The Progress Mechanism
Economic progress comes from our ability to keep growing the value of outputs relative to the cost of inputs.
If an academic economist happens to leaf through my book, I’ll guess their thinking would go something like “OK, clearly a book for the general public, not the profession. The writer is very pro-free-market, so this must be a popularization of Austrian Economics” (AE, not to be confused with AI.)
I’m not sure whether one of the few Austrian economists in academia would consider me one of them or not. I end up in the same place, but I get there by a very different path through some aspects of the economy that Austrians seem not to have noticed. The fact that I don’t see certain strong arguments in favor of free markets being made suggests that, despite the odds, I might have come up with something original.
AE shows why free markets creates prosperity, but it mostly ignores the issue of who within the society benefits the most. AE’s biggest intellectual enemy is Marxism, which focuses on the alleged exploitation of the working class within a capitalist society and fails to notice that the free market generates rising affluence for most people. Perhaps that is why AE ignores which groups do relatively better or worse from the processes at work in a free market economy, assuming, correctly, that they all benefit, even if not equally.
That is a shame, because that leaves a great argument for free markets unmentioned. Change in living standards rather than in GDP is the best measure of society’s economic success. Looking at living standards, you see that capitalism does indeed come with a class based system for distributing the growing pie, but it is the exact opposite of what is commonly thought.
The view that capitalism is good for the rich but not the poor, although nearly universal, is wrong. Free markets operate almost as if they were specifically designed to benefit the poor more than the rich. Here is why:
The Progress Mechanism is my term for a universal pattern within capitalism. Economic progress comes from our ability to keep growing the value of outputs relative to the cost of inputs. That is the purpose of business investment, not just in new equipment and factories, but in R&D, engineering, and employee training.
The ostensible goal is higher profits from being able to offer a better product produced at a lower cost. But usually every competitor within an industry is trying to do that, so higher profits tend to be short lived.
Making workers more productive puts upward pressure on their wages, and while companies with big market share are happy to keep prices high even when costs go down, smaller competitors will do better if they start a price war, since greater market share gives them higher profits than higher margins on a small market share. The price war erodes the share of the big players, who eventually cave and cut prices too. For that reason, most companies in every industry are on a treadmill where they have to keep investing to avoid being the high cost producer who gets wiped out when a price war erupts.
People’s living standards increase when either their income goes up or when the prices of what they want goes down. Both of those are good, and the Progress Mechanism creates both.
But the impact of rising income and lower prices is not distributed equally. Let’s arbitrarily divide the country into the poor and the rich. The poor are those who must spend all their income to maintain their living standards. They live paycheck to paycheck and have little or no savings or credit. Their living standard is strictly constrained. Anything that reduces their income or raises prices forces them to buy less. By raising their pay and reducing the prices of what people buy, the Progress Mechanism directly benefits the poor.
Note that poor people themselves don’t have to save and invest even a penny to improve their living standards. They receive that benefit because of what businesses must do to stay competitive.
The rich are defined here as those with more than enough income and savings to buy what they want. If their income rises or prices decrease, that is nice, but it has no current effect on their living standards.
You may be asking, what price decreases? Prices have been going up forever! That has nothing to do with capitalism, but is entirely the fault our governments and the Fed, to be discussed in a coming post. As a preview, you’ll see why nearly all of the cost of government and its policies end up on the backs of the poor, no matter who or what is taxed.