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The Marvel That Is Capitalism

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04/08/2002Llewellyn H. Rockwell Jr.

This speech by the president of the Mises Institute was given before students, professors, trustees, and others at an awards dinner sponsored by the Adam Smith Club, Campbell University, Buies Creek, North Carolina, April 4, 2002. Rockwell and entrepreneur Lewis Fetterman received the club's Free Enterprise Award.

Free-market economics, of which the Austrian School is the preeminent exponent, asserts that every government intervention in the market generates consequences that are deleterious for prosperity and human liberty. However much such interventions may assist one group in the short run, everyone is made worse off in the long run. Government intervention destabilizes economic life in artificial ways, and ultimately does not work to bring about the results that its exponents claim to desire. 

Rather than dwelling on the theoretical apparatus that demonstrates this, I would give some examples of how this works, based on recent issues you may have read about in the news, and draw some broad lessons from them. 

Let us begin with the economic recovery. The headlines of the business pages have been trumpeting its arrival now for months. How do the experts decide when recession has turned to recovery? By looking at the data, which come in packages labeled in various ways: the GDP, the leading indicators, the unemployment rate, industrial production, housing starts, commercial borrowings, office vacancy rates, and a host of others. If these tend in the negative direction, we are said to be entering a recession. If they move in a positive direction, it is said that we are recovering. 

Let’s grant, first, that the larger the data set, the more subject to manipulation it is. We can count housing starts, but measuring something like national productivity is very tricky business. The great scandal of the way that GDP is collected is that it does not measure wealth destruction, as caused by something like September 11 or the 40 percent of private wealth consumed by government at all levels every year, and neither does it make a distinction between private production and outright government spending. Because of this, looking at the data alone, without a proper theory of economics, can produce a highly misleading picture. 

For about a year, the government has been engaged in a serious effort to bring us out of recession through a variety of fiscal and monetary policies. If recovery is really here, can we say that these policies have worked? Not necessarily, because we must establish a firm relationship between cause and effect to draw such a conclusion. The economy might have recovered without such stimulus efforts. In fact, such stimulus efforts might make the recovery weaker than it otherwise might be. 

Is It Real?

A more serious possibility is that the stimulus efforts have actually created an illusion. While everyone is celebrating the unexpected economic recovery, which is also unexpectedly robust, it serves us to look beneath the surface. There are aspects of this recovery that are highly unstable because they were brought about through artificial means. There are also certain policy trends which suggest that it might not last or that it will not be as robust as it might otherwise be. 

Look at a new report from the Congressional Budget Office. The report points out that new government spending has surpassed the amounts envisioned in the stimulus measure, exceeding what even the most spendthrift law-makers dared demand. The spending surge along with consumer debt helps to explain why the recession seemed mild and why everyone is talking about recovery. 

The government spending, which has very quickly pumped an extra $100 billion into the economy, began in October. Outlays are up over last year’s increases by 13.1 percent. In terms of GDP, it accounts for fully 1 percent. As for consumer spending, it is financed almost entirely by new borrowing fueled by artificially lower interest rates. 

Looking even deeper, we can see that Federal Reserve policy has been astonishingly loose since the beginning of 2001, reaching as high as 20 percent per annum by some measures. Let’s say I set out to stimulate economic production in this room. We could all gather together to write some software that is valued by the market, or we could teach each other new skills that increase our labor productivity. 

But what if I stood here with a photocopying machine and made a thousand copies of the $20 bill I have in my pocket, passed them around, and then announced that we are all $20,000 richer than before? I would hope you would be skeptical of this claim. When the Federal Reserve does this same thing with its money-creation machine, we should be also skeptical.

While recognizing that some of the rebound may consist of sustainable investment begun after the great shakeout of 2000, these factors just cited strongly suggest that the current economic recovery consists of more myth than reality. We need to ask ourselves whether and by what means it can be sustained.. The only means for doing so is for it to be supported through strong economic development and sound investment--investment that is borne out in consumer purchases and long-term profits. 


It turns out, however, that the federal government seems to be doing everything possible to undermine the likelihood of a sustainable recovery. Last month, the U.S. imposed a 30-percent tariff on steel. The idea here is to help one inefficient, bloated, and pampered industry at the expense of all U.S. consumers of steel, including U.S. businesses, and all producers in Europe, Asia, Brazil, and Australia. This is brazen protectionism, deeply harmful all around, not to mention morally repugnant.

Will it help the steel industry? In the short run, yes. But we have to ask ourselves whether this kind of help is a good thing in the long run. The tariffs permit an inefficient industry to continue to produce inefficiently, and forestall improvements in technology and cutbacks in wages that are necessary if the industry is to adjust to 21st-century realities. There is no virtue to keeping dying and inefficient technology humming along so that workers who might be better employed elsewhere can continue to enjoy fat checks doing outmoded work. 

How long must such tariffs remain in place? The steel industry says they are only necessary in order to get it back on its feet. But that belies that question of what, precisely, is going to inspire this sector to clean up its act? Protecting an industry from competition is a method that permits everything wrong with the industry to persist and not change. Either this tariff will have to be in place permanently, or the industry will have to be shaken up. 

If you think about it, Soviet socialism survived for 72 years on precisely such policies. The Soviet state protected all its industries from market competition under the alleged need to build socialism. Factories were never closed, and workers were never let go except for political reasons, when their services were employed in the Gulag. The system worked only if your standard is not efficiency but merely the guarding of the status quo. Eventually this system collapsed, as they must, and the Soviets woke up to a world that was backward and decayed. 

The steel tariff imposed by the Bush administration is different from Soviet socialism only in degree, not in kind. It is an attempt to circumvent the market process through a centrally administered system of rewards and subsidies for industry to abide by political priorities rather than market dictates. In the meantime, all purchasers of steel, whether consumers or other businesses, are harmed by being forced to pay a higher price for an inferior product. 

Most recently the U.S. also imposed massive punitive duties on softwood imports from Canada. Why? Because Canada refused to obey a U.S. demand that it place a new tax on its softwood. The new duties raise the price of softwood, used for building nearly every home in America, by 27 percent. This is going to distort the housing market, among many others sectors that use wood. Higher prices for steel and wood put additional pressure on other businesses that use these products in production. 

In economic terms, tariffs are indistinguishable from taxes. They take people's property by force by requiring businesses and consumers to pay higher prices for goods than they would otherwise pay in a free market. To that extent, they harm the prospects for economic growth. If anyone says otherwise, he is ignoring hundreds of years of scholarship and the entire sorry history of government interference with international trade. 

The repercussions of these two actions are already being felt via damaged relations in Latin America and Europe. The World Trade Organization will likely give the green light for retaliation. Protectionist lobbies all over the world are rushing to take advantage of the opportunity. The EU has imposed tariffs on U.S. steel, and Canada is considering retaliatory measures. This way lies trade war, which is the worst thing that can happen to an economy outside hot war. 

War Against the Economy

And speaking of war, another policy that endangers recovery is the war on terrorism. I’m not taking issue with the need for justice after September 11. But it seems clear that the government is using this tragedy as an excuse to vastly increase spending and regulation over the American and world economy. President Bush, who campaigned on a platform of cutting government, has asked for another $28 billion to pour into the military, even as he is pushing for more regulations on banks and financial privacy in the name of rooting out terrorism. The total increases for 2002 could be as high as $250 billion, depending on whom the U.S. plans to conquer next. 

Here again, this spending can create the illusion of prosperity, but we must also remember that first lesson of economic science: the world is a finite place where the use of any and all resources are constrained by scarcity. This is just another way of saying that you can’t always get want you want, and when you do, it must come from somewhere. When the government spends resources, it must drain them from the private economy through taxation, borrowing, or inflating the money supply to pay for the new spending. 

Economics doesn’t deny that redirecting resources from one sector where they are valued by consumers, to another sector where they are valued by government, cannot create pocket of expansion. What economics suggests is that this is not an efficient or sustainable use of such resources. Only the unhampered competitive market economy, with its system of market prices, profits, and losses, can reveal to us with any certainty the most desirable destination of economic goods. 

But in the examples I have just given, you can see how government intervention is redirecting resources from their most desired uses to purposes deemed desirable by political planners. The politicians believe that the military needs resources more than you and I, so they take them. They believe that the profits of the steel industry are more important than the international division of labor, so they protect that industry. They believe that the softwood industry deserves to obtain the highest possible prices for its products, so they intervene to hamper imports. 

As for the explosion of consumer spending that has taken place over the last six months, this does indeed encourage businesses to expand. If low interest rates are encouraging consumers to dig deep to borrow for and buy new homes, this will encourage more investment in housing on the production side as well, and this too will be encouraged by the interest rates being depressed by the Federal Reserve. Artificially low interest rates also tend to discourage savings, and encourage people to put money back into the stock market where, they hope, it can earn a higher rate of return. 

If credit expansion, protectionism, and government spending were a path to prosperity, mankind would have long ago created heaven on earth. But the politicians engaged in this activities have to contend with reality, and the reality is that economic forces in society must be mutually sustaining. To have production and borrowing, there must be savings, which only occur when people forestall consumption today to prepare for tomorrow, and in investment that pans out in the form of consumption. Absent such conditions, economic growth lacks a foundation in reality and turns to dust when economic conditions change. 

We have seen many examples of this in recent years. The Internet bubble was one such case. There was nothing unreal about the technology nor its potential to provide massive gains in efficiency, as well as a vibrant new commercial marketplace and information delivery service. Nor was there anything ignoble about investors who pumped money into dot-coms on the promises of future profits. What distorted the picture was too much credit, courtesy of the Federal Reserve, chasing too few capitalized companies. 

When the Fed began to reduce the pace of monetary pumping, lenders pulled back, investors pulled back, and dot-coms and their support infrastructure found themselves overextended, well beyond what the market would have borne if it had not been subsidized by a reckless Fed policy. The collapse of the Nasdaq was nothing more than reality reasserting itself. Some malinvestments were cleaned out and the ground was prepared for new investment. 

Dot-coms weren’t the only ones affected by the bubble. Enron is another case in point. This company profited and dramatically expanded at a time when investors were encouraged to recklessly purchase stocks without regard to balance sheets. The auditors are catching the blame, but the truth is that Enron profited in a time when portfolio managers weren’t paying very close attention either. The only way such a "cluster of errors" comes to predominate in a market economy is when the central bank unleashes new money and credit beyond anything that the market can sustain.

Prior to our own bubble, we saw a similar situation in Asia, and, before that, in Mexico. In each of these cases, what we find is not market failure but a failure of the system of money and credit to provide reliable signals for investors and lenders. It is helpful to think of the interest rate as a price signal, so that Fed attempts to drive down rates simply mis-price credit. In the same way that a government price ceiling would cause overconsumption of any good–whether eggs, gas, or electricity--distortions of the interest rate encourage overconsumption of credit. 

It is not surprising, then, that we are seeing a spending boom take place today among consumers even as producers are pulling back in many areas. Certain sectors have prospered since the reflation began after mid-2001. Housing, in particular, has boomed all out of proportion to what it would otherwise do in a free market. If any sector is being set up for a fall today, it is this one. 

But I don’t want to make a series of quantitative predictions concerning the future of the macroeconomy. Instead, I would like to help you come to think about the issue of economic intervention in a way you might not have thought about it before. Carl Menger, the founder of the Austrian School of economics, was a firm believer in the law of cause and effect. He believed that economic affairs could be analyzed in these terms as well. 

The Laws of Economics

His followers in this tradition of thought, including Ludwig von Mises and Murray N. Rothbard, spelled out the implications of this idea for a huge range of issues that confront us on a daily basis in the world of economics and politics. They focused on universal principles that can be derived from the teaching of economics. The laws of supply and demand, for example, cannot be repealed by any legislature or court. Government regulators can impose price ceilings, price floors, or limits to the size of firms like Microsoft, but economic law bites back by yielding shortages, surpluses, and reduced profitability. 

It is important that we think of economic life as an intricate global system of exchange, one that works without any central direction, and which generates prosperity and its own form of order within the framework of liberty. This is what is sometimes termed the magic of the marketplace, and we should never underestimate its power. We can see by looking south to Argentina how a failing economy, one thrown into shock by bad legislation and monetary policy, has destroyed the livelihoods of the entire population. 

We are not just talking about the earnings in people’s stock portfolio. We are talking about whether mothers can afford to buy milk for their children, and whether the businesses that deliver milk have the freedom to be entrepreneurial and find the least-cost methods to make such deliveries possible. When we speak of economics, we are talking about the health of society, and whether medical equipment is working and affordable, and whether the labor market is sufficiently free to permit everyone a place within the division of labor. 

People who dismiss the teachings of economics forget that many of the world’s wars and ethnic slaughters began in economic intervention. Before warfare broke out in Yugoslavia in the 1990s, the country was afflicted by one of the most extreme hyperinflations in the history of the world. This literally destroyed the standard of living and helped turn a previously settled society into a killing field. 

If we look back at history, we can see that many wars began in trade disputes, when governments attempted to reward some producers at the expense of others. This was the origin of the Civil War, for example. Even in our own times, the perception in the Muslim world that U.S./U.N. sanctions against Iraq have slaughtered hundreds of thousands of children has fueled hatred that has culminated in terrorism. The general lessons we can draw is that economics is really just a fancy word for the quality of our lives, and that the quality of our lives has no greater enemy than the governments that attempt to restrict economic liberty. 

The Quality of Life

Looking at people’s life spans, we see the hidden history of the rise of economic development. Throughout the first huge period of human history from the beginning until the birth of your father’s great-grandfather, the average life span was 20 to 35 years, and a third to half of all children died before reaching the age of 5. Economic conditions before very recently in the history of man could not sustain a world population that rose above a few million. Even by the year 1800, the average life span was only 40. 

The standard of living for the average person throughout all but the smallest slice of human history can be aptly summed up in the words of Thomas Malthus: "At nature's mighty feast there is no vacant cover for him. She tells him to be gone, and will quickly execute her own orders." That was life as everyone but kings knew it after the Fall and before the Industrial Revolution. 

But in the last tiny fragment of the history of the world, life spans have more than doubled and the world population has increased one thousand times. By far the largest improvements in these vital statistics have occurred since 1800, at a time when the division of labor expanded dramatically around the world; when property rights were secure; when capital could be accumulated, invested, and a return paid and reinvested; when technological improvements permitted new forms of productivity. What made this possible was the free market. 

We take for granted such luxuries as refrigeration, the air conditioner, the internal combustion engine, and electricity, to say nothing of email, the web, and fiber-optics. But we rarely reflect on the fact that all of these technologies, so integral to our lives, were absent when our great-great-grandfathers were alive, along with every previous generation in the history of the world. What set this revolution in motion was the world of ideas, when great thinkers began to understand the internal logic of the market economy and its potential for liberating mankind from poverty, dependency, and despotic rule. 

Given this history, one might think that everyone would sit and marvel at the products of capitalism. We might think that intellectuals would dedicate their lives to defending this system and explaining its merits. We might imagine that statesmen would dedicate themselves to protecting this system of economic progress from every attempt to curb it or abolish it. 

Alas, that is not true. Quite the opposite. The intellectual world often appears to be a conspiracy against market economics, and the media routinely ridicule capitalism. Statesmen spend every waking minute trying to curb, regulate, hamper, or otherwise loot the capitalist system. 

Those who attacked the World Trade Center were driven by revenge but also by a belief that the towering products of the commercial society somehow represent an evil that must be destroyed rather than a virtue that should be emulated. They were merely absorbing a view of that is pervasive in our culture today, where the anticapitalistic mentality runs rampant. 

In our own times, we have seen the evil produced by this mentality, in the former Soviet Union and in many Third World countries, where politicians do everything possible to keep the entrepreneurial spirit penned up, where property rights are not secure, and where investment for the long term is not permitted. The result is always the same: poverty, despotism, death. 

Mises: His Life and Work

As the founder and president of the Mises Institute, I have a special attachment to the ideas of Mises and to the courageous life he lived in defense of the idea of freedom. He began his career in Vienna, writing about the problem of the business cycle and the role of money and credit in fostering it. 

The core point he made in his great 1912 book, A Theory of Money and Credit, was that artificial increases in the money supply are not a substitute for real economic production; indeed such increases cause economic damage that can only be rectified through painful economic contractions. His point has continuing relevance. 

His next book, from 1919, sought to defend the idea that governments ought to be small and geographically limited, for the sake of social peace. Next, in 1920 and 1922, he proved that socialism could not work as an economic system because it abolished property rights in capital and thus destroyed the system of profit and loss that allows for economic calculation. His methodological and business cycle writings from the 1930s are some of the most profound in the history of the social sciences. Finally in 1940 and 1949, he produced what is quite possibly the finest product of any economist in history: his monumental treatise called Human Action

Incidentally, he wrote most of his treatise in exile in Geneva from his native Austria. The invading German armies deemed his work dangerous. They entered Mises’s apartment and looted his files and papers. Mises, you see, was against socialism, whether Bolshevik or Nazi. Reflect on that and begin to understand the absurdity of calling communism leftist and Nazism rightest, as if they were polar opposites. They are both varieties of the very opposite of freedom itself. 

If I were able, with Professor Cwik’s permission, to give you a reading assignment today, I would recommend Human Action above all else. Yes, at nearly 1,000 pages, it can be intimating, and you will probably need to read with a dictionary nearby. But it will open up new vistas of thought for you, and help you to rise above conventional wisdom. I continue to believe that this book points the way for us to bring about rising and sustainable prosperity, and also to guard civilization against its enemies. 

Mises believed that no power on earth is as strong as ideas. You live in the world of ideas, so take your responsibilities very seriously while you are here at Campbell University. The achievements of freedom should speak for themselves, but sadly they do not. Freedom needs courageous individuals who are willing to stand apart from the mob, and state an unconventional truth.



Contact Llewellyn H. Rockwell Jr.

Llewellyn H. Rockwell, Jr., is founder and chairman of the Mises Institute in Auburn, Alabama, and editor of LewRockwell.com.

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