The Bankruptcy of the Mixed Economy

Part 2 Part 4 Table of Contents

Throughout the ages, governments have regulated the economic affairs of their citizenry. The common belief of mankind was that economic chaos would result if government did not plan and direct the economy. It was also widely believed that government management of the economy was necessary to help alleviate the plight of the poor.

There were extensive price controls that prohibited producers from selling their products for more than the legally established maximum price. There were anti-speculation laws that imposed severe punishments on people who bought low and sold high in the expectation of making a profit.

It was illegal to be a middleman, a person who facilitated trade between a buyer and seller. For example, when farmers transported their crops to sell at the village market, it was a criminal offense for someone to buy the crops on the outskirts of town with the intent of selling them at the market at a higher price.

Royal monopolies were often granted to producers, which meant that the law prohibited anyone from competing against them. The monopoly status enabled the producer to stay in business without fear of competition, thereby assuring the public of a continued supply of his product.

Subsidies were granted to important businesses to make sure that they survived. The government also provided poor relief or welfare to the poor.

The primary justification for all of these laws and regulations was that they were needed to combat poverty, which was deep and widespread during the mercantilist period. The standard of living of the average person was horrible, a fact reflected by the average life span, which was in the low 20s for both men and women. People lived in squalor and died at an early age from famine, malnutrition, or disease. In The Wealth of Nations, Smith told how families would have a dozen children, in the hope that a few would survive into adulthood.

Hardly anyone questioned the morality or usefulness of this extensive economic control. Most everyone believed that if government didn’t manage the economy, the plight of the poor would be even worse than it already was. Perhaps most important, hardly anyone questioned the authority of the king to regulate people’s economic affairs, because he was the ruler and they were his subjects. The common mindset was that rulers ruled and people obeyed.

Adam Smith and economic liberty

Then along came Adam Smith and turned the world upside down with one of the most revolutionary ideas in history. Smith said that the reason people had remained mired in poverty throughout the ages was that governments had waged war against poverty. If people would only prohibit government from waging war on poverty, Smith argued, the standard of living of people would soar. That was the key, he said, to the nature and causes of the wealth of nations.

Would there be chaos if governments were not managing the economy? No, because the “invisible hand” of the market would coordinate the economic affairs of the people. Would producers fail to provide essential items if government did not direct them to do so? No, because it would be in their self-interest to produce what other people were willing to buy.

Would the poor be gouged without price controls? No, because prices were simply market signals to producers and consumers. If prices were high, producers would produce more and consumers would consume less. If they were low, producers would produce less and consumers would consume more. The market would balance supply and demand.

Rather than subsidize inefficient businesses, Smith suggested, the consumer, through his buying habits, should decide which producers and sellers remained in business.

Entrepreneurs and speculators provided a vitally important service, Smith suggested. Their role was to more quickly anticipate market conditions and to assume the risk of market changes, which resulted in more efficient use of resources. They also provided a degree of economic security for sellers. For example, by buying the farmer’s crops on the outskirts of town, the middleman assumed the risk that the price would be lower by the time the items got to market.

When someone asked Adam Smith whether he would see the triumph of his free-market ideas in the near future, he responded that it would be a long time before the world would see the triumph of his philosophy. After all, not only had people been living in a managed economy for centuries, not only did they believe that it was beneficial to them, not only did they believe that the king had the sovereign right to regulate their affairs, but also multitudes of people both inside and outside government were dependent on the mercantilist system. It is not difficult to understand Smith’s pessimism.

Yet within a relatively short period of time — some 50 years — Smith’s economic philosophy of free enterprise prevailed. Virtually the entire mercantilist structure came crashing down, especially in Great Britain. Laws and regulations governing economic affairs were repealed. In England, this was primarily due to the political efforts of two Englishmen — Richard Cobden and John Bright, who traveled the nation explaining the benefits of free trade.

The triumph of economic liberty brought phenomenal, almost miraculous, results, especially for those at the bottom of the economic ladder. Despite all the bad things that have been said about the Industrial Revolution, the truth is, the standard of living of poor people throughout the 19th century soared. The mistake that critics of that period make is to compare living standards of the 19th century with those of the 20th, when the accurate comparison is between the 19th century and the centuries that came before it. Compared with the past, people during the Industrial Age were not only surviving, they were living longer and actually prospering.

Two revolutionary ideas

The most dramatic outcome of Smith’s ideas took place in the United States. The confluence of two revolutionary ideas published in the same year — the Declaration of Independence and The Wealth of Nations — brought into existence the most unusual society in history, one that would do more to alleviate the suffering of the poor than anyone could have ever imagined.

The Declaration proclaimed the revolutionary idea that man’s rights of life, liberty, and the pursuit of happiness came not from government but instead from Nature and Nature’s God. The purpose of government was to ensure the exercise of such pre-existing rights by capturing, prosecuting, and punishing violent people who interfered with such rights. Since people’s rights pre-exist government, government could not legitimately control them or take them away.

By the time 1787 came along, those two revolutionary ideas — one political and the other economic — had gripped the hearts and minds of the American people. Thus, when the Constitution called the federal government into existence that year, the Framers were primarily guided by the political philosophy expressed in the Declaration of Independence but, at the same time, were deeply influenced by the economic philosophy of Adam Smith.

Despite the tragic and ultimately costly exception of slavery, the result was the freest society in history. For most of the 19th century, there were no occupational licensure laws — that is, people were free to engage in any occupation without asking for government permission. Lawyers, doctors, farriers (people who shoed horses), gunsmiths, restaurant owners, alcohol and tobacco sellers, and everyone else could enter into business simply by opening up shop. This was what was once meant by the term “free enterprise.” Through their buying and abstention from buying, the consumers, not the government, decided which businesses succeeded and which ones failed.

There were virtually no regulations on economic activity. People were free to enter into mutually beneficial economic transactions with one another, and it was none of the government’s business. People believed that “liberty of contract” was a right, not a privilege. The practical consequence of liberty of contract confirmed a thesis set forth by Adam Smith — that through the simple act of exchange, the standard of living of people rises.

For example, suppose that one person had 10 apples and another person had 10 oranges and that they traded 3 apples for 3 oranges. Both of them gained from the trade because they had both improved their respective positions. Their standard of living had risen through the exchange. Thus, Americans figured out that to the extent government regulations interfere with mutually beneficial trades, people’s standard of living is reduced. There were no taxes on income. No withholding tax. No Internal Revenue Service. No income tax returns. People were free to accumulate unlimited amounts of wealth from the enterprises in which they were freely engaged and through the trades into which they were freely entering with others. And there was nothing the government could do about it, because the supreme law of the land — the Constitution — did not permit the federal government the power to impose a tax on people’s income.

No welfare. No Social Security. No Medicare and Medicaid. No monopolies. Relatively few government subsidies (railroad grants being a notable exception). There also were no drug laws, virtually no public schooling, no immigration controls, and no travel restrictions, including passports.

That is what it once meant to be an American. That is what it once meant to be free. That was the concept of liberty that Americans once celebrated every year on the Fourth of July. It was not to last.

Jacob Hornberger is founder and president of The Future of Freedom Foundation in Fairfax, Va.

If we are to keep the term "capitalism" at all, then, we must distinguish between "free-market capitalism" on the one hand, and "state capitalism" on the other. The two are as different as day and night in their nature and consequences. Free-market capitalism is a network of free and voluntary exchanges in which producers work, produce, and exchange their products for the products of others through prices voluntarily arrived at. State capitalism consists of one or more groups making use of the coercive apparatus of the government — the State — to accumulate capital for themselves by expropriating the production of others by force and violence.

Throughout history, states have existed as instruments for organized predation and exploitation. It doesn't much matter which group of people happen to gain control of the State at any given time, whether it be oriental despots, kings, landlords, privileged merchants, army officers, or Communist parties. The result is everywhere and always the coercive mulcting of the mass of the producers — in most centuries, of course, largely the peasantry — by a ruling class of dominant rulers and their hired professional bureaucracy. Generally, the State has its inception in naked banditry and conquest, after which the conquerors settle down among the subject population to exact permanent and continuing tribute in the form of "taxation" and to parcel out the land of the peasants in huge tracts to the conquering warlords, who then proceed to extract "rent." A modern paradigm is the Spanish conquest of Latin America, when the military conquest of the native Indian peasantry led to the parceling out of Indian lands to the Spanish families, and the settling down of the Spaniards as a permanent ruling class over the native peasantry.

To make their rule permanent, the State rulers need to induce their subject masses to acquiesce in at least the legitimacy of their rule. For this purpose the State has always taken a corps of intellectuals to spin apologia for the wisdom and the necessity of the existing system. The apologia differ over the centuries; sometimes it is the priestcraft using mystery and ritual to tell the subjects that the king is divine and must be obeyed; sometimes it is Keynesian liberals using their own form of mystery to tell the public that government spending, however seemingly unproductive, helps everyone by raising the GNP and energizing the Keynesian "multiplier." But everywhere the purpose is the same — to justify the existing system of rule and exploitation to the subject population; and everywhere the means are the same — the State rulers sharing their rule and a portion of their booty with their intellectuals. In the nineteenth century the intellectuals, the "monarchical socialists" of the University of Berlin, proudly declared that their chief task was to serve as "the intellectual bodyguard of the House of Hohenzollern." This has always been the function of the court intellectuals, past and present — to serve as the intellectual bodyguard of their particular ruling class.

In a profound sense, the free market is the method and society "natural" to man; it can and does therefore arise "naturally" without an elaborate intellectual system to explain and defend it. The unlettered peasant knows in his heart the difference between hard work and production on the one hand, and predation and expropriation on the other. Unmolested then, there tends to grow up a society of agriculture and commerce where each man works at the task at which he is best suited in the conditions of the time, and then trades his product for the products of others. The peasant grows wheat and exchanges it for the salt of other producers or for the shoes of the local craftsman. If disputes arise over property or over contracts, the peasants and villagers take their problem to the wise men of the area, sometimes the elders of the tribe, to arbitrate their dispute.

There are numerous historical examples of the growth and development of such a purely free-market society. Two may be mentioned here. One is the fair at Champagne, that for hundreds of years in the Middle Ages was the major center of international trade in Europe. Seeing the importance of the fairs, the kings and barons left them unmolested, untaxed, and unregulated, and any disputes that arose at the fairs were settled in one of many competing, voluntary courts, maintained by church, nobles, and the merchants themselves. A more sweeping and lesser-known example is Celtic Ireland, which for a thousand years maintained a flourishing free-market society without a State. Ireland was finally conquered by the English State in the seventeenth century, but the statelessness of Ireland, the lack of a governmental channel to transmit and enforce the orders and dictates of the conquerors, delayed the conquest for centuries.[2]

The American colonies were blessed with a strain of individualist libertarian thought that managed to supersede Calvinist authoritarianism, a stream of thought inherited from the libertarian and anti-statist radicals of the English revolution of the seventeenth century. These libertarian ideas were able to take firmer hold in the United States than in the mother country owing to the fact that the American colonies were largely free from the feudal land monopoly that ruled Britain.[3] But in addition to this ideology, the absence of effective central government in many of the colonies allowed the springing up of a "natural" and unselfconscious free-market society, devoid of any political government whatever. This was particularly true of three colonies. One was Albemarle, in what later became northeastern North Carolina, where no government existed for decades until the English Crown bestowed the mammoth Carolina land grant in 1663. Another, and more prominent example was Rhode Island, originally a series of anarchistic settlements founded by groups of refugees from the autocracy of Massachusetts Bay. Finally, a peculiar set of circumstances brought effective individualistic anarchism to Pennsylvania for about a decade in the 1680s and 1690s.[4]

While the purely free and laissez-faire society arises unselfconsciously where people are given free rein to exert their creative energies, statism has been the dominant principle throughout history. Where State despotism already exists, then liberty can only arise from a self-conscious ideological movement that wages a protracted struggle against statism, and reveals to the mass of the public the grave flaw in its acceptance of the propaganda of the ruling classes. The role of this "revolutionary" movement is to mobilize the various ranks of the oppressed masses, and to desanctify and delegitimize the rule of the State in their eyes.

It is the glory of Western civilization that it was in Western Europe, in the seventeenth and eighteenth centuries, where, for the first time in history, a large-scale, determined, and at least partially successful self-conscious movement arose to liberate men from the restrictive shackles of statism. As Western Europe became progressively enmeshed in a coercive web of feudal and guild restrictions, and of state monopolies and privileges with the king functioning as the feudal overlord, the liberating movement arose with the conscious aim of freeing the creative energies of the individual, of enabling a society of free men to replace the frozen repression of the old order. The Levellers and the Commonwealthmen and John Locke in England, the philosophes and the Physiocrats in France, inaugurated the Modern Revolution in thought and action that finally culminated in the American and the French Revolutions of the late eighteenth century.

This Revolution was a movement on behalf of individual liberty, and all of its facets were essentially derivations from this fundamental axiom. In religion, the movement stressed separation of Church and State, in other words the end of theocratic tyranny and the advent of religious liberty. In foreign affairs, this was a revolution on behalf of international peace and the end to ceaseless wars on behalf of State conquest and glory to the ruling elite. Politically, it was a movement to divest the ruling class of its absolute power, to reduce the scope of government altogether and to put whatever government remained under the checks of democratic choice and frequent elections. Economically, the movement stressed the freeing of man's productive energies from governmental shackles, so that men could be allowed to work, invest, produce, and exchange where they wished. The famous cry to power was laissez faire: let us be, let us work, produce, trade, move from one jurisdiction or country to another. Let us live and work and produce unhampered by taxes, control, regulations, or monopoly privileges. Adam Smith and the classical economists were only the most economically specialized group of this broad liberating movement.

It was the partial success of this movement that freed the market economy and thereby gave rise to the Industrial Revolution, probably the most decisive and most liberating event of modern times. It was no accident that the Industrial Revolution in England emerged, not in guild-ridden and State-controlled London, but in the new industrial towns and areas that arose in the previously rural and therefore unregulated north of England. The Industrial Revolution could not come to France until the French Revolution freed the economy from the fetters of feudal landlordism and innumerable local restrictions on trade and production. The Industrial Revolution freed the masses of men from their abject poverty and hopelessness — a poverty aggravated by a growing population that could find no employment in the frozen economy of pre-industrial Europe. The Industrial Revolution, the achievement of free-market capitalism, meant a steady and rapid improvement in the living conditions and the quality of life for the broad masses of people, for workers and consumers alike, wherever the impact of the market was felt.

An undeveloped and sparsely populated area originally, America did not begin as the leading capitalist country. But after a century of independence it achieved this eminence, and why? Not, as the common myth has it, because of superior natural resources. The resources of Brazil, of Africa, of Asia, are at least as great. The difference came because of the relative freedom in the United States, because it was here that the free-market economy more than in any other country was allowed its head. We began free of a feudal or monopolizing landlord class, and we began with a strongly individualist ideology that permeated much of the population. Obviously, the market in the United States was never completely free or unhampered; but its relatively greater freedom (relative to other countries or centuries) resulted in the enormous release of productive energies, the massive capital equipment, and the unprecedentedly high standard of living that the mass of Americans not only enjoy but take blithely for granted. Living in the lap of a luxury that could not have been dreamed of by the wealthiest emperor of the past, we are all increasingly acting like the man who murdered the goose that laid the golden egg. www.mises.org