The Free Market 23, no. 12 (December 2003)
The Economist magazine asked in a recent issue: “Why on earth can’t the world’s richest country ensure that Baghdad has water and electricity?” One might think that a publication dedicated to covering the world of markets would already know the answer. The US government is trying to solve economic problems in Iraq, including the provision of essentials like utilities, through military means. If guns and force could provide the essentials of life, the Soviet Union would have been a utopia.
Every government that seeks to provide goods and services faces the problem of economic calculation. Without markets and prices, rooted in private property and exchange, there is no way to place a value on resources up and down the structure of production. Government can order people to make this and install that, but it cannot solve the problem of how to resolve competitive uses of resources. That is only possible in an exchange economy.
This insight not only shows why socialism does not work. It shows why a militarized economy of any sort cannot work. Even the most simple task takes on the appearance of impossibility when the bureaucracy is in charge. Water and electricity in the US is provided through a mixed system that combines public and private properties; the problems left in the system (resulting in blackouts, antique technology, and the like) derive entirely from its public nature.
The market economy is the only means to solve the essential economic problem of the creation and allocation of goods and services essential to life and a flourishing civilization. We are not dealing here with technical considerations of management and following instructions. We are dealing with a problem that is exclusively economic: sorting out the competitive uses of time and resources. This is a point so all-encompassing that it is ironically easy to forget.
Such is the case with many insights from economics. But we disregard them at our peril. As Mises says, economics touches on the pith of life itself. It deals with problems that affect everything and everyone. While Mises was in school, he saw that the most important problems of the next century would be economic ones, and this concerned him because many people do not have the patience to understand economics. This is why he dedicated his life to investigating economic problems and explaining them in every way he knew how.
As a sample of how easy it is to overlook economics, consider what Alan Greenspan said in testimony earlier this year: “Economists understand very little about how technological progress occurs.” Perhaps he should have said that he, Greenspan, understands very little about how technological progress occurs. At least as regards the Austrian economists, his statement is false.
How does technological progress occur? Within the framework of the freedom of exchange, entrepreneurs make judgments about what consumers might want in the future, including new technologies. Capitalists and investors assume the risk, employing private property, that this judgment is correct. Investments that are profitable attract more resources and those that yield losses are shelved.
This is the free-market capital structure at work in a complex economy. It is truly a miracle of coordination—extending through all sectors and across a huge range of time horizons—with no central management, and needing none. It balances human needs with the availability of all the world’s resources, unleashes the amazing power of human creativity, and works to meet the material needs of every member of society at the least possible cost.
It does this through exchange, cooperation, competition, entrepreneurship, and all the institutions that make possible capitalism—the most productive economic system this side of Heaven. This system of capital coordination not only works without central management; the attempt to manage it creates dislocations across sectors and across time.
Let us never underestimate the social benefits that flow from this seemingly technical mechanism. The market economy has created unfathomable prosperity and, decade by decade, century by century, miraculous feats of innovation, production, distribution, and social coordination. To the free market we owe all material prosperity, all leisure time, our health and longevity, our huge and growing population, nearly everything we call life itself. The market economy alone has rescued the human race from degrading poverty, rampant sickness, and early death.
In the absence of the market economy and all its underlying institutions, the world’s population would, over time, shrink to a small fraction of its current size, with whatever was left of the human race systematically reduced to subsistence, eating only what could be hunted or gathered.
And this is only to mention the economic benefits of the free market. It is also an expression of individual liberty. It is not so much a social system but the natural result of a society wherein individual freedom is respected, and where businesses, families, and every form of association are permitted to flourish in the absence of coercion, looting, and war.
The market protects the weak from the strong, granting choice and opportunity to the masses, who once had no choice but to live in a state of dependency on the politically connected and their enforcers. But the free market has many enemies, among them those who would attempt to gin up economic production through loose credit. Mises focused on the effects of this particular attack on the free market: expansion of money and credit by the central bank, and, in particular, the attempt to drive down the price of credit to spur business investment.
Doing this through the interest rate injects new money into the economy. One effect of this has been known for centuries: it causes prices to rise. But the other effect Mises discovered: it subsidizes long-term capital investment in a manner that cannot be supported by the patterns of consumption and saving. As one Austrian economist puts it, when the central bank drives down interest rates, it causes the economy to bite off more than it can chew.
The effects of artificially inflating the economy can be to cause prices to increase. But as we saw in the late 1920s and other times since, that is not always the case. It often causes a kind of investment euphoria that leads people to believe that nothing can go wrong.
The monetarists, for example, believe that so long as prices remain in check, there is no problem associated with money expansion. The supply-siders, though sound on many issues, have an unfortunate faith in the power of loose credit to make bread from stones.
Mises developed his theory throughout the 1920s and warned of the coming of the 1929 stock market crash. His work was carried forward by F.A. Hayek throughout the 1930s. Hayek later received the Nobel Prize for this. Indeed, the theory was widely embraced until Keynes dreamed up an alternative view that resurrected all the old fallacies about the miracles of money creation and centralized economic management.
Then the Misesian theory languished for decades until the downturn of 2000. Today it is getting new attention as the leading explanation of the insanity of the late 1990s and the following bust. Only the Austrians knew all along that reality would strike back. The Fed and the administration have worked ever since, using the only tools they have —regulation, spending, and credit expansion—to reverse the course of the recession.
It is always an illusion to believe that more money is the answer. The federal funds rate is at a 40-year low, and that hasn’t done the trick. During the 1990s, the Bank of Japan tried again and again to manufacture a recovery through absurdly low rates, but that didn’t work either. There is no evidence from either theory or history that pounding interest rates into the ground can create anything resembling a sustainable prosperity. And yet, people believe it, or want to believe it, because it seems better than the alternative.
This entire affair illustrates the underlying reality of American political and economic life: the state’s ability to create money and credit. All other powers of government—regulatory, fiscal, even military—pale in comparison to this.
But the monetary sins of the interventionist state are hardly the only ones. Our age is dominated by the state and its errors in both domestic and foreign policy. The state has given us recession and war, while liberty has given us prosperity and peace. Which of the two paths prevails in the end depends on the ideas we hold about freedom, capitalism, and ourselves.
May we never forget the great truth that our founding fathers worked so hard to impart: tyranny destroys, while liberty is the mother of all that is beautiful and true in our world. Make no apologies for being a champion of prosperity and its source, the free-market economy. It is what gives birth not only to production but to civilization itself.
Llewellyn H. Rockwell, Jr. is president of the Mises Institute and editor of LewRockwell.com (Rockwell@mises.org). This essay is excerpted from his forthcoming book, Speaking of Liberty.
