Market economy (without any state interference) was the mainstay of capitalist world up to the thirties of last century. Soviet Russia’s socialist experiment provided a new light and nearly an alternative to market economy. But after the collapse of Soviet Union, and in the wake of present globalisation the importance of market economy has again come back.
Here producers have not to find the problem about any takers of their product. The commodities are sold normally in the market. The individual supplier has very limited role in deciding the supply quantum.
In the classical sense “every supply creates its own demand”. Price mechanism process determines the market clearing output.
It is not known who operates market system and determines prices. In such a system every person acts in his own interest, producers produce in the best possible manner, consumers consume for maximisation of utility, producers also maximise their own profit.
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In such a situation everybody is working according with best possible manner. Thus, social welfare is automatically ensured. This self love and motivation for work and economic well being works according to invisible hand mechanism, a scheme imagined and analysed by Adam Smith.
This invisible hand mechanism is a feature of laissez faire economy. After the histories of the last century following the worldwide great depression such a system became a thing of the past. Presently in the wake of globalisation, liberalisation and privatisation as well as revival of supply side economics an attempt has been made in the west to revive the principles of market economy. The old and classical model of market economy cannot be revived.
Those features of market economy are no longer in existence now because of wider market imperfections. Market economy though theoretically ensures rational allocation of resources but in reality it is far from that.
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Lack of adequate direction from above and decontrolled regime caused various crises and problems as well as system failure such as Great Depression, recent failures in Argentina, Mexico, Thailand, Indonesia in last decade characterised with a massive foreign exchange crisis, under employment, flight of capital, unrest in the minds of people, fear psychosis and uncertainty in the financial sector and an indeterminate government policy.
After Second World War, many countries in the World adopted a planning strategy for a smooth and steady economic growth and to maintain steadiness in the market mechanism process, thereby to reduce uncertainties. But market mechanism had failed, due to inadequate strategies, improper selection of priorities and various imperfections and lack of transparency at many stages.
Nicholas Stern in an Article in the Economic Journal in 1989 indicated some brain storming analysis towards reasons for market failures. (i) Individuals may know their preferences, needs more than what the government can offer, (ii) Government’s direction of planning has brought homogeneity in the institution building, movement in same direction which has been full of mistakes in many cases, than markets, (iii) The revised market economy may face obstacle by bureaucratic handling of the situation limiting the growth of private sector, (iv) Due to lack of proper direction people may lose energy for innovation, costs control and allocative efficiency. Too much governance and control in the modified market mechanism has failed to yield optimum results.
The ideologies of market, private enterprise, rational expectation and supply-side economics adopted aggressive stance against the state control regime. It was believed, all economic ills have come from faulty macroeconomic and sectoral policies and of excessive governance.
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Market forces began to be considered as necessary condition to promote resource allocation and utilisation of resources. In the late eighties the entire approach towards development wanted that market approach should be people friendly.
The recent thrust is on socially responsible market economy. New paradigm is to avoid both market excess and government excesses and to ensure an equitable mix of a strategy in which all economic agents are benefited.