems later.

Retreat from Strategic planning: mid to late 1970s

Central planning retreated into pragmatism as:

Micro-economic techniques for analysing competitive advantage became more powerful.

Central planning and conglomerate diversification became intellectually tarnished.

Oil price hike of 1973 and stock market crash of 1974 hit the more progressive companies.

Creative Reaction to BCG school excesses: from 1973 to present.

Focused more on the intuitive, adaptive and creative aspects of strategy, making managers less reflective planners and more face-to-face communicators and decision-makers.

Rigorous micro-economic analysis: from 1980s to present.

Elaboration of the BCG framework of competitive advantage to include:

Threat from new entrants.

Bargaining power of customers and suppliers.

Threat from substitutes.

The overall message was that companies should find markets and market niches it could dominate, erecting barriers against competition by low costs or product/service differentiation.

Skills and capabilities: from 1990s to present.

Focus has shifted to a company's skills and capabilities (its core competencies) in expressing its vision and mission statements. Corporate strategy is more seen as the definition, creation, stimulation and reinforcement of competencies across many market segments. Drawing on works of military strategy, these approaches observe that plans give way in practice to the judgment of frontline officers making snap decisions. The battle plan must always be complemented by the instincts of the leaders. Similarly, a good strategy should give managers the general direction and focus, while remaining open-ended and not over-planned. People are more valuable than plans, which is why strategy should be developed by company executives and not outside consultants.

Other influences have been:

Integration of strategic analysis and cost reduction through business process re-engineering.

Improved data-gathering and analysis on competitors to better select acquisition candidates.

Unlocking customer value.

Cutting times in developing and delivering products to customers.

Concentrating on fewer products and relying more on outsourcing.

In short, the key today is seen as:

Differentiating the company from its competitors.

Developing skills and positions that no competitor can approach.

Specializing in areas that fostered a superior better technology, product or service, or a lower cost position.

Business Strategies

Business strategies themselves owe nothing to economics, moreover, but are commonly grouped as:

Outside-in: what do our customers want from us?

Inside-out: how can we sell what we've got or could develop?

Unbundled: how can get our businesses to improve by standing on their own feet?

Multisided: what strengths and economies can we achieve by getting our different divisions / acquisitions to work together?

Government-supported: how can we use government aims and institutions to assist sales?

Loss leading: how can we attract customers with initially free or low-price offers?

Long tail: how can we make a profit with the sale in small numbers of a great range of products?

Open model: how can sell what originally comes free?

Custom value leader: how can we be seen as the best in this market?

Value innovator: how can serve a need that hasn't been recognized before?

Customer capitaliser: how can we earn even more from our customers?

Brand capitaliser: how can we improve and get more from our brand reputation? {26}

Markets are Rigged

Far from being rational and fair, markets today are rigged, and in three ways:

The sums available to hedge funds, particularly those operating out of tax havens with looser regulations, are sufficient to manipulate markets. Commodities and currencies are sold short — i.e. 'bought' from a friendly trader, kept with the dealer without payment while rumour and sudden selling depress the price, and then actually bought so as to return the shares (now purchased at a lower price) to the dealer, the difference being a handsome profit. In this way were engineered — by taking advantage of 'structural' weaknesses and government mistakes — the financial crises of Latin America, Russia and Asia. {27}

Large banks and/or quasi government agencies also maintain 'market stability' with shadowy institutions like the Plunge Protection Scheme (Working Group on Financial Markets) and the Exchange Stabilization Scheme. {28}

More of some commodities (like gold and silver) are 'sold' than are deliverable. {29}

Economics is a Fiction

A minority of critics go further and argue that conventional economics acts as a cover, a fig-leaf of respectability to power politics. Largely missing from trade models are economic power, military spending, 'hot money', capital flight, smuggling, and fictitious transfer pricing to evade tax, all with government complicity. Recessions do not simply happen through the interaction of market greed and fear, for example, but are created by banks working with government and big business. F. William Engdahl observes that banks and big business have furthered US globalist ambitions, and will be supported for that reason, even at the cost of American jobs and civil liberties. {30}

Such analyses espouse political realism of the Morgenthau school, i.e. that countries are motivated by perceived national interests, or national interests disguised as moral concerns. Sometimes the national interests are more sectional interests. A case in point was the 1973 quadrupling of oil prices, which is commonly seen as retaliation imposed by the OPEC countries for Israel's occupation of Arab lands after the Yom Kippur war, but analysed very differently by Engdahl. The 'oil-shock', which permanently damaged US industries, leaving industrial wastelands and the attendant problems of unemployment, social deprivation and crime as manufacturing gradually moved offshore — arguably the single most devastating blow to western and third world growth — was created in Washington to favour oil interests, banks and the American dollar. Preposterous as the story must seem, a summary is this: The Shah of Iran, who owed his throne to CIA actions in 1953, was allowed to strengthen his army with American weaponry in exchange for oil price hikes. Saudi Arabia, with whom the US had an agreement to trade oil for American protection, was similarly instructed. Other OPEC countries followed. The new profits created a world awash with petrodollars, which were first invested in New York and London, profiting the oil families and banks handling the transactions. From banks the petrodollars went as loans needed by third-world countries now suffering from recession and increased energy costs — loans made essential by the 'oil-shock' but increasing the debt burden under which they still labour. North Sea oil, uneconomic at earlier prices, became profitable, and demand for the dollar in which oil is bought (but previously weakened by dollar printing to fund the Vietnam war and by money laundering activities in Europe and Lebanon) strengthened its position as the world's preferred currency. {31}

Corruption of the Economics Profession

Contrarian economists contend that mainstream economics has betrayed its principles. Far from being a science, i.e. objective and disinterested, the economics taught at college and published in academic journals is now subservient to those who ultimately (however indirectly) pay the salaries: i.e. banking and big business. Michael Hudson, for example, observes that the wealthiest 1% have rewritten the tax laws to a point where they now receive an estimated 66% of all returns to wealth (interest, dividends, rents and capital gains), and a reported 93% of all income gains since the Wall Street bailout of September 2008. {32}

To achieve that success, the rich have secured control of the major news media that shape peoples' views, and have used the financial crisis they themselves created to argue for further privatisation. The public debt is now too large for everyone to be paid, and the financial interests representing the wealthiest 1% have incorrectly argued that a reduction in social services, education, Medicare and upkeep of local amenities is imperative. Books have to be balanced, they argue, forgetting that productivity increases will cover expense, and that sovereign states are not businesses but can print money, as they famously did in bailing out Wall Street. The problem in fact, contends Hudson, is not social security and the like, which can be paid out of normal tax revenue, as in Germany's pay-as-you-go system, but the lopsided treatment of real estate, oil and gas, natural resources, monopolies and the banks, which unfairly benefit from light taxation and tax loopholes. {33}

Some writers indeed argue that economics has never been a science but an elaborate justification of the status quo. Routh: 'By leaving this [power] out, and thus separating itself from politics, economics has become an arrangement for preventing the citizen and student from seeing how he is governed.' And: 'Of course this neglect of the real world in favour of creations of the mind is a leading feature of orthodox economics. That it is generally accepted gives it academic respectability and removes the danger that economics might be used as an instrument in reshaping the world.' {34}

The financial crisis is not an aberration, critics of globalisation argue, but part of a carefully orchestrated policy to run a society on debt — a debt forgiven banks by bailouts but maintained in student loans, mortgages, and business loans. Free money (quantitative easing) furthers the interests of the banking and military machines but not the ordinary citizen. On the latter's default — and defaults are inevitable — the funding institutions pocket the collateral, further increasing their wealth and political influence. Market economics is a small part of a larger picture involving the Washington consensus, and possibly 'deep state' power. Some believe economists overlook the obvious, that it's energy costs that are curtailing world prosperity, and one where alternative energy sources are not receiving the needed research. {35}


Monetarists emphasise the role of governments in controlling the amount of money in circulation, believing that variations in the money supply influence national output in the short run and the price level over longer periods. Best known through the advocacy of Milton Friedman, monetarism was influential in the 1970s and 1980s, though governments in the USA, Chile and the UK were generally unsuccessful in controlling the money supply. The simple relationship is given by:

MV = Py

where M is the money supply, V is velocity (turnover), P is the price change and y is real growth. There are several measures of money, and not all are easy to regulate, but the V is the more troubling measure. It is based on psychology, general feelings. For the USA, population growth is about 1.5% p.a., and productivity increases around 2 to 2.5%. From those figures, the country ought to comfortably manage a GDP increase of 3.5-4% year on year. But the velocity of money peaked at 2.12 in 1997, and has been on downward course since, falling to 1.67 in 2009 and levelling off at 1.71 in 2010. The Fed has therefore been printing money to offset this fall in money velocity. {36}

The Fed indeed controls the monetary base, about 20% of the money supply. Banks create the remaining 80%. Between January 2008 and January 2011, the monetary base has been increased by 242%. As that was having little effect, the Fed used other methods to boost confidence. For a while it supported house prices. When that proved impracticable, it turned to another indicator that is closely watched: the stock market, which is now being manipulated. Bernanke is quite open about depreciating the dollar, hoping a fear of inflation — echoed in magazine leaders across the country — will push Americans to consume more. {37}

Markets in Practice

Free markets should allow the free movement of labour, but in practice most countries prevent or limit immigration, placing the social order above market concerns. Highly qualified Indian doctors could make US medical fees more affordable, for example, but overseas staff are generally restricted to those undergoing training. Europe is also stemming the flow of immigrants from Africa and the Middle East, by force if necessary, although many are escaping the destabilising effects of western military action.

Politics plays a central role in the organization of all societies, and thus in markets. Even in western democracies, politics is not a simple choice between policies by informed electorates, moreover, but is often based on class attitudes common to occupation and social background. Voters are also guided strongly by their genetic make-up in being more comfortable with conservative or liberal policies, even against their best interests. Wall Street is corrupt. {39}

Commentators who favour a mixed economy argue that free market forces should apply in the private sector, but that government regulation is essential otherwise. Free markets are not automatically efficient, fair and sustainable. Fundamental research and development often needs government investment to get off the ground, and to ensure successes are not hampered by burdensome patent protection. Indeed as economic life becomes more complex and interconnected across the world, there is a corresponding need for government involvement and cooperation. {40}

References and Further Reading

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