THE FREE-MARKET SYSTEM

3.2 THE FREE-MARKET SYSTEM

The defining elements of capitalism are that capital goods are privately owned, and that decision about how or whether to use these capital goods rest solely with private owners in a free market. There is no implement to competition, and the free market generally encourages it. Capitalism endorses the private pursuit of profit, and there are unique vehicles, such as the joint-stock, limited-liability corporation, through which to pursue the maximum profit with the minimum risk. Capitals, by definition, are the assets used in the process of further production of goods and services, rather than being exhausted through consumption. We generally think of land, raw materials, and machinery equipment as capital goods. This might be an overtly simplistic approach, and de Soto (2000) points out that there are plenty of capital goods in the in the hands of the poor across the world, but that their assets are held defective forms and therefore cannot count as capital:

3.2.1 Property rights

The key to converting movable or immovable assets into capital appears to be the quality and protection of the property rights assigned to the rightful owners of the assets. For the private individual to be capable of deciding how and when to deploy certain assets in the productive process, it is an absolute requisite to have clear and uncontested ownership of such an asset. In the West, where landholding requires title, raising a mortgage on the privately-held family home is one of the most frequent ways by which entrepreneurs fund their start-ups, and is recognised by law because of the intrinsic trust in our system of land title and register.

3.2.2 The marvel of the pricing system

A centrally-planned economy, such as with Communism, tries to set pricing and production schedules for the whole market, and loses the benefit of thousands of little adjustments that private entrepreneurs can make when closer to the market. Nobel Prizes economist Kenneth Arrow referred to these productive adjustments as the ‘marvel of the pricing system’ (1974). By rapidly and repeatedly adjusting either the price or the quantities produced, the entrepreneur forever moves closer to the optimum production capacity. When this phenomenon plays itself out many times every day, and over many years, the rate of the expansion of an economy, and the overall prosperity in a society would accelerate beyond that which a centrally planned, and arguably a very slow and bureaucratic process of price and production planning could achieve. Regulation

There is no completely free market anywhere in the world. Each country has some form of regulation in place to ensure that the rights of other individuals are

affected by the nominal right of each individual to enter the market in any way he or she pleases. Regulation is often enforced to guard against so-called

‘externalities,’ i.e., when a company managers to shift a cost associated with its production onto other parties, and most likely the unsuspecting public. The best

example is pollution, where companies may be spewing dangerous emissions into the air, without having to account for the negative side effect to the general public ’s health. Through emissions taxes or the sale of emissions credits, a make a contribution towards the cost of health care that the public health system will incur in treating victims of the pollution.

Another form of regulation occurs at industry level, where certain industries undertake to become self-regulated. For instance, the auditing profession sets its own standards by which new members of the profession are allowed to enter practice, and guides its members by holding their conduct to a particular code. In this manner, the public who wishes to use the services of such members are ensured of a certain quality of service and integrity in conduct. Markets also have a way of regulating themselves. If an entrepreneur had to decide to open a type of business inconsistent with the community ’s norms and values, private protest by members of the community or simple lack of support for the business may eventually force the entrepreneur to shut it down. An area such as Camps Bay in Cape Town does not allow any liquor stores within its boundaries, and several communities have previously banded together to shut down strip clubs or adult shops close to their children

’s schools.

Despite the opposite claims by laissez-faire libertarians, people who are ardent proponents of the free market with the absolute minimum government interference, this interference by government in the commercial sphere is not inconsistent with the views of the father of the free market, Adam Smith, who dedicated several sections of The Wealth of Nations (1776) to the role f government ensuring justice in the more. At minimum, our understanding of the concept of free market entails that each individual may choose which business to open, where to open it, and with whom he or she wants to trade. One needs to remain mindful though that these choices may affect the rights of other parties, and it is in this grey area regulators often need to step in to ensure a just solution for all affected parties. The dramatic meltdown of the global financial system towards the latter part of 2008, with governments having to pour billions of dollars in to try and keep the system afloat, is one of the clearest signals in many years about how the lack of proper checks and balances, and oversight of the market, may lead to problems.

3.2.3 Competition

Capitalism promotes healthy competition. The assumption is that when several producers compete directly against one another, they become more efficient and productive at what they do, put downward pricing pressure on each other to the benefit of the consumer, and have to improve the quality of their product or service to remain competitive. All three of these elements eventually work, not only to the advantage of the consumer, but when multiple across several industries and geographical markets, they increase the economic gain to society at large.

The opposite of free competition is to allow monopolies to dominate a particular market segment. Monopolists can extract higher prices from the market, and may even reduce their production output in order to optimise their profit. This happens at the expense of the consumer and of society at large. In South Africa, we have been particularly tolerant of monopolies in certain sectors, in part, because the survival of these firms has been perceived to be of strategic interest to our country. However, very few consumers today would support the continuation of economic dinosaurs such as Telkom without healthy competition.

3.2.4 Profit and personal motivation

Under a centrally-planned economy and in the absence of the profit motive, there is little inspiration for the individual to get out of bed early, and to work harder, longer and more efficiently than the next person, as the individual might not share in the gains of the extra effort. The combination of the profit motive and the free-market system. When the entrepreneur knows that he or she will personally reap the benefits of the harder work, there is a true incentive to perform better. Even if the entrepreneur has no interest in the social wellbeing of society, it is through his or her reaching for their own dream that the overall welfare of the economy and of society improves. Adam Smith (1776) put it succinctly when defending the free-market system in his famous book, The Wealth of Nations: It is worth remembering that personal motivation could consist of more than just the wish for more profit. The privately-held business enterprise is a vehicle through which individuals in the free market can create meaningful change in their own lives and in society, and still make a profit for themselves. Smith himself saw justice, rather than self-interest as the more important objective. Donaldson et al. (2002) explain how to Adam Smith, a father of Capitalism, there could only be large-scale social gains from the private pursuit of wealth when economic actors acted with restraint, prudence, fair play, and respected the basic principles of justice and the rights of others.

3.2.5 The joint-stock, Limited Liability Corporation

STUDY : Rousseau & Van Vuuren

A revolutionary ide a’- that is how historians Micklethwait and Wooldridge (2002) described the modern corporation, an essential element of our economy and perhaps the major contributor of economic growth in the West for the past 160 years. The modern corporation as separate legal entity owes its origin to an Act of English Parliament in 1862. Courts have subsequently upheld the idea that corporations are separate legal personae, and may have an infinite life beyond the inconvenient morality of their shareholders. There is a strong school of thought that the corporation even has its own moral agency, independent of its officers, and that the corporation should be held liable for its own ethical failures. In the extreme, consumer advocates in the US, under the leadership of Ralph Nader, have argued for the death the penalty in the case of recidivist corporations. That is, the termination of the licence to operate that society grants the corporation, in the event of the corporations repeatedly flouting to laws of society. There are two real reasons why the concept of the corporation has contributed so immensely to economic expansion in the West, Firstly, because it

is a ‘joint-stock’ entity, it allowed for the pooling of investment by multiple parties in one venture, thereby creating the ability to achieve scale and reach that would have remained beyond the capabilities of most individuals. Today, we take the concept of owning shares in a company, along with thousands of other unknown individuals, for granted, and we can trade in and out of a corporation within seconds through the click of a mouse.

The second reason for the success of the corporation and its contribution to society is its ability to limit the liability of each individual investor to the sum total of his or her investment. The only part of your fortune at risk is that which you used to purchase your shares in the company. Prior to 1862, mavericks and adventurers could wipe out their whole estate on one misguided or failed venture. Through limiting risk and allowing the pooling of resources, along with the perpetual lifespan of this legal construct, the corporation has become the dominant institution in our societies. Robert Phillips (2003) describes how the church or the King ’s palace dominated urban landscapes in earlier times, and now you see corporate headquarters first before you head into a new v city. Of course, the revolution brought by the limited liability, joint-stock corporation would not have been possible without the essential underpinnings of the capitalist ideology, namely property ownership and pursuit of profit.

3.2.6 Justification of the free market

In this chapter so far, there has been constant reference to the success of capitalism in expanding economic growth, improving social gains, and generally leaving nations better off than what was the case under communism. These are the productive successes of capitalism. However we are struck by the inequality that is the direct result of this system. Some nations are far richer than others and the gap between rich and poor nations is forever increasing. Likewise, in almost all rich and poor nations, the gap between the rich citizens and poor citizens too has been getting progressively successes have been distributed across populations is highly problematic. There is no agreement on what is just and fair under capitalism, or even whether capitalism is morally sound. There are several theoretical approaches to argue for economic justice under capitalism, which might be useful in guiding each of us individually towards some resolution of these tougher questions. Philosopher, John Rawls (1999), explains why we need to seek justice in our economic affairs: To seek out the set of principles on which society can agrees as just, however, is

a more difficult task, and as Rawls continues, ‘what is just and unjust is usually in dispute ’. What he claims most people could agree on as a requirement of justice, at minimum, is that a system is just when it does not draw any arbitrary distinction between individuals, and when competing claims for justice can be heard in an unbiased manner, for example, in the courts. Before we consider two different sets of claims upon what the content of economic justice should

be, we clarify what is understood under

‘equity’ and ‘equality.’

3.2.7 Equity and Equality

There are some economic principles for which there is broad support. Most of us would agree that every person should have an equal opportunity to compete fairly in the marketplace. That we would refer to as a ‘level playing field’. Some would go further and insist that everybody starts with the same opportunity and resources, yet would be entitled to more gains and a better life if they used their opportunities and resources better than the next person. This state we could refer to as ‘the same starting line’. Few of us would still agree, as was the case under communism, that all of us should end up with exactly the same amount of wealth and opportunity, which could be called ‘full equality’, as this state leaves the case of moral free-riding, i.e., riding on the back of other people ’s effort, unanswered.

The classic example of moral free-riding is motor insurance. Here, multiple motorists pay monthly premiums in order to pool resources so that in the event of one of them being involved in an accident, this pool of funds can pay for any The classic example of moral free-riding is motor insurance. Here, multiple motorists pay monthly premiums in order to pool resources so that in the event of one of them being involved in an accident, this pool of funds can pay for any

Equity vs Equality

One of the differences is the fact that equality obviously denotes that everyone is at the same level, whereas equity, in business parlance, denotes the ownership of the shares of a company. Equality alludes to the identical apportionment where dealings, values or qualities are concerned. Equity represents fairness, or what may be termed as the equality of outcomes. This involves factoring in aspects of the system that have put particular groups at a disadvantage.

An example, which would bring out the principal difference between the two, would be how a turkey may be carved up at at family’s dinner table. Equality

would mean that everybody ‘“ father, mother and children – would get a piece of the same size. Equity, on the other hand, would mean that they take the sensible

option, and divide it according to their needs, i.e. larger sized pieces for the adult and smaller pieces for the children.

When we say equity, we refer to the qualities of justness, fairness, impartiality and even handedness. When we talk about equality, we are talking about equal sharing and exact division.

A perfect example of the practical demonstration of the difference between the two concepts, is the feminist movement. Now, if women demand they should be treated in the same way as men, that would not be possible – equality would not be possible – because women and men are different, and cannot be treated in exactly the same way. However, if they demanded equity in how the world treats them, it would be a genuine demand, because now they are demanding that they be given the same rights as men have as human beings. It is equity that is desirable, not sameness.

Once again, in business parlance, equity denotes the value of something. Suppose

I bought a laptop for $500 a year ago, and tried selling it today. It would probably fetch around $250. That is its equity value. Equality, of course, only means exact distribution. Really the difference between the two alludes to the old debate about the preference of quality over quantity.

If one were to take a classical example to distinguish between the two concepts, one could go back to the days of the cold war when the communist block countries tried to practice equality by paying everyone the same, irrespective of their station If one were to take a classical example to distinguish between the two concepts, one could go back to the days of the cold war when the communist block countries tried to practice equality by paying everyone the same, irrespective of their station

Therefore, although seeming to be similar, equity and equality are indeed very different kettles of fish.

Summary:

1. Equality denotes that everyone is at the same level, whereas equity in business parlance denotes the ownership of the shares of a company.

2. Equity refers to the qualities of justness, fairness, impartiality and even handedness, while equality is about equal sharing and exact division.

3. Equality equals quantity, whereas equity equals quality.

Read more: Difference Between Equity and Equality | Difference Between | Equity vs Equality http://www.differencebetween.net/language/difference- between-equity-and-equality/#ixzz3zZSEqnIG

The difference between equity and equality is explained by Phillips (2003): Equality implies similar outcomes; that is, that regardless of the level of the playing field, or of the nature of the starting line-up and each economic agent ’s efforts, each individual gets exactly the same in the end. Equity, on the other hand, finds some acceptable metric or ratio on which the population can agree, whereby the distribution of goods may be determined. For example, if society decides that an acceptable wage rate is R25 per hour, it would be seen as equitable if Paul works 10 hours and therefore earns R250, while Susan works 100 hours and therefore earns ten times more than Paul did. Capitalism strives for equitable solution, having left the full equality aspirations of communism behind in its wake. The problem of wealth distribution, however, still remains unresolved, regardless of the attempt towards equity, because the metrics and ratios by which economic gains may be distributed do not enjoy broad consensus. Wage rates are hardly ever uncontested, for example. Furthermore, the case becomes even more convoluted, because despite our theoretical approval of the notions of ‘level playing fields’ and ‘the same starting line’, some people are simply better endowed than others. This is what John Rawls

(1999) called the ‘natural lottery’. Should society try and make amends for the fact that some people have better talents than others when they enter the economic race? And should parents not be allowed to do their very best to give their children a head-start in life? Why should the next generation be forced to start on the same line-up if their parents were prudent in making provision for them, or worked as slaves, like many first generation immigrants tend to do, in order for their children to better opportunities?