Free markets or Command Economy?
The allocation of scarce resources has been the fundamental economic problem throughout the history of mankind. The simple fact is that resources are limited, whereas our wants and needs are infinite. Therefore, it is crucial that the allocation of these scarce resources is done fairly and efficiently for a society to prosper. The Free Market and Command economies provide two (conflicting) potential solutions to the fundamental economic problem and have been thoroughly experimented with over the past century and beyond.
To compare the two, we should define them first. A free market economy is one in which the decisions regarding investment, production and distribution are guided by the price signals created by the forces of supply and demand. A command economy is a system where the government, rather than the free market, determines what goods should be produced, how much should be produced, and the price at which the goods are offered for sale. Wages and investment are also determined by the government.
Looking at history alone, free market economies have largely been more successful than command economies. Of course, perfect free markets and command economies do not exist in practice. Today, all countries have a mixed economy, with some leaning towards a free market and some towards a command economy. There are numerous successes and failures on either side of the spectrum. I will also reference examples of these to support my arguments.
Firstly, free market economies are better at allocating resources because of the simple fact that they are ‘free’. There is no government intervention, which means goods are produced in quantities aligned with the demand for that product. Prices are also determined by how much consumers are willing to pay for the product. Firms in a free market will always want to produce at the equilibrium quantity and sell at the equilibrium price, in order to maximise profit. This means that theoretically there should be no shortages or surpluses from production (since at Equilibrium Price, quantity supplied equals quantity demanded). This would ensure that everything that is produced is consumed by consumers. In this sense, wastage of scarce resources is limited. Allocation of resources is also efficient as resources go where the demand is in a free market.
This also links to Adam Smith’s theory of the Invisible Hand. Adam Smith thought that economic entities acting in their own self interests is actually better for society than if they acted with the goal of improving society. This is because when economic entities such as firms want to maximise profits, they will take actions which will also raise economic output. When workers will want to get a pay rise, they make work harder, increasing productivity and therefore economic output, which would raise overall standard of living.
In a command economy, on the other hand, allocation of resources is often quite inefficient. This is because the government decides which goods are produced, how much of each good is produced and what price it is sold at. If, like in a free market, these were determined by demand, allocation of resources would likely be efficient by default. While it is true that these factors which are decided by the government are likely based on consumer demand data, it is often very difficult to get a true idea of it. Examples of this include the USSR, where shortages of various goods were commonplace. A lack of understanding on price setting would mean that in almost all cases goods would be sold at non-equilibrium prices leading to shortages or surpluses. This would be a wasteful allocation of resources.
However, it is true that in free market systems, many people are unable to afford basic needs such as food and healthcare. Therefore, it is often advantageous for countries to have things such as a national health service and food banks as a social security net for its citizens. The UK is an example of such a country. The NHS in the UK has been fairly successful in this regard, providing free healthcare to all citizens. An NHS-like healthcare system comes with its own problems, but it does help with the allocation of the healthcare resource by ensuring all citizens have access to it.
Although, such an assumption only holds true for basic needs - resources such as healthcare and food – everyone should have access to these. Access to other resources is, and should be, determined by whether you are able to afford it or not. Yes, this is inequality. However, this is not necessarily a bad thing. Firstly, inequalities in wealth are largely because there are significant disparities in how hard people are willing to work and how skilled they are at their jobs. In this sense, it would be wrong to say that allocation of resources is unfair in this case, because people are able to afford what they have worked for.
The fact that free markets are meritocracies is also very helpful in keeping labour markets competitive. Seeing people around us who are earning more than us may motivate us to work even harder or acquire new skills which are in demand by firms or society. Such initiatives, although driven by inequality, are effective in increasing worker productivity and therefore boosting economic output. While a greater economic output does not improve the allocation of scarce resources, it does increase the supply of resources to be divided, and thereby raises the overall standard of living of the country. Greater GDP also means a higher national income, which increases the access of resources for poorer people.
The same analogy could also be applied to firms. For example, inequality may also drive innovation. Competition between firms would be very healthy for the economy as it would facilitate technological advancement and drive growth. It would also mean that consumers have better quality products available to them
Corruption is also a big problem with command economies. Since almost everything is regulated by the government, there is great room for corruption by government officials. Things such as the ease of doing business in a country are greatly reduced, meaning foreign investment would also likely decrease. Corruption is a barrier that automatically limits future growth. It also makes distribution of resources more difficult. Things such as government officials taking commissions at various steps of the supply chain, are hugely disruptive to the distribution of resources in a command economy. On the other hand, a free market has problems with administration too. A country without things such as criminal laws and police to enforce it; without legal agreements for financial deals and courts to resolve disputes would also be extremely inefficient.
Theoretically, a pure command economy would be extremely successful and eradicate inequalities by allowing equal and complete access to resources for all. Unfortunately, such a system could never work. This is not just because of the fact that resources are scarce but also simply because humans are selfish. There would always be inefficiencies such as government officials being corrupt because of selfish interests. A farmer would not be motivated to grow crops for society but would be more than happy to invest in new GM crops technology if it means more profit for him. For these reasons, humans would be much more suited to a mixed economy that leans toward free enterprise rather than a command economy, and would then be able to take full advantage of the Invisible Hand. Altogether, I do believe that free markets are significantly better at the allocation of resources than command economies.