John Kilcullen
Macquarie University
Copyright 1993,  1996, 1998, 2006, R.J. Kilcullen.


Statement of the Free Enterprise Theory Criticisms of the Free Enterprise Theory

1. Free enterprise
2. The natural law argument
3. The utilitarian argument
4. No paternalism
5. The invisible hand
6. Free trade
7. Price control
8. The labour market
9. Poverty
10. The functions of government

11. The invisible hand
12. Imperfect competition, imperfect information
13. Rent
14. Tariffs; unions
15. Marx
16. Moral ideas
17. Inheritance
18. Incentives
19. Ideology

Postscripts:  1993 (Revival of the Free Enterprise Theory) | 2005 (Revival of the Free Enterprise Theory Continuing) | 2006 (Rudd, "Faith, Values and Politics"; Climate Change)

The best way to understand a demand for freedom is to consider what it is directed against. The free enterprise movement began in the 18th century as a protest against various restrictions on business enterprise imposed by governments and by corporations sanctioned by government. Corporations (guilds, colleges, companies, universities) had existed since Roman times, ostensibly to guarantee their member's good behaviour, and especially good service to the public. But they served their members' interests also at the expense of the public by restricting competition. Non-members were excluded from the trade; to become a member one had to serve a long and low-paid apprenticeship to an established member, and to pay various sums of money (for entry fee, graduation fee, compulsory gifts and banquets, etc.). Government sanctioned these practices, and imposed restrictions of its own, ostensibly in the public interest, but also to raise revenue and to provide fees and bribes for officials: the guild had to pay for its monopoly. Viewed cynically, government was an ancient and successful branch of organised crime, a respectable protection racket.

Not only domestic but also foreign trade was subject to such interference. Guilds such as the East India Company monopolised various branches of foreign trade, backed by the navy and the customs service. Colonists were restricted in many ways in the interest of industry in the home country. Government justified its policies as means of fostering the nation's industries and thereby increasing national power. The aim was self-sufficiency, to import little and export much. The unacknowledged by-product was violence and corruption: members of the East India Company by questionable means made great fortunes with which they bought political influence; positions in the customs service were treated as 'spoils' in a system of political patronage.


1. Free enterprise was the slogan of outsiders disadvantaged by these restrictions. They demanded:

  1. That anyone should be free to set up a business enterprise of any sort, without having to serve an apprenticeship or become a member of a guild or get anyone's permission.

  2. That people should be free to run their businesses in their own way, unhampered by guild or government regulations about treatment of employees, hours of work, location and type of premises etc.
  3. That anyone should be free to trade with anyone else anywhere in the world on whatever terms the parties concerned agree upon, without price or quality controls.

These points can be summed up as freedom of contract: people should be free to make and carry out contracts with anyone they please on whatever terms the parties concerned find mutually acceptable: if the agreement is voluntary (no force or deception), then no-one else should interfere; people should not be compelled to part with what is theirs for less than they think it is worth, others should not be prevented from offering as much as they think it is worth. Freedom of contract implies point (3) above; it also implies (1), since setting up in business simply means making and carrying out contracts, and if members of the public are free to deal with anyone they please, then anyone is free to offer to deal with the public; it implies (2), since employment and the use of premises are a matter of contract.

Another summarising concept is property. People can use their property as they please, no one else can use it without their consent, they can part with it on whatever terms they like, and no one can make them part with it against their will (that is, can rightly, without injustice). Liberal writers included in property not only things but also a person's power to perform services for others: people cannot rightly be prevented from doing services on whatever terms they like, or be made to do it for less. If they are compelled in that way, then they are to that extent slaves, and no human being ought to be a slave; personal freedom thus implies freedom of contract with respect to services, and the notion of property was extended accordingly.

To protect property in this extended sense is one of the main functions of government according to writers in this tradition: that is, to prevent the exaction of involuntary service and the use or taking of property without the owner's consent, and to enforce contracts (since one way of getting property without consent is to obtain it in exchange for a service yet to be done and then default).

2. The Natural Law Argument

One type of argument for the theory outlined above was in terms of the natural right to property. 'Natural law' meant, in effect, morality: a set of rights and duties independent of laws enacted by government ('positive' law) and of social custom, in terms of which positive law and custom could be evaluated as morally right and just or the opposite. A person has certain 'natural' rights to property, it was argued, which positive law and custom ought to respect.

The most influential writer on the natural right to property was John Locke; see Chapter 5 'Of Property' in his Second Treatise of Government (Readings). Locke based property in things on individuals' property in themselves and in their own labour (i.e. on personal freedom). If I plough a field or make an artefact I mix my own labour with it, and it thereby becomes my property. In some cases the labour is minimal, merely the labour of appropriating (e.g. of picking up acorns in the woods), but this is enough to establish property in the thing. The extent of the right to property differs before and after the invention of money. Before money the right to appropriate is limited by the proviso that a person should not appropriate so much that it cannot be used before it spoils. If a person farms so much land that the produce rots before it can be used, then the farm is larger than anyone has a right to. The invention of money removes this limit; produce that would otherwise have gone to waste can be converted into durable money.

Locke's theory is in many ways open to criticism, but it articulates a widely shared belief that it is wrong to take things that another person has worked on, or appropriated from an originally common stock -- e.g. to take food from the plate of another member of the family, or to take acorns picked up by another member of the tribe. If there is uncultivated land left, it is wrong to move on to land others have cultivated; this would be an attempt to appropriate their labour, and make them to that extent slaves.

3. The Utilitarian Argument

During the 18th century it became popular to judge institutions (including rules of morality) by their usefulness in advancing the happiness of mankind in general. 'Utilitarianism' (Jeremy Bentham, James Mill, J.S. Mill, etc.) is the doctrine that actions, rules or institutions are to be evaluated morally (as right, good, just etc.) by considering their effects on human happiness, each person's happiness counting as equally important (no special weight being given to oneself or one's friends or any social class). The Utilitarian argument for property is as follows (see James Mill, An Essay on Government, section 1). Civilisation, even mere survival, depends upon productive labour. Slavery is inefficient; so is reliance (to any great extent) on the sense of duty or the desire for praise, since in most people these are weak motives. The best way to encourage productive labour is to make it a rule that whatever people produce is their own property, to use exclusively or share or exchange as they like. Since land is more productive if privately owned, and since encouragement is needed not only for manual work but also for thought and exploration, it is useful to recognise property in land, in ideas (patents, copyright), in discoveries (mining rights), and so on. The exact nature and extent of property rights are to be determined by considering the usefulness to mankind generally of the various possible codes of rules. However, existing rules should not be changed suddenly and without compensation so as to abolish any 'vested' right, i.e. a positive right recognised for some time so that people have planned on its continuance; respect for long-established rules is useful because it encourages long-term planning. So the utilitarian argument for respecting property rights (in some form or other adapted to the social circumstances) is that the happiness of mankind generally will be greater if people can work and plan with some assurance that they will enjoy the fruits of their labour; property is a useful incentive.

4. No Paternalism

Many Utilitarians (notably Jeremy Bentham, and J.S. Mill On Liberty) have argued that generally individuals know their own interests better that anyone else can, and care about them more; others who profess concern for someone's interests may in fact be trying to further their own -- probably will be, given the strength of self-interest. So generally people should not be controlled by others 'for their own good'. The happiness of mankind is best served by leaving people free to care for their own interests, provided they carry out certain minimal duties to others. Freedom of contract is a corollary: provided minimal duties to others are met, people should be free to make whatever contracts they like. If a paternalistic government, for example, interferes with labour contracts for the workers' good, the paternalism will probably be a disguise for the self-interest of politicians and officials; and in any case, no one knows or cares about the workers' good as much as they do themselves.

5. The Invisible Hand

When property-owning individuals compete in offers of exchange they form a market. The paradigm is a market place where buyers and sellers meet in person and go from one to another haggling for the best deal; other arrangements are called markets by analogy with this. In so far as productive activity aims at producing things to exchange in a market the society has a market economy. A 'free' market is one in which there is freedom of contract.

Starting from the theories of Adam Smith (An Inquiry into the Nature and Causes of the Wealth of Nations, 1776), 'Political Economists' argued that a free market economy moves toward --

  1. increased production,

  2. a correspondence between what is produced (so much food, so much housing, etc.) and what people really want in order of urgency, and
  3. equitable distribution.

These are just the goals that an intelligent and benevolent central planner would aim at, but there is no need for a central planner. In fact central planning by government does more harm than good: government is not benevolent (generally speaking politicians and officials like other people are self-interested), and it is impossible or too costly to centralise all the necessary intelligence about needs and resources. Individuals know (imperfectly, but better than anyone else can) their own needs and resources, and self-interest is generally a stronger motive than benevolence. But if individuals are free to seek their own goals through the market, it will be as if an 'invisible hand' guided their self-interested and apparently uncoordinated activities towards the goals which a benevolent super-human intelligence would seek.

(Compare Darwinian biology, which was influenced by the ideas of Political Economists: the blind struggle for survival leads to an appearance of design, as if nature were the work of a divine intelligence. Since Adam Smith, many thinkers in various fields have been interested in 'unintended consequences' (sometimes good consequences, as here, sometimes bad) which may look like design, but happen without, or even against, the will of the individuals acting.).

According the Free Enterprise theorists, the unintended good consequences of self-interested behaviour in a free market economy can be analysed as follows:

(1) Increased production. Exchange makes possible a division of labour (specialisation). This increases production, because people will specialise in what they can do well, and will get better with practise; it will be worth their while to invest in special tools and other means of increased production (e.g. a specialist miller might have a dam and water mill built, which no one would do if each family made its own flour). If individuals, or families, or nations, are self-sufficient, division of labour is correspondingly limited; the wider the market, the more productive labour will become. Competition encourages and even compels specialisation: the producer who carries specialisation a little further can undercut other sellers.

(2) Correspondence between production and wants. It is not possible to satisfy completely everyone's wants. Some order of priorities must be established, and scarce supplies must be 'rationed out' to those who need them most. A central planner would have to be guided by what people said they wanted (perhaps untruthfully), and would have to compare impartially the wants of different people. In a free market economy the urgency of a want is measured objectively by 'willingness to pay', i.e. by how much effort a person is prepared to make and what other wants he or she is willing to sacrifice to get this want satisfied. How much purchasing power people have depends on how much well-directed effort they make to supply what others want, and it is allocated in a way that reflects willingness to go without one thing for another. Individuals set their own personal order of priorities in deciding how much of each thing to buy as prices fluctuate. If someone is willing to pay more for A, leaving less for B, C, D etc., then he or she must want A more urgently. Now suppose more people want a certain item at the current price than can find one to buy; some of these people would want that item even at a higher price; so they offer the higher price, and sellers seeking the best deal sell to them. So the scarce item is automatically 'rationed' according to need: those who want it most get it, and others satisfy some other want instead. Meanwhile, the higher price motivates producers to divert labour and resources to bring more of that item into the market. Then the price will fall again (perhaps not as low as the earlier level), some less urgent buyers will be satisfied, and sellers' profits will fall to the average level. Exceptional profits are temporary, a signal that there is an unmet need, and a reward to those quickest to notice the need and to respond effectively. Conversely, if more is for sale than buyers think worth having at the current price, the price will fall, less will be brought to market, and labour and resources will be freed for producing something wanted more urgently. The price mechanism adjusts the allocation of resources to need.

(If it is objected that wants are often artificial, induced by advertising, the free enterpriser will reply that this objection is paternalistic: if people act on a certain want, it is presumption (and probably hypocrisy) for others to say that they do not really want it, or that it is not good for them).

(3) Equity. Adam Smith and his school held a 'labour theory of value'. On this theory long-term prices in a free market economy represent the amount of productive labour each commodity requires; our income represents the amount of our labour that others find useful, and things cost us the equivalent of the labour they require to produce. Thus distribution is equitable, in proportion to well-directed effort contributed. Yet because of the greater productivity of specialised labour, we all get a great deal more than our individual labour could produce if we tried to be self-sufficient.

The labour theory of value was persuasively explained by Frederic Bastiat (Les Harmonies economiques, 1850; tr. W. Hayden Boyers (HB163.B3312) p.99f, p.284f). Suppose I live at a distance from the water supply, and suppose someone offers to bring me water at a price; the upper limit to the value I will put on this service is set by the amount of labour it will save me - if the water carrier's price is too high I will get the water for myself. The labour it saves I can devote to productive work; the upper limit to the value others will put on my services is set by the labour I save them. As long as the water carrier's price is no higher than what others will pay me for an equivalent amount of my labour, it is worth my while to pay for water; otherwise I will get it for myself. Competition, and the attempt to get the most for one's labour, brings prices generally into line with the amounts of productive labour required. The value of all other factors of production is reducible to labour; if the water carrier uses a cart, the cart costs the equivalent of the labour required to make it, to prepare the materials required, to cut down trees or mine the metal, and so on. According to Bastiat, no charge can be exacted for the 'gifts of god'; if the water carrier tries to charge me for the water as well as for the labour of bringing it, I will get free water from somewhere else (e.g. rain). One's own labour on free materials can always be substituted for something bought from others.

On the labour theory of value our purchasing power is proportional to the service we render others, which seems equitable. Later economists held that other factors of production besides labour generate income. Their owner's right to payment is just as good: assuming that they are rightful owners, they cannot be expected to part with their property without an equivalent in exchange. People's shares are proportional to their sacrifices in foregoing either leisure (i.e. by performing labour) or the use of some thing that is theirs.

So much for increased production, adaptation to need, and equity. There are certain things the 'invisible hand' cannot be relied on to achieve, which free enterprise theorists add to the legitimate agenda of governments. First, full employment. J.M. Keynes showed that there is no automatic mechanism to ensure that everything saved will be invested. People do not save only for the purpose of immediate investment. So it may happen that some income is not being spent; and since other persons' incomes come from what this person spends, other incomes will then fall, expenditure will fall further, and so on in a downward spiral to depression -- with no forces to counter the movement, except action by government. Second, the maintenance of competition. The free market does not automatically move toward the three goals discussed earlier unless there are many buyers and many sellers competing. However there is a trend toward monopoly (one seller), monopsony (one buyer), oligopoly (just a few sellers) and oligopsony: competitors band together in various ways. Consequently, government action is needed against trusts, pricing agreements and other restrictive trade practices, to restore and preserve competition. Third, there are sometimes costs in a certain production process, such as air pollution, which fall outside the market ('externalities' or 'spillover' effects). Government must find some way to impose these costs on the sellers or buyers of the product, or more of it will be produced than is justified by the criterion of willingness to pay, and some costs will be imposed on some people against their will, in violation of their property rights.

6. Free Trade

Adam Smith, Cobden, Bastiat and others campaigned strongly against government restrictions on international trade. There are arguments in terms of rights: If governments use guns and bayonets to keep apart parties willing to exchange and restrict them to exchanges they would not otherwise make, there is a violation of freedom of contract. If property cannot be exchanged on the most profitable terms, part of its value is destroyed. When protected industries charge higher prices, it is as if government levied a tax on consumers and handed it over to private interests. Import restrictions destroy part of the value of property meant for export, since if foreigners are prevented from selling to us they will not be able to buy from us. In short, restrictions reduce the value of some people's property to increase the value of others', and this is disguised theft.

Tariff barriers are a legalised conspiracy not only against consumers in the 'protected' country but also against people in other countries whose right to exchange is violated. This right is especially valuable to the people of poor countries, who may not be able to survive without it. There is a right of capital to migrate to low-wage countries: 'free enterprise' implies that owners of capital should be free to set up business where they like and that workers in low-wage countries should be free to make whatever contracts they like. This is the way workers in underdeveloped countries enter the international market, so capital's right is their right also.

Besides arguments in terms of rights, there are economic arguments. To export much and import little is impracticable. Imports must in the long run equal exports; if exports exceed the result will be inflation, which will encourage imports and price exports out of foreign markets and so re-establish equality. National self-sufficiency restricts the development of the division of labour, which hurts everybody, including the country practising a nationalistic policy. Free trade widens markets and enables specialisation to be carried further. Each country does better to specialise in the things it does best (e.g. because of climate, natural resources, culture), and import other things, from some country which specialises in those. Such inter-dependence is, incidentally, a guarantee of peace.

The idea that a country should specialise in what it does best is worth closer attention. 'Best' means not in comparison with other countries, but in comparison with the other things this country can do. Some backward countries may not do anything best in comparison with other countries, but there are always some things they do better than the other things they do. They will get the chance to specialise in their best thing if international trade is free. Suppose country A produces a unit of food with half the labour it needs to produce a unit of clothing, and suppose in B it is the other way round. Then if A specialises in food and B in clothing and they trade, each will satisfy its needs for food and clothing with less labour and both will be better off, though perhaps not equally. This is true even if one is much less productive than the other even at what it does best. E.g. suppose in B it takes more labour to produce clothing than it does in A; still A will get its clothing with less labour if it works to produce food to exchange for B's clothing -- it will produce the food needed for exchange with less labour than it could produce the clothing for itself. This means that advanced countries may have a reason to import even from absolutely less productive countries. Thus even backward countries can find a niche in international trade and benefit from it (country B gets its food in exchange for clothing produced with less labour than it would need to produce food for itself). The benefit may not be equal (that depends on how much more productive each is in its speciality than it is in the commodity), but both will benefit. Even if trade leads to a 'widening gap', the worse-off country is better off than it would be without trade, and there is no injustice if the exchange is voluntary.

The same analysis applies to individuals.

Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats, he can only exceed his competition by one-fifth, and in making shoes he can excel him by one-third; will it not be for the interest of both, that the superior man should employ himself in making shoes, and the inferior man in making hats? (Ricardo, Principles (Penguin) p.154).

Even people who are not much good at anything can find a place in the market economy, and get in exchange more than they could ever produce for themselves (though there may be a 'widening gap').

International trade, like other exchange, is of mutual benefit to all parties; it is not the case that if one does well the others must be worse off. Countries (and individuals) have an interest in the efficiency of their trading partners: the more efficient these partners are the less they need (and in the long run, can) demand in return for their products; competition ensures that the benefits of efficiency are passed to consumers in all countries and this increases real incomes. Thus it is not in any country's or individual's interest to do anything to raise barriers against or otherwise injure the efficiency of another's industry. 'Buy Australian' is bad advice; the best policy is to buy best value, wherever it comes from.

7. Price Control

Price control has a long history: Diocletian's edict on prices, medieval prohibitions on speculation and profiteering (e.g. in corn in time of famine) and on usury, the French Revolution 'law of the maximum'. If the price is fixed below the market a 'black market' will develop, and police action will be needed to repress it; holders of the commodity will hoard it in the hope that price control will be abandoned, so the police will have to find out who holds it and compel them to sell; if the item is scarce (and otherwise price control is pointless) some sort of rationing is needed and someone must assess needs; in the long run compulsory allocation of labour and productive resources is needed, or production of the controlled item will fall. So price control leads to manifold invasions of freedom, privacy and property rights.

The early liberal political economists argued that even in times of famine dealers should be allowed to charge as much as they could get (e.g. service stations should be free to raise prices during a petrol shortage), because this would encourage speculation, which is a good thing. A speculator tries to predict future shortages and buys where there is plenty intending to make a profit when the price goes up. This is a public service (unintended, motivated by self-interest): by buying when there is plenty the speculator prevents the price falling as low as it otherwise would, which keeps production up and alleviates the shortage when it comes; speculators bring their own hoard into the market when it is needed most urgently, and supply it to those who need it most (need being measured by the objective criterion, willingness to pay). Price control directed against speculators makes famines worse, and wastes the scarce supply by pricing it so that some is bought by people who would not think it worth having at a higher price. Similar arguments justify the slow extraction and high pricing of natural resources (e.g. by OPEC). Similarly laws against usury reduce future production by discouraging savings and lending, and rent controls lead to shortage of accommodation. In general, price controls reduce responsiveness to need, make shortages worse, and discourage the development of other supplies and substitute products. So well-intentioned efforts to improve the condition of the poor may have unintended consequences harmful to the poor.

8. The Labour Market

'Labour is a commodity like every other', 'an article of trade' (Edmund Burke, Thoughts on Scarcity (1795). 'Property' includes the labourers' right to sell their services, 'freedom of contract' includes their and the employers' right to make whatever terms both parties find acceptable, without interference from others. People become employees because they think that it is in their interest to work for someone else: their own land is less fertile or their tools are less effective, they may be better at working than at planning or selling; in any case, their motive is a belief that they can get more in wages than by working for themselves. Employers take them on because they believe they can make more by selling what the worker produces than the wage will cost. So employer and employee both judge that they will be better off, and there is no reason why anyone else should override their judgement concerning their own interests: freedom of contract should prevail.

A contract may be made with an association of workers bargaining as a unit, but this is not what 'collective bargaining' usually means. Unionists do not merely 'withdraw their labour' when the bargain is not acceptable; they prevent others from accepting it (by picketing, intimidation of strike-breakers, retaliation against scabs etc.). This violates other workers' property in their own capacity to work, and their freedom of contract. If unions or government make an employer pay workers more than the employer thinks they are worth, 'what is this but to make an arbitrary division of his property among them?' (Burke).

If there is no compulsion to employ a particular number, then a compulsory minimum wage restricts not the employer but the workers: it forbids them to accept less than the set minimum wage. This means unemployment for less productive workers (the inexperienced, the handicapped etc.); employers will not take workers on unless they expect the worker's product to be worth more than the wage. If less productive workers were free to accept lower wages, the employer would add them to the workforce. Some people would prefer lower wages to unemployment, but a compulsory minimum denies them this choice. The employed are also worse off: the community is denied the services of less productive people, and must support them in idleness out of taxes or charity.

Unions sometimes compel an employer to agree to employ a certain number of workers, or to undertake to pay substantial sums upon retrenchment. This protects the jobs of present workers, but employers will free themselves from this burden by substituting machinery and not replacing workers as they die or retire: this generation of workers may go through life with a secure job, but the job is abolished behind them. If as a result their children cannot get jobs (their unemployment being disguised perhaps as longer education), they will have support them for longer, and they may be no better off overall. Meanwhile the price of their product is kept above what it would be if the labour market were free. The arrangement is like a tariff, a conspiracy against the rest of the community, against consumers and the less productive workers.

In a free market economy undistorted by minimum wage rates and job-security provisions, labour-saving machinery will not be introduced unless it reduces the cost of production, which will eventually (through competition among producers) reduce the price to the consumers: the larger profits are temporary, a reward for entrepreneurs who find more economical methods of production. Workers displaced are temporarily disadvantaged, but other entrepreneurs are looking for new ways of using idle workers and they will eventually get jobs again, and benefit as consumers from the lower cost of what they produce. Machinery sets labour free for other uses, and in the long run everyone benefits from increased productivity. The same goes for other causes of temporary unemployment, for example, amalgamation of firms. If it is cheaper to do something on a large scale small firms will go out of business and some people will be out of work. But then new kinds of small business will spring up, providing new kinds of services for which the resources were not previously available; old needs are met more economically, and something can be done about needs formerly neglected, and the standard of living rises.

It is sometimes said that poor countries, or the unemployed of this country, need labour-intensive industry. But this is just waste if there are more productive methods, waste which reduces what is available to meet real needs. To put people to work even with primitive equipment costs something more than to keep them alive at the same living standard in idleness; it may be cheaper to send most people off to the beach while a few use the most productive methods than to set them all to work with primitive means. In a free market economy the few will be volunteers who prefer the money to leisure -- and the many will also be volunteers who prefer leisure.

In general, union action (and government action by politicians seeking union support) to enforce minimum wages and to prevent the introduction of new technology is a violation of property rights leading to unemployment, migration of capital, or higher prices -- short sighted selfishness, ultimately self-defeating. This is true of all the things unions do. They can pursue their objects only by some sort or coercion (picketing, closed shop, intimidation etc.) which violates freedom of contract and causes disorder. According to free enterprise theorists unions ought to be illegal as they were in the early 19th century, only they have so much power they have to be tolerated.

9. Poverty

As Jeremy Bentham remarked, poverty is the original condition of the human race. Free exchange encourages division of labour which increases productivity, and some people may advance out of the original poverty. This is no injustice to those who do not, provided the relation between the two groups is one of genuinely free exchange and not spoliation. Even if a gap between rich and poor opens up and widens, free exchange benefits even the poor: there is always something they can exchange, and they will get more than they could have got in self-sufficient isolation (see above, part 6).

The questions which the workman ought to ask himself are not, "Does my labour give me much? Does it give me little? Does it give me as much as it gives to another? Does it give me what I desire?" The questions he should ask himself are these: "Does my labour give me less because I employ it in the service of the capitalist? Would it give me more if I worked in a state of isolation, or if I associated my labour with that of other workmen as destitute as myself? I am ill situated, but would I be better off were there no such thing as capital in the world? If the part which I obtain in consequence of my arrangement with capital is greater than what I would obtain without that arrangement, what reason have I to complain?" (Bastiat)

According to the early Political Economists (after Malthus) the chief enemy of progress is population increase. For a given state of technology, productivity per person and average living standard diminishes as population increases: twice the agricultural population will not produce twice as much food, unless technology improves (and this cannot be counted on). They suggested that the poor should be encouraged to aspire to a more comfortable life and to spend any surplus on non-necessaries; this will given them a motive to restrict the number of their children (to maintain their new comfort), and the non-necessaries can be temporarily dispensed with if conditions temporarily worsen, constituting a buffer against actual starvation. To discover and demonstrate a more comfortable life-style is an unintended service the rich do for the poor. Well-intended charity (e.g. to underdeveloped countries) may merely do harm by encouraging population increase (see G. Hardin, 'Living on a Lifeboat', Bioscience 24 (1974) p.561-8 (QH1.A277), and his Limits of Altruism (BF637H4.H37), and see here; and J.S. Mill, Principles of Political Economy, Bk.II chs. 11-13 (B1602.A2Vol.2)).

Charity and government welfare services are needed and morally justified to secure a decent life for those who through no fault of their own cannot work (the sick, the aged, the handicapped etc.). However, it is a violation of tax-payers' property rights if charity or welfare goes to people who could work. It is also necessary to watch for unintended consequences - population increase, irresponsibility etc. One important consequence may be an ever-increasing burden on productive labour. Taxation reduces the rewards of work; some will work less, or drop out of the workforce and seek welfare support; fewer workers supporting more on welfare must pay still more tax; and so on. This was the fear behind the New Poor Law of 1834, and it recurs in various forms.

10. The Functions of Government

The free enterprise movement stands for private enterprise, the principle that businesses should be owned and controlled by private persons and not by government. When government interferes actively in economic life there are too many opportunities for corrupt alliances between politicians and officials and other to fleece the public (tariffs, monopolies, subsidies, etc.) Further, freedom is threatened by concentration of power.

A liberal is fundamentally fearful of concentrated power. His objective is to preserve the maximum degree of freedom for each individual separately that is compatible with one man's freedom not interfering with other men's freedom. He believes that this objective requires that power be dispersed. He is suspicious of assigning to government any functions that can be performed through the market, both because this substitutes coercion for voluntary co-operation in the area in question and because, by giving government an increased role, it threatens freedom in other areas. Milton Friedman, Capitalism and Freedom (HB501.f7), p.39.

If the same people control police, army and employment prospects, dissent is too easily repressed.

There are other arguments in terms of efficiency. The 'invisible hand' is a better organiser than government. In a private enterprise economy there are indefinitely many centres of independent initiative: anyone who thinks he or she has a good idea can start a business and try it on the market; if it serves a genuine need, and people are willing to pay what it costs, and no competitor can do it more efficiently, then the business survives and prospers; otherwise it fails. Compare Darwinian biology: new variants constantly arise and are subjected to natural selection; in a private enterprise economy initiatives are like variants, and competition is like natural selection. Bureaucrats in government service, on the other hand, have secure jobs, and promotion depends not on the impersonal market but on personal relationships with superiors; the organisation is centralised, and initiative is hampered and discouraged by the need to get the approval of superiors. An established government enterprise will survive if it suits politicians and officials - it can always get subsidies and protection against competition; so there is no guarantee that people will really want what government supplies, or want it urgently enough to justify what it costs in terms of other things done without. So in the government sector there are fewer new ideas and selection is less rigorously controlled by objective criteria of need.

Comparisons are sometimes made between electoral politics and the market (cf. J. Schumpeter, Capitalism, Socialism and Democracy (HX86.S33) Ch.XXII): parties 'sell' policies in competition for electors' votes, in the market consumers 'vote' for a product by buying it. But the market does better in adjusting production to individual needs. If the majority values something then that is what the minority gets too, in politics; but the market caters to minority and even individual preference. To win power a political party needs a majority, and extra votes beyond that make no difference; it aims therefore to satisfy a majority. If houses were supplied by government there would be just enough variety to satisfy a majority of voters, whereas the market will supply to individual specification. Further, government is unresponsive to different degrees of urgency: some people might not really want a good house, and might prefer to have more to spend on something else; others might go without other things for a better house. The market allows individuals to substitute one thing for another according to their own priorities. Further, voting is not a reliable expression of need: the link between services supplied by government and their cost is often not obvious - government can pretend that what it supplies is 'free'. A person can vote for something not realising its cost, or hoping that the cost will fall on someone else: voters demand things they do not really want, if want is measured by the only fair and objective criterion, willingness to do without something else instead. If resources were allocated by majority vote rather than by the market, production would be much less finely adapted to real need.

So on the free enterprise theory whatever can be left to private enterprise is not a proper function of government. A number of legitimate functions were noted earlier: to protect property and free exchange against force and fraud, to manage the general level of economic activity to damp down the trade cycle, to ensure the welfare of those who cannot be expected to make a reasonable living in the market economy. There are others: one is to supervise quality in matters too difficult for the ordinary buyer to judge (e.g. safety in travel, drugs, buildings etc.) Another is to undertake, or supervise, certain 'technical monopolies' in which the existence of competing firms would lead to wasteful duplication or complexity (e.g. landline telephone services or piped water supplies). Another is to control 'neighbourhood' or 'spillover effects' or externalities, such as pollution, either by prohibition or by imposing charges revenue from which can be used to clean up or to compensate those adversely affected. Another is to provide or subsidise services for which it is impracticable to charge those who benefit (e.g. lighthouse, preventive medicine). And so on: see J.S. Mill, Principles of Political Economy, Book V, chapter 11.

In all these things exponents of free enterprise exercise their ingenuity to devise alternatives to government intervention (see e.g. M. Rothbard, R. Nozick) in the belief that government activities which are in principle legitimate tend to get out of hand, and come to be used as a disguise for various rackets. Protection of property can be left in part to private security firms, social welfare functions can be performed to some extent by insurance. Testing of the quality of complex commodities can be done y private consultancies which sell their reports to consumers (copyright laws make information a saleable commodity), or by private retailers who stake their reputation on the quality of the goods they retail (thereby indirectly selling the service of testing). In the case of telephone services and other technical monopolies, the plant might be owned by government, but operated on lease by a private firm, the lease being auctioned off to the bidder who undertakes to give the best and cheapest service (cf. TV licences). 'Spillover effects' might be dealt with by legislation creating new kinds of marketable property consisting in the right to be free of such an effect; those who really need to engage in the activity concerned (need being measured by willingness to pay) could then buy the right. Various ways can be devised to ensure that 'users pay' for public facilities such as lighthouses, e.g. port dues.


11. The Invisible Hand

The price mechanism is supposed to adjust production to need; high prices motivate producers to bring more of a needed item into the market (see above, part 5). Suppose there is a mining boom, and geologists are in great demand and are well paid; students enrol for geology - but when they emerge from the academic pipeline several years later the mining boom is past; enrolments switch to school librarianship, but most jobs in that field are taken while there are still many trainees in the pipeline; another mining boom begins... A person might train and retrain several times without ever getting a job, because of the time taken in training and because he or she does not know how many others are being trained and how many will be needed by the time the training is complete.

In general, if many producers decide to bring more to market and no one co-ordinates their decisions, by the time they get to market they may find there is too much, with even more on the way; prices fall, production is cut back, again by too much, and some time later there is a shortage; and so on. Unless the price mechanism is very sensitive and quick acting and production periods short, the economy will oscillate violently about the equilibrium point without ever actually being in a state where resources are rationally allocated. J.S. Mill quotes Coleridge: instead of saying that in a market economy all things find their level it would be better to say that things are always finding their level, 'which might be taken as a paraphrase or ironical definition of a storm'. In a storm at sea air pressures and water levels are tending toward calm equilibrium, but for anyone caught in it the process of getting to that state may be unpleasant and even fatal.

Futures markets and other long-term contracts may stabilise prices and shift risks to persons or institutions better able to bear them and better able to predict, but even so decisions made several years in advance may turn out to have been wrong, and resources will have been misallocated. Could socialism do better? 'Market Socialism' (see Schumpeter, Capitalism, Socialism, Democracy (HX86.S33), ch. 16) makes the 'invisible hand' theory applicable to a socialist economy: the managers of each plant act like their capitalist counterparts, though (apart from bonuses and incentives) any profit goes to the one owner, the State representing the community. If market socialism is a genuine form of socialism (and socialists disagree about this), then at least socialism is no worse than free enterprise in the allocation of resources, and argument for and against the free market then becomes strictly irrelevant to the choice between private enterprise and socialism.

12. Imperfect Competition, Imperfect Information

It is sometimes said that the free enterprise theory assumes free competition and perfect information available to the competitors. It may be that some models of the market economy have been constructed on these assumptions, but the free enterprise theory need not take this form. All that need be assumed (and all that was assumed above) is (1) that each buyer and seller has potential competitors, i.e. that they have no means (such as guild or government restrictions) of preventing others from competing (perhaps by offering a substitutable product) if the high profit attracts them, and (2) that in general individuals know and care about their own interests better than anyone else does. On monopolistic practices see Schumpeter chs. 7 and 8; he argues that they may be equivalent to patent or copyright, giving innovators the temporary protection needed if innovation is to continue.

[Addendum 2011: For another criticism of the "invisible hand" theory, a criticism independent of assumptions about imperfect competition, see Robert Frank, "Charles Darwin, Economist".] 

13. Rent

Consider the leisured life of the landed gentry as portrayed (e.g.) in the novels of Jane Austen and Anthony Trollope. How can a landlord get a good income (in the form of rent) from agriculture without ever doing any ploughing or reaping? Bastiat's answer was that rent is payment for work done to develop the land (clearing, removing stones, making drains, fences, roads, etc.) But David Ricardo (and indeed Adam Smith) had already given a better answer; some component of what is called rent may be payment for services such as Bastiat mentioned, but there is another component ('economic rent') which cannot be accounted for that way. Suppose there is a fertile country only partly occupied, so that no one need cultivate any but best quality land; no rent could be charged, because an immigrant offered the use of land at a price would always prefer to take up good unoccupied land available free. As population increases the best land may eventually all be occupied, and an immigrant must either pay to use the best land or use free land of lower quality which produces less; the difference in production is the upper limit of rent - if more than that is demanded it would be better to use free land. As population continues to increase the quality of land unoccupied becomes progressively lower, and the difference in production between good rented land and the best available free land increases, and accordingly so do rents. Economic rent arises and increases without the landowner doing any service whatsoever, merely because of increasing population.

If population continues to increase, eventually newcomers will have to pay in rent the whole of what they produce except for just enough to keep them alive and working. This will happen when the only free land is desert and competition for rented land has become intense. Imagine a small island to which castaways swim as ships are successively wrecked on a nearby reef; eventually the earlier occupants will be able to present new castaways with the choice: be our slave, or keep swimming.

According to Malthus, population will eventually increase to this point; or rather it has throughout history and will continue to do so in this or that locality (destitute people cannot travel far, so free fertile land at a distance might as well not exist). In recent years millions have died in Nigeria, Bangladesh, the Sudan etc. and many who survived did so at the price of heavy debt and high rents to landlords. The conflict between landlords and tenant farmers is an important theme of third world politics. Malthus' argument is simply this, that generally (unless they practice birth control) a couple will have more than two children, so if most people marry, population will increase from one generation to the next (unless numbers are reduced by war, disease, natural disaster etc.). So eventually in this locality or that rents increase to the point where landlords take everything except what the farmer needs just to stay alive, and those who cannot rent enough land even on those terms starve. If Malthus and Ricardo are right, the normal course of social development leads to great wealth without work for descendants of those who first occupied the land, and hard work and poverty for the rest. (See R. Heilbroner The Worldly Philosophers (HB76.H4), Ch.4).

Ricardo's analysis can be adapted to show that something like rent is collected by the owner of an especially well-situated or easily worked mine (or other natural resource), by the owner of the best quality machinery, and so on. The income of especially talented people also includes something like rent; to be more productive because of natural talent is like owing a naturally fertile piece of land. Rent is yielded by any productive resource of limited quantity and varied quality; the owner of the best can appropriate what it produces above what is produced by the worst unit which can profitably be used, without doing anything to earn it. (For a persuasive presentation of Ricardo's analysis of rent, see George Bernard Shaw, "Economic", in Fabian Essays. Ricardo's analysis  lies behind Marx's account of surplus value, behind J.S. Mill's views on land tax, inheritance tax and land reform, and behind the key ideas of the Henry George movement and the Labor Party.)

If some people collect rent or the like without working while others have to work hard just to stay alive, there is something wrong with the argument (above) to prove that the market distributes the product in proportion to effort. What was supposed to establish this proportion was the possibility of substituting one's own labour on free materials for something bought from others. But if people are unequal in natural capacity for labour, and if free materials are greatly inferior to resources already appropriated, then this possibility will not be enough to establish equity.

This vitiates the argument to show that the market adapts production to needs in order of urgency (above). Willingness to pay is an equitable criterion of need only if purchasing power is distributed equitably.

A whole school of cheerful optimism has been based upon the creed that if every man pursues his own interests in an enlightened manner we shall get the best of possible results, because it will be to his interest to apply his energies when they are "most useful to others". Yes, but what others? The answer is, "those who already have most of everything else that they want". This automatic action of the economic forces is at the service of every man exactly in inverse proportion to the urgency of his wants. The very fact that he is in want of everything prevents his giving much for anything, and makes his command of the economic forces light. The very fact that he has abundance of all things enables him to give largely of valued things for the gratification of the slightest impulse, for he is only checking impulses equally slight. The weight that his passing whim can throw into the economic scale is heavier than that which his neighbour can pit against it to save his life. (H. Wicksteed, The Common Sense of Political Economy (HB171.W6), Vol.1, p.191.)

The market adapts production to effective demand, that is demand backed by purchasing power.

On the assumption that rent of some sort is likely to be an important component of high incomes, and progressively more important the higher the income, there is a strong argument of equity in favour of progressive income tax (as well as for land taxes, resources rent taxes, etc.), viz. that it simply removes what was never earned by effort. Property is not a single simple right, but a collection of rights; it is possible to nationalise some of these while leaving others intact. To tax away income generated by a right is virtually to nationalise it. Progressive income tax is virtual nationalisation of the rent-generating aspect of property, i.e. of the power to demand a ransom for access to land, talent, (etc.) of the best quality.

14. Tariffs; Unions

The invisible hand uses unemployment (of labour and of other resources) as a means of moving the economy toward efficient allocation of resources. But this goal is never attained (above). If resources were efficiently allocated, and if they were all actually in use, then production would be at its greatest; but since these conditions are never met, the greatest attainable level of production may be reached by tolerating some inefficiency for the sake of a higher level of actual use. This goes some way to justify government and union action to protect employment.

The existence of economic rent (above) goes some way to justify collective bargaining and strikes. In a market economy rent is almost certain to be appropriated by somebody, even if in equity no-one has a right to it. For example, if some housing sites are better than others, economic rent will be collected by the farmer who sells to the developer, or (if the government compulsorily buys the land at rural use prices and auctions it) by the government, or (if the government distributes it by lottery at low prices) by the first homeowners when they sell or rent their house. Similarly with other rents. Strikes are often simply an attempt by employees to extract a share of the economic rent which would otherwise be appropriated as profit by the employer. Workers in the oil industry, for example, can hold the community to ransom only because of the community's need for oil, which enables oil companies to hold the community to ransom quietly every day. The community is no worse off, unless the oil companies have been more benevolent than free enterprise theory assumes people are; the union is merely getting a share of the 'rent' already being collected.

It may be worth pointing out that it takes two to make a quarrel. A strike occurs only if 1) the union makes a demand which 2) the employer refuses. To decide which side is to blame one would need to decide which is justified, the demand or the refusal, and for this news coverage is generally insufficient. Some union demands are met without a strike; employers' demands made on consumers in setting prices do not usually lead to public and organised resistance. Demands quietly made and quietly met are not necessarily more justified than demands enforced by strikes.

15. Marx

The labour theory of value (above, part 5) was used by some (neglecting or misunderstanding rent) to show that distribution in a free market will be proportional to effort. But on this theory, how is capitalism possible? It is a distinctive feature of capitalism that most workers are employees. Now if an employer buys an hour of labour for wages, it would seem on the labour theory of value that it ought to cost the employer the money equivalent of the product of an hour's labour; i.e. the wage should equal in value what the worker produces. How can a capitalist make a profit by employing labour, then, except by paying less than its value? It would seem that in equity the worker should get 'the whole product of his labour', which became the slogan of some of the early socialists.

Marx argued that this is a misapplication of the labour theory. What the employer buys is not so many hours of labour, but the right to use the worker's productive powers for so many hours. The value of the use of the worker for a 12-hour day is calculated by adding up the total hours of labour required to keep the labourer alive and working for 12 hours a day throughout a typical working life (including costs of upbringing and training) and dividing by the number of days in a working life . (Compare the hire of a machine: on the labour theory the value of a day's hire is equivalent to the total labour required to make the machine and maintain it until it is scrapped averaged over the number of days it will be in use.) Now if productivity is high enough in the industries producing wages goods (food, clothing, housing and other things needed to produce and maintain workers), what is needed to bring workers to and keep them in the labour market for a day may take less than a day's labour to produce. This is what makes it possible for the employer to make a profit: if the necessities of life for the average day take four hours to produce and labourers are hired for twelve hours, then the value of the right to use them for the day is equivalent to what they produce in the first four hours and the remaining eight goes towards the employer's profit. In Marx's terminology the eight hours produce 'surplus value', four hours are 'necessary labour', and the ratio between these determines the 'rate of exploitation'.

If the employer pays full value, where is the injustice? Despite the evaluative overtones of Marx's language (e.g. 'exploitation'), Marxists generally say that Marx had no intention of passing moral judgement on the wages system. Marx and Engels, like many of their contemporaries, seem to have believed that morality is relative to the social system, so that the capitalist system creates its own justifying morality, and cannot be judged from any non-relative standpoint. Marx's thesis, on this interpretation, is not that capitalism is unjust, but that it cannot last. He argues that as the system develops, the rate of exploitation will increase and workers will become poorer (relatively or even absolutely) and capital will be concentrated in fewer hands; the gathering of workers into large workplaces will help them organise for their own purposes; the boom-and-bust trade cycle will show how disorganised the capitalist system is; eventually the large and organised mass of workers will expropriate the few discredited capitalists and institute socialism. The purpose of revolutionary activism is to hasten this change and shorten the agony.

However, many readers look to Marx for a moral critique of capitalism. Some find it in the notion of alienation: if hiring an employee is just like hiring a machine, then human beings are treating one another and themselves as non-human things. Others find it in a line of thought like Ricardo's criticism of landlords. Landlords get income without effort by charging rent for access to land, holding it to ransom as it were; the surplus value appropriated by capitalists is a charge for access to the means of industrial production. As population grows, rent increases, until tenants are reduced to starvation and landlords appropriate all the benefits of economic progress; similarly the development of capitalism intensifies exploitation and leads to the 'immiseration of the proletariat' while the benefits go to a decreasing number of great capitalists. In both cases the advantages of the few bear no proportion to effort, need, or any other just title; they result simply from having the good luck to control access to what others need.

16. Moral ideas

Exponents of free enterprise assume that if a contract is consented to by both parties because both believe that it is in their interest, then it must be just. But what of the castaway confronted with the choice 'Be our slave or keep swimming'? People faced with such an alternative may consent to the bargain, and it may be in their interest to do so; is this enough to make it just? If a person must have access to land or to other means of production in order to stay alive, freedom of contract may not be enough to secure fair exchange.

The free enterprise theory takes as its point of comparison what individuals could achieve in isolation by their own efforts; they can do better by making exchanges, which may be fair even if the result is a widening gap (see above, part 9). To many people this approach seems morally unsatisfactory in that it leaves out of account the value of fraternity or solidarity. This is generally accepted as an ideal in family life, and the human race should be regarded as being in some sense the human family. A sense of solidarity should suggest that a 'widening gap' is unacceptable even if it results from fair exchange.

17. Inheritance

It may be said that owners of land and other means of production owe their position not to good luck but to hard work and self restraint. But in fact most owners owe their position mainly to inheritance, and that is a matter of luck. One element of ownership is the right to give the property away for nothing, or on whatever conditions the owner chooses; if inheritance were abolished, owners would give property away at the approach of their death or earlier (perhaps on condition that they are allowed the use of it during life), and inheritance would have returned in a new guise. Even if private property in the means of production were abolished completely, the problem would still arise. Wealth, power and influence can be turned into one another reciprocally: money can buy power, power can get money. What is originally got as a just reward for effort can be used to obtain more with less effort. As long as there are families parents will find ways of passing to their children whatever advantages they have obtained, justly or unjustly, for themselves. For the middle classes in Australia these days an important form of inheritance is education at prestigious schools, which can be converted into property later. Insofar as the most expensive education includes much which is not really needed to perform the jobs it traditionally leads to, it is an artificial barrier against competition for those jobs from those whose families cannot afford it.

If inheritances were traced back, many would derive from some injustice. White Australians, for example, inherit the results of the early dispossession of the aborigines. As Bastiat noted (rather late in his book) spoliation is not a minor incident in history: 'spoliation, in the traditions of families, in the history of nations, in the occupations of individuals, in the physical and intellectual energies of classes, in the schemes and designs of governments, occupies nearly as prominent a place as property itself': Economic Harmonies, p. . Legalised spoliation sanctioned by government is especially noteworthy. The third world labours under disadvantages which result largely from the armed interventions and trading policies of European governments over the last several hundred years. Investment in third world countries has often been shaped by the interests of the rulers of those countries in alliance with foreign investors against their own poor. Spoliation is also a factor in the history of distribution within the wealthy countries. In England and America in the eighteenth century and later fortunes were sometimes based on negro slavery in America. In England the landowners used their control of Parliament to enclose common land and make other changes in land law to their advantage, and to erect barriers against imports of agricultural products. In the United States in the nineteenth century and later great fortunes were made by questionable means. Insofar as the present social structure is based on inheritance it is tainted with original injustice. See Marx 'The So-Called Primitive Accumula-tion', Part VIII (Chs. 26f) of Capital, Vol.I, (HB501.M35). The drug traffic is a new slave trade, in which the slavers need never see their slaves, need take no care for them, need not even drive them to work; in time the wealth now being derived from this new slavery will have become respectable.

18. Incentives

Critics of the free enterprise system often denounce the profit motive as essentially selfish, and contrast production for profit with production for use. Advocates of the system reply that no one can make a profit except by offering something for which others have a use, and they argue that it is one of the great strengths of the system that it relies on strong commonplace motives - it does not demand too much of human nature. Some advocates (e.g. James Mill) have held that human nature is essentially selfish: apparently altruistic acts are always somehow really in the agent's interest, altruism is merely selfishness disguised. This thesis has been rejected by other advocates of free enterprise:

In laying down as a philosophical axiom, that men's actions are always obedient to their interests, Mr. Bentham did no more than dress up the very trivial proposition that all persons do what they feel themselves most disposed to do, in terms which appeared to him more precise, and better suited to the purposes of philosophy, than those more familiar expressions. He by no means intended this assertion to impute universal selfishness to mankind, for he reckoned the motive of sympathy as an interest, and would have included conscience under the same appellation, if that motive had found any place in his philosophy, as a distinct principle from benevolence. He distinguished two kinds of interests, the self-regarding and the social: in vulgar discourse, the name is restricted to the former kind alone.

But there cannot be a greater mistake than to suppose that, because we may ourselves be perfectly conscious of an ambiguity in our language, that ambiguity therefore has no effect in perverting our modes of thought. I am persuaded, from experience, that this habit of speaking of all the feelings which govern mankind under the name of interests, is almost always in point of fact connected with a tendency to consider interest in the vulgar sense, that is, purely self-regarding interest, as exercising, by the very constitution of human nature, a far more exclusive and paramount control over human actions than it really does exercise. Such certainty was the tendency of Mr. Bentham's own opinions. Habitually, and throughout his works, the moment he has shown that a man's selfish interest would prompt him to a particular course of action, he lays it down without further parley that the man's interest lies that way; and, by sliding insensibly from the vulgar sense of the word into the philosophical, and from the philosophical back into the vulgar, the conclusion which is always brought out is, that the man will act as the selfish interest prompts. (J.S. Mill, Essays on Ethics, pp.13-14)

As Wicksteed shows (Vol.1, pp.163-183), the theory of the market does not assume that buyers and sellers are essentially selfish, merely that people seek their own goals, whatever they are, selfish or idealistic; a mother buying food for her family looks for the best bargain, but is not necessarily acting selfishly. (Wicksteed says that a market transaction is based on "non-tuism", from the Latin word for "you", in contrast with "egoism", from the Latin word for "I", and "altruism", coming through French from the Latin word for "other"; in the market I am not concerned for your goals, only for my own, but my goals may not be selfish.)  The market economy is a way of organising human co-operation without the need for prior consensus upon goals.

However, since the market is indifferent to the moral quality of motives, its rewards go alike to the unselfish and the selfish; and since the latter can more easily free themselves of burdens and moral constraints, they excel in competition. So selfish ambitious people are respected and rewarded, with money, power and prestige. Is it realistic to expect more idealistic values to have much influence in a society in which the market is the dominant institution which sets the tone? In our society there are complementary institutions - government, churches, charities, cultural and educational institutions etc. - which we rely on to correct injustice, care for the handicapped and foster values the market neglects. But these institutions themselves are often infected by the market ethos, and their leaders seek the co-operation or acquiescence of businessmen; they are too weak to act as an effective counterweight.

Economic incentives are effective because the appeal to strong and common motives. However incentives often have unintended consequences; e.g. in educational institutions incentives meant to encourage the quest for truth may in fact motivate intellectual pretentiousness or cheating. Similarly the strong incentives of the market economy may have unintended and undesired consequences: 'The reward of good work may be snatched by False-Semblant. The art of making promises convincing threatens to supplant that of making performances sound'. (Wicksteed, p.188). Another consequence is white collar crime, the economic cost of which 'dwarfs that of all other forms of crime' (U.S. National Crime Commission, in R.N. Purvis, Corporate Crime, p.65; see also T. Hall, White Collar Crime in Australia (HV6771.A8.H3). In 1980 the N.S.W. Law Society paid over $1.8 million in claims on its Solicitor's Fidelity Fund. The free enterprise system rests upon respect for the property of others; this is what 'honesty' has come to mean. Honesty is continually undermined by the incentives the system offers.

There are psychological costs also to be set against the benefits of this incentive system. It raises hopes which are bound to be mostly frustrated. Extrinsic rewards (money, grades, promotion etc.) take the place of satisfaction in doing well something believed to be worth doing. The division of labour makes jobs less interesting. The pressure of competition forces people to neglect activities which do not contribute to success (e.g. friendship - except for business 'friendships'). See H. Burenstam-Linder, The Harried Leisure Class (HB199.B84).

The criticisms outlined in the last few pages are forcefully summed up by one of the classic exponents of the free enterprise theory, J.S. Mill:

Since the human race has no means of enjoyable existence at all, but what it derives from its own labour and abstinence, there would be no ground for complaint against society if every one who was willing to undergo a fair share of this labour and abstinence could attain a fair share of the fruits. But is this the fact? Is it not the reverse of the fact? The reward, instead of being proportioned to the labour and abstinence of the individual, is almost in an inverse ratio to it: those who received the least, labour and abstain the most.... The very idea of distributive justice, or of any proportionality between success and merit, or between success and exertion, is in the present state of society so manifestly chimerical as to be relegated to the regions of romance. It is true that the lot of individuals is not wholly independent of their virtue and intelligence; these do really tell in their favour, but far less than many other things in which there is no merit at all. The most powerful of all the determining circumstances is birth. The great majority are what they were born to be. Some are born rich without work, others are born to a position in which they can become rich by work, the great majority are born to hard work and poverty throughout life, numbers to indigence. Next to birth the chief cause of success in life is accident and opportunity. When a person not born to riches succeeds in acquiring them, his own industry and dexterity have generally contributed to the result; but industry and dexterity would not have sufficed unless there had been also a concurrence of occasions and chances which falls to the lot of only a small number. If persons are helped in their worldly career by their virtues, so are they, and perhaps quite as often, by their vices: by servility and sycophancy, by hard-hearted and close-fisted selfishness, by the permitted lies and tricks of trade, by gambling speculations, not seldom by downright knavery. Energies and talents are of much more avail for success in life than virtues; but if one man succeeds by employing energy and talent in something generally useful, another thrives by exercising the same qualities in out-generalling and ruining a rival. It is as much as any moralist ventures to assert, that, other circumstances being given, honesty is the best policy, and that with parity of advantages an honest person has better chances than a rogue. Even this in many station and circumstances of life is questionable; anything more than this is out of the question. It cannot be pretended that honesty, as a means of success, tells for as much as a difference of one single step on the social ladder. The connection between fortune and conduct is mainly this, that there is a degree of bad conduct, or rather of some kinds of bad conduct, which suffices to ruin any amount of good fortune; but the converse is not true: in the situation of most people no degree whatever of good conduct can be counted upon for raising them in the world, without the aid of fortunate accidents. (J.S. Mill, 'Chapters on Socialism', in Essays on Economics, pp.714-15.

19. Ideology

In ordinary use 'ideology' means almost any social or political theory. In some circles, however, the word is used pejoratively to mean a theory which misrepresents social realities so as to justify or conceal the dominance of those in power. To those who use the word this way, the free enterprise ideology is the prime example of ideology in the bad sense. It misrepresents by over-simplifying. The examples of authors such as Bastiat presuppose a simple society of farmer and artisans using simple means of production: one offers to fetch water for the spring, the other considers whether to fetch his own water or concentrate on making spears for hunters who will take them in exchange for some of their kill, and so on; there is no sense of the dominant realities of nineteenth and twentieth century economic life - rent, wage labour, expensive investments in machinery, inheritance, etc. When the over-simplified model is applied to modern society attention is taken away from some of its most important characteristics.

It is ideological also in the way it is used, as selective justification for things done for less respectable reasons. 'Free-enterprise' political parties, for example, when in government do not really act on the theory. A political party is usually an alliance between idealistic people attracted by its official ideology and others with other purposes ('realists'). When it is out of power the idealists have free rein; they recruit supporters by explaining the ideology. When the party gets into power the realists sweep the idealists aside, and allow them to influence the public only when it can do no harm. In effect, the theory is a screen. This is true also of socialist parties.


This collection of arguments for and against free enterprise is by no means complete, but it should provide a framework for further thought and discussion. In mathematics the sound arguments are all on one side of the question, but in practical matters there are usually good arguments on both sides. It is necessary to muster the arguments, look at them carefully, and compare their force. This tests a person's intellectual honesty; there is a temptation to ignore arguments on the side one disagrees with. To counter this it is necessary to make a point of trying to state those arguments as strongly as someone on that side would state them; for an impressive example of this see J.S. Mill's 'Chapters on Socialism'. The weighing of pros and cons has to be done for all the competing theories comparatively: it may be, for example, that the drawbacks to free enterprise outweigh the advantages and yet its competitors may be even more unsatisfactory.

Further reading

M. Friedman, Capitalism and Freedom (HB501.F7)
K. Marx, Value, Price and Profit (HB771.M3)
J.S. Mill 'Chapters on Socialism', in Essays on Economics and Society, Vol.2, p.703f (B1602.A2Vol.5)
George Bernard Shaw, The Fabian Essays in Socialism (HX246.F2), p.1-25.

Postscript 1993

Since the above essay was written (early 1980s) there has been a strong revival of the 'free enterprise' theory under the slogan 'market forces'. Governments are deregulating and removing tariff barriers. Politicians describe these developments in optimistic language, as if they were good ideas they happened to have, but in fact the changes seem to be forced: no national government is now strong enough to stand against currency speculation, economies in formerly undeveloped countries are now strong enough to bargain their way through tariff barriers, shifts in demand have made the traditional products of many established economies (e.g. Australian wool) less saleable. Under these circumstances it seems no longer possible for the traditionally well-off countries to continue to protect their populations against competitors in other countries (the justice of this was always problematic). Regulations and taxation imposed by national governments are burdens that reduce a firm's competitiveness in international markets (e.g. if our firms cannot pollute but firms in other countries can, then our firms' products will be priced out of the international market). Taxation is like lead in a firm's saddle-bags, so the government's share of national income has to be reduced, government activities and services (e.g. to the handicapped, to the mentally ill) have to be cut back to lessen the burden and improve the competitiveness of our industry. Instead of being excluded by tariff barriers and other means, the 'third world' enters 'first world' societies in the form of unemployment and poverty. Politicians suggest that after some pain things will improve for everybody, but their optimism seems unfounded. Neither side in politics has any 'answers'; in fact both sides pursue essentially the same policies and use the same rhetoric.

The criticisms of the free enterprise theory are at present not getting much attention. The inequity of rent (above, part 13) and inheritance (part 17) and the drawbacks to monetary incentives (part 18) should not be forgotten. Also, note the problem described in part 11, of violent oscillation about the equilibrium point (even if the equilibrium point is not shifting, as it constantly is). Notice also 'spillover effects' or 'externalities' (above, part 5, part 10). If no government can control environmental damage because the other governments are not simultaneously doing so as well (because they cannot risk handicapping their own firms in comparison with international competitors), and especially if populations continue to increase, the human race together with most other species will perish miserably. The Darwinian analogy (part 5) is relevant here. The process of adaptation through natural selection may guarantee that the survivors will be effective competitors ('lean', 'efficient', etc.), but it gives no guarantee whatever that the whole system will not in the end be destroyed by the activities of the most successful of those competitors.

Postscript 2005

The revival of the "free enterprise" theory evident twelve years ago is continuing. There seems to have been a marked shift in bargaining power in favour of people with money to invest ("capitalists" in 19th century terms) and against people who earn a living by their work, skilled or unskilled. One possible cause of this is the application of information technology to the financial markets--it is now very easy for investors move their money from one line of investment to another, from one country to another; whereas it is very difficult for workers to retrain or relocate. Another possible cause is the growth in population, and more specifically the increase in the number of people in the international labour market (helped by the end of colonialism). The shift in bargaining power makes it easier for investors to insist on the removal of various barriers they find inconvenient -- hence further deregulation of international trade, further deregulation of financial institutions, deregulation of the labour market, reduction in trade union influence--and such deregulation further increases the bargaining power of investors and leads to a cascade of futher deregulation. The threat to move investment elsewhere is usually effective. For example, if trade unions are strong in a certain country in a certain industry, investment in that industry will move overseas to some place where trade unions are weak or non-existent--knowing this, trade unions will usually be ready to make concessions to keep the jobs.

The tendency of these developments is toward an economy in which each individual worker is a contractor or sub-contractor, on a short-term contract individually negotiated, and not an employee with "entitlements". (See the Independent Contractors Act.) This will lead to the "flat tax"--progressive income tax will be difficult to maintain when employees can easily become contractors. Theoretically a flat tax could be part of a redistributive social system--if the tax is high enough, poorer people could receive extra assistance. But taxation of all sorts, being a burden to firms in a competitive world, must be minimised, and government services must therefore also be minimised (see above), and re-distributive schemes will never favour the lowest social strata since the poorest minority will always be outvoted.

This will not necessarily be a "low-wage" society. Those with in-demand skills will be well paid. Those without such skills will be motivated to set about acquiring them (if necessary borrowing money to finance their training). But this overlooks problems of oscillation, and of rent. Unskilled younger workers are in a poor position to make the investment decision to undertake training, especially since many other people may be making the same decision, with many of them likely to emerge from the training pipeline after the vacancies have been filled. And the people most likely already to have the in-demand skills, and those most able to take advantage of the demand for training, will be able to collect rent, at the expense of the unskilled. The "free-enterprise" society will have a strong trend toward inequality.

It is probably the shift in bargaining power that has given the free enterprise theory its boost. The arguments for and against the theory don't seem to have changed in the last 30 years, but the increased bargaining power of the people who like the theory have made it dominant.

Postscript 2006

Faith, Values and Politics

Recently one of the leading members of the Australian Labor Party, Kevin Rudd, has been arguing that the Free Enterprise theory, particularly as implemented by the Howard government, is at odds with Christian values. See his web page "Faith, Values and Politics", and also his essay "Faith in Politics", in The Monthly, Oct. and Nov. 2006. Rudd himself was brought up as a Catholic and is now an Anglican. The Christian churches (including notably the Catholic Church), have a strong tradition of social doctrine, which in this country has often inclined Christians to support the Labor Party. Rudd would like to revive this connection.

According to Rudd, there is a conflict between the free enterprise ideology and family values. He takes Hayek as representing the neo-Liberal theory, and quotes David McKnight's summary of Hayek's ethics:

Hayek defines morality as those attitudes that are necessary for, and developed within, the market ... These concern rules about private property, honesty, contract, exchange, trade, competition, gain and privacy. These are what Hayek understands by moral rules. The unexpected ... concomitant of this notion of cultural evolution is that feelings of altruism and obligation are here seen as its antithesis, as primitive instincts from earlier hunter societies, which have to be overcome.

But on moral values Hayek cannot be taken as the typical free enterpriser. Adam Smith and John Stuart Mill were undoubtedly representatives of the free enterprise theory, and they both explicitly, and for well-argued reasons, rejected egoism. Some exponents of the theory did subscribe to egoism, probably under the influence of Hobbes; for example, J.S. Mill's father James Mill, and Jeremy Bentham. In recent history Ayn Rand has been an influence in "libertarian" thinking. In continental European thought egoism has had an influence--Max Stirner and Sigmund Freud come to mind, and perhaps Hayek was influenced by that tradition. But it is important to note that the free enterprise theory does not essentially depend on any assumption of Egoism. I think Wicksteed got it exactly right (above): a market transaction is one in which the parties are not seeking to futher one another's purposes, but their own purposes are not necessarily selfish:--"non-tuism", not egoism and not altruism, is the presupposition of the free enterprise theory. The theory is that if individuals pursue their own purposes through market transactions, much social good will result, even though social good is no part of their purpose in these transactions. A participant in a market economy "generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. . . .  he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it"; Adam Smith, Wealth of Nations, ed. Cannan,  p. 477. 

It was out of concern for the welfare of society, including the welfare of its poorest members, that Adam Smith and J.S. Mill and others advocated free enterprise. Their contention was that when individuals are left free to make their own bargains, the general level of welfare will rise, and, even if there is an increasing gap between rich and poor (see above), the poor will be better off (in absolute terms) than they would have been under any other regime. Smith, Mill and others in this tradition did not say that there should be no social institutions besides the market. One necessary institution is government, and its function is not merely to underpin the market--government intervention is needed also to mitigate the inequalities and injustices that would result from the workings of a completely unregulated market (see above).

Is the market economy at odds with family values, and more generally with humane values, and has the conflict been getting stronger in John Howard's Australia? I think there is no doubt that a market economy is hard on family life, and that the difficulty of striking a right balance between work and family life has been increasing. The market economy rewards labour mobility and penalises immobility, but family life requires stability and predictability. It also requires time, and competition leaves everyone short of time for family life and friendship (see Burenstam-Linder, above). Many recent government policies entail "risk shifting" to the detriment of individuals: instead of regarding society itself as a sort of "insurance" scheme, in which risks are pooled, government policies in education (e.g. the HECS scheme), healthcare, superannuation, etc., compel individuals to assume the risks, which has an adverse impact on family life. (See Jacob Hacker, The Great Risk Shift;  for a review, see here) [Addendum 2009: see also here, here and here.]  The increasing prestige of the market culture has invaded the institutions that earlier liberals expected to balance and correct the workings of the market--mega churches are (in part) a branch of the music and entertainment industry, universities are expected to behave to some extent commercially (and cutbacks in government funding force this on  them), public broadcasting is under similar pressure, private schools are flourishing while public schools languish, and so on. The competitive ethos invades every part of life, and altruism, cooperativeness and public spirit are in retreat.

I think Rudd is right in claiming that the conflict between the market economy and humane values has been increasing, but I don't see this as a triumph of ideology and I don't attribute it to the efforts of political villians. The neo-liberal ideologues may seem to be influential, but their influence is really due to the increasing power of the people who like their ideology. The rise of "market forces" seems to me to be due to factors already discernable in the time of the Hawke and Keating governments; see above. In fact, long ago Malthus and Ricardo saw all this coming--the growing intensity of competition is due largely to world-wide population increase, and the growing inequality is due to rent taking.  In defence of the Howard government, one might say that unless goverments do the things our governments have been doing, the people of this country will not be able to hold their own in a competitive world economy. A demanding job is bad for family life, but unemployment might well be worse. 

The challenge for a "social democratic" party is to find ways in which governments can reduce the bad effects on the lives of individuals and families and other institutions of increasing competition. Parties on the other side of politics have the same concern. Neither side presents a "radical alternative" , but there are differences of emphasis due to the fact that the interest groups to which the parties look for support are different.

One thing social democratic parties need to look at is taxation. Many government schemes have reduced the progressivity of the tax-and-benefits (or "transfer") system; for example, "two-tier" education or health systems, in which entry to the upper tier requires an up-front payment--if the upper tier is then subsidised by government, the higher taxes wealthier people pay are being returned to them in benefits. On the assumption that higher wealth is usually due to rent taking, and that rent is unearned, the transfer system ought to be progressive (see above). But this is naturally opposed by the party that high income people mostly support.

As for the connection between religion and social justice,  it seems to me that, while it is true that in European history Christianity has been an important carrier of concern for justice, justice is not based on faith but on ethical attitudes common to humanity (rooted perhaps in human biology--see my reading guide on the ethical aspects of Darwinism). In a religious society ethical seriousness takes a religious form, but before Christianity became the religion of the Roman Empire concern for the public good was strongly expressed in Greek philosophy and in Roman law (the Roman ethical notion of humanitas is the ancestor of our concept of the humanitarian).  What politics needs are people who can explain their ethical concerns in ways that make sense to everyone. See Philosophy and Religion.

Climate Change

In 2006 "spill-over" effects on climate can no longer be ignored--see above, here, here and here. (The worry is the possibility of a "runaway" greenhouse effect--as ice and snow melt, the sunlight formerly reflected is absorbed; as temperature rises, gasses  formerly frozen or dissolved in water escape into the atmosphere; as vegetation dies and decays and burns carbon dioxide and other gasses are released. See here and here.)  The remedy now being seriously considered  is carbon trading or a carbon tax. To avoid the economic shock of a sudden change to the rules, it would seem sensible to enact a carbon taxes or emissions limits that gradually bear more heavily in a pre-announced way over a period of some years.

In urging a nuclear solution, Mr Howard is obviously trying to wedge his green critics.  However he may have wedged himself--nuclear power will be economically feasible only if government introduces a carbon tax or carbon trading and/or provides financial subsidies to nuclear generators: each of these proposals would divide his own supporters. The introduction of a carbon tax/trading scheme would stimulate all green power  projects, and the enviromental argument (such as it is) for nuclear power might be overtaken by other developments long before any nuclear power station could be built.

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