Why Free Markets Are Not Enough

It is a striking and frequently noted fact that modem democracy has existed only in countries with economic systems in which production and distribution are mainly carried on by privately owned enterprises that are strongly oriented toward markets—that is, in countries with capitalist economic systems. Though not all capitalist countries are or have been democratic, all democratic countries have had capitalist economies.

This connection does not seem to me to be a historical accident. Elsewhere I have recently attempted to spell out the argument that modem democracy requires a market economy.¹ I believe that we have compelling reasons for concluding that a centrally directed command economy would provide political leaders with access to such powerful resources for persuasion, manipulation, and coercion as to make democracy extremely unlikely in the long term, no matter whether firms were collectively or privately owned. The only feasible alternative is some kind of market economy.

Might democracy he compatible, then, with a market economy based not on private but preponderantly on public, state, or social ownership? Schumpeter's solution, in which "the control over means of production and over production itself is vested with a central authority," seems to run risks very much like those of a command economy—as he himself was well aware.² The Yugoslav experience does not decisively settle the question of whether democracy might be compatible with a "socialist" market economy based on some form of decentralized "collective" or "social" ownership and control. After all, despite the extraordinary pluralism and decentralization of Yugoslavia, Tito and his successors were not liberal democrats; they insisted on maintaining the hegemony of the Party and the suppression of opposition political parties.

Let me assume, however, that democratic countries will have market economies in which economic enterprises are mainly privately owned. One theoretical possibility is that in democratic countries, markets will be, by and large, strictly competitive. Historically, however, no democratic country has steadily chosen this path. Here, I want to discuss several reasons why all democratic countries have rejected strictly competitive market economies in favor of mixed economies in which markets are significantly modified by state intervention.

In his excellent essay, Adam Przeworski shows why competitive markets are not necessarily efficient and may not necessarily lead to economic growth. As he also suggests, an additional defect of a strictly competitive market economy is its severe moral weaknesses. For even if competitive markets were to produce efficient outcomes, these efficient outcomes (in the sense of Pareto optimality) would not necessarily be justifiable; and some justifiable outcomes may be inefficient.

There are many reasons why an efficient outcome might reasonably be judged to be unjustifiable, but let us content ourselves with two very broad ones: justice (or fairness), and democracy. As to justice, one crucial example may suffice. We would be justified in accepting an efficient outcome as just or fair only on the heroic assumption, which is often stated and thereafter ignored, that the initial distribution of income and bargaining power was also just. An allocation of resources that is maximally efficient (Pareto optimal) is perfectly consistent with an indefinite number of different income distributions, ranging from perfect equality to the most extreme inequality. Thus the statement that unregulated competitive markets are a necessary means to "efficiency" and "socially optimal" outcomes, and therefore desirable, is morally trivial unless it is further grounded in an argument about the justice and feasibility of alternative distributions of income and other crucial resources.³

As Przeworski points out, no small part of the effort to regulate markets has been stimulated by the attempt to alter the distribution of income. This is not to say that the results of these efforts have produced a fairer distribution of income (though if fairness requires less unequal incomes, then some countries have brought about a more just distribution of income), Nor is it to say that the methods chosen have necessarily been the most efficient ones available; on the contrary, they may often be highly inefficient, ineffective, and even perverse.⁴ It is only to say that if one believes that the existing distribution of income is unjustified...