Dwight R. Lee is the Ramsey Professor of Economics at the University of Georgia, Athens. Richard B. McKenzie is the Hearin/Hess Professor of Economics at the University of Mississippi, Oxford. Both authors are adjunct scholars at the Center for Study of American Business, Washington University, St. Louis.
The struggle to protect our liberty against the abuses of government is long-standing, and certainly one over which the defenders of liberty can declare no permanent victories. Yet, in recent tunes there seems to have been a shift in favor of liberty in the struggle between government suppression and individual liberation. The most dramatic evidence of this shift comes from Eastern Europe where the yoke of Communism has loosened with the fall of several totalitarian regimes.
But even in those countries based on democratic capitalism, in which the power of government has been limited, at least in a relative sense, the evidence justifies cautious optimism for believing that the threat of government has reached its zenith and has begun to recede. Marginal tax rates have been lowered, regulation has been reduced, privatization proposals are being implemented, and governments are finding it increasingly diffi cult to initiate new programs and controls. While the existing controls and intrusions of government certainly have not become irrelevant, there seems little doubt that they have become less relevant to the choices people make and the freedoms they exercise.
But why? Is the current retrenchment in government power an aberration, nothing more than a temporary fluctuation in the long-run trend of increasing state control? Or can we point to fundamental forces at work which are systematically shifting power from governments to individuals? In our view, it is the latter.
Changes taking place in the global economy, changes rooted in continuing technological progress, are reducing the threat governments pose not only to our liberty, but to our prosperity as well. The explanation of why technology is increasing the freedom of the individual, rather than the power of the state, requires an under standing of the importance of information and its coordination to a free and prosperous social order.
Freedom and Economic Prosperity
As Friedrich Hayek pointed out in 1945, economic prosperity depends on the ability of each of us to respond appropriately to an enormous amount of information, most of which no one person can possess directly. Economic progress requires the use of information that exists only as widely dispersed knowledge which each of us has about our own condition, circumstances, and preferences. Without the proper utilization of such seemingly trivial bits of information as the personal idiosyncrasies of those with whom we work, the peculiarities of a machine we operate, a shortcut on a delivery route, and our willingness to sacrifice a promotion for locational amenities, our ability to produce wealth would be greatly reduced.
This information is typically tacit; it is impossible even for those who possess it to communicate it in any meaningful way to others. The only way to make use of such locationally specific knowledge is by giving those who have it the freedom to act on it. Without freedom, the information that is essential for prosperity is rendered largely useless. Freedom is necessary for economic progress.
Yet, freedom is not sufficient for economic progress. For the localized information possessed by an individual to be utilized to best advantage, it has to be used in a way that is compatible with the use others are making of the localized information that they alone possess. No matter how appropriate individual decisions may appear when judged against the particular information each individual has, unless these decisions are somehow melded together into a coordinated pattern of consumption and production, the performance of the economy will frustrate the pursuits of all.
The seriousness of the problem of economic coordination cannot be overemphasized. The need to coordinate economic decisions if economic progress is to be realized is an undeniable fact, and has provided much of the rationale for those who favor restrictions on individual freedom in the name of “rational” economic planning by the state. Supposedly government planners with a broad social perspective, and the ability to gather economy-wide economic data, are necessary to coordinate the otherwise conflicting pursuits of individuals acting on only local information.
A crucial problem with central economic planning is that, by restricting the freedom of individuals with government commands and controls, much of the local knowledge so essential to economic progress is effectively destroyed. This is a problem that advocates of central planning have either: 1) ignored, 2) assumed could be overcome by advances in technology that would allow the collection of local information, or 3) seen as a necessary cost of solving what is perceived as the more important problem of economic coordination.
If it were the case that economic activity could be coordinated only through central direction, then the justification for central economic planning for the purpose of coordination would have merit. There would be a trade-off between the use of localized knowledge and the coordination of that knowledge. The individual freedom that increased the former would reduce the latter, and freedom would be insufficient for economic progress.
The fatal flaw in the case for central economic planning is the failure to recognize that the best way to coordinate economic activity is by giving individuals the freedom to act on the knowledge that only they have within the institutional setting of a free market. In a free market, characterized by private property and voluntary exchange, prices emerge which convey far more information and coordinate economic decisions far better than can the most diligent and dedicated team of central planners. Market prices convey to each individual the value that others place on the marginal units of those goods and services that are exchanged in the marketplace. Therefore, whether making a decision on how much of a product to consume or how much of a productive input to employ, each decision-maker, because of the market prices he faces, has both the information and the motivation to acquire additional economic resources only as long as these resources are worth as much or more to him than they are to others.
The result is a coordinated pattern of economic activity that directs resources and efforts into their highest value uses by giving individuals the freedom to utilize their dispersed and localized knowledge. When individual freedom is subject to the accountability of the marketplace there is no trade-off between the freedom and coordination upon which economic progress depends. Individual freedom, exercised within the constraints imposed by the private market, is a powerful and essential force for economic progress.
Yet for the very reason that individual freedom can be so productive, it is also vulnerable to suppression. The advantages we realize from individual freedom derive from the fact that it will be exercised in a wide variety of unpredictable ways. As Hayek has pointed out, “If we knew how freedom would be used, the case for it would largely disappear,” and “the benefits I derive from freedom are thus largely the result of the uses of freedom by others, and mostly of those uses of freedom that I could never avail myself of.” There is a tendency in all of us, however, to view with suspicion the decisions of others when those decisions deviate from those that we would make. Suspicion quickly turns into intolerance when the freedom of others results in decisions which conflict with our own pursuits. The only hope for maintaining the tolerance required for freedom to flourish is a market setting in which the freedom exercised by each in pursuit of his objectives takes account of, and facilitates, the pursuits of others.
Tolerance for freedom requires that people be accountable for their actions, and in the absence of accountability through the general rules of the market, one can be sure that more detailed rules will be imposed on individual behavior. It should come as no surprise that in those countries in which reliance on private property and exchange is officially frowned upon, one finds not only the poorest economic performance, but also the most blatant violations of basic human rights and freedom.
Government as Protector and Pirate
Ironically, the market setting that allows for freedom is one that cannot long remain viable without coercion. The productive accountability and coordination of the marketplace depends upon people obeying the general rules of private property and exchange. These rules are not self-enforcing. The benefits of economic productivity and tolerance for freedom that result from respect for the rules of the market are general benefits. When respect for property fights is widespread, the general advantages of the marketplace that result accrue to all in the country, including those who transgress against the property rights of others. Therefore, those who promote the general advantage by exercising restraint find themselves victimized by those who do not. It is this which justifies granting to government the coercive power to enforce the rules of the market. Without such enforcement the market order, and the freedom and productivity it allows, cannot long remain viable.
Unfortunately for the very reason government is needed to enforce the general rules which are the foundation of a social order based on freedom and responsibility, a persistent tendency exists for government to expand, and then undermine both freedom and responsibility. The existence of government power creates the opportunity for people to benefit legally at the expense of others in ways that are analogous to the illegal practices that it is the primary purpose of government to prevent.
The accountability imposed by the market, although providing general benefits, is seen as an inconvenience from the perspective of each individual. Being held accountable to the whims of consumer preferences creates problems for producers that from their perspective are best resolved by having government interfere with the social coordination of the marketplace. When government uses its coercive power to give a particular firm and its employees exemption from the rules of the marketplace, the general benefits of market coordination are diminished. Like the thief who violates rules of private property and voluntary exchange, those who benefit from government infringements of those rules live, as a consequence, in a less productive and free society.
This cost does little, however, to dampen enthusiasm for government action that reduces the accountability of the private market. As with the thief, those who gain advantages from preferential governmental treatment receive all the benefits while the costs (in terms of diminished freedom and productivity) are spread over the entire population.
Government can become the means by which everyone is engaged in the activity of “political piracy,” or in the words of Frederic Bastiat, “the State is the great fiction through which everybody endeavors to live at the expense of everybody.” Obviously this situation is collectively destructive. Piracy can be a profitable activity when the pirates are few and the victims are many. But when everyone is a pirate, everyone is also a victim, making it possible for all to gain by a reduction in piracy.
Pessimism comes easy when considering the relentless pressures for governments to expand and, by so doing, destroy the general benefits it is government’s duty to protect. Aided by single-issue dedication, organizational advantage, and a rationally ignorant public, special interests are able to dominate the general interest in the com petition for political influence.
The intellectual force of classical liberalism that guided the drafters of the United States Constitution was undeniably a major factor in the establishment of a government that was largely limited to maintaining an environment conducive to freedom and economic progress. But while this intellectual force hasn’t been destroyed, it has been overwhelmed by the relentless and increasingly entrenched political influence of special interests.
Technology and the Power of the State
While not denying the power of special interests and the strong and unrelenting pressure for government expansion that is destructive of our freedom and prosperity, pessimism is premature. The world is changing in ways that are imposing constraints on government power that reinforce (or supersede) those of written constitutions, and prodding unmistakable evidence that the classical liberal model of limited government and decentralized markets allows far more freedom and prosperity than state dominance and centralized economic direction. There are reasons for optimism that these two forces are in the process of interacting in a virtuous cycle of reinforcement that will expand the scope of human liberty and economic progress around the globe. The force initiating this cycle of freedom and prosperity is technology.
In the past it was widely believed that technological advances would expand the control of the state, with some being appalled by this prospect and others welcoming it. Whether one feared the Big Brother of George Orwell’s 1984, or looked forward to the day when government could gather the information necessary to calculate efficient socialist prices, the expectation was that technology would shift control from the level of individuals to that of central authorities.
This expectation was not completely unfounded. Certainly technological advances have increased the ability of government to monitor private activities, to gather information on the economy, and to solve the huge systems of simultaneous equations called for by the schemes of the rational socialist “calculators.” Moreover, this new technology might be used to destroy the economic freedom that is incompatible with the directives of central planners.
The initial effect of the technology that ushered in the Industrial Revolution was to increase the power of government. This technology created tremendous advantages resulting from the exploitation of economies of scale. Economies became characterized, and landscapes dotted, by huge plants and factories. Efficiency was increased by building yet more massive units of physical capital and by bringing yet larger numbers of workers in close physical proximity in order to coordinate their use of that capital. Such large concentrations of productive wealth create tempting targets of opportunity for political exploitation through regulation, taxation, and central direction. Also, the large productive facilities called for by economies of scale created the illusion that large sections of the economy could be efficiently concentrated and controlled by central planners.
Certainly governments have used technology to increase control over their populations. It is possible to point to many cases in which this control has seemed almost complete. And the experience with increased state control is far better characterized by Orwell’s Big Brother than by the socialist fantasy of the calculator of efficient socialist prices. The primary accomplishment of totalitarian governments has been to snuff out both individual freedom and economic prosperity.
Technology continues to progress, however; and as it does there are reasons for believing that it is becoming more a force for liberation than for suppression. The atrocities of state power that have characterized so much of the 20th century are likely to be the darkness before the dawn.
Technology as a Force for Freedom
Recent technological progress has altered the production of wealth in fundamental ways, and by so doing has reduced the ability of government to control and exploit the productive process. The most cost-effective plant is no longer the largest plant. Small machines are now able to produce a host of products more efficiently than formerly was the case with large machines. Just-in-time delivery systems based on more rapid communication and transportation are reducing the warehousing space needed for inventorying productive inputs. The productive activity of a large number of people can be supervised and coordinated without having them in close physical proximity to each other. And increasingly it is knowledge and creativity embodied in human, rather than physical, capital which is the decisive factor in the creation of wealth.
The result is not only productive units that are far smaller than in the past, but far more mobile as well. Increasingly the tax base that governments were able to treat as captive have become fugitive. The governments of countries are now finding themselves facing the same type of competition that governments of local jurisdictions have always faced.
No claim is being made that this competition will ever rival that faced by grocery stores or pizza parlors. But the gap that can exist between the attractiveness of the tax and service packages of different governments without adversely affecting the tax base of the least attractive is diminishing. As measured by the discretion governments have to tax, regulate, and exploit the productive process for political ends, technological advance is reducing the control of governments.
Of course governments have always recognized a threat in the emigration of productive resources, and those governments pursuing the least “competitive” policies have never hesitated to employ brutality in order to limit that emigration. But technological advance is making government attempts forcefully to prevent capital flight less likely to be successful; and increasingly futile even if successful. The increasing mobility of capital goes a long way in explaining the difficulty of preventing capital flight. The changing nature of capital explains the futility of attempts to overcome this difficulty, even if successful.
Productive capital has become increasingly dependent upon intellect and creativity. As George Gilder has expressed it, “innovation tends to devalue the materials of the established system and create a new means of production with a higher content of intellect and ideas. The displacement of materials with ideas is the essence of all real economic progress:”
How Governments Undermine Creativity
Attempts by central authorities to confine, control, and manipulate creativity are sure to destroy creativity. Those governments that have been most successful at imposing internal controls over their populations in order to prevent the exodus of capital (both human and physical) have succeeded only in destroying the creative process upon which a productive capital base ultimately depends.
Technology is shifting the advantage even more than in the past to decentralized economies based on the coordination of the marketplace. For reasons discussed earlier, the market has always dominated central planning in the utilization of localized information and in coordinating that use into an overall pattern of efficient production and consumption choices. But it is important to recognize that, by accelerating change and further fragmenting the distribution of knowledge, technological advances are rapidly increasing the dominance of market-based economies.
In an economic setting characterized by completely static production processes and preferences, and a few huge production units, central economic planning might work tolerably well. In such a setting there would be fewer units to coordinate, and maybe some semblance of coordination could be realized by repeated iterations toward a stationary target. It is not surprising that those who dream of economic progress through industrial policy controls find comfort in the thought of mega-sized corporations (see, for example, John Kenneth Galbraith, The New Industrial State) and see disruption rather than progress in the spontaneous changes that are leading to a dynamic global economy (e.g., Robert Reich, The Next American Frontier).
But the thought of central economic control becomes a complete absurdity in a world in which large corporations are losing ground to creative entrepreneurs, who, armed with the latest technology and a relatively few employees, outperform their rival Goliaths at innovating, manufacturing, and marketing. Smaller organizational units whose productive power has been enhanced by technological advances possess far greater agility in responding to the rapid changes brought on by those technological advances.
The greater productive power of smaller organizations comes from superior use of localized knowledge and increased specialization, and depends completely upon the information flows that can be collected and distributed only through markets. The information that pulses through the market in the form of prices, profits, and losses is information that is being utilized to ever greater advantage in decentralized economies and which is being neutralized and destroyed in centralized economies.
The same technology that is driving the production and rapid distribution of goods, services, and information in those countries that are plugged into the global market is ensuring that those who live in economically stagnant and politically repressive regimes are becoming increasingly aware of their plight. All regimes based on central economic and political control are being under mined by “the three most powerful political factors at work in the world today: democracy, market economies, and the microchip.”
When the theory and experience of democratic capitalism is presented to those whose political and economic lives are subject to the detailed control of unelected authorities, those authorities soon begin losing their grip. When people couple improved knowledge of alternative systems of political economy with greater ability to vote for these systems both with their feet and their capital, the power of governments over their citizens is further weakened. By quickening the flow of information and increasing the mobility of capital and populations, recent technological advances are ushering in a new era in which the prospects for individual liberty and accelerating economic progress are greatly improved.
Summary and Conclusion
Genuine economic progress isn’t possible without the freedom of individuals to use the localized knowledge that only they can possess. Yet individual freedom is a force for economic progress only when subject to the accountability imposed by the market institutions of private property and voluntary exchange. Somewhat ironically, the freedom of the marketplace depends upon the coercion of government. In the absence of government enforcement of the rules of private property and exchange, temptations exist that convert individu ally rational behavior into collectively destructive outcomes.
Unfortunately, the power to protect freedom is also the power to destroy freedom by undermining the accountability of the marketplace. And the use of government power to undermine market accountability is exactly what numerous special interest groups see as individually rational. Each such group realizes private advantage at public expense by being exempted from the discipline of the marketplace.
Yet, there is cause for optimism. Technology seems to have entered the struggle between government power and individual freedom on the side of freedom.
The concern has long been that the power of government is undermining the freedom and productivity of the market. This remains a concern. But there is reason to believe that the threat is turning, and we are now observing the freedom and productivity of the global market in the process of undermining the power of governments around the world.
5. Even in a static economic setting with only a few production units, localized information would remain important and market coordination still would be superior to bureaucratic coordination. Also, it is unrealistic to assume that central authorities are motivated to take the task of economic coordination seriously. The reality of central economic planning is that it requires concentrations of coercive power that always are exploited for private advantages which generally conflict with public-interest objectives such as economic coordination.