A Market Economy – What, How and Why

The recent hubbub about granting ‘market economy status’ for China has promulgated quite a debate. The concept of distinction between a market economy and a non-market economy was first embedded during the time when transition economies were considering their role on the global trade platform. It all started with the introduction of anti-dumping investigations and laws thereof; the distinction between a non-market and market economy status lies in the process of determination of prices. When the prices are determined by demand and supply in the market and not (thoroughly) by government intervention, the economy is a market economy. Normal value of goods is arrived by government intervention, in a non-market economy. There is a chance that prices may be distorted due to this intervention. However, this is just for the sake of definition. The really difficult part is to know that for an economy to transition to (into) a market economy from a non-market economy, there are several changes or transitions to be experienced and witnessed. Transition towards a MES requires a lesser political hand and a more social and economic hand. However, without a strong political development, neither social nor economic reform is possible in the long-run. Therefore, more than economic challenges, political challenges come to play during such transition. And then there are issues that accompany transition. Some notable consequences of transitioning to a market economy are new levels of inequality, regional imbalances, unemployment/employment, environmental issues like increased levels of pollution, rapid energy consumption, neo-political empowerment, and others alike.

The fear of ‘market failure’ is always imminent when there is a nouveaux transition. To counter market failure and the potential outcomes as stated above, both government intervention and market strategies may be followed. One of the main objectives of a transition is (ideally), not just making the economy independent, but also making it sustainable in the long-run. A combined, innovative approach that addresses several of these issues comprehensively, may be a plan.

The goal of a market economy is inclusiveness and equality, and therefore, self-sustenance. A better way to put it would perhaps be, a market economy is ‘where one gains without the other losing’. Nevertheless, one of the looming demerits of such an economy is that there is a chance that there are imbalances of wealth, opportunities and performance.

Spend less? Spend more? Save more?

How much did an average American retail consumer spend in 2015? Less than 2014? Or more? Spending is a habit. But saving is a good habit. However, the consumers in America are being asked to relinquish their desire to save more.

The reasons cited are many: dipping exports, lesser investments by the oil and gas firms – in line with decreasing oil prices, and reduced consumer spending. Consumer spending worsened with little or no growth at the end of 2015, and now in the beginning of 2016.

An economy’s GDP depends essentially on the purchasing power or in other words ‘spending power’ of its dwellers. The more the consumers are willing to spend, the more the production will be, of retail as well as industrial goods and services. It is all about matching supply and demand. American consumers seem adamant on spending much these days.

The best reasons that one can come up with are behavioural. When a consumer has surplus cash, he splurges on necessities and luxuries, almost equally on luxuries. And when the same consumer is strapped for cash, he uses what he already possesses and purchases only necessities. There is a significant point here – his purchasing power has decreased, because of reasons like loss of employment, rising prices, etc. But in the existing case of the US, purchasing power seems intact, and the habit of saving seems to have taken over. A person whose job is intact and whose earnings are just the same, will save only if he has learnt some lessons from splurging in the past, or if he is saving for something really big in the future (education and real estate/property come into mind). This behavioural reason seems most appropriate at this juncture.

 

The path to a self-fulfilling economy and the existing scenario

A self-fulfilling economy is a fairly basic concept in economics. Demand generates production- which generates employment and therefore wages – and wages generate consumption – which again generates demand. Lets keep this aside for a minute.

Secular Stagnation has been the phenomenon since 2008, and the only solution seems to be in the root of this cycle – Demand. Increasing the level of aggregate demand and therefore providing an inducement to the system, may be a solution for the short-term and medium-term. Then, what about the actual part where the economy must become self-fulfilling at some point?

The starting point to the explanation is probably in a paper by Krugman (1979, 1996)[i]. The paper talks of models (and changes in models) describing the then existing currency crisis – essentially from two perspectives; the need to monetize and maintain a fixed exchange (to run away from the then existing crisis, to be exact), and the need to contemplate the crisis from solutions to it and thereby maintenance of objectives (for the long run).

When just one fundamental factor like interest rate is considered, rising interest rates were predicted to create major credit crunch starting in economies like China, Brazil, Chile and others, seemed inevitable, back in September 2015. There is bound to be some spillover effect, particularly in the emerging markets like India, China (yet again) and some more countries that are particularly labour-intensive. More on this kind of effect is detailed in this study.

[i] Krugman’s paper: http://www.nber.org/chapters/c11032.pdf