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Time to get back to economic basics

by Jim West

September 2, 2009
Originally appearing in The Morning Call

The U.S. Chamber of Commerce is launching an education campaign designed to save capitalism. Chamber President Thomas Donahue says he is prepared to spend $100 million of Chamber money to educate (or re-educate) Americans on what is being called a ''Campaign for Free Enterprise.''

As a longtime professor of economics, I support increased economic education, but fear this task will not be easy. First, there is the growing supply of critics that blames market capitalism for the current state of affairs in the U.S. economy. Second, the counterintuitive nature of many economic concepts is not easily digested. The Chamber would do well to stick to the basics.

Like grade schools returning to the ''three R's,'' I propose the Chamber take a page from my freshman economics course and focus on the four ''P's'' of capitalism. These ''P's'' are: Production, Property, Prices and Profits. Each of these concepts is a pillar in the edifice of capitalism. Each is also widely misunderstood, resulting in poor and costly public policy.

Production is the foremost concern of the free enterprise system. When politicians focus on employment numbers -- e.g. ''how many jobs can we create?'' -- they tend to confuse cause and effect. Full employment is the result of incentives motivating efficient private production. Just ''creating jobs'' or ''making work'' to reach full employment is unsustainable and expensive. The father of modern economics, Adam Smith, in his aptly named 1776 book, ''The Wealth of Nations,'' made exactly this point.

Private property rights are critical to motivating production and constitute a moral foundation of our free society. While the property debate usually centers on the rights to acquire and protect private property, these rights are dependent on the more fundamental and moral imperative of property rights, which is the need to respect the property of others. Failure to respect property rights is where the path to prosperity takes a bad turn. State coercion to reallocate property, while at times necessary, must be exercised with prudence. Corporate ownership, eminent domain, taxation and intellectual property concerns are a few, among the many, critical property-related issues faced by society today.

Prices are such a common phenomena that their origins and significance often go unappreciated. Prices are at their root a means of economic communication. Like the letters that make words and sentences, prices communicate information about values that buyers and sellers need in order to make to make beneficial decisions. The complex economy requires that this information be rapidly developed and disseminated. Prices generated by market processes create that information. We may not always like the prices we get, but artificial manipulation of prices will undermine the important communication function that prices play. An overly managed pricing system underlies much of the weakness of the health care system.

Finally, profits are the most demonized of all the ''P'' concepts. A prosperous, vibrant economy requires creativity and risk-taking. Yet, critics complain about the very concept that encourages creative and sensible risk-taking. Profits are a driving force of human creativity. Not all creativity, of course, but a lot of it. Profits reward those who take the risks to create products, services and explore new frontiers. Suffering the consequences of the failure to make profits -- i.e. bankruptcy -- is likewise a part of healthy capitalism. The political desire to sustain unprofitable business is short-sighted, as are policies that discourage individuals and firms from making profits. In recent decades, many developing nations have abandoned their profit phobias and have transformed their societies.

The four ''P's'' are at the heart of what Adam Smith called the ''system of natural liberty.'' Smith knew that private production, not the accumulation of government wealth and power, is the driving force of prosperity. A system of property rights, prices and profits, as he predicted, would and did generate unparalleled production and prosperity. While Smith identified many important roles for government in the economy, he cautioned that this system of natural liberty must be left free to work its magic.

The swinging pendulum balancing private and state action appears to be swinging heavily toward the state these days. As the U.S. Chambers of Commerce takes up its education campaign, these principles of economic liberty should be at the center of the syllabus. Abandoning these principles will be very costly down the road.

Perhaps, when these lessons are learned, we can focus on the ethical issues raised in Smith's other great work, ''The Theory of Moral Sentiments.'' This is another ''must-do'' lesson for American business and government.

James West is a professor and chairman of the Department of Economics and Business at Moravian College.