In a free market economy, price – of raw materials, labor, finished goods, services and capital itself – works a lot like a thermostat in your house. Prices reflect what is happening in the market with respect to supply and demand and signal to individual markets what is needed in terms of more or less supply. Your thermostat reflects what is happening to the temperature of the air in your home and signals what is needed in terms of more or less heat or air conditioning.
When the government sets or influences prices, it displaces this market pricing. The results are rather like a false reading on your thermostat. Both the market and you will respond to a false stimulus leading to results which are not optimal. The market will provide more or less supply based on inaccurate pricing information just as you will adjust the heat or air conditioning in response to inaccurate temperature information.
The analogy ultimately fails, only because you have your own internal thermostat which will ultimately override the mechanical thermostat – you will rather quickly figure out that the mechanical thermostat is not working correctly and will adjust the heat and air conditioning based on your own judgment. Unfortunately, markets have no quick functioning redundant system for making adjustments to supply. As a result, when the government influences or sets prices, supply either increases or decreases for extended periods of time. This, in turn, spreads misallocations of capital throughout the involved industry. If the government influences or sets prices in multiple industries, the effect is magnified, misallocations can overlap between and among industries, and widespread economic distortions ultimately result. If you had no redundant system to override your broken mechanical thermostat, you would waste fuel for heat or air conditioning and withstand the inconvenience and discomfort of being perpetually too hot or cold. You would waste capital and suffer a lower standard of living. The same negative results occur when false pricing effects spread throughout an economy.
Only capitalism i.e., free markets, enable this extraordinarily accurate and amazingly efficient price setting mechanism. In all planned economies, i.e., non-free markets, prices are distorted and do not provide accurate signals as to what commodities are being produced in quantities too high or too low for an efficient economy. False prices lead to distorted economic decisions and the misallocation of capital.
Capitalism is so resilient and so superior to any other economic system that it has been able to sustain mixing some elements of planned economic theories within its overall superstructure and still continue providing a standard of living and efficiencies in markets which far exceed that which could be achieved in any economic system based entirely on planning. However, it is a fallacy to think a mixed economy is superior to a completely free economy. A thermostat that works properly part of the time and only misreads the temperature by a few degrees when it is not operating correctly may be better than no thermostat at all, but it is not the optimum. The same is true when components of planned economic systems that don’t work are mixed with free market capitalism. The results may be tolerable, but it’s a mistake to think they are optimal. Moreover, if you eliminate capitalism completely, or even dilute it sufficiently by mixing in too much government imposed ‘planning’, the pricing mechanism will break down completely, immediately followed by a severe malaise in the broader economy and its ultimate failure.
A truly free market, checked only by the rule of law including the enforcement of contracts and strict sanctions against fraud, represents an economy working at full efficiency for the benefit of society, allocating resources in the most efficient way possible and continuously increasing the general standard of living over time. Government efforts to modify free market pricing dislocate capital, reduce the efficiency of the economy and its ultimate capacity and, all too often, provide economic advantages to favored constituencies and cronies.
Those who advocate for socialism do so, not because they believe it is efficient and will provide a rising standard of living for society at large, but because they wish to achieve a more equal distribution of wealth. They ignore or don’t understand that only capitalism grows the economic pie. Socialism provides a disincentive to productivity while simultaneously introducing these inefficiencies and misallocations which can do nothing but damage the capacity of an economy to produce goods and services for the benefit of everyone. Thus, Winston Churchill’s words are as true now as they were when he spoke them and will be true for all eternity. “Socialism is a philosophy of failure, the creed of ignorance, and the gospel of envy. It’s inherent virtue is the equal sharing of misery.”
We should embrace the “perfectly working thermostat” economic model. Free market capitalism will again unleash the best and fastest mechanism ever understood by the mind of man for improving the lives of the most people in the shortest amount of time while creating the conditions for the advancement of society at large.