Why the Free Market is Efficient

When it comes to the argument on capitalism and the free market you will hear many arguments from critiques claiming that if we moved towards capitalism it would use up all the world's resources. 

This argument is often used by Keynesians in a concession, although, they are more honest of their position in stating that they live under a mixed economy. This is a common argument used against capitalism, the claim that capitalism is inefficient and that the free market would result in a 'free-for-all' and the word 'profits' is thrown around with negative connotation as if to claim that if something is "for profits" then it must mean "greed" and 'every man for himself.'

You will always hear critiques from Keynesians and Marxists alike arguing that capitalism is a dog-eat-dog world. Keynesians will argue that capitalism just needs to be kept in check via government regulations for this reason or all hell would break loose, likewise, Marxists make bold assumptions and claims of the complete destruction of the environment as a result of the free market.

The problem with these bold claims made by the critiques, history and economics is not on their side. As I have argued numerous times in the past, one only needs to look at the most efficient economies in world history and those economies just so happened to have been relatively strong free markets. What you find is that on a question of scale, the freer the economies from government intervention, the greater level of efficiency.

The reason for why free markets are efficient is in relation to do with the relation to do with market-driven prices. So in order to understand, we must first cover why the study of economics exists.

Economics is not about finances, how you run business or even about the stock market, a lot of people wrongly assume that economics is all about money, whilst these things are certainly part of an economy, it's not what the study of economics is about. Rather, economics is a study about our place on this earth with scarce natural resources and is a question of how we better improve our material standards of living whilst using the fewest resources as possible.

So, why the fewest resources, one may ask? Well, resources are finite, not infinite. If resources were unlimited, there would be no requirement for the study of economics because there would be no requirement for 'ECONOMISING.' The reason for economising is to ensure we allocate resources efficiently to the correct parts of the market where demand exists, also, to ensure we're not overusing said resources.

Resources are scarce and scarcity simply means that people's expectations far exceed what is actually available to them. It is something people take for granted that people's expectations are endless and when we speak about scarce resources, it's in reference to resources that exist and has been discovered. It must be said, however, that there could possibly be more of that resource, but just hasn't yet been discovered.

So economics is all about finding the most efficient system possible that enables us to translate the scarce natural resources to turn that into commodities (produce) to provide for the market to help improve our material standards of living. The most efficient economic system would obviously be the system that is able to use the FEWEST resources whilst achieving greater results to people's living standards.

So what does this have to do with prices?

Prices are without question the single most important thing to the operation of an entire economy, many people misinterpret prices as merely being an obstacle to getting the things that they want. Rather, prices are signals, they contain important pieces of information that convey to the market consumers needs and wants. It is through price information signals that enables the free market to be efficient over resource allocation and usage.

A higher price in the market is a price signal telling the market there is a shortage and the lower price in the market is a signal that there is abundance. This correlates to the laws of supply and demand. If you don't understand the laws of supply and demand, think of it like this:

If you stood in the middle of the Sahara Desert with a bottle of water with nothing around you in every direction but miles of sand to walk in each direction in order to reach safety, the question would be: how valuable is every drop of that water in the bottle you hold to your life? Then imagine being in the middle of Scotland filled with crystal clear rivers, streams, waterfalls and being in the middle of the countryside with a bottle of water, how valuable is the bottle of water then?

The bottle of water you hold in the middle of a desert is going to be worth more to you than in the middle of Scotland because of scarcity; the less you have of something and greater demand, the greater the value. Likewise, the greater the quantity of supply of the water around you, the lower the demand, the lesser the value.

This is why if you see soaring house prices in the market, you know for a fact that the quantity of people in demand is much greater than the supply of housing itself, the higher price conveys the shortage. When Detroit fell into a state of despair and countless droves left Detroit, house prices fell sharply which conveys a large quantity of housing was available on the market, however, the demand wasn't there.

Scarcity is all around us, such as the land you live on is scarce, take Great Britain for example, it is an island, there is only so much land available, even if you were to fill in land from under the north sea, even that area of land is scarce. As a result of scarcity, there are trade-offs in economics, what that simply means is, governments often make political decisions through policy decision-making, but such policies do not fulfill everyone's desires, often those decisions neglect a percentage of people in exchange for others.

This is something Marxists don't understand, socialists have a very hard time understanding scarcity and prices are so vitally important for resource allocation for this very reason because resources have 'ALTERNATIVE USES,' which simply means that there is more than one use for each natural resource. Take wood for example; there are a variety of different types of wood, even then, there are hundreds of different uses for wood, think of the hundreds of different products out there produced using wood, such as; tables, chairs, desks, kitchen utilities, units, bookcases, drawers, etc. 

What you can see is that for each resource, there are hundreds of different uses. The importance of efficiently allocating resources, for this reason, is to ensure that you are not misallocating such scarce resources into producing what is not in demand. Governments are famous for doing this, especially socialist countries. The reason this is problematic is that by misallocating scarce resources, not only does it waste the resource, it could have been used for better uses that could have gone to bettering the material wealth of people elsewhere in the economy.

Two of the most important pieces of information we gather from prices that enable such efficiency is PROFITS and LOSSES. It is from this information that determines much important information.

PROFITS tells the market:
• what to produce more of.
• how much to produce.
• what scarce resources to use.
• where to allocate scarce natural resources.

• what to invest more in.
• how the resources are transported.

LOSSES tells the market:
• what to stop producing.
• what resources to stop using.
• where to stop allocating scarce natural resources.
• what to stop investing in.

How the market knows this information is by consumers driving prices in the market. In other words, prices in a free market are NOT determined by business people setting prices they freely choose to, economic reality tells us that businesses can only set prices to what consumers are willing to pay for something.

When consumers freely shop around and they walk into stores, purchase goods, at the end of every month, a business can determine what their most bought products are and even what their least bought products are. This information conveys to the business what their profits and losses are; the profits being the most bought and losses the least bought.

Since businesses can see what their most bought products are, they know the information on what resources to use, so scarce natural resources will be allocated to production for the products that are selling most of. Whereas all the products not selling that conveys the losses, production is stopped, therefore, resources are not allocated to those parts of the market.

It is also important to note that there is a colossal difference when speaking about efficiency in a free market economy to that of the wasteful corporatist system with which we live under today. This is because capitalism (the free market) rewards success and punishes failure. Businesses that are wasteful in a free market would quickly spiral into decline against more efficient competitors. In the absence of government subsidies, they would be left to face liquidation.

People confuse this as a failure of the capitalist system, instead, it's actually a sign that a capitalist system is working. Capitalism weeds out the deadwood by punishing failure and rewards the success, allowing room for the newer more efficient industry to come through in the market. 

Under corporatism where you see failure being propped up by bailouts (subsidies) and success being punished, it encourages inefficiency, therefore, it is only natural that you see a lot of waste being produced. Britain today is a prime example where the giant supermarkets that dominate the market formed a collusion, not only are they exploiting the British farmers telling them to reduce their prices to sell to them or they will import food from elsewhere, they are wasteful as a result of the absence of competition.

In a recent argument in response to Viki 1999 I covered an example of government subsidies and the disastrous consequences they had in the 19th century, one of which I mentioned on the Northern Pacific railroad company. I would like to make a correction, however, regarding the figure sum of the per-mile-track subsidy the Northern Pacific railroad company was given, I mentioned over a $1,000 subsidy for each mile, however, as Thomas J. DiLorenzo points out in his book 'How Capitalism Saved America' he says:

"The Pacific Railroad Act of 1862 created the Union Pacific (UP) and the Central Pacific (CP) railroads, the latter to commence building in Sacramento, California, and the former in Omaha, Nebraska. For each mile of track built Congress gave these companies a section of land—most of which would be sold—as well as a sizable loan: $16,000 per mile for track built on flat prairie land; $32,000 for hilly terrain; and $48,000 in the mountains."

This puts into even greater perspective how calamitous it really was and the point I addressed in my video remains every bit as valid.

As I addressed in my video briefly, the Northern Pacific railroad company ended up rushing into building the railroad out of their own self-interest. Not only did they ignore neighbourhoods surrounding them, they used poor quality resources. As I mentioned about the damages the railroad would face due to such inefficiency as a result of the government subsidies Burton Folsom states:

"Since Dodge was in a hurry, he laid track on the ice and snow . . . Naturally, the line had to be rebuilt in the spring. What was worse, unanticipated spring flooding along the Lower fork of the Platte River washed out rails, bridges, and telephone poles, doing at least $50,000 damage the first year. No wonder some observers estimated the actual building cost at almost three times what it should have been."

A correction I must address from my video response to Viki 1999, I stated about the damages, but it turns out the damages led to rebuilding that would result in soaring wasteful costs. Still more or less the same message, the argument remains the same.

The point behind this message is to point out the fact that government subsidies encourage inefficiency, it is why the hundreds of railroad and steamship companies went bankrupt and for why it resulted in bad banks getting away with legally protected fraud that resulted in the eventual banking crisis of 2008.

The other story I mentioned briefly was in relation to John Davison Rockefeller. It is important to note that he most certainly was not this evil monopolist as made out to be, however, for the purpose of this argument, I addressed this example to show what capitalism does to businesses that are inefficient. 

In short, the other competitors in the oil refinery market competing against Rockefeller were rapidly in decline, this is because when Rockefeller and many of them entered the oil refinery market in 1863, the greater the supply of business, the greater the productive output. This resulted in a barrel of oil dropping in price by 50 percent in that decade. The price drop resulted in big losses for many of these other businesses pure and simply because they were very wasteful.

This proved the point that capitalism punishes inefficiency and rewarded efficiency, which explains why Rockefeller became so dominant as he was an accountant by trade who was utterly obsessed about efficiency. I will cover for a separate argument more on Rockefeller and Standard Oil relative to the Standard Oil monopoly myth, but this example proves that capitalism does the opposite for what the critiques claim.

In fact, Rockefeller's wealth stemmed from using fewer resources and as I've mentioned before, it costs you more to use more resources, which explains the rational behind this argument. If you wish to maximise your profits, you minimise your costs, which means to use fewer resources.

Overall, a free market operates efficiently down to consumer-driven prices in the market and explains the reason why it is impossible to run an economy efficiently in the absence of prices pure and simply because there are trillions of different products out there on the market and with the thousands of different options of every product, the only way to determine what is in greater demand and where to allocate the resources efficiently and how much to use is by leaving it down to consumers to determine that information that prices convey.

This explains why in socialist countries you end up seeing vast surplus waste and shortage problems and the argument of the economic calculation problem doesn't just pertain to full-blown socialist economies, but also under mixed economies that attempt to fix prices in the public sector, etc.

I will cover more in-depth on the economic calculation problem in relation to prices separately, but this brief explanation gives you an understanding for why derailing from the free market proves problematic.