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Thursday, August 23, 2012

Economic Equilibrium: the Possible Systems

We have now, perhaps, established the truth that in every economic system man is bound by the necessities of choice and limitation. Every economic system consequently must have available to it a device for balancing means with ends. We already have gained some idea of the equilibrium mechanism which is peculiar to our economic system. But for a still clearer apprehension of how this mechanism functions, we must examine briefly the several possible systems of equilibrium:
(a) System of the queue, which could as well be called the system of elbowing one’s way through the crowd, or the system of first come, first served. It is the simplest and most brutal form of equating supply with demand. It consists in offering the available supply to the public gratis and it invariably results in a more or less violent use of fist and elbow. This system is so unsatisfactory and so little able to guarantee that the most urgent needs of the community will be met that recourse to it is had only in exceptional cases. We are reminded, perhaps, of those occasions on which the beer runs out at “free beer” parties, or of neighborhood get-togethers at which the refreshments set out are quickly devoured by the first wave of guests to the dismay of those who come after. The experiment undertaken by the Soviet dictatorship in its early years is very instructive in this connection. The streetcars and other means of transport were placed at the disposal of the public free of charge. The result, as was to be expected, was such a crush of passengers that the government was soon compelled to return to the “capitalist” equilibrium mechanism (price system). Anyone who has ever tried to watch a parade through the head of the man in front of him knows that the best viewing spots must be preempted well ahead of time. Indeed, when the crowd is very large—as, for example, at the coronation or the funeral of a monarch—it is common practice to resort to the price system for the disposal of the better places. It is to be noted that the system of the queue is the more undesirable the greater the elasticity of demand for a good or service (see pp. 10 ff.). Hence, it will prove easier to put the water of the public fountains at the free disposal of the citizens than to allow them, as in the Russian case, to use the streetcars without paying. The proposal to have free medical services supplied by nationalized doctors should be examined in the same light. The experiences of the British with their National Health Service provide a costly lesson of what may be expected from such an arrangement.
(b) A rationing system shows a certain advance over the system of the queue. Here, too, goods are supplied gratis, but equilibrium is obtained by a systematic distribution of the available goods (rationing). It is such a mechanism which would operate in a pure Communist economy. Even in our economic system, however, it is occasionally necessary to have recourse to this method. Every soldier will recall that in the field not only was food rationed, but also cigars, cigarettes and pipe tobacco. The distribution of food did not involve any great difficulties since individual wants were fairly uniform. But the distribution of tobacco, cigarettes, etc., given the pronounced differences in individual preferences, was regularly followed by a lively private exchange where, under a primitive form, the price system again prevailed. This example shows that under a system of rationing (as well as under the queue system), the difficulties increase with the increase in the elasticity of demand for the rationed product.5
(c) The mixed system. Where prices are introduced, as in a mixed system, the disadvantages of queueing and rationing are somewhat mitigated. Generally, in such cases, the prices are fixed at levels insufficient to balance supply and demand. Nevertheless, the very existence of these prices tends to bring about a certain limitation of demand. What results, therefore, is a mixture of the price system with one or the other of the systems already described. During both World Wars the mixed system, under the names of “ceiling prices” or “price control,” was regularly imposed by the belligerent governments on their respective economies. Experience with this system, however, soon compelled abandonment of the queue-price system in favor of a rationing-price system. For it had become apparent that once the maximum prices were established, the equilibrium mechanism of the price system refused to work. When prices were prevented from rising to the point where supply and demand exactly balanced, a part of demand necessarily remained unsatisfied. The people who were ready to pay the maximum price queued up before the shops, but invariably those at the end of the line went away empty-handed. So intolerable did this situation become that recourse was finally had to a system of ration tickets for a list of selected goods.
Ultimately, of course, the disturbances which price controls provoked on the supply side, required government intervention in production itself. Indeed, during World War II, such intervention was universally practiced. The result was that each day that went by saw a further disappearance of the regulating principles of our economic system, ending in a veritable economic muddle. Following World War I, most countries hastened to put an end to the confusion by reestablishing a free economy, i.e., the unhindered price system. And in the post-World War II era, all advanced countries have sought, and rightfully so, to dismantle the system of wartime controls.
Rent controls, the most durable of the wartime price-ceilings, offer a good example of the evolution we have described, beginning with the queue-plus-price system and ending with the rationing-plus-price system. Our experiences with rent control have shown how intolerable in the long run is the situation created by the mixed system. Even in its less noxious form of prices combined with rationing, the marked inferiority of the mixed system vis-à-vis the price system is obvious. This has been publicly acknowledged even in the Soviet Union where the ending of rationing on certain classes of goods was celebrated as an example of progress on the road leading to a more normal situation.
The thoroughly abnormal circumstances of the Great Depression and later of World War II pushed many countries to new experiments with the mixed system. Thus, exchange control is in reality only a variant of the rationing-plus-price system, as is also the control and distribution by government of imported raw materials. The system of ceiling prices was also revived in the foodstuffs markets both under the form of the queue-plus-price system and the rationing-plus-price system. And here again the consensus was that the mixed system is at best only a temporary expedient. The continued repression of a natural force builds up explosive pressures with the result that the price system in one form or another inevitably breaks through the unnatural tensions and rigidities of the mixed system. The greater the amount of unsatisfied demand, the more numerous will be the subterfuges used to circumvent the maximum prices and the bolder will become the disregard for the law. Black markets, under-the-counter deals, illegal currency transactions—a thousand years’ experience has shown that these things accompany price control as shadows do the light. Such activities, customarily denounced as “fraud,” “smuggling,” etc., appear from the objective standpoint of economics merely as corrections of the mixed system by the price system. From the standpoint of ethics these “corrections” are less than edifying and are certainly not the work of the better members of society. Economically speaking, however, they are not always and necessarily harmful.
The United States’ experience with Prohibition in the pre-war era and in the postwar period the collapse of the command economy in Germany, Austria, and France prove that the maintenance of economic regulations to which the bulk of the population is opposed in conscience ends by exercising a strong demoralizing influence. A sort of respectability is attached to breaking the law. An economic system which continues to function thanks only to bootleggers, black marketeers, and smugglers becomes a focus of corruption which, little by little, poisons all the arteries of society. Here is a bitter lesson for those who continually petition for state control of economic life out of their moral indignation at the workings of the free economy.
All too often we hear a system of rationing being justified on the grounds that the goods in question are in “short supply” and that their distribution ought not to be left to the working of the price system. The reader is already aware that this point of view rests on a fundamental misconception. All goods which are not “free goods” are “scarce goods,” meaning that not everyone can get as much of them as he would like. To say that a “scarce good” is one for which the demand exceeds the supply can have meaning only in relation to a specific price, namely the price which is held by the public authorities below the so-called equilibrium price at which supply and demand are in equality and whose function it is to bring about this equality. Hence, demand can really exceed supply only in those extraordinary situations in which the shortage of essential commodities is so acute that it is considered advisable to ration the available goods equally among the citizens rather than to permit distribution to take place on the basis of the unequally distributed dollars.
Consider, in this connection, the extreme scarcities which prevailed in practically all types of goods during World War II. The plight of the economy is then comparable to that of a besieged fortress whose commander is compelled to ration bread and water with the utmost severity. In such case, everyone will approve the rationing of the vital commodities. But it is extremely doubtful whether this notion of the “besieged fortress” can be validly applied to the economy in peacetime. We should not forget that what we are concerned with in peacetime is not only fair distribution, but an increase in production itself. The dilemma inherent in any system of rationing thus becomes clear: in seeking to distribute the available supply as fairly as possible we run the risk of causing a constant diminishment of the amount available for distribution until, in the end, we get a system of rationed poverty, or “poorhouse socialism.” The more we depart from the situation of the “besieged fortress,” the more necessary it is to recommence production and the more self-defeating, therefore, does a policy of rationing with price control become. Keeping the prices of commodities as low as possible for reasons of social justice discourages their production precisely in the degree to which the price-controlled goods are essential. Such a policy ends by requiring the scarcest goods to be sold at the lowest prices. If the policy is not applied uniformly to all goods and services, it amounts to the conferring of a premium for nonproduction of the very goods most needed. The result is that in countries where such a policy is pursued, the stores are filled with the most nonessential and useless goods, the prices of which, precisely on this account, the authorities have left uncontrolled.
From the above it might assumed that a discussion of the mixed system should be reserved for a chapter on economic pathology. But this assumption would be incorrect. For although it is true that this system, when extensively applied, is dangerous and sometimes fatal, in small doses it is relatively harmless. We find it operative in an astonishingly large number of normal economic processes where it appears inopportune, for one reason or another, to use the price system in its pure form. Railroad, bus, and taxi fares, the prices of theatre and movie tickets, as well as many other prices, are ordinarily rigidly fixed, in spite of daily fluctuations in demand (institutional prices). The consequence is that these prices under certain circumstances fulfill only imperfectly their equilibrium function; such prices, for all practical purposes, become maximum prices, proof of which is seen in the block-long queues in front of movie houses and theatres where a hit show is playing, in the throngs that pack trains and busses, in the desperate mien of some paterfamilias as, homeward bound from vacation with his numerous offspring and equally numerous valises, he stands before the railroad station waving frantically (and vainly) at passing taxis. Even in these cases, there is a tendency for the price system to reassert itself. So we have the perennial ticket scalper, reserved seats on trains and . . . tips. If even these devices fail to correct the disequilibrium in demand, the institutional prices themselves will be changed in the end.
(d) The price system. The systems analyzed so far show so plainly the nature of the price system that a long explanation seems unnecessary. Its principal characteristic is that equilibrium (choice and limitation) is attained by leaving prices free to adapt themselves to the market situation, so that there is neither an excess of unsatisfied demand nor an excess of unabsorbed supply (equilibrium price). In the systems previously described, the question of who will bear the costs is distinct from the question of whose needs will be satisfied. In the price system, these elements are fused. The cost of satisfying a given want is imposed on the demanding individual in the price itself. But, as we have already seen, the existence of costs shows that the factors of production which are used for one purpose might have been used with equal advantage for some other purpose. Thus, the price system allocates the factors of production in a way which allows us to perceive, in broad outline, the process by which general economic equilibrium is attained.
Since, in a free price system, costs are necessarily borne by consumers, it is the consumers who decide what and how much shall be produced. Hence, it is the consumers who decide how the factors of production themselves are to be used. This mechanism functions ideally when not an iota of productive resources is employed in a way which yields less utility than if it were used in some other way. The tying of prices to costs, which many regard as one of the stupid quirks of “capitalism,” thus assumes a function which is central to any economic system, whatever its organization: the function, namely, of effecting the best possible allocation of the nation’s productive resources. This does not in the least imply that our economic system, founded for the most part on the price system, is perfect. For in the price system, only those individual demands count which are backed up by the requisite purchasing power. Even if the price system functioned ideally, the factors of production would be employed in the “best possible” manner only in relation to the existing (and unequal) distribution of income. No one will seriously pretend that our present distribution of income is the best possible. As the result of such unequal distribution a rich cat fancier, to take one example, can buy milk to feed her animals while milk is denied to the mother of a family of poor children because she cannot pay for it. We should not make the mistake of equating the explanation of the price system with a glorification of it, for this would be to fall into the error of the classical school which derived from such explanation premature conclusions with respect to economic policy (laissez-faire liberalism).
When we consider economic history, on the other hand, and in particular the recent history of the Soviet Union, we must conclude that the price system, in spite of all its imperfections and in spite of the situations in which it is inapplicable, remains the most natural method of solving the problem of economic equilibrium. Indeed, its essential irrepressibility is shown in the spectacular failure of the efforts to displace it and to frustrate it. An extremely differentiated society such as our own, resting on an intensive division of labor, is inconceivable outside the framework of the price system. Indeed, if the Communist economic experiment, and the National Socialist economic experiment which so closely resembled it, have proven one thing, it is that the most resolute will to impose collectivism is forced, in the end, to capitulate to the elemental equilibrium forces of the price system.
(e) The system of collective economy. To understand this last of the possible equilibrium systems, we must take account of a group of special needs to which none of the systems of which we have spoken thus far can be applied. Up to now, we have tacitly supposed that we were concerned only with the needs of individuals which are satisfied by an act of individual consumption (individual demand). But there are still other wants which are experienced by the members of society collectively (collective demand), without it being possible to distinguish the specific utility accruing to individuals from the satisfaction thereof. Some familiar examples are the collectively felt wants for armed forces, for a police force, for protection against epidemics, for street lights. The street light is an indivisible good which cannot be distributed individually to those who declare themselves ready to pay their “share” of the cost. Neither can we deny street lights to the general public because some people, such as lovers or burglars, are annoyed by them. It is the business of the state to satisfy these collective demands. It is the state which assumes the task of choosing and of limiting; it must procure the means of meeting costs in a manner which, contrary to the price system, is completely divorced from benefits accruing to individuals as such. The equity of the procedure resides rather in basing the collection of funds for the given collective demand on the ability of individuals to pay (taxation) . All the questions which arise with respect to this collective method of achieving equilibrium belong to the sphere of public finance which is consequently properly studied as part of general economics.6
The system of collective economy frequently finds application in cases where collective needs do not actually exist. Although in these cases the other equilibrium mechanisms could be employed, it is regarded as desirable on various grounds to treat the want in question as a collective want. Bridges and roads, for example, are, as a general rule, paid for on a collective basis out of taxes, although there is no reason why the price system would not work equally well in such cases. For proof, we need only recall the practice, common enough in former times and now revived in some countries, of charging tolls for the use of highways and bridges. It is our modern concern for social justice that has resulted in the placing of many hitherto individual needs in the category of collective needs. Primary education, for example, is today almost universally supplied on a collective basis. Other wants have become partly collective, such as secondary and university education, the cost of which is met for the greater part by the state.
The case of secondary and university education is particularly instructive. For in the degree in which the state assumes the costs, there arises a danger of oversupplying candidates for the professions, unless a method of limiting the admission of students is developed to replace the older ability-to-pay criterion (for example, numerus clausus, or better, a rigorous examination of students’ intellectual aptitudes). Hence, the cheaper higher education becomes, the more necessary it will be to increase the difficulty of examinations.
It should be noted, finally, that a system of complete “Communism” is reached when all needs are treated as collective needs and hence are satisfied in accordance with the system of collective economy (“from everyone according to his capacity, to everyone according to his needs”). The continued enlargement of the collective sector of the national economy, which is characteristic of the economic evolution of the last one hundred years, must therefore be considered as an enlargement of the “Communist” element in our economic system. The continued growth of the public sector (system of collective economy) at the cost of the private sector (price system) must, by the same token, be taken as an indication that an increasing number of economic processes are taking place in accordance with laws radically different from those which regulate the market economy.

Economics of the Free Society

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