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March 8, 2009

The Magic of Markets

This essay is in response to David Kretzmann's Think Localization, Not Nationalization
The primary problems that I see with government intervention and central planning on all levels is that it assumes that those select few individuals know what's best for the people, the economy, etc.
Let's give the select few the benefit of the doubt. Let's take for granted that they have the best intentions at heart. These visionaries see a lot of problems and come up with a lot of solutions. Just recently President Obama said in a speech at a police academy that he was sure he had done the right thing in approving the rescue package in February because he was seeing the results, some 65 cops got jobs that otherwise would have been left vacant. This is powerful stuff for political speeches, proof of political action!

President Obama saw 65 new jobs. What did he fail to see?

For one, a 160 year old essay on political economics by Frédéric Bastiat: What Is Seen and What Is Not Seen. The core of Bastiat's argument is that the money spent on the 65 cops must have come from somewhere and the visible benefit in the police force is offset by an invisible deterioration elsewhere, that possibly 65 invisible jobs were lost elsewhere.

In making this argument, Bastiat is assuming that the economy is a zero sum game and that is not necessarily the case. If it were, there would be no harm to society as a whole, there would only be some winners and some losers picked by the anointed. I'm not sure who gave the anointed this godlike power to make and to break people but that is for another essay to consider.

But the economy is not a zero sum game. Some jobs are more productive than others. A cop essentailly makes sure that nothing bad happens. A paramedic tries to improve a bad thing. A production worker creates something new. Even if they are all paid the same salary, their productive output differs. I'm not going to say which is more and which is less productive because I don't have the vision of the anointed. Having cops patrol the streets to make them safe is a very good thing and so is flipping hamburgers to feed people and so is curing the ill and the injured. I can't make the determination of who to reward and who to punish.

But there is a method of impartially applying resources to those places where it does the most good, at least in economic terms. It's called "The Market Place." The market is magical, it insures that buyers get the lowest price possible that still allows some producers to make a profit. Here is how it works:

Let's start with two factories making widgets. Some factories are more efficient than others so they will have different costs of production. To simplify the explanation, let's assume that the producers try to sell at 30% above cost to make a nice profit.

Producer A has a cost of $100 per widget
Producer B has a cost of $120 per widget

They go to market to sell their widgets and initially they mark their widgets at:

Producer A: $130 per widget (100 + 30)
Producer B: $156 per widget (120 + 36)

People are only buying from A so B decides to lower his price to $130 and he starts to take away some business from A who responds by lowering his price by just $1 to $129. They get into a price war (or an auction which is the same thing) and they keep lowering the price until it hits $120. At this point B is not making any money anymore but he cannot lower his price without going broke.

And this is the magic of markets, the low cost producer makes money while the next lowest cost producer sets the market price, below that price there is no supply! In the process, A is kept in check, he cannot charge more than B's cost of production without B taking business away from him.

But it does not stop there. B still wants to be in the business of making widgets so he finds a way to lower his cost to $90 and the game is repeated now with one producer's cost at $90 and the other's at $100. By the above method, the street price should be around $100 per widget until A lowers his cost to $80.

How can the anointed possibly fine tune prices with such efficiency? They simply cannot. They can only reward those who vote for them and punish those who don't which is not a particularly fair or efficient way of running an economy. To answer the question of which jobs are more productive, if one believes that markets are the efficient way to put money to work and if the market didn't create those 65 jobs for the 65 cops, then other jobs elsewhere are more productive. That is not to say that the 65 jobs for 65 cops should not exists. But the decision was not an economic decision, it was a political decision, political economics to be more exact.

Denny Schlesinger

Recommended reading:

Reinventing the Bazaar by John McMillan
What Is Seen and What Is Not Seen by Frédéric Bastiat
The Vision of the Anointed by Thomas Sowell

Think Localization, Not Nationalization by David Kretzmann

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Last updated March 8, 2009.