Ronald Reagan first introduced the “magic of the marketplace” into political language in 1981, in an address to the International Monetary Fund and the World Bank. The “most spectacular” societies, he claimed, “are neither the most tightly controlled, nor the biggest in size, nor the wealthiest in natural resources. No, what unites them all is their willingness to believe in the magic of the marketplace.”

Almost four decades later, this magical thinking is global, fueling the spread of neoliberal ideas and strongly influencing policies around the world. But where does it come from, and what if it’s wrong?

No economist is going to say that any part of the economy is “magic”, but the Austrian economist and philosopher Friedrich Hayek got pretty close. What he thought matters for us today, because he was central to the development of neoliberalism.

Hayek thought of the market as a “spontaneous order” that works through the information carried by undistorted prices – the prices set by private sellers and buyers in one-on-one transactions. It is so large and complex that we cannot try to predict or manage it. Instead, we should trust it to provide everyone with their best opportunity for gain, even though some must inevitably lose.

Hayek’s market is not good or bad, it just is. But Hayek believed that interfering with it would certainly be bad because that would limit everyone’s chances.

It’s an idea that has captured politicians since before Reagan’s 1981 speech. It was a central element of Barry Goldwater’s 1964 presidential bid. Margaret Thatcher famously slammed a copy of Hayek’s The Constitution of Liberty onto the table at a Conservative Party policy meeting and declared “This is what we believe!” Today, when politicians and commentators talk about “unleashing the power of the market,” they are invoking Hayek.

But there are other ways to think about markets – and one, in particular, that may be more helpful to policy-making.

A crowd protesting outside a public building. Getty/PeopleImages

A businessman’s view of the market

In my research, I have explored the possibility that the economy is more in line with the views of Gardiner Means, an American businessman turned academic economist who was a contemporary of Hayek.

Like Hayek, Means advocated against direct interference in the market, or the “directive planning” that he thought had no role outside of individual organizations. But Means did not subscribe to Hayek’s vision of the market; he is reported to have given up after 50 pages on Hayek’s The Road to Serfdom.

Looking at page 49, it is not hard to see why: Hayek writes that the “conscious control” of the market is impossible. Instead, coordination can only be achieved by a competitive price system, a result “which no other system even promises to accomplish.”

Means, however, knew perfectly well that in most sectors prices were consciously controlled – not by the government, but by the companies themselves, which have considerable flexibility in setting prices.  Companies also compete on features other than price, like reliability or service, which buyers associate with their brand. And they tend to adjust output more readily than prices when demand changes.

In other words, another system not only promised to accomplish the coordination of economic activity, but was doing it in real life, every day.

Whose version of the economy sounds more lifelike to you, Hayek’s or Means’? I would say that Means wins the reality contest hands down.

But to quote an old economist joke, “Sure, it works in practice, but does it work in theory?”

No slippery slope to serfdom

The economic schools of thought that dominate academic research and policymaking today embed a version of Hayek’s market in their models. Aside from the question of realism, those models don’t guarantee stability, so they aren’t able to explain market coordination. (The curious reader will find references in the papers linked to below.) Means’ ideas, and ones like them, are not currently fashionable, but there is a substantial community of economists that sees them as more realistic, and continues to work on them.

I have been studying mathematical models of market coordination under the assumption that firms set prices. The results are quite encouraging. In one paper, I’ve shown that the price system is self-stabilizing when firms set prices as a mark-up on costs and adjust prices rarely. In another paper, I explored another stabilizing mechanism, in which firms administer prices, but they also respond to prices by their choice of technology. Price changes do matter in this theory, but they act slowly and indirectly, as companies systematically work at cutting costs.

How we think about the economy matters. If we believe that it acts like Hayek’s market, then we should interfere with it as little as possible; he believed that to do otherwise would put us on the road to serfdom. Yet this does not mesh with reality: most high-income countries today feature mixed economies – not total free markets – and life is far from Hayek’s nightmare scenario.

We don’t have to accept Hayek’s view of a precarious spontaneous order perched on the brink of a slippery slope to serfdom. Instead, we can take the reins and decide together how we want the economy to work for us.

High-income countries already do this, to a greater or lesser degree. The neoliberal argument, inspired by Hayek, would reduce government as far as possible in preference to “letting the market decide.” Gardiner Means offers a different vision: one of an economy that leaves room for democracy and for policies that reflect the way the world actually works.