Open Market
An economic situation that resembles free trade
Updated:
September 15, 2022It refers to an economic situation that resembles free trade. This implies that companies can trade freely without government-imposed limits or trade barriers.
In such an economic system, buyers and sellers can freely trade due to little or no market barriers. Moreover, the market is accessible to all economic agents as they all have an equal opportunity to enter the market.
Common market barriers include taxes, subsidies, unfair licensing agreements, tariffs, unionization, and all other regulations that interfere in market activities. These market barriers, if enforced, act as barriers to entry into international trade.
The prices of goods and services are set according to the free market mechanism; that is, the forces of demand and supply determine them. Goods with higher demand than supply are priced higher in the market than goods with a higher supply than demand.
It is essential to understand that the degree of 'openness' in a market is determined by the extent of government regulations and influence on trade. It is not a bivariate concept but a relative one.
An economy can be less than fully open due to minimal interference by the government. However, in the modern world, there are no fully open economies as a market cannot function without a legal framework to protect the interests of buyers and sellers from unfair market practices.
Regulations in the modern world are necessary to ensure the standard of services, quality of goods, and transaction compliance. Restrictions are placed on producing and distributing certain drugs and harmful products like cigarettes and liquor.
The United States, Canada, and Australia are close to free-market economies.
Due to many competitors and key players, there may be competitive barriers to entry. For instance, without government intervention, a new tech startup would find it difficult to compete with major players like Google, Oracle, and Microsoft.
An open market system follows free trade policies to avoid discrimination between imports and exports. Every trader wishing to sell a good or service can do so without facing any selling charges or taxes.
The US stock market is a typical example of an open market. All investors are free to trade and are offered the same price depending on the market forces.
Open vs. closed markets
The opposite of an open market system is a closed market system. A fast market is restricted by government-imposed regulations like tariffs, taxes, import duties, quotas, etc.
It also includes cultural norms or other influencing mechanisms restricting free market activity. For instance, prohibition laws prohibit the manufacturing and distribution activities related to alcohol. Similarly, religious influences may also restrict market activity.
Closed markets involve any situation where people cannot freely indulge in trading activities, and the price is not set according to market mechanisms.
A typical example is the enforcement of binding price floors and price ceilings wherein the government sets a minimum or maximum price level for a commodity. As a result, the producers are forced to set prices accordingly.
The minimum wage concept is an example of a price floor set by the government to protect the interest of laborers. Unfortunately, this regulation of wages in the market leads to less demand for labor in the market as producers are unwilling to pay higher than the equilibrium wage rate.
This reduction in demand for labor increases unemployment and forces workers to work for less than minimum wages in a black market system.
While closed market mechanisms are detrimental to the economic agents' interests, governments opt for these measures to protect a large section of people.
For example, international trade barriers and import duties are enforced by governments to protect the interests of domestic producers from highly-efficient global traders. In addition, this protects small domestic traders from unfair competition by international market players.
A closed market is also called a protectionist market based on protecting domestic agents. Some examples of protectionist markets include North Korea and Cuba.
The restrictions placed by the government can take two forms:
- Pricing restrictions affect the price of goods through tariffs, taxes, and various duties. A common practice is to charge import duties to discourage the sale of foreign commodities in the domestic economy.
- Participation restrictions dictate who can enter the market. It involves restricting sellers or buyers in a market.
A typical example is the Middle Eastern market system, where foreign companies can only compete in the local market if they have a 'sponsor' or a native citizen owning a certain percentage of the business.
It is empirically proven that free-market systems show higher economic growth than closed-market systems. Furthermore, due to the size of the market and the large number of resources involved, the level of economic activities and volume of trade are more significant in free markets.
This means citizens in such economies enjoy higher living standards, better infrastructure, more vital institutions, innovation, and higher productivity. This also reduces instances of poverty in such countries.
Most developed countries are relatively more open than undeveloped and developing countries.
Open market operations
In banking, the term 'open market' refers to trading government bonds or securities by the Central Bank of a nation and its member banks to manage fluctuations in interest rates.
Open market operations also manage the bank reserves available for credit to consumers in an economy. But, again, this is done primarily to decrease to increase the money supply in an economy.
When member banks face a shortage of funds due to reduced money supply in the economy, the Central Bank of a nation buys government securities from banks at a given price using cheques or electronic transactions. This increases the banks' reserves.
With increased reserves, the bank increases its lending activities to consumers and the money supply. With an increase in money supply, the interest rates on financial investments, also known as the cost of credit in an economy, reduce.
People can now take loans at lower interest rates which promotes economic growth. This is an expansionary monetary policy measure.
On the other hand, during high money supply and inflation, the Central Bank sells government securities to banks obligated to comply. This reduces lending activities and manages inflation. It is also known as a contractionary monetary policy measure.
Open market operations do not follow a free market system as the Central Bank enforces many restrictions on member banks.
The open market may also refer to any investor buying a company's stock through the stock exchange and not directly through the corporation.
Free-market organizations
Following are a few of the free-market organizations:
1. The European Union
It is a political and economic union of 27 member states located primarily in Europe. One of the founding principles of the European Union was free trade among member countries. To that effect, it is the world's largest single market area.
It is considered to compromise the most outward-oriented economies of the world. The EU represents each member country while negotiating trade agreements and thus has more power in international trade than members would have individually.
The European Union represents the rights of European exporters by providing them access to world markets. It works to remove trade barriers while simultaneously helping foreign companies access the European market.
The EU facilitates free-market activities among its member nations by adopting a single currency, the euro. This reduces transaction costs and provides ease of doing business and trade.
2. The World Trade Organization(WTO)
Another such organization is the WTO-World Trade Organization which aims to regulate trade among member countries. Lowering trade barriers and managing lines of communication among countries helps promote international business.
It has also enforced trade barriers to protect economic agents' interests. A typical example is the enforcement of trade barriers on disruptive elements in international trade like China and North Korea.
It keeps global trade running smoothly and facilitates the resolution of disputes among members.
The workings of the EU and WTO have undoubtedly benefited multinational companies with high stakes in the global economy. However, it has also negatively impacted domestic economies due to reduced employment opportunities and unfair competition.
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