The Free Market Economy, Economic Systems, and the Proper Role of Government

Section 01: The Free Market Economy

The economic story of America is one of success. It is a story about the triumph of an idea that changed the world. Imagine you were the prophet Isaiah or Moses, and were shown by the Lord the vista of human future on this planet. What type of change would you see up to the time of the Constitutional Convention (1787) and the Restoration of the Gospel (1830)? It might surprise you to learn that you would see families in Europe and America in 1800 with a standard of living similar to what it was during the life of Christ. Stephen Ambrose points out that in 1805, when Lewis and Clark set out to explore the western part of the North American continent, nothing traveled faster than a horse—not even communication. [1] Almost nothing had been invented. For this reason, the vast majority of Americans worked long hours for nothing more than just enough calories to survive, one set of clothes barely sufficient for protection from the elements, and a small one-room dwelling with a dirt floor and no running water. The American life expectancy was about 36 years.

Imagine if the vision then jumped ahead, just 100 years, to New York City or London. What do you see? If you were actually living before the time of Christ and were having such a vision, you might think the vision had jumped to another planet. After centuries of almost no change in the income of the common man, the world dramatically changed sometime between 1820 and 1830. [2] Before Moses was translated, he prophesied to each of the tribes about their futures. Joseph was to be “separated from his brethren” and be blessed with the “precious things of the earth and the fullness thereof.” They were to have the “chief things of the ancient mountains, and … the precious things of the lasting hills” (Deut. 33:13–17). This blessing has been realized in America with the fulfillment of another ancient prophesy, the establishment of this land as a land of liberty. [3] In this essay we will explore the moral foundation of a free market economy, the basics of how such an economy works, and then some of the actual facts illustrating the effects of the market economy on the American quality of life.

The Moral Foundation

When Edmund Burke tried to warn his colleagues in British government of the difficulty in meddling in the affairs of the American colonists, he emphasized the “free spirit” and enthusiasm for liberty possessed by the colonists. And this spirit of liberty had to be taken seriously because its source was their religion. He argued, “Religion, always a principle of energy, in this new people is no way worn out or impaired; and their mode of professing it is also one main cause of this free spirit. The people are Protestants, and of that kind which is the most adverse to all implicit submission of mind and opinion. This is a persuasion not only favorable to liberty, but built upon it ... The religion most prevalent in our northern colonies is a refinement on the principle of resistance; it is the dissidence of dissent, and the protestantism of the Protestant religion.” [4] Ezra Taft Benson stated “that the principle of supremacy of the individual over government is rooted in religious precept. This is why the founders of our nation were so influenced by the writings of John Locke, who declared that man was naturally in a state of perfect freedom, that he had a right to preservation and property, and that the source of this was God.” [5]

The Importance of Property Rights

The idea at the heart of a free market economy was expressed valiantly in just one part of one sentence of the Declaration of Independence. “Men … are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness.” If men have from God the right to life, it follows that they then have the right to sustain life, and thus have the rights to the fruits of their labors, or in other words, the right to pursue happiness. This is what we mean by the right to property. Modern economists believe that the right to property is the key institution to the establishment of a free market economy. That is, a society establishes a market economy by enforcing property rights. As laws are enacted that infringe upon the right to property, a market economy is replaced by some other system. For this reason, the free market economy can be appropriately labeled the private property order.

That God has given man the right to property is established throughout the scriptures. The 8th Commandment given through Moses, “Thou shalt not steal,” presupposes the existence of private property. In this dispensation the doctrine of the Church reaffirmed the paramount importance of the right to property: “We believe that no government can exist in peace, except such laws are framed and held inviolate as will secure to each individual the free exercise of conscience, the right and control of property, and the protection of life.” [6]

The right to pursue happiness or the right for man to use the fruits of his labors as he sees fit is essential for man to have agency and thus act as a steward over his own property. Elder Marion G. Romney taught that through the right of private property man’s agency is preserved. For this reason, when the city of Zion is built up and we live the law of consecration by entering into the United Order, “the United Order [will be] operated upon the principle of private ownership and individual management.” [7]

Speaking on the moral foundation of a free market economy Ezra Taft Benson taught, “Our governmental system, like the systems of ancient Israel and biblical Christianity, recognizes man as a special creation of God. He is not, as some theorists reason, a product of chance or merely an educated animal. His paternal origin is from God. Thus, man inherently possesses God implanted attributes and potential: reason, free agency, judgment, compassion, initiative, and personal striving for perfection.” [8] Man can only flourish in an environment of freedom where he can act as an agent unto himself in the development of these divine attributes. It is under a governmental system based on “just and holy principles” such as ours, that the “moral agency” of man is protected, so that he may “be accountable for his own sins at the day of judgment.” [9] In an atmosphere of liberty we can be held accountable for the development of these divine gifts.

Return to the course in I-Learn and complete the activity that corresponds with this material.

Section 02: Socialism: An Alternative System

Deviation from a market economy takes place through the violation of private property rights. Under pure socialism, individual ownership and management of property is replaced by state ownership and state or democratic management of property. The agency of man is thus restricted and the opportunity for development along with it. For instance, “Charity, the greatest of godly virtues, would never be possible without property rights, for one cannot give what one does not own.” [10]

“Someone once said: It isn’t that Christianity has been tried and found wanting; it has been tried and found difficult—and abandoned. Perhaps the same thing might be said about freedom.” [11] In countries like the United States that have a relatively free market economy, we often observe behavior among its most successful participants that we find to be deplorable. Take for instance the actions of executives of Enron that were jailed for dishonest business practices. Disparities in wealth, economic depressions, and dishonest business practices often cause people to call into question whether a market economy is truly based on a foundation of “just and holy principles.” However, acts of fraud and theft violate the right to property and must be prosecuted in order for a free market economy to be truly free and to function well. Further, freedom requires responsibility. In order to maintain the blessings of liberty, we must remain moral. [12] Ultimate freedom for individuals and nations come through living the gospel of Jesus Christ. [13]

How a Market Economy Works Compared to Socialism

The most famous of the first European settlers, the Pilgrims, implemented 100 percent pure, unadulterated communism upon their arrival to America. They did this for their first two and half years due to the demands of the settlement’s investors. They were, in effect, forced to put into practice the ideals that Karl Marx would articulate two and a half centuries later—from each according to his ability, to each according to his need. All land and profits were held in common. After the first year, only 53 of the original 102 Pilgrim settlers were still alive to celebrate the first Thanksgiving. According to William Bradford, the Governor of the colony, the common ownership “was found to breed much confusion and discontent and retard much employment that would have been to their benefit and comfort.” During conditions of starvation, each person was deprived of the right to sustain his or her own life as the fruits of labor were taken and distributed to all. The system bred resentment among the settlers who saw the forced redistribution as “injustice.” “And for men’s wives to be commanded to do service for other men, as dressing their meat, washing their clothes, etc., they deemed it a kind of slavery, neither could many husbands well brook it.” [14]

After nearly two and half years of starvation, according to Bradford, “God in His wisdom saw another course fitter for them.” They came up with a new idea that resulted in such abundance that Bradford wrote decades later that “any general want or famine hath not been amongst them since to this day.” In the spring of 1623, “they began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery.” Consistent with their new idea, Bradford “assigned to every family a parcel of land.” Each man was to “trust for themselves.” Doing away with communism by giving to each individual his own property and allowing the farmers to keep the fruits of his labors resulted in abundance. Bradford tells us “This had very good success, for it made all hands very industrious, so as much more corn was planted than otherwise would have been by any means the Governor or any other could use, and saved him a great deal of trouble, and gave for better content. The women now went willingly into the field, and took their little ones with them to set corn; which before would allege weakness and inability; whom to have compelled would have been thought great tyranny and oppression.” [15]

Socialistic systems like the one tried by the Pilgrims for their first couple of years in Massachusetts are sometimes advocated as a “planned economy.” The system of every man owning his own property and thus planning his own affairs is said to be, by the advocates of state planning, too chaotic. Rather than competing with each other, wouldn’t it be better to have the whole community cooperate with each other in some sort of communal relationship where a wise planner orchestrates everyone’s efforts? Bradford made it clear, that by simply giving each man his own property rather than personally directing the economic activities of the settlement, everyone was made “more industrious” and the settlers actually did a better job of tending to each other’s needs. Somehow when each man was able to plan and “trust for themselves,” the results were more affluence, less “discontent,” and even less “confusion.”

How could this be? How could a system where each man is left to plan for himself be more organized and produce more prosperity than a system where a benevolent and wise mastermind plans the whole system for everyone? The answer lies in Adam Smith’s insight into how the price mechanism of a free market economy works. He characterized the market forces of the price system as the invisible hand. In a free market economy, the invisible hand guides each self-interested market participant to act in the interests of others. In order for us to accomplish our goals we must become a business person, professional, or laborer and help others accomplish their goals by providing them with goods and services they want in exchange for money. With the money, we are able to purchase from others the goods and services we need or want.

Like the Pilgrims, each of us is faced with scarcity. Our wants generally outstrip our time and resources. For this reason, we face tradeoffs and must make choices. If a Pilgrim went hunting for deer, he could not at the same time plant corn. If he caught a fish, he could eat the fish or he could use it to fertilize the corn, but he could not do both. Even though we are so much more prosperous today than the pilgrims were in the 1620s, we still face tradeoffs and must make choices. The very act of reading this article has required you to forgo some other activity.

Because we face tradeoffs, every choice we make involves an opportunity cost, which is the value of the best forgone alternative. The Pilgrim that chooses to work hard in the corn field must give up deer hunting. Thus, the opportunity cost of planting corn is the deer he would have shot. For you, the opportunity cost of reading this article is the value of the activity that you gave up to read this article. Perhaps you could be at work right, now earning $20 in the course of time that you spend reading this. If this is the case, the opportunity cost of reading this would be $20.

Society as a whole also faces tradeoffs. The choice of Pilgrims to hunt deer rather than plant corn meant that the Pilgrims would have more deer meat and less corn. Today, since we too are faced with scarcity, if we build more missile factories, less labor and natural resources are available to produce other items, like automobiles or schools. So, without more resources or better technology, any time one industry expands, some other industry must give way.

Return to the course in I-Learn and complete the activity that corresponds with this material.

An Example

To help illustrate the concept of the invisible hand and relate it to the concept of opportunity cost, consider the story of a young entrepreneur who sets out to create an inflatable floating trampoline business. He had an idea to create a large inflatable floating trampoline, about the size of a traditional yard trampoline, that would allow people to paddle the contraption into a lake, and jump on it and off it into the water. It would have rope ladders on the side so that once a person jumped into the water, he or she could climb back on and do it again. The entrepreneur believed that customers would be willing to pay as much as $1000 for such a watercraft. He found in the area where he lived a manufacturer of whitewater rafts that used a material that would be perfect for the manufacture of the large inflatable donut that would comprise the base of the trampoline. After a few calculations, the entrepreneur discovered that he would have to spend over $2000 to purchase the material for just one large inflatable donut. After labor and other parts, the trampoline would cost close to $3000 to build. Obviously, if the entrepreneur was correct about people’s willingness to pay for the trampoline being about $1000, it could not be built and sold at a profit.

Though the entrepreneur only saw a blunt and discouraging message in the profit and loss statement, the invisible hand was actually conveying a very sophisticated message on behalf of millions of market participants throughout the world. You see, the large inflatable trampoline was to be created with scarce resources from all around the world, and the fact that the trampoline could not be produced at a profit implied that society would rather have the scarce resources employed in their alternative pursuits.

Take for instance the rubber material that would go into the inflatable floating base. Because it is scarce, if it is used for large inflatable trampolines, fewer whitewater rafts could be made. The opportunity cost of producing a floating trampoline is fewer whitewater rafts. The invisible hand is communicating to the trampoline manufacturer that the opportunity cost of a floating trampoline is greater than the benefit. Or in other words, the message is that society would rather have whitewater rafts than floating trampolines. This message is communicated to the trampoline manufacturer by the self-interested producer of the rubber material by the fact he sells the rubber to the highest bidder. In order for the trampoline manufacturer to secure some, he must pay at least as much as the whitewater raft manufacturer. Since the entrepreneur was not able to profitably purchase some of the material for the production of a trampoline, the invisible hand was ensuring that the scarce resource be used in the production of the more valuable whitewater rafts.

Just as the invisible hand directs resources to their best use, it coordinates the actions of millions of individuals around the world for the production of even some of the simplest items. For instance, Leonard Reed used the story of the creation of a simple #2 yellow wooden pencil to illustrate the wonders of the free market system. [16] He pointed out that there is not a single person on the face of the earth who knows how to do everything required to make a pencil. When one considers the millions of individuals that each contribute small pieces of know-how to the construction of the pencil, he could not help but be convinced. First there are the cedar trees that are cut in Oregon. Think of the expertise of all those working for the logging company and also the expertise that went into the creation of the heavy equipment used by the logging company. The heavy equipment uses petroleum products. Think of the expertise contributed by millions of individuals around the world to supply the gasoline and oil that the loggers use in their equipment. And this is just scratching the surface of the complexity of supplying the wooden shaft of the pencil. Consider the graphite which comes from mines in Ceylon. There is also the paint which is made from petroleum products from around the world. What is the story behind the piece of metal that holds the eraser? It has its own complicated international history. There is not a single person on the face of the earth which could sit down and write the how-to manual for the creation of the simple yellow wooden pencil. It is too complicated.

Perhaps you will find the following fact to be even more astounding. “Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor any who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on [the] bit of metal nor the president of the company performs his singular task because he wants [a pencil].” Their motivation is something other than a pencil. Each of these millions that participate in the creation of the pencil performs their individual tasks out of self-interest. Each has their own goals, dreams, and desires. After considering the opportunities that they have, each of these millions have decided to participate in the creation of a pencil. Many of them participate without even knowing that they are participating in making a pencil. Some of the participants around the world may not even know what a pencil is.

Perhaps the most astounding fact pertaining to the creation of the pencil is that the millions of individuals that have lent their creativity and know-how to the creation of the pencil did so without any human mastermind. None were forced. There was no body of experts directing or orchestrating the pencil’s creation. Market forces or the “invisible hand” is what is behind the cooperation of millions of people in the creation of the simple wooden yellow pencil. Each of the millions of individuals that contributed a small piece of know-how to the creation of the pencil did so in exchange for some money so that other goods and services, other than a pencil, could be acquired. Because there is no master mind, each individual is able to freely choose whether to contribute his expertise and labor. Rather than being forced, each was acting in his inherent and inalienable right to pursue happiness.

When choosing between economic systems, the choice is sometimes framed as a planned economy or an unplanned economy, but the question really is not whether there should be planning. It is a question of who should plan. Should a mastermind, a state bureaucracy, or elected politicians make decisions about what should be produced, how, and by whom? Or should each individual be able to plan in accordance with his own dreams and goals? The invisible hand makes it clear that it is most beneficial to society for each individual to plan for himself. As each individual makes his own plans in accord with his self-interest, the invisible hand guides the individual to act in the interests of others. If you are to become wealthy in a free market economy, you must come up with a good or service that millions of others are willing to voluntarily give up some of their scarce money for. History has taught that in a system where each is able to plan for himself, the coordinating effects of the market system create more abundance out of the scarcity we are given than the centrally planned alternative.

It is important to understand that the notion that a free market is a system that runs on greed is incorrect. Self-interest is not the same thing as greed: especially unbridled greed rooted in pride. Those that are greedy for wealth and power are generally in favor of legal changes that destroy property rights and markets. We learn in the Book of Mormon that pride leads to secret combinations which lead to legal plunder and the destruction of the rule of law, thus undermining free markets. [17]

Section 03: Market Failures

There are two market failures that are commonly cited as justification for government intervention into the free market. The first is called an externality. In a market transaction, we assume that when two people trade, they receive the entire benefit from the trade and/or bear the entire cost. If I go into a store and buy a loaf of bread for $2.50, the store gets the entire $2.50 and I get the entire loaf of bread. No one else receives a side benefit from that. If, when I purchase the loaf of bread, some third party were to receive half the loaf, I would be less likely to buy the bread because I would be paying the full cost but only receiving half the benefit.

There are some transactions that are like that and they are called externalities. Consider the situation when you go to the doctor to be vaccinated against a communicable disease like the measles. When you receive the vaccine, you only receive part of the total benefit from being vaccinated. There are external benefits because if you do not get the measles then you will not pass that disease on to your neighbors. Many people in the society benefit from you being vaccinated. Economic theory would suggest that if you as an individual have to pay the full cost of the vaccine but you do not receive the full benefit, you may not choose to be vaccinated at the socially optimal level. In this case, the argument goes, the government should step in a pay part of the cost of the vaccine so that the right level of vaccination takes place.

A second market failure is called a public good. A public good is one where once the good is produced its use is non-rival and non-excludable. The loaf of bread mentioned above is obviously rival and excludable–if I buy the loaf of bread, you cannot, and if I buy it, I can keep you from consuming it. A loaf of bread is a private good. What about a good like national defense? Once we produce a missile to protect our population, the fact that it protects me does not prevent it from protecting you (it is non-rival) and it would be very difficult to prevent that missile from protecting a particular person, even if he did not want to help pay for it (it is non-excludable). Notice that even if I did want to be protected, I would have an incentive to not want to help pay for the missile once it is produced because I know that the missile will protect me even if I claim I do not want the protection. This behavior is called being a free-rider.

Economists argue that the government must step in and force people to pay for public goods (through taxation) which they enjoy the benefit of since it is impossible for the market to force people to reveal whether they want the good or not.

In both of these two market failures, there is a limited role for the government to intervene in the market to make sure that the proper level of economic activity takes place.