The Remarkable Blessings of the Price System

Adam Smith famously inquired into the causes of the wealth of nations. His inquiry wasn’t into the ‘causes’ of poverty – of privation – of a world severely lacking goods and services that humans find to be useful. Such an inquiry would be pointless. Poverty is simply a consequence of the failure to produce useful goods and services.

Poverty isn’t caused by anything; it’s humanity’s default. If you want evidence, consult history.

That which must be caused is wealth – the escape from poverty. And so when we observe humans having access to useful goods and services, we ask – or should ask – “Why? What causes this movement away from privation and toward prosperity?”

For very low levels of wealth the cause is obvious. Human beings need food, water, clothing, and shelter and so, observing their immediate surroundings, they perceive opportunities to hunt, gather, skin, and build crude dwellings. But the cause of levels of wealth that are commonplace today is categorically different. The astronomically high living standards that are widespread today do not result from a conscious decision by each of us to produce our own food, clothing, and housing – never mind our own smartphones, air-conditioners, and antibiotics.

No One Knows How to Make It

The wealth enjoyed by us denizens of modernity consists of a cornucopia of goods and services each one of which has this astounding feature: no one knows how to make it and no one can possibly know how to make it. The production of nearly everything that ordinary people today consume requires the coming together and use of bits of knowledge dispersed across the minds of millions or, often, billions of individuals spread around the globe.

The best-known explanation of this amazing fact is Leonard Read’s 1958 essay “I, Pencil,” the reading of which I enthusiastically recommend. But if you’re too busy to read it, just look around and ask yourself if you can imagine any single person realistically knowing all that must be known to make from scratch the shirt on your back, the roof above your head, and the computer screen at which you now gaze. If you answer “yes,” read Read.

Adding further cause for amazement at our high standard of living is the reality highlighted in my previous column – the reality of the factorial.

Recall the impressive fact that the number of different ways to arrange a mere 20 items, in a single dimension, is greater than is the number of seconds there are in 77 billion years. Because production requires the specific arrangement of different resources, and because the number of different resources on this earth is in the trillions, the number of possible arrangements of resources is … is … well, the English language has no word that begins to convey even a hint of this number’s enormity.

So how is it that the relatively minuscule few arrangements of resources that are worthwhile are ‘chosen’ from among the astronomically vast number of arrangements that are possible?

The Division of Resources, Labor, and Knowledge

The answer is found in the modern world’s extensive division of resources, of labor, and of knowledge.

In a legal regime of private property rights, each individual has dominion over a tiny fraction of the world’s resources, including her own labor. Each person can choose how to arrange and rearrange the resources under her control – the resources that she owns.

Each person, of course, has goals formed by her preferences. (The specific character of these goals, by the way, matters not. The person in question might be a shallow and greedy hyper-materialist or a wise and magnanimous philanthropist or anything in between.) And so each person arranges her resources in the hope of enhancing as much as possible her ability to achieve as many as possible of her goals. As long as this person’s choices do not violate the property rights of others, this person is free to choose whatever arrangements of her resources that she wishes.

Among the possible resource uses is exchange. Smith can offer a week’s worth of her labor to Jones in exchange for Jones giving to Smith some food and clothing. Through exchange, the number and kinds of resources owned by each person changes. And the terms of the exchanges are prices. In a money-using economy, prices are expressed in money.

Each person in a money-using economy then gets a reasonably good sense of how much her fellow human beings value the resources that she owns. She can sell her labor for $33 per hour, her car for $11,500, and her house for $200,000.

Likewise, the prices that other people fetch for their resources inform each person of what is best for her not only to buy but also to sell. As a buyer, she’ll buy the apples priced at $2.99 per pound if she estimates that the satisfaction that she’ll get from consuming those apples is greater than the satisfaction that she would get if she spent her money in some alternative way.

As a seller, she might observe workers in an occupation different than hers earning more income – say, $12 more per hour – than she now earns. She can then decide whether or not it is worthwhile for her to allocate some of her time and energy toward learning new skills in order to get employment at $45 per hour.

In no case is this person obliged to spend her income in any particular way or to allocate her resources in any particular way. But the money prices of goods and services are a highly efficient source of information about the different consequences likely to be experienced by this person by her decision to use her resources in one way rather than in other ways.

This system of prices and wages conveys reasonably reliable information to each individual about the consequences that will be experienced not only by her, but also by other people – most of them complete strangers – as a result of her choice of how to use her resources. And because the value of each person’s resources generally rises when that person uses her resources in ways that make other people, on net, better off, each person in a regime of private property has strong incentives to use her resources in ways that not only improve her well-being but also the well-being of countless strangers.

The division of ownership of resources in a regime of private (“several”) property rights and freedom of contract combines with humans’ “propensity” (as Adam Smith put it) “to truck, barter, and exchange one thing for another” to create a vast array of prices. These prices both inform and incite each individual to arrange the resources under his or her control in ways that give rise to an unfathomably complex and productive globe-spanning arrangement of resource use.

This overall arrangement of resource use is not and could never be comprehended by any individual or by any committee. Much less could it be consciously designed and built. It emerges unplanned and unplannable from billions of individuals, each informed by market prices about how he or she might better arrange the tiny clump of resources under his or her control. That what we notice of this system are its imperfections testifies to just how well and smoothly – indeed, how magnificently – it routinely performs.

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