Freedom and Economic Order Read online

  Capitalism: The Price System

  The term capitalism is widely applied to the economic system that emerged in the West over the course of centuries, a system also referred to as the free-enterprise system, free market, market system, process, or order, and, perhaps most precisely, the price system. The nature of capitalism and its contribution to human wellbeing is not universally understood or appreciated, even within traditionally capitalist societies such as the United States. Failure to appreciate the market order is perhaps related to the human propensity to take things for granted. Participants in a developed capitalist economy may easily assume that the bounty and plenty that surrounds them is somehow a fact of nature like the sun and seasons, an aspect of life itself. Their main concern usually involves the ability to afford the goods and services they desire, whether they personally possess sufficient resources to acquire them. Few persons pause to wonder how the desired goods and services came into being in the first place, why they exist at all, available for the taking to anyone with the requisite means of purchase. Persons who were born into less-developed societies, travel extensively, or study history, on the other hand, well understand that the prosperity and abundance characteristic of contemporary American society is among the rarest experiences in human history. The lives of most people who have lived and continue to live on this earth are characterized not by plenty but rather want and privation, poverty and unsatisfied need. It has often been noted that the poorest person in contemporary American society enjoys a higher level of material wellbeing than enjoyed by most kings and royalty of previous historical eras. Prosperity and abundance are the exception to human experience, not the rule.

  The question, then, is how the United States and other developed societies came to achieve such a high level of material wellbeing. Certain possibilities can be eliminated out of hand. Prosperity did not arise because the American people are smarter than other peoples; intelligence is rather evenly distributed throughout the world. It did not arise because Americans work harder than other people. Consider the millions upon millions of people who must labor for the greater part of each day merely to provide the barest subsistence for their children, as is not uncommon in less-developed societies. Nor did abundance arise because the United States has greater natural resources than other countries; natural resources, like intelligence, are widely distributed throughout the world. The reason for the exceptional prosperity that characterizes the American experience is the fact that throughout most of its history the United States embraced the free market as its preferred economic system. Capitalism, the market process, and the presence of the necessary conditions of its operation, account for American prosperity and plenty.

  The classic definition of capitalism is an economic system characterized by “private ownership of the means of production.” While such a definition is accurate, it provides little insight into the nature of capitalism or the actual manner in which the market process solves the economic problem. As previously noted, the essential difference between capitalism and socialism concerns the locus of economic decision-making within the two systems, that is, who decides what is to be produced, how to produce it, and who is to receive the fruits of production. In a market economy, all such choices are made by private individuals or groups of private individuals voluntarily associated in pursuit of a common objective (business firms and the other voluntary associations that constitute civil society, the private sector). Individuals in a society ordered by market exchange are able to make such choices because a market order, as the textbook definition indicates, presupposes the right to private property.

  A “property right” in an economic context is best understood as a “decision right.” The existence of defined property rights in a market-based society means that private individuals—those who own various resources—are morally and legally entitled to decide how such resources are to be employed. Private property, as we have seen, is regarded as a natural and universal right in American society, which means that every person is entitled to make relevant economic decisions with respect to his personal possessions and, moreover, typically does so on a daily basis. In a market economy, every private individual, and not governmental or public authority, decides how his personal property is to be employed in acts of both production and consumption. Private individuals decide what is to be produced, and how, and they also decide who is to receive or consume the goods and services so produced. In other words, the essence of a market economy is the radical decentralization of decision processes, and such, as we shall see, is the chief reason for the unrivaled material prosperity of capitalist economic arrangements. As said, the economic problem, in the end, is a knowledge problem. The success of capitalism can be attributed to the fact that a market order formalizes or institutionalizes the decentralization of decision processes, which allows in turn for the emergence and utilization of the knowledge upon which the solution of the economic problem ultimately depends.

  Kinds of Knowledge in Society

  The economic achievements of modern Western civilization, then, do not reflect superior knowledge per se. Such success must rather be attributed to the historical development and eventual embrace of a method of coordinating human activity that encourages greater generation and utilization of knowledge than any other method yet discovered, namely, the institutionalized market process known as capitalism. No human mind or group of minds could consciously assimilate or coordinate the vast knowledge and information that daily enters the social process via the market mechanism. Human knowledge, as we shall see, is an extraordinarily complex entity. A recognition of such complexity is crucial to grasping the complexity of the economic problem confronting modern society as well as the means of its solution.

  Accordingly, an elaboration of the divergent manners in which capitalism and socialism attempt to solve the economic problem, discussed in following chapters, requires a preliminary exploration of certain epistemological issues in some depth. Such is essential background not only for understanding the ordering principle of the market but also the reasons for its demonstrated superiority over socialized economic organization.[2] As we shall see, the success of capitalism stems from its ability to bypass the difficulties raised by both the inherent complexity of human knowledge and inherent limits of the human mind. Socialism and other forms of planned economy, by contrast, are constitutionally unable to overcome the obstacles posed by such epistemological constraints. For that reason, socialized economic organization is ultimately incapable of solving the economic problem, that is, achieving an efficient allocation of scarce resources toward fulfillment of actual human needs and desires.

  Human knowledge comprises distinct kinds or categories, all of which are relevant to solution of the economic problem. It includes not only explicit knowledge, consciously systematized theories and data (“knowledge that”), but also the tacit or inarticulate “know-how” embodied in culturally acquired habits of thought and practice, disposition and custom. The former kind of knowledge, explicit and systematized knowledge, can generally be articulated and deliberately or consciously communicated from one person to another and is of course crucial to rational human action. Tacit or implicit knowledge is equally crucial to human action but, unlike explicit knowledge, is not generally susceptible of deliberate interpersonal communication. A further type of knowledge, one that is of special economic relevance, involves the fleeting knowledge of local circumstances, knowledge relating to particular time and place, the utilization of which is essential to the functioning of a complex social order constrained by the fact of scarcity. Both tacit and fleeting knowledge, in contrast to the systematized knowledge communicated by books, lectures, and similar vehicles of communication, are held within and only within the minds of individuals and, again, generally in a form that is not consciously transmissible to other persons. Such kinds of knowledge, in the formal language of economic theory, are said to be essentially dispersed.

  The first kind of relevant knowled
ge, as said, is technical knowledge, expertise, “knowledge that” such and such is true, knowledge that may be embodied in and conveyed by textbooks, college courses, and other forms of explicit communication. Technical knowledge or expertise, as said, is transmissible to other persons. Scholars and scientists can study the laws of physics or biology and transmit that knowledge to other interested persons through education. They can study engineering techniques or foreign languages or auto mechanics and pass that knowledge on to others through books or personal instruction. Such technical knowledge, however, is only one dimension of the totality of knowledge possessed by individuals and that must be incorporated into the social process if scarce resources are to be allocated to their best possible use. The economic problem is decidedly not a simple problem of expertise or technique. The most brilliant engineers in the world cannot determine, for instance, whether it is economically desirable to build a bridge in a certain location. They can explain how to build the bridge but not establish whether such would be a rational use of scarce resources, a very different matter. Perhaps people in the community do not want or need a bridge; perhaps they would prefer that scarce resources be instead used to produce bread or clothing or cell phones. An engineer as engineer has no way of knowing such crucial facts. His expertise is technical and not economic, that is, concerned with rational choices in the face of scarcity, with efficiently employing scarce resources to produce goods and services that people actually want or need. Once an economic decision to build a bridge has been made, the special kind of expertise of the engineer is of course essential, but such technical knowledge is distinct and separate from the question of desirability from an economic point of view.

  The second kind of knowledge essential to solving the economic problem is the aforementioned concrete and local knowledge of time, place, and circumstance. Such knowledge and information, unlike technical knowledge, is not readily transmissible by means of books, lectures, courses, and the like. It is different in kind from technique or expertise—conscious and explicit knowledge that can be systematized or centralized and made available to anyone with an interest in learning. As mentioned, the second kind of knowledge is rather essentially dispersed or decentralized knowledge, that is, held within the minds of individual members of society and in no other form. Such knowledge cannot be assembled or collected, consolidated in a universal data base that anyone might consult. Nor can it be organized and transmitted through formal channels of education or communication. This is because knowledge of time, place, and circumstance is not only essentially dispersed but also fleeting and, moreover, often tacit or implicit rather than conscious or explicit. The tacit knowledge possessed by every individual is not usually recognized until some circumstance or other raises it to consciousness. The individual is generally unaware that he actually possesses such knowledge unless and until some trigger in his immediate environment calls it to mind. For that reason—the fact that the individual himself is not consciously aware of possessing relevant knowledge—tacit knowledge cannot be formally transmitted to other persons. No individual ever possesses full conscious awareness of everything that he actually knows and that actually informs his daily activities; every individual always knows more than he can say. Every individual’s daily activities, including economic activities, invariably rely upon continual guidance by both his explicit and tacit knowledge. A society that aims to make the best possible use of scarce resources in service of human needs, constituted as it is by individuals guided in this manner, must make use of all available knowledge, tacit, implicit, and perhaps fleeting, as well as technical, explicit, and more or less stable.

  A concrete if homely example may be helpful in recognizing the existence of tacit knowledge and its relevance to the economic problem. Suppose that the kitchen pipes in an individual’s residence suddenly spring a major leak; water gushes all over the floor. Such an emergency requires immediate response; a plumber is urgently needed. Recall in this regard that resources are scarce or limited, not only for society as a whole but also for every individual. The individual confronted by the emergency will want to find a plumber who can not only quickly fix the pipes but do so at the lowest cost. He can take his chances with the telephone directory, calling various plumbers and comparing cost estimates. Such, however, is time-consuming and, moreover, his emergency will probably command a premium price for plumbing services.

  While contemplating his options, suppose the individual suddenly remembers that his friend has a brother who is an excellent plumber. He calls his friend. She agrees to help him and persuades her brother to fix the pipes at a reasonable price. The brother arrives and repairs the pipes: problem solved, and efficiently. The individual with the broken pipes utilized his knowledge, explicit and implicit, to deal with the unanticipated situation. He explicitly understood, for instance, that a plumber was the proper remedy for the broken pipes. The economically relevant knowledge he utilized, however, was mainly of the tacit kind. The individual was not explicitly aware that he possessed knowledge of the brother-plumber until a particular circumstance—the leak in the pipes—raised it to consciousness. He previously knew of the plumber but only tacitly.

  Every human being, as mentioned, possesses similar tacit knowledge relating to myriad topics, and the use of such knowledge is essential to solving the economic problem arising from scarcity. Resources are limited, both individually and for society as a whole. No individual wants to pay more than necessary for any good or service; to do so is to have fewer resources available to obtain other needed or desired items. Nor would this be beneficial from the point of view of society as a whole. To pay more than necessary to repair the pipe is wrong not only from the individual’s point of view but also the social point of view, and for the same reason—the additional resources used to pay a more expensive plumber could instead be used to produce items urgently needed or desired by other members of society. Resources are scarce, and both individuals and society at large benefit if they are employed as efficiently as possible, with minimum waste. The individual’s tacit knowledge of the brother-plumber assisted him in achieving a more efficient use of intrinsically limited resources, which means a greater availability of resources, individually and socially, for the production and consumption of other needed or desired items. Such is good not only from the individual’s point of view but also the point of view of society as a whole. The possibility of achieving such economic efficiencies, however, depends crucially on the effective utilization of tacit knowledge.

  A second concrete example will serve to illustrate yet another crucial dimension of human knowledge essential to rational economic activity, so-called fleeting and local knowledge of time, place, and circumstance. Fleeting knowledge is knowledge of immediate circumstances that do not remain stable over time; local knowledge is knowledge confined to one’s immediate and particular environment. To perceive the overwhelming significance of such knowledge for solving the economic problem, consider the case of a woman who unexpectedly discovers a hungry kitten on the side of the road. She is confronted with a particular and unanticipated need that is both fleeting (impermanent) and local (within her immediate purview). The Good Samaritan who wants to help the kitten has by chance discovered an urgent need, one that would not have been known to anyone if she had not happened to be driving down that particular road at the precise time the kitten was visible.

  A good or rational economic system, one that efficiently employs scarce resources to meet the actual needs and wants of human beings (in this case, cat food), must have some means of satisfying such unanticipated demand in a timely manner. Indeed, many of the goods and services individuals come to demand are contingent in this manner, that is, cannot be foreseen in advance of some unexpected circumstance. Demand of course can only be satisfied by corresponding supply or production, in this case, supply of cat food. An economic system that provides for the needs and wants of the community thus requires some means of incorporating unanticipated demand into pla
ns of production. As we shall see, and as is attested by daily experience, a market economy is eminently capable of meeting the innumerable contingent needs and desires that inevitably arise within human existence. Every American knows that our Good Samaritan has simply to drive to the nearest grocery store, where she will undoubtedly find a ready supply of cat food awaiting her purchase. Such good fortune is not accidental but an expected feature of capitalism, more or less taken for granted by persons accustomed to life in a market-based society. The ready availability of goods and services to meet both stable and fleeting demand, however, is far from the norm in societies that do not enjoy the benefits of free enterprise. Indeed the inability of non-capitalist economies to respond to contingent needs and desires in a timely manner is among the many reasons for the relative failure of such economic arrangements to promote human wellbeing, as will be further discussed in a following chapter.

  Epistemological issues, then, are central to the economic problems of production and distribution, and the alternative solutions to such problems offered by capitalism and socialism must be comprehended in their light. If human beings were omniscient or an omniscient god were immediately to direct all economic activities on earth, there would be no economic problem for any society to solve. An omniscient being, as previously remarked, would know the best means of utilizing scarce resources and would also know who should consume them. Human beings, however, are not in such a position. The extent of human knowledge is constitutionally circumscribed by the inherent limits of the human mind. No human being can know more than an infinitesimal fraction of all the relevant facts that must be taken into account in directing scarce resources toward their optimum allocation. Moreover, certain kinds of knowledge, as we have seen, are held only within individual minds and often in a form that cannot be communicated to other persons. Nor can any human being anticipate the ever-changing circumstances of human existence with any precision. The relevant facts that impel economic activity are continually in flux; concrete circumstances change in unpredictable ways (weather, birth and death, accidents, creativity and invention, and so on).