How Real Is the Asian Economic Miracle? A Reprise

Economics on Trial — THE FREEMAN – APRIL 1998

By Mark Skousen


“In retrospect, all fools become wise.”
–LUDWIG VON MISES

In the November/December 1994 issue of Foreign Affairs, Stanford economist Paul Krugman wrote a controversial article titled “The Myth of Asia’s Miracle.” He argued that, like Stalinist Russia and other centrally planned economies of Eastern Europe, the Southeast Asian nations were authoritarian and engaged in “growth achieved purely through mobilization of resources” rather than real productivity. He predicted that growth would continue, but at a slower pace. In sum, these Asian tigers were subject to the law of diminishing returns.

In my July 1996 Freeman column, I disputed Krugman’s thesis, countering that they had adopted sound principles of economics, such as budget surpluses, low taxes on investment, no welfare schemes, and high levels of saving and investment.

Krugman proved to be more accurate, although the reasons for the Asian crisis are more complex than either one of us realized.

As I see it, there were two factors at work that led to the collapse in the Asian markets and recession. First, overinvestment, and second the strength of the U.S. dollar. Let’s review each of these factors and the lessons we can learn from each.

Malinvestment and the Boom-Bust Cycle

First, it is clear that most of the Southeast Asian economies, including Singapore, Thailand, Malaysia, the Philippines and South Korea, suffered from overinvestment, or what Ludwig von Mises called “malinvestment.” The authoritarian regimes engaged in a “forced savings” program, demanding its citizens and businesses to overinvest. When voluntary savings were deemed insufficient to build up the nation’s infrastructure and capital formation, the state promoted industrial planning. Moreover, it created cheap credit policies and encouraged foreign investment at low interest rates. In sum, Southeast Asia created a classic inflationary boom.

The Austrian school has warned time and time again that an inflationary boom in capital investment not only causes prices to rise, but also makes unsustainable projects look attractive. Eventually, interest rates must rise and the economy is hit by a recession.1

The Dollar as a Quasi-Gold Standard

What brought about the crash in Asia? Strangely enough, it was the strength of the U.S. dollar. While not predicting the Asian crisis, I did forecast a strong dollar in the second half of the 1990s.2 I just failed to think through all the ramifications of a strong dollar around the world.

Most of the Southeast Asian currencies were tied to the dollar, and that was their demise. In some ways, it reminds me of the specie-flow mechanism under the gold standard. Under a classic gold standard when a nation inflates, gold flows out of the inflationary country, forcing the economy to contract. That’s more or less what happened in Southeast Asia, except that instead of gold, the standard was the U.S. dollar.

When the dollar rose 30 percent against the other major currencies, Southeast Asian economies that were export-oriented and linked to the dollar were placed at a disadvantage. Their exports suddenly became 30 percent more expensive, and demand for their goods declined. Exports dropped, profits fell, and debts couldn’t be repaid at current exchange rates. Consequently, their governments were forced to delink from the dollar and their currencies collapsed. The boom turned into a bust.

Silver Lining: Free-Market Reforms Coming

There is a silver lining in the Asian crisis. It is forcing Southeast Asian countries and their governments to adopt market capitalism. No longer can these authoritarian regimes afford to subsidize favored corporations or play political favorites. Inefficient or corrupt businesses must be allowed to go bankrupt. Easy credit is not the solution to a shortage of capital. In all this, Business Week has sounded the alarm and warned Asia not to fall back to angry nationalism or anti-capitalism. This is all the more amazing because Business Week has long had the reputation for being anti-free market. But it has changed for the better. To quote a recent editorial: “There is a strong chance that the Asian crisis can act as a solvent, dissolving authoritarian governments and economic practices while spreading democratic market capitalism” (January 26, 1998). Amen.

Notes:
1.The best summary of the Austrian position can be found in The Austrian Theory of the Trade Cycle and Other Essays, Richard Ibeling, ed. (Auburn, Ala.: The Ludwig von Mises Institute, 1996 [1983])
2. See my January 1995 issue. “The New Dollar Boom.” Forecasts & Strategies (Potomac, Md.: Phillips Publishing).

THE FREEMAN – APRIL 1998

Keynesianism Defeated

WALL STREET JOURNAL — THURSDAY, OCTOBER 9, 1997

By Mark Skousen

In 1992, Harvard Prof. Greg Mankiw was paid an unprecedented advance of $1.1 million to produce the “next Salmuelson”–a successor to Paul Samuelson’s “Economics,” the most successful economics textbook ever written, with more than four million copies sold in 15 editions and 41 foreign translations since 1948. Mr. Mankiw’s 800-page “Principles of Economics” has now been published, to great publicity. And for good reason: Mr. Mankiw has written a revolutionary–or rather, counterrevolutionary–work.

Virtually the entire book is devoted to classical economics, leaving the Keynesian model as an afterthought in the end chapters. Mr. Mankiw’s pedagogy is all the more remarkable given that he considers himself a “neo-Keynesian.” His liberal bias has allowed him to do what no other mainstream economist dares: He has betrayed Keynes.

Almost all economics textbooks published in the past 50 years have taken their cue from Mr. Samuelson, whose major influence was John Maynard Keynes’s “The General Theory of Employment, Interest and Money” (1936). Keynes’s book taught that Adam Smith’s classical model–founded on the virtues of thrift and balanced budgets, laissez faire capitalism and free trade–was a “special” case and only applied in times of full employment.

Keynes’s model portrayed the market as a driver without a steering wheel, a driver that could push the economy off the road at any time. He taught that the economy needed a large and activist government to steer it on the road of full employment. Keynesianism, or the “new economics,” became widespread–the “general” theory.

Modern economics textbooks thus focused primarily on the ups and downs of the capitalist system and how government policy could attempt to ameliorate the business cycle. They include many chapters studying cyclical fluctuations, while burying the study of economic growth and development–otherwise known as supply-side economics–in the back pages. Now Mr. Mankiw has changed all that, putting classical economics back at the forefront, where it belongs.

This is more than some free-market economists have been able to accomplish in tile past. James Gwartney and Richard Stroup, authors of “Economics: Private and Public Choice” (Dryden, 1997), don’t believe in the Keynesian model of aggregate supply and aggregate demand, or AS-AD, but they were forced to include it by their publisher’s review board, which consists of mainstream economists. Roger LeRoy Miller, author of another best-selling textbook, “Economics Today” (Addison-Wesley, 1997), told me, “AS-AD is a bunch of nonsense, but I’m required to teach it.” (One small victory: Paul Heyne refused to put AS-AD in his “The Economic Way of Thinking” (Prentice-Hall, 1997) and got away with it because he writes for a niche market.)

So, in a Nixon-goes-to-China twist, it took a Keynesian to accomplish what the free-market economists couldn’t–relegating Keynesian models to a minor role in textbooks.

Mr. Mankiw calls his classical model “the real economy in the long run.” His textbook, published by Harcourt Brace’s Dryden Press, teaches that increases in government spending crowd out private capital, producing higher interest rates. Higher thrift and greater savings produce lower interest rates and higher economic growth. Unemployment is caused not by greedy industrialists, but by minimum wage laws, collective bargaining, unemployment insurance and other regulations that raise the cost of labor.

Mr. Mankiw even approvingly quotes Milton Friedman: “inflation is always and everywhere a monetary phenomenon”–not the product of rising labor or supply costs, as many Keynesians believe. In fact, Mr. Mankiw cites Mr. Friedman more than he cites Keynes.

This is not to say that Mr. Mankiw’s textbook isn’t without a few sins of omission. He fails to tell students about the great postwar economic miracles of Japan, Germany, Hong Kong, Singapore and Chile. He also ignores the current debate over Social Security privatization. And there are no references to the great Austrian economists Ludwig von Mises and F.A. Hayek, or to Nobel laureate James Buchanan and the public choice theory he espouses.

But these complaints are small compared with the book’s overall message, that classical economics is now the “general” theory and Keynesian economics is the “special” case. Amazingly, Mr. Mankiw doesn’t mention most of the standard Keynesian analysis: No “consumption function,” no “Keynesian cross,” no “propensity to save,” no “paradox of thrift”– and only one short reference to the “multiplier”!

That’s quite a feat for Mr. Mankiw, a man who named his dog Keynes.

Keynesianism Defeated

WALL STREET JOURNAL — THURSDAY, OCTOBER 9, 1997

By Mark Skousen


In 1992, Harvard Prof. Greg Mankiw was paid an unprecedented advance of $1.1 million to produce the “next Salmuelson”–a successor to Paul Samuelson’s “Economics,” the most successful economics textbook ever written, with more than four million copies sold in 15 editions and 41 foreign translations since 1948. Mr. Mankiw’s 800-page “Principles of Economics” has now been published, to great publicity. And for good reason: Mr. Mankiw has written a revolutionary–or rather, counterrevolutionary–work.

Virtually the entire book is devoted to classical economics, leaving the Keynesian model as an afterthought in the end chapters. Mr. Mankiw’s pedagogy is all the more remarkable given that he considers himself a “neo-Keynesian.” His liberal bias has allowed him to do what no other mainstream economist dares: He has betrayed Keynes.

Almost all economics textbooks published in the past 50 years have taken their cue from Mr. Samuelson, whose major influence was John Maynard Keynes’s “The General Theory of Employment, Interest and Money”  (1936).  Keynes’s book taught that Adam Smith’s classical model–founded on the virtues of thrift and balanced budgets, laissez faire capitalism and free trade–was a “special” case and only applied in times of full employment.

Keynes’s model portrayed the market as a driver without a steering wheel, a driver that could push the economy off the road at any time. He taught that the economy needed a large and activist government to steer it on the road of full employment. Keynesianism, or the “new economics,” became widespread–the “general” theory.

Modern economics textbooks thus focused primarily on the ups and downs of the capitalist system and how government policy could attempt to ameliorate the business cycle. They include many chapters studying cyclical fluctuations, while burying the study of economic growth and development–otherwise known as supply-side economics–in the back pages. Now Mr. Mankiw has changed all that, putting classical economics back at the forefront, where it belongs.

This is more than some free-market economists have been able to accomplish in tile past. James Gwartney and Richard Stroup, authors of “Economics: Private and Public Choice” (Dryden, 1997), don’t believe in the Keynesian model of aggregate supply and aggregate demand, or AS-AD, but they were forced to include it by their publisher’s review board, which consists of mainstream economists. Roger LeRoy Miller, author of another best-selling textbook, “Economics Today” (Addison-Wesley, 1997), told me, “AS-AD is a bunch of nonsense, but I’m required to teach it.” (One small victory: Paul Heyne refused to put AS-AD in his “The Economic Way of Thinking” (Prentice-Hall, 1997) and got away with it because he writes for a niche market.)

So, in a Nixon-goes-to-China twist, it took a Keynesian to accomplish what the free-market economists couldn’t–relegating Keynesian models to a minor role in textbooks.

Mr. Mankiw calls his classical model “the real economy in the long run.” His textbook, published by Harcourt Brace’s Dryden Press, teaches that increases in government spending crowd out private capital, producing higher interest rates. Higher thrift and greater savings produce lower interest rates and higher economic growth. Unemployment is caused not by greedy industrialists, but by minimum wage laws, collective bargaining, unemployment insurance and other regulations that raise the cost of labor.

Mr. Mankiw even approvingly quotes Milton Friedman: “inflation is always and everywhere a monetary phenomenon”–not the product of rising labor or supply costs, as many Keynesians believe. In fact, Mr. Mankiw cites Mr. Friedman more than he cites Keynes.

This is not to say that Mr. Mankiw’s textbook isn’t without a few sins of omission. He fails to tell students about the great postwar economic miracles of Japan, Germany, Hong Kong, Singapore and Chile. He also ignores the current debate over Social Security privatization. And there are no references to the great Austrian economists Ludwig von Mises and F.A. Hayek, or to Nobel laureate James Buchanan and the public choice theory he espouses.

But these complaints are small compared with the book’s overall message, that classical economics is now the “general” theory and Keynesian economics is the  “special” case.  Amazingly, Mr. Mankiw doesn’t mention most of the standard Keynesian analysis: No “consumption function,” no “Keynesian cross,” no “propensity to save,” no “paradox of thrift”– and only one short reference to the “multiplier”!

That’s quite a feat for Mr. Mankiw, a man who named his dog Keynes.

Welcome back, Professor

Ideas Matter
FORBES

By Mark Skousen

Millions of college undergraduates, myself included, studied economics using Paul A. Samuelson’s famous textbook. My first economics course, at Brigham Young University, used the 7th edition (1967). Since its first edition in 1948, Economics has sold more than 4 million copies and has been translated into 41 languages. It is the most successful textbook ever written. It has made the MIT economist rich.

What were we taught, even at a conservative institution like Brigham Young? I did a study of 15 editions of Samuelson’s book in the spring 1997 issue of the Journal of Economic Perspectives. What I found was a heavy dose of Keynesian folly. For example, that saving was bad (the so-called paradox of thrift), deficits were beneficial, fiscal policy was all that mattered and Soviet central planning could work.

Samuelson spent whole chapters in serious discussion of the socialist economics of the Soviet Union and China, while writing little or nothing on the success stories of West Germany, Japan, the East Asian Tigers or Chile. As late as the 12th edition, in 1985, Samuelson still believed the Soviet Union had growth rates exceeding the U.S., Japan and Germany. He had numerous sections on “market failure,” while offering little on “government failure.” He criticized laissez-faire, favored progressive taxation and endorsed the pay-as-you-go Social Security program.

Samuelson was no socialist. He frequently declared his optimism about the future of capitalism and rejected doomsday predictions about another Great Depression or national bankruptcy. He regularly defended free trade and was critical of Karl Marx and Marxian economics.

In short, Samuelson was a fairly standard Keynesian liberal. But say this for him: Unlike a lot of his fellow liberals, Samuelson is willing to change his mind when the facts demand it. Under the influence of Yale Professor William D. Nordhaus (co-author since 1985) and recent events, Samuelson is gradually shifting back to classical economics from pure Keynesian economics. In more recent editions of his textbook, he has reversed on a number of important issues. In the 15th edition (1995), for example, Samuelson states that Soviet central planning was a “failed” model, that national savings are too low and that the national debt is excessive.

The accompanying table compares some of the old Samuelson with the new.

Samuelson’s conversion from Keynesian heresy back to Adam Smith is far from complete. While favoring a capital gains tax cut, he recommends higher progressive income taxes to reduce the federal deficit. “America is not   remotely near the limits of taxation,” he told the New York Times (Oct. 31, 1993).

Nevertheless, I say, “Welcome back to classical economics, Professor Samuelson.” There’s only one problem: A lot of policy is still being made and a lot of journalism written by men and women who absorbed an earlier form of the Samuelson gospel.

A return to basics

Topic Old Samuleson New Samuelson*
Savings “The attempt to save only results in the reduction of income.” (8th ed., p.225) “The savings rate is too low to guarantee a vital and healthy rate of investment in the 1990s” (p.654)
Deficit “Incurring debt… induces more current capital formation than would otherwise take place.” (7th ed., p. 346) “A large public debt can clearly be detrimental to long-run economic growth.” (p.638)
Monetary policy “Today few economists regard Federal Reserves monetary policy as a panacea for controlling the business cycle.” (3rd ed., p.316)
reduction of income.”:(8th ed.. p. 225)
“Fiscal policy is no longer a major tool of stabilization in the United States…. Stabilization policy will be performed by Federal Reserve monetary policy.” (p. 645)
Soviet planning “The Soviet economy is proof that…a socialist command economy can function and even thrive.” (13th ed., p. 837) “The failed model: Soviet Communism.” (p. 714)

*15th edition

It took nearly 50 years, but Paul Samuelson is changing for the better.

Forbes · September 22, 1997

Best Textbooks for a Free-Market University

Economics on Trial
THE FREEMAN

By Mark Skousen

“I don’t care who writes a nation’s laws … if I can write its economics textbooks.” –Paul A. Samuelson

When I majored in economics in the late 1960s and early 1970s, there were precious few textbooks with a strong free market bent. My introductory course required Paul A. Samuelson’s Economics, a strictly Keynesian work favoring heavy state intervention. My class in the history of economic thought relied on The Worldly Philosophers, by Robert Heilbroner, a socialist who said that Karl Marx was a good family man. My economic history book was History of the American Economy, by Ross M. Robertson, who wrote that high federal deficit spending got us out of the Great Depression. And this was at Brigham Young University, a conservative institution.

Fortunately, free-market economists have gradually filled a gap by teaching sound principles at every level of economics. There’s still much more to do, but the direction is clear–more textbook writers are producing books that teach market principles.

Here are my choices for the best textbooks in each category:

Introductory Texts: Significant Progress

There are quite a few introductory texts to choose from. Most of my colleagues select The Economic Way of Thinking, by Paul Heyne (University of Washington), now in its eighth edition (Prentice-Hall, 1997). It focuses primarily on the micro foundations of the economy and avoids defective macro concepts such as aggregate supply (AS) and aggregate demand (AD). Economics: Private and Public Choice, by James D. Gwartney (Florida State) and Richard L. Stroup (Montana State), now in its eighth edition (Dryden Press, 1997), is another favorite. It consistently applies market principles to a host of problems, including the environment, taxes, and government spending. It is the only textbook I know that spends several pages on Social Security privatization.

The only drawback is that it begins its macro section with AS-AD, a fundamentally Keynesian concept (the idea that the economy can be stuck indefinitely at equilibrium at less than full employment). Gwartney and Stroup should take a cue from Greg Mankiw’s popular new textbook, Economics (Dryden Press, 1997), which begins its macro section with the classical model (which he terms “the real economy in the long run”) and relegates the short-term
AS-AD model to the back of the book. AS-AD is introduced in chapter 8 of Gwartney and Stroup but chapter 31 in Mankiw!

Another free-market textbook that puts classical economics ahead of the Keynesian model is Principles of Economics (Addison-Wesley, 1997) by Roy J. Ruffin and Paul R. Gregory, both professors at the University of Houston. They introduce AS-AD in chapter 27. Economic growth (the long-run classical model) is emphasized over the ups and downs of the business cycle (short-run Keynesian model).

Ruffin and Gregory have many other advantages: They are the only major textbook to cite favorably the Austrian economists Ludwig von Mises, Friedrich Hayek, and Joseph Schumpeter throughout the textbook, including the first chapter. Most textbooks quote liberally from John Maynard Keynes, Milton Friedman, and Karl Marx, but Ruffin and Gregory break new ground here. The authors focus on four major historical events (“Defining Moments in Economics”) and their impact on economic thinking: the industrial revolution, the rise and fall of socialism, the Great Depression, and globalization. They also devote major sections on privatization, public choice, the gold standard, and economic success stories in Europe and Asia.

Overall, the works by Ruffin and Gregory, and Gwartney and Stroup, are quickly becoming known as the most innovative textbooks on the market today.

Breakthrough in American Economic History

Now let’s turn to economic history. Gene Smiley (Marquette) has written a first-rate textbook for American economic history classes: The American Economy in the Twentieth Century (South-Western Publishing, 1993). It is the only textbook I know that considers all the major conflicting theories for explaining the major events of the twentieth century. It even includes an Austrian interpretation of the Great Depression and the World War II economy. I just wished Smiley covered events prior to the twentieth century; his book is that good.

History of Economic Thought

Many economics teachers have wisely replaced Heilbroner’s Worldly Philosophers with New Ideas from Dead Economists, by Todd G. Buchholz (Plum, 1990). Among other things, Buchholz is much more critical of Marx and central planning. Unfortunately, Buchholz’s book says almost nothing of the Austrian school. One book that does is A History of Economic Theory and Method, by Robert B. Ekelund, Jr., and Robert F. Hebert (McGraw-Hill, 1990). Murray N. Rothbard originally intended to write a one-volume history of economics, but his work gradually developed into a series of tomes, only two of which were completed before his untimely death: Economic Thought Before Adam Smith and Classical Economics (Edward Elgar, 1995). Both books are more appropriate for advanced courses in economic theory and philosophy.

Other free-market books may be helpful in various courses. For money and banking classes, Murray Rothbard’s The Mystery of Banking (E. P. Dutton, 1983) is useful. Dominick T. Armentano’s Antitrust and Monopoly, second edition (Holmes & Meier, 1990) is an ideal supplement in classes on industrial organization. And, of course, there is a wide variety of books on free-market economics to supplement the textbooks–works by Ludwig von Mises, Friedrich Hayek, Israel Kirzner, Henry Hazlitt, George Reisman, Hans Sennholz, and a host of others.

In short, free-market economics is back in the college classroom.

Economics in One Page

Economics on Trial – THE FREEMAN – JANUARY 1997

By Mark Skousen

“What makes it [economics] most fascinating is that its fundamental principles are so simple that they can be written on one page, that anyone can understand them, and yet very few do.”1
–Milton Friedman

The above statement by Friedman got me thinking: Is it possible to summarize the basic principles of economics in a single page? After all, Henry Hazlitt gave us a masterful summary of sound principles in Economics in One Lesson. Could these concepts be reduced to a page?

Friedman himself did not attempt to make a list when he made this statement in a 1986 interview. After completing a preliminary one-page summary of economic principles, I sent him a copy. In his reply, he added a few of his own, but in no way endorses my attempt.

After making this list of basic principles (see the next page), I have to agree with Friedman and Hazlitt. The principles of economics are simple: Supply and demand. Opportunity cost. Comparative advantage. Profit and loss. Competition. Division of labor. And so on.

In fact, one professor even suggested to me that economics can be reduced to one word: “price.” Or maybe, I suggested alternatively, “cost.” Everything has a price; everything has a cost.

Additionally, sound economic policy is straightforward: Let the market, not the state, set wages and prices. Keep government’s hands off monetary policy. Taxes should be minimized. Government should do only those things private citizens can’t do for themselves. Government should live within its means. Rules and regulations should provide a level playing field. Tariffs and other barriers to trade should be eliminated as much as possible. In short, government governs best which governs least.

Unfortunately, economists sometimes forget these basic principles and often get caught up in the details of esoteric model-building, high theory, academic research, and mathematics. The dismal state of the profession was expressed recently by Arjo Klamer and David Colander, who, after reviewing graduate studies at major economics departments around the country, asked, “Why did we have this gut feeling that much of what went on there was a waste?” 2

On the following page is my attempt to summarize the basic principles of economics and sound economic policy. If anyone has any suggested improvements, I look forward to receiving them.

ECONOMICS IN ONE PAGE

1. Self-interest: “The desire of bettering our condition comes with us from the womb and never leaves till we go into the grave” (Adam Smith). No one spends someone else’s money as carefully as he spends his own.

2. Economic growth: The key to a higher standard of living is to expand savings, capital formation, education, and technology.

3. Trade: In all voluntary exchanges, where accurate information is known, both the buyer and seller gain; therefore, an increase in trade between individuals, groups, or nations benefits both parties.

4. Competition: Given the universal existence of limited resources and unlimited wants, competition exists in all societies and cannot be abolished by government edict.

5. Cooperation: Since most individuals are not self-sufficient, and almost all natural resources must be transformed in order to become usable, individuals–laborers, landlords, capitalists, and entrepreneurs–must work together to produce valuable goods and services.

6. Division of labor and comparative advantage: Differences in talents, intelligence, knowledge, and property lead to specialization and comparative advantage by each individual, firm, and nation.

7. Dispersion of knowledge: Information about market behavior is so diverse and ubiquitous that it cannot be captured and calculated by a central authority.

8. Profit and loss: Profit and loss are the market mechanisms that guide what should and should not be produced over the long run.

9. Opportunity cost: Given the limitations of time and resources, there are always trade-offs in life. If you want to do something, you must give up other things you may wish to do. The price you pay to engage in one activity is equal to the cost of other activities you have forgone.

10. Price theory: Prices are determined by the subjective valuations of buyers (demand) and sellers (supply), not by any objective cost of production; the higher the price, the smaller the quantity purchasers will be willing to buy and the larger the quantity sellers will be willing to offer for sale.

11. Causality: For every cause there is an effect. Actions taken by individuals, firms, and governments have an impact on other actors in the economy that may be predictable, although the level of predictability depends on the complexity of the actions involved.

12. Uncertainty: There is always a degree of risk and uncertainty about the future because people are often reevaluating, learning from their mistakes, and changing their minds, thus making it difficult to predict their behavior in the future.

13. Labor economics: Higher wages can only be achieved in the long run by greater productivity, i.e., applying more capital investment per worker; chronic unemployment is caused by government fixing wage rates above equilibrium market levels.

14. Government controls: Price-rent-wage controls may benefit some individuals and groups, but not society as a whole; ultimately, they create shortages, black markets, and a deterioration of quality and services. There is no such thing as a free lunch.

15. Money: Deliberate attempts to depreciate the nation’s currency, artificially lower interest rates, and engage in “easy money” policies inevitably lead to inflation, boom-bust cycles, and economic crisis. The market, not the state, should determine money and credit.

16. Public finance: In all public enterprises, in order to maintain a high degree of efficiency and good management, market principles should be adopted whenever possible: (1) Government should try to do only what private enterprise cannot do; government should not engage in businesses that private enterprise can do better; (2) government should live within its means; (3) cost-benefit analysis: marginal benefits should exceed marginal costs; and (4) the accountability principle: those who benefit from a service should pay for the service.

Endnotes:
1. Quoted in interview, Lives of the Laureates, William Breit and Roger W. Spencer, eds. (Cambridge, Mass.: MIT Press, 1986), p.91.
2. Arjo Klamer and David Colander, The Making of an Economist (Boulder, Colo.: Westview Press, 1990), p. xiv. See also David Colander and Reuven Brenner, Educating Economists (Ann Arbor: University of Michigan Press, 1992).

Sorry, Charley, But That’s Not Capitalism

Economics on Trial
THE FREEMAN
June 1994

Sorry, Charley, But That’s Not Capitalism
By Mark Skousen


“All economic transactions involve a win-lose proposition. Every gain involves a loss.”
–Charley Reese, Orlando Sentinel, May 22, 1994

Lord Acton once said, “There is no error so monstrous that it fails to find defenders among the ablest men.” That was my reaction to a series of articles recently written by national columnist Charley Reese. Over the years, Reese has made a reputation as a strong defender of individual rights against a growing Leviathan, the federal government. So it was all the more perplexing when I read some of his claims about free-market capitalism:

“Two people can’t eat the same bean. That’s the essence of economics.”

“All economic transactions involve a win-lose proposition.”

“The historically visible trend [in capitalist societies] is always for the rich to get richer and the poor to get poorer.”

“Only the youngest, the strongest can put stock in pure capitalism.”

Statements like these were demolished years ago in Leonard Read’s classic little book, Cliches of Socialism, which was recently updated by Mark Spangler under the new title, Cliches of Politics (Foundation for Economic Education, 1994).

Unfortunately, some cliches die slowly.

Let me respond to each one of these commonly held criticisms of the free market.

Voluntary Exchange Is Win-Win

First, is the free market similar to a sporting event, where one team wins and the other loses? Not at all. In every voluntary transaction, both the buyer and seller gain. Here’s a simple proof: Suppose I sell an apple to a student for $1. The student buys the apple because he would rather have the apple than the dollar bill. Thus, by purchasing the apple, he improves his situation. On the other hand, I sell the apple because I’d rather have the dollar bill than the apple. I too am better off.

In Das Capital, Karl Marx popularized the view that all exchanges under free enterprise capitalism involved an equality of values and therefore one person’s gain must be another person’s loss. But now we see that just the opposite is true: All transactions in a voluntary exchange involve an inequality of values. In fact, without an inequality of values, no voluntary exchange would ever occur.

Because of an inequality of values, both the buyer and seller gain in every transaction. The only exception to this law is when fraud or deception is involved. When that happens, one party gains at the other’s expense. But in a voluntary exchange, where full and honest information is revealed, everyone benefits.

The Essence of Capitalism

Reese says that the essence of capitalism is contained in the statement, “Two people can’t eat the same bean.” Not so fast, Charley. A free market is not just an “either-or” proposition. Capitalism is also a highly cooperative system. If there are two people and only one bean, the free market provides a better alternative: plant the bean and harvest enough beans to feed both people! That’s the true essence of capitalism.

Granted, natural resources are limited. But the beauty of free enterprise is its ability to multiply these resources into goods and services that people can use to increase their standard of living. What really matters is not so much the amount of resources in their natural state but the supply of economically useable natural resources, which are limited only to the extent of our know-how and physical ability to transform these inputs into useable wealth. In that sense, there is virtually no limit to further advances in our standard of living. In reality, nature isn’t scarce, only the productive capacity of labor to change nature into real wealth is.

Capitalism Can Improve Everyone’s Standard of Living

Finally, Charley Reese is wrong in suggesting that capitalism breeds inequality, that the rich get richer and the poor get poorer. Under the free market, the rich get richer and the poor get richer too. Historically, citizens of capitalistic nations have enjoyed higher real wages and steady advances in the quantity, quality and variety of goods and services. Only government, the politics of coercion, causes a decline in the standard of living.

Moreover, the free market does not only benefit the young and the strong, as Charley Reese suggests, but the weak, the poor, and the discriminated. Contrary to popular belief, capitalism is not a dog-eat-dog jungle where only the fittest survive. As the classical economist David Ricardo demonstrated, the market is characterized by comparative advantage, not just absolute advantage in the division of labor. Therefore, opportunities abound for people of all abilities, talents, religions and races. The less fortunate may not earn a high wage, but they can and do benefit from the blessings of a technologically advanced capitalistic society. Today practically everyone, rich and poor, enjoys the benefits of electrical power, the telephone, the automobile, television and radio, books and newspapers, and a myriad other goods and services. Such everyday products were available only to the wealthy less than a century ago.

A free society is by no means perfect. People make mistakes, employers sometimes take advantage of workers, sometimes workers shortchange their employers, and salesmen may deceive the public. But the strength of the market is that bad business, deceptive practices, and shoddy merchandise are constantly being overwhelmed by good business, accurate information, and quality products. On net balance, there is no substitute for the free-enterprise system.