In 1927, at the height of the Roaring 20s, the renowned Austrian economist, Ludwig von Mises wrote in his classic work, Liberalism:
 
“Whoever does not deliberately close his eyes to the facts must recognize everywhere the signs of an approaching catastrophe in world economy. Antiliberalism is heading toward a general collapse of civilization.”[1]
 
Within months of his writing this, the world economy had begun to sink into depression and within a few years World War II had begun.
 
It is interesting to note that Mises did not say that economic collapse was to be caused by poor monetary policy, or excessive taxes, or a drop in consumer demand. It was to be caused by “anti-liberal” philosophy. Just exactly what did he mean by this? He meant the rise of a belief in central planning and government intervention in its various forms—such as fascism in Germany, Spain and Italy, socialism in Russia and Great Britain, and the Progressive movement in the United States. This turning away from the predominant belief in what was then called liberalism, away from a political philosophy consistent with market capitalism, is what will cause the economic collapse. Essentially Mises makes the argument that the system by which we organize our economic activity, and thus the type of public policy that we follow, is the primary determinant of the economic performance.
 
First, we need to see why market capitalism creates wealth for the masses. The case is a straightforward logical argument. Market capitalism is a system based on voluntary exchange. When you go to the Wal-Mart they don’t start throwing things in your basket and make you pay for them at the checkout line. Nor can you place things in your basket and then offer the clerk $5 for the lot and walk out. Wal-Mart tells you how much it is willing to take for a product, say a hammer. It will be clearly marked—perhaps $4.98. If you are willing to give Wal-Mart $4.98 it is willing to give you the hammer. 
 
Nor do you see Wal-Mart vans driving down the street grabbing people and taking them back to the store to work as clerks. The clerks are there because they are willing to voluntarily give their labor in exchange for the wages Wal-Mart pays them. Wal-Mart is not forced to pay their clerks the amount that the clerks force upon them. Every worker at Wal-Mart is engaged in a voluntary exchange with Wal-Mart, as is every customer. All parties must have agreed to the exchange or it would not be taking place. That is why the Wal-Mart symbol is the smiley face—everyone at Wal-Mart is making themselves happier than they would otherwise be.
 
From this we know that all producers must have paid resource owners, the owners of labor, of steel, of land, of any resource, an amount greater than those owners could have received somewhere else. This value is what economists call the opportunity cost of resources—its value in its next best alternative. If Ford Motor Company buys a ton of steel for $100, then that steel could not have produced $100 of value for some other producer or that producer would have purchased it.
  
What must Ford Motor Company do with that steel? It must turn it into a product that consumers value more than $100 or Ford will go out of business. Ford Motor Company cannot use up $1 billion in resources in order to produce products that consumers are only willing to pay $900 million for. One cannot lose money on every unit and make it up in volume, although General Motors seems to have tried that technique. One of the roles of profit in a market capitalist system is to ensure that only those firms who make the most efficient use of resources stay in business and get and maintain control of resources. 
 
The logic of this argument makes it clear that market capitalism, private ownership of property and voluntary exchange, must be the most productive means of organizing resources. Producers must pay for resources their value in their next best alternative and then produce with them something that consumers value even more or go out of business. It is difficult to think of a system that makes more efficient use of resources.

Why cannot socialism or any other form of central planning create wealth for the masses? There are two primary reasons: one is an incentive problem, and the other is an information problem. The incentive problem is how you get people to work hard and more importantly to innovate. As Adam Smith in 1776 put it:
 
“But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and shew them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard for their own interest.”[2]
 
Smith was describing the market capitalist system that was beginning to dominate the British Empire. The market capitalist system relies upon incentives created by voluntary exchange and property rights to induce producers to take risks and put resources together to produce consumer goods. It also is the driving force for innovation, and it is innovation that has created wealth for the masses in those countries that have market-based economies. We are not wealthier today because we have more wheat than people in the Middle Ages. We have lots of goods and services that didn’t exist then. In fact, it is unlikely that any of us would trade places with a 13^th-century king. We would prefer indoor plumbing, electricity, color television, and refrigerators to living in a castle and eating dried mutton.
 
How does one get people to innovate in a system of central planning without profit and prices? Socialism can only use persuasion or rely upon the benevolent butcher. Now Adam Smith did not say he would never find a benevolent butcher. Some people will work hard and will innovate despite little incentive for them to do so. The father of Beauty in the Disney movie, Beauty and the Beast, is a tinkerer and invents things; though he obviously is not living in a market capitalist system (magic castles and beasts turning into princes are not distinguishing characteristics of market capitalism). There was some innovation in feudalism and mercantilism, and there is some innovation in socialist systems. But these systems do not, as a system, drive and encourage innovation. I do not recall my mother telling me how she longed for the latest Soviet washing machine, nor my dad wishing he could be driving an Eastern European car. Market capitalism, on the other hand, does drive innovation because profits can be earned by the innovator. Steve Jobs, Michael Dell, and Bill Gates were able to become wealthy because of the profits they made by making products and services that make our life easier. Their example provides the incentive for the person who is at this very moment thinking of how she can make something that will make my life easier and enable her to become wealthy in the process.
 
The other major problem that plagues central planning is the information problem. How can a central planner possibly know how many rolls of toilet paper will be needed at every moment in time by 1.3 billion Chinese, or how much dental floss 300 million Americans want each Tuesday? Leonard Read wrote his famous paper, “I, Pencil,” in the 1958 issue of The Freeman, [3] which Milton and Rose Friedman included it in their 1979 book, Free to Choose. [4] In an insightful way Read describes all the social coordination that is required to simply produce a simple pencil. The paper’s insight is that it requires the reader to observe how much information must be exchanged to produce something as elementary as a pencil. The parts of a pencil come from all over the world, and it makes us realize that no one person could produce a pencil.   But we can go beyond that, and begin to think about how a central planner could possibly even allocate pencils correctly. The fundamental problem is that information is so decentralized. Millions, billions world-wide, of individuals have their own needs and desires and constraints on their choices. No planner can possibly garner and process all of that information.
 
Just imagine that you were the Secretary of Pencils in the President’s cabinet and your job was to make sure that each one of all the thousands of retail establishments throughout in the United States had exactly the right amount of pencils, even if the pencils were magically brought into existence.  Your intuition is correct – there would be lots of places with excess pencils and lots with pencil shortages. Yet every morning you wake up and New York City magically has the right amount of orange juice, coffee, bread, auto repairs, gasoline, and every other product and service, with no one in charge. 
 
Mises would point out that the reason it works out this way is exactly because no one is in charge. Instead, the price system works to make sure that the right amount of everything is available in every place in America at every moment in time. We intuitively know how this works. If there are more Chevrolet pickups at Frank Beck’s Chevrolet in Hillsdale than consumers want and pickups begin to pile up at Frank Beck’s place, then we are likely to see “a sale,” meaning the price will fall. And as prices fall, then consumers will purchase more and the producers will produce less—in this case, Frank won’t supply so many pickups. This will continue until the demand for pickups equals the supply of pickups. If there is a shortage of some good, then the opposite occurs. The producer will raise the price, so fewer people will purchase it, and as the price rises more will be produced by the producer. Prices in a market capitalist system act to bring together the demand for and supply of all goods and services, which is why you didn’t wake up today wondering if there would be enough coffee at all the Starbuck’s stores in America. This is a marvel. As Hayek put it in his 1945 paper, “The Use of Knowledge in Society:”
 
“I am convinced that if it (the price system) were the result of deliberate human design, and if the people guided by the price changes understood that their decisions have significance far beyond their immediate aim, this mechanism would have been acclaimed as one of the greatest triumphs of the human mind.”[5]
 
Central planners cannot know how consumers value relatively all of the resources in a modern economy. How can they tell if cotton is more valuable in the production of tee shirts, underwear, or socks? In a market capitalist system this happens through the price and profit system. If consumers decide they want more cotton underwear, then the price of underwear will begin to rise, this will cause more production of underwear by existing firms and the profit coming from the production of underwear will eventually attract more firms into the production of underwear. Cotton will thus move out of the production of tee shirts and into the production of underwear without a Minister of Undergarments guiding the process.

The logic of the argument should be persuasive that market capitalism is the most efficient system for producing goods and services for all and as a system will drive innovation. It should also be persuasive that a system of central planning cannot make efficient use of resources, nor can it lead to innovation in the production of goods and services for the masses. The evidence in support of this is also obvious.
 
The wealth of the average individual in a market capitalist society would have been beyond the comprehension of anyone living under the feudal system. A person living in 1250 in Europe would be living a life pretty much like the person living there 100 years prior, and would presume that someone living 100 years later would have a very similar lifestyle. Yet look around you today and simply observe how many of the goods and services you will consume that did not exist even twenty years ago. When I was in college, if you wanted to call someone you had to stand next to the phone. If they had zeros in their phone number, your inclination was not to call them. Today our cell phones can do everything but make us tuna casserole. People in India who live in villages fifty miles from the nearest health clinic can call the clinic and find out when the doctor is going to be there before walking the fifty miles. This is the power of the market system. 
 
Again, to put this in perspective. It took 6000 years from the invention of the wheel until we developed the two wheel cart. When we watch The Ten Commandments on television, we see Moses parting the Red Sea to let the Israelites escape from the Pharaoh’s army, which is riding in two-wheel carts. From the time of Moses to Wyatt Earp we move from two-wheel carts to four-wheel carts—buckboards and stagecoaches. Yet Wyatt Earp, who is an adult when he participates in the gunfight at the OK corral, sees the movement from four wheel-carts to motion pictures and the Model T. My grandmothers were born before man had ever seen powered flight, yet lived to see a time when you could buy a ride on a spaceship. The rapid increase in innovation and the wealth of the masses occurred because the West gradually developed the economic system of market capitalism and a political system consistent with that.
 
One can use either the Index of Economic Freedom published by the Heritage Foundation and The Wall Street Journal or the Economic Freedom Index published by the Fraser Institute. It become immediately obvious that the countries that have the most economic freedom, that rely most on market capitalism as their economic system, are the wealthiest countries, and those that have the least amount of economic freedom, that are farthest removed from market capitalism, are where people are the most impoverished. The Heritage Foundation report includes a chart that demonstrates the strong correlation (correlation coefficient of .667) between economic freedom and per capita GDP.[6] A simple listing of the top 10 countries and the bottom 10 countries in the Index of Economic Freedom is persuasive.
 
Top 10: Hong Kong, Singapore, Australia, New Zealand, Ireland, Switzerland, Canada, United States, Denmark, Chile
Bottom 10: Equatorial Guinea, Central African Republic, Guyana, Angola, Lesotho, Seychelles, Sierra Leone, Uzbekistan, Chad, Burundi
 
As an experiment to test your belief of whether market capitalism produces wealth for the poor, let’s pretend that I am God, and you are about to be born into the world. I tell you that you can choose whatever country you would like to be born into, but the stipulation is that you will be the poorest person in the economy. You know that your answer will be to place you in a country that primarily relies on market capitalism to organize its resources. 
 
Robert Rector has published two papers that tell us what it means to be poor in the United States.[7] Of those classified as poor by the United State Census Bureau, about the bottom 12% of the income distribution, 46 percent own their own homes, which is on average a three-bedroom house with one-and-one-half baths; 76 percent have air conditioning; nearly three-quarters of poor households own a car, and about a third own two or more cars; 97 percent have a color television. Contrast this with what it means to be poor in Mumbai, where some families have to sleep on their side for all of them to fit into their living space.
 
North and South Korea are a stark example of the difference in economic development that results from central planning and capitalism. East and West Germany were examples from the past. More than 400 million people have moved out of poverty since China began its experiment with moving to market capitalism from communism. The empirical evidence is overwhelming that market capitalism creates wealth for the masses and central planning cannot.
 
A lesson for Americans from this is that public policies have an enormous influence on economic performance. Those policies that interfere in the economic system of market capitalism, policies that move the allocation of resources away from the system of voluntary exchange and towards a system of government planning, will reduce economic performance. Unfortunately, the public policies have been moving us in the direction of central planning and away from market capitalism—reminiscent of what Mises observed more than 80 years ago. 
 
The United States dropped two spots in the 2010 Index of Economic Freedom. We have witnessed massive government intervention in the auto industry, finance industry, and housing industry in the past two years. The current administration is attempting to drastically increase government intervention in both the health industry and the energy markets. These policies have increased the uncertainty of property rights and have substituted government planning for market forces in the economy. The logic of how price systems and profit incentives are a powerful force for driving economic growth and how central planning cannot efficiently coordinate the activity of millions of persons in a modern economy should warn us of the dangers of the direction our public policy is taking. 
 
Public policies that protect property rights and create certainty about the rule of law will allow the marvel of the market capitalist system and the ingenuity of Americans to set us on the path for further economic growth. These policies will not be possible politically until people understand how the market process works and how interfering in this process through government policies will reduce economic wealth. As Hayek put it in The Fatal Conceit, “The curious task of economics is to demonstrate to men how little they know about what they imagine they design.”[8]

Notes

[1] Ludwig von Mises, Liberalism In the Classical Tradition, 3rd Edition (San Francisco: Cobden Press, 1985 (1927)), pg. 3.

[2] Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, (Indianapolis: Liberty Classics, 1981 (1776)Book I, pg. 27

[3] Leonard Read, “I, Pencil,” The Freeman, December 1958: pp. 32-37.

[4] Milton and Rose Friedman, Free to Choose (New York: Harcourt Brace Jovanovich, 1980) pp. 11-12.

[5] Friedrich Hayek, “The Use of Knowledge in Society,” The American Economic Review, Sept. 1945, pg. 527

[6] 2010 Index of Economic Freedom, The Heritage Foundation and The Wall Street Journal, Executive Summary, pg. 2.

[7] Robert Rector and Kirk Johnson, “Understanding Poverty in America,” The Heritage Foundation, Backgrounder No. 1713, January 5, 2004

[8] Hayek, The Fatal Conceit (Chicago: University of Chicago Press, 1988) pg. 76.