How does a Conservative differ from a Socialist? Part 3 (Basic Economics)

In a lot of ways, capitalists and socialists look at the world very differently. Where capitalists celebrate profits as the lifeblood of a thriving economy that represent prosperity, socialists denounce profits as excesses lining the pockets of greedy business owners. Socialists primarily see value in the labor that went into a product, whereas capitalists look to other attributes to explain a product’s worth. Capitalists see private property as the cornerstone of a healthy society while socialists are either skeptical of such claims or even hostile to property rights altogether.

Both economic viewpoints have numerous assumptions baked in, making it difficult to truly judge between them without first examining these assumptions. To that end, we will spend the remainder of this post examining some of these core assumptions.

Toilet Paper Shortages and Price Gouging

The Youtuber Internet Historian hilariously depicted the great toilet paper mayhem that began in Australia and spread around the world during the beginning of the COVID-19 pandemic. Misinformed news reports and sensational rumors led to a nation-wide panic where shoppers bought all the toilet paper they could find which—unfortunately—actually did lead to a temporary shortage.

As is predictable in any crisis that generates shortages, angry accusations of price gouging ensued, leading to lawsuits against companies suspected of such selfish misdeeds. How could anyone be so avaricious that they would raise the prices on toilet paper just when the people—to say nothing of the poor—were in such dire straits? Many states have anti-gouging laws in place that freeze prices during an emergency for this very reason.

But however well intentioned these laws may be, when laws prevent prices from rising during a shortage, the problem is only exacerbated. With the sudden increase in demand for toilet paper, and no corresponding increase in the price to mitigate that demand, what might have been a temporary inconvenience for a handful of communities in Australia because an international bathroom quagmire.

While it is certainly true some business owners would happily profit at the misfortune of others, the surest way to prevent price gouging is to simply let the free market do its thing. If, in the middle of an international shortage of toilet paper, a store owner tripled the price of the toilet paper they had for sale while all the other stores in the community had only doubled the price, the savvy shopper would simply buy from those other stores. So long as there was a relatively stable quantity of toilet paper in all of the stores in the local community, the greedy store owner would be foolish to triple the price of the toilet paper they were selling because that would divert customers to their competitors.

Who Determines the Price?

But let’s back up a step. What exactly does it mean that our greedy store owner “raised” the price on toilet paper to three times what it had been selling for the day before? Does this imply he was watching the news one evening and, upon hearing of the shortage, rushed to the store shelves to triple the price? If so, how did he arrive at that amount? Do we imagine that the store owner first checked around all of the other stores in the community to see if they had raised their prices also? What if the other stores had actually quadrupled the price to adjust to the new demand, but our store owner had no knowledge of this when he tripled his price? Would that still make him greedy or just misinformed?

Charges of price gouging are hardly straightforward, once you peel below the actual accusation and begin to look for the supposed perpetrators. The actual price of toilet paper is determined by a multitude of factors—from the availability of the raw materials to the production process, to distribution, wholesale, retail, and consumer demand—each of which involve a complex web of individuals making estimates on the actual costs associated with their limited exposure to the entire process. Our store owner might put a price on the final product he’s made available to his customers, but he has no control on the various costs inherent in the rolls of toilet paper by the time they arrived at his store. And these are costs that don’t go away simply because an anti-gouging law holds the price down.

In a capitalist society—where the price is determined by the free exchange between individuals—the price is not some arbitrary value that can be increased or decreased by the whims of a greedy capitalist. Rather, price conveys information that shows the inherent cost imbedded in the goods or services. To demand “reasonable” prices is to misunderstand the role costs play. “It is completely unreasonable to expect reasonable prices,” charges economist Thomas Sowell explains:

“Free-market prices are not mere arbitrary obstacles to getting what people want. Prices are symptoms of an underlying reality that is not nearly as susceptible to political manipulation as the prices are. Prices are like thermometer readings—and a patient with a fever is not going to be helped by plunging the thermometer into ice water to lower the reading. On the contrary, if we were to take the new readings seriously and imagine that the patient’s fever was over, the dangers would be even greater, now that the underlying reality was being ignored.”

None of this is to suggest that shortages in goods and services—particularly during a crisis—isn’t a problem. But the nature of the problem is among the legions of factors that gets conveyed in the price of those goods and services that are in short supply. To effectively deal with a shortage we must first turn our attention to the real problem, not the make-believe problem of greedy store owners. If toilet paper was in short supply during the pandemic because most toilet paper is manufactured overseas, or because too many workers are sick and unable to manufacture more rolls, or—as was actually the case—mass panic led to people buying far more rolls than they needed such that manufacturers couldn’t keep up with demand, then those problems must be addressed if we want the inherent costs to come down. Forcing store owners to hold their price below the actual cost ignores the actual problems contributing to those costs and will likely make things worse.

Are Profits Evil?

Once we can grasp the relationship between cost and price we are in a better position to evaluate the socialist’s distain for profit. To the socialist, profit serves no purpose beyond the enrichment of the individual enjoying that profit and may, in fact, be evil as it represents the exploitation of workers. George Bernard Shaw called profits “overcharges” whereas Karl Marx referred to them as a “surplus of value”. But to the capitalist, profits represent invaluable information.

“The high-minded socialist slogan, ‘Production for use, not for profit’, which we find in one form or another from Aristotle to Bertrand Russell, from Albert Einstein to Archbishop Camara of Brazil…betrays ignorance of how productive capacity is multiplied by different individuals obtaining access to different knowledge whose total exceeds what any single one of them could muster,” argues economist and Nobel laureate F. A. Hayek. That store owner may not understand the current availability of the raw materials that go into the manufacturing of toilet paper, but he has some insider information—that is, the price he had to pay to acquire the toilet paper to stock his shelves—that accurately reflect the inherent costs in the product.

“Profitability works as a signal that guides selection towards what makes man more fruitful,” continues Hayek, “only what is more profitable will, as a rule, nourish more people, for it sacrifices less than it adds.” In other words, profit is what helps convey the price at which the consumer, retailer, wholesaler, manufacturer, and those who acquire the raw material are willing to pay for their contribution to the entire chain of events. And because each individual in this long line of participants see value in paying the price to participate, each individual is better off as a result.

Far from exploitative excess, profit is the natural, and positive, consequence of individuals forming mutually beneficial cooperative relationships. There is nothing sinister about private enterprise that produces greedy excess. In fact, says Thomas Sowell, “when a company makes a million dollars in profits, that does not mean that its output would cost a million dollars less if produced by a non-profit organization or by a government-run enterprise. Without the incentives and constraints created by the prospects of profit and the threat of losses, the same output might well cost millions of dollars more.” What makes private enterprise more efficient than non-private efforts is that they rely on the information conveyed in price rather than the good intentions and limited knowledge of individuals presuming they understand the price that works best at all levels of production for all involved.

How Do We Measure Value?

But the information conveyed in price does even more than generate a mutually beneficial series of exchanges between individuals. It also conveys the true value of a good or service. Human beings are hard wired to recognize the value inherent in a product when we can observe the process of transforming raw materials into the finished good. But we have a harder time apprehending the added value of information and processes that aren’t easily observed. Hayek elaborates on this point:

“The market process deals with material objects, but its shifting around of them does not seem to add (whatever might be claimed or really be so) to their perceptible quantities. The market transmits information about them rather than producing them, and the crucial function played by the conveying of information escapes the notice of persons guided by mechanistic or scientistic habits who take for granted factual information about physical objects and disregard the role played, in the determination of value, by the relative scarcity of different kinds of objects…An increase of value—crucial in exchange and trade—is indeed different from increases in quantity observable by our senses. Increase in value is something for which laws governing physical events, at least as understood within materialist and mechanistic models, do not account. Value indicates the potential capacities of an object or action to satisfy human needs.”

The true value of a good or service—in an economic sense—will always be relative to the individual. Toilet paper may be a hot commodity in the West, but it’s of little value in India where 95% of the population use water instead. Raw materials such as oil, uranium, or sulfur were of little value to armies in the ancient world but are a deciding factor in how wars are fought today. The value of everything from the clothes you wear to the food you eat to the place you live cannot be fully determined independent of your unique circumstances, knowledge, needs, and preferences.

No economic model has done a better job at providing goods and services to consumers at a price they are willing to pay than capitalism. That is because the free market price conveys information about both the cost and relative value of those goods and services. “It is not costs which create value,” explains Sowell, “it is value which causes purchasers to be willing to pay for the costs incurred in the production of what they want. Where costs have been incurred in excess of what the consumers are willing to pay, the business simply loses money, because those costs do not create value, whether they are labor costs or other costs.”

Marx and the Labor Theory of Value

Undeterred, the socialist is quick to decry prices under capitalism as undue obstacles to achieving material goods, and profits as greedy employers depriving their workers of the actual value of their labor. Why should the employer have a right to the value produced by their worker? Certainly, we can agree that the worker adds value by pouring their labor into a product. But is labor sufficient for determining value? Karl Marx argued that the economic value of a good or service could be reduced to its total necessary labor. In fact, he claimed this “hidden” value wasn’t a matter of opinion but scientific fact:

“Let us take two commodities, e.g. corn and iron. The proportions in which they are exchangeable, whatever these proportions may be, can always be represented by an equation, in which a given quantity of corn is equated to some quantity of iron, e.g. 1 quarter corn = x cwt of iron. What does this equation tell us? It tells us that in two different things—in one quarter of corn and x cwt of iron—there exists in equal quantities something common to both. The two things must therefore be equal to a third, which in itself is neither the one nor the other. Each of them, so far as it is exchange-value, must therefore be reducible to this third.”

Thus, Marx’s labor theory of value contends that the fact commodities such as corn and iron could be shown to be proportionally exchangeable via a simple equation, we could use a similar thought process to deduce that what gave each commodity its value can be reduced to the one thing they have in common: labor. While not all socialists are Marxists (as we discussed in Part 2), Marx’s assertion that it is labor that determines value provides the foundation to a lot of socialist teaching.

“While modern economists take price, empirically defined, as their explanandum, Marx tries to explain another, hidden variable, of which ‘price’ is the mere ‘phenomenal form’,” countered Sir Roger Scruton, “Not surprisingly, such ‘phenomenal’ entities as supply and demand (which explain price) cannot explain the hidden ‘essence’ of ‘value’, nor even provide us with reasonable grounds for its existence.” The path to Marx’s labor theory of value requires a suspension of disbelief and something akin to dogmatic faith. It is not something that is scientifically demonstrable to those who have not already accepted Marxism as “scientific fact”.

Scruton’s reference to “modern economists” is not a chiefly partisan statement. Outside of those who accept Marxism on faith, you would be hard-pressed to find economists who still ascribe to the labor theory of value. “By the late nineteenth century,” Thomas Sowell contends, “economists had given up the notion that it is primarily labor which determines the value of goods, since capital, management, and natural resources all contribute to output, if these inputs into the production process are to continue to be supplied. More fundamentally, labor, like all other sources of production costs, was no longer seen as a source of value. On the contrary, it was the value of the goods to the consumers which made it worthwhile to incur the costs required to produce those goods…If labor were in fact the crucial source of output and prosperity, then we should expect to see countries where great masses of people toil long hours end up richer than countries where most people work shorter hours, in a more leisurely fashion, and under more pleasant conditions, often including air-conditioning, for example. In reality, we find just the opposite.”

Labor vs. Ability

But if labor is not the primary determinant in the relative value of a product or service, what is? “Ability,” answers Russell Kirk. “Labor without Ability is simply the primitive effort of natural man to obtain subsistence. Recognizing that mankind cannot prosper by mere labor, society hitherto has endeavored to encourage Ability by protecting its incentives.” Two laborers taking the same amount of time producing toilet paper will only produce the same value if they possess the same ability. But what if one of those laborers had either the natural or developed ability to produce toilet paper at twice the rate or at a much higher quality as the other laborer? Better yet, what about a good or service where the relative value is even less transmittable in the production process? Say, for instance, artwork or music or writing. Is the inherent value that’s produced by artwork or music or writing primarily (or even remotely) dependent upon the amount of labor exerted, or by the ability the laborer brings?

It is easy to imagine why the socialist would be fixated on the labor component of value: labor is more easily manipulated and transferable. If what produced value—and the wealth of nations—was the mere labor that goes into goods and services, government compulsion could induce even more labor or, at least, provide for full employment where everyone was laboring and thereby generate wealth. But this has the opposite effect, says Kirk: “Under compulsion, Ability sinks to the level of mere Labor; no man will exert unusual talents if he is to get no reward.”

Yet ability is a doggedly stubborn value-driving-commodity. Try as the socialist might, you cannot distribute or induce or transfer ability between person to person nearly as easily as you can labor. Education, training, and experience can go a long way in bolstering ability, but there is no guarantee of success and—worse still—there persists an absolute guarantee individuals will not develop equally in ability. This is because a certain component of ability is innate and cannot be reproduced by human effort or especially legislation. This does not mean labor is not an important factor in the overall value of a product or service. But it is far less of a factor than the ability of the laborer—which cannot be manipulated by the whims of socialist central planners.

Privatizing Property

Both labor and ability are necessary ingredients of the relative value found in goods and services. But for most goods and services, there is another important ingredient: property. It wouldn’t matter that two laborers had different abilities in the manufacturing process of toilet paper if they were denied access to the raw materials and manufacturing equipment utilized in the production process. While the capitalist and socialist are in agreement on this point, they differ on the question of whether such property should belong to individuals or to the community as a whole.

It was the French Enlightenment philosopher Jean-Jacques Rousseau who first called into question the efficacy and morality of private property:

“The first person who, having enclosed a plot of land, took it into his head to say this is mine and found people simple enough to believe him, was the true founder of civil society. What crimes, wars, murders, what miseries and horrors would the human race have been spared, had someone pulled up the stakes or filled in the ditch and cried out to his fellow men: ‘Do not listen to this imposter. You are lost if you forget that the fruits of the earth belong to all and the earth to no one!’”

At first glance, this would appear to be a powerfully compelling argument against private property rights. Indeed, the history of any nation is littered with sad tales of “crimes, wars, murders, miseries, and horrors” involving disagreements and fights over lands and property desired by competing individuals. But it doesn’t follow that humans behave much differently before the advent of private property. Are we to assume hunter-gather societies where no one in the tribe claimed ownership of the land were free from such miseries? Are the few remaining places on earth where such primitive practices still exist noteworthy for their relative peace and serenity? Would you want to live in that condition?

The truth is, private property marked a major advance in the human condition. It was the necessary condition to establishing civil society in the first place. Thomas Sowell surveyed the nation-states that attempted to achieve some sense of “community” ownership and warned it impeded prosperity: “In a country without property rights, or with the food being owned ‘by the people,’ there was no given individual with sufficient incentives to ensure that this food did not spoil needlessly before it reached the consumers.” Nor was this tendency limited to products humans produce: “The only animals threatened with extinction are animals not owned by anybody…likewise, it is inanimate things not owned by anybody—air and water, for example—which are polluted.”

From the question of whether private property marks an advancement in the human condition or the beginning of our societal ills, to the role price plays in communicating the true costs of goods and services, to how the value of those goods and services are determined and what is most responsible for producing that value, capitalists and socialists start with different economic assumptions.And it is precisely because of mistaken assumptions that socialism cannot compete with capitalism.Socialism doesn’t work.Precisely why it doesn’t work is where we’ll pick things up in Part 4.