Free trade and free markets, two sides of the same coin, were the lynchpins of the global consensus on economic policy forged in the wake of the Cold War. The 'Index of Economic Freedom' brought out for the last 20 years by the Wall Street Journal and the Washington DC-based think-tank Heritage Foundation, illustrates statistically that economic "un-freedom" is the cause of human misery, and the close fit between societies that have for years been economically free and had a high median per capita national income. The fastest growing economies in the world today started growing rapidly only after opening up trade and markets for factors and products. The removal of entry barriers to economic activity showed that Adam Smith's invisible hand works after all.
Reams have been written on the subject. There is nevertheless room for reiterating the case for free markets succinctly, because an irrational fear of markets still pervades civil society. This fear holds back this great country from realising its true potential. At the turn of the century The Economist described India as the world's greatest under-achiever. With globalisation and information technology - in which India has a competitive edge - expanding the range and efficiency of markets, the description is even more apt now.
Although the philosophical case for trade and markets is usually traced back to the fathers of modern economics, Adam Smith and David Ricardo, these are of course much older than both. Their origins are lost in antiquity. The 13th-century Arab scholar Ibn Khaldun cautioned kings against crowding out private enterprise through excessive state intervention, as this would bring dynastic ruin through fiscal collapse. Europe's Dark Ages and the rise and subsequent decline of feudalism are linked to the decline and revival of long-distance trade.
This trade, till it was supplanted by trans-Atlantic trade in the nineteenth century, was centered in our own backyard in the Indian Ocean, and over land through the Silk Roads. India's putative opulence derived from this trade. It catered primarily to ruling elites till fairly recently in historical terms, as transportation technology constrained its scope, reach and volume.
The state has both facilitated markets by providing public goods without which they cannot function efficiently, and has also been one of their arch enemies.
The state's role in regulating markets to address market failures is frequently underscored to prevent non-state actors from subverting free markets through monopolies that limit competition and erect barriers for new entrants. Adam Smith noted that participants tend to abuse the market, paving the way for state intervention. States also impede markets through war, taxes and sundry market interventions. The reductio ad absurdum was the socialist state which did away with markets altogether! But even free societies have tried to eliminate certain markets, especially for hallucinogens like alcohol, tobacco and other drugs, pornography, prostitution, etc, by criminalising them. There are thus market failures and state failures.
The compelling force of trade and markets can be compared to that of the ocean, whose boundless energy can be harnessed but never fully constrained. Wherever there is demand, human ingenuity will exploit the opportunity through supply response. Steering the ship of state against such elemental forces merely generates 'grey', 'black' or 'illicit' markets that ultimately weaken the state because it loses its taxation power over the considerable income generated through these markets. Revenues fall into the hands of a powerful mafia that undermines the authority of the state. Thus high tariffs and prohibition generate widespread smuggling, capital controls lead to financial repression, visa and immigration controls spawn vast networks of illegal immigration, and an increasingly stringent IPR regime promotes technology piracy.
Attempts by the state to stifle these markets are ultimately self-defeating. The state has in the end acknowledged them and tapped their resource base to maximise the welfare of its subjects. At one stage the state even sought to suppress exotic articles like tea, cocoa, coffee and chocolate. They were considered dangerous or subversive hallucinogens before becoming popular items of mass consumption. The list of banned items has shrunk sharply over the years, tariffs and capital controls have diminished, prohibition has mostly been given up as a lost cause, as the world moves towards greater integration.
While all restraints on trade and markets reduce efficiency by increasing costs and widening the demand-supply gap, and on the whole reduce human welfare, four kinds of restraints may nevertheless enhance it. The first is protection of infant industry by nation-states in the early stages of industrialisation; the second safeguards the commons; the third regulates natural monopolies to simulate competitive markets; and the fourth taxes economic activity to provide public goods, including infrastructure, good governance and redistribution, to underwrite a basic standard of living.
Such restraints however need to be judicious and market-friendly. Domestic lobbies will seek to extend trade protectionism indefinitely to the detriment of consumer welfare.
There will always be a 'market' for criminal activities, and the state needs to come down heavily on them through the provision of good governance, which lies in the core domain of the state rather than markets. However, the state may set the bar too low by criminalising activities such as alcohol, drugs, and 'obscenity', on the basis of majoritarian civil society views that impinge on individual liberty and minority rights.
The state often tries to ensure equality of outcomes through redistribution. This is not possible under free markets and, as demonstrated by the experience of socialist states and the 'Index of Economic Freedom', only results in greater misery in the absence of markets. But free markets abhor indigent poverty as it depresses demand and stifles their growth. Public goods, including redistribution, can be provided most effectively when markets grow. Redistribution should therefore lean towards equalising opportunity that builds social capital to equip individuals to optimise their own genius within the market framework.