Freedom and Economic Order

by Linda C Raeder

  That is only to say that individual income in an extended market order is not, and cannot be, the consequence of any person’s deliberate choice. Any individual’s income in a market economy is ultimately determined, on the contrary, by the impersonal decisions of the millions of people who buy one another’s goods and services. Their aim in purchasing such goods is to satisfy their personal needs and wants. In so doing, however, they unintentionally and simultaneously contribute to the determination of the income of every person involved, directly or indirectly, in producing the goods and services they purchase, persons whose individual identity is largely and necessarily unknown to them.

  Such are the inescapable facts that lead to our previously stated conclusion: no one distributes income in a market economy. The concept of “distribution,” as mentioned, implies a “distributor,” that is, a conscious mind that decides to arrange things in a particular manner. Such is emphatically not the manner in which income is determined in a market economy. No one consciously or deliberately decided to “distribute” billions of dollars a year to Michael Jordan or, say, $15,000 a year to the worker at McDonald’s. Such results follow from the impersonal decisions of all those consumers who chose to purchase goods or services produced by Jordan and McDonald’s. Such consumers are not generally concerned with the basketball player or the fast-food worker but rather with satisfying their personal needs and desires. Indeed, as previously observed, even if their purchases were motivated not by self-interest but rather the altruistic desire to raise the income of particular persons or groups, they could not do so in a complex market order: they have no way of knowing precisely whose income is affected by their purchases. As has been discussed, contemporary market exchange extends across a far-flung global economy. No one can ever know all the particular individuals whose income he is partially determining by his purchases; they may be his neighbors or people living in the most remote regions of the world.

  This aspect of modern market exchange is often difficult to accept, conflicting as it does with a widespread and understandable emotional propensity and yearning. Many if not most people would undoubtedly prefer that their individual purchases, say of cat food, support the income of a deserving and poverty-stricken mother of five rather than a wealthy person of means. Such might be possible in a local village economy, where people can know of individual need and direct their purchases accordingly, but it is impossible in the modern market order that unites people across the world. We have seen that individual participants in modern market exchange have no way of knowing who will ultimately receive the proceeds of their purchases; the items at the local grocery store could have been manufactured anywhere in the United States and indeed almost anywhere in the world. Modern society involves participation in a global economy, and the income derived from most individual purchases is impersonally distributed to the four corners of the earth, beyond the range of conscious knowledge.

  In conclusion, the reason why Michael Jordan is a billionaire and the worker at McDonald’s is relatively poor is that Jordan succeeded in producing goods and services highly valued by millions and millions of people and the fast-food worker did not. Millions of customers have been willing voluntarily to exchange their personal resources for Jordan’s goods and services because they value them at least as much as they value the money they exchanged for them. Jordan obviously possessed talent, creative insight, and the skill to produce goods and services that many people want to possess and with few ready equivalents or substitutes. Not only his personal income but also the income of the numerous individuals he employs is ultimately determined by the value that Jordan’s customers place on the final products he supplies to the market. If customers stopped purchasing his products, Jordan’s income and that of all his employees would fall to zero.

  The same market forces are responsible for determining the income of the McDonald’s worker. The relatively low income of such a worker is a consequence of the fact that other persons do not place a relatively high value on the limited skill he brings to market. The limited skills required for fast-food service are not in great demand and, moreover, in abundant supply (many people possess them). The relatively low demand for fast-food workers, in conjunction with the abundant supply of such unskilled labor, means that the market price offered for their service will be relatively low; ceteris paribus, both decrease in demand and increase in supply lead to reduction in price, including the price of fast-food service. The disparity of income between Michael Jordan and the dishwasher is not the result of anyone’s deliberate choice—any act of “distribution”—but rather the spontaneous and unintended consequence of impersonal market forces.

  For precisely this reason, moreover, one must conclude that the common criticism of income distribution in a market economy—that it is unfair or unjust—is unfounded. It is true that market exchange inevitably results in an unequal distribution of income; some persons will be relatively richer and some relatively poorer. The pattern of income distribution produced by the market process, however, is not the consequence of anyone’s deliberate intention or decision but rather the impersonal choices of market participants in accord with their subjective values. Those persons with skills more highly valued by fellow members of society will earn relatively higher income and those with skills less highly valued will earn relatively lower income. Such an outcome is unintentional, insofar as market participants generally do not and cannot know the effects of their consumption choices on the economic position of particular human beings.

  For that reason—the impersonal and unintentional manner by which income is determined in a market economy—the pattern of distribution that results from market exchange is not and cannot be a matter of justice. Strictly speaking, there is no such entity as a “just society” or an “unjust society.” We have previously discussed in another context the merely nominal character of the term “society.” As we have seen, the abstraction “society” is not a conscious, thinking, willing entity capable of bearing or exercising moral agency. There is no concrete entity called “society,” which is rather a name for an association of individuals united by common values and experiences. Only such individuals bear the capacity for moral agency, for acting justly or unjustly. It is true that careless use of language does commonly lead to a description of society as “just” or “unjust,” but such can only be true in a metaphorical and not a literal sense. Society in itself is incapable of acting justly or unjustly or in any conceivable manner. To speak of a society as “just” or “unjust” can only meaningfully refer to the actions of the individuals comprised by that society. The joint actions of individuals who behave justly may thus be said, loosely and metaphorically, to produce a “just” society. Accordingly, the pattern of income distribution that results from market exchange must be regarded as “just” so long as individual market participants behave justly in conducting their personal economic activity (and “unjust” to the extent they behave unjustly). There is no other possible measure of the justice of an abstract entity such as “society.” We will return to this crucial question—the morality and justice of a market economy—in a following chapter, in which we also examine the justice of planned or collectivized economic organization.

  The Broken Window Fallacy

  The chief difference between sound and unsound economic reasoning may be summarized in two short statements. First, sound economic reasoning considers not only the immediate or short-run effects of a given act or policy but also attempts to trace its long-term consequences; second, it considers the effects of an act or policy not only on one person or group but on all persons and groups in society.[20] Errors in economic reasoning typically stem from failure to consider one or the other of such considerations, errors which can, and do, lead to advocacy of unsound and even irrational economic policy by government officials, academics, journalists, and members of the general public. It is not difficult to understand why human beings are prone to such errors. Human beings are often short-
sighted: our tendency is to perceive that which is immediately before our eyes and that which affects us directly and personally. It takes mental and imaginative effort, on the other hand, to perceive beyond our immediate range of experience, to trace direct and indirect effects on persons other than ourselves, and to consider the longer-term consequences of action.

  Such a common human propensity is classically illustrated by the so-called “Broken Window Fallacy.”[21] The story opens on a sunny afternoon in a major American city. A small group of teenagers stroll along the sidewalk of a busy city street. One of them impulsively throws a rock through the plate-glass window of a tailoring shop; the window shatters and the kids run away. Passers-by soon begin to gather outside the tailor’s shop, expressing indignation at the destructiveness of the teenager’s action. At some point, however, one of them attempts to brighten the mood by suggesting that the seemingly negative situation may actually have a silver lining:

  “Cheer up,” he says to the crowd. “Yes, I agree that the boy should not have acted so recklessly and destructively. But if you think about it, the damage he wrought may, in truth, be a good thing, beneficial to society. The window that was broken must now be replaced and that means the glassmaker down the street will receive an order he would not otherwise have received. His sales will increase and thus his profit. The act of destruction, one might say, is “stimulating the economy’—encouraging economic activity by increasing demand, in this case, for a plate-glass window. The boy’s motivation may have been wrong but he seems inadvertently to have done society a favor. Things may not be as bad as they appear!”

  The passerby’s remarks are comforting but they defy common sense, which regards wanton destruction of property as wrong. Perhaps, however, common sense is not a reliable guide in this instance and the passerby is correct: the teenager’s action will ultimately benefit society as a whole and should thus inspire gratitude, not anger or contempt. Unfortunately, however, such is not the case. The cheerful passerby’s conclusion, which may seem plausible at first glance, is fallacious. Its plausibility derives from the fact that certain elements of the reasoning involved are sound. It is true that the glassmaker will benefit from destruction of the window; he will indeed receive an additional and unexpected order that will increase his sales and income. Contrary to the passerby, however, other members of society have no reason to rejoice, for there is no benefit to society as a whole. The passerby’s judgement is flawed because he fell victim to the common human propensity to perceive only the immediate effects of an act and only its effects on one person or group. A careful analysis of the actual situation, including its long-term effects and effects on all persons involved, confirms the common-sense judgment that reckless destruction is intrinsically undesirable and harmful.

  The passerby’s first error was to consider the effects of the broken window on only one person—the glassmaker. The glassmaker, however, is far from the only person affected by the teenager’s action. Consider, first and foremost, the situation of the tailor. Let us assume that prior to the destruction of his property he was in possession of a plate-glass window and other assets, including, say, $3,000 in savings intended for purchase of a new computer. The teenager broke his window. In the aftermath of the destruction, the tailor’s situation has changed, and for the worse. He still possesses the $3,000 and other assets but no longer the window, which will have to be replaced. Assume for ease of illustration that the replacement cost is about $3,000. Accordingly, the tailor must now spend his $3,000 savings, not to buy a computer as intended but instead to replace the broken window. He will once again possess a window but have lost his $3,000 savings. The rock-thrower’s action certainly brought the tailor no benefit but, on the contrary, an absolute loss equal to the $3,000 cost of replacing the window. He is without question economically worse off than before the incident.

  The tailor, moreover, is not the only person worse off than before the act of destruction. Consider the situation of a second “forgotten man,” namely, the seller of computers.[22] Prior to destruction of his window, the tailor had planned to use his $3,000 savings to purchase a new computer. He can no longer do so because those funds were spent to replace the window. That means the seller of computers has lost a sale that would have occurred if the window had remained intact; his income is consequently lower than it would have been if the destruction had not taken place. The teenager’s action has resulted in the decline not only of the tailor’s economic wellbeing but the computer seller’s as well.

  The passerby’s analysis is flawed because he neglected to consider the effects of the destructive act on all persons involved, the tailor and seller of computers, as well as the glassmaker. Such an error derives from the previously mentioned human propensity to short-sightedness. Everyone sees the broken window right before their eyes and can readily relate it to the glassmaker. It is more difficult, however, to identify the unseen but nevertheless real effects on the tailor and seller of computers. Such requires imaginative effort, tracing the consequences of the teenager’s action beyond the immediate and short-run effects. It further requires consideration not only of the effects on one party—the glassmaker—but on all parties affected, directly or indirectly, by the incident—the tailor and computer seller. The passerby failed in both respects, leading to his erroneous conclusion. Acts of destruction do not and cannot produce net gain for society as a whole; the glassmaker’s gain is offset by the losses of the other two parties involved. In the final analysis, the teenager’s action has at best effected a mere redirection of resources, that is, a redistribution of wealth from the tailor and computer seller to the glassmaker. Destruction of things of real economic value can never produce net benefits for society at large.

  The Broken Window fallacy is classic because it perfectly illustrates the two main causes of faulty economic reasoning, again, the failure to consider both indirect and long-term effects and effects on all persons, not only those immediately impacted by any act or policy. Despite repeated demonstrations of the errors embodied in the fallacy, it nevertheless continues to distort economic reasoning, not merely among the general public but also influential persons such as journalists and politicians.

  A few contemporary examples will demonstrate the stubborn persistence of the fallacy in the public mind. Several years ago a series of hurricanes struck the Palm Beaches in Florida and caused significant damage to personal property such as homes, roofs, cars, and much else. Both common sense and personal experience affirm that such destruction is bad or harmful; any person who experienced damage to his personal property knows quite well he is worse off than prior to the hurricane. Nevertheless, the hurricane destruction brought renewed life to an old fallacy, the Broken Window Fallacy—the idea that acts of destruction can produce net economic benefits for society as a whole. The local newspaper ran an editorial that cheerfully anticipated the economic boom that was sure to follow in the wake of the hurricanes. Readers were reassured that the recent destruction would soon be met by expansive and vigorous economic activity in the Palm Beach community, stimulated by the need to rebuild and repair damaged property. The hurricanes (like the rock thrown through the tailor’s window), they were told, will increase demand, in this case for roofers, glassmakers, debris-removal firms, and a host of construction workers, all of whom will experience a rise in sales and income. The newspaper account did involve an element of truth: such firms and industries do indeed gain from destruction, as did the glassmaker. But it neglected to mention that the gains of construction and allied firms are offset by the real losses experienced by those whose property has been damaged or destroyed and who must pay for needed reconstruction. Hurricane damage produces no net gain to the community as a whole but rather, at best, only a redistribution of wealth from those who suffer the damage to those who repair the damage. Even journalists seem unable to extricate themselves from the tenacious hold of the fallacy.

  Indeed the aftermath of the 9/11 attack on the World Trade Cen
ter in New York City met with a similar response. Newspapers of the period published similarly cheerful editorials anticipating the amazing economic boom that was bound to follow the destruction of the Towers.[23] The act of terror, readers were informed, had a silver lining—the powerful economic stimulus it will provide to the local community. Firms involved in reconstruction will experience an enormous increase in demand for their services, as will individual New Yorkers employed in such trades. The identical argument was made with respect to the German economy in the aftermath of World War II. The wartime destruction of the German infrastructure was said to promise massive economic benefits for industries involved in rebuilding and reconstruction, in particular, American construction firms contracted by the U.S. government for the task. The anticipation of economic benefits was similarly touted in the destruction of the Iraqi infrastructure in the early years of the Iraq war. Such destruction, it was suggested, would benefit the U.S. economy by raising demand for American firms and workers involved in subsequent reconstruction. The Broken Window Fallacy is alive and well to the present day.