By: Dr. Charles Ormsby – August, 2004
Last month we discussed (The Valley Patriot, July 2004, Page 3, Freedom’s Laboratory) how free societies, by respecting the rights of property owners to keep their property and to dispose of it as they see fit, permit the maximum degree of rational experimentation and therefore maximize our rate of gaining knowledge. This lesson applies broadly, to every aspect of our lives … from social relationships, to education, to medical science, to transportation, to product design/ manufacturing/ marketing/ distribution/ …, to how we communicate, to entertainment, to … everything!
The value of this experimentation is to maximize the rate at which society learns and the rate at which we apply the lessons learned. The faster we learn and apply the knowledge gained, the higher our average productivity and the higher our overall standard of living. It’s no surprise: the freer a society, the higher its standard of living.
But what motivates this experimentation (i.e., the learning process) and the application of the resulting knowledge to “standard practice”? What drives innovation (i.e., conceiving new ideas and trying new experiments) when it is less risky to just use tried and true techniques? Furthermore, why would anyone invest resources (e.g., in new factories or capital equipment) to take advantage of new knowledge gained when markets are not certain and competitors are potentially deploying even better methods? If there is no motivating incentive, it won’t happen and progress will come to a halt. Well, the answer to these questions is obvious in a capitalist society: PROFIT.
But gaining new knowledge and/or making investments do not guarantee profits. In fact, losses are much more likely than profits unless three conditions are met:
1. The knowledge acquisition and investment process are conducted more efficiently than competitors,
2. The object of these efforts are focused on products/services people want, AND
3. You have not invested more in these efforts than people are willing to pay.
This is a daunting challenge when it is realized that failure means personal financial losses. Profits are payments both for the efforts required to carry out these advances but also for the risks of failure and potential losses. Profits are not a gift. Profits are fully earned and are the property of those who achieve them. Like any other property, profits honestly acquired should be fully protected for moral reasons.
But there are also practical reasons that we should insist that society respect the property rights of the owners of profits: Our own self-interest.
If we want our standard of living to rise at the fastest possible rate, we want to motivate those who can achieve the three prerequisites of profit listed above to do so as often and as aggressively as possible.
Those who fail will, like the incompetent gambler, lose their chips and will no longer be able to squander resources on additional ill-conceived attempts. Those, who can make these advances competently, will create new wealth and can reinvest this in development of additional products and services … that are new, better, or cheaper.
Which brings us to our conclusion. How does the average Joe (or Jane), who does not have the skills needed to make these profits directly, benefit from this process? Let us count the ways.
First, and most obviously, we all benefit by the availability of substantially better products/services. Examples are all too easy to list: automobiles vs. horse-drawn carriages, jet travel vs. Conestoga wagons and sailing ships, the computer vs. the abacus, penicillin vs. blood letting, HDTV vs. the radio, air conditioners vs. heat prostration, etc.
Second, because producers are competing for our business, the cost of these products and services are dramatically lower (in terms of average labor hours needed to buy them) than equivalent alternatives, if any, previously offered (just review the examples above).
Third, as standards of living are raised, working conditions must improve. Why? Because as the workers’ standard of living is raised, they become less willing to work under poor working conditions … they would rather trade some luxuries to avoid onerous working conditions. In parallel, companies are also competing for workers and compete on the combination of compensation, benefits, and working conditions.
Finally, with the advent of modern investment markets, average Joes can become part owners of companies that are competent in producing profits and, therefore, they can directly participate in profit making even if they do not have the talent to guide such profit making activities themselves. Profit makers are unheralded heroes. They are largely responsible for the riches that surround us. They do it by seeking their own self-interest. They weren’t thinking of improving our lot (and we weren’t thinking of them), but they continually enrich our lives.
Adam Smith figured it out while our forefathers were fighting for our freedom. Why is it so little understood and appreciated 228 years later.