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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Why a Capitalist economy is the only way to prosperity

Why a Capitalist economy is the only way to prosperity

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Kumar

Kumar
Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
by R.M.B Senanayake

"The ultimate resource is people - especially skilled, spirited, and hopeful young people - who will exert their wills and imaginations for their own benefit, and so, inevitably, for the benefit of us all."
— Julian L. Simon

Although Communism as an economic system collapsed in 1989 and the former Communist countries adopted Capitalism and free market economic principles (except for Cuba and North Korea although Cuba has been moving in this direction recently), our intellectual leaders have not accepted the changes in the world. So Professor Carlo Fonseka thinks that poverty is due to Capitalism, not realizing that wealth itself is a modern creation from the time of the Industrial Revolution of 1760 onwards. Before that most of the world was in poverty. Famines were common in both China and India and every ten years or so a few million people died in both countries. It is only in the last 50 years that there have been no famines in these two countries. Here is what Adam Smith stated about China of his time

"The poverty of the lower ranks of people in China far surpasses that of the most beggarly nations of Europe. In the neighborhood of Canton many hundred starve, it is commonly said; many thousand families have no habitation on the land, but live constantly in little fishing boats upon the rivers and the canals. The subsistence which they find there is so scanty that they are eager to fish up the nastiest garbage thrown overboard from any European ship. Any carrion, the carcass of a dead dog or cat, for example, though half putrid and stinking, is as welcome to them as the most wholesome food to the people of other countries."

Today the per capita income in China is that of a middle income country. The conditions referred to by Adam Smith no longer prevail. It is the same with millions of Indians as well. How did this transformation come about? Through the adoption of the Capitalist economic order and the use of free market principles.

What are these free market principles?

Economics teaches that there is scarcity of resources which is the underlying cause of poverty. Goods and services have to be produced by human effort combined with scarce natural resources like land (which includes mineral resources etc.); all production requires land and labor. But the ultimate resource is the human mind and hence these resources have to be put together by an entrepreneur. Goods have to be produced before they can be sold and the demand has to be forecast before the resources are put together to make a product. So there is a risk when the entrepreneur assembles resources without knowing exactly what would be the demand for his product. Politicians and their servile bureaucrats are lousy entrepreneurs. When the State undertakes investment the chances of their being productive and meeting a felt demand is problematic and we find governments building bridges to nowhere.

The inevitability of rationing

The principle of scarcity means the products of wealth must be rationed. How products are rationed is an important factor in wealth creation itself. The core idea in this approach of economics is that there are two fundamental observations of commercial society: (1) individual pursuit of self-interest, and (2) a complex social order that aligns individual interests with the general interest.

Many critics point out that all people are not pursuing their self interest. Of course, but the majority do. Critics also say the free market is based on the greed of humans. What other principle of human nature fits economic behavior?

The second principle arises from the scarcity of resources. Scarce goods have to be rationed. The choice isn’t between rationing and not rationing. It’s between rationing well and rationing badly. What free market economists say is that rationing through the free markets is better and more efficient than bureaucratic rationing. We saw in the 1970-77 period how government bureaucrats rationed goods such as imported milk or white poplin cloth. People had to stand in queues neglecting their other work just to buy their ration of scarce imported goods. Prices of course were kept low through price controls so rationing was through administrative devices like permits or licenses.

In the case of the free market economy rationing is through prices. Prices are to reflect the scarcities of the goods. Yes it means those who cannot afford to pay the higher prices will have to forego them. But this is regular feature in any economy and we know how the Communist Russian apparatchiks enjoyed a luxurious life away from the sight of the ordinary people. But what are the chances that the poor would be better served by administrative rationing? We know how bureaucrats and politicians gave preference to their kith and kin or friends in the award of permits. In practice the poor were not better served by administrative rationing. There is another advantage of rationing through higher prices. Those who are enlightened enough see that there are new economic opportunities in the prevailing high prices. This could provide them high profits if they enter the market as new producers and increase the production of the scarce good. So will the existing producers who will increase their production to get more profits. All of this works for the benefit of the public since more production will tend to reduce the price and make it more available to the poor. When prices are kept artificially low there is no increase in supply forthcoming.

The crucial question is who does the rationing, a centralized decision-maker or a decentralized system? Centralized decision makers influenced by political pressure inevitably ration badly. Decentralized systems with no one in control can potentially avoid the problem of political pressure. The free market economic system is a decentralized system which requires no one to do the rationing. This is one reason people tend to be suspicious of prices—they appear to be rigged and are assumed to give the rich an advantage. And they let suppliers make high profit. But those high profits produce greater supply. The drive to increase profit margins provides incentives to control costs that are missing from the centralized bureaucratic administrative system that rations goods to people.

Rationing through prices

Each time prices go up there are politicians who want to introduce price controls or argue for the State take-over of the import and distribution of the particular good. But over the last 50 years we have learnt that State intervention with the market is a not a solution to the problem which is basically due to the scarcity of the resource or the product.

How well are we rationing the educational ad medical services provided to the people by the government and the private sector? Today we have free education where there is no charge for tuition. It is impossible to ensure that all schools are of the same quality although our crafty politicians put off people by promises to make all village schools like the Royal College and hoodwink the people to accept the status quo. But the people have become wiser and prefer to pay money to enter their children to the better schools. The bureaucrats seek to ration the school places by a so-called area rule but people won’t abide by such administrative rationing. The answer is to introduce prices for the scarce places but not to allow the principals or other politicians to gather such moneys but to collect if for the State’s coffers.

Since politicians hoodwink people and people also believe in a free lunch such a free market solution is anathema. So we have bad rationing where the affluent buy school places through corrupt means. Is this rationing better than rationing by price? The only reliable and foolproof measure of the value of an economic good, be it a school place or medical care or a ticket to the cinema, is what people are willing to pay for it. Since some parents willingly pay for the school placement they get, it’s ipso facto worth it for them.

It is the economists great insight to see that when price signals are eliminated or obstructed, other signals & subjective costs take their place — such as queues, scarcities, bribes, waits, unreliable and chaotic production, political quid pro quos, bureaucratic power games, the consumption of leisure, etc.

The Fundamental Capitalist Rule: You’ll get what you pay for — if and only if you insist on paying for what you get. The free market approach is to let each individual ration for himself. The less socialized and/or regulated the economy is, the more effectively the price system works for economization of scarce resources.
http://island.lk/index.php?page_cat=article-details&page=article-details&code_title=86524

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