The economic system. The Free Market
We explained in the last chapter that many previous economic systems have failed to produce human prosperity. Hunting and gathering, subsistence farming, tribal ownership, feudalism, mercantilism, and socialism and communism all ended in failure. The modern welfare state is still living off earlier prosperity, but it is quickly discovering that current tax income falls massively short of promised obligations. The entitlement state is collapsing.
These systems neglected many (and sometimes all) of the factors that matter most for economic growth: the rule of law, private ownership of property, specialization and free trade, economic freedom, and the incentives necessary to create wealth and the hope of reward.
In this chapter, we will discuss various advantages of the free market. But first, what is a free-market system?
A. The free-market system defined
In the previous chapter, we defined a free-market system in this way:
A free market system is one in which economic production and consumption are determined by the free choices of individuals rather than by governments, and this process is grounded in private ownership of the means of production.
In this definition, the phrase “means of production” refers to all the non-human factors that go into making goods and services, such as factories, equipment, agricultural land, and mines. In very simple terms, in a free-market system, people, not the government, own the farms and the businesses. In addition, the people “own” themselves in the sense that they have freedom to choose where to work. The government does not decide where they work (as in slavery or in communism).
By calling this a “free-market system,” we also intend to distinguish it from various undesirable forms of “capitalism” that are really not free-market systems, such as “state capitalism” and “oligarchic capitalism” (explained in chapter 6, 211-15).
But what, then, is the “market” part of a free-market system? Can we define a free market? Economist Murray Rothbard offers this definition: “‘Free market’ is a summary term for an array of exchanges that take place in society. Each exchange is undertaken as a voluntary agreement between two people or between groups of people represented by agents.” He adds that this “array of exchanges” has more complexity: “The market, then, is not simply an array; it is a highly complex, interacting latticework of exchanges. . . . The free market and the free price system make goods from around the world available to consumers.”
Writing from the perspective of a Christian theologian, one of us (Wayne Grudem) elsewhere explains the free market in a similar way, but viewing it as a divinely ordained process that is built into human nature and emphasizing the beneficial results of the entire process of voluntary exchanges:
The free market is a wonderful, God-given process in human societies through which the goods and services that are produced by the society (supply) continually adjust to exactly match the goods and services that are wanted by the society (demand) at each period of time, and through which the society assigns a measurable value to each good and service at each period of time, entirely through the free choices of every individual person in the society rather than through government control.
Another writer, Jay W. Richards, also sees the providential hand of God in the free market:
Rather than despising the market order, Christians should see it as God’s way of providentially governing the actions of billions of free agents in a fallen world. . . . The market is, as [F. A.] Hayek said, “probably the most complex structure in the universe.” It deserves our admiration . . . a stunning example of God’s providence over a fallen world.
The functioning of such a free market is important for the main point of this book, that countries that want to move from poverty toward prosperity must produce more goods and services of value. But how can governments get their people to produce more? Some nations tried to force productivity through slavery, but it did not work. Nations that adopted socialism and communism also tried government planning and compulsion to make people work, but their economies failed miserably.
The genius of a free-market system is that it does not try to compel people to work. It rather leaves people free to choose to work, and it rewards that work by letting people keep the fruits of their labor. In a free market, no government officials have to force people to work. The government simply has to get out of the way and let the free market work all by itself (with some appropriate restraints on crime; see the next section).
The reason that market freedom produces prosperity was explained in 1776 by Adam Smith:
That security which the laws in Great Britain give to every man that he shall enjoy the fruits of his own labour, is alone sufficient to make any country flourish. . . . The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principle, that it is alone, and without any assistance . . . capable of carrying on the society to wealth and prosperity.
Smith’s oft-repeated statement has been demonstrated again and again in subsequent history. In today’s world, there is a strong correlation between economic freedom and prosperity. Those countries that have the highest levels of economic freedom (which can be calculated statistically using at least ten different factors) also have the highest per capita incomes. This can be seen when we plot the countries of the world on a graph comparing their economic freedom with their average per capita income (see Figure 1 following page 192).
The rest of this chapter and the next will explain just how the free market produces such amazing results—or, rather, how the free people in a free market produce such amazing results.