Freedom for Prosperity

ForLibertyJusticeMutual Prosperity

Dr. Tom G. PalmerTom.Palmer@AtlasNetwork.orgWarsaw School of Economics22.March.2011

Let’s start with a Fact:

The Natural Condition of Humanity is

PovertyThe Change from

Poverty to Prosperityis

“The Big Fact”of History

What Accounts for the “Big Fact”???

Did the Earth simply become more generous?Did people start to work harder?

Or did people start to behave differently?

People Started to Respect the Freedom of Entrepreneurs to Innovate and to Keep

the Profits they Made

For the first time, Europe, and then the world, became “a business respecting civilization,” according to Joseph Schumpter

“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effects; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.” Frédéric Bastiat, “What Is

Seen and What Is not Seen”

Institutions Shape Incentives, which Shape

Human Behavior

“Institutions provide the incentive structure of an economy; as that structure evolves, it shapes the direction of economic change towards growth, stagnation, or decline.”Douglas North, 1993 Nobel Prize

Winner in Economics

The Key is Incentives

Intentions should be distinguished from consequences

Consequences arise from the interaction of behavior with behavior and with the natural world

Behavior is shaped at the margins by incentives

The Problem of Economic and Social Coordination to Produce Order ….

“is a problem of the utilization of knowledge which is not given to anyone in its totality.” F. A. Hayek, 1974 Nobel Prize Winner in Economics

Humans Need Some Institutional Means of Transmitting Knowledge and

Coordinating BehaviorProperty and the Market Rely

on Voluntary Action and Provide Signals to Guide

Behavior

Legally Secure Property Rights Create both Freedom and Incentives for People to Utilize their

Knowledge and to Cooperate Peacefully with Others

Property Rights Create Incentives for Cooperation and Wealth Creation and for Social Development

To do that, they must be characterized by the “Three D’s”; they must be: Definable (the legal system must be able to

define them clearly to avoid conflicts)

Defendable (they must be secured through access to a legal system)

Divestible (they must be transferrable through gift, sale, or other form of contract)

Wealth Production Requires:1) Property that is Well-Defined, Legally Secure, and Easily

Transferrable; and

2) Freedom to Negotiate and Agree to Prices

1. The point of productive work is to add

value, not just to be busy.

2. Net wealth production (wealth in excess of

cost) requires prices to guide producers and

consumers

2. Without prices, production is blind

3. Without property, including the right to

freely negotiate, there are no efficient prices

Let’s Examine the Effects of Price

Controls

Through

Supply and Demand Analysis

Free Trade Based on Comparative Advantage

Creates Wealth

Through Specialization and

Trade, We Can Be Much More

Productive

An Example

“Blazej” and “Tom”

Consider an Economy of Apples and Fish

Blazej has an absolute advantage in production of both:

If Tom specializes only in apples, he can gather 50 and

if he specializes only in fish, he can catch 50; in the

same time, Blazej can gather 100 fish or 200 apples.

Blazej is better at both….How could he benefit from

trading with inefficient Tom? By choosing to trade with

the lower cost producer.

Production in Isolation (No Trade)

Tom Blazej

Fish 25 50

Apples 25 100

Blazej proposes a trade…

37 apples for 25 fish

Production for Trade

Tom Blazej

Fish 50 25

Apples 0 150

Trade Takes Place

Tom Blazej

Fish 25 (same as before trade)

50 (same as before trade)

Apples 37 [12 more than before trade]

113 [13 more than before trade]

Tom can produce more….and benefits from the trade

And Blazej can now produce more because of trade

It’s not a mystery…it’s comparative

advantage

Despite being less productive in absolute terms than Blazej, Tom is the lowest cost producer of fish:

Producing one fish costs Tom one apple, but for Blazejto produce one fish costs him two apples;

By specializing in his comparative advantage -- fish production, Tom allows Blazej to exploit his comparative advantage, for producing one apple costshim one half of a fish, whereas it costs one whole fish to Tom.

Economic Freedom: A Definition

“Individuals have economic freedom when (a)

property they acquire without the use of force,

fraud, or theft is protected from physical invasion

by others and (b) they are free to use, exchange,

or give their property as long as their actions do

not violate the rights of others.” -- Definition used in

Multi-nation study of economic freedom: Economic Freedom of

the World Report

(www.freetheworld.com)

Let’s Consider the Consequences of the

Institutions of Secure Property and Free

Prices, as Measured in the Annual Economic

Freedom of the World Report of the Fraser

Institute:

www.freetheworld.com

To have a Prosperous Economy, the State

Must Be Both Efficient and Limited

1.Provide Security

2.Provide Justice – Protect Property and

Enforce Contracts

3.Provide a Few Public Goods (Roads,

Courts, Police)

4.Leave Production of Wealth to

Entrepreneurs and the Market Exchange

Process

Successful and Desirable

Institutions

Create Space for Human Freedom

Create Incentives for Peaceful

Cooperation to Create Prosperity and

Order

Create the Foundation for Civil Society

Create Constituencies that Support

Liberty and the Rule of Law

Good Incentives and Institutions are

More Important than Good Intentions

Incentives give signals to rational actors about what will advance their purposes

Institutions give form to incentives

What incentives do different people have to create light?