Systems Matter Part 10: The Magic of Free Enterprise

By the early 1990s, I was spending a lot of time in the Marxist/Communist countries of the world: Cuba, Russia, North Korea, Romania, and even the philosophically tainted countries of South America. In the Soviet Union, members of the average household spent nearly forty hours per week standing in lines attempting to procure just the basic necessities for the family. 

In places like Ukraine I would occasionally stand in lines with my new friends just to see what it felt like to participate in the economic debacle of Marx, Engles, Lenin, and Trotsky. We would line up behind the old faded blue military flat-bed trucks, draped with a swatch of gray canvas, and wait our turn to have a government comrade hand down the loaves of bread or canned vegetables . . . if they still had any left. 

Marx and Lenin had not only scoffed at, but had officially outlawed, anything that even smacked of free market, free enterprise, or portrayed the slightest capitalistic nuance. With that stance they negated any advantage of market-generated information that would have helped guide them with their economy. 

There was no concept of economic growth or production. They had squelched any intrinsic market signals and had shut off any built-in factors for motivation and incentive to help the economic system run smoothly. They had locked themselves into a system that glorified mediocrity and stymied excellence. That was the price they were paying so that they could retain absolute control over a centralized economic system of redistribution. They really believed that they could figure it all out by themselves and control the attitudes and actions of millions of individual workers in their centralized system. But, they could never get it right.

  • The flash of genius regarding the magic of prices had been observed and written down by Adam Smith, and it had been available to the socialists for a hundred years. Its efficiency had been well documented and not hidden at all from the public. Smith had recognized that the prices that emerged from individuals entering into voluntary transactions in a free market could silently coordinate the activities of millions of people almost immediately. Each individual would be seeking the area of his own interest, but his actions would result in an experience of unintended consequences where everybody ended up better off. Those transactions sent silent signals out to the entire economic system. Those signals guided the actions of the other individuals in the economic system so that they could make enlightened decisions on their own without the necessity of any politburo or centralized Marxist Gosplan telling them what to do.

In Milton Friedman’s bestselling book, Free to Choose, he brilliantly explains the three elements of Prices: Prices perform three functions in organizing economic activity. First, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product – the distribution of income. These three functions are closely interrelated. (1) 

Prices are the nervous system of the free enterprise economy. Individuals like to buy at the lowest price possible, and sell at the highest price possible. At some point there is a mark where the seller is willing to sell his product and the buyer is willing to buy the product, and each feels that he is coming out of the deal better off. If that mark cannot be struck, then the deal fails to be consummated. If agreement is made, then price for the product or service has been established. Additionally, the successful transaction encourages the individuals to pursue yet more transactions in order to feel better off again and again, thus expanding the total economy. 

In experiencing the Gosplan in action in the old Soviet Union, I observed that there were constantly surpluses of the wrong things and shortages of the things needed. In Armenia, my new friends at the shoe factory pointed out that the Gosplan would try to figure out how many comrades needed to plant enough hectares in hay to feed enough horses and cattle to provide sufficient leather hides to be delivered to the shoe factory for the making of military boots. They always got it wrong somewhere along the line. They would experience a drought (that was always one of their favorite excuses for failure) where there was not enough water to grow sufficient hay for feed, or they would grow so many tons of hay that it would spoil or mold and have to be discarded. 

In a free enterprise economic system we do not observe many incidents of surplus or shortage or inconsistent availability of products. Prices make that happen. That is because prices balance the demand for goods and services with their supply. The quantity that the consumers want to purchase is assured to match the quantity producers want to sell. The balance between supply and demand is no accident. Prices make it come out right each time . . . unless there is interference by some control-seeking government entity. Even in times of economic upset or disaster, goods and services are available at the present market price. 

To pursue our shoe factory example, let’s return to the Soviet Union’s Gosplan and see how it differs from an economic system of free enterprise. If a retailer needs to purchase from the open market certain numbers and styles of shoes in order to advertise and sell them from his spring shoe catalogue, he may contact a shoe manufacturer and enter into an agreement to purchase said shoes to be delivered to a certain location by a certain date for a certain price. Each party is free to enter into such an agreement. As soon as the shoe manufacturer commits to fill the order for the retailer, he immediately secures the necessary leather to fill the order. 

But, let’s say the manufacturer is dilatory and waits for a period of time to purchase the leather. And in the meantime there is a drought, (or some other kind of impediment in the leather supply). Immediately information goes out into the marketplace regarding the shortage of leather, and the cost of the remaining available leather supply goes up. But leather is still available at the new price. The cattle growers in Texas receive the free information and may decide to not sell the entire cow to their beef steak market in Japan, but, rather, butcher the cattle in Texas and save the leather hides to sell to the shoe industry, and just send the custom steaks to Japan that year. The cattleman’s neighbor hears of the leather shortage and decides that next year he will switch his ranch operation from growing sorghum to raising cattle, because the selling price of leather has increased sufficiently and he now has an opportunity to make a handsome profit. 

The prices of shoes for the spring season are going to go up. There will not be a shortage of shoes, but the potential customers will have to make a decision as to whether or not they want to pay a higher price. Since the company with the spring shoe catalogue has a firm contract with the manufacturer for the leather products at a lower price, he stands to make a better profit from raising his shoe prices, or he has an edge on the market and can afford to sell his shoes faster at a lower price than his competitors who had to increase all their prices because of the increased leather costs. 

But the manufacturer now has to scramble and find some leather available at the price that existed when he signed his contract with the retailer, or he will experience a sad loss. 

The manufacturer grabs the Wall Street Journal and turns to the commodity price page in search of leather. All this information is free and available in the open marketplace. He locates a leather supplier in Brazil who is willing to sell him the leather at the previous year’s price and even assume part of the shipping costs. The manufacturer has covered his potential losses and can fulfill his contract with the spring shoe catalogue. All that information exchange and human initiative happened almost instantaneously, without needing to be gathered, sorted, and distributed to everybody in the economy. Everyone had access to all the information, but those who did not have a personal interest in the leather or shoe industry could simply ignore the information and go on with their own interests. There is no way in God’s green earth that all that could have taken place under Gosplan! 

Of course, all the cattle ranchers who jumped in to raise more cattle and sell the leather at the increased prices, now have the prerogative of going back to raising sorghum. But everybody in the system had the right to pursue his or her desires to become better off. Everybody in the system had instant and pertinent information available making it possible to pursue those free choices. 

Nothing has ever been designed to match the efficiency of free enterprise. That is because nobody designed the free market. Nobody manages the free market. Nobody controls the free market. It is a phenomenon that registers thousands of personal preferences in a nanosecond. 

It can deliver information that can peg the market value of a million different products all at the same time. It can inform people in every corner of the earth what to produce, when to produce it, how much to produce, and how much to buy at any given time. It can even let you know where to go to search out job opportunities within your scope of interest. If none of that information is pertinent to you . . . you can simply ignore all of it! 

All of that instant information is not mined, gathered, filtered, stored and made available by one individual or one big box superstore of technology. All that collaborative wisdom is freely made available and is the result of millions of individuals working in union with one another while seeking to be better off within the scope of their own interest. 

The anomaly tagged as free market that operates within the phenomenon of free enterprise just simply exists in all of its sophistication wherever individuals exist who have been granted freedom of choice in areas of culture and economics. Those are the individuals who have a deep desire to end up better off. That phenomenon of free enterprise is a precious gift to the world! 

Next Week: SYSTEMS MATTER Part 11: Profit and Loss

  •  Profits
  •  Losses
  •  Wages

(Research ideas from Dr. Jackson’s new writing project on Cultural Economics) 

© Dr. James W. Jackson   

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