The Price of Market Freedom

I’ve found that many people conflate supply and demand, or price-based resource allocation, with the pseudo-ideal of a libertarian “free market”.

Supply and demand is an explanation for how the world works, not a value statement. If the number of people who want X and don’t have it exceeds the number of people who have X and don’t want it, then there is scarcity. Somehow, X will be allocated, and not everyone will get it.

Broadly speaking, there are three ways that you can allocate scarce resources. You can use pricing (whoever pays the most wins), queueing (whoever waits the longest, or exerts the most effort, wins), or lotteries (totally random). Each of these schemes can be modified by giving “bonus points” to certain people, which could make the system more or less fair, depending on how points are awarded. For example, you could give cash to people who don’t have much (welfare), or you could give cash to people who have a lot (the stock market). You can let disabled people cut in line (reserved parking spaces), or you can let rich people cut in line (business class security bypass at the airport). You can give extra lottery tickets to disadvantaged people (can’t think of an example), or you can give extra lottery tickets to advantaged people (think Charlie and the Chocolate Factory).

There are two advantages that pricing has over the other two forms of allocation. Queueing involves truly wasted time/money/effort that could otherwise be put to more productive (or enjoyable) use. Lotteries do a poor job of allocating resources efficiently; the person who wins may not be the person who wants the item the most, or who will make the best use of it. Pricing — assuming that every person has equal resources [1] — avoids any wasted effort, and ensures that the scarce resources are allocated to the people who will make the best use of them.

However, if you commit to pricing-based allocation, and you don’t restrict prices, then any government regulations that influence supply or demand will also influence the market-clearing price. There is simply no way around this. Artificial supply restrictions will raise prices; artificial supply increases will lower prices. Artificial demand restrictions (like taxes) will lower prices; artificial demand subsidies (like tax deductions) will raise prices.

You can try to work around this problem by restricting prices, too, like with rent control. But if you’re artificially restricting supply, and you’re artificially restricting price, then you’re going to end up with shortages — which means that you aren’t really using price-based allocation at all, and you have all the disadvantages of queueing or lotteries. (Seattle Housing Authority and Capitol Hill Housing have multi-year wait lists for most properties, which isn’t exactly an ideal situation for homeless people.)

Alternatively, you can work with the system. For example, if the government builds huge piles of market-rate housing, then it will lower the market price for housing. (If you don’t believe that this would work, here’s another example: if the government builds huge piles of parking, then it will lower the market price for parking. This has actually happened in Seattle, and in almost every other American city.)

So we have two different model. In one of them (we’ll call it the San Francisco model), most housing is built and/or operated by private parties, but the government restricts pricing and building, leading to chronic shortages, and to overpricing of the subset of housing that is not price-contrlled. In another (we’ll call it the Singapore model), most housing is built and/or operated by the government, which purposely tries to build enough housing for everyone who needs it.

Does the Singapore example sound more like “the free market” to you? To me, they both sound like markets that are heavily affected by a single actor (the government). The difference is that Singapore’s intervention works with supply and demand, while San Francisco’s model works against it. It hopefully won’t come as a surprise that Singapore does a much better job at providing affordable housing.

[1] When inequality is very high (like in the US), the efficiency of pricing breaks down somewhat, since rich people who weakly want something can outbid poor people who desperately need it. This is only one of many problems with inequality. The solution is not to abandon pricing, but to abandon inequality, by enacting a set of policies designed to bolster the income and wealth of disadvantaged people, and to limit the income and wealth of those at the very top. This is yet another example of how a libertarian “free market” actually disregards the laws of economics.

This article is a cross-post that was originally published on Medium.