It seems that the one thing Americans of all political ideologies can agree on is the importance of a solution to the economic uncertainty that has gripped the United States since 2008. Therefore, it is no surprise that we look to the government to get our economy growing again. Unfortunately, our desire to believe that some all-powerful being holds the answers to our problems makes us vulnerable to the fallacy that the government can create prosperity by manipulating of markets. However, any introduction to economics class can tell you that trade, not ‘twists’, creates wealth and prosperity.
One of the first things that economics students learn is that mutually beneficial exchange through markets creates value by tying the pursuit of self interest to the benefit of others. Markets give us the incentive to think, create, innovate, and act such that society benefits without a collective intention. However, this idea that Nobel prize winning economist F.A. Hayek called spontaneous order sounds foreign, unpredictable, and on some levels ridiculous especially when one proposes it as the solution to an economic crisis.
As incomprehensible as a spontaneous order may seem, demonstrating it is easy. Last week I purchased 25 random items from the local dollar store; placed each item in a paper bag, and distributed them randomly to students in Dr. Dirmeyer’s Introduction to Economics class. After receiving a paper bag with an item in it, the students evaluated their new belongings on a scale of 1 to 10 (10 indicating a strong affinity for the item). I recorded the ratings of each item and then permitted the students to trade. The students were allowed to break items into pieces, trade multiple times, or simply choose to keep their original item. After just two minutes of trading, I asked the students to stop and rate their new items on a scale of 1 to 10. After collecting all of the post-trade ratings, not only was the total of all ratings higher than the pre-trading total rating, but also each individual rating was higher (unless a student decided not to trade, in which case his rating stayed the same).
Our classroom “market” created value right before our eyes without collective intention or a central planner. The students pursued their own self interests via mutually beneficial exchange which left everyone better off. Additionally, we got this result without even allowing for the innovation and production that are the usual partners of trade in the real world. If we allowed students to produce items, they would each specialize in the production of, or part of, in an effort to trade for items that others specialized in producing. As students continued to trade, specialize, innovate new products and pursue their self interests the wealth generation process would be endless.
One clever student inquired about the effect of injecting money into our market. What would have happened if we had instituted our own “stimulus” package? I could have decided to hand out $1.00 bills to those who those political representatives deemed them worthy of stimulus funds. As a select few received stimulus funds, they no doubt would be able to buy and trade more. However, without a long-run increase in the ability to produce, $1.00 gifts would only cause prices to rise as sellers raise prices to compensate for the increasing abundance of money. The effects of our stimulus package would end with inflation; once my credit line of $1.00 bills is exhausted, I would be in debt. In order to pay back the debt, I might have to tax trades, require licensing fees or implement other methods of raising revenue, all of which would marginally restrict trade- the creation of wealth.
Hampden-Sydney Economics 101 students know that money cannot create wealth. Even though all of the items in our economy cost exactly $1.00, if I would have just distributed $1.00 bills, no value would have been created since no trade would be mutually beneficial. Money is a means of exchange, not a resource itself. The Economics 101 students were instantly able to see right through the smoke and mirrors of stimulus packages, QE2, or the latest Federal Reserve stunt, operation “twist” all of which attempt to stimulate the economy by manipulating the money supply.
Economic uncertainty is scary, but it is even scarier to let ourselves believe that government can substitute for trade when it comes to creating value. Our simple experiment shows that government intervention is not the answer. Stimulus packages, bail-outs and other rent seeking activities create opportunities for large corporations to leech off the government; even if they stimulate the economy in the short run, only trade will make us better off in the long run.