Invisible and visible hands

Jargal Defacto
Jargal Defacto 3.4k Views
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“There are no free markets, only markets with state regulation.” – Khurelsukh.U

This quote from the Premier Minister has made the Mongolian public think about free market economy once again. Since the transition 30 years ago, Mongolians have become richer than ever before and accustomed to diverse commodities, cars, clothes and housing. Hence, it’s apparent that some of them were angry about this quote when questioning whether the state would, in exaggeration, decide which clothes they would wear and what to eat. In coincidence with the Premier Minister’s quote, the Head of Agency for Fair Competition and Consumer’s Rights stated that there is “no reason for price increase of flour and bread”, demanding business entities to reduce the prices.

While a price reduction sounds comforting to most of the citizens, thousands of business entities which are the backbone of Mongolia’s economy, are puzzled and cautious about the direction our economy will take in the next four years and what policies the government would adopt behind the cover-up of the Covid-19 pandemic situation.

In fact, we transitioned from a command economy model, in which production rate and prices are planned by the state, into a free market economy. It’s time to discuss about the free market economy, whether interventions are required from the state and how to fix the state failures once again.

Visible and invisible regulations

In order to live in a society, basic needs of food and shelter need to be covered. Hence, fundamental decisions are required about what needs to be constructed, how to construct and for whom these shall be. Historically, these three decisions were made based on either tradition, command or free market. In many countries, for example, the oldest son makes decisions on these issues traditionally. The command economy, in other words, how the state decides everything and why the society becomes poorer, we Mongolians know from our 20th century history. A purely free market, laisser-faire (leave it) solution, in which the invisible hand regulates, has been preferred in the 18th and 19th century England and America.

In fact, the free market economy (the invisible hand senses the prices, supply, demand, profit and loss) and the command economy (government’s “visible hand” directing the economy with decisions, regulations and decrees) have been used in combination.

We Mongolians know the magics of the invisible hand very well by now. Two million citizens of Ulaanbaatar do not have to worry about whether there will be enough bread and meat the next day. They can just wake up the next day and buy them in the required amount. How much of which bread needs to be produced and whom it will be distributed to, is planned by no one. The small shop owner from your home street knows exactly how many breads shall be bought, for how much they should be sold in order to sell them all by the end of the day. The “invisible hand” connects the various distributers with its consumers in this way.

An efficient solution for the above mentioned 3 fundamental questions is the classical market economy. What needs to be produced depends on the customer’s money, since the businesses want to make profit by delivering the most desired products. How it will be produced is determined by the competition. For whom it will be produced is determined by factors (natural resources, labor force, capital) of supply and demand.

However, the invisible hand too makes mistakes since there is the factor of greed in human nature – exceeding the limits of profit. The greed to conquer the market for oneself or to conspire in order to sell products and services at too high price (monopoly), or at lower price (dumping) than production cost in order to force out their competitors causes the market to have imbalance of supply and demand. In other words, the prices do not inform about the reality anymore. This is called market failure. Our animal husbandry sector presents a good example: pastureland capacity has been exceeded, whereas 40% of 70 million livestock are goats.

Free market can also cause environmental, soil, air and water pollution. The affectedness of a third party which had nothing to do with the transaction between two actors is called negative externality. For example, factories that are polluting the environment comply with the regulations enforced by the state (visible hand). Or they are charged with taxes and other tools.

At the same time, there is positive externality. For example, companies conduct studies and invest in developments. While doing that, they create new knowledge that can be used by the society.

This way, the market failures are regulated by the visible hand of the state. This is called government regulation. However, if the government tries to regulate which doesn’t need to be regulated, and do not regulate that which needs regulations, the economy suffers too.

What needs to be regulated?

The state involvement, interventions and regulations need to be oriented towards encouraging a fair competition, not limiting it. Democratic governance’s purpose lies originally in defending human lives, security, property and freedom. Even if a private company delivers these goods, it is impossible to be rewarded in every case. Thus, public goods are created by the state. This includes military, environmental protection, roads and bridges, public education and health service.

Free competition also has its own rules and procedures. When the competition is intense, the price cannot be willfully increased as it would risk losing the confidence of customers. However, if the competitors conspire (oligopoly) or if there is a monopoly situation, an imperfect competition is constituted. In Mongolia, we have a situation in which the merging of “APU” and “Spirt Bal Buram”, “Gobi” and “Goyo” are allowing them to have an advantageous standing in the competition.

For bread and meat prices, it is relatively less possible to have a price fixing situation, since the involved businesses are small and numerous. If they set the price too high, the purchase will reduce. Thus, there are limits. Especially, the price deviation of replaceable goods is of short-term nature. In contrast, a few companies that import oil from Russia have a single source of distributer, hence, the probability that they’d conspire to fix the price is high.

All these differences shall be considered by the Agency for Fair Competition and Consumer’s Rights. In the end, if the government’s involvement in the economy stays limited to fixing market failures and leaves the fundamental questions of what goods to be produced, how to be produced and for whom, in the hands of free market, the economy will develop efficiently.

If the state (visible hand) keeps on intervening in the free competition with their regulations, the economy slows down and enters a crisis. This is called government failure. Until this failure is fixed by the “invisible hand” when the time comes, growth doesn’t occur. This correction takes place in a democratic country only after the regular voting has taken place and, if as a result the government’s policies change.

The state regulation and free market regulation are both needed for an economic development.


Trans. by Riya.T and Munkh-Erdene.D

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