The Market Economy and Its Limits

2 May 2009: Draft of Entry for Encylopedia of Islamic Economics

Dr. Asad Zaman

By the Market Economy, we mean a method of organizing economic affairs

within a society so that an un-regulated market is the means for conducting nearly all
material transactions within the economy. In such economies, decisions about production
of goods, valuation, trade, distribution, etc. are all settled by individuals or small groups
acting with maximum possible freedom, and a minimal set of legal or social constraints.
Since this is the dominant mode of organizing economic activity currently, it appears
natural, and alternatives are hard to imagine. In fact, as Polanyi (1946) notes, Previously
to our time, no society has ever existed that, even in principle, was controlled by
markets. To understand the functions and effects of the market economy, it is necessary
to delve into the history of its emergence and rise to a global system. This analysis,
undertaken below, leads to the following conclusions:
1. A market economy requires supporting institutions, social structures, political
structures, ideologies, and ways of organizing knowledge. Labelling all of these
elements combined as a market society, we can say that market economies can
only exist within market societies.
2. Social structures required for market economies conflict with traditional social
mechanisms. This implies that transitions to market economies are accompanied
by violence and destruction of traditional social norms. Recent history is a record
of resistance and conflict between traditional society and market society.
3. The global dominance of market economies has led to glorification and praise of
their virtues. The tremendous damage inflicted on the world and society by the
emergence of market economies has been suppressed A realistic assessment
shows that urgent action is needed to rescue man and society from the brink of
disaster to which the market economy has brought all of us.
Because of the damages caused to society by the market economy, Polanyi (1946) in The
Great Transformation forecast its demise following the largest crisis in his time, namely
World War 2. The unexpected recovery and rise to global dominance of the unregulated
market, and its dreadful consequences have been documented by Klein (2008) in SThe
Shock Doctrine: The Rise of Disaster Capitalism . Many of the central elements of the
analysis which follows are borrowed from these two sources, referred to simply as
Polanyi and Klein hereafter.

1. The Emergence of the Market Economy

A confluence of historical forces led to the emergence of a market economy in
seventeenth century England. The most important of these are the weakening of the hold
of religion, and also the rise in the power of the landed aristocracy in England. Both of
these forces are conveniently represented in the brief realm of Oliver Cromwell, who
beheaded King Charles I, and also massacred large numbers of Irish Catholics.
1.1: Rise of Secular Thought: The European experience of massacres, violence, and
massive social disturbance due to religious conflicts led even religious leaders to agree to
the use of secular principles to organize society for the sake of social harmony. Release
of the constraints of religion allowed the introduction of values and principles
dramatically opposed to traditional values. The most important of a large number of such
changes was the replacement of the Biblical idea that The love of money is the root of
all evil by Bernard Shaws sentiment that The lack of money is the root of all evil.
Traditional society honors those who renounce material possessions, values simplicity
over luxury, and considers gluttony, avarice, covetousness, and greed as sinful
characteristics. Market societies honor the wealthy, consider poverty as a vice, promotes
luxurious lifestyles, and consider greed and selfishness as natural and socially useful.
This transition of thought is in accordance with the Quranic verse (2:257) that those who
deny God will move from the light into darkness.
1.2: Rise of Landed Aristocracy: In the long standing battle between monarchs and
aristocrats, kings had supported commoners against the nobles, to keep a check on their
power. Efforts of the aristocracy to gain complete control over their landholdings (the
commons, in particular) had been successfully resisted for some time, but Cromwells
victory shifted the balance of power permanently in favour of the landed aristocracy.
They wasted no time in putting up enclosures, which prevented access of large numbers
of the poor to grazing land and other means to eke out a living. The resulting social
catastrophe has been described by Polanyi as follows:
The lords and nobles were upsetting the social order, breaking down ancient laws
and custom, by violence . They were literally robbing the poor of their share
in the common, tearing down the houses ( of ) the poor. The fabric of society
was being disrupted; desolate villages and the ruins of human dwelling testified to
the fierceness with which the revolution raged, endangering the defenses of the
country, wasting its towns, decimating its population, turning its overburdened soil
into dust, harassing its people and turning them from decent husbandsmen into a
mob of beggars and thieves.
2. Consequences of Social Disruption
These events in England had far reaching consequences, both temporally and spatially.
We list those most important to our current theme, the emergence of the market economy.

2.1: Property Rights: Political tussles frequently led to re-allocation of lands in favour
of victors. Utilizing their newly gained power against the monarchs, aristocrats sought to
prevent this by developing new theories of property. Instead of viewing land as a sacred
trust, a gift of God to all humans, the idea of ownership and private property as a natural
right was introduced. Philosophers like Locke argued that the right to own property was
prior to the social contract, so that governments could not alienate property.
The effects of this historical change on modern thought can be seen in the concept
of Pareto efficiency. According to this theory, re-allocation of property must command
universal support. In a society where a few have all the resources, and the masses have
nothing, modern economic theory prohibits us from recommending a redistribution in
favour of the poor. Instead of seeing this as an ethical commitment to property rights over
the rights of the poor to a decent living, economists view Pareto efficiency as an ethically
neutral and value free scientific idea.
2.2 Changing Conception of Poverty: Poverty is an honourable condition in traditional
societies. Christian monks take vows of poverty, and the Bible states that it is harder for a
rich man to enter paradise, than for a camel to pass through the eye of a needle. Our
prophet Muhammad s.a.w., refused riches and wealth, lived with very few possessions,
and prayed to Allah to be counted among the poor. Poverty emerged as a social problem
for the first time in England, following the first privatization that is, the enclosures.
While the poor have always been with us, traditional societies accept and fulfil collective
responsibility for feeding the poor. An essential element of a market society is the idea of
blaming the poor for their poverty, which was first introduced by Malthus. According to
him, it was over-breeding that led to poverty, while poverty led to vice, misery and
squalor. To the natural cures of plague, pestilence, and wars for the reduction of
population, Malthus added birth control as a means of combating poverty.
For reasons to be discussed, the traditional concept of social responsibility for the
poor must be destroyed to allow unregulated market economies to function. Malthusian
ideas created the possibility not only of blaming the poor for their poverty, but also of
arguing that helping the poor would hurt society in the long run. Feeding the poor would
lead only to more over-breeding, which would create even larger numbers of poor in the
long run. This idea, that helping the poor hurts them in the long run, takes many different
shapes in modern economic thought. Reagan and Thatcher reduced taxes on the rich,
arguing that this would increase growth because the rich would invest and increase
productivity. The poor would only consume the tax cuts, reducing savings, investments
and growth this would hurt the poor in the long run.
3. Essential Requirements of a Market Economy
The many institutions and ideologies required for self-regulating markets to function are
listed below. This section relies fundamentally on the analysis of Polanyi.
3.1 Labour Markets: Production in a market economy depends on the ability to hire
labor and a market for labor. Labor is time or the material from which human lives are

constructed. It is not normally for sale. England got a fifty year headstart on the industrial
revolution because of the surplus pool of labor created by the enclosures. It was the
desperate condition of the large numbers of people evicted from their homes and barred
from their conventional means of livelihoods, that led to the possibility of a labor market.
Under normal social conditions, people would not submit to the indignity of a labor
market requiring them to sell their labor for money. Massive disruption of the social
fabric created the conditions required for large scale production in factories to come into
existence. A similar catastrophe did not take place in Europe, which caused it to lag
behind.
3.2 The Market for Land: Traditional societies value a harmonious relationship
between man and nature, treating land and all that lives on it as a sacred trust, a gift of
God to humankind. Yet a market economy must separate the man from the land, and turn
both into commodities freely available for sale and purchase. Strengthening of property
rights and large scale enclosures created the possibility of agricultural capitalism, and the
production of large amounts of surplus food as well as industrial raw materials like
cotton. This coincided with the industrial needs for raw materials as well as the need for
food for large numbers of laborers not engaged in agriculture. The remoteness of the
owner from the land allowed him to view it as merely an input to a production process, a
means for producing wealth. In a traditional society, a labourer invests his life energies
and efforts, and enjoys the reward of bringing valuable products out of dead land. In a
market society, economic necessity compels the labourer to sell his time for money. He is
alienated from the land and the produce, both of which belong to his employer. It is the
loss of this sense of mother earth as an organic entity with an intimate relationship to
man that has led to the global environmental catastrophes that threated to destroy us all.
3.3 Money and Financial Markets: The strength of the market economy lies in its
ability to produce far beyond the minimal requirements of society. This surplus
production creates its own inexorable demands on the structure of market societies.
Subsistence economies have small self-sufficient subgroups with minimal trading
requirements and hence little use for money. Demand for surplus must be created by
promotion and marketing of luxurious lifestyles. Having large amounts of surplus
necessitates trade and hence also the use of money for trading purposes. Commodity
money functions adequately in non-market societies where trading is marginal and
peripheral. Commodity money is not flexible enough be adequate for market economies
which engage nearly everyone in monetary transactions and have large and fluctuating
amounts of trade, conducted over long distances in geography and time, and with
unfamiliar trading partners. This accounts for the rapid introduction of token monies in
market economies. Since token money is directly of no use, the best way to understand it
is as a government guaranteed financial instrument it allows trade based on promises to
pay which are flexible, backed by the government, and (hence) obligatory on all members
of the society.
Fluctuations in the quantities of money as well as the needs of trade can lead to
fluctuations in price levels these have been the bane of market economies which require
stable prices to function smoothly. Many mechanisms, including the introduction of

central banks and other government policies have been tried to smooth out the business
cycle without success. Problems are substantially exacerbated by international trade,
which cannot be conducted in terms of token money for obvious reasons. Polanyi (1946)
discusses the mechanisms for price stabilization at the international level, and how their
breakdown led to both world wars. He also suggests that the market economy is
inherently unstable, inflicts tremendous damage on man, society and environment, and
must be replaced by alternative mechanisms for productions and distribution of goods.
4. Market Ideologies and Consequences:
The Quran (104:2) condemns those who gather wealth, and count it, instead of
encouraging the pursuit of wealth. Furthermore, wealth in excess of needs should be
spent for Allah that is, on socially useful projects, and on other needy people. In direct
contrast, market economies encourage the pursuit of wealth to the point of being
absolutely irrational, according to Max Weber. Excess wealth is to be spent on personal
luxuries, or to be used to multiply wealth even further, but not on social welfare or on the
poor and needy! Spending on the poor and needy undercuts the labor market, strengthens
the laborers against the capitalists, and results in reduced profits for investment and
growth. Classical economist Ricardo wrote that The principle of gravitation is not more
certain than the tendency of (laws providing relief for the poor) to change wealth and
vigor into misery and weakness (and) universal poverty. Similar sentiments can be
found in contemporary writings of economists. Milton Friedman argued that firms should
exclusively pursue profits and should not engage in socially beneficial activities.
The relentless demand for profits, the production of surplus goods, the legitimization of
the pursuit of wealth, and greed and selfishness, has led many disasters and crises both
local and global. Polanyi has documented how the demands of the market economy led to
world wars 1 and 2. Naomi Klein has picked up the story of capitalism from the 70s to
the recent times, and documented the sequence of disasters generated by the market
economy. In the three major dimensions (Land, Labor, Money), replacement of
traditional values by market society based values has resulted in catastrophe:
4.1 The Market for Human Beings: The Collapse of Values
Traditional social transactions are based on a mutuality, and partnership in the service of
community and humanity. The market society replaced these by anonymous arms length
trades of money for services. The gradual erosion of the sense of community, which
accelerated in the post world war 2 era, has resulted in the destruction of family, in ethics
of cooperation, generosity and trust. The family is the most fundamental unit of society,
where children learn the rules governing social interactions. If the wife cannot trust the
husband and the Clinton-Lewinsky affair demonstrates that this is true from the top to
the bottom then no one can trust anyone else. This erosion of trust has been
documented in many studies. For example, a report on Fractured Families put out by
the Social Justice Foundation(2006) in the UK states that We now have one of the
highest divorce rates in the Western world and the fabric of family life has been stripped
away in the past thirty years.

Some effects of this breakdown are documented by Josephson Institute survey (2008)
which shows that more than 30% of the 30,000 USA high school students admitted to
having stolen from a store, parents or friends. According to the Center for Disease
Control, USA also has the highest teen pregnancy rate in the world. The vast majority of
approximately a million such pregnancies per year are unintended and have devastating
social, economic and health consequences for both the unwed mother and the offspring.
Promotion of the Invisible Hand idea that individuals pursuing selfish goals will
produce socially beneficial results has led widespread corruption. Leaders like Madoff
pursue Ponzi schemes, and the greed and dishonesty of followers in the finance industry
has led to worldwide financial chaos and collapse. Many sources document massive
corruption in post-Katrina, Iraq war, and recent bailout payments following financial
meltdown. All of these developments can be directly traced to promotion of the core idea
at the heart of market societies: all is fair in the pursuit of wealth.
4.2. The Market for Land: Environmental Disaster
By treating land, its products, and all that lives on it, as merely inputs into the process of
the production of wealth, the market economy has done large scale environmental
damage, destruction and depletion of forests and other natural resources, and created a
looming catastrophe due to global warming. The idea that the market is self-regulating
leads to the delusion that we dont need to worry about these problems; if they matter, the
market will automatically take care of it. The recent financial collapse should be a
warning to those who believe this core belief of a market society. Barack Obama states
that All across the world, in every kind of environment and region known to man,
increasingly dangerous weather patterns and devastating storms are abruptly putting an
end to the long-running debate over whether or not climate change is real.
Environmentalist Daniel Quinn writes that Upwards of two hundred species.. mostly of
the large, slow-breeding variety.. are becoming extinct here every day These species
are being burnt out, starved out, and squeezed out of existence. The endless production of
radioactive wastes and other poisons are hazardous to the future of life on this planet.
For the first time in the history of the world, every human being is now subjected to
contact with dangerous chemicals, from the moment of conception until death. With great
difficulty, consensus has been reached on global warming and how it threatens human
life on the planet. Market societies have prevented a solution, which requires shared
sacrifice and cooperation. Leading capitalist countries put self-interest and profits above
cooperation for survival. Instead of proportionately sharing the burden of environmental
cleanup and costs of anti-pollution measure, they attempt to put all the blame and the cost
of adjustments on the poor and powerless countries.
4.3 The Market for Money: Financial Crisis and Collapse
As discussed earlier, commodity monies impose discipline and constraint which
unregulated market economies cannot cope with. Token monies are able to adjust to
changing market conditions and keep prices stable. However, use of token monies
involves a crucial element of trust. Even when backed by gold or other commodities, no

one is in a position to detect over-issuance of paper. For a large number of different

reasons betrayals of this trust are common, and result in financial crises which have been
extremely common in the twentieth century. Among the big ones, Taleb (2007) in The
Black Swan writes that In the summer of 1982, large American banks lost close to all
their past earnings (cumulatively), about everything they ever made in the history of
American bankingeverything.
Can we trust the invisible hand which guides selfish profit seekers to produce socially
beneficial outcomes? The deep financial crisis currently enveloping the globe suggests
otherwise. Even if the global economy recovers, which many pundits doubt, should we
continue with a system which delivers shocks disrupting lives and livelihoods of vast
numbers of people on a regular basis? There is ample evidence to suggest that
alternatives which provide more comfortable lives for all human beings can readily be
devised.
5 Concluding Remarks
The market economy is a European experiment with an alternative method of organizing
society. Instead of intrinsic values of cooperation, trust, generosity, and other social
virtues, many of which go against the natural grain of man, they sought to built a society
with maximum freedom. Everyone is allowed to do whatever he desires, with a minimum
of rules and regulations. The outcome of this experiment has been a complete failure on
all fronts. Lane (2005) in The Loss of Happiness in Market Economies documents the fact
that this freedom has not resulted in happiness. Numerous studies in the emerging field of
well-being studies provide evidence for this. At the same time, crucial social structures
like family, communities, as well as social values like cooperation, generosity and trust
have been substantially depleted more so in the heartland of the market economy, but
also, to a lesser extent in the periphery. In addition to eating up social capital, the natural
resources of the planet have also been depleted at an astonishing rate by the market
society. Many have noted that a sure recipe for complete collapse and disaster is to
simply continue in our present ways.
Fundamental and radical change is an imperative at this time. Islamic economics provides
a radically different system which remedies the fundamental difficulties of market
economies. A detailed analysis of the differences between the two, and how Islamic
economics can deal with problems generated by market economy concepts is provided in
Zaman (2008) Islamic Economics: A Survey of the Literature .