Recently, a group called “Students for Liberty”, which described itself as “the largest pro-liberty student organisation in the world”, invited me to speak at a webinar themed: “Why innovation comes from a free market economy.” They said they invited me because they knew I “believe in the Free Market concept”, which I do!
I was impressed that there are students – young people – who are committed to the idea of economic liberalism and open markets. Usually, students, especially university students, are attracted to left-wing radicalism, and tend to espouse socialist or Marxist views. So, it was good to know that there are students who believe in the idea of economic liberty. Well, I want to discuss the idea in this week’s column, especially to stress the point that Nigeria needs to be a robust free market economy to spur innovation, productivity and growth.
The starting point, of course, is the definition. What is a free market economy? Well, it is an economy underpinned by open and competitive markets. In a free-market economy, markets allocate resources, government facilitate the process. Adam Smith describes free market as a system of natural liberty in which government provides sensible regulation, but leaves economic agents – individuals, businesses etc – to pursue their own interests.
critics would argue that open markets create losers, such as the factories that close down and the workers that lose their jobs. It is futile, even disingenuous, to deny that these consequences exist. But the truth is that the winners from open markets or free trade are more than the losers
But why would government leave economy activities to the markets? Well, because the skills of politicians and officials do not include running businesses successfully or allocating resources efficiently. Free markets, under which people compete freely through voluntary exchange in a process shaped by the forces of demand and supply and the price mechanism, are better allocators of resources than government officials.
From a theoretical or philosophical perspective, the case for open markets was first made by the classical liberals in the 18th century, and the theory was put into practice with remarkable success in the 19th century, known as the “golden era” of economic liberalism when trade, investment and finance flowed freely. The international economic integration of the 19th century, which reached its high water-market around 1900 before World War 1 interrupted it, was a precursor of today’s globalisation.
There are three main arguments for open markets. These are the static efficiency case, the dynamic efficiency case and the moral, political and institutional arguments. By static efficiency gains, we mean that when markets, rather than government, allocate resources, they do so more efficiently, thus promoting growth and prosperity.
For instance, if government protects and pours money into an industry that would not otherwise survive on its own without the protection and subsidy, it means that the government is wasting resources. If the matter were left to the market to determine, that industry would not have existed in the first place; or if it existed, it would not survive. Take another example, import bans protect inefficient domestic industries, while imports could replace inefficient and costlier domestic production, thereby releasing domestic resources for more productive sectors, such as exports.
So, the static efficiency argument for open markets says that the market mechanism allows for more efficient allocation and productive uses of resources, and that the efficiency benefits contribute to economic growth and prosperity in the form of rising household incomes. Therefore, President Buhari’s penchant for import bans, border closures and protection and subsidisation of struggling domestic industries amounts to inefficient allocation of resources, and, of course, undermines economic growth and prosperity, as such policies reduce household incomes.
But static efficiency apart, there is also the dynamic efficiency argument. As David Hume said: open markets are “a conveyor belt for the transmission of ideas and technology across borders.” This allows economic actors to spot and imitate better practices abroad and improve their own performance. The diffusion of ideas and technology enables a Nigerian company to spot and learn from the best practices globally. That, of course, would not be possible without the free flows of trade, investment, information and technology.
Adam Smith adds another advantage. Open markets widen the geographic extent of the market and enables firms to tap into world markets to reap economies of scale. Several studies have shown that exporting companies are more productive than those that produce only for the domestic market. But it’s only through open markets, through gaining access to overseas markets, that a domestic firm can expand its reach globally. So, when Nigeria pursues import-substitution at the expense of export-orientation, it is failing to enable Nigerian firms to become more productive and profitable by tapping into world markets.
What about the moral case for open markets? Well, according to John Stuart Mill, “the economic advantages of commerce are surpassed in importance by those of its effects which are intellectual and moral.” This moral argument relates to economic liberty or freedom of exchange. Why should anyone be forced to buy a domestic product when an imported one is cheaper and of a better quality? Protectionism denies citizens their natural liberty to buy best-quality product and at the cheapest price possible worldwide.
Then, there are the political and institutional arguments. Open markets engender strong domestic institutions. Countries that are open economically tend to be less corrupt, tend to respect the rule of law and tend to have strong domestic market and social institutions. By contrast, protectionist or dirigiste economies inherently promote arbitrary and opaque decision-making, with officials exercising wide discretionary powers. For instance, Nigeria’s trade policy is widely believed to be opaque and shrouded in executive discretion.
But as Professor Ernst-Ulrich Petersmann said open markets have domestic constitutional functions. He argued that they limit arbitrariness and promotes transparent policymaking, including regard for rule of law, due process and individual rights.
Of course, against the above, critics would argue that open markets create losers, such as the factories that close down and the workers that lose their jobs. It is futile, even disingenuous, to deny that these consequences exist. But the truth is that the winners from open markets or free trade are more than the losers, and the solution is not to erode the huge benefits of globalisation through protectionism but to provide adjustment support for the losers through targeted social interventions and training that enable workers to find new jobs.
But we must never ignore the strong links between economic openness, innovation, productivity and prosperity. Put simply, without innovation there will be no productivity growth, and without productivity growth there will be no wage growth and better living standards, and, thus, no prosperity. But it is economic openness that drives innovation, and, therefore, productivity, growth and prosperity.
In his recent book titled “Dynamism”, Edmund Phelps, the economics Nobel laureate, identified two types of innovation. The first is “indigenous” innovation, which comes from within a nation; the second is “imported” innovation, which comes from exposure to the outside world. Both can only happen in an environment of economic openness, that is, in a free market economy. For instance, indigenous innovation will not happen when firms face huge supply-side constraints or when government over regulates, overtaxes and intervenes arbitrarily in economic activities. Truth is, government policies can stifle indigenous innovation!
But it is imported innovation that brings the greatest benefits. This happens in three ways. First, open markets drive innovation through the transfer of ideas, know-how and technologies across borders. Second, open markets facilitate imitation or emulation. When domestic firms are exposed to the world economy through imports, exports and FDI, they can learn from others. And third, imported innovation comes through international competition. Put simply, open markets put domestic economies and firms on their competitive toes and force them to innovate and become efficient
So, open markets drive innovation, productivity and prosperity. Intellectually, Nigeria must embrace the idea, and practically, it must align its policies with it to become a genuine free-market economy. Therein lies its economic future!
