- Markets are financial in nature and are a function of business. The goal of a market is not the goal of an economy. The relevance of markets to the discipline of economics is tangential and indirect.
Economics has been labeled as ‘the dismal science’. It will be argued here, this label can be attributed to a failure on the part of the discipline of economics to properly conceptualize the nature of an economy. It’s offered that much of the confusion centers on the role markets play within an economy. Some hold that markets play an active role where the forces of supply and demand dictate economic health. Others suggest markets play a more passive role within economic policymaking. The disagreement centers on whether the economy is, itself, a market or simply the result of an accumulation of all self-regulating markets. The question to be addressed here is, “Do we in the U. S. have a market economy, or is it more appropriate to say we have an economy of markets? This may seem like a distinction without a difference but is critical to a proper understanding of the nature of an economy. Consider the following metaphor:
Most of an iceberg is not visible from a ship at sea. Imagine the visible part above the waterline to be the economy and the part unseen to be free markets which support the economy. The visible part may be massive but pales in comparison to that less visible. While part of the same structure, two separate and distinct conditions exist, both metaphorically and in reality. This visualization can be useful in better understanding the nature of an economy in which markets for goods and services provide the basis for financial activity.
This visualization makes it clear there are two distinct forces at play. The forces that act upon an economy, that is above the waterline, are not the same forces that act upon a free market for goods and services below. It’s important those differences are recognized.
Free markets work to set price and quantity for a given product or service. They operate on the principle of supply and demand. Free markets allow competitors to make financial decisions in support of their own self-interest once a price is set. The competition inherent in all free markets enforces the law of supply and demand and is the cornerstone of the free enterprise system.
Economies, on the other hand, do not respond to these same forces. Economies are not subject to competition. The natural law that allows markets to set price and quantity are not available to an economy. To influence an outcome, human intelligence is necessary.
Throughout history, financiers have imagined economies to benefit from and operate on the same principles as those of a market. Imagining the principles inherent in the law of supply and demand to affect an economy was a natural extension of the business decision-making process. It wasn’t until the Keynesian Enlightenment of the 1930s that economies were shown to operate on principles different than those which govern business decisions. It was shown economies operate by way of adjustment to output resulting from the operational demand for goods and services. This new reality moved economies into a social function of maximizing employment levels, within constraints, and left markets to reside exclusively within the business purview.
Assigning the task of administering a value free economy to Adam Smith’s “invisible hand” and to the proven abilities of market forces was a worthy enterprise prior to Keynes’ General Theory. History and logic, however, have shown this assignment is without merit. The law of supply and demand works well where a recognizable objective is in play and appropriate desires can act upon those forces. The economy writ large does not have a resource objective and, therefore, cannot benefit from this principle.
The discipline of economics measures an economy and prescribes corrective actions to achieve a goal. This goal is not the goal of markets. While markets actively seek a price goal, economies have an employment goal. Economies do not compete to establish price. Economies are viewed in terms of aggregates. An economy is the amalgamation of markets but is not itself a market. From this, it follows we have an economy of markets and not a market economy. That is to say, an economy is synthesis of market activity but not, itself, a market.
The misuse of the principles associated with the law of supply and demand are commonly accepted by mainstream economists but do not end here. A perusal of leading macroeconomic textbooks suggests the principle of supply and demand is helpful for understanding how economies work. These textbooks assume an economy has an overall price that can be used to influence an overall quantity. The overall economy-wide price is then used to demonstrate how an increase in that price will affect quantities purchased. This abstraction is the initial sleight of hand on the path toward economic malfeasance. It has yet to be demonstrated an economy has an overall price. The ability to generate one mathematically does not make it meaningful. Prices are a function of a market, and to suggest the law of supply and demand operates in the absence of competition abuses this principle.
Introducing the concept of supply and demand to the student of economics in an introductory macroeconomic course is brilliant if the intent is to deceive. This well-known and intuitive law is readily accepted by the student as useful in the attempt to understand how economies work. Unfortunately, it sends the student off into a blind alley by suggesting an economy can be understood in terms of market forces.
The distinction which separates the interests of society from those of business is subtle. What is not subtle is the damage done when the nature of an economy is not properly recognized. Regardless of how beautifully markets self-regulate in setting price and quantity for the financial community, incorporating the principle of supply and demand into the discipline of economics is harmful to everyone. Economists should reclaim their profession from the business community and, in the process, put an end to the label of ‘the dismal science’.
