Freedom and Economic Order Page 9
Suppose our young man has a talent for baking and greatly enjoys that activity. He thus conceives the idea of becoming a baker and eventually owning his own bakery and sets his mind to realizing that goal. His motivation is entirely self-interested. The young man desires personal happiness and financial wellbeing and hopes to fulfill such desires by means of a congenial profession that also generates sufficient income to live a pleasant life. He is not considering the welfare of others but solely his own; some might call this “selfish.” Further assume that the young baker eventually succeeds in establishing his own bakery. While he been successful in achieving his intermediary goal (owning a bake store), he has not yet realized his ultimate goal (happiness and financial wellbeing). Owning a bakery is a necessary but not sufficient condition of his ultimate success. Whether or not he achieves personal and material wellbeing depends not only upon his own skill and determination to pursue a profession he loves, but also upon his fellow men. No man is an island, least of all those who live in modern liberal society wherein human activity is coordinated by market exchange. In a market economy, the realization of the young man’s personal life plan will depend not only on the establishment of his bakery but also his ability to thereby make a living. The interdependence among members of a market economy means that his ultimate success depends only in part on his personal dedication, skills, and preferences. To achieve ultimate success he will also have to take into account his fellow men.
To better perceive the situation, let us assume the young baker particularly enjoys making cheesecake and wants to specialize in its production. He himself loves cheesecake, takes great pleasure in its creation and is highly skilled in its production. In a market economy, such factors may or may not be helpful to our aspiring baker but, in either case, they will not alone ensure his success. His personal tastes and skills in this regard are not decisive. In the market, as we have seen, the consumer is sovereign. That is, the young baker who hopes to achieve his life plan—happiness and material security—must not only possess relevant skills and motivation but also produce goods that other persons, his customers, actually and voluntarily purchase. In a free society ordered by market exchange, as said, no person can be forced to purchase any seller’s goods, however high their quality or however important they may seem to the producer. It is possible that people simply do not care for cheesecake and refuse to purchase it. In that case, our baker must overcome his self-interested or even “selfish” desire to produce cheesecake. He may in fact produce the best cheesecake in the world, and love doing so, but such is irrelevant if his potential customers do not want it. If he aims to earn a living as a baker, then, he must put aside personal tastes and preferences and consider instead the subjective preferences of other persons, what they might want. Such, according to Smith, is more or less the manner in which the market serves to restrain rather than encourage selfishness. Producers who want to be successful are forced to consider not their own needs and desires but those of their potential customers. There is no other way for our baker (or any other producer in a market economy) to achieve his personal goal—the profit through which he hopes to gain happiness and material security.
The young baker in a market economy faces the further problem of competition from other bakers or potential bakers. His goal of earning a living through operating his own bakery can only be achieved by offering his customers products that they both subjectively value and prefer over those of his competitors. In order to win their business, he must produce either better products, better in the subjective judgment of the consumer, or items identical to his competitors’ but at a lower price. Producers certainly do not welcome such competition. Smith, in fact, was among the first economic theorists to highlight the fact that capitalism, contrary to popular misconception, chiefly serves the interests not of producers or “businessmen” but rather consumers. Market competition spontaneously leads producers to further benefit their fellow men by providing them with opportunities to purchase either better products or identical products at lower cost. Such is generally not the intention of any producer, whose aim is not to help his fellows but rather further his personal self-interest, that is, gain profit. In a market economy, however, a producer can only further his own self-interest by serving the consumers; as we shall see, there is no other way to earn income or profit in a society ordered by market exchange. Every producer’s income is entirely dependent on the value that other persons place on the goods or services he provides.[18] Producers can only realize their personal goals by successfully meeting their customers’ needs and desires, providing them with products superior to that which they can find elsewhere, in their own subjective judgment.
Such is the relation that spontaneously produces the harmony of interest among buyers and sellers in a market economy so brilliantly captured by Smith’s famous metaphor. Observing such unintended harmony, it seemed to Smith as if producers in a market economy are guided by an “invisible hand” that leads them to channel their self-interested and even selfish desires, such as the desire for personal profit, into actions beneficial to their fellow men, namely, providing them with the particular goods and services they themselves (subjectively) value. It seemed to Smith as though a higher power, nature or God, were involved in the design of a system as beneficent as the market order, a system that spontaneously, without conscious intent, leads to social harmony and mutual wellbeing among members of society.
The Determination of Income
We next turn to explore yet another important if frequently misunderstood dimension of capitalism, namely, the manner in which individual income is determined in a market economy. Why do celebrated basketball players such as Michael Jordan earn multimillions of dollars and a fast-food worker at McDonald’s barely enough to sustain his existence? Critics of capitalism commonly allege that an economic system that permits such wide disparities of income is somehow unfair or otherwise morally suspect. In order to evaluate the justice of such charges, it is essential to understand how income is determined in a free society ordered by market exchange.
We have seen that the income of the baker in the prior example is ultimately determined by the value that other persons, his customers, place on the goods and services he provides. His income consists solely in the revenue he derives from voluntary purchase of his products. Such holds true not only for the baker but for every person employed in a market economy. There is basically one, and only one, way to earn income in a capitalist economy—to produce a good or service that other persons will voluntarily purchase because they subjectively perceive its value as equal to or greater than its asking or purchase price. We have repeatedly emphasized that in a market economy all exchange is voluntary; force is prohibited by definition. No one is permitted to put a literal or metaphorical gun to another person’s head and coerce him to purchase a particular good or service, whether a concrete material item or the skills and abilities embodied in another person’s “labor.” An individual who does not want to purchase a particular item may simply refrain from purchasing it, which of course happens on a daily basis. An individual who chooses, on the contrary, to purchase an item demonstrates by the very act of purchase that he would rather have that item than the resources (usually money) he must exchange for it. His partner in trade—the seller on the other side of the transaction—demonstrates the converse, that he would rather have the money than the item in question. A market exchange will occur if, and only if, both conditions are met. If either buyer or seller is unhappy with the proposed terms of trade, either of them can, and often do, refuse to trade.
Exchange on the free market always benefits both buyer and seller, in their own subjective judgment; otherwise it would not occur. Such mutual benefit is of the essence of market exchange; provided that the previously discussed preconditions of a market economy are met, it always results in a “win-win” situation. Market exchange or trade improves the subjective wellbeing of both parties to a transaction and does so in a manner that h
onors the individual freedom—the ability to act in a voluntary manner—of both buyer and seller. This of course is one of the principal reasons why valorization of individual freedom typically involves concurrent valorization of the market economy.
In a society ordered by market exchange, we have seen that the income of any individual is only partially a consequence of his own abilities and efforts. Individual income is also dependent upon the values and choices of other persons, in particular, the subjective value that market participants, buyers or consumers, place upon the individual producer’s skill or ability. More specifically, the income of every individual is impersonally, unintentionally, and jointly determined by all those consumers who purchase the good or service in whose production the individual is directly or indirectly involved. Producers or sellers may of course be either self-employed or employees of a firm owned by other persons. The category includes not only individuals who personally provide concrete goods to consumers (such as the baker) but also those who provide nonmaterial skills and talents (“labor,” knowledge, and other immaterial services). “Employees” of all kinds are producers or sellers in this sense and “employers” the corresponding buyers of their skills and talents. The income of an employee, like that of all producers in a market economy, is determined by the value that other persons place on his particular skills or services—the proximate value perceived by the employer which, in turn, is a function of the ultimate value perceived by the consumer of the final good or service produced by the firm.
The fact that individual income is ultimately determined by consumers is most readily perceived in the case of a person who is self-employed, whose sole source of income is the payment he receives from his customers for the good or service he directly provides to them. The baker in our previous example is a case in point. It is obvious that one hundred percent of the self-employed baker’s income is derived from sale of his baked goods to his customers. If they are pleased with his products he may attract more customers and his income will increase. If customers are dissatisfied, they will no longer purchase from him, and his income will decrease. He is of course free to offer his goods at whatever price he chooses but, again, no one can be forced to purchase them. Customers will only do so if they regard the value of the baker’s goods as equal to or greater than his asking price. In the final analysis, the income of the baker is entirely dependent upon the perceived or subjective value of his goods to those who purchase them. His customers determine his income.
The baker’s income, like the income of every individual in a capitalist economy, is not intentionally “distributed” to him by any conscious human agent but is rather an impersonal and largely unintended byproduct of market exchange. The baker’s customers jointly determine his income as a consequence of their decision to purchase his goods. Buyers, like sellers, are generally self-interested; they generally purchase a product because they need or want it, not to provide income to its producer. [19] Indeed, even if one’s aim were to increase the income of a particular producer, it would be difficult to do so in an advanced capitalist order. It is rarely possible to know the identity of those responsible for the production of most goods and services, especially those indirectly involved in their production, in the spatially extended order of the modern market. We have discussed the complexity of the market process, involving as it does thousands if not millions of individuals in the mere production of a gallon of orange juice. The intricacy of a far-flung global market order means that income determination in a developed market economy is not, and cannot be, the result of conscious decision on the part of any person or persons. It is rather an unintended and impersonal outcome of voluntary market exchange. The prevailing pattern of income distribution in a market-based society is a spontaneous consequence of the actions of countless individuals pursuing their own self-interest, purchasing goods and services to which they subjectively attach value, individuals who possess neither knowledge of the particular persons responsible for production nor the intent to affect their income.
We previously noted the relative ease of perceiving the relation between the income of a self-employed individual and the value placed on his goods or services by his customers. It is not as easy to perceive the same relation in the case of an individual employed by a firm or other large organization. Nevertheless, the same factors determine individual income in either case—self-employment or employment in a business owned by others. The income of individual employees, like the income of the self-employed, is ultimately determined by the value imputed by the firm’s customers to the final good or service produced by the firm. The self-employed personally retain one hundred percent of total receipts from sales to customers. Individual employees of a business firm, by contrast, receive only a portion of the proceeds from all sales of the final good or service, one proportionate to the value of their particular contributions to the production of the final good or service.
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A concrete example may clarify the impersonal process of income determination in a complex market economy that includes not only the self-employed but also numerous firms and corporate enterprises, large and small. Consider a common everyday event: an individual stops by the grocery store after work to pick up a few items, say, a gallon of milk and Fancy Feast cat food. His intention is simply to fulfill a personal need or desire, certainly not to determine another person’s income. Such, however, is precisely the unintended outcome of his action, in conjunction with the action of every other individual making similar purchases. However little he or she may be aware of the fact, such indeed is the effect of every individual’s action any time he or she makes a purchase on the market.
The relation between individual consumption and the determination of income is more clearly perceived by exploring both short-and long-run dimensions of the market process. We begin with an individual who purchases a can of Fancy Feast cat food at a local grocery store, paying for the item by cash or credit card. The money or purchase price is received, in the first instance, by the retail store. The retailer, however, does not retain the entire amount. He does not personally manufacture the cat food but typically purchases it from a wholesaler or distributor. A portion of the price the customer paid for the Fancy Feast, then, is distributed by the retailer to the wholesaler to pay for the cat food. The wholesaler, however, is also a middleman who does not personally produce the cat food but rather purchases it from the manufacturer, the Fancy Feast firm. Thus a portion of the money the original retail customer paid for the cat food, transmitted by the retailer to the wholesaler, will in turn be distributed by the wholesaler to Fancy Feast. Nor will the Fancy Feast firm retain all the money received from the wholesaler. It will rather spend a portion of its proceeds from sales to purchase the inputs necessary to make its cat food. Thus another portion of the retail purchase price is distributed by Fancy Feast to firms that produce meat, grains, and other ingredients used to make the cat food. Fancy Feast will also distribute portions of the original customer’s purchase price to pay for its capital and operating expenses, for instance, wages of workers and other staff hired by Fancy Feast; costs of the machines used in the Fancy Feast factory and electricity to operate the plant, and so on. Yet other portions of the original retail purchase price will be distributed, by Fancy Feast or its direct suppliers, to firms or workers indirectly involved in bringing Fancy Feast to the retail shelves—the truckers who transport the cases of cat food to the wholesalers and retailers, the butchers, miners, farmers, manufacturers of paper labels, ink, glue, and so on.
Innumerable individuals, then, are involved, directly or indirectly, in bringing a simple can of Fancy Feast cat food to the retail shelves. The income of every person involved in that process is partly determined by every consumer who purchases a can of Fancy Feast cat food at the local grocery store. Their income is determined, in the end, by the value that consumers place on the final product, the Fancy Feast cat food. If consumers do not want to purchase this product, there will be
no money to distribute to the retailer, wholesaler, manufacturer, or workers in all the myriad industries involved in its production. If all consumers were to stop purchasing Fancy Feast, the income of the owners and all other persons directly employed by the Fancy Feast firm would fall to zero, and the income of all other persons employed throughout the chain of its production would decline. The Fancy Feast firm would have no revenue because no one is purchasing the product it manufactures. Because the salaries of all employees of the Fancy Feast firm are paid from the revenue derived from sales of its product, the firm’s owners would be unable to pay them. In the total absence of customers, the Fancy Feast workers would have to be laid off and the factory closed. Such an outcome is the inevitable result of the market process, driven as it is by consumer demand. In the end, the income received by every person involved in the production of Fancy Feast cat food, directly or indirectly, is determined, wholly or partly, by the consumers who purchase that particular brand of cat food. Each individual purchaser is partially responsible, and all such purchasers jointly and fully responsible, for the total income earned by the Fancy Feast firm, the income of workers as well as owners and managers, and also for a portion of the income of all those individuals and firms indirectly involved in bringing Fancy Feast to market (truckers, miners, butchers, and so on).
The complexity of capitalist production, in conjunction with the spatially extended reach of modern market exchange, makes it impossible to know precisely whose income is determined, and in precisely what manner, by the individual actions of the millions of consumers in an advanced market economy, such as that of the United States. It is usually impossible for the consumer to know or learn which particular individuals will receive a portion of the price he pays for his various retail purchases. In the case under discussion, the individual purchaser of Fancy Feast knows in principle that he, along with all other customers who purchase Fancy Feast, ultimately determine the income of all those persons directly employed by the Fancy Feast firm. It would be difficult if not impossible, however, to know precisely how each of the firm’s individual workers is affected or even to know their identity. It is even less conceivable that any individual could know the identity of the innumerable persons whose income is also affected by his decision to purchase a can of Fancy Feast.