What if we had the following economic system?

This system would shower the globe with free goods day and night, asking nothing and giving nearly everything. Most of what it generated would be free goods, and every living person would have access.

Anyone who amassed a private profit would do so only because he or she served others, and the system would require this person to cough up communally owned information: Everyone on the planet would know the reason for anyone’s success.

It would serve all races and classes this way. It would serve the common man slavishly and knock the elites when they become proud and arrogant. It would make it beneficial to everyone to include ever more people in its productive potential and give everyone who wants it a stake in the outcome.

That system has a name. It’s called the free market. This is more obvious in the digital age, but the proliferation of free goods has always been a major feature of capitalism. It’s just that people haven’t really talked about it, though Robert Murphy’s outstanding Lessons for the Young Economist does an excellent job.

In fact, the free market is the most misunderstood idea out there, by its detractors and, just as often, by its proponents as well. As for the characterization of the market as a utopia for profiteers, moguls and scamsters, one doubts that people who think this way have ever really tried to make a buck in a competitive system. It’s hard as heck. The whole process is seriously tilted against private gain at public expense.

Now, I could go on with a theoretical argument here, but sometimes personal examples get the point across better. To be sure, we do not live in a free market now; instead, the world’s largest and most intrusive apparatus of intervention interferes with ours. But there is enough of a market remaining in this world to clue us in to how it works, and sometimes the simplest retail example suffices.

So let me tell you about the barbershop I stumbled into yesterday. The people there cut hair. But they also have pingpong tables, darts, pool and free beer that you can drink at a bar.

I walked in with a friend and stood marveling at the pingpong table and asked: “Can we play?” They said, “Oh, sure.” So we played and played.

Finally, after a while, I asked, “Pardon me, but can I have a haircut?” They were pleased but surprised since they thought I was just another person who wanted to only play pingpong! They were perfectly happy to let me play for free.

The haircut happened; I hung around for a beer, continued to be dazzled by this extraordinary entrepreneurial venture and finally asked if they had a Facebook page. “Of course,” came the answer. I took a picture, posted it on my page, liked their page and, within minutes, people all over the world were talking about this little place. “Salon de barbier avec tables de pool et pingpong, dards et bière gratuite,” said one share in France that swirled around that network.

Now, consider this: Did I do the place a favor? The owners probably think so. It is a new business just starting out. It needs advertising and promotion. On the other hand, look what I did: I immediately alerted every other potential competitor to a great idea to get customers in the door. Now every barbershop in town can “steal” the idea. They can buy a pingpong table, grab a case of beer, put up a dartboard and off they go.

The barbershop would absolutely love to find a way to reach possible customers without also giving away its tricks to its competitors. But you know what? This is not possible. One comes with the other. Information is a free good; once it is released, it can be consumed and used by anyone who runs across it.

What then happens to the competitive advantage enjoyed by the new and struggling place? It is seriously threatened. It faces wicked competition, even from big chains that can implement these suggestions in a few days at very little cost. The thing that made the new place cool and great is now copied by everyone else. If this happens, the new place will face new pressure on its bottom line. It will be forced to innovate again.

To be sure, every other barbershop in town is unclear whether this pool-and-darts thing really is the magic bullet to achieve success. So rather than emulate that strategy right away, others might wait to see how it works for the first adopter. It might flop. Or it might be amazing. If it is amazing, others will adopt the practices, but there’s a problem: The first mover has the advantage. It already has a loyal clientele and a fan base.

Billions of bits of information (free goods!) hit business owners every day that allow them to copy the successes (and failures) of others. Knowing which to implement and which not to is an essential part of the job. It might even be the hardest part of the job.

But here’s the point I’m making: It is not possible to succeed in this market without giving away the “secret recipe” to success. Fortunately, there is no patent or copyright on things like putting a pool table in a barbershop, so the government can’t stop learning from taking place. And this is the way it would be in a pure free market in every industry. To succeed means first to give — giving goods and services to customers (this is the key to profitability) and then giving away the method by which you succeed (or the reason for your failure) to everyone in the world who cares. The very act of doing commercial enterprise — which always tends toward being an open-source undertaking — make your methods an object of study.

The information you give away is the price you pay for the prospect of profits. But those profits are always being threatened by competitors who emulate your successes. This means that you can never rest, you can never be satisfied with the status quo. You must innovate and revamp on an ongoing basis — and you have to do this with an eye to bringing the public what it wants in the most-efficient possible way. This is what gives the market such dynamism, such forward motion, such an innovative spirit.

Chances are that you are reading this article in a venue that is perfectly free to you. Maybe you saw it on a website you did not pay for or saw it linked on a social network that you do not pay to use. These are free goods, the means that capitalists use to entice your interest in what they are doing.

But these free goods are only the start of what the market offers. The most-valuable free good that that market is cranking out by the minute is the ocean of information about success and failure, about what people want and don’t want, about what works and what doesn’t work. This vast reserve of information is being poured out globally and constantly, and it is like a relentless shower of blessings on civilization. Digital networks have increased the blessing by degrees no one ever imagined possible.

The example of the barbershop might not seem like much, but if you understand it — really understand it, and the underlying dynamic it reveals — you understand the thing that has lifted the entire world out of the state of nature into the glorious prosperity that is currently spreading all over the world. This is the market at work — that network of exchange, cooperation, service, innovation, emulation and competition that makes the world tick, all in the service of human well-being. The more market we have, the more progress we will see.

So let’s ask the question: Why is it that so many people think they are against the free market? It must be because they don’t really understand it. I would first suggest Robert Murphy’s book. Then I would invite them to join me for a beer and a game of pingpong and ask what they think made this little slice of heaven possible?

Regards,

Jeffrey Tucker,
Executive editor, Laissez Faire Books

The Market That Really Matters was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

A closer look reveals that you can learn so much about the way the world works just by looking at this history of this pliable plaything.

Who invented it? There are several competitors for the title, and at least two patents. Earl L. Warrick, who died in 1992, always claimed that he and a colleague at Dow Corning, Rob Roy McGregor, invented it in 1943. But the claim is so uncertain that Warrick’s New York Times obituary even hedged. It appears that James Wright, who was a researcher at General Electric, also has a claim and a patent dated from 1944 to prove it.

More likely, it is a case of simultaneous invention. It turns out that this is not unusual in human history. It is actually the norm. In fact, if you look at the history of just about anything from the cotton gin to the telephone to flight itself, you find a raging dispute over who was first. Patents settle nothing: The bureaucrats approving those things mix things up constantly, and much depends on how the lawyers write them.

Lesson No. 1: The legend of the lone inventor in his lab is a myth. We all breathe the same air of ideas. Those ideas get mixed and remixed. Researchers in the history of invention have found that innovations occur on the margin and simultaneously over large parts of the world, a bit of improvement here and there, all stemming from trial and error and the targeted purpose of the product. This applies not only to products, but also to ideas.

To freeze one stage and isolate one inventor with a government monopoly grant of privilege (the patent) is wholly artificial and injurious to the process of discovery. This is why the lawsuits by Apple against Samsung (among a million other wasteful patent lawsuits) are so pointless. Everyone “steals” from everyone else, except that it is not stealing to learn from others, adapt, improve, remix. That’s how society advances.

In any case, the scientists who discovered the initial putty imagine revolutionary uses for the new rubber substitute. Guess what? No one ever found such a use, unless you include the desire to make a quick and rubbery copy of your favorite Sunday comic. The main use of this stuff turns out to be pretty much what it was in the lab: a fun thing to play with.

Lesson No. 2: No man is smart enough to foresee the most highly valued economic contribution of any good or service. We think we know, but we do not. The only way to discover economic value is to put something out there in the marketplace and see what happens. Most of the time, we are surprised.

In any case, Silly Putty languished in the world of labs and science until the owner of a toy store in New Haven, Conn., Ruth Fallgatter, saw some potential and put it in the catalog. It was a smash hit, selling millions, for adults at first and later to kids. Even then, Ruth didn’t quite see the possibilities here. It took the marketing executive that she hired, Peter C. L. Hodgson, to push it to the limit and become the first Silly Putty millionaire.

It wasn’t easy, however. Everyone told Hodgson that he was crazy, that this stupid stuff had no use. He forged ahead in any case, making more millions in the early fifties. Then the Korean War nearly shut him down with its rationing of essential ingredients. Still, after the war, he persisted and adapted to the changing market.

Lesson No. 3: Invention is never enough. You need marketing to make something wonderful and change the world. Nothing sells itself. You can invent the greatest food, drink, drug or shoe in the history of the world, but it will languish unless there is someone around to take the risk to get it to market. In the course of this marketing, the product often changes. Invention is overrated; marketing is underrated. And even when there is a successful push, it still takes a special entrepreneurial mind to see a possible future of continued success.

By the 1960s, Silly Putty was huge, a massive seller all over the world. It was the classic case of a fad gone wild, except for one thing. It wasn’t a fad. This stuff continues to be an integral part of the cultural experience, generation after generation. In fact, consider this: How many consumer products that you know have been largely unchanged for 50 years and yet still sell millions per day?

Lesson No. 4: Nothing can be dismissed a priori as a fad, and nothing can be declared a priori as a valuable item destined to be a classic. There is no way to know for sure. This is because what we call value is ultimately bound up with the individual human mind. Value is subjective, as the Austrian economists say. We make value by our thinking, and our thinking is notoriously unpredictable. What is useless and what is useful is bound up with human experience. No one can know in advance, which is one reason that central planning is impossible.

Peter Hodgson, the world’s great champion of this stuff, a man whose whole life was dedicated to selling a stretchy, bouncy substance, died in 1976. The next year, the product and the marketing apparatus was taken up by the same company that sells Crayola crayons. It remains an amazing success, unchanged from its long tradition.

Lesson No. 5: Corporate takeovers do not spell disaster. They are sometimes the best means for preserving a tradition and taking it to a new level. It all depends. In the case of this one product, Silly Putty has been an amazing seller for decade after decade. Even for huge corporations, the rule still applies: If it isn’t broken, don’t fix it.

Looking from the outside in, taking on the role of a dictator who knows what we need and what we don’t, one would never say that Silly Putty was an essential contributor to life just because, for some odd reason, we are intrigued by its capacity for both bouncing and stretching. And yet there it is — a staple of civilization as we know it. And why? It makes us happy. That’s a good enough reason.

Regards,

Jeffrey Tucker

Economic Lessons of Silly Putty was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

So what? Well, none of this could have happened 10 years ago. Not only that, you would probably wouldn’t have understood the paragraph in the slightest because it contains words and actions no one had heard of. Had I told you in 1992 that in 20 years, virtually anyone would be able to speak in wireless real-time video to anyone else on the planet, even to the point of sharing a real-time digital experience, you would not have believed it.

And if I had added that the technology was not outrageously expensive, but rather being carried around in the pockets of students and commuters everywhere, this would have seemed too outrageous for science fiction. What amazing force in the universe hath rained down such blessings on us mere mortals?

The truth is that we all live in a world today that would have been unimaginable to us only very recently. It is so much woven into our lives that we don’t think about it much anymore. And contrary to the rap on the digital age, that it is all about geekery and gadgetry, the real driving force behind this innovation is the flesh-and-blood human being and the oldest desires known to humankind (such as wanting to stay in touch with family).

Another quick example. I was emailing with a U.K. choir director two nights ago, and I mentioned a book of chanted music. He hadn’t heard of it, so I sent him a link, from which he downloaded the material (that magic click that creates a copy!). This morning, his choir sang the piece in church halfway around the world, and he let me know that it was fabulous.

Here we have it: digits flying over oceans in a matter of seconds, and then embodying themselves in beautiful music, sung now with the same human energy as music was sung in the ancient world, that transforms real lives. The person kneeling to prayer didn’t know and didn’t need to know how the music arrived there. The technology is just the means; the end is the improvement of human life.

Such cases like this are only a tiny snapshot of two things I can briefly recall. Just today so far, I’m sure I’ve read articles I never would have seen, talked with people I would have long ago lost touch with, found out about events that would have remained forever unknown to me, connected with someone who found something I said interesting enough to consider…and just now, I recall that I heard word that a friend with asthma is out of out a Shanghai hospital all safe and sound. None of this would I have known only a few years ago.

Again, ask the question: What is causing all of this amazing change? What is the driving force, the source of the manna, the wellspring of all this avalanche of human progress?

I’ll tell you what is not causing it: politics. It’s the great lie, the most-gigantic drain of valuable human energy ever conjured up in the mind of man. What is politics but a grand argument about how we should rule each other? Meanwhile, every step forward in history has come not from this task, but a completely different one.

American politicians are always running on a platform of change. They explain how their policies will make your life better. They map out timetables. They present a portrait of a future. Above all else, they presume that the future is theirs to control, and voters often go along with this idea. As an example, look no further than the history of the State of the Union address.

What if none of it is true? Just think about education. Everyone has a plan for how to improve what exists. So it has been for a hundred years. Meanwhile, the private sector, through physical and digital technology, is reinventing the entire enterprise from the ground up through every possible means. This decentralized, private-sector-driven, technologically sophisticated education reform is making it almost impossible not to be educated about something with each passing hour.

Online academies are opening by the day. Universities are putting their courses online for free. For-profit companies are distributing every manner of teaching tool one can imagine. For-profit learning centers are opening in every town, all making a buck from teaching kids what the public schools have failed to teach. For that matter, the History Channel alone offers more sweeping programs than any public school textbooks two generations ago.

Anyone in the world can be a teacher to the world today, with a laptop and an Internet connection, and so, too, anyone can be student.

It’s true in health care reform, too. For all the problems in the pricing system and terrible insurance system, health care is getting better, mainly due to private-sector innovations. The best radiologists in the world can examine your scans in minutes, no matter where they actually happen. Access to medical information is no longer trapped in a dusty book but flies all over the world from hand-held devices. Error is more likely to be corrected this way, saving and changing lives.

Society is not waiting for the politicians. When you listen to what they say, when you watch what the bureaucrats do, when you look at what the agencies are regulating, you suddenly realize that the political monstrosities that burden the world are hopelessly out of touch with the kind of progress that people are experiencing in their daily lives now.

Politicians can make the world a worse place, to be sure. But if you look at the actual trends that are driving change in a positive direction in our world today, none of them is inspired by political initiative. They take place outside the public sector, and even outside the purview of the politicians and bureaucrats. Sometimes it seems as if the political class is clueless that the world has long ago moved on.

What is driving the world in a forward direction? It is people connecting with people through free association, communication, money exchange, enterprise, risk taking, commercial aspirations and the practical arts. And from these forces, we are newly discovering the wonderful fruits of civilization: arts, music, philosophy, faith.

And truth. Truth above all. The truth that is all around us, the one that the public-sector machinery somehow cannot and will not see, is that global society is making a future for itself without the help of the world’s self-described public servants. The state in all its manifestations struts and preens — builds monuments to itself and waves its flags — but when it comes to really making change, we must look elsewhere.

Regards,

Jeffrey Tucker

How Change Happens was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Innovation, Savings, and Demand

“From a fishhook to the space shuttle, every material human advancement has been the result of a combination of technological innovation and capital savings. In other words, we are now building on the savings and innovation of our ancestors.”  — Victor Sperandeo, Trader Vic II: Principles of Professional Speculation

THIS PAST WEEK, the April issue of MIT’s Technology Review hit my desk. Its cover story this month is “World-Changing Ideas…25 Innovations From Around the Globe.” Among the more interesting:

What do these developments have in common? They are all focused on natural resources, and they highlight the intersection of three key forces that form the heart and soul of capitalism. What are those three forces? Drumroll, please…they are innovation, savings, and demand.

• Brazil is making a major commitment to biodiesel, an oilseed derivative with strong potential as a long-run alternative to fossil fuels.
  
•  In China, Shanghai’s Solar Energy Institute is focused on advanced solar technology. The ultimate goal: a home with 70% of energy needs met by the sun.
  
•  Chile hopes to increase its copper reserves substantially through genetic advances in biomining, a process that uses bacteria (rather than noxious heat or chemicals) to extract copper from the ore.

Let’s go over them briefly, because a proper understanding of these forces is imperative for investing success.

The Heart and Soul of Capitalism: Innovation

Innovation is perhaps the most intuitive of the three forces, but it is still overlooked or misunderstood. Through innovation, we become more productive and are thus able to reap greater output from the same or less input. In a rare instance of serendipity, the innovator is able to increase his wealth while increasing the productivity of others at the same time. The first fisherman to use a net would have had substantially greater numbers of fish to trade relative to his peers, without exerting greater effort. Once the idea caught on, greater quantities of fish would be available to the benefit of all. Alternatively, if greater quantities of fish were not desired, then fewer fishermen would be required to bring in the necessary catch, allowing some of them to pursue other productive pursuits. With every additional innovation, we are given the beneficial choice between greater levels of output or a surplus of resources available for alternative pursuits. And so we continue trading up to the present day, where the innovative fisherman’s descendants find themselves engrossed in solar energy and biomining.

Down through the centuries, innovations have shaped history and accelerated progress in sudden jumps. The plow led to agriculture-based societies rather than hunter-gatherer ones, which in turn created the locational stability required to build cities. Gunpowder led to the demise of feudalism and the first stirrings of democracy by bringing cheap weaponry to the masses. The printing press fueled the Protestant Revolution, which in turn sowed the seeds of Western-style capitalism.

This highlights another characteristic of innovation, namely, its incredible disruptiveness. When a promising new idea changes things for the long run, there are always vocal protesters in the short run. The term “Luddite” honors the memory of Ned Lud, a noted loser in the innovation process, who led mobs of workers in the destruction of British textile mills between 1811 and 1816 out of fear that they would destroy jobs. Ned has many descendants, in spirit if not in blood, and they are equally vocal today. Unfortunately for Ned and his descendants, the short-term pain of disruption is unavoidable, and in fact vital, in the pursuit of progress. In 1942, Joseph Schumpeter immortalized the concept by coining the phrase “creative destruction.”

The Heart and Soul of Capitalism: Savings

Savings are required to pursue innovation. Innovation is essentially an investment in future production, and one cannot make an investment without savings. This investment does not have to be in the form of money. It can be time, energy, education, other opportunities forsaken, or a number of other things. And like any investment, there is risk involved. When our intrepid fisherman first conceived of the idea for his net, he had to make a number of investment decisions. Was this idea worth pursuing in terms of energy and effort? Could he afford the time taken away from his regular fishing day? Did he have access and means to acquire the necessary materials? Would he have to budget time for trial and error as he tried different weaving patterns in the construction of the net? Was it worth the opportunity cost of foregoing other avenues of production? All these questions go back to savings (in the form of human capital rather than fiduciary), and a willingness to put a portion of those savings at risk. Without an available surplus of time, energy, and resources, the net would never have seen the light of day.

The immutable relationship between savings and innovation is now clouded because there are so many hidden links in the chain. Thanks to the modern application of credit, it’s tempting to forget that savings are still required to innovate. After all, don’t entrepreneurs borrow money to start businesses every day? Indeed they do…but it is still someone else’s savings they are borrowing (and putting at risk), as well as their own time, energy, and opportunity cost. Ah, yes, but what about fractional reserve banking and the stimulative “easy money” activities perpetuated by the Federal Reserve? Even here, the circle remains closed. When excess liquidity is pumped into the economy, it only serves to devalue the real savings that previously existed, like a watered-down drink not worth the inflated price.

Coincidentally, America’s great hope is that we will innovate our way out of the current savings straits. In essence, bulls are betting the next long cycle of innovation will pay off big enough to cover the current tab. No matter how you slice it, savings are still required, be they already earned or mortgaged against the future. The only problem is we aren’t investing our borrowed funds in ideas, education, and means of future production; we are loading up on DVD players and SUVs while our next generation’s education rankings slip down the board.

The Heart and Soul of Capitalism: Demand

Demand is where the rubber meets the road. Without it, the innovations produced by way of savings have no benefit. In the case of natural resource development, demand usually comes first, spurring innovation through a sense of urgency or a clear long-range price advantage. When it comes to consumer innovations, like ATMs or iPods, the innovation usually comes first, with demand to follow once the value of the new technology or process is widely recognized. Either way, demand is the catalyst that ultimately allows the innovation to bear fruit. 

Demand is also important enough to stand on its own as an investment concept. As an investor, you can earn your keep simply by gauging fluctuating levels of demand properly. This, in fact, is how fortunes are made in commodity markets. By recognizing critical periods when demand is set to significantly outpace supply for a long period of time (or vice versa), it’s possible to make a great deal of money as prices wax and wane. The same applies to business expansion, in terms of applying a successful idea to a new city, region, or country. We don’t have to reinvent the wheel to make money; in fact, we don’t even have to improve on the wheel. All we have to do is uncover market opportunities where rising demand for wheels has not yet been met.

Of course, there are multiple factors that have to be taken into effect when considering potential demand. Among them are the level of competition, the economics of production, logistics of delivery, comparative substitutes, political risk, barriers to entry, potentially disruptive innovations, and so on. But when it’s all boiled down, the heart of the matter remains relatively simple. Economics deals with the allocation of raw materials and finished products that exist in limited supply, be they crude oil deposits, atomic physicists, or iPods. Demand is the root of the equation.

In part II of this series, we will take a closer look at innovations and economic factors in the world of natural resources. Through this lens, we will uncover some of the predictable ways in which innovation, savings, and demand tend to interact over the long cycle…and see how we can directly apply these observations in our relentless pursuit of profit. “The Death of May, 12 October 1949

And of course, comments and observations are sought with extra emphasis this time around, given my relative newness to the Whiskey & Gunpowder community. Let me know what you think – simply reply to this e-mail!

Justice Litle
March 23, 2005

“In the early summer of 1949 my daughter graduated from the Madeira School in Virginia, and shortly afterwards my wife and the children came to Switzerland, where we spent happy weeks at Pontresina and Saas Fee.  May said occasionally that she could hardly keep up with the children on walks; unfortunately, I paid too little attention to these remarks.  She was never ill, and I took that to mean that her health must be perfect.  In September she returned to Washington with the children, and I was to follow in November

“On 12 October, shortly after noon, May was stricken by a heart attack and died within a few minutes.  The two days that then followed must have been terrible for my children, who had been with their mother that morning; because of fog I was unable to arrive for two days.  I found the children grown up far beyond their years. 

“In my shock, I found myself questioning God’s will: why had my wife, who was so much younger than I, been torn away from me and the children?  Soon I came back to my senses.  Our marriage had brought me deep happiness in middle life.  I had to be grateful for that, bowed down as I was by present sorrow. 

“I pressed the children to me.  They tried to conceal their sorrow in order to comfort me.” 

The Heart and Soul of Capitalism: Innovation, Savings and Demand was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.