The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system . . . is . . . an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

Columbia University Professor Edmund S. Phelps, who won the 2006 Nobel Prize in economics, and his coauthor, Saifedean Ammous, assistant professor of economics at the Lebanese American University, write that the U.S. economy ceased to be a free market some time ago, yet the free market is blamed for the economic crisis. (The real question is whether the American economy was ever really free.)

Phelps and Ammous condemn corporatism unequivocally.

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic, wasteful, unproductive, and well-connected firms at the expense of dynamic newcomers and outsiders, and favors declared goals such as industrialization, economic development, and national greatness over individuals’ economic freedom and responsibility. Today, airlines, auto manufacturers, agricultural companies, media, investment banks, hedge funds, and much more has [sic] at some point been deemed too important to weather the free market on its own, receiving a helping hand from government in the name of the “public good.”

State-Chosen Goals

It’s great that their list includes the corporate state’s declaration of goals. Too many people are willing to accept government-set goals (such as energy independence) so long as the “private sector” is induced to achieve them. Regardless of how the goals are achieved, if government sets them, that’s statism.

The cost of corporatism is high, and Phelps and Ammous provide a partial list:

dysfunctional corporations that survive despite their gross inability to serve their customers; sclerotic economies with slow output growth, a dearth of engaging work, scant opportunities for young people; governments bankrupted by their efforts to palliate these problems; and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal.

Again, kudos to them for noting the increasing concentration of wealth. The corporate state, after all, is a form of exploitation, the victims of which are workers and consumers, who would have been better off (absolutely and comparatively) without anticompetitive privileges for the well-connected and government-induced recessions.

The authors are optimistic that time will work against the corporate state. Young people coming of age in the Internet’s decentralized and wide-open market of ideas and merchandise can’t be expected to show enthusiasm for a system that protects entrenched corporations from the forces of competition. Moreover “the legitimacy of corporatism is eroding along with the fiscal health of governments that have relied on it. If politicians cannot repeal corporatism, it will bury itself in debt and default….”

Capitalism versus the Freed Market

My main beef with Phelps and Ammous’s essay is their use of capitalism to name the economic system that corporatism corrupted. Like many others, they believe that word “used to mean” the free market. To be sure, it was used that way beginning in the mid-twentieth century. But there was an older usage (of capitalist specifically), coined by free-market liberals like Thomas Hodgskin who predated Marx, associating it with government privileges for the capital-owning class. That undertone has never left. (Long-time Freeman writer and historian Clarence B. Carson expressed misgivings about the word here.)

It’s tempting to dismiss this as mere semantics. But we are trying to communicate, aren’t we? Libertarian theorist Roderick Long, however, shows that more than semantics is involved. For Long, capitalism is what Ayn Rand called an anti-concept, a term that confuses rather than enlightens. One kind of anti-concept is the package deal, “referring to any term whose meaning conceals an implicit presupposition that certain things go together that in actuality do not.”

As a thought experiment, Long asks us to consider his coinage of zaxlebax, which he defines as “a metallic sphere, like the Washington Monument.”  Obviously this is incoherent. Nevertheless,

some linguistic subgroup might start using the term “zaxlebax” as though it just meant “metallic sphere,” or as though it just meant “something of the same kind as the Washington Monument.” And that’s fine. But my definition incorporates both, and thus conceals the false assumption that the Washington Monument is a metallic sphere; any attempt to use the term “zaxlebax,” meaning what I mean by it, involves the user in this false assumption.

Long sees capitalism in its common usage as similar.

By “capitalism” most people mean neither the free market simpliciter nor the prevailing neomercantilist system simpliciter. Rather, what most people mean by “capitalism” is this free-market system that currently prevails in the western world. In short, the term “capitalism” as generally used conceals an assumption that the prevailing system is a free market. And since the prevailing system is in fact one of government favoritism toward business, the ordinary use of the term carries with it the assumption that the free market is government favoritism toward business.

Similarly for socialism, Long writes. He thinks most people mean nothing more specific than “the opposite of capitalism.”

Then if “capitalism” is a package-deal term, so is “socialism” — it conveys opposition to the free market, and opposition to neomercantilism, as though these were one and the same.

And that, I suggest, is the function of these terms: to blur the distinction between the free market and neomercantilism. Such confusion prevails because it works to the advantage of the statist establishment: those who want to defend the free market can more easily be seduced into defending neomercantilism, and those who want to combat neomercantilism can more easily be seduced into combating the free market. Either way, the state remains secure.

In sum, the system that most immediately threatens individual liberty is corporatism (with its militarist component) and the word capitalism is too closely associated with corporatism in people’s minds to be useful to advocates of the freed market.

One commenter on Facebook noted that we should not be surprised that market critics expect perfection when so many economists and others use models that do indeed stress how markets solve problems “perfectly.”  This is quite correct, and it raises some points worth exploring in more detail.

The mainstream economists’ foremost model describes “perfect competition.” It shows how, under particular assumptions, markets will produce ideal results: Resources will all be allocated to their highest valued use, prices of goods will reflect marginal costs of production, and producers, knowing exactly what goods consumers want, will produce them at minimum average total costs.  Any firm that makes a profit above opportunity cost will attract in new rivals to compete away those excess profits.  The world of perfect competition is a world of optimal resource allocation across the board.

To get that result, the model requires five assumptions:

1. Everyone has perfect relevant information;
2. There is a large number of buyers and sellers so no one has monopoly power;
3. Each market has one perfectly identical product;
4. Everyone takes the price determined by the market as given;
5. There is costless mobility of resources.

Not in This World

Obviously these are extremely strong assumptions, pretty much none of which ever holds in the real world.  Not surprisingly, no part of the economy looks as perfect as the model predicts.  As Austrian economists have argued for decades, the fundamental problem with this model is that it misunderstands the nature of the economic problem.  In particular, by assuming everyone knows what they need to know and that firms are selling identical products, the model assumes away the discovery process at the heart of competition.  As F. A. Hayek wrote in “The Use of Knowledge in Society,” the fundamental problem facing us is a problem of the dispersion of knowledge.  Competition is justified by our very ignorance.  We need competition to figure out what demand is, what our costs are, and what sorts of products and features people want.

The deeper problem arises when economists and others confuse “perfect competition” and “free markets.”  The perfect-competition model may well have a few useful elements to it, but it is only a model and not a description of how real-world competition will or should work.  To the extent that defenders of markets rely on the model to argue for free markets, they are setting themselves up for precisely the response I discussed last week: Markets are in fact never perfect.  If we premise our case for their desirability on their alleged perfection, our case will be impossible to make.

Antitrust Fallacy

Thankfully, this confusion of perfect competition with laissez faire is less common than it used to be.  However, in antitrust law there still is often a presumption that any behavior which seems to deviate from the ideal of perfect competition is highly suspect.  The government’s challenge to the proposed merger of AT&T and T-Mobile is a good example. The merger would indeed reduce the number of competitors, but from a more Austrian perspective, the merger would be pro-competitive since it would better enable the combined company to take on Verizon.  Using the perfect-competition model as the goal of competition policy confuses the model with actual competitive processes and leads to really big policy errors.  As Robert Bork once said, using antitrust to make the economy look like perfect competition would have roughly the same effect as several well-placed nuclear weapons.

Defenders of markets make a mistake when they rely on perfect competition and similar models to defend free markets.  The perfect-competition model assumes away the key function of actual competition, which is to discover the very things the model takes as given.  Economists who ignore this point, as well as the messiness of markets, have no one to blame but themselves when the unavoidable imperfections of the market’s discovery process become the critics’ reasons for rejecting it.

The Market

It is customary to speak metaphorically of the automatic and anonymous forces actuating the “mechanism” of the market. Such metaphors disregard the fact that the only factors directing the market and the determination of prices are purposive acts of men. There is no automatism; there are only men consciously and deliberately aiming at ends chosen.

The market is a social body; it is the foremost social body. Everybody in acting serves his fellow citizens. Everybody, on the other hand, is served by his fellow citizens. Everybody is both a means and an end in himself, an ultimate end for himself and a means to other people in their endeavors to attain their own ends.

Each man is free; nobody is subject to a despot. Of his own accord the individual integrates himself into the cooperative system. The market directs him and reveals to him in what way he can best promote his own welfare as well as that of other people. The market is supreme. The market alone puts the whole social system in order and provides it with sense and meaning.

The market is not a place, a thing or a collective entity. The market is a process, actuated by the interplay of the actions of the various individuals cooperating under the division of labor.

The recurrence of individual acts of exchange generates the market step by step with the evolution of the division of labor within a society based on private property. Such exchanges can be effected only if each party values what he receives more highly than what he gives away.

The divisibility of money, unlimited for all practical purposes, makes it possible to determine the exchange ratios with nicety.

The market process is coherent and indivisible. It is an indissoluble intertwinement of actions and reactions, of moves and countermoves. But the insufficiency of our mental abilities enjoins upon us the necessity of dividing it into parts and analyzing each of these parts separately. In resorting to such artificial cleavages we must never forget that the seemingly autonomous existence of these parts is an imaginary makeshift of our minds. They are only parts, that is, they cannot even be thought of as existing outside the structure of which they are parts.

The market economy as such does not respect political frontiers. Its field is the world. The market makes people rich or poor, determines who shall run the big plants and who shall scrub the floors, fixes how many people shall work in the copper mines and how many in the symphony orchestras. None of these decisions is made once and for all; they are revocable every day. The selective process never stops.

To assign to everybody his proper place in society is the task of the consumers. Their buying and abstention from buying is instrumental in determining each individual’s social position. The consumers determine ultimately not only the prices of the consumers’ goods, but no less the prices of all factors of production. They determine the income of every member of the market economy. The consumers, not the entrepreneurs, pay ultimately the wages earned by every worker, the glamorous movie star as well as the charwoman. It is true, in the market the various consumers have not the same voting right. The rich cast more votes than the poorer citizens. But this inequality is itself the outcome of a previous voting process.

If a businessman does not strictly obey the orders of the public as they are conveyed to him by the structure of market prices, he suffers losses, he goes bankrupt. Other men who did better in satisfying the demand of the consumers replace him.

The consumers make poor people rich and rich people poor. They determine precisely what should be produced, in what quality, and in what quantities. They are merciless bosses, full of whims and fancies, changeable and unpredictable. They do not care one whit for past merit and vested interests.

Market prices tell producers what to produce, how to produce, and in what quantity. The market is the focal point to which activities of the individuals converge. It is the center from which the activities of individuals radiate.

The market economy, or capitalism, as it is usually called, and the socialist economy preclude one another. There is no mixture of the two systems possible or thinkable; there is no such thing as a mixed economy, a system that would be in part capitalistic and in part socialist. The market economy is the product of a long evolutionary process. It is the strategy, as it were, by the application of which man has triumphantly progressed from savagery to civilization.

Praxeology

It is no longer possible to define neatly the boundaries between the kind of action which is the proper field of economic science in the narrower sense, and other action.

Acting man is always concerned with both “material” and “ideal” things. He chooses between alternatives. No matter whether they are to be classified as material or ideal.

The general theory of choice is much more than merely a theory of the “economic side” of human endeavors and of man’s striving for commodities and an improvement in his material well-being. It is the science of every kind of human action. Choosing determines all human decisions.

Out of the political economy of the classical school emerges the general theory of human action, praxeology. The economic or catallactic problems are imbedded in a more general science, and can no longer be severed from this connection. No treatment of economic problems proper can avoid starting from acts of choice; economics becomes a part, although the hitherto best elaborated part, of a more universal science, praxeology.

Praxeology—and consequently economics too—is a deductive system. It draws its strength from the starting point of its deductions, from the category of action. No economic theorem can be considered sound that is not solidly fastened upon this foundation by an irrefutable chain of reasoning. A statement proclaimed without such a connection is arbitrary and floats in midair. It is impossible to deal with a special segment of economics if one does not encase it in a complete system of action.

The empirical sciences start from singular events and proceed from the unique and individual to the more universal. Their treatment is subject to specialization. They can deal with segments without paying attention to the whole field. The economist must never be a specialist. In dealing with any problem he must always fix his glance upon the whole system.

In speaking of the laws of nature we have in mind the fact that there prevails an inexorable interconnectedness of physical and biological phenomena and that acting man must submit to this regularity if he wants to succeed. In speaking of the laws of human action we refer to the fact that such an inexorable interconnectedness of phenomena is present also in the field of human action as such and that acting man must recognize this regularity too if he wants to succeed.

In physics we are faced with changes occurring in various sense phenomena. We discover a regularity in the sequence of these changes and these observations lead us to the construction of a science of physics.

In praxeology the first fact we know is that men are purposively intent upon bringing about some changes. It is this knowledge that integrates the subject matter of praxeology and differentiates it from the subject matter of the natural sciences. We know the forces behind the changes, and this aprioristic knowledge leads us to a cognition of the praxeological process. The physicist does not know what electricity “is.” He knows only phenomena attributed to something called electricity. But the economist knows what actuates the market process. It is only thanks to this knowledge that he is in a position to distinguish market phenomena from other phenomena and to describe the market process.

Praxeology is a theoretical and systematic, not a historical, science. Its statements and propositions are not derived from experience. They are, like those of logic and mathematics, a priori. They are not subject to verification or falsification on the ground of experience and facts.

The teachings of praxeology and economics are valid for every human action without regard to its underlying motives, causes, and goals. The ultimate judgments of value and the ultimate ends of human action are given for any kind of scientific inquiry; they are not open to any further analysis. Praxeology deals with the ways and means chosen for the attainment of such ultimate ends. Its object is means, not ends. The only standard which it applies is whether or not the means chosen are fit for the attainment of the ends aimed at.

Only the insane venture to disregard physical and biological laws. But it is quite common to disdain praxeological laws. Rulers do not like to admit that their power is restricted by any laws other than those of physics and biology. They never ascribe their failures and frustrations to the violation of economic law.

Profit and Loss

Profits are the driving force of the market economy. The greater the profits, the better the needs of the consumers are supplied. For profits can only be reaped by removing discrepancies between the demands of the consumers and the previous state of production activities. He who serves the public best, makes the highest profits. In fighting profits governments deliberately sabotage the operation of the market economy.

The profits of those who have produced goods and services for which the buyers scramble are not the source of the losses of those who have brought to the market commodities in the purchase of which the public is not prepared to pay the full amount of production costs expended. These losses are caused by the lack of insight displayed in anticipating the future state of the market and the demand of the consumers.

There are in the market economy no conflicts between the interests of the buyers and sellers. There are disadvantages caused by inadequate foresight. It would be a universal boon if every man and all members of the market society would always foresee future conditions correctly and in time and act accordingly. However, man is not omniscient. It is wrong to look at these problems from the point of view of resentment and envy.

If profits were to be curtailed for the benefit of those whom a change in the data has injured, the adjustment of supply to demand would not be improved but impaired. If one were to prevent doctors from occasionally earning high fees, one would not increase but rather decrease the number of those choosing the medical profession.

Profit and loss are favorable to some members of society and unfavorable to others. Hence, people concluded, the gain of one man is the damage of another; no man profits but by the loss of others. This dogma is at the bottom of all modern doctrines teaching that there prevails, within the frame of the market economy, an irreconcilable conflict among the interests of any nation and those of all other nations. It is entirely wrong with regard to any kind of entrepreneurial profit or loss.

What produces a man’s profit in the course of affairs within an unhampered market society is not his fellow citizen’s plight and distress, but the fact that he alleviates or entirely removes what causes his fellow citizen’s uneasiness. What hurts the sick is the plague, not the physician who treats the disease. The doctor’s gain is not an outcome of the epidemics, but the aid he gives to those afflicted.

An excess of the total amount of profits over that of losses is a proof of the fact that there is economic progress and improvement in the standard of living of all strata of the population. The greater this excess is, the greater is the increment in general prosperity. Entrepreneurial profits and losses are essential phenomena of the market economy. There cannot be a market economy without them.

It is absurd to speak of a “rate of profit” or a “normal rate of profit.” Profit is not related to or dependent on the amount of capital employed by the entrepreneur. Capital does not “beget” profit. Profit and loss are entirely determined by the success or failure of the entrepreneur to adjust production to the demand of the consumers. Entrepreneurial profits are not a lasting phenomenon but only temporary. There prevails an inherent tendency for profits and losses to disappear.

The entrepreneurial function, the striving of entrepreneurs after profits, is the driving power in the market economy. Profit and loss are the devices by means of which the consumers exercise their supremacy on the market. The behavior of the consumers makes profits and losses appear and thereby shifts ownership of the means of production from the hands of the less efficient into those of the more efficient.

Production for profit is necessarily production for use, as profits can only be earned by providing the consumers with those things they most urgently want to use.

Money

Money is a medium of exchange.

A medium of exchange is a good which people acquire neither for their own consumption nor for employment in their own production activities, but with the intention of exchanging it at a later date against those goods which they want to use either for consumption or for production. Nothing can enter into the function of a medium of exchange which was not already previously an economic good to which people assigned exchange value before it was demanded as such a medium. Money is the thing which serves as the generally accepted and commonly used medium of exchange. This is its only function. All other functions which people ascribe to money are merely particular aspects of its primary and sole function, that of a medium of exchange.

What is employed as money is a commodity which is used also for nonmonetary purposes. Under the gold standard, gold is money and money is gold.

A medium of exchange is a good which people acquire neither for their own consumption nor for employment in their own production activities, but with the intention of exchanging it at a later date against those goods which they want to use either for consumption or for production. Nothing can enter into the function of a medium of exchange which was not already previously an economic good to which people assigned exchange value before it was demanded as such a medium. Money is the thing which serves as the generally accepted and commonly used medium of exchange. This is its only function. All other functions which people ascribe to money are merely particular aspects of its primary and sole function, that of a medium of exchange. What is employed as money is a commodity which is used also for nonmonetary purposes. Under the gold standard, gold is money and money is gold.

It is immaterial whether or not the laws assign legal tender quality only to gold coins minted by the government.What counts is that these coins really contain a fixed weight of gold and that every quantity of bullion can be transformed into coins. Under the gold standard the dollar and the pound sterling were merely names for a definite weight of gold.We call such a money commodity money.

A second sort of money is credit money. Credit money evolved out of the use of money substitutes. It was customary to use claims, payable on demand and absolutely secure, as substitutes for the sum of money to which they gave claim.

As long as these claims had been daily maturing claims against a debtor of undisputed solvency and could be collected without notice and free of expense, their exchange value was equal to their face value; it was this perfect equivalence which assigned to them the character of money substitutes.

Fiat money is money consisting of mere tokens which can neither be employed for any industrial purposes nor convey a claim against anybody. The important thing to be remembered is that with every sort of money, demonetization—i.e., the abandonment of its use as a medium of exchange—must result in a serious fall of its exchange value.

In the course of history various commodities have been employed as media of exchange. A long evolution eliminated the greater part of these commodities from the monetary function. Only two, the precious metals gold and silver, remained. In the second part of the nineteenth century more and more governments deliberately turned toward the demonetization of silver.

The choice of the good to be employed as a medium of exchange and as money is never indifferent. It determines the course of the cash-induced changes in purchasing power. The question is only who should make the choice: the people buying and selling on the market, or the government? It was the market which in a selective process, going on for ages, finally assigned to the precious metals gold and silver the character of money. For two hundred years the governments have interfered with the market’s choice of the money medium. Even the most bigoted étatists [statists] do not venture to assert that this interference has proved beneficial.

I’ve heard that story before, but this time it got me thinking: Would the free-market movement have been perceived differently by the outside world if Mises had used the other title? With the question phrased so narrowly, the answer is probably no. So let’s broaden it: Would the free-market movement be perceived differently if its dominant theme was social cooperation rather than (rugged) individualism, self-reliance, independence, and other synonyms we’re so fond of?

Maybe.

There’s no mystery why that other title occurred to Mises. I haven’t tried to make a count, but I would guess that “social cooperation” (or “human cooperation”) is the second most-used phrase in the book. First is probably “division of labor,” which is another way of saying “social cooperation.” Human Action is about social cooperation or it isn’t about anything at all. The first matter Mises takes up after his opening disquisition on the nature of action itself is … cooperation. He begins, “Society is concerted action, cooperation…. It substitutes collaboration for the – at least conceivable – isolated life of individuals. Society is division of labor and combination of labor. In his capacity as an acting animal man becomes a social animal.”

The Need for Peace

It is through cooperation and the division of labor that we all can live better lives. Naturally, he laid great stress on the need for peace. The absence of peace is the breakdown of that vital cooperation. This put Mises squarely in the pacifistic classical-liberal tradition as exemplified by Richard Cobden, John Bright, Frédéric Bastiat, Herbert Spencer, and William Graham Sumner. Mises writes in Liberalism:

The liberal critique of the argument in favor of war is fundamentally different from that of the humanitarians. It starts from the premise that not war, but peace, is the father of all things. What alone enables mankind to advance and distinguishes man from the animals is social cooperation. It is labor alone that is productive: it creates wealth and therewith lays the outward foundations for the inward flowering of man. War only destroys; it cannot create. War, carnage, destruction, and devastation we have in common with the predatory beasts of the jungle; constructive labor is our distinctively human characteristic. The liberal abhors war, not, like the humanitarian, in spite of the fact that it has beneficial consequences, but because it has only harmful ones.

Given Mises’s orientation, it is unsurprising to see him attach so much importance to what he calls the Ricardian Law of Association. This is known as the law of comparative advantage (or cost), which states that two parties can gain from trade even if one is more efficient at making every product they both want.

The key is opportunity cost. A $500-an-hour lawyer who is also the fastest, most accurate typist in the world will find it advantageous to hire a typist. Why? Because every hour the lawyer spends typing instead of practicing law costs him $500 minus what he would have paid a typist. The typist faces no such opportunity cost. So lawyer and typist both benefit by cooperating. This is true of groups (countries) too. People will discover the benefits of concentrating on what, comparatively, they make most efficiently (or least inefficiently) and trading with others. As a result more total goods will be produced than could be attained without the division of labor and social cooperation.

Broader Application

This law is an important part of the argument for free international trade because it answers the objection that a national group that can’t make anything as efficiently (absolutely) as others will be left out of the world economy. But Mises understood that the law of comparative advantage was merely an application of the broader law of association. As he wrote in Human Action:

The law of association makes us comprehend the tendencies which resulted in the progressive intensification of human cooperation. We conceive what incentive induced people not to consider themselves simply as rivals in a struggle for the appropriation of the limited supply of means of subsistence made available by nature. We realize what has impelled them and permanently impels them to consort with one another for the sake of cooperation. Every step forward on the way to a more developed mode of the division of labor serves the interests of all participants. In order to comprehend why man did not remain solitary, searching like the animals for food and shelter for himself only and at most also for his consort and his helpless infants, we do not need to have recourse to a miraculous interference of the Deity or to the empty hypostasis of an innate urge toward association. Neither are we forced to assume that the isolated individuals or primitive hordes one day pledged themselves by a contract to establish social bonds. The factor that brought about primitive society and daily works toward its progressive intensification is human action that is animated by the insight into the higher productivity of labor achieved under the division of labor.

This seemingly simple idea leads to counterintuitive conclusions. As a result of expanding cooperation, human beings compete to produce, not to consume (as other animals do). Mises expressed this with my favorite sentence in Human Action: “The fact that my fellow man wants to acquire shoes as I do, does not make it harder for me to get shoes, but easier.” The expansion of cooperation also necessarily means we can deal with strangers at great distance – a further incentive for peace. (See Steven Horwitz’s previous column on this subject.)

Unfortunately, the emphasis on cooperation is not what nonlibertarians are likely to “know” about free-market economics and the normative freedom philosophy. They are more apt to associate these with “rugged individualism” than “social cooperation.” I have no doubt that a major reason for this is that our opponents who know better want the public to have a distorted sense of the genuinely liberal worldview. When President Bill Clinton declared (disingenuously) in his 1996 state of the union address, “The era of big government is over,” he followed up that sentence with this: “But we can’t go back to the era of fending for yourself.” But human beings have always been social/political animals. There was no era when men and women fended for themselves individually. The choice was between free and forced association.

The Fault in Ourselves

Of course libertarians and free-market advocates do emphasize the importance of the division of labor. Nevertheless we are partly responsible for the public misperception. Our rhetoric too often implies atomism, however inadvertently. (The appropriate individualism is molecular individualism.) I understand the value of the terms “individualism,” “self-reliance,” and “independence,” but we should realize that they can easily lead to undesirable caricatures. Let’s not encourage anyone to think that the libertarian ideal is Ted Kaczynski minus the mail bombs.

We’re all grappling with an uncertain future. Social cooperation unquestionably makes that task easier than if we attempted to go it alone. That’s why individuals formed mutual-aid (fraternal) organizations. Besides camaraderie, these groups provided what the welfare state feebly and coercively provides today: islands of relative security in a sea of uncertainty. (Peter Kropotkin’s Mutual Aid is worthwhile reading.)

If people support the welfare state, don’t be puzzled. It’s because they cannot see a better voluntarist alternative. That’s where libertarians come in.

We libertarians might have an easier time persuading others if we emphasized that freedom produces ever-more innovative ways to cooperate for mutual benefit and that when government dominates life, social cooperation is imperiled.

Google appears to have created a legitimate challenge to Facebook’s dominance over the social networking market. Haters of Facebook are already predicting its demise once people realize how vastly superior Google+ is. Facebook defenders are arguing that it will take too long for enough people to sign up to make it dense enough, or that Google’s privacy protections aren’t so great, or that the software is too buggy, or any of a bunch of other things. The Google+ folks are convinced it will “kill” Facebook, while the Facebook partisans keep pointing out the failures of prior Google innovations, such as Google Wave.

Beneficial Unintended Consequences

All this bickering misses the bigger picture, which is that whatever the outcome of this competition, we will all be winners thanks to the beneficial unintended consequences of competition. Competition, as F.A. Hayek argued years ago, is a discovery process through which firms learn what their customers want and customers learn what sorts of products and features best serve their needs.

Part of what drove Google to create a competitor was the belief that Facebook lacked or poorly implemented some features and that providing them competently would attract people. The most obvious of these is Google+’s “circles,” which give users easier and more precise control over which friends see or don’t see particular things they wish to share. Facebook does not allow users to direct posts to subgroups of friends, and Google believes enough users find this sufficiently frustrating that they will jump to a network that does. This is just one example.

Google’s innovation will produce one of four outcomes: 1) So many people think “circles” are valuable that they jump to Google +, leaving Facebook to become the next MySpace, consigned to the back corner of the Internet; 2) most people don’t find that “circles” or other innovations add sufficient value, so Google+ becomes the next Google Wave and dies a quiet death; 3) Facebook realizes the value added by “circles” and introduces something similar (note Facebook’s partnership with Skype, a preemptive strike against the video chat capabilities of Google+); 4) some people prefer “circles” and others prefer Facebook so the two coexist like the Coke and Pepsi of the 21st century. The important point is that no matter which outcome emerges, most people will get what they want.

What Do We Want?

The beauty of competition is that it is how we find out what people want. Google’s executives are not certain that users will prefer “circles,” although they are confident enough to roll out the software. The only way they will know for sure is the market test: Will the differences with Facebook be attractive enough for people to join up? It’s also worth noting that this is not an either-or choice – just because you think Google+ is better doesn’t mean you have to give up Facebook. It’s possible they will turn out to be complements not substitutes. Some people drink Coke and Pepsi.

The broader lesson here is the importance of freedom of entry. Having had the market largely to itself for so long, Facebook may well have become unresponsive to users. Google’s ability to create a meaningful competitor is what will force Facebook to innovate, even if Google+ fails in the long run. This is why we need to be wary of complaints about firms being “too big.” If a firm like Google couldn’t leverage its size and unique market position to pose an effective competitor to Apple in the smartphone market or Facebook in the social network world, we would lose the competitive threat that keeps incumbents innovating.

The irony is that breaking up a large firm to avoid monopoly can enable monopolies elsewhere by removing that firm as a competitor. As the battle of the new century unfolds in the months to come, we should all celebrate that free entry and competition have their way and that we will all learn what people want in social networking. That’s a battle that everyone will win.

The usual dichotomy is between the “unregulated” or “deregulated” market and the “regulated” market, which includes significant government intervention.  Advocates of free markets have long made the case for the advantages of unregulated markets and exposed the problems associated with regulation, often using spontaneous-order arguments.  The fundamental insight of economics from Adam Smith forward has been that free markets are capable of producing order without design.  We do not need “regulation” in the sense of State intervention for markets to generate socially beneficial outcomes.  And when we do attempt to “regulate” them through the State, the result is a variety of undesirable unintended consequences.

Order without Design

This is all correct, of course, but it misses an opportunity to emphasize even more strongly the idea that markets produce order without design.  The language of “unregulated” or “deregulated” markets makes it difficult to talk about order without design because those very words seem to suggest that there is no order to the marketplace. A “regulated market” in contrast sounds orderly.  I think we can get around this problem by arguing that free markets are in fact highly regulated and that government-“regulated” markets often lack any meaningful regulation.

Merriam-Webster offers this definition of “regulate” first:  “to govern or direct according to rule.”  It also includes a second definition: “to bring order, method, or uniformity to.”  One understanding of “regulated” is that some process operates according to a rule or rules and thereby is orderly.  This is the sense we use when we talk about a regulated physical process being predictable and orderly, or to describe something that repeats in predictable ways, for example, “our regular waiter” at the local restaurant.

In this sense, free markets are indeed highly regulated.  Economic theory demonstrates that free markets operate according to rules that we can recognize and understand.  These rules enable us to make what F. A. Hayek called “pattern predictions” about the behavior of markets.  We know, for example, that when price rises, all else constant, quantity demanded will fall, or that above-normal profits in an industry will bring new sellers into that market — even if we cannot predict either outcome precisely.  Market participants will not act haphazardly, nor will outcomes be chaotic.  People’s behavior is regulated by the laws of economics, which in turn produce orderly patterns.

Government attempts to improve on markets are often described as “regulation.”  In some sense this is accurate: Government does try to impose its own set of rules that are intended to produce something more orderly in the eyes of the regulators.  In addition, economists can make similar pattern predictions about the unintended and undesirable results of that regulation, for example that a price ceiling set below the market-clearing price will produce a shortage.

State Reduces Order

However, we could also argue that such intervention reduces the level of regulation in the market because intervention invariably puts a great deal of discretion in the hands of both the “regulators” and those being regulated.  Are “regulated” markets more predictable than “unregulated” ones?  Is it easier for entrepreneurs to anticipate the actions of bureaucrats with discretionary powers or of competitors seeking profits according to the rules of the marketplace?  Is behavior more “regular” when firms are genuinely profit-seeking or when they attempt to manipulate the “regulators” through rent-seeking?  Bob Higgs’s concept of “regime uncertainty” captures how government intervention makes markets less regulated by undermining rules that generate predictability for participants.

In the free market truly competitive firms can’t simply do whatever they wish, at least not if they want to make profits and continue as viable enterprises.  Their desire to make profits regulates their behavior in ways that drive them to serve consumers by expanding and diversifying output and reducing prices.  In contrast to the implicit picture of “unregulated” markets in which firms can do whatever they wish, economics depicts the free market as governed by clear rules.

Years ago, Hayek pointed out that the question facing societies is not “to plan or not to plan” but “who should plan – individuals and firms or the state?” Similarly, the question is not to regulate or not to regulate, but which type of regulation – market rules or State discretion – works better.

In other words, free markets are regulated.

It’s a topsy-turvy world. “Anarchists” protest cuts in government spending, while “socialists” live in the lap of luxury, including $3,000-a-night Manhattan hotel suites, working, in at least one celebrated case, to impose corporatist-flavored “neoliberalism” on the troubled countries of the world.

The sex scandal involving the just-departed International Monetary Fund director, Dominique Strauss-Kah,n is of course no reason to abolish the agency – but then we didn’t need another reason. The agency, centerpiece of J. M. Keynes’s postwar inflationary Bretton Woods brainchild, should never have been created in the first place, since it was another calculated step toward global government-controlled money. Its re-creation after its original mandate – maintaining the system of dollar- based fixed exchanges rates – became obsolete 40 years ago is a textbook case of bureaucratic mission creep, but its existence is no more justified by the new mission – a 9-1-1 for profligate, debt-ridden governments — than it was by the old one.

The IMF has 187 member governments, which together this year have provided $340 billion to the agency. Each country is assigned a contribution quota and a vote count weighted roughly according to its quota. The U.S. government’s financial quota is over 17 percent of the total, almost three times that of the second largest contributor, Japan. It controls 16.74 percent of the votes, with Japan, at 6.01, next in line. Treasury Secretary Timothy Geithner is the U.S. member of the board of governors, with Federal Reserve Chairman Ben Bernanke as alternate governor. This should be enough to establish that the IMF’s agenda is not free markets.

Funded by Force

All IMF money comes from the taxpayers and central bank printing presses. So there’s the first charge against it: It’s financed through compulsion. That should our shape our expectations about the agency.

What does the IMF do? In The White Man’s Burden, former World Bank economist William Easterly calls the IMF “the West’s most powerful agency for dealing with many poor countries.” No cause for optimism there. Here’s how it describes its mission:

• Surveillance: “oversees the international monetary system and monitors the financial and economic policies of its members”;
• Technical assistance: “assist[s] mainly low- and middle-income countries in effectively managing their economies”; and
• Lending: “provides loans to countries that have trouble meeting their international payments and cannot otherwise find sufficient financing on affordable terms.”

Regarding the first, the IMF has been notoriously bad at foreseeing crises. But that should not be surprising. Why would bureaucrats living rather well off the taxpayers, with no personal capital at risk, be expected to be competent at spotting economic trouble? Did any official agency of the U.S. government foresee the housing bubble and its explosion? Bureaucrats can’t know what they need to know because the crucial knowledge is particular to time and place – and most of the time unarticulated.

Who Advises Whom?

The promise of “technical assistance” is dubious and even risible because the dominant countries of the world can hardly be said to have “effectively” managed their own economies. Who’s giving this advice? The knowledge problem strikes again. The IMF often advises distressed countries to raise taxes – except corporate taxes – and to cut government spending to reduce budget deficits, upsetting both Keynesians and supply-siders. This is regarded as market-oriented, or neoliberal, advice, but to the extent that externally imposed measures engender public resentment, they give real market reform a bad name and set back the cause of genuine liberalism.

For example, the IMF may advise a government to remove price controls on food, which in itself would be a pro-market measure if accompanied by other reforms. However, if corresponding government-created scarcities — through licensing, franchises, patents, and so on — remain in place, average people will suffer and blame “the free market.” Food riots occurred some years ago in Egypt under just such circumstances, and as a result market reforms are widely distrusted there. Easterly calls such violence “IMF riots.” The IMF says it obliges its clients to soften the blow by “strengthen[ing] the use of resources for social safety nets.”

IMF loans constitute a double bailout. First, they save kleptocratic politicians from the consequences of their exploitative schemes, sparing them the necessity of the radical reform these countries badly need — including land reform and free banking. (Can you see Geithner or Bernanke pushing  those?)

Second, IMF loans rescue the failing country’s creditors – Wall Street banks typically – from a government default on its debts. In addition, U.S. agricultural interests have supported increased support for the IMF in order to stimulate American farm exports. In 2009 the debate over increased U.S. funding of the IMF was framed in the context of pushing an export-led American economic recovery.

This is surely doing well by doing good– with the taxpayers’ money.

Who pays? Aside from the taxpayers who supply the IMF with money, the tab is eventually paid by the working people of the subject countries through the higher taxes prescribed by the IMF.

Planner’s Mentality

Easterly writes,

[The IMF’s] core function of enforcing financial discipline is flawed by an intrusive Planner’s mentality that sets arbitrary numerical targets for key indicators of government behavior. Like all Planners, the IMF fits the complex reality of economic systems into a Procrustean bed of numerical targets that have little to do with that complexity. The conditions on its loans often roil internal politics in a way that is much too intrusive. And in the end, it is not even clear that the conditions contribute to the repayment of the loans.

The knowledge problem is pervasive.

The IMF emphasizes that loans always come with “conditionality,” but for reasons already alluded to, that should be of little reassurance to advocates of free markets. The agency notes that it uses the principle of “parsimony” when writing conditions: “program-related conditions should be limited to the minimum necessary to achieve the goals of the Fund-supported program….” Thus the deepest violations of individual liberty and market principles – feudal land distribution, for example – will be left untouched. Real markets don’t exist when large tracts of land are controlled by a privileged elite, leaving most people little choice but to take whatever is given. Their acceptance may represent the “best available option,” but if their choice set has been artificially constricted, that’s not saying much. (Fortunately, the informal economy offers some hope.)

IMF loans of course channel resources to central governments, reinforcing their power and further politicizing the “aided” countries. As P. T. Bauer wrote,

Foreign aid has thus done much to politicize life in the Third World. And when social and economic life is extensively politicized, who has the power becomes supremely important, sometimes a matter of life and death…. In such conditions, people at large, especially those who are alert or ambitious, become much concerned with what happens in politics and in public administration, as decisions taken there come crucially to affect their livelihood…. People divert their resources and attention from productive activity into other areas, such as trying to forecast political developments, placating or bribing politicians and civil servants, operating or evading controls.

In the end the IMF has fostered long-term dependency, perpetual indebtedness, moral hazard, and politicization, while discrediting market reform and forestalling revolutionary liberal change. The solution is not for the IMF to impose free markets, even if it could. That would smack of imperialism and, writes Easterly, would have “patronizing echoes of the White Man’s Burden.”

The IMF should be scrapped and the people suffering under kleptocracy left to discover the requirements for improving their own conditions. How much more “help” can they stand?

What’s interesting about this argument is that it’s almost always applied to immigration but rarely to native population growth.  If the claim were true, every child born in the United States (at least in excess of the death rate) would someday take a job from a working adult when he enters the labor market in adulthood .  If markets can find work for the native born, why can’t they do the same for immigrants?

To see through the fallacy we need a little economic theory.  According to economists, wages are determined by the value of a worker’s marginal product, or VMP. We look at how many units of output are added by hiring that worker and multiply that number by the value of the output to determine the value of the marginal product.

Neither More Nor Less

Employers will be unwilling to pay workers more than their VMP because that would mean spending more than the workers earn for them.  The risk to paying workers less than their VMP is that a competitor could bid them away, making a small profit by paying them that slightly higher wages and collecting the revenue the workers add.  So wages and VMPs tend to be closely related.

This means that in a genuinely free market there is always a job for anyone whose VMP is greater than zero. Even the least-skilled worker, say a teenager who can produce only three dollars worth of output an hour, is potentially employable at a wage just under that VMP.  Or consider someone with a physical or mental disability.  That person may be capable of producing only a limited amount of value per hour, but in a genuinely free market he or she can find work at a wage just under that amount.  This insight, combined with the idea that each of us has some comparative advantage, shows that every productive person has a way to contribute to society and be compensated for it.  It’s one of the great things about free markets.

The job you get is not taken from someone else.  (Even the person who loses out to someone else for a given job can find another one if his or her VMP is positive.) Firms will be willing to hire additional employees if they believe those workers will create a bit more value than the wage paid (including, to be technical, the costs of hiring them).  After all, the U.S. economy had no problem finding jobs for the massive influx of women into the labor force in the twentieth century, not to mention the various waves of immigrants.  There is always work to be done to provide the goods and services people want, and where employers are free to pay people a wage commensurate with their VMPs, that work will mean jobs.

Less-than-Free Market

Of course this is not how things work in our less-than-free market.  Teenagers, the disabled, those with little education, new immigrants with limited language and other skills, as well as other groups, often have trouble finding work because their VMPs do not exceed the minimum wage or other minimum compensation laws.  As economists like to point out, minimum wage laws are really minimum productivity laws.  They essentially say that those whose VMPs are less than the legislated wage may not work.

Considering that such laws cause unemployment, it is ironic that they are supported out of supposed compassion for low-skilled workers in order to prevent exploitation.  Real exploitation comes from laws that prevent perfectly productive people from contributing to the well-being of others, consigning them to lives of unemployment and perceived inadequacy. Cutting off the bottom rungs of the income ladder also prevents these folks from gaining valuable job skills and moving from their current low wage to a level of compensation that will enable them to live progressively better and more independently. Compassion should be judged by results not intentions.

Free markets by contrast have room for everyone.  If you can create pretty much any amount of value, there’s a wage at which you can be hired and a job for you to do.  Jobs aren’t a zero-sum game. On the contrary, they are as limitless as human wants and human creativity  – as long as people are free.

Freeing the market is the best way to create security.

FEE Timely Classic
“A Free-Market Energy Vision” by Robert L. Bradley Jr.

This issue came up briefly in a recent installment of the excellent podcast series “EconTalk,” when George Mason University professor Russ Roberts interviewed Australian economist John Quiggin, author of Zombie Economics: How Dead Ideas Still Walk among Us. Quiggin, a social democrat, thinks free-market ideas should be seen as a casualty of the late financial crisis, yet those ideas continue to stalk the world: Hence, they constitute “zombie economics.” He favors vigorous government regulation of the financial industry because he assumes bailouts of big integrated financial companies are inevitable. The price of this safety net, he says, should be close oversight by the State. (Quiggin commits the Nirvana Fallacy — comparing “imperfect” real-world markets to idealized  but impossible regulatory regimes.)

Admirably, Roberts protested that since the federal government and the Federal Reserve have stood ready to bail out the influential creditors of financial companies at least since 1984, it can’t be that the free market has been tried and found wanting. After all, if there were no prospect of a bailout, creditors would monitor risk and act as a brake on reckless financial activity – they don’t want to lose their money. But if creditors can count on being rescued by the government or its central bank, they will not perform that watchdog role, as least not as vigilantly as they would in a free market. (See Roberts’s paper “Gambling with Other People’s Money.”)

So, Roberts asked Quiggin, “Why wouldn’t you simply be in favor of no bailouts? …We’ve never tried market liberalism, so why do you think we should go in a different direction?”

To which Quiggin responded: “Of course, we’ve never had a pure system of market liberalism but equally of course my remaining communist friends tell me we’ve never had pure communism. At some point you have to say this is as close as we are likely to get, and the contradictions only get worse.”

Glibberish

This is a glib answer, which Quiggin should be called on. One hears it often, and frankly it makes little sense. Right off the top, so what if communists say — defensively and incorrectly — that pure communism hasn’t been tried? That in no way undermines the proposition that the free market — particularly free banking — has not been allowed to exist in this century, and was not allowed in the last or the one before that either, and therefore that none of the depressions and other economic debacles that occurred in that time can be attributed to it.

For the record, communism – in the sense of a State-planned economy with the market essentially suppressed — was tried, certainly in Cambodia and North Korea, if not elsewhere. The results were disastrous. It was also tried during the postrevolutionary Soviet period known as War Communism. The result? “The country, and the government, were at the very edge of the abyss,” Trotsky said. So Lenin enacted his New Economic Policy, reintroducing money (a gold ruble) and allowing some independent entrepreneurship (by the NEPmen). (See my article “War Communism to NEP: The Road from Serfdom” [pdf]. For the full story, see Peter Boettke’s first book, The Political Economy of Soviet Socialism.)

As for a free market in banking, I see no reason to join Quiggin in saying, we are as “close as we are likely to get.” First, we have never been very close. Between the state and national governments, banking has always been substantially regulated in the United States. From the start it was one of the commanding heights of America’s “Merchant-state,” to use Albert Jay Nock’s term. Intrastate branch banking was long illegal, interstate banking was forbidden until 1994, and governments almost always had the power to cap interest rates and regulate the currency, even when gold played a role. Alexander Hamilton, James Madison, and Abraham Lincoln gave us national banks. Then came the Federal Reserve, followed 15 years later by the 1929 crash, which raised the curtain on the Great Depression and more regulation.

To say the latest financial debacle has roots in the free market is simply to confuse the competitive market economy with the corporate state, the competition-inhibiting partnership between influential businesses and government officials. Implicit taxpayer-backed guarantees to creditors, government-sponsored enterprises such as Fannie Mae and Freddie Mac, deposit insurance that anesthetizes depositor wariness, Fed-organized bank cartelization — none of this has anything to do with the free market.

Moreover, Quiggin is in no position to say that we’re as close as we’re going to get to the free market. How could he possibly know this? The government-sponsored banking cartel is a key party to an impending economic crisis that just might wake people up to the need to remove government from this realm in favor of market competition without privilege. Criticism of the Fed at the grassroots has never been harsher.

Finally, Quiggin did not say what contradictions he had in mind, but the theory and history of free banking, in the few places it has been given a chance, justify confidence that banking without government – that is, freedom — is not only possible but also practical and efficient – not to mention just. (For details see various works by Steven Horwitz, Lawrence H. White, and George Selgin.)

It is the failed doctrines of statism that constitute the zombies that still stalk us.