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Sunday, December 17, 2017

Creativity and Competition Are the Heart of Capitalism

Competition is useful and, indeed, essential to the creative processes of the market.

Market competition is at the heart of the capitalist system. It serves as the driving force for creative innovation, the mechanism by which supply and demand are brought into coordinated balance for multitudes of goods, and as the institutional setting where individuals freely find their place to best earn a living in society.  

Yet, listening to the critics of capitalism, competition is made out to be a cruel and dehumanizing process that feeds unnecessary wants and desires, or has a tendency to evolve into anti-competitive monopolies that are contrary to the “public interest.” Competition fosters a “selfish” disregard for the “common good” and misdirects resources from their most important socially-valuable uses.

Competition Through Political Means

As long as resources are scarce and social positions are too limited to satisfy everyone’s desire for status, competition will exist. The crucial questions concern: how will it be decided what gets produced and for whom, and how shall social positions in society be determined and filled?

For almost all of human history these questions were determined by conquest and coercion. Those with greater physical strength or manipulative guile used these superior abilities and skills to gain the goods they wanted and the status they desired over others.

Most, if not all, forms of competition were battles for political power and position.

In a competition between the physically “strong” and the “weak,” it was often the case that “might made right.” Pillage and plunder enabled some to seize goods and to then subjugate and enslave those they conquered to work for them and accept their conquerors as their legitimate masters.

Most, if not all, forms of competition were battles for political power and position. Closeness to the throne and having favor with the king or prince gave one control over land and people, and therefore possession of material wealth in the forms in which they existed in those earlier times. The mythologies of the aristocratic nobility – the lords of the manor – asserted that they were the repository of grace, charm, and culture, the carriers of civilized manners and the benefactors of civilization. This hid the fact that their leisure time for and attention to the “higher things” of life were only made possible – to the extent that any of them were actually concerned with anything other than their personal pleasures and pastimes – due to their success in gaining legitimized authority over the productions of others.

Commerce and trade is as old as recorded history. Anyone who peruses, for instance, Marco Polo’s (1254-1324) famous account of his experiences traveling to China from Europe and back in the late 1200s finds descriptions of merchants and manufacturers, exporters and importers, everywhere that went around the Mediterranean, the Middle East, Central Asia, and eastern and southern Asia. But all these market activities operated under various forms of government regulations, restrictions, and prohibitions, given the reach and methods of control by the political rulers of the time in different parts of the world.

Entry into professions, occupations, and crafts were all controlled by trade guilds in the Europe of the Middle Ages. The guilds limited competitive entry into various lines of employment and they restricted the methods of production that sellers could use in manufacturing goods to those approved by the respective town and city guild associations. In the countryside, the peasants were tied to the land that was owned by the nobility and bound within the tradition-based techniques of farming and craftsmanship to meet the needs of those living on the properties.

Market Competition Liberated People and Provided Opportunities

The slow liberation of men and production from these restraints and the opening of both labor and manufacturing to greater market-based competition freed a growing number of people from a life of oppression and wretched poverty. Competition meant that a man could leave behind the legal tethers that had tied him to the land and obligatory work for the aristocracy. Now, an individual could more freely find work more to his own liking where it might be offered in towns far away from where he had been born, and earn a far greater income than he ever had in the rural areas, however modest those incomes may seem by today’s standards.

No longer was production focused on meeting the whims of the privileged few.

Competition meant that a resourceful individual with a willingness to bear risk could found his own business, make a product of his own choice, and market it to those with whom he increasingly freely negotiations and contracts. He could experiment with new manufacturing methods and techniques, he could hire based on mutually agreed upon terms of work and wages, and he could retain the profits he may have earned to not only live better himself but to plow a good part of those profits back into his business to expand production in new and better ways.

No longer was production focused on meeting the whims of the privileged few who circled the king and the landed aristocracy. Market-based competition now was directed to serving the growing wants of the wider population who were increasingly participating in the manufacturing processes of the emerging and intensifying industrial revolution. The “revolutionary” character of the new industrial era of the late eighteenth and then nineteenth centuries was due to the fact that men were freer in mind and body to experiment and to voluntarily associate with others in radically different ways than in previous ages.

“Capitalism,” as this new economic arrangement of society has come to be called, had as its hallmark the new philosophy of human liberty, based on the revolutionary idea that individuals have inherent and inviolable rights. They own themselves; they are not and may not be the owned property of another. They have liberty to live for themselves, guided by their own conception of the good; they may not be coerced into the role of sacrificed servant to the wants and desires of others.

The ethical principle behind capitalist competition is a moral and legal prohibition on coercion in all human relationships. If you want what others have, if you would like to have the material means to achieve the goals that will offer you happiness (as you define it), if you desire the association and companionship of others to advance purposes that you consider worthwhile, your only means to them are mutual agreement and voluntary consent with your fellow human beings.

Capitalism as a System of Cooperative Competition

In Ludwig von Mises’s (1881-1973) famous treatise on economics, Human Action (1966), he explains:

Competing in cooperation and cooperating in competition all people are instrumental in bringing about the result, viz., the price structure of the market [for consumer goods and the factors of production], the allocation of the factors of production into the various lines of want-satisfaction [consumer demand], and the determination of the share of each individual [the relative incomes earned in the market].”

If we step back and look at competition as a wider social process at work, Mises’s words help to explain the logic and the humanity of the capitalist economy. Peaceful and voluntary cooperation is the hallmark of the market economy. Sellers compete in offering their goods to the potential buying public, and buyers’ demands attract sellers to produce. All cooperate in this competitive process by following the “rules” of the market game that excludes violence and fraud. Everyone must attempt to get what they want by focusing their mental and physical efforts on devising ways to offer to others what they want and are willing to take in agreed upon trade.  

Resources must be applied to produce those goods that all of us as demanders desire.

Each must apply his abilities, talents, and skills to offer better products, new products, and less expensive products to their possible trading associates since each knows that every one of those potential exchange partners is at liberty to accept the offer of some rival who is also keen on getting their business. The interaction of competing buyers and sellers brings about the resulting structure of prices for all the goods and services offered on the market and determines how much of each one is bought and sold in a way that tends to bring about a coordinated balance between what is demanded and what is supplied.

At the same time, virtually all that is bought and sold first must be produced. This means the existing resources in society must be directed and applied to produce those goods that all of us as demanders desire. Those in the social system of division of labor who undertake the role and task of entrepreneur – the designer, coordinator, and director of the activities of a private enterprise – must marshal the land, labor and capital judged to be most economically effective and efficient in bringing a final, finished good to market.

These enterprising entrepreneurs must compete amongst each other for the hire of workers, raw materials, and the capital goods (machinery, tools, and equipment), and coordinate their use to bring consumer demanded goods to market. Competition estimates what each of those various factors of production is worth.

In turn, the owners of those factors of production – the workers looking for employment, the owners of land and resources, and lenders of savings who are looking for interested borrowers – offer their services or products to those competing entrepreneurs. Again, the cooperative outcome of this two-sided competition determines the allocation of those scarce means of production based on the appraisement of their most highly valued uses in producing alternative goods and services. This also determines the cost of each of those factors of production, including the wages for different types of labor, upon which each laborer may then reenter the market as a consumer to demand the very products that their activities have assisted in bringing to market.

Entrepreneurs as the “Driving Force” of the Market

As Ludwig von Mises summarized the nature of the competitive process:

The market economy is the social system of the division of labor under private ownership of the means of production. Everybody acts on his own behalf; but everybody’s actions aim at the satisfaction of other people’s needs as well as the satisfaction of his own. Everybody in acting serves his fellow men . . .

“This system is steered by the market. The market directs the individual’s activities into those channels in which he best serves the wants of his fellow men. There is in the operation of the market no compulsion or coercion. The state . . . protects the individual’s life, health and property against the violent or fraudulent aggression on the part of domestic gangsters and external foes . . .

“Each man is free; nobody is subject to a despot. Of his own accord the individual integrates himself into the cooperative system. The market directs him and reveals to him in what way he can best promote his own welfare as well as that of other people. The market is supreme. The market alone puts the whole social system in order and provides it with sense and meaning.

“The market is not a place, a thing, or a collective entity. The market is a process, actuated by the interplay of the actions of the various individuals cooperating under the division of labor.”

The entrepreneurs who imagine, coordinate and direct those production activities through time are what Ludwig von Mises referred to as the “driving force” of the entire market process. While it is consumer demand that ultimately directs all the activities of the market, it is the entrepreneurs who decide what shall be produced, how, where, and by whom. All production takes time, whether this is a day, a week, a month or even years. Thus, decisions must be made “today” to set production processes in motion so a finished product can be offered on the market at some more distant tomorrow.

The entrepreneur also runs the possibility of suffering losses rather than earning profits.

Thus in the system of division of labor, entrepreneurs are tasked with anticipating future demand, to infer what prices those desired products might sell for in the future, and which ways of producing them would minimize their production costs so as to (hopefully) earn a profit – that is, earn revenues greater than incurred expenditures. While all others participating in the production process normally do so for contractually agreed upon wages, input prices, or interest,  the entrepreneur bears the uncertainty of whether or not he will, in fact, gain a profit from the enterprise that he directs.  This means that he also runs the possibility of suffering losses rather than earning profits, and that burden of uncertainty resides with him alone.

Profit and Loss and the Spirit of Entrepreneurship

Entrepreneurial competition is ultimately a rivalry over alternative visions for the shape of market things, with the final outcome determined by the consumers who may or may not buy a product, and who may or may not be willing to pay a certain price, such that revenues earned cover or exceed the expenditures incurred by entrepreneurs.

Unsuccessful entrepreneurs who suffer losses and who are unable to repair their faulty forecasts finally go out of business, with their assets passing into the hands of other enterprising entrepreneurs who are confident that they can more effectively manage their use to serve the consuming public. Successful entrepreneurs are able to use all or a part of the profits they have earned to expand their businesses to better fulfill the demands of consumers.

Thus, the competitive profit and loss mechanism always tends to put business decision-making and allocational discretion over scarce resources into the hands of those who more successfully demonstrate their competency within the capitalist economy. But as Mises also emphasized in his essay on “Profit and Loss” (1952), entrepreneurial success is ultimately based on the creative imaginings of the human mind, the capacity of seeing the possibilities of the future better than others and bringing production to fruition, which is then tested by the choices of consumers in the market:

In the capitalist system of society’s economic organization the entrepreneurs determine the course of production. In the performance of this function they are unconditionally and totally subject to the sovereignty of the buying public, the consumers.

“If they fail to produce in the cheapest and best possible way those commodities which the consumers are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve the consumers replace them . . .

“It is the entrepreneurial decision that creates profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market. It is a spiritual and intellectual phenomenon.”

Competition as a Discovery Procedure

To this may be added Friedrich A. Hayek’s (1899-1992) focus on “Competition as a Discovery Procedure” (1969). Competition is useful and, indeed, essential to the creative processes of the market. As Hayek pointed out, if in, say, a foot race we already knew ahead of time who would come in first, second, third, etc., along with each runner’s relative times, what would be the point of running the race?

It is only through competition that we can find out how a race will end.

It is only through competition that we can find out how a race will end. Only through the competitive process can we discover the abilities of each individual relative to others. It is also true that each individual cannot know for sure what he or she is capable of in a particular setting unless they try to find out what they can accomplish by challenging themselves.

What will consumers want in the future in terms of existing or new goods and services; who can effectively devise the most cost-efficient way of bringing a good or service to market; which competitor can do so better than his supply-side rivals; what applications of resources will reflect their most highly valued uses among the alternatives? There is no way of really knowing the answers to any such questions independent of a open competitive market in which the opportunities for earning profits exist and individuals have the motives to try.

All of these characteristics of a competitive market economy are only possible and available due to the institutional prerequisites of a capitalist system. It is the liberation of individuals from political restraints, the freeing of market interactions from governmental regulations, and the recognition that every market participant must be presumed to possess rights to his life, liberty, and honestly-acquired property that enables competition to fully come into play. And from which liberty and prosperity are made possible for mankind.   

But what about the critic’s criticisms that left to itself, competition may degenerate into a socially harmful and detrimental monopoly, or that competition serves misdirected and wasteful consumer demands? We will turn to these issues in the next part of this series.

  • Richard M. Ebeling is BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel in Charleston, South Carolina. He was president of the Foundation for Economic Education (FEE) from 2003 to 2008.