There is a continuing, although increasingly not very persuasive, myth perpetuated by contemporary neoliberals that market relations are the best way to decide allocation of resources in all circumstances. In some cases of course they are correct, and intuitively people see some sense in this. After who, who is the best person to decide what food they should eat, what clothes they should wear, or what music they should listen to? Nearly all people would decide that they are the best person to make such a choice. But it doesn't apply to all markets and all situations.
The Rarity of Perfect Competition
In order to answer this question on needs to understand where this intuition comes from, and why in some circumstances it does have a large degree of truth. It has the highest degree of veracity in those markets where there is such a large number of buyers and sellers with equal market power, where the there is high level of information and equal information among the buyers and sellers, where the products are very similar to each other, where there is very lower barriers to enter or leave the market, where transaction costs are extremely low, where there are few externalities, where the factors of production are highly mobile, where there is a clear transfer of property rights in transactions, and where buyers and sellers are rational economic actors with no internal or external compulsions.
Such markets are, in reality, actually quite rare. indeed, in the optimal form they are described as perfect competition, a highly idealised model from which mainstream economics is taught. Some produce marketplaces can come relatively close to this model. There is intense competition between the sellers, as price takers, to differentiate their product from everyone else's (monopolistic competition). Indvidual changes in price or demand create the effects expected, but with the general trends of the market prevailing. There is of course an assumption that the supply of goods pre-exists to the vendors, the buyers are interesting only their aesthetic choices, and the issues of political economy is quite removed.
Imperfect Competition, The Typical Experience
In reality, most real markets are examples of imperfect competition. Most labour markets are a particularly well known example, which has been previously discussed. Few buyers of labour and many sellers of labour means that the buyers have a market advantage. Wages and employment are lower than what they would be in a more competitive market with greater equality between the buyer and seller of labour. Wealth is distributed away from the employee to the employer. However this gain is less than the loss to the employee, resulting in an aggregate social loss overall.
Commodities are by no means immune to concentrated markets. Various firm ratios and indicies of market power are often used for illustrative and policy orientations. In the early 2000s, a five-firm ratio in the UK indicated the following levels of concentration, indicating an oligopoly: Sugar: 99%, Tobacco products: 99%, Gas distribution: 82%, Oils and fats: 88%, Confectionery: 81%, Man-made fibres: 79%, Coal extraction: 79%, Soft drinks and mineral waters: 75%, Pesticides: 75%, and Weapons and ammunition: 77%. Australians would be very familiar with the levels of extreme concentration in their media outlets (News Corporation, Time-Warner, Fairfax), retail groceries (Coles Group, Woolworths), banking (ANZ, Westpac, NAB, Commonwealth), and telecommunications (Telstra, Optus, Vodafone).
Perfect competition is an ideal that produces an optimal allocation of resources, but is perfectly rare; imperfect competition is the common situation with its distortions of power and wealth among market participants and losses in aggregate social wealth. The transition from imperfect to more perfect competition is rarely generated from within; disruptive technologies may assist in some cases, but in the main, capital does its utmost to accumulate and centralise. Advocates of capitalism always and sometimes even rightly argue for the virtues of competition. Actual practitioners of capitalism however desire to become monopolies, or at least a very close approximation thereof.
If trends towards perfect competition are not generated from within, then they must come from without. If labour markets existed as perfect competition, the trite argument from neoliberals would be right - minimum wages would create unemployment by establishing a price floor. But labour markets are not usually in anything approximating perfect market conditions. That is why single-seller labour (unionised collective bargaining) establishes an equality between employer and employee, and why minimum wages (as long as they are not higher than what the perfectly competitive wage would be) actually increase
The same principle is applied whenever there is a significant deviation from the expectations of perfect competition and the reality of imperfect competition. Consumer rights legislation, minimum standards of occupational health and safety, occupational licenses, and so forth are all examples of regulative practises which, in principle, actually push imperfect markets towards a more perfectly competitive environment, marketplaces that are both freer and fairer. It is not laissez-faire, as in "to leave alone", but rather "à faire de la liberté", to make freedom in both the positive and negative sense.
These interventions do not always succeed. Sometimes the policy decisions are badly informed. In other cases there is overreach which stifles innovation. Of greatest concern is the possibility of public policy making being captured by the very industry groups that are being regulated, resulting in a moral hazards, conflicts of interest, and rent-seeking. Neoliberals often take great delight at illustrating such instances when they occur. They are curiously silent however, on the far more prevalent problems that result from the lack of public oversight.
Externalities: Positive and Negative
The assumption in perfect competition of discrete transactions is another hypothetical taken to the point of folly by neoliberal arguments. The assumption that all transactions are entirely independent, carried out by entirely voluntaristic actors, with no effect upon others is not a reality, but rather a model. Rather than forcing reality to try to fit the model - and all the problems that result from such adventures - a more succesful approach is to apply policy that fits the reality.
Transactions are typically not discrete. There are 'neighbourhood effects', both in a positive and negative sense which are transferred as social costs and benefits. From within, it is in the interests of the economic actor to minimise the positive benefits that they provide as that is wealth that is lost to them, and likewise they desire to push as many costs as possible unto others.
Thus we see that industry that lacks a public spirit often objects to being subject to internalising negative externalities. They go to extraordinary lengths of denial of responsibility, as the current debate over climate change and the murderous obfuscations of the tobacco industry should serve as an obvious examples. On the other hand, there is also the provision of deliberately 'damaged goods' in the information industry; instead of information good being available at the cost of reproduction, additional cost is expended to restrict their availability through "digital rights management" and so forth.
Where there are externalties in a transaction, the appropriate public policy is to engage in activities which minimise or internalise the negative externalties (regulation, credits, taxes) so that the social costs are incorporated into the transaction, and to engage in the activities which encourage positive externalties (subsidies, public expenditure). Much maligned by neoliberals, the public expense on health, education, and welfare actually includes general economic benefit. A person who have learned road traffic regulations is not the only one who benefits from their education, and nor is a person who is in good health the sole beneficiary of their fitness.
Markets for Freedom
The general point is not to treat abstract entities such as free and perfect markets as somehow being more important that real visceral people - a principle which can also be applied to many other ideologies as well! Nearly all neoliberals end up engaging in arguments which, for practical purposes, are actually damaging to the health, welfare, and ultimately the freedom of people because they have started with the assumption of free and perfect markets and have tried to force people to fit that model even when it doesn't exist. Instead, a more sophisticated approach begins with acknowledging how real markets actually deviate from the perfect model, and what changes are needed to make the axioms of those perfect markets a real practise - that is, to apply the knowledge of the model to provide greater wealth, security, and freedom to actual people.
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