In like manner several commentators are singing the praises of the federal government lately, claiming that in the wake of recent natural disasters, federal agencies like the Federal Emergency Management Administration (FEMA) have done a fantastic job.

The Washington Post’s Dana Milbank is typical of the pro-government cheerleaders. “Big Government finally got one right,” writes Milbank of FEMA’s response to Hurricane Irene. Arguing that “the federal government can still do great things,” Milbank reckons that FEMA’s response to Irene should help restore the public’s sagging confidence in government. Yet despite this stellar government performance, wouldn’t you know, FEMA faces budget cuts at the behest of those scornful Tea Partiers in Congress. Thus instead of improving the federal government’s image in the eyes of citizens, FEMA’s newfound brilliance is liable to go unnoticed.

I’ll concede that Hurricane Irene was FEMA’s best showing ever. (We’re all still here, aren’t we?) This sudden outbreak of governmental competence notwithstanding, Milbank’s appraisal of FEMA as a model of salubrious big government is flawed on economic grounds. Resting his newly buttressed faith in big government on a sample size of n=1, Milbank precludes some highly relevant comparisons. Perhaps FEMA functioned well for once, but should we take this as the new normal for FEMA, or the exception to the rule? And even if we can count on a better FEMA, is federal government-centered emergency response the best we could possibly have?

It’s easy to say FEMA was better this time than in its dismal past. The agency’s infamous blundering response to Hurricane Katrina (a truly epic category 5 storm) would be comic if it weren’t so tragic. Bureaucratic ineptitude led to a hesitant response, as federal officials actually halted emergency supplies and workers coming into New Orleans in the days after the storm. FEMA arguably contributed directly to Katrina’s death toll of over 1,800 by blocking or overriding local evacuation efforts. FEMA’s top-heavy D.C. bureaucracy was roundly criticized as, well, a disaster.

In stark contrast, a slew of nonfederal response initiatives, from local government authorities to mega-corporations, brought in all manner of people and supplies quickly and effectively, where they were needed most. As Freeman contributor Steven Horwitz has amply documented, companies like Walmart were far more efficient and proactive than the centralized FEMA bureaucracy in getting relief goods to the people in need.

Horwitz and others have noted that incentive structures facing different organizations explain the difference between successful and bungled relief efforts. Those in decentralized competitive situations, such as retailers like Walmart, have the localized knowledge of what goods are needed and where, as well as profit-and-loss incentives motivating them to act on this knowledge. Folks in centralized bureaucracies, on the other hand, naturally lack intricate knowledge of the local details and tend to be motivated by political concerns in distributing the resources they do have.

The divergent results after Katrina are not surprising. While FEMA bureaucrats were halting relief convoys, misdirecting their own supplies, and hosting phony press conferences to placate the media, Walmart, Home Depot, and others were tracking the storm and massing supplies days in advance. They delegated authority to local store managers, some of whom took drastic steps to get their stores open and supplies flowing immediately.

Politicians’ knee-jerk response to government failure is, naturally, to increase their own budgets. But with bureaucracies facing such systematically bad incentives, increasing their budgets is not guaranteed to improve results. Nonetheless, Milbank frets about as-yet-unspecified potential cuts to FEMA’s budget. To put his worries into perspective let’s look at FEMA’s spending record over the last few years. In 2005—a year of at least three major hurricane strikes in the United States—FEMA spent around $4.8 billion. By 2010, a year with many hurricanes (but none making landfall in the United States), FEMA’s budget had been pumped up to a whopping $10.4 billion, and it was on pace to meet or exceed that number last year.

So FEMA’s budget has doubled since Katrina, and only now do we see basic competence, in relatively quiet disaster years? If FEMA faces another really harsh hurricane season—a repeat of 2005—and drops the ball again, does this mean its budget will again need to be doubled, to $20 billion? I can see the dollar signs in the bureaucrats’ eyes already. Indeed, as Public Choice economics predicts, and former Obama White House chief of staff Rahm Emmanuel conveniently admitted, big-spending bureaucrats like those in FEMA have strong incentives to “never let a crisis go to waste.” They thrive on crises as a primary rationale for larger budgets, even if they played a big hand in making such crises worse to begin with.

In light of this it’s not at all surprising that the number of “major disaster” declarations has been rising over time, even in years when nature is relatively calm. FEMA had already declared 78 disasters by the fall of 2011, 30 more than the mega-storm year of 2005. Because disaster declarations are a prerequisite for unlocking federal disaster funds, it’s not surprising that FEMA finds ways to define disaster down, or that the number of declarations goes up for election years and in politically sensitive swing states (tinyurl.com/5usys7s).

In reality FEMA’s seemingly fantastic response to Irene is likely a product of media hype. The storm had basically fizzled out by the time it hit densely populated areas. Recall that Irene had weakened to a mere tropical storm by the time it reached the Jersey shore, and the main effect on the mid-Atlantic and New England states was torrential rain—not nearly as severe as the massive storm surge and catastrophic flooding from Katrina. Yes, there were power outages and locally severe flooding with Irene, but such are common in the United States. Private businesses and local authorities responded well, as they always do. Milbank offers no compelling reason to believe that a bloated FEMA bureaucracy is essential, or even beneficial, in helping these responses along.

But is that so? Without denying the value of perseverance, and recognizing that the slogan “never give up” can be useful in overcoming certain obstacles, we must keep in mind that failure can act as a guide to more worthwhile activities. For example, in 1921 Walt Disney started a company called the Laugh-O-Gram Corporation, which went bankrupt two years later. If a friend of Disney or the government hadn’t let him fail and move on, he might never have become the Walt Disney we know today.

More important than this individual learning process is the irreplaceable role failure plays in the social learning process of the competitive market. When we refuse to allow failure to happen, or we cushion its blow, we ultimately harm not only the person who failed but also all of society by denying ourselves a key way to learn how best to allocate resources. Without failure there’s no economic growth or improved human well-being.

Economists, especially those of the Austrian school, often emphasize how entrepreneurs discover new knowledge and better ways of producing things. But entrepreneurial endeavors frequently fail and the profits thought to be in hand often don’t materialize. According to the U.S. Small Business Administration, over half of small businesses fail within the first five years. But failed entrepreneurial activity is just as important as successful entrepreneurial activity. Markets are desirable not because they lead smoothly to improved knowledge and better coordination, but because they provide a process for learning from our mistakes and the incentive to correct them. It’s not that entrepreneurs are just good at getting it right; it’s also that they (like all of us) can know when they’ve got it wrong and can obtain the information necessary to get it right next time.

On this view failure drives change. While success is the engine that accelerates us toward our goals, it is failure that steers us toward the most valuable goals possible. Once failure is recognized as being just as important as success in the market process, it should be clear that the goal of a society should be to create an environment that not only allows people to succeed freely but to fail freely as well.

The Knowledge Problem

Understanding this point requires a broader vision of the market process. For Austrian economists the fundamental economic problem is not the efficient allocation of given resources to our most valued ends at a given time, but rather how we overcome the “knowledge problem”—the division of knowledge that characterizes the social world. It is more important to figure this out than to master the problem of resource allocation because new knowledge drives economic growth and creates prosperity. If the main task of the market were merely to allocate known resources to their most efficient uses, economic growth would seem impossible, since we would be stuck in a primitive world. Where is there any room for the innovation or change that drives progress and improves our lives? If a plow is deemed the most efficient use of iron and all iron is constantly allocated to making plows, how could iron ever be allocated for a new invention such as a tractor? The answer is that entrepreneurs change the most efficient use of resources by discovering new uses. By understanding the economic problem posed by limited, unique, and dispersed knowledge, we can better understand the role failure plays in coping with this problem.

Competition figures prominently in this system. Competition promotes entrepreneurial activity and the discovery of knowledge by empowering a variety of decision-makers to try to find new and better ways of using resources as well as new ends to achieve. This decentralization ensures that what F. A. Hayek called the local knowledge of time and place will be best used. Centralized planning, like other forms of government allocation, necessarily relies on the knowledge of fewer people, limiting discovery and restricting knowledge-dissemination to fewer channels. Competition is a better way to overcome the knowledge problem.

Failure and Opportunity

We can understand the role of failure if we recognize, as Ludwig von Mises did, that all human action intends to “remove felt uneasiness.” We are always striving to improve ourselves by achieving our highest valued ends as often as we can. On these terms, failure is all around us because no human ever achieves a complete lack of felt uneasiness. We always have unsatisfied ends. Israel Kirzner uses the term “alertness” to describe how the entrepreneurial element of human action identifies which ends to strive for and which means are available. Kirzner says that for market action to occur, entrepreneurs must first be alert to opportunities for profit. The possibility of profit keeps entrepreneurs alert to the ways people strive for ends or make use of means that fail to remove felt uneasiness. Once they’ve noticed this failure in human knowledge, the same opportunity for profit spurs entrepreneurial activity to find a new way to achieve those ends, or to find better ends themselves. So a failure in human knowledge becomes the catalyst for producing new knowledge via the entrepreneurial process.

When entrepreneurs attempt to correct a particular failure in knowledge, they often fail themselves and incur losses because of competition. Although bankruptcy is painful in the short term, such failure is an integral part of how entrepreneurial activity and the market function. Failure in a competitive society informs market participants about which activities or jobs to strive for and which to avoid, lest they waste time and money. Jobs that add value to society should be pursued, while those that fail to add value should be eliminated. Markets help guide market participants far better than any bureaucracy can because bureaucracies lack the market’s key components of competition, profit, and loss, which reveal failures and allow for their correction.

Because competition is a voyage into the unknown, we can only know after the fact what works and what does not. Thus economic failure is not “waste.” Calling entrepreneurial failure a “waste” implicitly assumes that one knew ahead of time what the best use of resources was. Such knowledge is not available to anyone, which is why failure is necessary to provide the needed signals.

The subsidies, bailouts, stimulus packages, and other interventions that now increasingly characterize the U.S. economy disrupt this process. Farm subsidies (including cheap water out west), for example, prevent entrepreneurs from finding and capitalizing on failures of knowledge in farming. While there may be new and better ways to grow food, it is difficult for entrepreneurs to find this out if farmers are kept afloat by the government. Perhaps decentralized, local farming would be discovered as more profitable if larger monoculture farms that are possibly damaging the environment were allowed to fail. By preventing inefficient methods of production from suffering losses, subsidies reduce the degree of failure in agricultural markets and make it harder to know that misallocation has taken place and to correct it.

Not letting Chrysler and General Motors fail during the Great Recession prevented an entrepreneurial response to this misuse of resources. The bailouts created two types of negative incentives. First, the companies were encouraged to keep making cars when their losses showed the resources and labor could better be used elsewhere. Second, the government deterred any new entrepreneur from entering the industry and doing things better. Many politicians defended the bailout because they did not want the hundreds of thousands of autoworkers to become unemployed. But when hundreds of thousands of workers become unemployed they do not disappear. They find different jobs that would contribute to society in a better way than working for a bankrupt auto company. The physical assets of bankrupt companies also get reallocated to alert entrepreneurs looking for bargains. Failure is necessary for learning and for success.

The Keynesian argument for government jobs programs is that any sort of work will restart spending in a recession, even hiring people to dig ditches and fill them up. But do a higher GDP and a job by themselves make society better off? Would it be better to have a 2 percent unemployment rate with 8 percent of the employed population doing jobs that don’t add real value (so around 10 percent of the labor force is not adding real value) or more unemployment with everyone who is working really adding value?

Unemployment

Unemployment is a form of failure, and it involves the same considerations as when businesses fail. If a job no longer contributes value this needs to be made clear so that those workers can find jobs that actually do. Imagine if the disemployment of farmers had been prevented during the transition to an industrial economy. In 1941, 41 percent of the U.S. workforce was in agriculture. In 2011 the portion was 3 percent. Where would industry be today if we had prevented the majority of the 41 percent from losing their jobs and finding new ones? It is right that this sort of “failure” was allowed to occur because the displaced farmers found new jobs in the cities and elsewhere. Those new jobs helped society transition from agriculture to industry to services, creating even newer jobs all along the way. This is strong evidence that learning from failure takes place in labor markets.

Autopoiesis (life’s continuous production of itself) is one of the principal characteristics of life, and constant change is its essence. This applies to the economy as well. For us to maintain or increase a high standard of living we must constantly change how we do things. This change won’t be fueled by lucky guesses or by bureaucratic decrees, but instead often by entrepreneurial activity in the face of failure in the market. Since that activity drives the train of progress, it is in society’s interest that the tracks be cleared of governmental obstacles.

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.

In her latest work, Bourgeois Dignity: Why Economics Can’t Explain the Modern World, Deirdre McCloskey argues that the critical factor was a change in how productive activities such as trade were regarded. Instead of being seen as menial, morally disreputable, and lacking in honor, they came to be regarded as respectable, dignified, and above all virtuous. This gave trade, merchants, and manufacturers (those who worked with their hands) the crucial respect formerly given only to aristocrats, priests, and even peasants. I think McCloskey gives too much weight to this explanation, but the phenomenon she identifies was undoubtedly real and important.

McCloskey identifies the Dutch Republic as the place where the cultural shift started in the early seventeenth century. In the European case this is undoubtedly true. However it was not unique. Another later but independent shift was even more self-conscious and deliberate. It happened in one of the most fascinating of premodern societies, Tokugawa Japan. (McCloskey discusses the striking similarities between Europe and Japan at this time).

From 1467 to roughly 1570 Japan went through what became known as the Sengoku, or “warring states,” period of its history. The central authority was weak to nonexistent and warfare was almost constant. Between 1568 and 1603 there was the Momoyama, or unification, period in which Japan was unified by several astute leaders. The last of these, Tokugawa Ieyasu, defeated his rivals at the Battle of Sekigahara in 1600 and established the Tokugawa Shogunate, which would rule Japan until 1868. Tokugawa Japan was simultaneously deeply conservative and yet dynamic. The Tokugawa Shoguns, particularly after the 1630s, banned almost all contact with the outside world (the losing side at Sekigahara had generally favored greater links). Internally they sought to encourage and enforce a strict conservatism. One aspect of this was a firm insistence on traditional social hierarchies of esteem and status: emperor, shogun, daimyo, samurai, peasant, artisan, merchant. In general the countryside was seen as morally superior to the city. Another aspect was a revival of interest in Confucianism, particularly by the samurai, with development of an elaborate moral code and philosophy known as bushido—the way of the warrior.

The other side of Tokugawa Japan, however, was rapid economic development. Population grew swiftly after the 1690s, and this went along with dramatic urbanization: By the late eighteenth century the capital Edo (now Tokyo) and other centers such as Osaka and Kyoto were among the largest cities on the planet. There was also a great growth of internal trade and manufacture, as well as some trade with the outside world via a small colony of Dutch merchants on an artificial island in Nagasaki harbor. This also went along with interesting cultural developments. The merchant class in Japan did not simply concern themselves with business and physical pleasure, accepting their lowly status, as is often supposed. Instead they also explored Confucian and other ideas. In doing so they developed their own philosophy and culture, that of chonindo—the way of the townsfolk.

The essence of chonindo was developed and articulated by a series of thinkers from the later seventeenth century onward in the mercantile centers of Japan and particularly in Osaka. (Osaka had been the center of the Toyotomi clan, the rivals of the Tokugawa and the losing side at Sekigahara).

The crucial event in many ways was the founding of the Kaitokudo academy in Osaka in 1726 by Miyake Sekian and Nakai Shuan. This was a private educational institution, funded by the great merchant and trading houses of Osaka, for the exploration of Confucian ideals and in particular the establishment of the connection between productive work, trade, and virtue. The founders and teachers of the Kaitokudo argued that hard work, skill, craftsmanship, and physical labor were virtuous and forms of human excellence. More dramatically, given the traditional hostility toward it in much Confucian thought, they argued that profit was itself virtuous and that its pursuit was not only compatible with a moral life but moral in itself. The deeper argument was that there was no contradiction between the traditional virtues of restraint, loyalty, honor, and magnanimity and the life of labor and commerce. Instead all these virtues were both necessary for success in that kind of life and embodied in the successful living of such a life. What was wrong was dishonest and predatory behavior in any way of life.

Another aspect of the urban life of Tokugawa Japan that had a close relationship to all this was the notion of the “floating world” as represented in the artistic genre of Ukiyo-E, the well-known woodblock prints of urban life. In its physical sense the “floating world” referred to the pleasure and entertainment sectors of the new cities of Japan. As such it is often thought of as a cult of hedonism and something opposed to both bushido and chonindo. Sometimes this was true but more often there was a connection between the ideals of the floating world and those of chonindo. The common element was the belief, also found in Enlightenment Europe, that this physical world was good, not cursed, and that physical pleasure and well-being were admirable and worth seeking rather than barriers to virtue. The connection with chonindo was through the idea that in fact greater comfort and physical pleasures encouraged virtue (while discouraging predatory or vindictive behavior) and were the outcome of following the virtues of the merchant or townsman.

We may think that today the arguments of people like Adam Smith in Europe or the teachers of the Kaitokudo in Japan are unimportant because they are so obviously true and uncontroversial. Nothing could be further from the truth. Rather they are now as unfashionable and deprecated as when those Japanese merchants got together and set up their academy in Osaka almost 200 years ago. Because they faced such a hostile culture they were in many ways more explicit and systematic in their arguments than their European counterparts were. (Arguably they also had a more congenial intellectual tradition to work with in many ways). Today too many of the arguments for a free economy and society are made on the basis of efficiency. Such arguments may be true but they butter no parsnips when faced with a moral rejection of the idea of profit and commerce. The argument that a free economy is a moral economy is one that needs to be made and won more than ever.

We should read people like Ito Jinsai, Nishikawa Joken, Miyake Sekian, Nakai Shuan, Tominaga Nakamoto, Goi Ranju, Nakai Chikuzan, Nakai Riken, Kusama Naokata, and Yamagata Banto as much as we do Adam Smith, David Hume, Lord Kames, and Milton Friedman.

“Choice, competition, reducing costs—those are the things that I want to see accomplished in this health reform bill,” President Obama told talk-show host Michael Smerconish back in August.

Choice and competition would be good. They would indeed reduce costs. If only the President meant it. Or understood it.

In a free market, a business that is complacent about costs learns that its prices are too high when it sees lower-cost competitors winning over its customers. The market—actually, the consumer—holds businesses accountable and keeps them honest. No “public option” is needed.

So the hope for reducing medical costs indeed lies in competition and choice. Today competition is squelched by government regulation and privilege.

But Obama’s so-called reforms would not create real competition and choice. They would prohibit them.

Competition Produces Knowledge

Competition is not a bunch of companies offering the same products and services in the same way. That sterile notion of competition assumes we already know all that there is to know.

But consumers often don’t know what they want until it’s offered, and their preferences and requirements change. Businesses don’t know exactly what consumers want or the most efficient way to produce it until they are in the thick of the competitive hustle and bustle.

Nobel laureate F. A. Hayek taught that competition is a “discovery procedure.” In other words, the “data” of supply and demand emerge only through the market process. We need open-ended competition not merely to see which rival is better, but to learn things we didn’t know before and aren’t likely to learn any other way.

“Competition is valuable only because, and so far as, its results are unpredictable and on the whole different from those which anyone has, or could have, deliberately aimed at,” Hayek wrote.

Well-meaning politicians have created untold misery by assuming they and their experts know enough already.

The healthcare bills are perfect examples. If competition is a discovery process, the congressional bills would impose the opposite of competition. They would forbid real choice.

If You Liked the Election, You’ll Love the Public Option

In place of the variety of products that competition would generate, we would be forced to “choose” among virtually identical insurance plans. Government would define these plans down to the last detail. Every one would have at least the same “basic” coverage, including physical exams, maternity benefits, well-baby care, alcoholism treatment, and mental-health services. Consumers could not buy a cheap, high-deductible catastrophic policy. Every insurance company would have to use an identical government-designed pricing structure. Prices would be the same for the sick and the healthy.

In this respect, it wouldn’t matter whether Congress created a “public option”—that is, a government insurance plan. In either case, bureaucrats would dictate virtually every aspect of the health-insurance business.

What Obama says in favor of a public option tells us how little he understands competition. The public option’s virtue, he told Smerconish, is that “there wouldn’t be a profit motive involved.” But as contributing editor Steven Horwitz, a professor of economics at St. Lawrence University, wrote in The Freeman, profit is not just a motive. Profit (along with loss) is what enables competition to perform its discovery role:

“Suppose for a moment that we try to take the profit motive out of health care by going to a system in which government pays for and/or directly provides the services. . . . For many critics of the profit motive, the problem is solved because public-spirited politicians and bureaucrats have replaced profit-seeking firms.

“Well, not so fast. By what method exactly will the officials know how to allocate resources? By what method will they know how much of what kind of health care people want? And more important, by what method will they know how to produce that health care without wasting resources? . . . In markets with good institutions, profit-seeking producers can get answers to these questions by observing prices and their own profits and losses in order to determine which uses of resources are more or less valuable to consumers. . . . [P]rofits and prices signal the efficiency (or lack thereof) of resource use and allow producers to learn from those signals.”

Profit is the key to competition. Anyone who claims to favor competition but looks down at profit has no idea what he is talking about.

Don’t misinterpret me. I am not suggesting that people not vote. Most Americans see voting as their civic duty and, despite the evidence shown by Professors Gelman, Silver, and Edlin, people have a feeling that their vote counts. If one thinks that his vote makes a difference, that is a worthy benefit deserving of the time and effort it takes to vote.

You Get What You Pay For

Voting has other problems in addition to the relative unimportance of each individual vote. When one votes for a particular candidate, is there any way to be sure that one will get what one votes for? There’s no older story in the political arena than that of the candidate who promises one thing when he campaigns and does something else when he wins office. Moreover, if he lives up to a promise made to one group of Americans, it will always come at the expense of another. Some political promises are incredible, such as Barack Obama’s promise that he would work to unite Christians, Muslims, and Jews. That’s true political arrogance in light of the hundreds of years of sometimes murderous conflict between these groups.

Americans cast millions upon millions of votes—that is, they make decisions—in the non-political arena where individual votes do count and where there is a much higher probability of being satisfied with the outcome. Moreover, what they get in return for their vote does not come at the expense of another. That arena is the marketplace.

In our wallets we have what amounts to ballot slips; we can think of them as dollar votes. When we take, say, nine of them and “vote” for two pounds of steak, we are fairly certain about the outcome. We get the two pounds of steak. If we don’t get the outcome we voted for—we get, say, steak of poor quality—there is swift retribution. We can simply fire the seller by taking our business elsewhere. We act unilaterally and don’t have to bother with costly organizing. Very often simply the threat of taking our business elsewhere is enough to get some kind of remedy.

An individual’s threat to vote for a politician’s opponent as an expression of dissatisfaction with the politician’s actions, on the other hand, is not likely to carry as much weight.

There is another contrast between the market arena and the political arena that can be appreciated by asking what draws the greatest public complaints: Is it market-provided goods and services, such as computers, televisions, clothing, and food? Or is it government-provided services, such as public schools, postal services, and motor vehicle departments? In the case of market-provided goods and services, the prospect of profit gives providers an incentive to please customers. The government sector, however, is not-for-profit, so it suffers no losses when it fails to please “customers.”

Better for Poor People, Too

You might say, “That’s okay, Williams, if you have enough dollar votes. But what about poor people?” Poor people are far better served in the market arena than the political arena. Check this out. If you visit a poor neighborhood, you will see some nice clothing, some nice cars, some nice food, and maybe even some nice homes—no nice schools. Why not at least some nice schools? The explanation is simple. Clothing, cars, food, and houses are allocated through the market mechanism. Schools are allocated through the political mechanism. By the way, if you are a member of a minority, it is in your interest to minimize those decisions over your life made in the political arena, where the majority rules.

There is another unappreciated feature of the market arena. It reduces the potential for human conflict. Different Americans have different and intense preferences for cars, food, clothing, and entertainment. When is the last time you heard about Chrysler lovers fighting with Lexus lovers? It seldom if ever happens. Why? Those who love Chryslers get what they want, and those who love Lexuses get what they want, and each can live in peace with one another.

It is a different story in government-provided education. Some parents wish for their children to recite a morning prayer in schools. Other parents are repulsed by the idea. The fact that education is produced by government means there is either going to be prayer in school or no prayer in school. Parents must enter into conflict with one another. Why? If, for example, the parent who wishes for prayers in school loses the political battle, that parent will not have his wishes met. Of course he can send his child to a non-government school that has morning prayers, but through the tax code he is forced to continue paying for school services for which he has no use.

If government decided whether Chryslers or Lexuses would be produced, we would see conflict between lovers of Chryslers and Lexuses.

The prime feature of political decision-making is that it’s a zero-sum game. One person’s or group’s gain, of necessity, comes at the expense of another person or group. As such, political allocation of resources is conflict-enhancing while market allocation is conflict-reducing. The greater the number of decisions made in the political arena the greater the potential for conflict.

I never cease to be amazed by Americans’ faith in government and the political arena, whose essence is coercion, and their suspicion of the market arena, whose essence is peaceable, voluntary exchange.

Leaving aside for a moment whether the health-care industry is really dominated by the profit motive (given that almost half of U.S. health-care expenditures are paid for by the federal government, it is not clear which motives dominate) and whether Moore knows better than millions of individuals what their health-care needs are, the claim that a “motive” is a root cause of social pathologies is worthy of some critical reflection. The critics seem to suggest that if people and firms were motivated by something besides profit, they would be better able to provide the things that patients really need.

The overarching problem with blaming a “motive” is that it ignores the distinction between intentions and results. That is, it ignores the possibility of unintended consequences, both beneficial and harmful. Since Adam Smith, economists have understood that the self-interest of producers (of which the profit motive is just one example) can lead to social benefits. As Smith famously put it, it is not the “benevolence” of the baker, butcher, and brewer that leads them to provide us with our dinner but their “self-love.” Smith’s insight, which was a core idea of the broader Scottish Enlightenment of which he was a part, puts the focus on the consequences of human action, not their motivation.

What we care about is whether the goods get delivered, not the motives of those who provide them. Smith led economists to think about why it is that, or under what circumstances, self-interest leads to beneficial unintended consequences. It is perhaps human nature to assume that intentions equal results, or that self-interest means an absence of social benefit, as was often the case in the small, simple societies in which humanity evolved. However, in the more complex, anonymous world of what Hayek called “the Great Society,” the simple equation of intentions and results does not hold.

As Smith recognized, what determines whether the profit motive leads to good results are the institutions through which human action is mediated. Institutions, laws, and policies affect which activities are profitable and which are not. A good economic system is one in which those institutions, laws, and policies are such that the self-interested behavior of producers leads to socially beneficial outcomes. In mixed economies like that of the United States, the institutional framework often rewards profit-seeking behavior that does not produce social benefit or, conversely, prevents profit-seeking behavior that could produce such benefits. For example, if agricultural policy pays farmers not to grow, then the profit motive will lead to lower food supplies. If environmental policy confiscates land with endangered species on it, owners of such land who are driven by the profit motive will “shoot, shovel, and shut up” (that is, kill off and bury any endangered species they find on their land).

The same issues can be raised in the health-care industry. Before blaming the profit motive for the problems in the industry, critics might want to look at the ways in which existing government programs like Medicare and Medicaid, the interpretation of tort laws, and regulations such as those that limit who can practice what sorts of medicine might lead firms and professionals to engage in behavior that is profitable but unbeneficial to consumers. Labeling the profit motive as the source of the problem enables the critics to ignore the really difficult questions about how institutions, policies, and laws affect the profit-seeking incentives of producers and how that profit-seeking behavior translates into outcomes. Placing the blame on the profit motive without qualification simply overlooks the Smithian question of whether better institutions would enable the profit motive to generate better results and whether current policies or regulations are the source of the problem because they guide the profit motive in ways that produce the very problems the critics identify.

For example, high medical costs may well be a result of profit-seeking providers’ recognizing that government programs are notoriously bad at pricing services accurately and keeping good track of their expenditures. Ignoring the way institutions might affect what is profitable is often due to a more general blind spot about the possibility of self-interested behavior generating unintended beneficial consequences. Before we attempt to banish the profit motive, shouldn’t we see whether we can make it work better?

Placing blame for social problems on the profit motive is also easy if critics offer no alternative. What should be the basis for determining how resources are allocated if not in terms of profit-seeking behavior under the right set of institutions? How should people be motivated if not by profit? Often this question is just ignored, as critics are merely interested in casting blame. When it is not ignored, the answers can vary, but they mostly invoke a significant role for government. The interesting aspect of such answers is that critics do not suggest that we somehow convince producers to act on the basis of something other than profit, but that instead we replace them with presumably other-motivated bureaucrats or have those bureaucrats severely limit the choices open to producers. The implicit assumption, of course, is that the government personnel will not be motivated by profits or self-interest in the same way as the private-sector producers are.

How realistic this assumption is remains highly questionable. Why should we assume that government officials are any less self-interested than private individuals, especially when the door between the two sectors is constantly revolving? And if government officials do act in their self-interest and are motivated by the political analogs of profits (for example, votes, power, budgets), will they produce results that are any better than the private sector’s? If blaming the profit motive entails giving government a bigger role in solving problems, what assurance can critics of the profit motive provide that political officials will be any less self-interested and that their self-interest will produce any better results?

One will look in vain in Sicko, for example, for any analysis of the failures of state-sponsored health care in Cuba, Canada, Great Britain, or anywhere else. To blame the profit motive without asking whether an alternative will better solve the problems supposedly caused by the profit motive is to bias the case against the private sector.

How Will They Know?

Even this argument, however, does not go far enough. We are still, after all, focused on intentions and motivation. What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not.

Suppose for a moment that we try to take the profit motive out of health care by going to a system in which government pays for and/or directly provides the services. Suppose further that we could, somehow, ensure that the political officials would not be self-interested. For many critics of the profit motive, the problem is solved because public-spirited politicians and bureaucrats have replaced profit-seeking firms.

Well, not so fast. By what method exactly will the officials know how to allocate resources? By what method will they know how much of what kind of health care people want? And more important, by what method will they know how to produce that health care without wasting resources? It’s one thing to say that every adult should, for example, have a checkup every year, but should it be provided by an MD, an LPN, or an RN? What kind of equipment should be used? How thorough should it be? And most crucially, how will political decision-makers know if they’ve answered these questions correctly?

In markets with good institutions, profit-seeking producers can get answers to these questions by observing prices and their own profits and losses in order to determine which uses of resources are more or less valuable to consumers. Rather than having one solution imposed on all producers, based on the best guesses of political officials, an industry populated by profit seekers can try out alternative solutions and learn which ones work most effectively. Competition for profit is a process of learning and discovery. For all the profit-critics’ concern—especially but not only in health care—that allocating resources by profits leads to waste, few if any understand how profits and prices signal the efficiency (or lack thereof) of resource use and allow producers to learn from those signals. The most profound waste of resources in the U.S. health-care industry stems from the incentives and market distortions created by government programs such as Medicare and Medicaid.

Thus the real problem with focusing on the profit motive is that it assumes that the primary role of profits is to motivate (or in contemporary language “incentivize”) producers. If one takes that view, it might seem relatively easy to find other ways to motivate them or to design a new system where production is taken over by the state. However, if the more important role of profits is to communicate knowledge about the efficiency of resource use and enable producers to learn what they are doing well or poorly, the argument becomes much more complicated. Now the critics must explain what in the absence of profits will tell producers what they should and should not do. Eliminating profit-seeking from an industry doesn’t just require that a new incentive be found but that a new way of learning be developed as well. Profit is not just a motive; it is also integral to the irreplaceable social learning process of the market. Critics may consider eliminating the profit motive the equivalent of giving the Tin Man from Oz a heart; in fact it’s much more like Oedipus’ gouging out his own eyes.

Why then, we wonder, wouldn’t similar plans be in order for other consumer goods? Why shouldn’t Americans have a nationalized, single-payer plan for, say, food? If we could save $200 billion a year in health care, couldn’t we save billions in “private-industry expenses” for victuals? After all, if we visit the PNHP’s website, we learn that “[p]rofit seeking inevitably distorts care and diverts resources from patients to investors.” This argument should be just as applicable to other industries, for example: “profit seeking inevitably distorts feeding and diverts resources from diners to investors.” The logical conclusion of the idea is to nationalize the entire economy, saving trillions! We all know how well such ideas worked out in the Soviet Union, Mongolia, Albania, and North Korea.

As with most fallacious arguments in economics, the physicians’ concern with one particular magnitude—total health-care expenditures—ignores the true criterion of success: the health of Americans. If researchers discovered a very expensive drug that would guarantee an active, 150-year life, it is possible that total health-care expenditures would increase. But such an outcome would hardly be a sign of disaster.

The reasonable person might still conclude that lowering health-care “costs” is an important goal. But we must be careful: one can reduce the satisfaction derived from health care faster than the costs. For instance, the government might reduce expenses by severely restricting consumer choice. By cracking down on “frivolous” product variety, it might indeed be cheaper to provide the basics. But such reasoning fails to appreciate the function of advertising and other measures taken to differentiate products. Whether it’s health care or computers, the professionals in an industry need the freedom to experiment with new products and techniques, to see which best satisfy consumers. Of course, this freedom goes hand in hand with certain expenditures on “redundant” systems and “counterproductive” advertising, but the only way to encourage innovation is to allow the pioneers to benefit from their discoveries.

In any case, we are confident that we would never see the cost savings these doctors predict. Do they think the Pentagon’s single-payer system has kept down the costs of military hardware? The Times notes, “The system envisioned . . . would be built on the foundation of the current Medicare program.” But the costs of Medicare at the turn of the millennium were running about 700 percent above original estimates.

Plans that lower prices of a good will logically prompt consumers to demand more of it. Those of us who have been caught between insurance plans know that certain “indispensable” visits to the doctor or dentist can often wait until our coverage is restored and somebody else has to pay for them. But the PNHP attempts to deny basic economics: “Co-payments and deductibles are . . . unnecessary for cost containment,” its website states.

PNHP also denies its plan would restrict the freedom of consumers: “Compare [our plan] to today’s system, where doctors routinely have to ask an insurance company permission to perform procedures, prescribe certain medications, or run . . . tests.”

This, of course, is nonsense: a doctor does not have to ask an insurance company for “permission” to deliver any treatment he recommends. He may have to ask an insurance company if it will pay for it. The insurance company could decline, but that in no way prevents the doctor from delivering the treatment.

Do the PNHP doctors really think that all potential treatments will be allowed under their socialized plan? That’s impossible: scarcity cannot be repealed by legislative whim; even in health care, tradeoffs are inevitable. Whether they realize it or not, under the physicians’ plan doctors will have to ask a government official for permission to perform procedures, prescribe medications, or run tests. And under the PNHP plan, it will be a criminal offense to pay for the treatment oneself if coverage is denied. How is that supposed to help patients?

Canadian Waiting Lists

The Times cites an associate professor of medicine at Harvard University, Dr. David Himmelstein, who “conceded that Canada’s single-payer system has waiting lists for some medical services.” He makes it seem as if these are minor matters, only for inconsequential services. But waiting times have been increasing—growing from an average of nine to an average of 16 weeks during the 1990s alone¹—and people have died while awaiting vital procedures.²

Himmelstein goes on to assert, “A single-payer system also would address the mounting billing and paperwork frustrations experienced by physicians.” We wonder if he can name any other activity where increased government involvement has reduced paperwork?

It is true that under current arrangements, the health-care situation of those who are not insured at work but who do not qualify for Medicare or Medicaid is quite difficult. Those with less wealth have more difficulty acquiring any good or service than those with more. But their particularly dire circumstances with regard to health care are almost entirely due to previous government interventions. The government-backed AMA severely restricts the supply of physicians and thus drives up the cost of doctors’ services. The special tax status granted to employers’ expenses for insurance further increases prices, as do Medicare and Medicaid subsidies.

Our preferred solution is a true free market in health care, one where anyone is permitted to provide any service he wishes, with consumers free to evaluate providers. But, indoctrinated with the notion that it is only government licensing that protects us from quacks, many Americans consider it absurd to argue that everyone should be legally allowed to practice medicine.

However, consumers are fairly adept at assessing suppliers of other products. A butcher who regularly makes his customers ill with food poisoning will soon go bankrupt. Similarly, in a free market an incompetent doctor will soon lose his patients. Undoubtedly, private certification and rating organizations would abound.

Curiously, interventionists believe consumers are (a) too ignorant to identify bad doctors on a free market, but (b) capable of voting for good politicians to improve health care. As PNHP declares, “The public has an absolute right to democratically set overall health policies and priorities.” Wouldn’t it be easier to pick a good doctor?

Notes

1. Sally C. Pipes, “Lessons from the North: Bus Travelers Bring the Reality of Rationed Health Care and Price-Controlled Drugs over the Border,” Pacific Research Institute Briefing, October 2002, pp. 2–3.
2. Pacific Research Institute, “False Promise of Single-Payer Health-Care: A Close Look Inside the ‘California Health Security Act,’” http://www.pacificresearch.org/pub/sab/health/single_ prayer/sphealth.htm

Let’s first get its definition out of the way. Profits represent the residual claim earned by entrepreneurs. It’s what’s left after all other costs—wages, rent, interest—have been paid. The entrepreneur is generally seen as the person who takes risks, innovates, and makes decisions. It’s important to recognize that profits are a cost of business just as are payments to labor, land, and capital. If wages, rent, and interest are not paid, labor, land, and capital will not be offered; similarly, if profit is not paid, entrepreneurs won’t be seen either.

Roughly six cents of each dollar companies take in represent after-tax profits. By far, wages are the largest part of that dollar, representing about 60 cents. As percentages of 2002 national income, after-tax profits represented about 5 percent and wages about 71 percent. Far more important than simple statistics about the magnitude of profits is the role played by profits, namely, that of guiding resources to their highest-valued uses, determined not by some tyrant but by ordinary people’s wants and desires. Let’s discuss just a few examples.

Remember when Coca-Cola introduced the “new” Coke? Pepsi president Roger Enrico called it “the Edsel of the 80s,” representing one of the greatest marketing debacles of the decade. Who made the Coca-Cola Company bring back the old Coke? Was it Congress, the courts, the President, or other government officials who claim to have our interests at heart? No way. It was the specter of negative profits (losses) that convinced Coca-Cola to bring back the old Coke. Thus one role of profits is to discover what consumers want. If producers make mistakes, profits work to correct them.

After the 1992 massive destruction caused by Hurricane Andrew, South Florida stores sold sheets of plywood for twice the price it had sold for prior to the storm. Escalating plywood prices brought charges of price-gouging and prosecutory threats. But look what higher prices and the potential for windfall profits did. Plywood destined to be shipped to the Midwest, West, and Northeast suddenly was rerouted to South Florida. Lumber mills increased production. Truckers and other workers worked overtime so as to increase the availability of plywood and other construction materials to Floridians. Rising plywood prices meant something else. All that plywood heading south meant plywood prices rose in other locations, thus discouraging “less valued” uses of plywood, such as home-improvement projects. After all, rebuilding and repairing destroyed homes is a “higher valued” use of plywood.

What caused these market participants to do what was in the social interest, namely, sacrifice or postpone alternative uses for plywood? The answer reveals perhaps the most wonderful feature of this process: rising prices and opportunities for higher profits encouraged people to do voluntarily what was in the social interest: help their fellow man recover from a disaster.

Profits also force producers to behave themselves. If producers waste inputs, their production costs will be higher. To cover their cost, they’ll charge prices higher than what consumers are willing to pay. After a while the company will make unsustainable losses (negative profits) and go out of business. As a result, the company’s resources will become available to someone else who’ll put them to wiser use. This process is short-circuited if government offers bailouts in the forms of guaranteed loans, subsidies, or restrictions on competitive products from abroad, such as tariffs and import quotas. Government “help” enables failing companies to continue squandering resources.

If we care about people’s wants, rather than beating up on profit-making organizations we should pay more attention to government-owned nonprofit organizations. Government schools are a good example. Many squander resources and produce a shoddy product, while administrators, teachers, and staff earn higher pay and perks, and customers (taxpayers) are increasingly burdened. Unlike other producers, educationists don’t face the rigors of the profit discipline and hence they’re not as accountable.

How about the U.S. Postal Service? They also provide shoddy and surly services, but the management and workers receive increasingly higher wages, while customers pay higher and higher prices. Again, wishes of customers can be safely ignored because there’s no bottom-line discipline of profits.

Here’s Williams’s law: whenever the profit incentive is missing, the probability that people’s wants can be safely ignored is the greatest. It’s not just the post office and schools, but delivery of police services and garbage collection as well. If a poll were taken asking people what services they are most satisfied with and those they are most dissatisfied with, for-profit organizations (supermarkets, computer companies, and video stores) would dominate the first list while nonprofit organizations (schools, post office, and offices of motor-vehicle registration) would dominate the latter list. In a free economy, the pursuit of profits and serving people are one and the same.

Though most Americans know something of that fateful day in 1903, far fewer are aware of the rivalry between the Wright brothers and another inventor/entrepreneur—one Samuel Pierpont Langley. It’s a story that deserves retelling, and there’s no better time to tell it than right now. A hundred summers ago, that rivalry was at a fever pitch, and it wasn’t at all clear at first that the two bicycle mechanics from Dayton, Ohio, would eventually best the distinguished and better-financed Langley.

By the close of the nineteenth century the possibility of a man-carrying “flying machine” had captivated visionaries in many countries, though the general public regarded the idea as bunk. Nobody knew enough about aerodynamics to build a craft that could generate its own power, get up in the air with a man on board and stay there, and be flown safely and with precision.

In 1878 a simple gift from a father to his two sons—aged 7 and 11—planted the seed that would change history forever. It was a toy helicopter made of cork, bamboo, and paper, and powered by a rubber band. Wilbur and Orville Wright were mesmerized. They built their own copies and versions of it, fostering a lifelong fascination with flight. Twenty-one years later, in 1899, they took time out from their modest bicycle shop to begin the work that would lead to the world’s first successful airplane.

Langley, meantime, was already way ahead of the Wrights. Born in 1834, he earned an international reputation for his work in physics and astronomy and by publishing a book on aerodynamics. He was secretary of the respected Smithsonian Institution in Washington, D.C. As early as 1896, he had even built and flown an unmanned “aerodrome”—a tandem-wing aircraft that used a lightweight steam engine for propulsion. He was sure he would be the man to invent the airplane, and probably deemed it unthinkable that young whippersnappers from small-town America could come out of nowhere with little money and beat him to it.

Both Langley and the Wright brothers had Smithsonian connections but with a huge and perhaps decisive difference. For Langley the Smithsonian was the conduit for a $50,000 federal grant, matched by the Institution, to finance his experiments (equivalent to about a million dollars in today’s purchasing power). As for the Wrights, in 1899 Wilbur wrote a letter to the Smithsonian asking for nothing more than a reading list on flight. He and Orville would finance their dream not with government money, but with the nickels and dimes they could scrape from the profits in their private business.

During the summer and fall of 1903 Langley worked feverishly at his Washington home base. Because he felt it safest to fly over water, he spent half his money building a houseboat with a catapult to launch his newest craft with a man, Charles Manly, aboard. A catapult launch meant that the plane would have to go from a dead stop to a flying speed of 60 mph in just 70 feet, a feat that would prove beyond the reach of his craft’s capabilities.

Meanwhile back in Dayton, Wilbur and Orville Wright worked on propeller design, a lightweight engine, and wings that mimicked the way pigeons flew, as the brothers observed them. What they put together solved the problem of controlling flight, which Langley’s craft would never have achieved even if it had taken to the air.

On October 7, 1903, Langley’s plane, with Manly aboard, was ready to go. At least that’s what Langley and Manly thought. But the stress of the catapult launch badly damaged the front wing, and the plane tumbled over and disappeared in 16 feet of water. A reporter present wrote that it flew “like a handful of mortar.” The hapless “pilot” was unharmed.

A second launch set for December 8 proved even more disastrous. The rear wing and tail collapsed at the moment of launch, and the plane dove right into the icy Potomac River. This time poor Manly nearly drowned. Financially, for both Langley and American taxpayers, it was a total loss.

Flying Money

Critics went wild. James Tobin, author of To Conquer the Air: The Wright Brothers and the Great Race for Flight (2003), quotes one congressman as saying at the time, “You tell Langley for me that the only thing he ever made fly was Government money.” The War Department concluded that “we are still far from the ultimate goal, and it would seem as if years of constant work and study by experts, together with the expenditure of thousands of dollars, would still be necessary before we can hope to produce an apparatus of practical utility along these lines.”

But just nine days after Langley’s second spectacular flight to the bottom of the Potomac, Wilbur and Orville Wright took turns flying their carefully designed plane for as long as 59 seconds over the Outer Banks of North Carolina. The craft cost them about $1,000. It cost American taxpayers nothing. Within a year, they were making flights of five miles at a time; within two years, they were flying distances of 20 to 25 miles.

In November 1904 the Wrights offered to sell planes to the War Department. They weren’t seeking a subsidy; they wanted to sell planes for military reconnaissance and communication. But they received the same form-letter refusal that the War Department routinely sent to “flying machine” cranks.

Now what on earth could be the lesson in this remarkable story? Could it be that government, as some argue, is more farsighted than the private sector and therefore subsidies are needed to spur new inventions? Or that government quickly sees the error of its ways and corrects its mistakes? Or that the pursuit of profit just adds another layer of cost and makes new inventions more expensive than necessary?

If you think any of those “lessons” apply, then the textbooks you’ve been reading belong right where Samuel Pierpont Langley’s plane landed.