How an Economy Works

There has been a lot of talk recently about the difference between the economic systems of Capitalism versus Socialism. This is especially true since a self proclaimed socialist is a serious candidate for President of the United States. This is not the first time in American history a socialist has run for the top office. In 1948, Henry A. Wallace, a dedicated socialist who had served as Vice-President of the United States from 1941-1945, ran for President as the Progressive Party candidate. He only got 2.37% of the popular vote. Ironically, if President Franklin D. Roosevelt had not replaced him as the Democratic nominee for Vice President in 1944 with Harry S Truman, Wallace would have become President in 1945 when Roosevelt died.

Anyway, enough about history. What I want to address in this blog is, just what an economy is anyway. Years ago I read a great book by the late economist Milton Friedman titled Free to Choose. In that book Friedman used a simple example as an illustration of how an economy works: a Number 2 wooden pencil. He explained that while a pencil is a simple utensil to use, it requires the work of a multitude of people to get it in the hand of a child. First, someone has to grow and harvest the trees from which the pencil stick is fashioned. Then, another must haul the wood to the factory. Another then operates the machine that fashions the wood into a practical instrument. In addition someone has to mine the “lead” that actually makes the marks on the paper and insert it in the wooden frame. Then the material for the eraser must be made and manufactures along with the little metal ring that attaches it to the pencil. That’s not the end of it, of course, someone must drive the trucks that deliver the pencils to the stores where another worker stocks them on the shelf. Still another checks the customer out. In all, maybe hundreds of different people are involved in the making and selling of a single pencil. All of them are paid for their work.

The point is that, in a modern economy, people work must together to provide goods and services for each other. In a socialist economy the state bureaucracy must determine what those goods and services are and design a plan to get them all provided. The problem is that the bureaucracy is not always aware of what is really needed or how to design the plan. So what happens is that somewhere along the line something goes missing or the plan is inadequate.

The amazing fact about a capitalist economy is that when there is a sufficient need or want (a demand), enterprising people will design a way to provide all necessary ingredients to meet the demand. Why? Because they know they can make a profit. They know that if the demand is high enough, and they price  the product (like a pencil)  at the level that consumers will buy it, and that the price can adequately provide enough resources to pay all the people involved in the manufacture and distribution of the product, and that they can make a good profit for the inventor or investors, it will almost inevitably get made and sold. The government bureaucracy is not involved at all. Where there is a demand, someone, or someones, will meet the need because they know they can make money doing it. Not only them, but all the people involved in the process will have jobs and have an income. The more demand, the more jobs. In a socialist system no such “invisible hand” exists.

I recall once hearing that great economist Jamie Farr (yes, Klinger from MASH), when asked if he had a chauffeur, say, “No, but if I did, it would give someone a job.” He gets it.