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Why Free Markets Succeed and Governments Fail
by Michael S. Rozeff
by Michael S. Rozeff
New (or radical) liberals and private property anarchists affirm
market success and government failure. Socialists affirm market failure and
government success. Success at what? Success at creating value for individuals.
Adam Smith called it the wealth of nations, but wealth is only a proxy measure
of value and one that does not entirely get at the essentials of why free
markets succeed.
Over 225 years later there is still disagreement over how to create
value. Fortunately, some of the human race know how to create it without
prompting from theorists and controlling from governments. Others, the
socialists, don't. In modern-day America, they think that value is created by
maintaining huge armed forces with hundreds of bases all over the world,
invading other nations, monitoring everyone's communications, licensing
television and radio stations and a hundred other occupations, taking from the
haves and giving to the have-nots, forcing everyone to join a government health
care plan, forcing everyone who works to pay a Social Security tax which is
then given away to the elderly, taking property for private business projects,
regulating the mileage of an automobile, forcing security markets to have a
national price system, forcing toilets to be smaller and washing machines to be
front-loading, paying farmers not to produce or paying them to produce, not
producing or working the land if there is some strange insect or lizard living
on it or if a stream flows through it, regulating trade, regulating interest
rates, controlling money, etc., etc. Being as human as the next person,
socialists have no end of ideas. Unfortunately, they are all bad.
Both sides cannot be correct. One side favors freedom of choice
over private property (or capitalism). The other favors government control over
private property (or socialism.) There is no mixed way, middle way, third or
fourth way, because new liberals and socialists affirm opposing principles of
freedom of choice over private property. As socialism waxes, free markets wane
and vice versa. As free markets wane, value creation subsides.
Value creation and destruction in brief
The term "free markets" is shorthand for free and voluntary
property exchanges of all sorts, private exchanges of private property that are
neither coerced nor coerce others. Exchanges are also termed trades or
transactions. It's basic economic logic that every such transaction is expected
to bring greater value (or utility) to those on either side of the trade. The
Toyota buyer expects to gain and so does the Toyota dealer. That's why they
trade. It's by way of such value-creating trades that markets create value
spontaneously and cooperatively.
The greater the personal valuation of an item is compared with its
cost to the person, the more the value creation that has occurred. The amount
of value creation is actually invisible and not measurable. Internet access may
cost $360 a year, but it may be worth far more than that to a buyer. Since each
person and only that person knows what something is worth to him, his actions
help to determine and decide the value creation (along with the many other
actions of manufacturers and other buyers who affect the price). He is the
judge, and only he can be the appropriate judge. Socialists can't properly
judge because they are clueless about personal valuations.
If markets do not produce something at all, like front-loading home
washing machines or automobiles with six air bags, it is because most people do
not value it more highly than what it costs them. They won't willingly buy it.
If they must buy such a machine because that's all that manufacturers are
allowed to make, some people will buy if its value is still higher than its
cost. But the excess of their personal valuation over the price paid will be
reduced. The regulation acts like a tax. Or it acts like a tie-in sale: you
must buy washing capacity tied in with front-loading and unloading that you
don't want. There will be invisible value destruction because front-loading is
not worth as much to the buyers as top-loading. Other people may use the old
top-loading machines longer, replace the tubs and motors, or buy a second-hand
machine. Value is again being destroyed compared with simply buying a new
top-loading machine. More or less the same type of analysis applies to all
socialist meddling in free markets.
Government
The term "government" is shorthand for an organization that
intrudes upon free and voluntary exchanges. It coerces individuals. It
interferes with trades and transactions: limits them, or stops them altogether,
or taxes them, or regulates them. Governments trench upon private exchanges and
private property, interrupting cooperation and trade. It's by way of such
forceful intrusions that governments destroy value. (This raises a question not
addressed here: If governments are destructive, why do we have them and why
have they grown over time?)
It is obvious that a government is not set up to work as
individuals work, to produce food or clothing or shelter or health care. It's
nothing like a business. It's set up mainly to pass laws.
Rozeff's law of organizational growth is that organizations by and
large do what they are set up to do and try to do more of it. Businesses
produce and sell, and usually try to grow and do more. Charities distribute
wealth and usually try to do more. Art museums display art (they claim) and
usually try to accumulate more. Governments, financed by forced exactions
called taxes, make laws and force people to live by them. Following Rozeff's
law of organizational growth, they try to make more laws, use more force, and
levy more taxes. Unfortunately, they succeed. We get more socialism, more value
destruction, and less value creation. Theories don't get any simpler than this.
Fire and water don't mix
Free markets and government are polar opposites, not complements.
Whereas market transactions involve freedom of choice over private property,
government transactions involve the opposite, compulsion and control that seize
private property. These two principles of human activity can no more have the
same effects than do fire and water. If one principle succeeds, then the other
must fail because they work in opposite ways.
One cannot mix these two methods of organizing human activity and
expect something new and better to emerge. Mixing fire and water produces
nothing but lifeless ashes. The idea that government is necessary for a free
market to work, or that it helps a free market work, or that a mixed economy of
free markets plus government is superior to a free market economy is, for all
practical purposes, entirely faulty. If 99.9 percent of the government's laws
were removed from the books today, this would end an enormous amount of
government intrusion that destroys wealth. Value creation in free markets would
rapidly accelerate. All that would remain would be laws against crimes. And
Bruce Benson and others make the excellent case that there is no aspect of
maintaining laws that has not in the past and cannot now or in the future be
handled and handled better by a free people than a government.
Uncertainty
Free markets and governments both operate under difficult
circumstances that feature uncertainties about the future, what things people
value, and how much they value them. Freedom of choice clearly doesn't mean
perfection on earth. There are uncertainties about what things people really
want and what they will give up to get them. There are uncertainties about how
to produce what people want and what other competitors are now or might
eventually produce. There are uncertainties about future prices, values, costs,
profits and losses. Exchanges create value but in many cases people are feeling
their way toward those exchanges that they expect will create value, and there
are no roadmaps that list the routes, the rest stops, the gas stations, and the
distances. And the nature of these exchanges often changes unceasingly.
Collections of telephones or automobiles or computers or dresses, ice creams,
and books show remarkable changes over time in what was exchanged.
Since there are always risks, uncertainties, limitations, and lack
of knowledge, an individual who decides how to use his property can make an
error. There can be a profit but also a loss. Toyota may beat out Chevrolet,
which loses business. The internet may deliver a movie, not the local theater
which loses business. A restaurant meal may disappoint, and the consumer loses.
A computer may crash minutes after the warranty expires. No one wants or likes
losses.
The individual who decides matters bears the responsibility for the
outcomes. Accountability for the decision falls on the decision-maker. Since
the result of a choice can be a gain or a loss and since gains are preferable,
each buyer and seller has an incentive to choose transactions that amplify the
gains and diminish the losses. Do distant socialists in government exercise the
same care? Are they even capable of exercising such care? No and no.
Because each person decides many matters, the individual
experiences the outcomes of his decisions, and experience is the best teacher.
One learns what sells or doesn't, where to buy and where not to, what to buy
and what not to, what to invest in and what not to, etc. One learns how to
create value, not lose it.
Learning to create value
Precisely how each of us works out our value creation is not
possible to say. I might guess that each individual has an incentive to
investigate, to learn, and to take care, but overdoing any of these can be
counterproductive. I might say that waste, haste, and misinformation create
losses, and maybe they usually do. But speed, adaptability and responsiveness
can pay off. What seems to be misinformation can turn into serendipity. What
looks like waste may have long-run payoffs. A reasonable generalization might
be that faulty judgment, errors, and lack of foresight bring losses, while
accurate judgment and foresight bring gains. In any event, freedom of choice is
a necessary condition for individuals to feel and think their way toward that
set of characteristics or behaviors that bring them gains and avoid losses.
They cannot do this if their choices are controlled by others.
We look around and what do we see? One man relies on what his
parents taught him. Another reads a book. Others use trial and error. Still
others believe in research, prayer, imitation, inspiration, science, or art.
Some listen to friends or their mates. Some believe in government. No one knows
all the answers or even knows where to go to find them. No one knows all the
questions. No one has a lock on the characteristics or information or
procedures that create success. Book after book after book is written, each
providing new keys. The dimensionality of the issues involved in creating value
is infinite. Nevertheless, we do it. We create value.
Why are free markets better than governments at creating value?
Here's another reason. Free markets are dispersed markets in which, under
uncertainty, different people try many different ways to create value using
both local information they possess and global information that they glean from
the activities of others. These trials have some degree of independence from
each other. This has a social benefit. It creates a beneficial diversification
effect that operates in insurance-like fashion. Furthermore, losing trials are
quickly terminated. But winning trials can be extended over the whole society
to enhance value creation.
Finale
We cannot analyze the particular pathways inside each person by
which freedom of choice over private property encourages them to amplify gains
and discourages them from making losses. Every life is a series of experiments
in creating value. What is important to one person may seem crazy to another.
But we can understand the basic foundation that, when it is in place, allows
each of us to find greater success and avoid loss. That foundation is
individual freedom of choice over private property. That foundation stimulates
every behavior and incentive for behavior that each of us thinks will bring
gain to us and discourages every one that we think brings loss to us.
How does this foundation encourage success? How do free markets
succeed in encouraging value creation? There are many reasons, some of which
I've already mentioned. Now I mention a few more. As Hoppe has argued, if each
of us keeps what we own without it being taken by government, each of us has
the maximum incentive to increase what we own and make the best use of it so as
to create value. As Mises has pointed out, free markets have prices. Prices
reduce the dimensionality of the value creation problem. We can easily find out
what something costs and compare it to our personal valuations. Businesses have
a clear measure of success: profit or loss. Government does not. One of
Rockwell's favorite themes is that accountability and responsiveness are
characteristic of business activity in free markets because of the direct link
between service to buyers and profit and loss. There is no such direct link
between voters and government, nor is there a clear link between a given
product and a given vote. Hayek and others have emphasized that value creation
requires specific knowledge that is available only to individuals, that is,
it's widely dispersed. Free markets are the natural way for individuals to
bring that knowledge to bear in their choices. Mises, Rothbard and Austrian
economists emphasize the role of free market entrepreneurial activity in
seeking out new opportunities for value creation and bringing them to fruition.
By contrast, governmental entrepreneurialism is directed at new restrictions
that promote value destruction.
Where there is freedom of choice over property, individuals decide
every aspect of a trade: when, what, how, how often, how much, where, at what
price, at what quality, and with whom. The individuals decide on every aspect
of a trade that they think affects value for them. Some of these choices are of
the "yes/no" variety, to be sure. Many transactions are small in size. But
every choice counts and in the aggregate they make their impact felt. Value
creation arises from an infinite number of finely-tuned individual decisions.
If government (a set of other people) is in the picture, deciding
these matters in the place of free individuals, how does it decide? By a clumsy
and ineffective voting and logrolling method, by arbitrary exercise of power,
and by whim and by interest group. It decides mainly by laws - limiting,
seizing, regulating, taxing, redistributing, wasting, absorbing, and destroying
property. When it decides for everyone and replaces the free market by its own
production of services like defense, its value destruction is amplified. The
experiences of every Communist country are testimony to that fact.
July 18, 2006
Michael S. Rozeff [send him mail] is the Louis M. Jacobs Professor
of Finance at University at Buffalo.
Copyright © 2006 LewRockwell.com
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