Monday, September 24, 2012

Our Mixed Economy - Capitalism vs Socialism

Here in America we have a mixed economy. We have capitalism in the private sector and socialism in the public sector. In other words...resources are allocated by the invisible hand in the private sector and by the visible hand in the public sector...


In this diagram I've illustrated that the invisible hand determines how $11 trillion dollars are spent in the private sector.  This is also known as a market economy and is best illustrated by Deng Xiaoping.  On the other side I've illustrated that the visible hand determines how more than $3 trillion dollars are spent in the public sector.  This is also known as a command economy and is best illustrated by Mao Zedong.

Deng Xiaoping represents humility while Mao Zedong represents conceit (see The Dialectic of Unintended Consequences). Here's how Hayek described the idea of conceit..."The curious task of economics is to demonstrate to men how little they really know about what they can imagine they can design." The idea of conceit can be traced back to the founder of modern economics...Adam Smith...
The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder. - Adam Smith, 1759
The idea of conceit is much older though.  For example...it was the point of Buddha's parable of the blind men touching different parts of an elephant.  Somebody who suffers from conceit fails to appreciate just how limited their perspective truly is.  As a result...they have no problem resorting to taking rather than solely relying on trading.  Taking forms the basis of the visible hand while trading forms the basis of the invisible hand.

The invisible hand works because it incorporates the perspectives of the individuals who engage in trade.  The buyer wants to purchase a product/service at the lowest possible price while the seller wants to sell a product/service at the highest possible price.  They both want to maximize the return on their labor so they engage in a bargaining process...which incorporates their unique perspectives.  If they can find a price that is worth their labor...then they will trade.

The visible hand does not work because it fails to incorporate the perspectives of all the members in a society.  If I resort to taking your resources...then I prevent you from applying your unique perspective to them.  Here's a diagram I created to help illustrate this concept...


How we use resources depends on our perspectives...which is why our perspectives are our most valuable resource.
When economists say, “We will never run out of resources,” what they often mean is that faced with increasing scarcity of one resource, we will always find new solutions to the problem that that resource originally solved. In an important sense, the actual economic resource was not copper but “the ability to convey voice and data.” And that resource has become “less scarce” by the substitution of sand. This illustrates Simon’s point that the “ultimate resource” is the human ingenuity that finds new and better ways of using physical resources. - Steven Horwitz, Economists and Scarcity
In the past we allowed the perspective of one king to shape the public sector.  Now we allow the perspectives of 538 congresspeople to shape the public sector.  But in the future we will allow the perspectives of millions and millions of taxpayers to shape the public sector.

What will the outcome be of allowing millions and millions of taxpayers to choose which government organizations they give their taxes to?  We can't know the specifics.  All we can know is that wasting limited resources has negative consequences.  Allowing 538 congresspeople to prevent 150 million taxpayers from trading their taxes in the public sector has negative consequences because it partially destroys the perspectives of 150 million of our most productive citizens.

We all understand this concept on the individual level...because we all inherently understand that a mind is a terrible thing to waste.  All the invisible hand says is that, if it's a terrible thing to waste one mind, then it's a catastrophic thing to waste millions of them.  We can avoid this catastrophic waste by allowing the people who labored, toiled and sweated to earn their money to choose which public goods are worth their effort.
If the socialists mean that under extraordinary circumstances, for urgent cases, the state should set aside some resources to assist certain unfortunate people, to help them adjust to changing conditions, we will, of course, agree. This is done now; we desire that it be done better. There is, however, a point on this road that must not be passed; it is the point where governmental foresight would step in to replace individual foresight and thus destroy it. It is quite evident that organized charity would, in this case, do much more permanent harm than temporary good. - Bastiat 
Apparently, then, the legislators and the organizers have received from Heaven an intelligence and virtue that place them beyond and above mankind; if so, let them show their titles to this superiority. - Bastiat 
Thus, considered in themselves, in their own nature, in their normal state, and apart from all abuses, public services are, like private services, purely and simply acts of exchange. - Bastiat
Treat all economic questions from the viewpoint of the consumer, for the interests of the consumer are the interests of the human race. - Bastiat

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