One of the great myths about the capitalist system is the presumption that businessmen make profits at the expense of the consumers and workers in society. Nothing could be further from the truth.
In the free market, consumers are the sovereign rulers who determine what gets produced, and with what qualities and features. The sovereign consumers also determine who will be the owners and entrepreneurs of business enterprises.
The "captains of industry" are not the businessmen, but the buying public who steer the directions into which production is taken. Businessmen, to use a metaphor, are more like the "first mate" aboard a ship who after being given his orders by captain consumer passes it on to the crew, that is, those employed within the enterprises, companies and firms in terms of the tasks to be done to bring the economic ship to where captain consumer wants it to go.
Consumers Appoint the Entrepreneurs Who Direct Production
As the Austrian economist, Ludwig von Mises, once explained,
"In the capitalist system of society's economic organization the entrepreneurs determine the course of production. In the performance of this function they are unconditionally and totally subject to the sovereignty of the buying public, the consumers . . .
"The consumers by their buying and abstention from buying elect the entrepreneurs in a daily repeated plebiscite, as it were. They determine who shall own [businesses and enterprises] and who shall not, and how much each owner should own . . .
"If they fail to produce in the cheapest and best possible way those commodities which the consumer are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve consumers replace them . . ."
The British economist William H. Hutt coined the term, "consumers' sovereignty," back in the 1930s, especially in his book, Economists and the Public (1936). His point was to emphasize that the essence of the market economy is to be found in the liberty of the individual to make his own choices as both a consumer and a producer.
The Consumers' Sovereignty Means Freedom in Market Choices
An essential element of an individual's liberty is that he may not be compelled by either the threat or the use of force by others in society to make him do that which he does not want to do or accept.
This is the hallmark of the meaning of voluntary exchange. You may be reasoned with, argued with, persuaded with. But coercion may not be applied to make you enter into a transaction or accept the terms at which an offer is made if you find it not to your benefit and liking.
In the market economy people divide their labor. Each finds a niche in which to specialize his talents and abilities to earn a living. But he can only earn that living if he successfully directs his energies and efforts to making and supplying some good or service that others are willing to purchase and at a price they are willing to pay.
In this role, each producer is servant to the masters of the market – the consumers. With the income that we have earned in our producer capacity we reenter the market as a consumer, ourselves, and those whom we have served to acquire that income now must serve us in their respective capacities as producers.
How much we have to spend, and therefore, to make monetary "claims" on the outputs and productions of others is a reflection of the extent to which we have satisfied the desires of others in society.
As William Hutt explained in Economists and the Public:
"In regarding the individual as a consumer, we do not see him in his full relationship to society. He is usually also a producer. But as a producer he is the servant of the community. He must apply himself and the property and equipment he possesses to producing what the community wants [that is, all other individuals in their role as consumers] or he will obtain nothing in the form of claims on others in return [in the form of the money income earned with which he demands as a consumer the things he desires from others].
"As a consumer, he commands other producers . . . As a 'consumer,' each directs. As a 'producer,' each obeys . . . The defense of consumers' sovereignty rests . . . upon an assumption that liberty does possess supreme importance . . . The complete sovereignty of the consumer is compatible with the fullest scope to the initiative of the individual . . . In other words, it is in harmony with the idea of liberty."
Free to Choose as Consumers and Producers
Now, it is certainly true that the professional sportsman or movie star has earned far more money than I have as an economics professor. But this is a reflection of the degree to which our fellow citizens place a higher entertainment value on watching the services of the sportsman or film star than they do on information to be gleaned from hearing a lecture or reading an article about "consumers' sovereignty" and the benefits from free markets.
Could I have attempted to pursue a financially more lucrative profession? Yes. Might I have succeeded? It is possible. But I, early on, made an implicit trade-off in my life: to forego other possible income-earning uses of my human skills to, instead, follow a calling that I both enjoy and find highly rewarding, namely the sharing of my understanding of economics with others and most especially with young minds in the classroom.
Thus, my capacity to "command" the services of others in the marketplace through the dollars that I have to spend is far less than the well-paid professional athlete or multi-million dollar movie "heart-throb."
Or again to quote from William H. Hutt's Economists and the Public:
"The sovereignty of the consumer over producers does not extend beyond creating a situation in which the latter can choose between various alternatives. There is no absolute coercion on any individual to act (i.e., to apply his property and powers) in a certain way in reply to society's [consumers'] indication of its [their] preferences.
"He has the liberty of following his own inclinations and sacrificing advantages which would be available to him from a higher income . . . When he ignores society's [consumers'] demands . . . he exercises his sovereignty over the disposal of his own powers and property . . . The artist, for example, who could earn [$50,000] a year producing 'commercial art' which pleases the public, may decide to follow his own inclinations and produce instead what gives him the greatest satisfaction, but has little commercial value."
Incomes Earned Reflect What Consumers Think Workers are Worth
In this is another significant lesson about the nature and workings of the free-market economy: the "distribution" of income in society is not arbitrary or a matter of the caprice or stone heartedness of the employer.
What businessmen and entrepreneurs offer to pay to those whose labor services and other productive abilities they employ is a reflection of what they think those people and skills are worth in terms of the value they add towards the manufacturing of some finished product they hope to successfully sell to consumers; and what they think they must offer to outbid other businessmen who are their rivals for hiring and employing those whose services of which they are also in need.
Thus, suppose that an employer judges a potential employee's services in his firm to be worth paying a maximum of, say, $12 an hour. If he could get that worker to take the job for $9 an hour he would view himself as having gotten a profitable bargain.
But he cannot ignore the fact that if there are two competing employers who, respectively, may value that same prospective worker's labor at $11 and $11.50 an hour, he must, then, offer enough to attract that worker to take a job with him instead of his next closest rival. He must offer a wage above that $11.50 his competitor may be offering and, thus, he tends to bring that employee's wage closer to the highest value of what some employer thinks that worker's labor to be worth.
This logic of the competitive process of the free market, however, is often misunderstood because the nature and workings of laissez-faire capitalism is confused with the effect of various government interventions on the outcomes of market interactions.
What are outcomes and effects resulting from interferences by government in the market process are erroneously identified with the results of the free market, or "capitalism."
This, too, was discussed and explained by William H. Hutt back in the 1930s through a distinction that he made between "natural scarcities" and "contrived scarcities."
"Natural Scarcities" of Means Insufficient to Fulfill All Desired Ends
Man cannot escape from the fact that he is always confronted with the need and necessity to make choices, to make trade-offs between alternatives, and decide what he values more highly and what he values less highly.
The inescapable reason for this is the scarcity of means available in their quantities and/or qualities to serve and satisfy fully all the ends, goals and purposes for which we would like to apply them.
Our time is scarce, with only twenty-four hours in a day. Our mental and physical strength is limited with which to pursue our purposes. The resources and raw materials around us that we identify as "useful things" to make the finished goods and services that we desire are limited in their amounts to produce all the things for which we think them useable.
In the free-market economy the relative scarcities of both finished consumer goods and the resources, labor and capital equipment out of which those consumer goods can be made are all registered in the form of the competitive prices at which they may be bought and sold.
If we, as consumers, demand more automobiles we offer to pay higher prices for the greater number of cars we wish to purchase. But to produce more automobiles off the assembly line means that fewer of the scarce resources that go into the manufacture of cars – workers and their labor time, resources, raw materials, component parts and the machinery needed – will not be available to produce other, alternative, goods that could have been produced with those same means of production, instead.
The prices paid to attract those greater quantities of scarce means into the auto industry (including the additional wages to draw more workers into this sector of the market) are what economists call their "opportunity costs." That is, the prices that need to be offered and paid that are just sufficient to attract them from an alternative employment in which they also have value in producing something else consumers also want, but not as intensely.
This is the reality of a world in which we are not able to have everything we want, where we want it, in the full amounts we desire. This is why, no matter how hard we try, we can never have it "all."
Even when through savings, investment, innovation and industry we succeed over time in increasing our ability to produce more of the things we wish to have, we still never have it all. It is part of the human make-up that as soon as we have successfully reached some desired goals our mind and imagination runs ahead to new and different things that are, once again, not fully within our reach.
It is like walking towards the horizon; no matter how far we go and how fast we try to get there, the horizon remains in front of us, and out of our reach. This is man's frustration but also the stimulus for all the material and cultural achievements that we call "civilization" that have raised humanity up from primitive subsistence existence.
In the competitive free market, the limits on how much of goods in general and the relative amounts of each within that total is possible of being produced is limited and constrained by what William H. Hutt defined as the "natural scarcities" existing in any society within a period of time. Said Hutt:
"We must conceive of a society in which there are no restrictions on the free movement, adjustment and full utilization of the productive resources in response to the dictates of consumers' will [as expressed in their market demands for various goods and services]."
Under the "natural scarcity" of things in a free market some people may wish that more hospitals were built for the sick or more research undertaken for a cure for cancer, or more wildlife areas set aside for peaceful contemplation of the beauty of nature. But the critic has no one to blame but the free choices of his fellow citizens and even himself in actually demanding more of other things that prevents the necessary scarce resources and labor from being available to do more of these other desired things as well.
"Contrived Scarcities" and "Contrived Plentitudes" Caused by Government
The critic may not be satisfied with his own (perhaps failed) attempts to persuade enough of his fellow citizens to demand and spend less on these other things so more scarce resources can be freed up and used for more hospitals, medical research and nature preserves. He may then turn to the government and its political power to get what he wants without the agreement and voluntary participation of his "preference-misguided" fellows in society.
William H. Hutt argued that when various individuals and special interest groups turn to the State to get what they want it brings about what he called "contrived scarcities" and "contrived plenitudes."
If the government increases taxes on the citizenry to fund the supplying of more hospitals, cancer research and wildlife areas, it creates a "contrived plenitude," that is, an amount of these things in excess of what the market would have found it profitable to supply if production had been guided by what consumers would have wanted and demanded if more of their earned income had not been taxed away.
The amount of such "good things" as hospitals, medical research facilities and nature areas are, in fact, out of balance – over supplied – with what a free market would have supplied of them if the determination of production in society had been left more fully to be guided by the wishes and desires of the "sovereign consumers."
On behalf of those not satisfied with the free choices of their fellow citizens and who are willing to use political compulsion to get what they want, government has intruded into and violated the "sovereignty of the consumer" to peacefully, honestly and voluntarily decide what he wants based on his values, beliefs and desires, and to make it profitable on the competitive market for others to provide him with what he wants out of the income he has peacefully, honestly and voluntarily earned in his own role as a producer.
But the other side of this coin is that there are "contrived scarcities" – a reduced availability – of the goods and services that those sovereign consumers would have been able to have if the greater taxes collected and spent by the government had not resulted in scarce resources and labor being drawn away from producing the goods and services those consumer/taxpayers would have spent their income on if it had not been reduced due to those higher taxes.
"Contrived Scarcities" from Import Tariffs and Price Subsidies
Such contrived scarcities take on other forms, as well, other than only the direct taxing away of people's income. If the government imposes an import tariff or an import quota on foreign goods entering the domestic economy, the available supplies of those goods will be less; and the prices of these goods that consumers will now have to pay will be higher, as a result, than if free trade was practiced and consumers had had a wider free-market choice of domestic and foreign suppliers.
Suppose that the government starts to guarantee dairy farmers minimum prices for their produce (as the U.S. government does under its farm price-support programs). With a higher guaranteed price than the market-established price, dairy farmers would find it profitable to expand their dairy cowherds. But this requires more grazing land for the increased number of cows.
The expanded grazing land will have to come from somewhere. Suppose that this land comes out of wheat growing. The wheat crops will tend to decrease, an essential ingredient in bread baking will be reduced in quantity, and the supply of wheat bread available in groceries may be less, with a resulting higher price per loaf that consumers now must pay.
Thus, government interventions such as these would abridge the market-based sovereignty of the consumers, bringing about too much of some goods being produced and too little of others being supplied.
Difficulty of Seeing Government's Hand in Contrived Scarcities
But the perversity from these types of "contrived scarcity" policies is that the consumers find it difficult to know whether and to what extent the supplies available and the prices paid for goods are due to market-determined "natural scarcities" and how much is due to government manipulation of quantities produced and offered on the market.
In the case of the farm price-support programs, consumers in the market end up paying no less than the government guaranteed price for dairy products, for example, since dairy farmers have no incentive to offer it for less since they know that any unsold surpluses at the guaranteed price will be bought up by the government at taxpayers' expense.
At the same time, the possible reduced wheat crops that negatively impacts the supply of wheat bread and raises its price, for instance, is so many steps away from the immediate vision and understanding of the consumers of bread that it is nearly impossible for ordinary citizens to appreciate the links in the chains of government intervention that has made bread more costly and less available.
Thus, the "free market" gets blamed for high or rising prices for various goods because of the businessman's "greedy profit motive" that makes him fail to produce more of what people want and desire.
Consumers seem to be unrestricted in their choices concerning how to spend whatever after-tax income that may remain in their pockets; market interactions of supply and demand seems to determine the prices that those consumers pay; and thus the reason for any frustrating scarcities and expensiveness of desired goods gets placed at the doorstep of "selfish" acts of profit-motivated capitalists and businessmen, in general.
But behind the scenes the incentive, profitability and opportunity to produce goods guided by the actual demands of the "sovereign consumers" have been thwarted by government taxing, pricing and regulatory policy manipulations bringing about contrived or artificial scarcities of some goods on the supply-side of the market or wasteful over production or "contrived plentitudes" of other goods not reflecting what those consumers would really want produced if the market was left free of the intervening and distorting hand of the those in political power serving particular special interest groups.
Getting Government Out of the Market Can End Contrived Scarcities
While "natural scarcities" can only be reduced in the longer-run through savings, investment, innovation and industry that increases the supply and improves the qualities of desired goods, in principle, "contrived scarcities" and artificial "plentitudes" can be corrected much sooner.
Or as William H. Hutt expressed it, "Contrived scarcities, unlike natural scarcities, are not beyond the power of change by individuals and hence of a different degree of permanence: restrictions can be overcome . . . Contrived scarcities involve, then the frustration of consumers' sovereignty; and what is usually meant when the removal of restrictions on competition is recommended is that such contrivances shall be eliminated."
One of the tasks of friends of capitalism and free markets, therefore, is to explain to our fellow citizens that while a "natural scarcity" of useful means to achieve our various ends is inescapable in the reality of the human circumstance, there are some scarcities of resources and desired goods that are artificial, "contrived scarcities," due precisely to government and its interventions in the market process.
Such contrived scarcities, in principle, could be gone tomorrow if the government's economic policies fostering, creating and sustaining them were abolished and eliminated. The individual's sovereignty over his choices and actions as both consumer and producer will have been more fully restored.
Free men in free markets would then be at liberty to improve their conditions without the disrupting and distorting hand of political power and special interest politicking that invariably makes many things less available and more expensive than if competitive capitalism were unshackled from the government policies that only succeed in making us poorer and far less free than we need to be.