By 1870, however, some 50 years after Austen’s death, things had improved enormously. Real wages were significantly higher and rising. Most people could now afford more than a single set of clothes, life expectancy was increasing, and London was a far healthier place in which to live. What happened to so dramatically improve the average Englishman’s lot in just two generations? Nasar explains:

The economic historian Harold Perkin argues that “Consumer demand was the ultimate economic key to the Industrial Revolution,” providing a more powerful impetus than the invention of the steam engine or the loom. London’s needs, passion for novelty, and growing spending power supplied entrepreneurs with compelling incentives to adopt new technologies and create new industries.

There you have it. For millennia people were starving to death and the solution was right there in front of them: Consume more. Similarly, those who died of thirst in the world’s deserts could have been saved if they had only drunk more water.

The Thrall of Ideas

This is not to deride Nasar, but to suggest that Keynes was on to something when he quipped that “even the most practical man of affairs [or the most intelligent historian] is usually in the thrall of the ideas of some long-dead economist.” Nasar’s passage, following as it does a recital of the terrible poverty that was the common lot for nearly all of human history, perfectly illustrates the emptiness and absurdity of popular Keynesianism. The work that Nasar quotes – The Origins of Modern English Society 1780-1880 – was published in 1969 at the height of Keynes’s popularity: during the presidency of Richard “We are all Keynesians now” Nixon and before the stagflation of the 1970s.

Nasar’s last sentence, however, contains an important truth in the phrase “growing spending power.” The term spending power implies effective demand, which means not just need or desire but the wherewithal to fulfill that need or desire. Wherewithal, in turn, implies previous production and saving (deferred consumption).

What a man produces is what he can bid for the produce of others. The value of what he creates – that is, its value to others – represents his effective demand in the marketplace. If he produces nothing, if what he produces has no value (mud pies), if what he produces loses its value (stone knives in the Bronze Age), or if he produces more than can be consumed (houses after a housing bubble has burst), he has no effective demand though his needs be unchanged.

Say’s Law

This restates Say’s Law, which Keynes in his General Theory popularly, though misleadingly, formulated as: Supply creates its own demand – misleading because a supply of goods with no value yields no effective demand and because supply that does have value to others does not create effective demand, it is effective demand.

What Keynesians do not understand is that if a man is hired to dig holes and then fill them back up, he is fully employed but he produces nothing of value; effective demand is not increased by his efforts. Nor does giving him money or goods in exchange for his useless labor create effective demand; it only shifts it from the people who produced what was given him.

Only production creates effective demand and only after what was produced is sold can other goods can be purchased and consumed. What changed England was not increased consumption but increased production, production that made increased consumption possible. And, yes, that increased production was due in large part to the entrepreneurial employment of the steam engine and the loom, inventions that Nasar so cavalierly dismisses.

The size of the market determines the degree of specialization possible and therefore the productivity of the caveman’s clan.  Its productivity in turn determines how well the members live.  If the market could be expanded, a higher degree of specialization would be possible, raising both productivity and living standards.

Suppose that Rok, an itinerant caveman, notices that his clan makes particularly good knives, another, miles away, makes excellent bone needles, and that still another makes fine loin cloths.  Rok is lucky in a hunt one day, killing a large deer.  He trades most of the meat for stone knives reasoning that he can easily transport the knives to the other clans and exchange them for needles and loin cloths, which he can then bring back and trade for even more knives – which he can trade with the other clans for still more goods.

Dynamic Process Unleashed

Rok has done far more than simply transport products between clans.  He has unleashed a complex dynamic, iterative process.  First, by expanding the marketplace to three clans, he has enabled more cavemen to specialize, increasing their productivity and raising the welfare of their clans.  By opening trade between the clans, he has increased each clan’s chances for survival.  If a hunt goes badly for one, it may be able to trade for food with another that has had better luck.

In addition Rok has introduced clans to goods they have never seen before, sparking new ideas and planting the seeds for improved and perhaps entirely new products.  If he profits by the exchanges he makes, he also provides an example to others who may go into direct competition with him, increasing the volume of trade among the three clans, or who may open trade with still other clans, potentially discovering new products and ideas.

No Value Added?

Unfortunately Rok also sparks anger among some clan members.  A few cavemen believe Rok is cheating them out of the full value of their labor.  They see that he is simply transporting goods between the clans and making a profit even though he does not improve the goods in any way.  They do not see that he adds value to the goods by moving them from where they are valued less to where they are valued more.  Nor do they, along with Rok himself, see the subtle, though critically important, processes he has unleashed by expanding each clan’s market, nor the clans’ greater resilience and rising prosperity through increased specialization and communication of ideas.

Rok moreover is seen as an outsider to the members of two of the clans with which he trades.  People’s natural distrust of strangers, their resentment of Rok’s “exploitation,” and their envy of his relative prosperity may lead them to drive him away.  If so, they may later wonder why their living standards fell after Rok’s exile and will probably see no connection.  These clans are far less likely to survive and prosper than those that welcome, or at least tolerate, Rok and other middlemen.

Rok’s descendants are what Thomas Sowell called “minority middlemen”: Jews across the world, “Armenians in the Ottoman Empire, Ibos in Nigeria, Marwaris in Burma, overseas Chinese in Southeast Asia, and Lebanese in a number of countries.”  A significant number of people from each of these groups have for a variety of geographical, cultural, and historical reasons, worked far from their homelands as peddlers, merchants, and money lenders.  They and other middlemen helped bring mankind out of caves and into prosperity. In return they have been reviled, persecuted, and killed.

Over the course of several decades politicians—both Democrat and Republican—encouraged banks and mortgage companies to ease lending standards in hopes of making housing more affordable for the poor. They also urged the government-sponsored enterprises (GSEs) Freddie Mac and Fannie Mae (the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association) to purchase the resulting low-quality loans from lending institutions. This freed up money, enabling banks to make more loans than would have otherwise been possible. These actions, along with low short-term interest rates set by the Federal Reserve and tax advantages for home buyers, sparked a housing boom. Home prices soared and investors flocked to purchase mortgage-backed derivatives. Speculation became rampant, and houses were bought simply to resell, or “flip,” when prices rose.

Eventually, the bubble burst. Housing prices collapsed and thousands of home buyers defaulted on their mortgages, sending derivative prices into a death spiral and sparking a Wall Street sell-off. The rest is history: a history that the government is apparently anxious to repeat. The Fed is still pushing its easy-money policies with a vengeance, down-payment subsidies for low-income home buyers are still available for the taking, and lenders are still being pressured to ease standards for minorities and for low-income home buyers. The thinking appears to be that if housing prices can be driven back up to their pre-bust levels, everything will be fine. Homeowners who are currently “underwater” (meaning they owe more on their homes than the homes are now worth) and all those banking and investment houses that saw the value of their mortgage-based securities plummet will supposedly be back in the black.

There is only one problem with this scenario: The pre-bust price levels are not sustainable. We have the bust to prove it.

In the midst of the attempt to reinflate the bubble, politicians, needing to deflect blame for the collapse, have settled on Wall Street and the mortgage lenders as the most plausible villains. (Which is not to say they are blameless; the State-banking partnership is as old as the republic.) Last September the Federal Housing Finance Agency, which oversees Fannie and Freddie, announced it was suing the nation’s 17 largest banks—some of which the government had recently bailed out—for selling risky mortgages to the two GSEs. Yet just two months before, the Department of Justice “requested” that a number of banks lower lending standards for minorities with poor credit ratings, threatening them with discrimination charges if they failed to comply.

How did banks get into this damned-if-you-do-damned-if-you-don’t nightmare? It started in 1977 with the Community Reinvestment Act (CRA). The act requires “each appropriate Federal financial supervisory agency to use its authority when examining financial institutions, to encourage such institutions to help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions.” As Thomas Sowell wrote in his book The Housing Boom and Bust, the act, though seemingly innocuous, was based on the “implicit assumption that government officials are qualified to tell lenders to whom they should lend money entrusted to them by depositors or investors.” Sowell notes that lawmakers never seriously questioned this assumption.

The CRA Gets Teeth

At first the CRA had little impact but it was given teeth by subsequent legislation. The main impetus for additional regulation came from Federal Reserve studies run in the early 1990s showing differing home loan approval rates for black and white applicants. Largely ignored were the findings by these same studies of no racial differences in default rates among approved borrowers. As Sowell explained in Economic Facts and Fallacies, had minorities been unfairly denied loans, their default rates should have been significantly lower than the rate for whites. Instead, the equal default rates indicate the various groups were being held to the same standards.

Imagine a thoroughly racist loan officer looking for the slightest excuse to deny a loan to a minority home buyer. Minor flaws that he would ignore if the applicant were white are eagerly used as justifications for rejecting a mortgage to a minority applicant. Only black and Hispanic borrowers with stellar credit ratings would have their loans approved. The few loans the officer did make to minority borrowers would have a far lower default rate than those he made to whites. The data, however, showed no such differences.

Regardless, lending institutions were subjected to a firestorm of media abuse. Under pressure from both Congress and the White House, federal regulatory agencies loosened lending rules and imposed penalties on lenders failing to meet politically dictated racial quotas.

In 1993 the Department of Housing and Urban Development (HUD) began legal actions against mortgage bankers who declined “too many” minority loan applications. HUD also pushed Freddie and Fannie to increase their purchases of low- and moderate-income (LMI) mortgages. In 1995 regulators required banks to prove they were making a mandated number of loans to LMI borrowers, directing them to use “innovative or flexible” lending practices to achieve their quotas. Still other ways were found to pressure banks into making risky loans. For example, when Congress repealed legislation prohibiting banks from affiliating with securities and insurance companies, it denied the restored freedom to banks with CRA ratings below “satisfactory.” Similarly, regulatory permission for mergers and for opening branch offices was tied to banks’ CRA community service activities, such as hiring minorities, making donations to approved nonprofit organizations, and earmarking loans for minority-owned businesses.

In 1999 the New York Times reported that Fannie Mae, under increasing pressure from the Clinton administration to buy more LMI loans, encouraged banks “to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans.” Clinton’s successor, George W. Bush, contributed to the expanding bubble as well, signing the American Dream Downpayment Act in 2003, which provided, and still provides, down-payment subsidies to low-income home buyers.

The drive to make homes more affordable actually made them less so. Prices soared as hundreds of thousands of first-time home buyers flooded into the market. Still, few people buy a home outright; most take out a mortgage. As long as the monthly payments were affordable, home sales could continue apace. To drive monthly payments down, politicians and lenders only needed to get a bit more creative. With plenty of reserves thanks to the Fed’s easy-money policies, banks were more than eager to step up. No-down-payment loans became commonplace, as did adjustable rate mortgages (ARMs) and even so-called “liar loans” for which borrowers were not even required to show they could pay the money back. It did not matter because, of course, housing prices would continue rising forever. If anyone defaulted on his mortgage, the lender would just foreclose on the house and resell it for a tidy profit.

According to Peter J. Wallison and Edward J. Pinto in Forbes (Feb. 16, 2009), in late 2004:

[The chairmen of Freddie and Fannie] were telling meetings of mortgage originators that the GSEs were eager to purchase subprime and other nonprime loans.

This set off a frenzy of subprime and Alt-A [rated between subprime and prime] mortgage origination, in which—as incredible as it seems—Fannie and Freddie were competing with Wall Street and one another for low-quality loans. Even when they were not the purchasers, the GSEs were Wall Street’s biggest customers, often buying the AAA tranches of subprime and Alt-A pools that Wall Street put together. By 2007 they held $227 billion (one in six loans) in these nonprime pools, and approximately $1.6 trillion in low-quality loans altogether.

From 2005 through 2007, the GSEs purchased over $1 trillion in subprime and Alt-A loans, driving up the housing bubble and driving down mortgage quality.

Critics argue that only 6 percent of the subprime loans made to low-income home buyers were provided by CRA-covered banks. However, CRA loans contributed disproportionately to the defaults. According to Bank of America’s October 2008 quarterly report, CRA loans represented only 7 percent of its total mortgage lending, yet these loans made up 29 percent of its mortgage losses.

CRA Infection

The CRA’s largest impact, however, was that it led to an overall drop in lending standards. As Thomas E. Woods, Jr., reported in Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse, “The push for relaxed lending standards for low- and middle-income borrowers was so pervasive and systematic, persisting for a full decade, that it is no surprise that it should have spilled over into the standards for higher-income borrowers as well.” Low standards did more than just “spill over,” however. HUD pressured mortgage lenders not subject to the CRA to sign “Memoranda of Agreement” stating they would make more loans to minority and low-income borrowers. Countrywide Financial was the first lender to sign and, perhaps not coincidentally, the first lender to go bankrupt when the housing bubble burst. Once hailed as a leader, Countrywide is now reviled as a “predatory lender.”

Speculators, availing themselves of zero-down-payment loans and ARMs, purchased house after house with no intention of actually living in any of them. Instead they resold them as prices continued climbing. In the end, a number of homes were built strictly as investment vehicles. “Flipping” homes in this manner could be very lucrative—right up until the housing market crashed. Many speculators, caught between sales, defaulted on their mortgages. Because they had put little or nothing down, the losses were borne by whichever institutions held the mortgages when the music stopped—or by the taxpayers.

Many homeowners, seeing the value of their houses soar during the boom years, cashed in by refinancing their homes at the higher market values and pocketing the difference. When prices tumbled back down, they were left owing more money on their homes than they were now worth. Some, like the speculators, simply walked away.

Still, critics point out that the dollar value of CRA loans paled in comparison to the leveraged debt that Wall Street investors amassed. Imagine an upside-down pyramid of debt with the pyramid’s apex serving as its base. This apex was made up of home mortgages. Piled on this relatively small base were trillions of dollars in leveraged derivatives such as credit-default swaps (essentially insurance against bond or, in this case, loan failure) and other mortgage-based securities.

As top-heavy as this inverted pyramid was, the fact remains that it could have survived had its base been solid. Instead, its foundation was riddled with bad home loans because the government had coerced banks and other lending institutions into handing out money to people who could not afford to repay it. Further, Congress demanded that Freddie and Fannie buy hundreds of billions of dollars’ worth of these subprime loans, enabling lending institutions eagerly to make even more such loans with no incentive to vet borrowers. Investors were blinded to the risks by triple-A ratings handed out by a government-sanctioned cartel of credit rating agencies evaluating the mortgage-based securities.

Three years after the housing bust, the Federal Reserve is still following easy-credit policies. Last September it doubled down with an announced purchase of $400 billion in longer-term Treasury securities hoping to lower long-term interest rates and thereby boost spending and investment. At the same time the government is continuing to pressure banks to make risky loans and sell them to Freddie and Fannie, which were taken over by the government after they went bankrupt. (Last fall Freddie said it needed to borrow $6 billion more from the Treasury after it lost $4.4 billion in the third quarter of the year.) The new twist is that federal regulators are now suing banks for doing what the government demanded, and is still demanding, that they do. This is not too surprising given Washington’s need to pin the blame on someone, anyone, other than Washington. The politicians and regulators also need to be looking ahead, though, for the villains on whom they can blame the new and bigger bust that they currently have in the works. It is nothing short of breathtaking. But then, blowing bubbles always is.

In this example Papa Stone has what economists call a “comparative advantage” in hunting while the children have a comparative advantage in collecting firewood. Even though dad can collect firewood more efficiently than the children, the family’s opportunity cost in lost game outweighs its benefit from the incremental tinder he could collect were he to forgo hunting in favor of gathering wood.

Once tasks are divided up among the members of the family, each will soon become more adept at his or her work until dad ceases to be the preeminent expert in all things Stone Age. Family productivity will increase and the Stones will become materially better off.

Suppose the members of a neighboring family, the Gravels, are far less capable than the Stones. Despite the disparity in skills, or rather because of it, each family can still gain by trading goods and services—just as the Stones benefitted individually by in effect trading goods and services among themselves. For example, let’s say it takes the Gravels two hours to gather a stack of wood and ten hours to capture a rabbit, while it takes the Stones only one hour of labor per stack of wood and three per rabbit. If the Gravels give the Stones four stacks of wood in exchange for one rabbit, they save two hours of labor while the Stones save one.

The exchange creates wealth. Both families gain time they can spend in leisure or in increasing their own material well-being. Note that no trade will occur unless each family benefits. Because of the opportunity for gain that trade offers, though, each family has an incentive to discover its comparative advantages with respect to the other and to find those things that can be exchanged to their mutual benefit. Through trial, error, and observation they will quickly learn the ways in which they can best serve each other.

Not only does trade increase the families’ wealth, it also makes them more resilient in hard times. If Papa Stone’s hunt goes badly today his family may have better luck gathering nuts and berries. If not, the Gravels might have fared better and be willing to exchange some of their harvest for a garment or tool that Mama Stone crafted. The community becomes more resilient as additional families are included in the circle of trade, allowing the realization of economies of scale and a finer division of labor.

Perhaps most important trade brings with it new knowledge and new thoughts. Far more valuable than a tool is the idea of a tool—a rock is just an inert lump until, mixed with knowledge, it becomes a hammer, club, or building block. Without knowledge there are no resources. Throughout history communities on or near trade routes have advanced far more quickly than have isolated peoples. Isolation yields ignorance and ignorance yields not bliss but poverty, disease, and death.

Jumping ahead a few score millennia, suppose that today’s Japanese are far more competent at every imaginable task than the citizens of any other country. Despite the disparity of skills, it would not make sense for Japan to produce all of the world’s goods while everyone else remains idle. Rather, the Japanese should do those things that only they can do, or for which they are best suited, while others do what they can. After such an international division of labor, people from other countries will become increasingly proficient in their work to the point that the Japanese are no longer the world’s experts in everything. People will grow into their niches, world productivity will rise, and poverty will decrease.

Comparative advantage is rooted in differences: differences in skills, culture, interests, location, climate, geology, geography. These differences lead to specialization, which in turn leads to still more differences and still more advantages. Comparative advantage and division of labor are locked in a virtuous cycle of ever-increasing productivity.

Who should determine those tasks for which the Japanese are best suited—to say nothing of the Australians, Brazilians, and Icelanders? Perhaps their respective governments can get together and determine how to best divide up the work. Unfortunately governments have had a dismal record of picking industry winners and losers.

Four decades ago, for example, Japan’s vaunted Ministry of International Trade and Industry (MITI) thought that the Japanese were best suited to building ships and actively discouraged the nation’s companies from trying to compete with American automobile and electronics firms. Had MITI’s view prevailed, the loss to Japan and to the rest of the world would have been incalculable. On the other hand, suppose that the Japanese auto and electronics companies had been mistaken and their attempt to break into American markets had failed miserably. The losses would have been substantial, but they would have been far less than those that would have stemmed from MITI’s error. Mistakes made on a small scale are far less costly than those made on a national or international level. They are easier to stop, too.

Far better to let individuals, with local knowledge and a stake in the outcome, decide how best to employ their own time, skills, and property. Prices will reveal the comparative advantages these individuals enjoy as they compete with each other in the marketplace.

As described in William J. Bernstein’s book The Birth of Plenty: How the Prosperity of the Modern World Was Created, France’s minister of finances under Louis XIV from 1665 to 1683, Jean-Baptiste Colbert, worked tirelessly to expand commerce by improving his country’s roads and canals. Unfortunately, trade was hindered by more than potholes—a complex system of internal tariffs was throttling commerce. Colbert tried to dismantle the tariffs but was only partially successful. After his death, “all fiscal restraint was lost. By the end of Louis XIV’s reign three decades later, the State had doubled the tolls on the roads and rivers it controlled, and the nation that had once been Europe’s breadbasket . . . was bled white. . . .” Bad regulations trumped good roads.

During the Great Depression Franklin Roosevelt initiated massive public-works programs to improve the nation’s infrastructure in hopes of putting people back to work and jump-starting the economy. The construction efforts were staggering. According to Conrad Black:

The government hired about 60 percent of the unemployed in public-works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York City’s Lincoln Tunnel and Triborough Bridge, the Tennessee Valley Authority, and the heroic aircraft carriers Enterprise and Yorktown. They also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields.

Yet these extraordinary accomplishments were not enough to pull the nation out of the Depression. Neither were the millions of jobs generated by this monumental work.

At the same time as he was directing resources away from the private sector, Roosevelt also unleashed upon it a regulatory blizzard that significantly increased the risk of doing business. Higher personal, corporate, excise, and estate taxes; wage and price controls; production restrictions; antitrust lawsuits; and constant experimentation provided few incentives for companies to expand. As in Louis XIV’s France, an improved infrastructure could not revive commerce in the face of stifling government regulations.

Enough Roads; Too Many Roadblocks

Today President Barack Obama is touting high-speed rail and other infrastructure improvements as keys to economic renewal. But if massive infrastructure investments were not enough to turn the economy around in the 1930s, they are far less likely to do so today. Because Roosevelt was starting from a lower base his improvements would have had a far greater impact on the economy of his day than would similar work done now. Also, the lighter regulatory burden in the 1930s meant there were projects then that truly were “shovel-ready.” Today environmental impact studies, possible archeological finds, and nuisance lawsuits may stall construction for years or halt it completely.

The real roadblock to economic growth is the burgeoning regulatory burden that President Obama, like Roosevelt before him, has placed on business. According to a study by James Gattuso and Diane Katz, “[T]he Obama Administration imposed 75 new major regulations from January 2009 to mid-FY 2011, with annual costs of $38 billion.” Hundreds of additional regulations will pour forth from Obamacare, Dodd-Frank, and proposed EPA greenhouse gas restrictions. All this on top of an already monumental regulatory burden imposed by government. A Small Business Administration report estimates the cost of regulatory compliance at over $1.75 trillion in 2008 alone.

Briefly, our current economic woes were triggered by the collapse of a housing bubble, produced by loose monetary policy together with federal pressure on mortgage companies to lend to bad credit risks. When the bubble burst, housing prices fell, causing many homeowners to default on their mortgages. Investment vehicles based on those mortgages lost much of their value, leading to huge investor losses and the failure of some major financial institutions.

Lost in Transition

Absent government interference industry would retool, shifting capital and labor out of home construction and into other areas. Because neither capital nor labor is homogeneous, this shift takes time. Equipment that can be put to other uses may have to be sold or physically moved. Other equipment may have to be modified or scrapped altogether. Workers may need to increase their market value by relocating or by gaining new knowledge and skills. In a recession consumers typically reduce spending and increase savings, thus freeing up the resources needed to complete the shift.

Keynesian economists, however, see both labor and capital as homogeneous, aggregated lumps. Where Austrians see capital in transition Keynesians see “idle capital.” Keynesian programs to put that capital back to work only hinder or halt the needed transition, either leaving capital in its malinvested state or forcing it into the very idleness they seek to remedy. For example, expanding credit may re-inflate the collapsed bubble for a time, leading industry to continue producing unneeded goods. Stimulus spending—whether for infrastructure or other things on the government’s wish list—transfers scarce resources from industry to government, further impeding the transition. New laws, enacted to prevent future recessions, make businesses reluctant to invest until the associated regulatory structures are defined—a process that can take years. Once in place the regulations may inhibit capital flow, locking inefficiencies and malinvestment in place and propping up companies that should be allowed to fail. Unemployment insurance and other such programs eliminate or at least reduce workers’ incentives to move or reeducate themselves.

The country’s problems are not the fault of inadequate highways. They are the result of government intervention: loose monetary policies, programs that encourage unsustainable debt, explicit and implicit guarantees to financial institutions, massive spending that crowds out private investment, oppressive regulations, higher taxes with constant threats of more to come, and political payoffs to “friendly” companies and unions. Building high-speed railroads will not stop the malign effects of these policies; the solution is to stop the policies.

Goods, people, and information will not flow freely across a nation, regardless of the quality and extent of its infrastructure, if taxes and regulations block their flow. Trade perished in France as Colbert’s improved roads and canals were made all but useless by high internal tariffs. Hundreds of thousands of miles of new and rebuilt roads were not enough to move commerce past the regulatory roadblocks that Roosevelt erected. President Obama’s proposed high-speed trains—indeed, his latest nearly half-trillion-dollar jobs program—will not pull the country over the mountain of regulations that has been created in the decades since the Great Depression and that Obama has raised to new heights.

In this example, Papa Stone has what economists call a “comparative advantage” in hunting while the children have a comparative advantage in collecting firewood.  Even though dad can collect firewood more efficiently than the children can, the family’s opportunity cost in lost game outweighs its benefit from the incremental tinder dad could collect were he to forgo hunting in favor of gathering wood.

Increasing Skill

Once tasks are divided up among the members of the family, each will soon become more adept at his or her work until dad ceases to be the preeminent expert in all things Stone Age.  Family productivity will increase and the Stones will become materially better off.

Suppose that the members of a neighboring family, the Gravels, are far less capable than the Stones.  Despite the disparity in skills, or rather because of it, each family can still gain by trading goods and services – just as the Stones benefitted individually by in effect trading goods and services among themselves. For example, let’s say that it takes the Gravels two hours to gather a stack of wood and ten hours to capture a rabbit, while it takes the Stones only one hour of labor per stack of wood and three per rabbit.  If the Gravels give the Stones four stacks of wood in exchange for one rabbit, they save two hours of labor while the Stones save one.

Wealth is created by the exchange.  Both families gain time they can spend in leisure or in increasing their own material well-being.  Note that no trade will occur unless each family benefits.  Because of the opportunity for gain that trade offers, though, each family has an incentive to discover its comparative advantages with respect to the other and to find those things that can be exchanged to their mutual benefit.  Through trial, error, and observation they will quickly learn the ways in which they can best serve each other.

Not only does trade increase the families’ wealth, it also makes them more resilient in hard times.  If Papa Stone’s hunt goes badly today, his family may have better luck gathering nuts and berries.  If not, the Gravels might have fared better and be willing to exchange some of their harvest for a garment or tool that Mama Stone crafted.  The community becomes more resilient as additional families are included in the circle of trade, allowing the realization of economies of scale and a finer division of labor.

Perhaps most important, trade brings with it new knowledge and new thoughts.  Far more valuable than a tool is the idea of a tool – a rock is just an inert lump until, mixed with knowledge, it becomes a hammer, club, or building block.  Without knowledge, there are no resources.  Throughout history, communities on or near trade routes have advanced far more quickly than have isolated peoples.  Isolation yields ignorance and ignorance yields, not bliss, but poverty, disease, and death.

New Age, Same Story

Jumping ahead a few score millennia, suppose that today’s Japanese are far more competent at every imaginable task than the citizens of any other country.  Despite the disparity of skills, it would not make sense for Japan to produce all of the world’s goods while everyone else is idle.  Rather, the Japanese should do those things that only they can do, or for which they are best suited, while others do what they can.  After such an international division of labor, people from other countries will become increasingly proficient in their work to the point that the Japanese are no longer the world’s experts in everything.  People will grow into their niches, world productivity will rise, and poverty decrease.

Comparative advantage is rooted in differences: differences in skills, culture, interests, location, climate, geology, geography.  These differences lead to specialization, which in turn leads to still more differences and still more advantages.  Comparative advantage and division of labor are locked in a virtuous cycle of ever-increasing productivity.

Who Decides?

Who should determine those tasks for which the Japanese are best suited – to say nothing of the Australians, Brazilians, and Icelanders?  Perhaps their respective governments can get together and determine how to best divide up the work.  Unfortunately, governments have had a dismal record of picking industry winners and losers.

Four decades ago, for example, Japan’s vaunted Ministry of International Trade and Industry (MITI) thought that the Japanese were best suited to building ships and actively discouraged the nation’s companies from trying to compete with American automobile and electronics firms.  Had MITI’s view prevailed, the loss to Japan and to the rest of the world would have been incalculable.  On the other hand, suppose that the Japanese auto and electronics companies had been mistaken and their attempt to break into American markets had failed miserably.  The losses would have been substantial, but they would have been far less than those that would have stemmed from MITI’s error.  Mistakes made on a small scale are far less costly than those made on a national or international level.

Immortally Stupid

They are easier to stop too. If the cars Japanese automakers had shipped to the United States hadn’t sold, the companies would simply have halted any further shipments.  By contrast, despite worldwide overcapacity, Japan’s government still subsidizes its shipbuilding industry.  As Kevin D. Williamson observed, when governments do stupid, they do immortally stupid.

As poor as governments are at allocating known tasks, they are even worse at assigning tasks that don’t yet exist.  What government official, wanting to keep his job, would have asked Fred Smith to set up Federal Express and deliver packages in competition with the U.S. Postal Service?

Far better to let individuals, with local knowledge and a stake in the outcome, decide how best to employ their own time, skills, and property.

No doubt most educated people consider themselves far more sophisticated than the average caveman.  Yet the average caveman knew he needed to produce things that others wanted if he and his family were to benefit from trade.  How many of today’s politicians and bureaucrats understand that?  How many think nothing of assigning useless tasks, such as building unneeded ships, to others?  It takes a Ph.D. to pass as wisdom arguments that wouldn’t fool a caveman.

I have devised a simple plan for improving Americans’ health by drastically reducing everyone’s weight, thereby significantly increasing longevity and reducing medical costs. All we need to do is revalue the pound. Instead of a pound being 16 ounces, it will now be 32, cutting everyone’s weight in half. We adjust our bathroom scales, our weights drop, and our health is improved.

Of course this “solution” rests on two fallacies. First, it conflates measurement with what is measured. Adjusting my bathroom scale does not change my weight, only my perception of my weight.

Second, the solution confuses cause and effect. My weight is not necessarily the cause of my health or lack thereof; in fact my weight may be caused by my ill health—an injury that keeps me from exercising or a thyroid condition, for example. More commonly, good health is the result of acting responsibly for many years: moderating calorie and alcohol intake, eating the right foods, engaging in regular exercise, getting quality dental and medical care. Such actions are likely to result in both moderate weight and good health. But I can no more make myself healthy by adjusting my bathroom scales than a doctor can cure a child’s cold by adjusting the thermometer he uses to measure her fever.

The two fallacies are so obvious that no one could possibly fall for them, right? Sadly, no. Many brilliant people have fervently believed in nearly identical fallacies for decades and are even now basing our country’s monetary policy on them.

Historian T. S. Ashton noted in his book The Industrial Revolution, 1760–1830:

If we seek—it would be wrong to do so—for a single reason why the pace of economic development quickened about the middle of the eighteenth century, it is to low interest rates we must look. The deep mines, solidly built factories, well-constructed canals, and the houses of the Industrial Revolution were the productions of relatively cheap capital.

John Maynard Keynes, making this same observation years before, concluded that simply by manipulating a country’s money supply and financial markets to artificially produce low interest rates, “deep mines, solidly built factories, well-constructed canals and houses” would spring into being. But Keynes confused “cheap capital” with easy money. Capital—inventories, pre-consumer goods, and the methods and means of production—cannot be conjured into being by manipulating interest rates. They can exist only through production and saving (deferred consumption).

Capital goods can be relatively cheap only if they are relatively plentiful. Increasing capital, all else equal, will lower interest rates. But interest rates are more than just a measure of capital availability; they also reflect lending risk. Risk in turn can be affected by such things as inflation and the reliability and efficiency of transportation, communication, and capital markets.

A lender would hardly agree to make a $100 loan unless he could reasonably expect to get at least $100 in purchasing power in return. If the government is debasing the currency, loans will be made only if interest rates are higher than the anticipated rate of inflation.

Costs and Lending Risks

Transporting goods by human or animal power is slow and costly. Sailing ships can carry far more goods far more quickly. Steam-powered ships are faster and more efficient still. Transportation costs, then, are inversely proportional to the level of technology. But costs also depend on the rule of law. When local chieftains can block mountain passes and extort steep tolls, or when highwaymen and pirates can exact their own tolls with impunity, transportation becomes risky and expensive. Conversely both transportation costs and lending risks are reduced if private property rights are respected and enforced.

Efficient capital markets foster trade by reducing transaction costs. Such markets depend on property rights and laws of exchange and on fast and reliable methods of communicating information such as prices, weather, and changing market conditions. Like transportation, communication depends on the level of technology.

Low capital costs are the result of a lot of people acting responsibly for many years: sound currency, institutions protecting private property and preserving the rule of law, inventors devising new and useful products, entrepreneurs bringing those products to market and finding ever-more-efficient ways to satisfy customers, and individuals producing more than they consume and saving for the future.

False Signals

Artificially low interest rates signal the existence of capital goods that were never actually created. While these low rates may spark investment bubbles, the bubbles must eventually burst when competition for scarcer-than-expected capital goods, services, and labor drives prices up.

Manipulating markets through monetary policy devalues a nation’s currency, destroys rather than secures property rights, and does nothing to sustain the rule of law constraining both the rulers and the ruled.

The costs of fooling ourselves can be high. By readjusting my bathroom scale I disable an indicator that might warn me when I need to change my eating and exercise habits. By overriding market money prices we similarly deny ourselves important data about the country’s fiscal health. Our weight and the real price of money are both valuable pieces of information providing vital feedback on our actions. Manipulating that feedback destroys the value of the information and, rather than giving us control, gives us only the illusion of control.

As described in William J. Bernstein’s book The Birth of Plenty: How the Prosperity of the Modern World Was Created, France’s minister of finances under Louis XIV from 1665 to 1683, Jean-Baptiste Colbert, worked tirelessly to expand commerce by improving his country’s roads and canals.  Unfortunately, trade was hindered by more than potholes — a complex system of internal tariffs was throttling commerce.  Colbert tried to dismantle the tariffs but was only partially successful.  After his death, “all fiscal restraint was lost.  By the end of Louis XIV’s reign three decades later, the State had doubled the tolls on the roads and rivers it controlled, and the nation that had once been Europe’s breadbasket … was bled white….”  Bad regulations trumped good roads.

Prometheus Bound (in Red Tape)

During the Great Depression, Franklin Roosevelt initiated massive public-works programs to improve the nation’s infrastructure in hopes of putting people back to work and jumpstarting the economy.  The construction efforts were staggering.  According to Conrad Black:

The government hired about 60 percent of the unemployed in public-works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana state capitol, much of the Chicago lakefront, New York City’s Lincoln Tunnel and Triborough Bridge, the Tennessee Valley Authority, and the heroic aircraft carriers Enterprise and Yorktown. They also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and a thousand airfields.

Yet these extraordinary accomplishments were not enough to pull the nation out of the Depression. Neither were the millions of jobs generated by this monumental work.

Not only did the work direct resources away from the private sector but, worse, Roosevelt unleashed a regulatory blizzard on the nation’s private sector, significantly increasing the risk of doing business in the country.  Higher personal, corporate, excise, and estate taxes; wage and price controls; production restrictions; antitrust lawsuits; and constant experimentation provided few incentives for companies to expand.  As in Louis XIV’s France, an improved infrastructure could not revive commerce in the face of stifling government regulations.

High-Speed Rail to Nowhere

Today, Barack Obama is touting high-speed rail and other infrastructure improvements as keys to economic renewal.  But if massive infrastructure investments were not enough to turn the economy around in the 1930s, they are far less likely to do so today.  Because Roosevelt was starting from a lower base, his improvements would have had a far greater impact on the economy of his day than would similar work done now.  Furthermore, the lighter regulatory burden in the 1930s meant that there were projects then that truly were “shovel ready.”  Today, environmental impact studies, possible archeological finds, and nuisance lawsuits may stall construction for years or halt it completely.

The real roadblock to economic growth is the burgeoning regulatory burden that President Obama, like Roosevelt before him, has placed on business.  According to a study by James Gattuso and Diane Katz, “[T]he Obama Administration imposed 75 new major regulations from January 2009 to mid-FY 2011, with annual costs of $38 billion.”  Hundreds of additional regulations will pour forth from Obamacare, Dodd-Frank, and proposed EPA greenhouse gas restrictions.  All this is on top of an already monumental regulatory burden imposed by government.  According to a Small Business Administration report (pdf), the cost of regulatory compliance was over $1.75 trillion in 2008 alone.

Goods, people, and information will not flow freely across a nation, regardless of the quality and extent of its infrastructure, if taxes and regulations block their flow.  Trade perished in France as Colbert’s improved roads and canals were made all but useless by high internal tariffs.  Some 700,000 miles of new and rebuilt roads were not enough to move commerce past the regulatory roadblocks that Roosevelt erected.  President Obama’s proposed high-speed trains will not pull the country over the mountain of regulations that has been created in the decades since the Great Depression and that Obama has raised to new heights.  A bridge wrapped in red tape is truly a bridge to nowhere.

There is always an easy solution to every human problem – neat, plausible, and wrong. –H. L. Mencken

I have devised a simple plan for improving Americans’ health by drastically reducing everyone’s weight, significantly increasing longevity and reducing medical costs.  All we need to do is revalue the pound.  Instead of a pound being 16 ounces, it will now be 32, cutting everyone’s weight in half.  We adjust our bathroom scales, our weight drops, and our health is improved.

Of course this “solution” rests on two fallacies.  First, it conflates measurement with what is measured.  Adjusting my bathroom scale does not change my weight, only my perception of my weight.

Second, the solution confuses cause and effect.  My weight is not necessarily the cause of my health or lack thereof; in fact, my weight may be caused by my health – an injury that keeps me from exercising or a thyroid condition, for example.  More commonly, good health is the result of responsible actions taken over many years: moderating calorie and alcohol intake, eating the right foods, engaging in regular exercise, getting quality dental and medical care.  Such actions are likely to result in both moderate weight and good health.  Conversely, I can no more make myself healthy by adjusting my bathroom scales than a doctor can cure a child’s cold by adjusting the thermometer he uses to measure her fever.

Brilliant Fools

The two fallacies are so obvious that no one could possibly fall for them, right?  Sadly, no.  Many brilliant people have fervently believed in nearly identical fallacies for decades and are even now basing our country’s monetary policy on them.

Historian T. S. Ashton noted in his book The Industrial Revolution, 1760 – 1830 (9-10):

If we seek – it would be wrong to do so – for a single reason why the pace of economic development quickened about the middle of the eighteenth century, it is to low interest rates we must look.  The deep mines, solidly built factories, well-constructed canals, and the houses of the Industrial Revolution were the productions of relatively cheap capital.

John Maynard Keynes, making this same observation years before, concluded that simply by manipulating a country’s monetary supply and financial markets to produce artificially low interest rates, “deep mines, solidly built factories, well-constructed canals and houses” would spring into being.  But Keynes is confusing “cheap capital” with easy money.  Capital – inventories, pre-consumer goods, and the methods and means of production – cannot be conjured into being by manipulating interest rates.  They must be produced through saving, that is, deferred consumption.

Capital goods can be relatively cheap only if they are relatively plentiful.  Increasing capital, all else equal, will lower interest rates.  Interest rates are a measure of capital’s availability. Dictating low rates will not improve a nation’s fiscal health any more than manipulating my bathroom scale will improve my physical health.

But low interest rates depend on more than just the availability of capital goods.  They are also a function of the risk in lending.  Risk in turn can be affected by such things as the reliability and efficiency of transportation, communication, and capital markets.

Transporting goods by human or animal power is slow and costly.  Sailing ships can carry far more goods far more quickly.  Steam-powered ships are faster and more efficient still.  Transportation costs, then, are inversely proportional to the level of technology.  But costs also depend on the rule of law.  When local barons can block mountain passes and extort steep tolls, or when highwaymen and pirates can exact their own tolls with impunity, transportation becomes risky and expensive.  Conversely, both transportation costs and lending risks are reduced if private property rights are respected and enforced.

Efficient capital markets foster trade by reducing transaction costs.  Such markets depend on property rights and laws of exchange and on fast and reliable methods of communicating information such as prices, weather, and changing market conditions.  Like transportation, communication depends on the level of technology.

Doing the Right Thing

Low capital costs are the result of a lot of people doing the right things for a lot of years: institutions protecting private property and preserving the rule of law, inventors devising new and useful products, entrepreneurs bringing those products to market and finding ever more efficient ways to satisfy customers, individuals producing more than they consume and saving for the future.

Artificially driving interest rates down cannot raise a nation’s level of technology, magically bringing railroads or fax machines into being.  Manipulating markets through monetary policy destroys rather than secures property rights and does nothing to establish rules of law that constrain both the rulers and the ruled.

The costs of fooling ourselves can be high.  By readjusting my bathroom scale I disable an indicator that might warn me when I need to change my eating and exercise habits.  By overriding market money prices we similarly deny ourselves important data about the country’s fiscal health.  Our weight and the real price of money are both valuable pieces of information providing vital feedback on our actions.  Manipulating that feedback destroys the value of the information and, rather than giving us control, gives us only the illusion of control.

Daniel Stone, in the November 13, 2010, issue of Newsweek, addresses the dilemma in his article “Hail to the Chiefs.” The essay’s subhead summarizes the problem: “The presidency has grown, and grown and grown, into the most powerful, most impossible job in the world.” Stone’s solution, as suggested by his article’s title, is to devolve presidential power either to cabinet members (oligarchy?) or to “outside agencies” (technocracy?).

Stone dismisses the notion that government or the president could simply do less. “It’s hard to imagine,” he writes, “how the office could sizably shrink, allowing the president to return to a more aloof, strategic role.”

The job’s impossibility stems from the sheer scope of government power and therefore the incredible array of issues with which any president must grapple: unemployment, Middle East peace, energy, homeland security, drug abuse, Iraq, offshore drilling and oil spills, foreign trade, terrorism, scandals, greenhouse-gas emissions, Afghanistan, North Korea, health care, the financial industry, pollution, education, transportation, nuclear proliferation, the national economy, the global economy—the list is endless. How can any one person competently deal with all that, no matter how many advisers he or she might have?

In Stone’s words, “Days in the West Wing are a constant, head-spinning oscillation between dozens of domestic, foreign-policy, and political eruptions and concerns.”

Imagine the mass of information flooding into the White House each day. Who could digest it? Some half-dozen aides are needed just to deal with incoming mail. Stone relates former chief of staff Rahm Emanuel’s instructions to senior staff members trying to deal with the daily deluge: “We need to make his memos shorter. Last night we sent the president a phone book.”

Yet a library of “phone books” would be needed to adequately cover all the issues a president attempts to handle. A country, not to mention the world, is too complex for anyone (or any group) to manage; they simply cannot gather, analyze, and act on the necessary mass of information in a timely fashion. In fact, this understates the problem: The most critical knowledge on which a society depends for its smooth operation—“knowing how” rather than “knowing that”—is widely dispersed and cannot be fully articulated. This is the “knowledge problem” emphasized by F. A. Hayek. Delegating power to cabinet members or agencies cannot solve that problem.

Consider the process by which a government policy is instituted. First, the goal must be clearly defined or the problem to be solved properly diagnosed. Next, a policy is formulated to achieve the goal or address the problem. Then a bill must make its way through Congress relatively intact. Once enacted, it has to be properly implemented and enforced. Finally, the policy’s impact must be monitored so that adjustments can be made in a timely manner. Performing any one of these steps successfully is difficult; performing all successfully is virtually impossible. And this only begins to identify the obstacles.

The chances of success decline rapidly as the complexity of the system to be controlled increases. Not only does predicting the impact of a given change become more difficult, but assessing the results also becomes harder. Did the policy really cause an observed behavior or was it the result of something else entirely? Further reducing the ability to determine cause and effect are the filters that ideology places on incoming information.

Ideological Filters

People use simplified models of the world to deal with its complexities. These models (aka paradigms, worldviews, or ideologies) provide logical frameworks for understanding cause and effect. Models also help filter out apparently unnecessary information from the flood of data we face every day, allowing us to concentrate on what we believe to be important. To the extent that our models are incorrect or only approximate reality, though, we can overlook important information that does not fit our worldview. This is known as “confirmation bias.”

Consider the CIA’s acceptance of the face the Soviet Union presented to the world during the 1970s, including its claim that its economy was enjoying an impressive 3 percent annual growth rate. President Ronald Reagan, familiar with free-market critiques of central planning, did not believe a command economy could work as well as the CIA thought. William Casey, Reagan’s CIA director, tasked agency analysts with exploring the possibility that the Soviet financial system was in fact crumbling. Specifically, Casey asked them what might be expected from a Soviet Union whose economy was shrinking.

The analysts speculated that popular discontent would rise. In response, Moscow would shift military spending to the civilian sector, perhaps by using steel to build locomotives instead of tanks. The Soviets might also purchase foreign technology to boost consumer-goods production, obtaining the necessary hard currency by increasing oil and gas sales to Europe.

Casey then asked analysts to determine whether any of these predicted signs of economic distress were in evidence. Within days, reports flowed in confirming the predictions. This data had long been available but was ignored as irrelevant given the assumption of a solid Soviet economy. (See articles by former intelligence official Herbert Meyer here and here.)

The lesson is not that models are inherently bad but that they must be periodically and critically examined to ensure they accurately mirror reality.

The Great Recession offers a more recent example of entrenched paradigms at work. There are many competing explanations for the current financial crunch: (1) an investment bubble produced by the Federal Reserve’s inflationary actions; (2) a housing bubble created by federal pressure on mortgage companies to lend to bad credit risks; (3) the federal government’s implicit backing of Freddie Mac, Fannie Mae, and other financial institutions, leading them to take excessive risks; (4) deregulation, notably the repeal of the Glass–Steagall Act; (5) unregulated derivatives trading; (6) housing speculators; (7) predatory lending; (8) Wall Street greed; and (9) tax cuts that allowed imprudent investments by wealthy individuals leading to a financial bubble.

Any of these views can be supported by citing isolated nuggets of carefully selected data. Predictably, libertarians and conservatives prefer explanations predicated on government failure. Proponents of government control favor theories rooted in market failure, while class warriors promote those blaming the rich in general and Wall Street in particular.

Theoretically, corrective policies based on each explanation could be implemented one after another. A policy’s success or failure might indicate whether the explanation on which it was based is correct. But a nation is not a laboratory, and uncertainty caused by such experimentation would bring the economy to a grinding halt. Furthermore, success or failure would not be conclusive. Opponents of a successful policy might argue that conditions improved despite, not because of, the action taken. Similarly, supporters of a failed policy could claim that things would have been far worse without it.

Rather than experimenting, policymakers might consult history to determine the results of similar past policies. Yet history is also seen through a filter. After 70 years of hindsight, economists and historians still argue whether market or governmental failure caused the Great Depression and whether the New Deal helped or hurt.

Politicians generally surround themselves with people who share their fundamental beliefs. The president’s staff controls the information he sees, and that information is likely to comport with their shared worldview. This alignment of “paradigm filters” exaggerates the importance of those bits of information that are consonant with the White House consensus and discounts those that are not. Failed programs are therefore more likely to be expanded than ended. The president and his advisers will want to believe that any problems were caused by insufficient funding or enforcement rather than an unsound worldview. Reinforcing this tendency is self-interest—admitting mistakes can shorten a politician’s career.

Increasing Efficiency, Dispersing Information

The notion that a president can oversee an economy is a fantasy. Unfortunately, although central planning has been discredited, Keynesian-style policies for maintaining employment or aggregate demand are still thought feasible—despite overwhelming contrary experience grounded in proper theory. But anything more complex than the most primitive economy simply is not amenable to such “assistance” from a central authority.

In Capital and Interest, Eugen von Böhm-Bawerk explained that economies become more efficient by employing increasingly “roundabout methods of production.” For example, a caveman could catch small animals for food with his bare hands, or he could increase his efficiency by using tools, perhaps using rocks or sticks as clubs. Hunting becomes marginally more complex, but the result is a bigger “harvest.” The caveman could raise his productivity further by crafting better tools—clubs, spears, snares, bows and arrows. It costs the caveman time and effort to construct tools and become proficient with them, but his investment is likely to be well rewarded.

The process of constructing hunting implements could itself be improved by fabricating tools such as knives and scrapers. The use of these tools is a further step removed from the process of hunting, constituting a yet more roundabout method of “producing” small game. This progression can be continued indefinitely as still other tools are created to facilitate the production of each new tool set.

Further efficiencies can be realized, as Adam Smith explained, through the division of labor. For example, while some cavemen hunt, others can concentrate on crafting snares or spears. With each improvement, either by creating new tools or further subdividing tasks, efficiency is increased, though at the cost of additional time and complexity. This process is repeated endlessly as economies advance.

In undeveloped countries, manufacturers must be relatively self-sufficient because suppliers and transportation are expensive and unreliable. This was true in the Soviet Union and in early twentieth-century America. The first U.S. automakers built their cars from the ground up. Nearly everything—nuts, bolts, springs, and engines—was made in a single factory. A company’s employees did everything from fabricating parts, to assembling them, to sweeping up afterward. As the nation’s economy and infrastructure developed, however, auto companies discovered they could make better cars at lower prices by purchasing components and services from specialized firms.

With inexpensive transportation, tools and subcomponents can now be fabricated far from final assembly points. Parts once built in one area of a plant then moved to another to be bolted onto a chassis are now transported from remote factories by ships, trains, and trucks over vast distances, often from other countries. Where once hundreds of companies helped to produce American cars, now tens of thousands from all over the globe help to produce far more vehicles of higher quality and with features unimaginable just a few decades ago.

With this explosion of companies comes an explosion of complexity. Those contributing to an end product’s manufacture may have no idea what that product is, where it will be built, or who will use it. Logistics is now key—ensuring that molded plastic parts, tires, paint, fasteners, adhesives, and countless other components from all over the world arrive at assembly lines in just the right number and at just the right time. All this complexity is managed by millions of people with local knowledge who quickly adapt to changes in everything from costs to the weather. None of this could be centrally directed by boards of bureaucrats incapable of even cataloging all the people, tasks, parts, and services involved before the list became outdated.

Managing the Unmanageable

As Hayek pointed out in his essay “The Use of Knowledge in Society,” the term “planned economy” is misleading. All economic activity is planned. The question is whether the planning is done by people on the scene with local knowledge and a stake in the outcome, or by remote bureaucrats with insufficient, outdated information and nothing to lose—bureaucrats ignorant enough to believe that people can be ordered like pieces on a chessboard and arrogant enough to try. Will planning be done by businesspeople who either replace faulty paradigms or fail, or by politicians holding fast to broken ideologies for fear of losing office?

Complex systems—from rainforests to economies—are less predictable than simpler ones. They are also harder to control because everything within them is interconnected. A tweak here or a prod there can have unintended and undesirable consequences. No one can anticipate how creative, entrepreneurial individuals will adjust their behavior to regulatory obstacles or stimulative measures. While a bad decision made at the local level can cause a manageable problem, that same decision made at the national level can create a nationwide or worldwide disaster.

The presidency has indeed grown beyond the capacity of any single individual. That is because government has ventured into areas where it has no business intruding. The answer is not to redistribute the government’s vast power but to radically reduce its power so that private individuals are free to control their own lives and property.