The mechanics of the system. How Does a Free Market Work?

Just how does a free-market system work? Who decides what is produced, how much, and of what quality? How does the system guarantee that the goods produced are what people want? In this chapter, we will seek to answer these questions as we examine seven features of a free-market system.

A. “No one” decides what, how, and for whom a national economy will produce

Nobel economic laureate Milton Friedman very simply answered the question of who decides what is produced: no one.[1]

Friedman explains that this fact can be seen even in the production of a simple lead pencil. After summarizing the I, Pencil story that we mentioned above (140-41), he writes:

No one sitting in a central office gave orders to these thousands of people. No military police enforced the orders that were not given. These people live in many lands, speak different languages, practice different religions, may even hate one another—yet none of these differences prevented them from cooperating to produce a pencil.[2]

This process is even more remarkable when we realize that economic knowledge does not exist in concentrated form. In fact, the more complex the system, the less amenable it is to individual direction, because no one person can know all the relevant facts. Because economic knowledge is in dispersed, incomplete, and even contradictory pieces, only the wisdom of the many can ever possess it. That wisdom is dispensed through the millions of free exchanges in the market. “No one” decides in an overall way what an economy produces.

The thousands of people involved in producing each piece of a pencil perform their individual tasks not because they want a pencil or even know what a pencil is for. They simply see their work as a way to get the goods and services they do want.

Every time you buy a pencil, you exchange a little bit of your money for the thousands of small services that multitudes have contributed toward producing it. All the exchanges in the production and distribution of a product create a mosaic of unity and coherence in which self-interest tends to be cooperative, economically beneficial, and productive.[3]

The mystery of the market is that it is an exquisitely complicated process that emerges spontaneously from the enlightened self-interest of billions of people who specialize, exchange, and produce wealth. The market is a complex, brainlike organism that evolves over decades. The immense requirement that someone consciously plan, manage, and list all the resources available, formulate all the tasks to be done, and answer all the questions of “Who?” “What?” “Why?” and “When?” is literally beyond the ability of any one human being or any designated group of central planners. Instead, it is directed by what Adam Smith called an “invisible hand”:

As every individual . . . neither intends to promote the public interest, nor knows how much he is promoting it . . . by directing [his work] in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an

invisible hand to promote an end which was no part of his intention. . . .

By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.[4]

From the standpoint of the Christian faith, we can add that the miracle of human creativity can best be understood in light of the fact that man is created in the image of God. Both individually and as a human society corporately, we are able to create remarkable products of value from the resources of the earth. The amazing functionings of the so-called “invisible hand,” of markets, and of creativity are a few of the many expressions of our likeness to our Creator, abilities bestowed by a sovereign God filling society with evidences of his common grace.

Human creativity honors God as but a faint reflection of his infinite wisdom and power in his act of creation: “In the beginning, God created the heavens and the earth” (Gen. 1:1). Then “God created man in his own image” (v. 27). After that, he told Adam and Eve to “subdue” the earth, which implied a responsibility to make useful products from the earth’s natural resources—to create products of value to human beings. In creating such products, they acted like “imitators of God, as beloved children” (Eph. 5:1).

Because God is pleased with such human creativity, he appointed skilled craftsmen to work in making the furnishings of the tabernacle: “Bezalel and Oholiab and every craftsman in whom the Lord has put skill and intelligence to know how to do any work in the construction of the sanctuary shall work in accordance with all that the Lord has commanded” (Ex. 36:1).

From the godly wife, who “makes linen garments and sells them” (Prov. 31:24); to Jesus, who worked as a “carpenter” (Mark 6:3); to Aq- uila, Priscilla, and the apostle Paul, who worked as “tentmakers” (Acts 18:3); to the Christian whom Paul commanded not to steal but to do “honest work with his own hands” (Eph. 4:28), God approves of those who create useful goods from the resources of the earth.

George Gilder writes about what he sees as a divine origin behind human creativity:

Because economies are governed by thoughts, they reflect not the laws of matter but the laws of mind. One crucial law of mind is that belief precedes knowledge.[5]

Creative thought is not an inductive process in which a scientist accumulates evidence in a neutral and “objective” way until a theory becomes visible in it. Rather the theory comes first and determines what evidence can then be seen.[6]

Imagination, intuition, and hypothesis are merely the first steps of learning. . . . Creative thought requires an act of faith. The believer must trust his intuition, the spontaneous creations of his mind, enough to pursue them laboriously to the point of experiment and knowledge. . . . It is love and faith that infuse ideas with life and fire. . . . But the essence of the universe is creative consciousness continually generating new energy and thought.[7]

Many of the most significant intellectual, scientific, and economic breakthroughs of the last three centuries were, in fact, driven by Christian beliefs. Niall Ferguson in his 2011 book Civilization: The West and the Rest, quotes a fellow of the Chinese Academy of the Social Sciences as saying,

We were asked to look into what accounted for the . . . pre-eminence of the West all over the world. . . . At first, we thought it was because you had more powerful guns than we had. Then we thought it was because you had the best political system. Next we focused on your economic system. But in the past twenty years, we have realized that the heart of your culture [the United States] is your religion: Christianity. That is why the West has been so powerful. The Christian moral foundation of social and cultural life was what made possible the emergence of capitalism and then the successful transition to democratic politics. We don’t have any doubt about this.[8]

While some might disagree, we believe that what this Chinese scholar is saying is basically true.

The free-market system allows creativity to flourish and produce great value through free human decisions, not through government direction and control. A free-market system is a spontaneous order that arises out of natural liberty. It is also a circuit of never-ending ideas.

While wealth might reside in some resources, not all resources are wealth. Gilder reminds us:

The market, as it generates the “news”—its ceaseless play of prices and ideas—passes its wand over the world of human possessions, conferring capital gains as some things become profitable in a new light of time and knowledge, and casting giant shadows of loss over looming wealth works of the past. . . . Qualities of thought and spirit in an economy can overshadow all the quantities of capital and contracts of labor. . . . Work indeed is the root of wealth, even of the genius that mostly resides in sweat.[9]

Entrepreneurs continually demonstrate that faith and imagination are the most important capital goods in a changing economy, and that wealth is a product less of money than of the mind to create, produce, invest, and, in the often-repeated expression of Austrian economist Joseph Schumpeter, to creatively destroy (to shut down businesses that are not working).

  • [1] Milton Friedman and Rose Friedman, Free to Choose: A Personal Statement (New York: Harcourt BraceJovanovich, 1980), 13.
  • [2] Ibid., 13.
  • [3] Ibid., 13-18.
  • [4] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, ed. Edwin Cannan (1776; NewYork: Modern Library, 1994), 485, emphasis added.
  • [5] George Gilder, Wealth and Poverty (New York: Basic Books, 1981), 261.
  • [6] Ibid., 262, citing John E. Sawyer, “Entrepreneurial Error and Economic Growth,” Explorations inEntrepreneurial History, Vol. 4 (May 1952), 199-200.
  • [7] Gilder, Wealth and Poverty, 262, 263.
  • [8] Niall Ferguson, Civilization: The West and the Rest (New York: Penguin, 2011), 287, citing David Aikman,The Beijing Factor: How Christianity Is Transforming China and Changing the Global Balance of Power (Oxford:Monarch, 2003), 5.
  • [9] Gilder, Wealth and Poverty, 51.
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