Abundance, Generosity, and the State

6

BENEFICIAL SIDE EFFECTS
OF HUMAN ACTION

In market exchange, there is no intention to gratuitously provide economic goods to other people. The intention is to provide and receive payments. Exchanges are based on contracts that regulate the obligations of buyers and sellers. Mutual obligation is not a mere by-product but the very purpose of a contract. We may therefore say that, by definition, the parties to an exchange do not intend to provide any economic benefits gratuitously.

Now, as we have seen, an exchange may be mixed with a gift. Smith might buy a bunch of flowers from a poor lady who does not wish to beg for money but offers to sell the flowers she picked in her garden. Or Smith might hire a nephew at a very generous wage. In both cases the observed exchange would include an exchange component mixed with a gift component.

Moreover, even though the partners to an exchange do not intend to provide any economic goods gratuitously, such provision may occur without being intended, or even contrary to the intentions of the market participants.

If an apple farmer decides to sell his product in town A rather than in town B, then this will attract more customers to A than B, so that other producers who sell in A will also have more customers. This consequence would result from his choice irrespective of (a) whether he knows it or not, (b) whether he takes it into consideration or not, and (c) whether he likes it or not. An experienced apple farmer is of course aware of these ramifications of his decisions. He is likely to take them into consideration and to have his own opinion on their desirability. Yet they would exist either way. Our apple farmer might very well hate the idea that the farmers who sell chicken in town A would benefit from his own business. But if he decides to sell in this market for any reason—for reasons that he intends—then the chicken farmers will benefit as well.

The example shows that unintended effects are not necessarily unintended in the sense that the agent ignores them or does not take them into consideration. Rather, he considers them to be side effects—sometimes also called spontaneous effects—in distinct contrast to those effects that are the central or deliberate objectives of his actions. Side effects may be desired (and in this respect intended in a larger sense) without being deliberately pursued.

In the present chapter, we will familiarize ourselves with the pervasive presence of beneficial side effects of human action within and outside of the context of market exchange.We will start off by discussing pure side-effect goods, which can only be obtained as an unintended consequence of human action, as well as economic goods that spontaneously result from leisure activities. This will be followed by a more detailed study of the numerous side-effect goods that spring from ordinary market activities. We shall see that the market economy is truly infused with them. It produces a panoply of economic goods which are not paid for by their beneficiaries— though these gratuitous benefits are not always intended, often ignored, and sometimes not even desired. The chapter concludes with some reflections on gratuitous evil resulting spontaneously from market activities.

From the outset, we should emphasize that like all other goods, side-effect goods have a subjective dimension. What is beneficial for one person is not necessarily beneficial for another person (and may even be harmful). Although some pedestrians may enjoy the performance of a street singer or the sight of a venerable historical building, others may find them to be a nuisance. The same pedestrian may enjoy the performance now and dislike it later, or the other way round. Moreover, since side-effect goods are by definition not exchanged on the market, there is no way to measure their monetary value.On the other hand, as we shall argue in chapter 8, the very impossibility of translating the value of side-effect goods into monetary terms protects them from being incorporated into the calculus of homo oeconomicus.

PURE SIDE-EFFECT GOODS

Let us start with immaterial goods of great importance which do result from human activity but can only be obtained as gratuitous side effects.It is impossible to pursue them directly and deliberately. Important examples of such pure side-effect goods are happiness and friendship.Both are the result of a virtuous life of “doing the right thing” even if it does not pay and even if it entails material disadvantages. Its driving force is the love of virtue. It leads us to do the right thing. It tends to make us happy and to bring us the friendship of other people who share this love. But we cannot lead a virtuous life in order to become happy or as a means to make friends.

The virtue of truthfulness may serve as an example. If I always speak truthfully, I may eventually earn the friendship of quite a few people who love truthfulness as I do. And I may speak truthfully knowing full well that I might for this reason be blessed with such friends. But the fact remains that this sort of friendship will always be a spontaneous rather than a deliberate consequence. For if I spoke truthfully in order to make friends, my truthfulness would be a means rather than an end in itself. It would cease to be a virtue, and it could therefore not earn me the friendship of people who appreciate the virtue of truthfulness. Similarly, by habitually speaking truthfully, I will tend to be happy because speaking truthfully is the right thing to do. But if I spoke the truth in order to be happy, I would reduce my truthfulness to a means, and happiness would not result.

In chapter 4, we saw that friendship is a typical consequence of genuine gifts. We then underscored that genuine gifts do not intend such consequences. While gifts are intended as expressions of friendship, friendship is an unintended effect of gifts. If Mary smiled at Sally in order to induce in her a feeling of thankfulness, then Mary’s smile would not have been gratuitous but calculated to oblige Sally. In this case, Sally would be thankful, but she would likely not become Mary’s friend. Thankfulness and friendship are not purely subjective or emotional outcomes. Rather, they are rooted in a rational response to a matter of fact. If Sally is the beneficiary of Mary’s smile—if she truly does benefit from it, rather than just dreaming or imagining it—then her thankfulness is at heart an acknowledgment of a matter of fact. But she would not react the same way to (what she perceives as) a gratuitous smile and to (what she perceives as) a calculated smile.

The idea that happiness cannot be deliberately “produced” but obtains only as a side effect of human action is a staple of philosophical thought (see, for example, Ferry 2016). It is also vindicated by psychological research (see, for example, Frankl [1979] 2005, p. 100–2; Haidt 2006).

Viktor Frankl argued that happiness is the consequence of leading a meaningful life. Man’s deepest desire is neither power nor pleasure but meaning. Those who succeed in giving meaning to their life become happy. But happiness cannot be achieved through deliberate action. It needs to be obtained as a side effect. The direct pursuit of happiness is the cardinal mistake of neurotics. They seek to produce what cannot be deliberately made or purchased.

Frankl summarized the key to a meaningful life in light of his personal experience as a concentration camp survivor:

What was really needed was a fundamental change in our attitude toward life. We had to learn ourselves and, furthermore, we had to teach the despairing men, that it did not really matter what we expected from life, but rather what life expected from us. We needed to stop asking about the meaning of life, and instead to think of ourselves as those who were being questioned by life—daily and hourly. Our answer must consist, not in talk and meditation, but in right action and in right conduct. Life ultimately means taking the responsibility to find the right answer to its problems and to fulfill the tasks which it constantly sets for each individual. (Frankl [1977] 1992, p. 67; [1977] 2016, pp. 117–18)

MATERIAL BENEFITS OF LEISURE

In chapter 5, we emphasized that market economies depend and thrive on virtues. They require a critical mass of market participants who cherish the most fundamental goods on which human cooperation depends—such as the will to do good and to be good, the love of truth, respect and for love of others, and the love of justice—and their active cultivation of these goods for their own sake. Although the material fruits of the market process depend on these dispositions, nobody behaves virtuously in order to make these material benefits possible. Nobody could do this, by definition.

Knowledge and love of the virtues requires leisure. It requires an abundance of time for activities that do not serve any practical purpose but which are carried on for their own sake. Hence, we might say with Josef Pieper that leisure is the cause of various material benefits, even though—or rather because—these benefits are not the intended outcomes of the leisurely contemplation of the true, the good, the just, and the beautiful.

There are certain things which one cannot do “in order to . . . ” or “so that.” One either does not do them at all or one does them because they are meaningful in themselves. Certainly the doctors are correct in saying that lack of leisure makes one ill. But just as certainly is it impossible to be at leisure for the sake of health. Such an inversion of the order of meaning is not merely inappropriate, it simply cannot be made to work. Leisure cannot be realized so long as one understands it to be a means, even as a means for “rescuing the culture of Christian Europe.” The celebration of the ritual of God’s praises cannot be realized unless it takes place for its own sake. But this—the most noble form of affirming the world as a whole—is the deepest source of leisure. (Pieper [1948] 1995, p. 88; see also pp. 44, 57–58.)

Leisure does not entail unintended material benefits only when it deliberately cultivates the virtues. Any genuine artistic, scientific, and spiritual activity is likely to bring such benefits about. Extreme cases, such as the lives of saints and the lives of creative geniuses, make this abundantly clear. The creative genius strives to live a pure life of leisure activity. He consecrates virtually all of his time to the perfection of one good, at the expense of all other dimensions of his being and of all other goods. He is an athlete of devotion and prayer, a great artist, a groundbreaking scientist, a pioneering engineer, an outstanding sportsman. He is wholeheartedly devoted to his cause. He is driven in an obsessive-compulsive way. He is passionate in the full sense of the word. He is an extremist.

Clearly, such behavior is anomalous if not downright pathological from a psychological point of view. But it is the behavior of many if not most creative geniuses in the arts and sciences. It is the behavior of religious mystics and of great athletes. It is also quite frequent among eminent leaders in other walks of social life.

Mises, the foremost theoretician of the logic of human action, considered the activities of such geniuses to be a special kind of behavior, in a category of its own within the general theory of human action. In his words: “The work of the genius is outside the orbit of ordinary human action and is like a free gift of destiny which comes to mankind overnight” (Mises [1949] 1998, p. 134).

What sets obsessive-compulsive behavior apart from ordinary human action is that the agent denigrates all alternative objectives for his life. He is single-minded in his pursuits and does not care about weighing the pros and cons of different ends. He does not wish to economize or to compromise. He dedicates all of his attention and energy to the one goal that obsesses his mind.

There is no guarantee that such behavior will lead to great goods. However, if it is combined with the inborn talents of a genius, it provides a very fertile ground for great creative accomplishments. Mises ([1949] 1998, pp. 138–40) stated:

For the pioneering genius to create is the essence of life. To live means for him to create For him there is no leisure, only intermissions of temporary sterility and frustration. His incentive is not the desire to bring about a result, but the act of producing it. The accomplishment gratifies him neither mediately nor immediately. It does not gratify him mediately because his fellow men at best are unconcerned about it, more often even greet it with taunts, sneers, and persecution. Many a genius could have used his gifts to render his life agreeable and joyful; he did not even consider such a possibility and chose the thorny path without hesitation. The genius wants to accomplish what he considers his mission, even if he knows that he moves toward his own disaster.

Neither does the genius derive immediate gratification from his creative activities. Creating is for him agony and torment, a ceaseless excruciating struggle against internal and external obstacles; it consumes and crushes him.

The creative accomplishment of the genius is an ultimate fact for praxeology. It comes to pass in history as a free gift of destiny. It is by no means the result of production in the sense in which economics uses this term.

Mises was right on target in pointing out that such accomplishments are gratuitous benefits for the rest of mankind. Beethoven was under no obligation to write his Symphony no. 9. All human beings may enjoy the writings of Dante, Shakespeare, and Goethe without having to pay the slightest bit. In the days of the internet, they do not even have to pay for a copy. However, contra Mises, we should not call all of these gratuitous benefits gifts in the narrow sense of deliberate donations to others. The creative genius may not have the slightest intention to provide any benefits to anybody else. He might do what he does because he does not care to do anything else. More often than not, he unintentionally provides gratuitous goods to others.

CULTURAL COMMONS

We have just seen how economic goods may be provided as side effects of leisure. But economic goods may also be the side effects of ordinary, self-interested activities. In his Investigation into the Method of the Social Sciences, and of Economics in Particular, Carl Menger famously argued that self-interested activities generate fundamental cultural goods such as language, legal codes, the division of labor, and money. All members of society benefit from these goods, even those who have not made the slightest personal contribution to them. Such gratuitous benefits are cultural commons.

Cultural commons are of vital importance for human community and society. Whereas the goods of the cultural commons are often called social institutions, they have not been established by deliberate human choice. Menger ([1883] 1985, bk. 3, chap. 2, pp. 139ff.) argued that they slowly “emerged” as the combined effect of countless human activities, even though their creation was not intended by the acting persons.

Consider the case of money, the generally accepted medium of exchange. Menger emphasized that it was not instituted ex nihilo. It was not created by a genius who anticipated the great benefits of an economic good that could serve as a medium of exchange, a unit of account, and a store of value. Rather, money came into being as a consequence of individual activities that did not at all have the purpose of creating something like money but which merely strove to improve the situation of those individuals themselves.

The crucial first step in this process was the invention of indirect exchange to overcome the limitations of direct exchange (barter). When Peter exchanges his apples for silver in order to exchange the silver for a hammer, rather than hoping to find someone willing to barter a hammer for his apples, he greatly increases his probability of obtaining a hammer. But he has not thereby created money. Money comes into being when many other people like Peter start to exchange indirectly and when they use the same medium. This does not happen overnight. Money comes into being as a result of a long, winding process of imitation, of marginal improvements, and of marginal discoveries. Eventually a monetary economy comes into being without having been imagined, planned, or understood by any of the people who have brought it about.

Menger ([1883] 1985, p. 157) contended that this mechanism is a general one. It does not only concern money. In his words:

In the same way it might be pointed out that other social institutions, language, law, morals, but especially numerous institutions of economy, have come into being without any express agreement, without legislative compulsion, even without any consideration of public interest, merely through the impulse of individual interests and as a result of the activation of these interests. The organization of the traffic in goods in markets which recur periodically and are held in definite localities, the organization of society by separation of professions and the division of labor, trade customs, etc., are nothing but institutions which most eminently serve the interests of the common good and whose origin seems at first glance to be based necessarily on agreement or state power. They are, however, not the result of agreement, contract, law, or special consideration of the public interest by individuals, but the result of efforts serving individual interests.

Cultural commons are a prime example of what we referred to as the unintended, “spontaneous,” or side-effect production of gratuitous goods. The persons who contribute to generating these gratuitous goods do obtain certain immediate benefits, like the ability to gain information from an unknown person in the street, to settle a conflict, and to perform an exchange. But the gains conveyed by a language in which the meaning of signs is standardized rather than idiosyncratic go beyond the immediate benefits that result from ad hoc communication with hand signs and grunts and shrieks. Similarly, jurisprudence, which provides systems of general and universal norms, provides greater benefits than ad hoc arbitration. And, as we have seen, the benefits of the money-price system are far greater than those which result from using a panoply of idiosyncratic media of exchange. The advantage of being able to learn from and to inspire people in distant times and places springs from language, not from the ability to communicate ad hoc. The advantage of large firms and other social groupings extending through space and time springs from a coherent system of norms, not from the ability to settle conflicts with ad hoc compromise. The possibility of assessing the most suitable course of action in terms of a monetary calculus comes with the use of money, not with indirect exchange per se. Similarly, an extended and complex division of labor springs from the competition of different agents within the framework of the money-price structure, not from the ability of any individual, be he ever so brilliant, to plan human cooperation within a single organization.

The wider benefits of the commons are great gratuitous boons for mankind. Language is the very foundation of human civilization. Language, law, and morals greatly facilitate the division of labor. Yet nobody has a claim on them and nobody has the obligation to make them available. They are brought into existence, maintained, and developed by human actions that are, as a rule, driven merely by immediate gratification. They are provided on a daily basis, but as a rule nobody intends to bring them about.

Menger was unequivocal in rejecting the idea that the cultural commons were created by deliberate human action. Clearly, there are deliberately created and privately owned network goods, such as football leagues, book clubs, and the internet. The economic benefits of these network goods can be privatized as well. But can the cultural commons be privatized? Does it matter whether money, law, and language result from a spontaneous process or are deliberately created? We will discuss these important questions in chapter 12.

OWNERSHIP

A surprising side effect of the market process is to promote market participants’ desire to become owners and to act as owners.

The material benefits resulting from exchange are the reason why people desire to exchange. But they are not per se a sufficient reason for people to fully own all the things that they exchange. For example, most people today buy their family residence with borrowed money. More often than not, what they really want is to receive the benefits that come from using the house and to reap a profit from reselling the house at a higher price. They want to be beneficiaries, but they do not really wish to be owners.

Ownership does not just involve some degree of effective control. It means responsibility. It means caring. An owner loves his property and looks after it. To be sure, this is not an altruistic or sentimental love affair. Ownership is a symbiotic relationship between the owner and his property. The mindset and the lifestyle of a person who owns a house outright are different from those of a person who owns no tangible property.

Now, in an unhampered market economy, people have an incentive to become full and exclusive owners of all durable goods because this is the most efficient way to obtain their associated benefits. The emphasis is on the word “unhampered.” As we pointed out in the previous chapter (see pp. 153ff.), in a world without monetary interventionism, price-deflationary tendencies would prevail. In such a world, it would rarely be worthwhile to purchase something with borrowed money. In nearly all cases, long-run investments would be funded out of personal savings or out of family savings.

Present-day real-world economies are of course very different, most notably because of the reigning monetary interventionism. In part three, we shall see how this difference is reflected in the cultural role of private property.

Here we need to emphasize that, in the absence of monetary interventions, price-deflationary tendencies would prevail. Debt finance would then tend to be more costly than self-finance out of savings, so that it would be desirable for all market participants to become full owners rather than mere users of durable goods. This also carries significant benefits for all other members of society, irrespective of whether these others own much, little, or nothing at all.

Let us highlight four relevant ways in which ownership entails positive external effects.

One, private property reinforces responsibility. Costs and benefits (but especially costs) are borne by the owner. Waste is penalized. Frivolous and selfish uses of land and capital are also discouraged, as they represent opportunity costs for the owner. The owner is encouraged to invest in the property and to think creatively about how to make the most of it. Moreover, because the profits on a private resource accrue to its owners, more capital will eventually be available to the persons who have wisely used their resources to the benefit of other people (their clients). Because any losses also accrue to owners, resources are withdrawn from incompetent owners’ control. This feedback mechanism facilitates the accumulation of capital and limits waste.

Two, private property naturally focuses people’s attention on the protection and development of the economic goods that they control. Owners naturally slip into the role of prudent caretakers and stewards. The importance of this role is obvious as far as depletable natural resources are concerned. But it is no less important when it comes to the preservation and fructification of capital and personal savings.

Three, private property greatly facilitates decision-making in the context of the painful trade-offs which can divide members of any larger community.

Four, individual private property encourages long-term goals. This is especially important in cases where short-run sacrifices are significant but their future outcomes are uncertain. Without strong owners, such choices would rarely be made. Among groups of minority owners and “stakeholders” there is usually a bias in favor of carrying on with current practice. Individual property helps to correct this bias because it concentrates the long-run gains. This can tip the balance in favor of longer-run considerations.

GOOD EXAMPLES

Acting man employs means to attain ends. But how does he know which means are suitable to which end? Such knowledge comes through learning and reflection.

Man learns from nature through observation and systematic study. He observes what others are doing and follows their example. He reads books and receives formal instruction from teachers. He thereby comes to obtain different types of knowledge. Some knowledge pertains to the superficial aspects of an object: where and when it exists, its typical variations of color and weight, and so on. There is also deeper knowledge involving some of an object’s causes and consequences and their limits. The deepest knowledge involves a comprehensive view of all of an object’s causes and consequences, as well as of their interrelations.

Knowledge may conceivably be obtained gratuitously via divine revelation. Like lightning, an unheard-of idea may just come. But learning is different. Learning is not gratuitous, even though some men learn more quickly and more easily than others.

In some cases, learning comes cheap. Imitating the behavior of others is usually not expensive in terms of time and money. But superficial knowledge is risky. Goethe immortalized its dangers in “The Sorcerer’s Apprentice.” It takes skill and effort to understand the practices of others. It takes even more skill and effort to improve on them, and it takes great talent and dedication to pioneer new and unheard-of products and practices.

These remarks are not meant to denigrate the economic merits of imitation. Quite the contrary. Our age is characterized by an infatuation with the new product and the technological pioneer. But the bread and butter of the market process is imitation and matching. Imitation may be fraught with risks, but entrepreneurs do not shy away from it.

This brings us to the truly gratuitous element in learning and knowledge: examples. Although our learning is not gratuitous, the examples provided by nature and by other human beings are gratuitous indeed. We do not have to produce them, we do not have a claim to receive them, and nobody has the obligation to provide them to us.

Some good examples come in the form of donations. The moral education of children comes from the good examples provided by their parents. The latter more often than not make a conscious effort to behave in front of their children. Such efforts are donations.

But many other examples are not at all intended as gifts. Very often they are provided against the wishes of those who give them. The example set by technology leaders, who are readily imitated by their competitors, is an important case in point, and it will be discussed in the context of the price effects of market exchange below. But it is not only technology leaders who provide gratuitous examples to their competitors. All entrepreneurs do this to the extent that their activities are visible to the outside world. Observing what one’s competitors do—imitating the successful ones and avoiding the failures of the others—is the most elementary form of competitive behavior.

This also concerns the observation of groups and of nations. They, too, thrive and perish. They, too, provide good and bad examples to outsiders. The history books are full of examples of nations copying what they found worthwhile in other nations.

For example, the Romans adopted and assimilated what they perceived as the best elements of Greek culture. Rémi Brague (1999) famously called this assimilation strategy “the Roman way.” Later on, the various Germanic tribes that flooded the territories of the disintegrating Roman Empire adopted the Roman way, too. They learned from the Greeks, from the Romans, and from all others who had something useful to offer. They practiced “cultural appropriation” systematically and on a massive scale. And their offshoots in other parts of the world have continued this pattern.

Arguably, the most resolute “cultural copycats” are the Jewish people, who have developed an astounding capacity to assimilate to, and contribute to, local cultures wherever they are—which is itself a significant cultural achievement. But cultural appropriation has also been practiced by other nations all over the world. Marvellous examples are Russia, Kemal Atatürk’s Turkey, Japan, China, Korea, and various smaller countries in Southeast Asia.

The Roman way and other methods of cultural appropriation are forms of cultural free riding. The copycat nation receives the gratuitous example of a functioning culture that it admires and which it did not bring forth itself. How does a copycat nation make use of this example? Adopting it is one way, by starting to do things the other nation’s way—eating, sleeping, loving, working, quarrelling, fighting, and making peace as the other nation would. Cultural appropriation of this sort goes hand in hand with transformation. The copycat nation changes its own behavior, attitudes, and outlook on life, its Weltanschauung.

An important consequence of adopting a culture is that the latter is thereby perpetuated, though not in its original form. Through adoption, the Romans preserved Greek culture, though with a Roman tint. The Germans continued the Roman and Greek culture, though in a Germanic way. And so forth. These cultural copycats get a free ride, but their love for the adoptive culture leads them to keep it alive. We see here a give-give of the sort we discussed in chapter 4.

There is also a second way to free ride on other cultures. Here the beneficiary is not a copycat. He does not change his own behavior, attitude, and objectives. He simply reaps some of the fruits that flow from the culture of others. Examples are tourists, foreign residents, and, more generally, all people who live in cultural ghettos in a foreign land. The tourist enjoys the monuments and art de vivre of his destination. The expatriate might stay abroad for years, working or in political asylum, yet without abandoning his native culture. His objective is to enjoy the revenue, the security, or whatever other advantage there might be in store for him in his adoptive land.

In this second case, therefore, the host culture is not nourished. It is not imitated and not copied. It is drained. The cultural free rider “internalizes” some of the goods that flow from the culture. He might pay for these benefits, but he does not become part of the culture that brings them forth.

OTHER PEOPLE’S ERRORS

We have noted that mistakes and failures may gratuitously stimulate other people’s learning. They may also convey material side effects to others.

Mistakes are by their very nature unintentional. Nobody strives to do a stupid thing. Error is always detected at some later stage, always after the wrong decision has been made. At the very moment when it is made, there is no intention to make a mistake. The acting person always sets out to do what he thinks is right and will be successful.

The unintentional benefits springing from human error are particularly striking and important in the context of entrepreneurship. The market economy is often characterized as for profit, and it is true that monetary profits are a driving force of market interactions. However, the aggregate benefits of the market economy do not at all spring from its profit orientation alone, but also from the prospect of losses. The market economy is not the profit economy. It is the profit-and-loss economy.

Both profits and losses spring from entrepreneurial error. An entrepreneur who suffers a loss has obviously made a mistake. He has bought factors of production at prices that were too high relative to the prices of his products. It is less obvious that investment errors are also the essential cause of profits, but this is very much the case. An entrepreneur who makes profits benefits from the errors of others (see Knight 1921; Mises [1949] 1998, pp. 286–91). Indeed, if those others had invested in his line of business, then the factor prices would have been higher and the product prices lower. His profits would have been lower, or they might not have come into existence.

Errors do not merely entail a zero-sum redistribution of wealth, favoring some at the expense of others. They also entail aggregate benefits. As we have seen, the money-price system contains a feedback mechanism that facilitates the detection, correction, and minimization of errors. Each market participant can thereby gratuitously learn from the errors of others, with corresponding advantages for the economy as a whole.

The most powerful mechanism through which one entrepreneur may benefit gratuitously from the errors of others is through the liquidation of assets, which often allows him to purchase these assets at prices below production costs. Such material gains resulting from the errors of others play an important role in moving capital into those hands that use it best.

Similarly, an entrepreneur who overestimates the contribution that any factor will make to the revenue of his firm is likely to overpay for this factor. He may, for example, overpay for a tool that he buys from a supplier or overpay for labor. Clearly, he does not intend to hand out gifts. He is making a mistake. His suppliers and employees will earn a higher income than they otherwise would have.

Errors of this sort are unavoidable in a market economy. It is unavoidable that employees, suppliers, customers, and competitors will obtain such gratuitous benefits. This has to be accepted in advance by anyone partaking in the division of labor. It is a form of spontaneous gratuitousness. There is no intention to provide a gift. The contracting parties may or may not be aware of the problem of evaluation. They assume good faith on the part of their exchange partner.

Profits and losses have often been portrayed as abnormal or morally shady income components that need to be rectified. Like a vast inheritance, a large profit is often looked upon as an unwarranted or unjustified benefit—a “windfall” profit. It is not luck, but undeserved luck. Like a plague, a ruinous loss and the hardships of unemployment are often decried as unfathomable manifestations of cosmic injustice. Not bad luck, but undeserved bad luck. It is precisely the seemingly gratuitous character of profits that is irritating to critics and prompts them to cast moral judgments. Clearly, there are profits that are illegitimate, most notably those obtained by illegitimate means, such as false advertisement, lies, threats, and force. But most profits are not of this sort. They are not only normal, but essential and beneficial elements of a market economy.

The usual response to the critics of profits and losses is that the profiteer did deserve the money he gained, that he worked much and hard and outwitted his competitors. This argument misses the point. There are lots of smart and hardworking people, but few of them ever make very large profits. Such profits only come into being when other people who could have supplied the same or similar services do not act. That they did not act can never be the merit of the person who did act and therefore did earn the profit. His merit is that he did the right thing, whereas his potential competitors did not. But the profit results from the error of these others, not from his own deeds.

SIDE EFFECTS OF EXCHANGE

Value Effects

First-year students in economics learn the concepts of “consumer surplus” and “producer surplus.” Most consumers do not pay quite as much as for the good in question as they would be ready to pay if they had to. They obtain a consumer surplus. Similarly, most producers obtain a higher payment than the payment for which they would sell if they had to. They obtain a producer surplus.

This phenomenon does not only concern the exchange of consumers’ goods. It is a universal feature of exchanges. If Smith exchanges his apple for Brown’s pear, then this means that Smith prefers the pear to the apple, whereas Brown prefers the apple to the pear. Both sides gain in this deal. The key factor here is that the exchanged goods cannot have the same value. The apple cannot have the same value as the pear, and the pear cannot have the same value as the apple. Rather, the apple-pear exchange manifests a two-fold personal-value difference. The price that the buyer pays is for him always less valuable than the good that he acquires (first difference) and the two goods have different personal values for each of the two partners to the exchange (second difference).

Although the value effects of market exchange are well known among economists, most non-economists believe that the exchanged goods have (or should have) the same value. One example among many is in the encyclical Caritas in veritate. Pope Benedict XVI presumes that a just exchange is by its very nature an exchange of equal values. This equivalence postulate, as we shall call it, is not spelled out in great detail. It is implicit and shines through in various statements, most notably in the passage (quoted in the introduction) where the Holy Father belittles the inner logic of a market exchange as “the mere logic of the exchange of equivalents” (Benedict XVI 2009, sec. 38).

The origin of the equivalence postulate is Aristotle’s analysis of the nature of a just exchange, as presented in the Nicomachean Ethics. Aristotle postulated that any exchange could only be just if the commodities exchanged had the same value. This view has inspired all subsequent generations of philosophers, but also the Christian theologians of the Western world, and even the classical economists. We will discuss its shortcomings in the next chapter. Here we need to emphasize right away that, whatever its merits may be as far as the justice of an exchange is concerned, it is irrelevant for the causal analysis of exchange. When Smith exchanges his apple for Brown’s pear, economists are only tangentially concerned with the justice of this interaction. Their main interest is to know why Smith exchanges his apple for Brown’s pear. And the only answer is the one that we have stated: Smith and Brown exchange because Smith prefers the pear to the apple, whereas Brown prefers the apple to the pear. The subjective value difference is the effective cause that makes the exchange happen. Without this value difference, no exchange would take place. No exchange could take place.

This is the economic point of view on the nature of exchange. It nicely completes the moral and juridical points of view in the study of gratuitous goods. The eyes of the lawyer allow us to see the bonds of claims and obligations between a buyer and a seller. The eyes of the economist allow us to see that such claims and obligations are not equivalent. Each exchange is based on a disagreement about the value of the exchanged goods. Both the buyer and the seller cherish their own claims more than the corresponding obligations. Each one receives value in excess of the value he gives, and the price he pays is sufficient and just to acquit him of his obligation. The inner logic of a market exchange is not “the mere logic of the exchange of equivalents,” but the logic of two-pronged gratuitousness in the midst of a contract. Both sides win, even though neither may have intended the other to win. In each exchange, there are beneficial side effects for both partners.

These benefits are spontaneous. They do not have to be specially arranged with win-win deals. They exist independently of the intentions of the market participants. This does not mean that they may not possibly be intended. If Brown and Smith understand the logic of exchange, then they know that each of them benefits therefrom, and they might then also conduct their exchange because they wish to provide such gratuitous goods to each other. Yet even if Smith and Brown were ignorant of basic economics, these spontaneous goods would nevertheless result from their exchange. The trading partners might very well believe that they are giving just the value that they receive. But such ignorance would not alter the fact that their exchange entails gratuitous goods. The partners to an exchange could do nothing to prevent this even if they so wished. They could refrain from exchanging, but that would be the only alternative. As soon as they engage in an exchange, they cannot prevent the double gratuitousness that it inexorably generates.

According to John Mueller (2010, chap. 2), the modern economic theory of the nature of exchange goes back to Saint Augustine, who in The City of God (1993, bk. 11, sec. 16, p. 447) introduced the idea of ranking goods in terms of utility. It was but a small step from there to understanding that in any exchange, the partners rank the goods differently. In the sixteenth century, Luis de Molina expressed this idea in his Theory of Just Price, stating that the just price of goods “depends on the relative appreciation that each man has for the use of that good.”The Jesuit Molina was a member of the School of Salamanca, which in the sixteenth and seventeenth centuries slowly started to realize that Aristotle’s approach was wrongheaded. The justice of an exchange is not determined by the quality of its objects, but by the quality of the decisions that bring it about. The primary questions are whether the property rights concerned are legitimate and whether consent is free and informed (see Chafuen 2003, p. 90). When these conditions are given, the exchange is just, and the market price that results from “common estimation” is a just or natural price.

Wealth Effects

Market exchanges not only generate the value effects that we have just discussed, but also price effects that are similarly unintended.

When the supply of any good increases, so that its market price sinks, the buyers are enabled to purchase greater quantities of this or other goods. They may therefore obtain greater quantities of goods in exchange for the ones that they themselves supply to the market. Whereas value effects make the market participants subjectively better off, such price effects make them materially better off. They come to own—or, more generally speaking, to control—more economic goods than they would have if the supply had not increased. This is why such price effects are usually referred to as income effects or wealth effects in the economics literature.

However, the standard microeconomic literature completely fails to appreciate that wealth effects of this sort are unintentional. That they are unintentional is most obvious in the case of price decreases which result from an increase in production. The general purpose of production is to alleviate scarcity. Increased production of any good means a greater abundance of it, which means that the good in question now has a lower marginal value. Now, a person who does not produce commodities for the market—think of Robinson Crusoe— intends this reduction of marginal value. When Crusoe grows potatoes, he wishes potatoes to become less important in his life, so that he can turn to other things. When he solves any problem, the point is precisely to reduce the importance—the value—of that problem. Solving a problem means creating a state of affairs in which no further action is required.

By contrast, in the context of the division of labor, the purpose of productive activities is to create goods that have value for other people. The producer does not necessarily intend to solve other people’s problems once and for all. He intends to exchange his product. His self-interest is not to reduce, but to increase the value that his product has for others. There is therefore a tension between his material self-interest (increasing his product’s value) and the objective consequence of his production (reducing his product’s value). In this sense, we may therefore say that the reduction of the subjective value of one’s products—and the resulting reduction of their market price—is an unintentional consequence of production in the context of the division of labor.

This unintentional effect is an important mechanism through which gratuitous goods are conveyed to others through market exchanges. Indeed, although there seems to be no gratuitous element in market exchange, a gratuitous element is in play in modifications of the exchange ratio. If three eggs are exchanged for one dollar, then one dollar pays for all three eggs. All benefits of the eggs are included in the price. But the question is: Why does a dollar buy three eggs rather than just one? Each increase in productivity improves the exchange ratio from the point of view of the customer. Each improvement is driven by the selfish profit motive of the producers. But the unintended consequence is to provide the customers with better deals.

Moreover, these unintended benefits of increased productivity do not remain confined to the exchanges in which they first appear. When a farmer works longer hours, produces more wheat, and sells his wheat at lower prices, then the buyers will tend to purchase wheat from him rather than from other farmers. As a consequence, these others will only be able to sell their wheat by lowering their prices, too. All buyers of wheat will therefore have more money available for other purchases. Their real incomes will increase. Thus we see that the price movement that started with the resolve of one man comes to spread through the rest of the economy. Similarly, when one shoe-maker improves the quality of his products, all other shoemakers need to propose better deals as well. To stay in business, they either need to lower their prices or increase the quality of their shoes. In all cases, the initial improvement entails an unintentional multiplication effect.

Competition

The foregoing consideration can be expanded and generalized by focusing on the nature of competition. In a famous essay on this topic, F. A. Hayek ([1946] 1948) argued that competition should not be defined as a state of affairs, and much less as a state of perfection, but as a process of piecemeal improvements.It is the process that improves the terms on which customers are served.

Hayek criticized the standard neoclassical model of pure and perfect competition. This model depicts a state of general equilibrium in which no human error occurs and where all prices are equal to their costs of production. Equilibrium prevails because all market participants benefit from perfect foresight, because their share of the market is infinitely small, and because they operate in a world in which all goods are perfectly divisible.It is obvious that this model does not represent any real-world economy, but it has been widely held to be a depiction of ideal market competition. On this point Hayek disagreed. He argued that the model misunderstands the very nature of what it seeks to explain. It depicts an “unachievable and meaningless ideal” (Hayek [1946] 1948, p. 100). Competition is not an optimal state of affairs. It is a process of improvement. Firms in a market economy try to provide economic goods on better terms than their competitors (by selling at lower prices, providing better goods, offering faster delivery, and improving their customer service).

This perspective on the nature of competition is also relevant to the theory of gratuitous goods. By definition, competitive behavior in Hayek’s sense entails additional benefits for other market participants. These benefits are gratuitous because in the cases Hayek envisioned, there is no obligation for individuals or firms to improve anything whatsoever and their customers do not have any right to claim such improvements. Moreover, these benefits are provided spontaneously because they do not strictly depend on the firms’ intentions.

This last assertion calls for a clarification. It seems to contradict the fact that all firms’ revenue depends on customer satisfaction and that virtually all firms are acutely aware of this. In response to this objection, we should stress the distinction between ultimate and instrumental goals. The fact that firms are conscious of the importance of customer satisfaction does not mean that their ultimate objective is to benefit the customer. The ultimate objective might very well be to increase the firm’s bottom line. Customer satisfaction would then enter the picture only from an instrumentalist perspective—it would be a means, or intermediate goal, to obtain profits.

In the context of a shrinking economy, entrepreneurs might very well make more money than before, even though their output is decreasing in quality and quantity. Yet even then, competition leads to product prices that are relatively low and product quality that is relatively high—compared to the prices and quality that would exist without competition.

Hence, we maintain our conclusion. The competitive market process provides spontaneous gratuitous benefits to the market participants. It is true that the latter pay for all the goods that the firms sell to them. But the point is that the relation between what they have to pay and what they receive tends to change in their favor. Thanks to competition, they may buy more and better products at lower prices. Their real income and their real wealth increase, even though their monetary income and their monetary wealth may remain unchanged. These improvements are obtained through the activities of people who are not necessarily driven by the ultimate desire to improve the lot of their fellow human beings.

Abundant Monetary Services

Another important and astonishing side effect of exchange is the abundance of monetary services, which we highlighted in chapter 2 (see pp. 87ff.). Any good that is used as a generally accepted medium of exchange can provide abundant services—in fact, unlimited exchange services—making it unnecessary to increase the money stock. The reason is that the services provided by money depend on its purchasing power, and the latter increases whenever the demand for money increases. If the demand for apples increases at a given stock, then apples become increasingly scarce. But if the quantity of money remains constant while the demand for money increases, money will provide ever more exchange services because its purchasing power will rise.

Technological Progress

The most striking case of the beneficial side effects of the competitive market process is the spread of technological innovations. New ideas spread through imitation and emulation. They can be transmitted fast and at low cost whenever imitating and emulating others is not impeded by intellectual property rights. In a free market, technological progress is limited only by the capital that is needed to apply new ideas. The latter can be adopted and copied by virtually all other market participants who have the intellectual ability to understand them and the capital to implement them. The economic value of new ideas is therefore limited by the time it takes imitators to understand and replicate them.

The first farmer who uses a wheelbarrow to carry his fruit to market is able to offer better terms than his competitors. He earns more revenue than they do. But when the latter understand his exploit and start to imitate him, all of them can offer the same terms. The consequence is that none of the farmers now receive much more revenue. All the benefits go to the customers. These benefits are gratuitous because there is no obligation for any farmer to provide fruit at a lower transportation cost and their customers do not have any right to claim such improvements. Moreover, these benefits are side effects because they do not strictly depend on the farmers’ intention to benefit their customers.

Bastiat (2007, p. 205) stated these facts with admirable clarity:

Nothing, whether favorable or unfavorable, can abide permanently with the producer. The advantages that nature and society bestow upon him, the inconveniences he may experience, pass through him, so to speak, and are absorbed and mixed up with the community in so far as the community represents consumers.

He illustrated this principle with the example of the invention of the printing press:

In the first instance, one man was enriched, and many others were impoverished. At first sight, marvellous as the invention proves itself to be, we hesitate to decide whether it is hurtful or useful. It seems to introduce into the world, as I have said, an indefinite element of inequality. Gutenberg profits by his invention, and extends his invention with its profits indefinitely, until he has ruined all the copyists. As regards the public, in the capacity of consumer, it gains little; for Gutenberg takes care not to lower the price of his books, but just enough to undersell his rivals. (Bastiat 2007, pp. 206–7)

But things do not remain this way. Bastiat went on:

At length the invention comes to be known. Gutenberg is no longer the only printer; others imitate him. Their profits at first are large. They are thus rewarded for having been the first to imitate the invention; and it is right that it should be so, for this higher remuneration was necessary to induce them to concur in the grand definite result that is approaching. They gain a great deal, but they gain less than the inventor, for competition now begins its work. The price of books goes on falling. The profit of imitators goes on diminishing in proportion as the invention becomes of older date; that is to say, in proportion as the imitation becomes less meritorious The new branch of industry at length reaches its normal state; in other words, the remuneration of printers ceases to be exceptionally high, and comes, like that of the copyists, to be regulated by the ordinary rate of profits. Here we have production, as such, brought back to the point from which it started. And yet the invention is not the less an acquisition; the saving of time, of labor, of effort to produce a given result, that is, to produce a determinate number of copies, is not the less realized. But how does it show itself? In the cheapness of books. And to whose profit? To the profit of the consumer, of society, of the human race. The printers, who have thenceforth no exceptional merit, no longer receive exceptional remuneration. As men, as consumers, they undoubtedly participate in the advantages that the invention has conferred upon the community. But that is all. As printers, as producers, they have returned to the ordinary condition of the other producers of the country. Society pays them for their labor, and not for the utility of the invention. The latter has become the common and gratuitous heritage of mankind at large. (Bastiat 2007, pp. 207–8)

He concludes:

What I have said of the art of printing may be affirmed of all the instruments of labor, from the nail and the hammer to the locomotive and the electric telegraph. Society becomes possessed of all through its more abundant consumption, and it enjoys all gratuitously, for the effect of inventions and discoveries is to reduce the price of commodities; and all that part of the price which has been annihilated, and which represents the share invention has in production, evidently renders the product gratuitous to that extent. (Bastiat 2007, p. 208)

It follows that in a free society, virtually all the benefits of technological progress fall on the final consumers, who gratuitously reap lower prices and better products.

The Theory of Positive Externalities

Present-day economists do not use the expression “side-effect benefits.” When they deal with the unintended repercussions of market exchange on third parties they speak of externalities. The problem is that this beautiful expression is used in a very special sense which precludes using it outside of the framework of the standard neoclassical theory. In what follows we shall briefly explain what is here at stake.

External effects, or externalities, are external to a market exchange in that they are not covered by the terms of the contract. They are not paid for. They are positive to the extent that outsiders benefit from them without paying. They are negative insofar as outsiders are harmed without compensation. The standard example of a positive external effect is the presence of a national army, which protects even those residents who have not paid for its services. The standard example of a negative external effect is the pollution from a nearby factory chimney.

Although these distinctions are valid and important, the standard microeconomic approach to external effects is deficient and leads to disastrously wrong policy conclusions. The reason is that it deals with externalities only in a highly contrived way; namely, by reference to the Arrow-Debreu theory of general equilibrium.

This theory presupposes that in general equilibrium literally all goods are paid for unless they are explicitly transferred as gifts; and that such a situation of complete markets is optimal. We will discuss these assumptions in more detail in chapter 7. Here we should highlight that, in an Arrow-Debreu equilibrium, there simply cannot be any side-effect benefits of the sort that we have discussed in this chapter. Wherever such side effects are present, the economy must ipso facto be in disequilibrium and therefore performing suboptimally.Similarly, the only pecuniary externalities known in present-day microeconomics are externalities resulting from various mistakes. People who do not perfectly foresee all the exchanges which they will make during their lifetimes, and which their descendants might make, are likely to make errors of various sorts. These errors will show up in market prices that are either too high or too low in comparison to the perfect-foresight benchmark, and there will be pecuniary advantages and disadvantages for other people in comparison to this benchmark.

However, we have seen that this is not a zero-sum game. Errors entail aggregate side-effect benefits. We have also seen that a market economy will always and everywhere entail various side-effect goods that do not spring from error at all. Within the ArrowDebreu framework the presence of all such goods denotes a state of imperfection; namely, a lack of markets. All goods should be paid for unless they are intended as gifts. Otherwise, the economy cannot reach its full productive potential. In other words, external effects are market failures, and they stand to be corrected through suitable government interventions.

These stipulations have wreaked great havoc. They have led economists to underappreciate one of the most important aspects of for-profit activities and market exchange; namely, their tendency to systematically generate gratuitous goods, both for the people involved in such activities and for other market participants. To stay clear of these pitfalls, we shall discuss the theory of positive externalities in some more detail in chapter 7.

SIDE EFFECTS OF SAVINGS

We have already emphasized that savings are crucially important for donations. Without savings, donations are quite simply impossible. But even savings that are not intended for donations—notably monetary savings, irrespective of whether they are invested or hoarded in cash—entail various beneficial side effects for other people, who typically do not pay for them.

Money Hoarding

Consider the consequences of an increase in the demand for money, or, as it is known in ordinary language, an increase in money hoarding.

Such an increase entails a tendency for the price level to sink or, what is the same thing, a tendency for the purchasing power of all money units to rise. Hence, thanks to the behavior of the money hoarders, all other market participants, who do not hoard but spend their money, can buy more goods than they could otherwise have bought (see Friedman 1969, p. 15; Patinkin 1956, p. 21).

Let us illustrate this effect with an analogy. Suppose Smith stands in a long line at a theater ticket booth. Now some people standing before him step out of the line. They just changed their minds and no longer wish to see the show. Smith then gets to buy his tickets faster. It is also possible that he is able to get tickets, whereas the show might otherwise have been sold out before he even made it to the booth. Clearly, Smith receives a benefit through the withdrawal of these other people. It is a gratuitous benefit because these others were not obliged to step out of the line, and Smith had no right to expect this service. It is a spontaneous gratuitousness because the benefit obtains independently of whether these others and Smith himself realize the implications of their actions.

In just the same way, the additional economic goods which some market participants can buy, thanks to the increased money hoarding of other market participants, are gratuitously provided to the beneficiaries. For the hoarders there was no obligation to hoard more than before, and the beneficiaries had no right to expect the hoarders to hoard more. These benefits were obtained spontaneously because they did not depend on the intentions of the money hoarders. Whether they knew it or not, and whether they liked it or not, their hoarding entailed gratuitous benefits for other market participants.

Those other market participants, in their turn, are not likely to notice the fact that they are the beneficiaries of such gratuitousness. After all, they pay for the goods that they buy. They might never ask themselves why they had to pay higher prices before. They might never ask themselves why they pay lower prices now. But if they looked at the world with the eyes of an economist, they would understand that they received a gratuitous service from the money hoarders, in the same way that Smith benefitted from those who stepped out of the line before him.

The social consequences that spring from cash hoarding are very different from those that follow from the stockpiling of any other good. The stockpiling of wheat, oil, apples, and many other goods is necessary for keeping the goods available through time. But stock-piling has the immediate effect of depriving all other people of the services of these goods. The oil that is kept in reserve does not serve current consumption. Oil’s market prices are higher than they would be if the oil were sold right away. Similarly, the wheat that is held in a silo could have been sold right away, with the effect of lowering prices in the near term (and the potential adverse effect of increasing prices in the more remote future).

The stockpiling of money has very different effects. The reason is the services of money are rooted in its market prices, whereas the services of all other goods do not have anything to do with their prices. What makes oil and wheat useful does not depend on their prices. But what makes money useful very much depends on its prices. When money is hoarded, its prices increase, just as in the case of oil and wheat hoarding. But as we have seen, the effect is that money owners now enjoy a greater purchasing power. In other words, the stockpiling of money conveys immediate benefits to others.

Savings-Induced Capital Accumulation: The Carey-Bastiat Effect

We have seen that savings in the form of money hoarding, entail gratuitous benefits for other market participants. But savings also bring about very similar effects when they are invested. To explain this momentous effect, we need to start off with a few preliminary remarks on the relationship between time and human productivity.

The more time we can spend on any venture before we have to get results, the better may be the results. More hours and days worked can lead to better products and to more products. But this is not only due to an increase in production, but also to an increase in production per hour worked (an increase in labor productivity).

This is not so because we can spend more time on the final products themselves. If we were to spend more time baking cakes with the same methods as before, then we would get more cakes, but not more cakes per hour. By contrast, our productivity increases when we can take time to create various tools to facilitate our labors. It increases when we can devote more attention to preparing for work and to coordinating with others, which brings us to our point: the more time we have before we have to get results, the greater can be the proportion of that time that we may devote to increasing productivity. If we do this in the right proportion, then the overall productivity of our labor will increase.

Now, the economic function of savings is to give us more time before results have to come in. When savings are invested and thus turned into capital, they can be invested in such a way that they fund the consumption of people who do not directly churn out any final products but who create tools and contribute to the production process in various other ways. This is why an increase in savings allows the productivity of labor to increase. Even if the population does not grow, even if people do not work longer hours, the overall output may still increase.

How is this additional output or surplus divided among the market participants? Here the following circumstance is crucial: when more savings are invested, capital becomes less scarce than it otherwise would have been. As a consequence, the return on capital on the market—in the form of interest rates and profits—will tend to fall. Since on the market all units of the same good tend to be remunerated by the same price (the law of one price), all units of capital, old and new, will tend to be remunerated less than before.And this implies, in general, that the proportion of aggregate revenue that is earned by the owners of capital falls over time relative to the proportion earned by those who provide labor services.

In other words, whereas it is the savers who sacrifice their own current consumption and who bear the uncertainty of investing, the benefits largely go to other market participants. When savings increase, capital still earns a return on investment, but it is less than before. Savers are still remunerated, but they do not reap all the fruit of what they have planted. A large part of the benefits accrues to people who have contributed nothing to enhancing the productivity of their own labor. It is the savings-induced process of capital accumulation that provides gratuitous economic goods to them. The savers had no obligation to save, and the beneficiaries had no claims on any additional benefits.

In many cases, such savings-induced gratuitous benefits are an advantageous and lasting legacy to subsequent generations. The drainage of swamps, the construction of buildings and roads, and all the intellectual achievements of previous generations provide gratuitous benefits to the living for generations to come. As Mises ([1949] 1998, p. 489) put it, all of us are “the lucky heirs of our fathers and forefathers.”

This insight about capital accumulation goes back to Henry Charles Carey (1837, pp. 140–41; 1851). A few years later, Frédéric Bastiat came independently to the same conclusions. In distinct contrast to Carey, however, Bastiat highlighted the gratuitous nature of the benefits that spring from savings-induced capital accumulation. Indeed, capital accumulation made it possible to put the gratuitous forces of nature at the service of man. Furthermore, Bastiat underscored that the presence of gratuitous gifts of nature is of central importance for the entire science of wealth. In his words:

Gravitation, volatile gases, the power of the wind, the laws of equilibrium, plant and animal life—these are so many forces that we learn to turn to our advantage. The pains, the mental energy, we expend to accomplish this are subject to payment, for we cannot be required to devote our efforts gratis to another’s advantage. But these natural forces, considered in themselves alone, and without reference to any intellectual or physical labor, are gratuitous gifts from Providence; and, as such, remain without value through all the complications of human transactions. Such is the central idea of this work. (Bastiat [1851] 1996, pp. 50–51)

Bastiat contended that in a growing society the amount of gratuitous goods constantly increases, while the amount of goods subject to payments stagnates. He arrived at this conclusion via a four-step argument (see Bastiat ([1851] 1996), pp. 51ff.).

One, he considered that the utility derived from forces of nature always comes free. Fruit grows, corn grows, cattle and fish multiply, water runs downhill, steam pressure drives a turbine. None of this needs human action to happen. It comes free. Parents’ spontaneous love for their children comes free as well, in the sense that parents do not have to be paid to love their children.

Two, a payment is only needed as compensation for others’ services because the time involved in rendering these services might be used elsewhere. Human action is needed to pick fruit; to plant and protect fruit trees; to make soil arable; to plant and protect corn; to develop and build a water turbine; and to build and develop a steam engine. But why should one do these things for the immediate benefit of others? Either because of love for these others or because the latter pay for these services.

Three, Bastiat argued that customers pay only for human services, and never for the forces of nature, which always come free. The reason is that competition drives down the prices of commodities to a level that corresponds to the compensation for human services.

Four, a progressing economy is characterized by a permanent increase in capital and in technical knowledge. More capital makes it possible to harness more natural forces and thus to produce more goods, or better-quality goods, with the same amount of labor as before. Hence, the gratuitous part of the overall product increases while the part that has to be paid remains the same. Greater knowledge makes it possible to transform natural resources into products in less time. As the gratuitous benefits of the overall product increase, the unit costs of production decrease.

It is true that Bastiat was steeped in the classical cost-of-production theory of prices. Consequently, his theory is flawed to some extent as far as the precise influence of human choice on market prices is concerned (see, for example, the early critique in Walras 1860, pp. 47–57). Similarly, one might admonish his binary distinction between gratuitous forces of nature and payable human services. But his insight into the meaning of capital accumulation—that it allows man to put more and more natural forces at his service—is unshakeable. It is the starting point of modern capital theory.

GRATUITOUS EVIL RESULTING
FROM MARKET ACTIVITIES

In the preceding pages, we have studied the beneficial side effects of the market process. We have seen that market exchange is not an exchange of equivalents. All market participants materially benefit in one way or another from the contributions of others, even of those with whom they do not have any direct contractual relations. In other words, gratuitous goods are built into the DNA of a market economy. Social cooperation based on private property and exchange can be understood as one great organism geared toward the production of gratuitous services.

But could one not argue that, for the very same reasons, gratuitous evil, too, belongs to the very nature of a market economy? After all, when people are free to choose, they might choose to do bad things. Bad things can also be occasioned inadvertently, coming in the form of negative side effects. The liberty and success of some might very well come at the expense of other people. There is always someone who benefits from the constant improvements that characterize the competitive process. But what about those who cannot effectively compete? Did we not focus too one-sidedly on the gratuitous good that may be produced in a market economy while neglecting the gratuitous evil that also seems to be part of the story?

We answered this question, though implicitly, when we discussed the definition of gratuitous evil (see pp. 58ff.). We then saw that a gratuitously evil deed is an action carried out in violation of one’s obligations, or in violation of other people’s rights. Accordingly, gratuitous harm is harm inflicted on a person despite this person’s contrary right and in violation of the perpetrator’s corresponding obligation to the person.

In other words, although competition—within and outside of the market—involves advantages for some and disadvantages for others, the latter are not gratuitous disadvantages. The harm is real, but it is not gratuitous harm.

Gratuitous harm is not just anything that displeases us. If Helen decides to marry Paul rather than John, then this might very well be bad luck and heartbreaking for John, but it is not evil, nor is it gratuitous evil. If most people in a neighborhood decide to buy their bread from baker A rather than from baker B, this is not a manifestation of gratuitous evil inflicted upon B. For gratuitous evil to exist, there must be an obligation, and a corresponding a claim, which comes to be violated by the evildoer. We speak of gratuitous violence and gratuitous insults precisely because there is a moral obligation to respect the person and property of others.

Air and noise pollution are often referred to as typical negative externalities of the market. But they are not always and everywhere gratuitously harmful. Suppose Mary suffers from the noise and smoke of an airport situated right next to her residence. These negative externalities are real. But they do not represent gratuitous harm unless Mary lived there first and the airport later started operating next door without Mary’s consent. If the airport was there first, Mary can not claim that her person or property is being injured against her will. In other words, the history of the case is decisive. Murray Roth-bard (1982), who emphasizes this crucial consideration, also points out that the harm must be demonstrable. Even if the airport moves in later, the smoke, gas, and noise emitted by the planes must measurably and intolerably impact Mary’s life and property. If the airport operator takes precautions to reduce all emissions to sufficiently low levels, there is no illegitimate harm to nearby residents.

As long as the legal professions operate with any modicum of efficiency, gratuitous harm can only be marginal and ephemeral. If the airport harms Mary demonstrably, then Mary has a claim on the airport to cease and desist immediately. And the same thing holds true with all other cases of negative external effects. This implies that gratuitous evil is as a rule intentional and can be a regular and permanent side effect of human action only in exceptional circumstances (under a corrupted legal and political order). He who violates his obligations usually knows these obligations, and therefore he violates them intentionally. Things would be different only if he could claim ignorance. Then his action, though in violation of the obligation, could not be said to be intentional. It would entail spontaneous bad effects on others, rather than intentional ones.

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This distinction is crucial from a moral point of view, too. See the discussion in Rhonheimer (2001, pp. 102–15, 332–41). See also Keown ([2002] 2018, pp. 22 ff.). Keown distinguishes the intended from the foreseen effects of medical interventions.

Catherine Gbedolo (2015, chap. 7) discussed three instances of spontaneous gratuitousness: means of production which are privately owned but (spontaneously) controlled by nonowners; entrepreneurship that creates information externalities; and the contributions of creative geniuses. Boulding (1973, chap. 4) touched on the subject of spontaneous gratuitousness under the misleading expression “implicit grants,” which he defined as “redistributions of income and wealth that take place as a result of structural changes or manipulations in the set of prices and wages, licences, prohibitions, opportunity or access; they are anything, in fact, that is not a direct or explicit grant that leads to economic redistributions. There are many examples of this phenomenon and we cannot do more than outline a few of them” (p. 49). He went on to discuss the implicit grants resulting from monopolies, tariffs, shifts in consumer demand, shifts in advertising, quotas, rationing systems, price controls, licensing, foreign-exchange controls, and credit and finance, as well as from monetary, fiscal, and environmental policy. The problem with Boulding’s approach, at any rate in light of our present purposes, is that it conflates market phenomena and interventionist phenomena under the single heading of “transfers” or “grants.” Boulding is most convincing when he explains how government interventions create unintended winners and losers. But his discussion of the implicit grants generated through the market process is rudimentary and unpersuasive. For example, he argues that unanticipated shifts in consumer demand create winners and losers among the producers. This is correct, yet it does not demonstrate the importance of shifts in consumer demand but of anticipations (p. 53). Similarly, although advertising is indeed “a one-way transfer of information,” it is not per se gratuitous nor is its impact on the distribution of income unintended (p. 53).

Substantial research has been carried out in order to find ways to assess the monetary value of goods that are not exchanged (see, for example, Appéré 2004; Travers 2008). We do not aim to insult the ingenuity of the authors by observing that their results are, at best, educated guesses and do not match the evidence of market prices.

Arguably, mankind’s most important goods are immaterial goods that cannot be purchased. Love, faith, and hope are of this sort. According to Christian theology, they are divine gifts or graces that come from God and cannot be brought forth by any human activity.

Eternal life is another one. In Matthew 16:25 we read: “For whoever wishes to save his life will lose it, but whoever loses his life for my sake will find it.” Similarly, “whoever finds his life will lose it, and whoever loses his life for my sake will find it” (Mt 10:39). See also Lk 9:24, Lk 17:33, and Jn 12:25.

Friends are made, and in this respect friendship is deliberate. But the foundation for genuine friendship is a virtuous life.

The meaning of creativeness and the social role of geniuses was a longstanding theme in Mises’s thought, running from Gemeinwirtschaft (1922) via Human Action (1949) to Theory and History (1957) and The Ultimate Foundation of Economic Science (1962). For a discussion, see Hülsmann (2007, pp. 966–71).

The theory of ownership has been much confused by the debates on managerial capitalism, stakeholder capitalism, and quasi markets (as substitutes for central planning). The central question in each case concerns the raison d’être of owners. Do they matter? Can owners be fully replaced by technically skilled managers? Many writers have answered affirmatively (see, for example, Keynes 1926; Berle and Means 1932; Hughes 2018), but the truth of the matter seems to be that owners can have more or less control but always act as owners, whereas pure managers can never act as owners, however much they might control (see Mises [1949] 1998, pp. 699–712, and more recently Foss and Klein 2012). Below, we will occasionally comment on the rise of managerial capitalism in light of the theory of interventionism.

The following list is adapted from Hülsmann (2018). See also Aristotle’s (1995) Politics, 1261b–1263b; Aquinas (1948, II-II, q. 66, art. 2).

See Stigler (1961). Omar Al-Ubaydli and Terence Kealey (2000) have rightly stressed this point in their critique of Paul Romer’s (1986, 1990) endogenous growth theory. Romer presupposes that knowledge is gratuitously obtained and transmitted to others. He therefore argues that knowledge is a non-excludable and non-rivalrous “public good” that should be produced by the state through the funding of education and research. But this argument fails by its premise.

The imitation of consumption patterns—mimetic consumption—has received much attention from economists, sociologists, and anthropologists, most notably Tarde (1895), Veblen ([1899] 1934), and Girard ([1982] 1986).

See Condillac (1776, chap. 2); Menger ([1871] 1976, pp. 156–57); Mises ([1949] 1998, p. 97); Rothbard ([1962] 1993, pp. 71–73); Boulding (1973); Callataÿ (2011, pp. 121–22).

Even if they buy something that they despise only to refute our contention, they would still be caught up in this logic of market exchange because they would prefer the purchase to keeping their money.

Molina (1981, p. 168); quoted in Chafuen (2003, p. 84).

See Karl-Friedrich Israel (2018, 2020, 2021). Jacob Viner (1931, pp. 38f.) had called these wealth effects pecuniary external economies.

See also Hayek (2002; 1979, chap. 15, pp. 406ff.).

The model goes back to Walras (1874) and Knight (1921). See the discussions in Machovec (1995), Salin (1995), and Machaj (2021).

“A person who possesses the exclusive knowledge or skill which enables him to reduce the cost of production of a commodity by 50 per cent still renders an enormous service to society if he enters its production and reduces its price by only 25 per cent—not only through that price reduction but also through his additional saving of cost” (Hayek [1946] 1948, p. 101).

In the introduction, we highlighted that the theory of externalities goes back to Marshall ([1890] 1920) and Pigou ([1920] 1932). A general overview can be found in Papandreou (1994) and more recent presentations in Bohm (2018) and Laffont (2008).

The issue of externalities had initially been sidestepped in the Arrow-Debreu approach to general equilibrium theory. Debreu (1959, p. 49n2) had expressly assumed the absence of externalities and increasing returns, whereas Arrow ([1964] 1953) assumed the existence of a fictional international stock market on which market actors could buy and sell securities representing each future “state of the world” in the sense of each possible economic situation that might prevail in the future. Thus, there would be a “complete set of markets” (one market for each economic good and for each future state of the world) and externalities would therefore not exist. At about the same time, Samuelson (1958) highlighted what he believed to be the normative dimension of this issue. He argued that the Arrow-Debreu model could be “used as an optimal social computing device” (p. 333) only in the absence of externalities. Elaborating on Samuelson, Stiglitz (1972) and Greenwald and Stiglitz (1986) then argued that market failures are unavoidable in the presence of externalities, because externalities are tantamount to lacking markets.

Their hoarding also entailed disadvantages for still other market participants, in particular for those who have to pay off debt at fixed interest rates. This seems to imply that the same action (hoarding) may bring about both gratuitous good and gratuitous evil, sometimes even for the same person. However, as we shall argue in more detail, the disadvantages that we just mentioned cannot be classified as gratuitous evil.

Notice that this concerns the monetary return on capital. In real terms, this return increases if the increase in output is sufficiently strong, so that the purchasing power of each money unit increases to such a point as to overcompensate for the fall in the monetary return on capital.

More precisely, this relative decline occurs when the demand for capital is inelastic. See the more detailed discussion in Hülsmann (2010).

On Bastiat’s contribution, see Hülsmann (2001, pp. 63–64). Among French economists, the emphasis on the gratuitous nature of certain benefits goes back at least to the physiocrats, who argued that all value is generated gratuitously by nature, whereas in human endeavors all value created comes at an equal cost. Bastiat relied most notably on Say (1861, pp. 69–70), who, in distinct contrast to Smith, and even more so than Ricardo, emphasized the importance of the gratuitous services of nature for the formation of the real revenues of market participants.

This idea was well understood by Ricardo, even though it was not central to his thought. He wrote: “M. Say accuses Dr. Smith of having overlooked the value which is given to commodities by natural agents, and by machinery, because he considered that the value of all things was derived from the labour of man; but it does not appear to me, that this charge is made out; for Adam Smith no where undervalues the services which these natural agents and machinery perform for us, but he very justly distinguishes the nature of the value which they add to commodities—they are serviceable to us, by increasing the abundance of productions, by making men richer, by adding to value in use; but as they perform their work gratuitously, as nothing is paid for the use of air, of heat, and of water, the assistance which they afford us, adds nothing to value in exchange” (Ricardo [1817] 2004, pp. 286–87).