Prices of goods and services are related to the quantity of money in circulation divided by the quantity of goods and services.
by M. Rizwan Muzzammil
Why Economics?
It is a reality of life that all resources, be it land, labour or capital, are scarce. This is why economizing is necessary.
In Sri Lanka the shortage of goods and services is in fact indicative of a general shortage of resources in the economy.
To address this problem resources must be increased, and hence the mechanism of economic growth must be understood.
In this essay we will examine the role of the entrepreneur in the context of free-market Capitalism.
Indeed in all economies everywhere it is only by the actions of entrepreneurs that economic growth can take place.
Why Do We Need Entrepreneurs?
Entrepreneurs create businesses that invest in scarce resources. They organize these resources in a way as to create products that society needs.
Entrepreneurs need to know if their investments are growing or shrinking, and the manner in which they determine this is through profit and loss.
When an entrepreneur profits, society is indirectly saying that the business is using scarce resources appropriately. Profit encourages the entrepreneur to continue the business and continue growing resources.
On the other hand, loss suggests the business is wasting scarce resources. Loss forces the entrepreneur to stop business and stop wasting resources.
Through trying to maximize profits, and the trial and error of organizing resources in various ways, entrepreneurs grow scarce resources to the gain of society as a whole.
It is the collective actions of all entrepreneurs that lead to the economic growth of a nation.
The Role of Prices
The entrepreneur's method of organizing scarce resources relies on prices.
In the free-market, prices of scarce resources are arrived at through countless interactions between buyers and sellers.
To understand how this happens it is helpful to visualize the proceedings at an auction.
The auctioneer tries to get the highest price for an item. The price is increased incrementally while the audience bids against each other. This continues until the item is won by the highest bidder.
A price is an important source of information that can signal abundance or scarcity, and whether the resource is easy or difficult to obtain.
It is only with free-market pricing that an entrepreneur can reckon with the true scarcity of resources, and organize such resources in a manner as to grow the economy.
Entrepreneur Calculation and Societal Need
The organizing of resources to create products requires that the entrepreneur calculate profitability.
Consider the situation of an entrepreneur who wants to rent manufacturing space. Is a city or rural location better?
The city has the advantage of shorter distances to retail stores and lower transport costs, but rent is higher. On the other hand a rural location has low rent but high transport costs.
By comparing rents and transport costs, the entrepreneur calculates that the rural location is profitable while the city is not.
From this example we can see how prices play a vital role in ensuring a profitable (resource increasing) business.
But prices also provide valuable information about societal needs. The high city rent is unaffordable for manufacturing. This implies the location is more urgently needed for alternative purposes.
An example of such a purpose could be a hospital which would need city traffic to be profitable.
In summary, prices cause entrepreneurs to organize and grow resources in a way that is harmonious with consumer need. This organizing takes place without any need for a government plan.
Why the Government Acting Against the Free-Market Causes Problems: A Price Gouging Example
When a natural disaster takes place, a supply disruption can happen. In this situation prices can increase sharply.
The sudden increase of prices is sometimes called price gouging. Unfortunately entrepreneurs are vilified for increasing prices. Greed is the popular accusation and government price control is touted as a solution.
However a simple analysis of the free-market shows how price gouging helps society in dealing with a serious problem.
Consider the example of a natural disaster that disrupts water to a town. Entrepreneurs in nearby areas heed the sudden urgent demand for water and direct investment towards its provision.
The supply of water is naturally more costly and carries higher risk due to the installation of temporary piping and use of lorries for transport.
However the higher cost and risk is alleviated with a higher price and profitability, and it is this that encourages entrepreneurs to invest.
A higher profit in particular would attract a greater number of participants. This helps to increase supply and reduce shortage.
Higher prices also dissuade wastage and unnecessary use, such as watering a garden, thus reserving supply for emergencies such as what may be needed at hospitals.
When the government artificially limits price it discourages supply investment and encourages waste and unnecessary use. A persistent shortage would therefore be all the more likely as a result.
In summary the fallout from natural disasters could be quite easily managed if the government simply allowed entrepreneurs to engage with the problem without interference.
Why Free-Market Prices Fall
Entrepreneurs compete against each other to sell more products to the consumer. To gain a competitive advantage they must reduce prices. This can only be done by improving efficiency.
A most striking example of efficiency improvement is in the technology sector where rapid progress has allowed products such as smart phones to become affordable to even the middle-class and poor within only a generation.
However we note that in contemporary economies prices of products are always increasing. This is solely due to money printing by governments. Money printing will be discussed in more detail later in this essay.
Monopolies and Predatory Pricing
A common argument against free-markets is that monopolies are possible. These are alleged to rip off consumers with exhorbitant profits. If competition arises the monopoly uses predatory (loss making) prices to chase them away.
An analysis of free-market dynamics shows us why this situation would be highly unlikely, if not impossible. Let us consider the example of a monopoly which controls 100% of the market and sets prices such that it is able to garner high profits.
The high profits attracts other entrepreneurs. One upstart entrepreneur decides to compete and is able to obtain 1% of the market while 99% remains with the monopoly.
In this situation it is presumed that the monopoly will slash prices and incur losses on a market share of 99%. As may now be obvious from the previous sentence, this would result in a significant loss in resources.
The monopoly that follows this loss making strategy would be financially weakened, and furthermore be less able to overcome the next competitor. Thus it is more likely that the monopoly will accommodate competition and lose market share.
A business can only maintain a monopoly by being as efficient as possible such that profit is at a bare minimum.
A very low-profit margin would discourage competition and allow the monopoly to be left alone.
Thus free-market monopolies, if ever they come about, are always providing consumers the best deal possible.
The Free-Market Saves the Environment
Another beneficiary of efficiency improvement is the environment. More efficiency means less scarce resources need to be extracted from the natural world.
Consider the example of energy production. Early energy was obtained from firewood. This resulted in deforestation which caused significant environmental harm. Firewood was replaced by the more energy dense coal, and later, the relatively cleaner oil. These improvements have gradually reduced the impact to the environment.
In today's world, Thorium based nuclear power technology is available. Despite the misgivings, this technology is extremely safe and has very little impact to the environment.
The Free-Market Punishes Discrimination and Harnesses Greed for Good
The entrepreneur is constantly striving to improve productivity to stave off competition and retain market share.
The employment of an individual for any reason other than merit could result in less productivity. This would create an opportunity for a competitor to capture more market share. Entrepreneurs that discriminate are hence punished with losses or less profits.
Similarly greed can only be sated if efficiencies are improved to serve the consumer. Thus the free-market provides a socially beneficial outlet for greedy entrepreneurs.
Entrepreneurs Make the Consumer Better Off
The entrepreneur sells a product in return for money from consumers. This exchange is always voluntary and there is no coercion involved. Exchanges in this manner can only take place if consumers deem that they are made better off as a result.
Entrepreneurs Make All Things Possible
Entrepreneurs are constantly coordinating with other entrepreneurs to meet consumer needs. This web of interactions between entrepreneurs makes possible the production of even the most complex of products, such as computer chips, aircraft or skyscrapers.
Indeed this coordination takes place without any government involvement. Adam Smith, known as the "Father of Capitalism" described the Capitalist economy as being guided by an "Invisible Hand". This is a metaphor for the unseen forces manifesting from the self-interest of millions of entrepreneurs who, only through freedom to produce and consume, fulfil the interests of society.
Free-Market Capitalism is Orderly, Central Planning is Chaos!
Through free-market pricing and entrepreneurial effort the Capitalist economy is ever resilient and able to roll with the punches. It functions in an orderly and harmonious fashion to steadily improve the well-being of all.
This happens without the need for central planning from politicians or academics. It is strangely ironic that the claim to central planning is that an economy left to its own devices would result in chaos when in fact the opposite is true.
Entrepreneur Activity Respects the Rights of Others
Mutual benefit, voluntarism and non-coercion are key characteristics of free-market Capitalism and entrepreneur activity. Indeed Capitalism is derived from the basic natural rights of life, liberty and property.
However entrepreneurial activity can also take place with the help of occupational licensing, intellectual property, subsidies or other political assistance (Crony Capitalism). This violates freedoms and natural rights, and negates the benefits of true free-market Capitalism.
Sri Lanka’s Revival is Contingent upon Entrepreneurship
The only method by which Sri Lanka can solve the problem of acute resource shortage is through the actions of entrepreneurs.
The removal of the barriers to entrepreneurship must therefore become the priority of all the people and government.
Abandon Laws that Interfere with the Economy
It should now be clear that for entrepreneurship to cause an increase in resources true price information representing reality must be available.
It is unfortunately the case that government laws distort and interfere with accurate pricing. This causes entrepreneurs to miscalculate and waste scarce recourses.
A most significant interference and distortion propagates from the actions of the central bank, which causes instability in the broader economy by virtue of its manipulation of the price and value of money. An example of this is the artificial lowering of interest rates through printing money.
Artificially Lowering Interest Rates Causes Entrepreneur Miscalculation and Recession
A market based interest rate reflects the level of savings in society. High savings result in low interest rates and thus low cost of borrowings. This allows the initiation of large long-term projects (such as a bridge or a dam) that can take years or decades to pay back.
On the other hand low savings (high interest rates) discourages long-term endeavours thereby causing entrepreneurs to focus on small projects able to produce near-term returns and resource increase.
Interest rates are an important economic indicator that guide entrepreneurs into planning projects commensurate with resource availability.
When the central bank artificially lowers interest rates it signals to the economy that more savings are available than in reality.
Entrepreneurs who rely on credit thus unwittingly plan projects that are too large for the economy to sustain.
When such projects get underway, after a period of time, the economy runs out of resources. This causes a recession.
The recession is the natural economic forces trying to heal the economy by expunging unviable projects. Unfortunately the original doomed path taken by entrepreneurs results in a net loss to the resources of a nation.
Printing Money, A Simple Equation to Remember
Prices of goods and services are related to the quantity of money in circulation divided by the quantity of goods and services.
In this equation if the numerator (quantity of money) is increased by money printing then prices of goods and services must also increase.
On the other hand if the denominator (quantity of goods and services) increases then prices of goods and services must decrease.
A sound economy is founded upon sound money that cannot be printed. Economies that use sound money experience continuous price drops as entrepreneurs improve production efficiencies. Sound economies have money that gets stronger with time.
It was mentioned previously in this article that some sectors of the economy (technology) undergo drops in prices. This is because production efficiencies of such sectors outpace the loss in money value.
Some Evil Consequences of Printing Money
Printing money transfers wealth from the general public to government and those nearest to it. The transfer is insidious and illegitimate, taking place gradually over an extended period of time. The public feels this wealth loss when it finds that money does not buy as much as it used to.
Printing money facilitates the expenses of an undisciplined government. Indeed government indiscipline and an accommodative central bank feed off each other to create an unnecessarily large government with greater excess and corruption in the public sector.
Printing Money Stains the Culture and Spirit of Human Society
While the aforesaid consequences of printing money are bad enough, the continued loss of money value over an extended period of time has a particularly damaging impact on human society. A few selected consequences from the literature are presented below.
1. It encourages power to be concentrated in the hands of those who are at the highest levels of government at the expense of other levels. This can manifest in the form of dictatorships or a very powerful elite class.
2. Individuals are discouraged from saving, and encouraged to go into debt. This artificially creates markets for financial institutions and causes society to be financially dependent.
3. When the value of a lifetime of savings disappears into thin air, it can result in significant despair among the older generation affecting their longevity. In the young it eradicates the moral and social standards of thrift by encouraging immediate gratification and living life only in the present.
4. Individuals who are unsuited to investing in financial markets are forced into doing so in order to preserve their wealth.
5. Individuals prolong the phase of their life in which they strive to earn money, and choose careers that place a greater emphasis on monetary returns as opposed to other criteria.
6. Individuals are encouraged to travel for economic reasons while leaving their families behind. Lacking familial restraints, youth easily fall prey to evil temptations and immoral behaviour.
7. Businesses may reduce the quality of product in order to remain viable. This encourages lying as a means to sell a product. In addition, for certain industries such as construction, poor quality can result in a need for constant repair or replacement.
Stop Printing! It's Just Bad Policy
A responsible government will discontinue the policy of printing and look towards backing money with real resources.
Five thousand years of history tells us that gold and silver are convenient for use as sound money. However any valuable physical resource can be used for this purpose.
Cost-Push Inflation is a Myth, Money Printing is to Blame
It is common to blame the overall increase of prices in an economy to the shortage of singular core products, such as oil. This is called cost-push inflation.
While it is true that products very closely linked to the affected core product may see price increases, other products that act as alternatives, or are unrelated to the core product, must see price decreases to offset this effect.
The average prices of goods and services across the entire economy remain the same as long as money supply and overall production remains constant.
Cost-push inflation is therefore a myth. It is an excuse typically used by governments to conceal the impact of money printing.
Inflation and Printing Money are One and the Same
In old (pre 1960s) dictionaries inflation was defined as the printing of money, as opposed to its current definition of price increase of goods and services.
The current definition is a consequence of governments trying to disconnect price increases from central bank money printing. This is done to mystify the problem and divest blame to others, in particular entrepreneurs.
It is shown in this essay why entrepreneurs always strive to lower prices. Thus it must be emphasized that all general price increases in the economy are a direct consequence of central bank action and has nothing to do with businesses.
The Central Bank is Unnecessary
In summary the central bank only harms the economy. Its actions are counter to entrepreneurial business interests and the interests of the general public. A responsible government will consider abandoning central banking in order to solve the resource shortage in the country.
Useful Further Reading
1. How an Economy Grows and Why It Crashes by Peter D. Schiff and Andrew J. Schiff
2. The Ethics of Money Production by Jörg Guido Hülsmann (free internet version available)
3. I, Pencil by Leonard Read (free internet version available)
4. The Law by Frédéric Bastiat (free internet version available)
The author can be emailed at write2rizwan.m@gmail.com
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