There are basically only two ways in which economic life can be organized...

The ABC of a Market Economy

by Henry Hazlitt


There are basically only two ways in which economic life can be organized. The first is by the voluntary choice of families and individuals and by voluntary cooperation. This arrangement has come to be known as the free market. The other is by the orders of a dictator. This is a command economy. In its more extreme form, when an organized state expropriates the means of production, it is called socialism or communism. Economic life must be primarily organized by one system or the other.

It can, of course, be a mixture, as it unfortunately is in most nations today. But the mixture tends to be unstable. If it is a mixture of a free and a coerced economy the coerced section tends constantly to increase.

One qualification needs to be emphasized. A "free" market does not mean and has never meant that everybody is free to do as he likes. Since time immemorial mankind has operated under a rule of law, written or unwritten. Under a market system as any other, people are forbidden to kill, molest, rob, libel or otherwise intentionally injure each other. Otherwise free choice and all other individual freedoms would be impossible. But an economic system must be dominantly either a free or a command system.

Ever since the introduction and spread of Marxism the great majority of people who publicly discuss economic issues have been confused. Recently a very eminent person was quoted as denouncing economic systems that respond "only to the forces of the market place," and are governed "by the profit motive of the few rather than the needs of the many." He warned that such a system could put "the world's food supply into even greater jeopardy."

The sincerity of these remarks is beyond question. But they show how phrases can betray us. We have come to think of "the profit motive" as a narrowly selfish drive confined to a small group of the already-rich whose profit comes at the expense of everybody else. But in its widest sense the profit-motive is one that all of us share and must share. It is our universal motive to make conditions more satisfactory for ourselves and our families. It is the motive of self-preservation. It is the motive of the father who is not only trying to feed and house himself but his wife and his children, and to make the economic conditions of his whole family, if possible, constantly better. It is the dominant motive of all productive activity.
Voluntary Cooperation

This motive is often called "selfish." No doubt in part it is. But it is hard to see how mankind (or any animal species) could have survived without a minimum of selfishness. The individual must make sure he himself survives before the species can survive. And the so-called profit motive itself is seldom solely selfish.

In a primitive society the "unit" is seldom the individual but the family, or even the clan. Division of labor begins within the family. The father hunts or plants and harvests crops; the mother cooks and bears and nurses children; the children collect firewood, and so forth. In the clan or the wider group there is even more minute subdivision and specialization of labor. There are farmers, carpenters, plumbers, architects, tailors, barbers, doctors, lawyers, clergymen, and so ad infinitum. They supply each other by exchanging their services. Because of his specialization, production increases more than proportionately to numbers; it becomes incredibly efficient and expert. There develops an immense system of voluntary productive cooperation and voluntary exchange.

Each of us is free (within certain limits) to choose the occupation in which he himself specializes. And in selecting this he is guided by the relative rewards in this occupation, by its relative ease or difficulty, pleasantness or unpleasantness, and the special gifts, skills, and training it requires. His rewards are decided by how highly other people value his services.
Free-Market Economy

This immense cooperative system is known as a free-market economy. It was not consciously planned by anybody. It evolved. It is not perfect, in the sense that it leads to the maximum possible balanced production and/or distributes its rewards and penalties in exact proportion to the economic deserts of each of us. But this could not be expected of any economic "system." The fate of each of us is always affected by the accidents and catastrophes as well as the blessings of nature—by rainfall, earthquakes, tornadoes, hurricanes, or what not. A flood or a drought may wipe out half a crop, bringing disaster to those growers directly hit by it, and perhaps record-high prices and profits to the growers who were spared. And no system can overcome the shortcomings of the human beings that operate it—the relative ignorance, ineptitude, or sheer bad luck of some of us, the lack of perfect foresight or omniscience on the part of all of us.

But the ups and downs of the market economy tend to be self correcting. Over-production of automobiles or apartments will lead to fewer of them being produced the following year. A short crop of corn or wheat will cause more of that crop to be planted the following season. Even before there were government statistics, producers were guided by relative prices and profits. Production will tend to be constantly more efficient because the less efficient producers will tend to be weeded out and the more efficient will be encouraged to expand output. The people who recognize the merits of this system call it the market economy or free enterprise. The people who want to abolish it have called it—since the publication of The Communist Manifesto in 1848—capitalism. The name was intended to discredit it—to imply that it was a system developed for and by the "capitalists"—by definition the disgustingly rich who used their capital to enslave and "exploit" the "workers."

The whole process was grossly distorted. The enterpriser was putting his accumulated savings at risk at what he hoped was an opportunity. He had no prior assurance of success. He had to offer the going wage or better to attract workers from their existing employments. Where the more successful enterprisers were, the higher wages also tended to be. Marx talked as if the success of every new business undertaking was a certainty, and not a sheer gamble. This resulted in his condemning the enterpriser for his very risk-taking and venturesomeness. Marx took profits for granted. He seemed to assume that wealth could never be honestly earned by successful risk-taking but had to be inherited. He ignored the record of constant business failures.

But the label "capitalism" did pay unintended tribute to one of the system's supreme merits. By providing rewards to some of the people who risked investing their capital, it kept putting into the hands of the workers more and constantly better tools to increase per capita production more and more. The system of private property and capitalism is the most productive system that has ever existed.

The Communist Manifesto was an appeal to "the masses" to envy and hate the rich. It told them that their only salvation was to "expropriate the expropriators," to destroy capitalism root and branch by violent revolution. Marx attempted a rationalization of this course, built upon what he saw as inevitable deductions from a doctrine of Ricardo. That doctrine was in error; in Marx's hands the error became fateful. Ricardo concluded that all value was created by "labor" (which might almost be true if one counted labor from the begin ning of time—all the labor of everybody that went into the production of houses, land clearing, grading, plowing, and the creation of factories, tools and machines. But Marx chose to use the term as applying only to current labor, and the labor only of hired employees. This completely ignored the contribution of capital tools, the foresight or luck of investors, the skill of management, and many other factors.

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