Capitalism, Competition and the Free Market

The modern study of economics was begun in large part by a Scottish philosopher named Adam Smith. Smith's most enduring work, An Inquiry into the Nature and Causes of the Wealth of Nations, is still studied and relevant in 2008, despite the fact that it was published in 1776. Smith discusses many things in this writing, but none so important to today's discussion as what he termed "the invisible hand". The invisible hand is the action of a free market economy as people - both suppliers and consumers - seek to make solid decisions. The invisible hand is driven by forces no more sophisticated than simple supply and demand.

Supply and demand are simple concepts, but their effect on the marketplace cannot be overstated. Given a few basic assumptions (people work for their own self-interests, for example), an open and competitive market moves to the beat clapped out by the invisible hand. The first concept to discuss is equilibrium. This is a condition where the quantity supplied equals the quantity demanded. It's a function of price. If the price goes above equilibrium, then fewer people will buy and more people will try to sell. This is a surplus. If the price drops below equilibrium, more people will try to buy and fewer will sell. This is a shortage. Shortages drive prices up, and surpluses drive prices down. As prices change, people will get in and out of either side of the marketplace accordingly, until equilibrium is reached. If supply or demand are affected in any permanent manner, equilibrium will change, but it will still be reached.

Smith's models assumed limitless capacity and complete ease at becoming a supplier of any commodity. While these don't stand up to scrutiny in the real world, the model still works. If demand exceeds supply - a shortage situation - and no further supply could be brought to market, the price would rise until the number of consumers for that commodity decreased to match available supply. This would create a new - higher - equilibrium point. And while people can't wake up today and decide to be selling a certain commodity by the end of the day, the model still works, although equilibrium may take longer to reach.

Many on the Left equate free markets and capitalism with greed and a mechanism to increase the wealth of only the wealthy. But the opposite is actually true. The opposite of a competitive market is one in which monopolies operate. In this case, suppliers are free to charge whatever they want, and there is no competition to drive down prices. An example of this is in the oil industry. Companies selling petroleum in the US (Exxon, Shell, BP, and Chevron are the top four) make between seven and ten cents on every dollar of gross revenue. For you "big oil" haters out there, that's less than a lot of grocery stores. They are all in the same range of profit margin, because the market dictates how they sell their product. However, in the more closed markets of Russia and China, oil companies make close to a 30% profit margin. Here are the numbers from 2007, by means of comparison:
Chevron - Sales: $203.97B - Profits: $18.69B - Margin: 9.16%
Gazprom - Sales: $81.76B - Profits: $23.3B - Margin 28.50%
Gazprom, a Russian company, has 100% of the oil business in Estonia, Lithuania, Latvia, Slovakia, and Finland, as well as most of the business in many other Eastern Bloc nations. With little to no competition, prices are limited only by what consumers can absolutely afford.

Another benefit of competition is supply. As long as there are demands for a commodity, there will be someone to supply it. How often in the '80s were there stories of heating oil shortages and food shortages coming from the Soviet Union? For that matter, were there enough doctors? Enough medical supplies? Self-interest, which advocates of socialism are so quick to decry, is a powerful motivator that can work for the common good.

Finally, the benefits of competition can best be seen where there is essentially none. Name a government program that is poorly run, and you can likely trace it back to inadequate competition. Public schools, for example, have no incentive to change how they operate. In any given area, the vast majority of children will attend public schools, and the government will fund them regardless of results. Imagine if schools had to compete for students and funding. There would be new ideas on how to cut costs, increase effectiveness, and attract business. Schools that didn't produce results would go out of business in favor of schools that did. Schools with competitive programs would bring students in and yield results.

The invisible hand may not be seen, but it is a strong force driving the marketplace. Where it is allowed to run free, its mechanism is undeniable. The consumer is protected, the ambitious are rewarded, and the market goes where it makes sense to go. Where it is tied up, the results are self-evident. Public education, ethanol subsidies, trade protectionism, CAFE standards - most cases where the government tampers with the market, it's both a wasted effort and a detractor for someone.

Looks like Adam Smith had it right!

Policy

From time to time, it becomes necessary for one to set forth his or her statements of policy. Often, in real life, there are not many opportunities to do this, since we are constrained by notions of propriety, etiquette, and the general desire not to anger those around us. For many, the forbidden topics of religion, politics, money, and baseball are taboo and never to be discussed except among the closest of friends. And, for fear of losing those friends, we often stop short of expressing complete thoughts or concepts. But I would like to use this forum to lay out ideas, concepts, and maybe even debunk a little misinformation now and again. So you the reader will be privy to my opinions - if indeed these are worth anything. But I hope you will be privy to facts, reasoning, and a touch of critical thinking. For those who don't know me yet, I'm a C^3 - a Christian, a cynic, and a conservative. In time, I hope you'll come to understand and respect where I'm coming from, even if you disagree.