The True Democracy of Voluntary Exchange

“In political democracy only the votes cast for the majority candidate or the majority plan are effective in shaping the course of affairs. . . But in the market no vote is cast in vain. Every penny spent has the power to work upon the production processes. . . The decision of the consumer is carried into effect with the full momentum he gives it through his readiness to spend a definite amount of money.”—Ludwig von Mises

“You will find that the State is the kind of organization which, though it does big things badly, does small things badly, too.”–John Kenneth Galbraith

 SYNOPSIS

In political democracy the minority must submit to the will of the majority. However, in the economic market place no one must submit to the will of anyone else. Every choice counts. Every decision of a consumer or buyer of goods and services is taken into account in the decisions of manufacturers, vendors, and other suppliers of goods and services. This is a true rule of the people, a true democracy of self rule, in which each person rules himself or herself and no others. Every purchase is a vote and every vote counts in the calculation of market participants as to what should be supplied to consumers.

The true democracy of the marketplace is a prototype for the way society as a whole could operate absent the interference of the political state and politics. At first encounter, the reaction to this idea is that it could not work as a foundation for all human social interaction. However, political democracy is not working either, as shown by the frequent wars involving countries operating under political democracy, and the extreme and growing financial instability of political democracies. Adopting the democracy of the marketplace as the foundation for society could eliminate the conflict and dissatisfaction inherent in political democracy. How this could be done is introduced in a preceding chapter entitled “Replacements for the Political State,” a subject that will be examined further in some following chapters.

While Galambos understood that the free market is the only means capable of supporting a dynamic, advancing civilization, he realized that creators of primary (intellectual) property are not well treated in the marketplace. Unfortunately, society has not developed means of enabling the creators of primary property to get their innovations into the marketplace in a way in which they can be compensated commensurate with the long term value of their creations and protected from misuse or unauthorized use of intellectual property. Remedies for this shortcoming in protecting innovators is a subject to be taken up in forthcoming chapters of this book.

TEXT

Voluntary exchange

One’s needs are obtained by voluntary exchange with others. People work and with the income from work they buy what they want from others, whether it is food, clothing, a place to live, a television, or a pencil.

In deciding what property to acquire, whether necessities or luxuries, people have to make choices. Their wants are potentially insatiable, but their acquisition capabilities are limited because they have only a finite amount of resources in the form of time, energy, and assets.

When it comes to acquisitions of property, people apply a subjective view of value. That is, what is valuable to a person depends upon his needs, wants, preferences, ability to pay and available alternative choices.

The Austrian school of libertarian economists deserves credit for developing the idea that value is subjective. ¹ The Austrian economists’  theory of subjective value is a theory, not a hypothesis, because it has been thoroughly corroborated by observation and logic. A competing idea, the labor hypothesis of value, is that all things owe their value to the amount of labor that goes into their production.

The falsity of the labor hypothesis of value is so easily demonstrated that it is rather startling that people still cling to it. Do you value a product by considering how much labor it took to produce it? You can observe that no matter how hard someone works at something, if the effort results in a product or service that is ineffective consumers will value it less or not at all. For example, if an automobile mechanic or plumber fails to make repairs properly customers will stop patronizing them. Over the past forty years or so, the labor of American auto workers may have been just as hard, skilled and diligent as that of Japanese and German auto workers, but car buyers in America and around the world valued the Japanese and German cars for their higher quality and better reliability, not for the labor involved in making the cars.

While recognizing the correctness of the Austrian economists’ theory of value, Galambos states that the theory of subjective value can be derived also from his postulates of volitional science, as follows. Galambos’ first postulate is that “All persons live to pursue happiness.” The second corollary to that postulate is that “All persons live to acquire property,” which they value subjectively according to their individual preferences.

The subjective nature of value is demonstrated by the fact that the last statement, that all persons live to acquire property, would not be correct if it meant only that people live to acquire what is usually called property, namely tangible assets and financial assets. Galambos calls these “secondary property” because they are derived from primary or intellectual property which is thoughts, actions, self-esteem, satisfaction, ability to comprehend, etc. The great physicist and philosopher Albert Einstein was not acquisitive when it came to secondary property. However, he was highly motivated to acquire primary property in the form of the knowledge that became the subject of his scientific discoveries.

Predominant among the greatest values created by the human race are the values created by innovators, ranging from those who discover the laws of nature to those who use such discoveries to develop the technologies and labor-saving devices that in many parts of the world have greatly augmented productivity, the comforts of life and the standard of living. Unfortunately for humanity, the greatest of such values, those of the scientists who discover the laws of nature, are the least well rewarded, if they are rewarded at all. To remedy that miscarriage of economic justice was one of the factors inspiring and motivating Andrew Galambos to develop the ideas set forth herein. Rewarding innovators in proportion to their contributions is a principal subject of the part of this book to be devoted to an exposition of the ideas in Galambos’ lecture course entitled V-201.

Money

The development of money has enormously facilitated exchanges of goods and services, by obviating the cumbersome and limited exchanges available through barter with nearby people. Today, money enables a global marketplace to exist, where one may make exchanges indirectly with people one never meets or even knows who may be located anywhere in the world.

Ideally, money has four characteristics. It is:

1. A medium of exchange
2. A unit of account
3. A store of value
4. Liquid (meaning that it can be exchanged for anything else without reducing its own value)

Today, in every country, the dominant money is a “fiat” money, i.e., a currency represented by paper or electronic means issued by a state monopoly that must be accepted in payment of all debts, public and private. The word “fiat” derives from medieval Latin, meaning “let it be done.” While state-issued fiat money, including the U.S. dollar, continually loses value—a subject to be discussed in a later chapter—as long as the loss in value is not too rapid, fiat money serves as a medium of exchange.

Prices

Prices provide important information to everyone: producers, consumers, entrepreneurs and investors. Prices guide economic decisions. It is through comparing prices and one’s subjective estimate of value in relation to price that people are able to make choices on how to deploy their resources, in everything from shopping at the grocery store to deciding what line of work to pursue. In a market free of coercion, prices are an amazingly effective, constantly updated stream of information that signals the relative availability and desirability of all goods and services. Everyone, producers and consumers alike, can  access it easily.

The law of supply and demand

Most prices fluctuate constantly in a free market. Sometimes a shortage or a surplus of a commodity may develop, increasing or decreasing prices above or below their usual range.

Over the years there have been shortages or surpluses of commodities, for example sugar, corn, wheat, lumber, and petroleum, to name just a few. When shortages develop, prices rise and it becomes profitable for producers to increase production to take advantage of higher prices. Conversely, when surpluses develop, producers who are only marginally profitable tend to cut back on production to minimize or avoid loss; and profitable producers may withhold product from the market until the price rises, rather than selling a valuable commodity at a price they deem too low.

When prices are high, calling forth increased production to take advantage of the higher prices, the increased production eventually causes lower prices because a high price causes demand to fall. Conversely, when prices are low and reduced production has reduced supply, there will be increased demand that brings about rising prices.

In the long run, there will be price fluctuation around an equilibrium point, where supply and demand are in relative balance. Any time there is an imbalance, operation of the law of supply and demand will bring it back towards balance.

Galambos posits that the law of supply and demand is a natural law. Therefore, it cannot be repealed by political action. It operates whether or not politicians like the result, as shown by the immediate or eventual failure of price controls wherever and whenever they have been imposed.

Although the law of supply and demand is basic to economics, it is also derivable from volition. People, in their pursuit of happiness, seek to acquire property. In doing so, they make an implicit calculation of the ratio of price to their personal subjective determination of value. Thus, they tend to buy less sugar or gasoline when prices are high and more when prices for these commodities are low. Not everyone responds in this way to price fluctuations, but enough do to bring about restoration of relative price equilibrium where supply and demand are balanced.

A true democratic concept of voting

The word “democracy” means literally rule of the people, which is the meaning of the word in the original Greek from which the word democracy is derived. Interpreted as Galambos does in his theory of volition, democracy means that everyone rules only himself and his own property. That is derived from and compatible with Galambos’ definition of freedom as that societal condition where every individual is one hundred percent in control over his or her own property and has no control over property of others, unless it is with their consent. This definition of freedom requires not majority rule but rather self rule.

In the case of voluntary exchanges, each person can make his own decisions about his economic life without interfering with anyone else. It works through a true concept of voting. A vote means a choice. Choices in the market place of voluntary exchange are, in effect, votes for the products and services of one’s choice. This was explained by Ludwig von Mises in his economic treatise, Human Action, and in an opinion editorial by Robert LeFevre ² published in the Orange County (California) Register in 1962.

Von Mises said:

“In the political democracy only the votes cast for the majority candidate or the majority plan are effective in shaping the course of affairs. The votes polled by the minority do not directly influence policies. But in the market no vote is cast in vain. Every penny spent has the power to work upon the production processes. . . The decision of the consumer is carried into effect with the full momentum he gives it through his readiness to spend a definite amount of money.” ³

Robert LeFevre expanded on the idea expressed by von Mises as follows:

“In the marketplace you go into a store and buy a can of beans that is put out by [Company A] . . . This is a ballot cast in the marketplace. This is your vote in favor the of the company you patronized. . .

“[L]et us see what happens as a result of your ballot cast in the marketplace. Your vote is tabulated by the storekeeper . . . This is called counting the inventory and knowing how much was sold of everything. He will find when he does his tabulation, that some (like yourself) have voted for [the beans of Company A].

“He will know this because he will have to re-order the [Company A] beans. Still others have voted for other brands, of companies [B, C, D, and E]. He will re-order these brands too in precisely the quantity he thinks necessary to take care of his customers in the future.

“What happens at the various companies which process these beans? The vote comes in, each time numerically different for each firm. Each firm is encouraged by each vote cast. [If there are enough votes for a company’s brand] such encouragement leads it to continue the process by which it pleased you or others.

“Let us suppose that Brand A, the kind you voted for, was the most popular. Let us suppose that this brand got 100 votes, each of the other brands getting fewer than 100. If there was [political-style] democracy in the marketplace, this would mean that an order would be issued which would say in effect, ‘Only Brand A need be processed any more. The voters have clearly shown that X brand is the best bean. Therefore, all other brands are hereby discontinued.’

“But we don’t have [political] democracy in the marketplace. We have [the democracy of the marketplace]. Therefore, even though Brand A proved to be the most popular, others were popular enough to encourage them in some degree. So, all firms which were voted on favorably enough continue to produce their product.

“Your action in buying Brand A does not compel [anyone else] to purchase Brand A. . . Let us suppose that [some others] happen to like Brand B. They cannot prevent you from buying Brand A and you cannot prevent them from buying Brand B.

“This is true democracy. It is the process wherein each governs each. This process is always moral and provides the greatest good, the greatest variety, and the lowest prices for the largest number.” ⁴

Most people upon initially encountering the foregoing concept of voluntary exchange as the source of freedom and democracy will think immediately that it could not work as the sole mode of human governance. But what we have now with majority rule political democracy is not working, witness the numerous wars throughout the history of political democracies and the financial difficulties or impending bankruptcy of every modern political democracy which has evolved into a full-fledged welfare state. ⁵

COMMENTARY

Greece is now, as of 2012, an example of financial failure of a political democracy, but it is far from the only example. Since Greece joined the European Union and adopted the euro as its currency in 2002, the Greek state has incurred large debts payable in Euros, but it cannot pay those debts. So the Greek state is repudiating its large debts to the banks of other countries and receiving life support in the form of bailout money principally from Germany, the most prosperous member of the EU.

Germany itself suffers from some of the same problems that trouble Greece and other countries including, but not limited to, unfunded future liabilities for social welfare programs, and large banks which would fail without the indirect support of the German state using taxpayers’ money to bail out countries, such as Greece, which owe enormous sums to German banks.

In the United States, many of the states such as California, New York, and New Jersey to name just a few, have terrible financial problems due to a shortfall in tax revenues compared to state expenses, especially retirement and health care obligations for state employees and the poor under the joint federal and state welfare program known as Medicaid. A few smaller American cities have declared bankruptcy or are on the verge of doing so as of early 2012.

The American federal state has large debts which for the past one hundred years have been growing significantly faster than America’s production (as represented by Gross Domestic Product). The real total U.S. debt, including unfunded obligations for future payments under a variety of entitlement programs including, but not limited to, Social Security and Medicare, is at least four times as much as the acknowledged debt.

The U.S. federal and local states must get their financial houses in order, or they will end up in big trouble. While that is a prospect not to be desired by even those most dissatisfied with the U.S. state, it may be inevitable given the failure to deal with the state’s financial problems by the leaders of both major political parties. If the U.S. becomes bankrupt, no other country is sufficiently large, wealthy or motivated to bail out the U.S.

In Chapter 1 entitled “Replacements for the Political State,” examples are given of many private services already existing in activities usually considered the exclusive province of the state. Accordingly, with continuation of the deterioration of state services, significant numbers of Americans may turn to the free market and private enterprise to fulfill more and more of  the functions that the state is performing badly, if at all.

Private services as a substitute for the American state could be a great financial bargain compared to the current and projected future costs of federal, state, and local jurisdictions.

As of 2010 the total spending at all levels of the state in America was $5.636 trillion, equal to about $18,000 per capita, and about $49,000 per U.S. household. But that is only part of the cost of the American state. In addition, as of 2011 there was $46 trillion in unfunded liabilities of federal entitlement programs including Medicare, Social Security and several other federal programs and another $3 trillion in unfunded liabilities of state and local jurisdictions for employee retirement and health care. ⁶

The term “unfunded liabilities” means the amount that the federal and local states have  promised in benefits, looking indefinitely into the future, minus the payroll taxes and premiums the federal and local states expects to collect. It’s the amount the federal and local states ought to have in the bank today, earning interest, for these entitlement programs to be solvent.

To fund similar future liabilities for a private enterprise would require annual payments (called amortization) in an amount sufficient to pay for the liabilities over a period not longer than thirty years. ⁷ Amortization payments resemble the payment of principal and interest on a real estate mortgage over the long term.

If the American state in aggregate, including all jurisdictions, were to amortize the $49 trillion of unfunded entitlement liabilities over thirty years, the annual payments would be at least $2.3 trillion, and over the long term closer to $3.3 trillion.  This assumes an interest rate of 3% over the next five years and 6% thereafter, such interest being a normal incident of installment amortization of long-term liabilities.

An additional $2.3 trillion of annual amortization costs would raise the cost of the state  to the American people to about $26,000 per capita and about $70,000 per household. That is the true current and projected future annual cost of the state providing its various services. To fund these costs, in 2010 all levels of the American state collected taxes totaling only about $15,000 per capita and only about $41,000 per household. The difference between state spending and revenues is accounted for partially by borrowing and partially by not funding annually the amounts necessary to amortize known unfunded liabilities for retirement income and health care. Any private business with expenses and liabilities of that kind, comparable to its revenues, would be considered bankrupt. ⁸

In effect the federal government social welfare programs are the world’s largest Ponzi scheme. The term Ponzi scheme originated with Charles Ponzi who in 1919-1920 in Boston concocted a plausible sounding story to support his offer to pay customers large profits in a short time, on the order of 50% in ninety days. After Ponzi made good on that promise to early customers, money poured into his operation. The scheme pulled in large sums of money from Boston and nearby states.

State and federal authorities looked into Ponzi’s operation but were fooled for awhile, until growing public suspicion caused customers to demand return of their funds. Then the scheme collapsed in a short time. Ponzi schemes occur frequently, as people abandon caution in pursuit of supposedly safe and  large profits offered by fraudulent operators.

Federal social welfare programs are like a Ponzi scheme in that money collected from current taxpayers is immediately paid out to current recipients. There is no amortization fund. At some point all Ponzi schemes run short of new money and collapse. Any private insurance company engaging in an operation like the federal social welfare programs would be exposed and put out of business by the state very quickly.

Note: It is unlikely that in 1935 and 1965 Presidents Franklin D. Roosevelt and Lyndon B. Johnson and the members of Congress who caused enactment of Social Security and Medicare believed them to be Ponzi schemes. Rather, it is likely that they never thought about the long-term funding of these programs, and that if critics pointed out the problem of long-term sustainability, the Presidents and the legislators paid no attention, given the political appeal of these programs.

A reliable commentator, David M. Walker, calculates that on a per household basis, the total liabilities and unfunded promises of the U.S. federal state were $1,391,605 as of 2011. Mr. Walker served as the seventh Comptroller General of the United States and was the CEO of the U.S. Government Accountability Office from 1998 to 2008. ⁹

Americans can consider how much of what the state provides they could provide better for themselves by obtaining private enterprise services if the average household had available for discretionary spending the $49,000 in taxes for current spending, or the $70,000 total that the American state should be spending to keep all its promises in the present and for the future.

Americans have little choice now but to pay the taxes and accept the services of the state. If Americans did have the choice to spend this $49,000 to $70,000 per household:

• Would they choose private security or the local police?
• Would they choose a private school for their children or the local public school?
• Would they choose to provide for their retirement through their own savings plan or via Social Security?
• Would they choose private health insurance for their older years or rely on Medicare?

We know already that some Americans, especially businesses, choose private security; that many Americans choose private schools if they can afford them; and we know that many Americans realize Medicare and Social Security will be unaffordable for future generations. So, despite paying taxes for security and education, many people and companies pay again for such services in the private market–a telling commentary on the quality of services the state funds through taxation.

In a preliminary chapter entitled “Replacements for the Political State” there is a discussion of private vs. state services in a variety of areas once considered the exclusive province of the federal or local state. In chapters to follow there will be an expanded discussion of the relative efficacy and cost of private vs. state provision of services. For now, suffice it to say that there is nothing the state does, including national defense, that cannot be done at lower cost and with higher quality by private enterprise.

The deficiencies of the state in this regard were summarized as follows by the famous economic historian John Kenneth Galbraith:

“You will find that the State is the kind of organization which, though it does big things badly, does small things badly, too.” ¹⁰