Progress pill
How freedom works

The role of profits and prices

Freedom as a Social Project

The role of profits and prices

  • The two forms of competition
  • The law of supply and demand: nothing other than freedom itself
  • The blindness of centralized planning
  • Everything in economically useful time

The two forms of competition

The history of mankind can be read as a gradual transformation of the ways in which individuals compete with one another. In the earliest ages, competition was exercised principally through war and violence: the seizure of goods and subsistence commodities obtained by hunting, fishing, and gathering. The market was extremely small, and production limited. Since the world is composed of finite resources, some form of competition for them was inevitable. But the real progress of civilization lay in replacing this violent competition with contract and voluntary exchange.
Frédéric Bastiat (1801-1850), the Gascon economist and pamphleteer who compressed more clarity into fewer pages than almost any writer in the history of economics, described this transformation with his customary precision in the Harmonies économiques (1850):
"There are two ways for man to satisfy his wants: production and plunder. Some men work; others wait for the fruit of their labour and then appropriate it by force. This is not an imaginary alternative, constructed for rhetorical effect. It is the fundamental choice that has confronted every human society from the beginning of history. And civilisation is nothing other than the slow, painful, never-completed work of substituting production for plunder."
In other words, the history of civilization is the history of competition itself being civilized: of the transition from violent to contractual competition. This is not a trivial observation; it is the key to understanding why freedom matters economically, not just morally.
Indeed, interventionism and socialism represent a reverse step in this great historical progress. They replace freedom with tutelage and centralized authority, substituting the contract with a return to appropriation through coercion. The resemblance between competition through violence and competition through politics is visible in their effects: the distribution of wealth through violence or through politics redistributes existing resources, but does not increase them. Competition through contract, by contrast, founded on the mutual benefit of the exchanging parties, distributes wealth on the basis of each contributor's merit, while simultaneously increasing the total through the motivation of self-interest.

The law of supply and demand: nothing other than freedom itself

Charles Coquelin (1802-1852), a brilliant economist and contributor to the Dictionnaire de l'économie politique published by Guillaumin in 1852, died prematurely before he could develop the full implications of his work, but left behind articles of remarkable clarity. In his entry on competition, he expressed a fundamental truth that goes to the heart of the liberal understanding of markets:
"The law of supply and demand is not an arbitrary convention, not a rule imposed by economists, not a device invented by theorists for the convenience of their systems. It is simply a description of what happens when free men are left to pursue their own interests in their own ways. Remove that freedom, and you remove the law. You do not replace it with a better law; you replace it with the arbitrary will of whoever holds power."
In other words, the law of supply and demand is nothing other than the functioning of economic freedom itself. Without freedom, this law simply cannot operate. Imagine a citizen receiving ration coupons: he has no possibility of reducing or increasing his demand according to his preferences. Similarly, companies subjected to political production decisions cannot vary their supply according to circumstances.
In a free economy, price plays an essential signaling role. In a vast market with a large population, economic agents need a compass to guide them through production: what to produce, when to produce it, where to produce it, and how. Price provides precisely this crucial information, assigning a value to the various productive combinations and, as it rises or falls, guiding the self-interest of individuals toward the actions that will enable them to achieve maximum satisfaction while meeting the real needs of society.
Bastiat captured this with characteristic elegance:
"The price is not set by the producer, nor by the consumer, nor by any authority between them. It emerges from the encounter of their respective desires and constraints, modified by all the circumstances that affect supply and demand throughout the world. In this price is encoded, implicitly and instantaneously, more information about the state of the world than any ministry of planning could ever hope to assemble."
Profits and interest rates are likewise signals: they indicate where there is need, and where there is not, among the various factors of production.

The blindness of centralized planning

Paul Leroy-Beaulieu (1843-1916), the most eminent economist of the second generation of French liberals, who held the chair of political economy at the Collège de France for decades and edited the Économiste français with tireless energy, anticipated with remarkable foresight the great developments of communism in the 20th century. In his Le Collectivisme (1884), he demonstrated that socialism, by rejecting profit and replacing the price mechanism with a centralized machine directing both production and consumption, was condemning itself to operate in complete darkness:
"The socialist state, having abolished private ownership of capital, finds itself unable to calculate. It knows what it has produced; it cannot know what it should produce. It knows what it has distributed; it cannot know what should be distributed. It is a blind giant, possessed of immense power and incapable of directing it, stumbling through the economy like an elephant through a china shop, destroying in an hour what generations of patient accumulation had built."
In other words, without the price signal, centralized management has no way of knowing real human needs, nor of perceiving the effects of changes in those needs or in the supply of production. This absence of signals makes the failure of centralized production and collectivist distribution inevitable.
The operation of freedom, by contrast, enables production in useful time. High profits encourage new producers to enter the manufacture of a given product; this participation continues until enough producers have stepped in to satisfy the additional demand. The potential or anticipated price signals to all market agents what should be produced, where, and how.

Everything in economically useful time

What is the decisive advantage of the free price system? It is that production is never too early or too late. Leroy-Beaulieu made this point with elegant simplicity:
"When an entrepreneur errs, believing a demand to exist that does not, he loses money. This loss is his punishment and his correction. When he succeeds, believing a demand to exist that does, he earns profit. This profit is his reward and his encouragement. The market teaches, constantly and without mercy, what the world actually needs. No ministry, no commission, no committee of experts can replicate this function, because none of them bears the personal cost of error."
In a system of freedom, we can rely on the self-interest and free will of individuals to seek out new opportunities as best they can. This pursuit of profit naturally involves failures and trial and error, the constant effort to distinguish real opportunities from those that prove disappointing. Interventionism, by contrast, organizes everything according to political signals and electoral imperatives. It produces in politically useful time, with "strategic investments" based on the idea that the state perceives latent needs in society.
Indeed, one may well ask: are these investments yielding profits or losses? If there are profits, it means the market demand is real; if there are losses, the state has misallocated the resources of its taxpayers. The answer is always the same. Political investments generate losses, because they respond to political needs rather than economic ones.
Quiz
Quiz1/5
Why does economic freedom enable production timing that is superior to political intervention according to free market theory?