The Conclusion of Market System

One of the best-known passages in the Wealth of Nations describes how the pursuit of self-interest leads to social benefit:

It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity, but to their self-love.

In retrospect, we see that the imposition of centralised decision-making on an

economy can achieve short-term successes. Among them might be included the

transformation of the Soviet economy under Stalin and the restoration of the

Chinese economy under Mao. But history suggests that the successes of such

centralisation soon reach a limit. The postwar experience of Central Europe

confirms this conclusion. Decades of socialism left this region weakened by

an inefficient allocation of resources, by the erosion of innovation and by

technological obsolescence.

One striking consequence of the neglect of the price system by the socialist

countries was the dramatic contrast between energy consumption patterns in

Eastern and Western Europe. Between 1965 and 1985, the energy intensity of GDP

fell from 0.52 to 0.38 per cent in the West, while actually rising in the East over the

same period from 0.73 to 0.78 per cent._9 Because internal energy prices in the Eastern economies were not set at the prevailing international levels, the increase

in world energy prices in the early and late 1970s, ‘signalling’ the need for energy

conservation, was not transmitted to their firms and consumers. As a result, industrialenergy intensity in the 1990s was five times higher in Poland than in the US,and five times higher in Hungary than in Germany. The high level of energy

intensity not only implied a waste of energy due to underpricing, but also encouraged

the growth of heavy pollution industries and gave insufficient incentives to

the development of less energy-intensive methods of production.

Writing of the contrast between East and West Germany, John Kay has

remarked that:

Whatever the superficial attractions of central direction and control, in practice it literally failed to deliver the goods. The immediate contrast between East and West Germany provided as close to a controlled experiment as social science is ever likely to see. The results of that experiment, and its dramatic end, imply that for the foreseeable future the private value-maximising corporation will be the principal engine of commercial activity in Europe.

The ‘private value-maximising corporation’ is the same as the profit-maximising

firm which determines supply. Given the increasing range and scope of the

market system, it has become more important than ever to understand this

system and the role of the firm in its working.

Where the institutional prerequisites are absent, however, market capitalism

can get a bad name. Essentially, the point is that the free market will not perform

efficiently without moral restraints. A legal system based on the principles of

profit maximisation would deliver little justice. Judges would make judgments on

the basis of the highest bribes. Paradoxically, the market system and the pursuit

of self-interest will operate effectively only when a significant proportion of the

workforce puts duty and propriety ahead of personal advancement and prosperity.

It has often been remarked that the definition of property rights based on the

market system depends precisely on the lack of universality of motivations of the

market system. An efficient economy needs an incorruptible judiciary and civil service. An interesting question is whether the market itself tends to undermine some ofthe values of trust, incorruptibility and restraint which we have identified as

essential to its proper functioning. Evidence from the history of economic development suggests that, while it may be relatively easy to pull down the monolith

of central economic control and to reinstitute private property and free exchange,

it takes longer to develop the cultural and social structures necessary to sustain a

truly successful society.