In defense of the market system

It’s a little wonder how everyone has become an Economist. Almost everyone is definitive of the consequences of economic policy and direction in Zimbabwe. Like any piece of cake, there is the good and bad.

It’s good, because people are roundly concerned about their economic well being above everything else. It’s bad, because most have neither the tools nor common sense judgement to embrace the logic of economics.

Many are shocked that Economics is premised on laws and indubitable truths, since all they are accustomed to are trained Economists head butting each other and never agreeing. They quickly take this cue, and assume nothing in economics is true.

While Adam Smith managed to capture the popular culture of the 18th century, his writings were merely a regurgitation of the French Economists, primarily Richard Cantillon. Cantillon’s principles were etched in the nature of things. That everything is determined by supply and demand no matter the intrinsic value of the product or service. As a practicing market wizard he correctly defined a phenomenon that we now take for granted but is at the heart of Economics.

For example, today there are many who argue for minimal wage rate. Whatever, the reasons, Economic laws will not suddenly fail because the law and moral forces advocate for minimal wage. Such intervention results in greater unemployment and black markets for labour. While minimal wage protects those already employed, common sense implies those unemployed will happily take sub minimal wage rates. The same applies for all else in society.

It was the machines that replaced labour and with it child labour. It was the rise of machine that increased production and productivity and with it reduced the working day and week. It was not the moral arc that gave rise to what we now consider basic rights of workers. It was purely the profit motive. As Adam Smith correctly highlighted , the butcher and the baker are not benevolent doves that feed us dinner. Rather they are profit hawks with eternal self interest.

Richard Cantillon’s book Essay on the nature of trade in General, was an important contribution to Economics in setting out the general principles. Not that these principles didn’t hold true before- Hesiod in 7 BC had correctly identified the scarcity problem. The scholastic jesuits, Thomas Aquinas and st Augustine had correctly positioned arguments of value and decision making in society. But it was Cantillon’s book just at the dawn of the Industrial revolution that condensed economic thought into a body of knowledge.

As prices rise, the supply of a good increases. As prices decrease the demand of a good increases.

This is sacrosanct in Economics.The laws of supply and demand hold and are indubitable. They form the basis of economic theory and philosophy.

The intersection between supply and demand brings forth a price. We call this a clearing price. The different economic theories are centred around this price.

On the extreme end is the economic theory that holds everything must be centrally planned. It acknowledges the scarcity problem and the laws of supply and demand. But reckons, a bureaucracy with serious computing power must make these decisions for society. After all, markets are prone to manipulation and people are neither rational nor possess full knowledge to make decisions. This is at the heart of Communist/Marxian thought. It discards the price mechanism.

All factors of production are owned by the state and the state decides what must be produced and how it must be produced and distributed.

The very opposite of this, is the free market system. It posits, individuals must determine and answer society’s scarcity problem. Even with little information and irrational behavior the individuals in society must decide what is best for themselves. Individual votes, decide what must be produced, by whom and distributed according to need. The price mechanism is nothing but merely a signal of society’s preferences.

It was Joseph Schumpeter that correctly alluded to the market price as a constant havoc. Equilibrium price is only true for a particular moment and time, as information and preferences change so does price. Hayek’s price mechanism cemented this thought. Price discovery can never be left alone to a few bureaucrats to decide. If it holds that society as a general does not have perfect information why would it hold true that a few bureaucrats have perfect information about all production of all goods in society. Decentralized price mechanism allows decentralized decisions.

The profit motive Ludwig Von Mises argued, is at the centre of the market system. Profits drive innovation, changing supply dynamics. Innovation, as machines replace human drives mass production. Humans change their minds all the time, and so too their preferences . Today they want a coke, tomorrow water and later fruit juice. Central planners cannot keep up with these changes. Nor will they have the motivation to innovate as quickly.

The third economic theory is one that finds fault in the two theories and advocates intervention policies. Where markets fail, the state must take a role. Keynesian thought argues the role must be short term, since markets fail in the short term and eventually recover. This is called demand economics and is concerned with stimulating demand in the economy. Markets he argued, may uncharacteristically overshoot, it is the state’s duty to protect the market from itself.

Fredrick Von Hayek another Austrian luminary, thought this knight in shining armour was a disingenuous fellow, bringing forth central planning through the backdoor. While noone disputes market failure, the market is best in correcting itself. History is littered with bubbles, tulips mania, the great Mississippi, railway bubble and many others. However, the market has a self correcting mechanism. By intervening, one sets dangerous precedents. And who decides when to intervene and how? Who is best to intervene in an industry? Industry experts or state regulators who do not have the knowledge and motivation.

While Keynes advice to Roosevelt , i.e. New Deal was supposed to be short term, 80 years later the 1930’s subsidies are still operating. While Japan started its quantitative easing program in the 1980’s. 30 years later this market intervention is now permanent. Market distortion become permanent , destroying the market system it purported to uphold.

The French minister of finance in the 18th century, Turgot was inundated with requests for market intervention. The Agriculture sector would come with their requests, so too the Miners, Exporters and Bankers. Each extolling its significance in the market and why it was necessary to intervene to save France from a national catastrophe. Turgot, fully aware that the price of intervention would be borne by society at large and create unnecessary precedents had a scripted answer. Laissez-faire!

The market mechanism directs scarce resources into the most productive enterprises to meet our needs. Society is composed, at any moment, of millions of markets. Firms in their hundreds of millions and participants in their billions. The market is not a snap shot of supply, demand and price. The market is the ebb and flow, the continuos interaction and direct participation of consumers in their billions.

Most people have no problem in recognizing how prices at an auction of exactly the same product continuously change by the hour, with wild differences. Neither Perfect information nor market efficiency is a requirement for Auction success. If anything, intrusion of any sort is the most debilitating aspect. This hour, a farmer may not get the right price, yet in the next double the price. Hours turn to days and days into weeks and so forth.

No one price can ever be the equilibrium price for longer than that moment.

Yet this empowers farmers to become innovative and entrepreneurs in redirecting their efforts into crops and endeavours that profit them the most. Changes in prices are not and should never be a cause for concern. It is only a signal of either supply innovation ( e.g. synthetic diamonds) or changes in consumer preferences ( polyester over cotton).

Since nothing is certain, all market participants do is speculate about the future. This is at the heart of price discovery. Firms compete with each other to get customers, before long a natural order is established. The winning firm, only through innovation takes the lions share of the market. Before long a new entrant disrupts the entire industry and with it astounding benefits to society. This is a system, that brought us our civilization.

The market has two kinds of speculators that help in price discovery. The long term speculator, that is the entrepreneur takes a position about the future state of the world. He/she borrows capital from the capitalist at a cost ( interest rate), hires labour at a price and rents operating premises. He literally hordes capital on a fool’s errant, speculating that the product or service he will produce will fetch a higher price than his costs. Seven out of ten fail. The few that succeed are rewarded not just for the risk taken but for the uncertainty.

Economic philosophies agree on the above turn of events, they disagree on profit distribution. Communists and interventionists agree that Capitalists and Landlords have been given their just return but labour, since its in the majority must take a significant chunk of the profit. Marx can be forgiven , when he wrote, the machines had not taken over and labour was essential in the production process. He was wrong none the less. Latter day interventionist cloth their theory with high degrees of moralizing that even Marx would be embarrassed of. They argue it’s immoral for the winning entrepreneur to take such high profits. He must first share with labour and second with the greater society. Their morality does not extend to the seven out of ten entrepreneurs who fail.

The second type of speculator is the one who arbitrages. They see short term distortions in markets and speculate for a profit. Never mind that most individuals are involved in this kind of speculation, there is an immoral cloud that hangs over it. Yet it’s very useful in ensuring markets behave. Any manipulation that gives rise to market distortion will result in higher speculative behavior punishing the manipulators. Countries that try to fix their exchange rates, minimum wage, price controls and such, increasingly makes citizens speculators. Making it illegal does not stop speculation. It just takes it from the formal market to the black market.

The market mechanism must happen, regardless of any moral or legal pretensions.

It is worth noting St Thomas of Aquinas thoughts as presented by Murray Rothbard:

“Finally, and most charmingly and crucially, Aquinas, in his great Summa, raised a question that had been discussed by Cicero. A merchant is carrying grain to a famine-stricken area. He knows that soon other merchants are following him with many more supplies of grain. Is the merchant obliged to tell the starving citizenry of the supplies coming soon and thereby suffer a lower price, or is it all right for him to keep silent and reap the rewards of a high price?

To Cicero, the merchant was duty-bound to disclose his information and sell at a lower price. But St. Thomas argued differently. Since the arrival of the later merchants was a future event and therefore uncertain, Aquinas declared justice did not require him to tell his customers about the impending arrival of his competitors. He could sell his own grain at the prevailing market price for that area, even though it was extremely high. Of course, Aquinas went on amiably, if the merchant wished to tell his customers anyway, that would be especially virtuous, but justice did not require him to do so.

There is no starker example of Aquinas’s opting for the just price as the current price, determined by demand and supply, rather than the cost of production (which of course did not change much from the area of abundance to the famine area).”