Anatomy of an Economic Ignoramus

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We all encounter more than our share of foolish blog posts. Most of the time you simply have to let them be. You could spend the rest of your life correcting drones and automatons who will never have an original or unconventional thought no matter how much you prod them. Their seventh-grade teacher, who was also the track coach, taught them what they know, and they’re sticking to it.

Once in a while, though, for your own sake and for the sake of readers who suspect the post is all wrong but aren’t quite sure why, you let loose with a full-blown response. And that’s what I’m doing here in reaction to a blog entry called "Peter Schiff: Medicare Recipients Are Lazy People Who Refuse to Pay for Their Own Health Care."

This is longer than my usual pieces, but I hope I am not trying the reader’s patience too much. In block quotes are the words of a blog author who identifies himself, interestingly enough, simply as "Che."

Here we go.

I love it when right wing economists talk about "market forces" and "letting the free market run our economy." They make it sound like the free market is some altruistic being that always knows exactly what to do and when to do it.

I do not know of anyone who subscribes to this junior-camper caricature. For one thing, no free-market economist is dumb enough to use a phrase like "letting the free market run our economy." The free market is merely the matrix of free exchanges entered into by individuals. How can a matrix of free exchanges "run" anything?

Secondly, no free-market economist thinks the market "always knows exactly what to do and when to do it." If that were the case, how could free-market economists account for firms that go out of business?

The argument that free-market economists actually make is that on the free market, decisions regarding what to produce, in what quantities, using what methods, and in what locations, are made in light of satisfying the most urgent demands of consumers. Business firms find out very quickly what consumers want and what they do not want, and they adjust their production decisions accordingly.

Profits indicate that a particular industry is combining factors of production in a way that pleases consumers. As a result, production in that industry tends to expand. Likewise, losses indicate that value is being reduced or destroyed, and that factors of production are being employed in lines of production that please consumers less, at the expense of other lines of production where they might have produced something consumers wanted more.

There are limitless ways business firms can combine factors of production to produce an equally limitless potential array of goods. Thankfully, firms do not have to grope around in the dark amid these trillions of choices.

If their production process uses an input more urgently needed elsewhere, that input gets bid away from them and they find a substitute. If they produce too much of something, their resulting losses prompt them to produce less, thereby releasing resources for the production of another good that consumers value more highly. At all times, resources are directed, in light of consumer wants, to those production processes in which they are most urgently demanded.

So no, markets do not know "exactly what to do and when to do it" — a juvenile caricature — but feedback from consumers’ decisions does constantly push markets toward a more efficient use of limited resources.

Government, on the other hand, has no rational basis for determining what to produce, in what quantities, and so on. It gets its money not by providing a good that people voluntarily choose to purchase, but by seizing the funds from its subject population.

Since it therefore lacks a profit-and-loss feedback mechanism, every single production decision it makes is absolutely arbitrary, and necessarily wastes resources. It operates completely in the dark. It cannot adjust to consumer demand, since it has no way of calculating the best, least wasteful way to produce. More than that, it cannot even know what to produce.

The free market is not some emotionless, all knowing entity. It is controlled by humans who are susceptible to greed, corruption, and exploitation. The free market is only as pure as the fallible human beings that control it.

As we’ve seen, the free market is just a matrix of exchanges, so no one in his right mind would describe it as any kind of "entity," whether "emotionless," "all knowing," or "yellow with purple polka dots."

We’ll deal with "corruption" and "exploitation" below. But in keeping with Che’s charming devotion to government, he doesn’t consider that its own officials might be susceptible to greed, corruption, and exploitation. Later, he suggests that corrupt politicians can simply be voted out of office (how’s that one working out for you so far, Che?). He does not consider the possibility that corporations that do not produce what consumers want can likewise be voted out of the economy by merely abstaining from buying their products.

If free market principles were allowed to rule, like Schiff wants, what that means is everything is based on maximizing profit.

At this point we are all supposed to gasp at what a terrible prospect this would be. After all, the track coach and Michael Moore have told us about the wickedness of "profits," so what more is there to say, really?

But as we’ve seen above, profit is simply society’s way of ratifying a firm’s past production decisions. It indicates what consumers want, and (by the process of imputation) the best process for producing it. Profits attract further investment in a given line of production, until the increased supply of goods in that industry brings the rate of return there back down to the level that exists elsewhere in the economy. This is how we ensure that our limited resources are not wasted, and that the most urgently desired goods are produced.

In the absence of profit as a driving force, how exactly would Che like to see resources allocated? We can either allow consumer preferences to guide production, or let the personal preferences of a monopolist (i.e., government) dictate what should be produced and how. When the question is posed this way, the choice is pretty clear, which is why the question is never posed this way.

Incidentally, would Che prefer to base economic decision making on maximizing losses instead? Would that be better?

Two major byproducts occur when the only concern of an economy is profit.

1. Quality goes down because corners must be cut to save money and compete (See China).

Now Che, think about this for a minute. Suppose you had an economy in which profit was of no concern whatever. Would quality go up, then? Would we enjoy products of ever-increasing quality if businesses were not required to satisfy the consuming public (which is what earning profits means) in order to stay in business?

You don’t think their freedom from the need to make profits might make them lazy, or unresponsive to consumer demand? You think they’d work overtime on high-quality products for the sake of the brotherhood of man, or the great fatherland, or whatever abstraction the regime proposes?

If the consumer wants high-quality merchandise, producers will compete to provide him with it. If everyone is producing low-quality garbage, there is a gigantic profit opportunity awaiting a newcomer who simply improves product quality. Don’t you believe those evil corporations would jump at the chance to profit? Why in your scenario do those wicked, wily, greedy characters suddenly lose their drive to earn a return?

You will say that consumers won’t pay higher prices for quality merchandise. But where does that arbitrary assertion come from? If they won’t pay the higher prices, then that means they are satisfied with the existing level of quality, and that the money they might have spent on nicer things is in their view more urgently spent on something else — basic, no-frills products, say.

You, Che, are not in a position to judge their decision. If they will pay higher prices, then more upscale firms will cater to them — which, if you’d turn your head slightly and glance around a bit, you’ll notice is how the economy already works.

There is, after all, no logical limit to the potential quality of merchandise. Following Chester Lampwick on The Simpsons, someone may purchase a solid-gold house. Now most people, in their search for higher-quality dwellings, may not want to live in a straw hut, but they are likewise prepared to stop well short of a solid-gold house. There is no nonarbitrary way to decide, apart from the voluntary spending streams emanating from consumers and the production decisions made on that basis, what ratio of quality to affordability people should choose.

Again, though, all we need to do is look around to find the refutation of Che’s strange claim. Are automobiles today of lower quality than they were in, say, 1977? Would anyone care to trade in his Blu-ray player for a 1981 VCR? The Blu-ray also costs a teensy-weensy bit less, in real terms, than the 1981 VCR, I might add. I trust you that there is something wicked in all this, Che, but I’m just not seeing it.

2. Wages go down, because it [employers’ drive for profits] pits workers against one another. For example, if there are no labor regulations, I can pay a woman significantly less than a man to do the same job. This forces wages down, because now a man must settle for a depressed wage if he wants a job.

This is why nonchemists do not write about chemistry, and nonbotanists stay out of botany. At this point our author is simply making things up.

Read the rest of the article

Thomas E. Woods, Jr. [visit his website; send him mail] is a senior fellow at the Ludwig von Mises Institute. He is the author of nine books, including two New York Times bestsellers: Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse and The Politically Incorrect Guide to American History. Read Congressman Ron Paul’s foreword to Meltdown.

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