Markets are Creatures of Government

This is not just a matter of markets requiring a system of enforced property rights, which presupposes government, at least in rudimentary form. In monetary economies, functioning markets also require a viable currency, one that is generally accepted in exchange. Government ensures a currency’s acceptance when it imposes and effectively enforces taxes that are payable only in that particular currency. This is true not only of exogenous taxes but of taxes on consumption, income and wealth so long as these are assessed in the government’s chosen unit of account.

In this sense, it is perhaps ironic that the most ardent supporters of markets tend to be the least enthusiastic about taxes while the least enthusiastic about markets tend to be the most ardent supporters of taxation. The former group views taxes as somehow hampering markets; the latter group views taxes as making government involvement in, or influence on, markets financially affordable. (In the case of currency-issuing governments, taxes as a source of initial finance is a misnomer, because the currency issuer is the original source of the funds needed for tax payment.)

In reality, markets for output priced specifically in a nation’s unit of account are formed as a result of the government’s decision to tax in that particular currency rather than some other. Far from being a hindrance to markets, taxes are what actually motivate the formation of markets in the currency of issue.

The institutional framework put in place by government helps to define the social context in which markets operate but does not fundamentally alter the way market signals are generated within that context. The existence of clear rules and boundaries clarifies the socially legitimate scope of markets and of market-based competition. Within those limits, market forces are permitted to operate.

Prohibiting, say, child labor or slavery or wage payments below a statutory minimum limits the sphere of markets but does not weaken market signals within those limits. If child labor is permitted, market signals will act to encourage the most profitable (to capitalists) employment of child labor. When, instead, child labor is prohibited, society in effect has made the judgment that the social benefits outweigh any impact on profits. Market signals, now generated within a modified institutional setting, act to encourage the most profitable employment of labor subject to the constraint that children cannot be employed. Similarly, when employment below a legislated minimum wage is prohibited, market signals act to encourage the most profitable employment of labor subject to the constraint that the wage cannot fall below the statutory minimum.

The same goes for any other aspect of the institutional framework. For instance, when government, through its decisions, encourages or permits continued destruction of the natural environment, market participants are incentivized to behave accordingly. If, instead, government acts to curtail environmental destruction and encourage environmental regeneration, the contours of market activity are reconfigured and price and quantity signals are emitted in conformity with the new configuration.

If government promotes wide inequalities of income and wealth, through a paucity of worker protections, a regressive tax regime, and so on, the composition of demand for goods and services will differ from what would occur under a more equal distribution of income and wealth. In the one case production for market will be geared more toward luxury items for the wealthy few; in the other case production for market will be geared more toward mass-produced items for the many.

In all these cases, market participants will simply be reacting to price and quantity signals that flow from the institutional and policy framework adopted by government. Decisions to alter the mix of market and non-market activity, or to adjust the rules applying to activity in this or that market, modify the social limits of markets but not the manner in which price and quantity signals are emitted within those limits.