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Market Change

January 8, 1999Christopher Mayer

Tags Free MarketsGlobal EconomyEntrepreneurshipProduction Theory

One of many virtues of the free economy is its flexibility. It is able to adjust to changing tastes, technology, and resource availability. In a living economy, property rights are secure but the uses to which they are "assigned" is in continual flux. Market signals embody individuals' subjective valuations of goods and services, and of money itself, and follow no pre-determined pattern. Entrepreneurs compete with each to correctly anticipate the uncertain future.

Market prices adjust according to individual demand and the market's supply of a particular good. Prices also respond to the demand and stock of money. Each of these influences figure into the mix and impel an economy in the direction of coordination. An economy unable to adjust, that is, an economy that is unable to reconfigure labor and capital to yield the best results, is an economy likely to be highly unstable and fraught with persistent misallocations.

The principle is nicely illustrated by comparing the booming economy of the Southern region of the U.S. and the continuing stagnation of the Japanese economy.

The Wall Street Journal reports on Hickory, North Carolina. Certain traditional sectors of Hickory's economy—namely the furniture, textiles, and chemical industries—have been shrinking for several months as more efficient importers beat out domestic producers for market share.

Ten years ago, this trend would have spelled doom for Hickory and for a large part of the South. However, Hickory is booming right now. It's unemployment is a rock bottom 2.3%, a thirty-two-year low. And job growth is strong throughout the South.

The region is booming because of new fiber-optic cable plants, medical centers, semiconductor plants and satellite manufacturing companies. The Journal story credits state spending on incentive packages and education to attract new industries to the region. But that is not the real story. (Newspaper writers often look for legislation rather than market adjustments to explain positive trends.)

The real story is that the free market doing exactly what it should be doing. The South has lost thousands of jobs in traditional industries such as textiles, chemical, and paper. These jobs also tend to be low paying and have low-skill requirements. The South could not compete with foreign producers in these areas. So, the capital in these industries migrated to those places where it would more efficiently employed. New industries have sprung to take advantage of relatively well-educated labor force.

Whatever the reason, the important point is what government did not do. If we had followed the policies prescribed by protectionists, these new industries would likely never have to come into being, and Hickory, emblematic of economic conditions in the bulk of the South, would have been on the front page for less favorable reasons, like stagnation and poverty.

A new round of tariff protection would have perhaps ensured a longer life for the South's textile mills. But at what cost? These new industries, which freely stand on their own merits in the competitive market, would have never come about. Instead, citizens would have been subsidizing textile mills and not enjoying the benefits of cheaper textiles and the additional goods created by the new industry. Clearly, these people would have been worse off.

The U.S. economy is heavily regulated in some ways, but price controls are largely absent, property is largely private, and entrepreneurs are free to make use of the profit and loss system to determine which projects are worth undertaking and which ones should be abandoned. Capitalists are relatively free to hire, fire, and pay workers according to market standards. As a result, production is constantly shifting to better serve consumers. Think about how this country's base shifted from agriculture, to heavy manufacturing, to financial services and technology.

Japan illustrates the same point as Hickory but in a different way. Where as Hickory is booming, Japan is mired in a terrible contraction, a slump of historic proportions. Unemployment in Japan is the highest it has ever been since such statistics have been kept.

This has occurred despite (and, in part, because of) Japan's social custom of lifetime employment and job security. It is also despite many attempts by government fiscal planners to stimulate the economy through credit creation, huge injections of spending, and legal protection of favored industries.

Japan's tale is one of inflexibility on the downside and of attempting to overlay a matrix of rigidity on a market economy in need of dramatic adjustment. Despite major economic distress, Japanese companies are still very reluctant to lay off workers and the government is still unwilling to let large banks and whole sectors fail. This has the effect of choking off the development of new industries and stifling the shifting of workers to the most highly valued ends of society.

Change is an inherent characteristic in the field of human action. Societies that are most flexible in their economic structure—allowing it to be shaped by market forces rooted in private property—are better equipped to handle the shifting needs of their economies. These societies will grow and prosper while those anchored by political chains and ruled by economic planners will go through periods of struggle and suffering.

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