10 Prerequisites for Prosperity

10 Prerequisites for Prosperity

By Harry C. Veryser

One of the basic tenets of free-market economics is that markets allocate resources more efficiently than government bureaucrats ever could. The countless businesspeople, entrepreneurs, and consumers making economic decisions every day draw on a vastly greater range of knowledge, skill, and experience than a relative few government planners could possess. Just as important, top-down management runs counter to the natural organization of society, whose traditions, customs, laws, goods, technologies, markets, and other components evolved over many generations, not from any plan.

The significance of this “spontaneous order” is easy to miss. But defenders of free enterprise must recognize that markets do not stand independent of the broader culture; they are inextricably linked to all the other organizations, associations, and political and legal systems that develop organically over time. In fact, truly free markets can develop only when crucial preconditions are met.

Let’s look at some of the most important (and often overlooked) prerequisites for a free, prosperous, and harmonious society.

1. Private Property

Private property rights are a corner­stone of a stable and prosperous society. Protections against government seizure of property date back at least as far as the Magna Carta in 1215. Sadly, however, governments in some countries still “nationalize” businesses or even entire industries, taking them out of owners’ hands.

Why are property rights so important? For starters, securing these rights eliminates unnecessary uncertainty about the future, allowing people to make reasonable estimations of risk.

Moreover, as Thomas Aquinas wrote back in the thirteenth century, “every man is more careful to procure what is for himself alone than that which is common to many or all: since each one would shirk the labor and leave to another that which concerns the community, as happens where there is a great number of servants.” In other words, that which belongs to everyone really belongs to no one. No one will take care of it because no one has an incentive to take care of it. People can reasonably expect to enjoy the rewards of their labor only when property rights are secure.

Property rights help establish social order as well. Aristotle made this point more than two millennia ago, arguing that “when every one has a distinct interest, men will not complain of one another, and they will make more progress, because every one will be attending to his own business.”

Finally, as the Nobel Prize–winning economist F. A. Hayek pointed out, “The recognition of property is clearly the first step in the delimitation of the private sphere which protects us against coercion; and it has long been recognized that ‘a people averse to the institution of private property is without the first element of freedom.’ ”

In short, without private property, there is no liberty.

2. A Sound Currency

Virtually all economists agree that inflation—the devaluation of the monetary unit—is a bad idea. It cuts into savings and distorts production, and in extreme cases (such as in Germany following World War I) it leads to chaos and poverty.

Free-market economists have proposed different methods to stabilize the currency, with a growing chorus calling for a return to the gold standard. Whatever the means to achieve it, a sound currency will, first of all, maintain its purchasing power, neither inflating nor deflating. When the currency is inflated, the value of savings drops, which constitutes an unfair tax on savers. With deflation, prices and wages fall—but the debt contracted before the deflation does not.

A sound currency will also stabilize interest rates. At bottom, interest rates account for the fact that people tend to value immediate satisfactions over satisfactions put off into the future. That is, they provide an incentive to save or invest money when that money could be used to purchase something today. Under a sound currency, the interest rate reflects nothing more than this “time preference,” plus the premium paid to account for the risk of default. But interest rates creep higher when market participants worry that manipulations of the currency by the central bank (the U.S. Federal Reserve) will lead to inflation, hurting the value of their principal.

3. The Rule of Law

The rule of law encompasses two categories. First, governments must provide an arena of public safety. One only has to look at areas where clerks serve the public through bulletproof glass to understand that violence acts as a restraint on investment and raises the costs of shopping and insurance. It is essential to create an environment where life, liberty, and property are secure against coercion, governmental or otherwise.

Second, government regulation of business and its settling of disputes must be predictable. An economy can never function smoothly if participants in the market cannot anticipate what actions the government will take—if risk cannot be calculated. As Hayek pointed out, there must be some generally enforced rules of operation to ensure future planning.

4. The Sacredness of Contracts

A contract is a hallmark of a free society, because it is an agreement between two equal parties. In earlier times, the bond between men could be called hegemonic—that is, one party was superior to the other and set the terms of the deal for both parties. This implies a society based on rank, serfdom, or even slavery.

Contracts allow productivity to flourish because they provide the ability to exchange things today for the promises of things to be done or given in the future. Most productivity takes place over time, and by stipulating that resources will be available at a later time, contracts allow individuals and businesses to plan. “Deferred exchanges,” the economist Harry Scherman wrote, “take place only because of the virtual certainty that they will be completed.”

Once the concept of contracts is broken, no one is sure what will happen in the future, and risk increases dramatically. To proceed with the bankruptcy of General Motors and Chrysler in 2009, courts allowed contracts and bonds to be superseded. This may have solved a temporary problem for labor, but investors then questioned the safety of their commitment, especially in an industry that requires huge amounts of capital.

5. The Free Movement of Prices

Prices freely set in the market play a vital function by “accomplishing priorities, allocations, and rationing,” in the words of the economist Benjamin Anderson. As prices for a particular good rise, more suppliers appear on the scene to overcome scarcity, meaning that more supplies and labor are applied toward that good. Conversely, a fall in prices means that a particular item is abundant and there is no need to produce more.

Central planning interferes with this vital pricing process. Balancing the needs of suppliers and demanders becomes more difficult; future planning breaks down; risk increases. This is a major reason why communism failed. Former Federal Reserve chairman Alan Greenspan explained, “Without the help of a market pricing mechanism, Soviet economic planning had no effective feedback to guide it.”

6. Entrepreneurship

Eli Whitney and his cotton gin, Thomas Edison and the lightbulb, Charles Goodyear and the process of vulcanizing rubber—these and countless other inventors and innovators have dramatically reshaped American life. Their impact illustrates the indispensable role of the entrepreneur in a vibrant economy and society. Entrepreneurs enhance standards of living by organizing resources to make new goods and services available to the market. The twentieth-century economist Ludwig von Mises (F. A. Hayek’s mentor) called them “the driving force of the market process.”

7. Family Structure

Declining fertility rates and the disintegration of families are not just “social issues”; they have serious economic consequences.

The financial health of social-welfare programs relies on a large number of people paying in and a small number collecting. Today, however, state and city governments face growing financial crises largely because the declining number of people paying in is unable to sustain generous retirement and medical programs. The federal government confronts similar problems with Social Security and Medicare.

The collapse of the family has led to other economic problems. As families have collapsed, more people arrive in the workforce without personal stability, responsibility, diligent work habits, a strong sense of how to deal with people, and other basic values the child first learns from the family—values needed to succeed in society and the economy.

8. Savings and Capital Formation

The ability to save money is crucial in two ways: it produces capital, which is essential to investment and innovation, and it provides economic security to the saver. Unfortunately, mainstream economics disparages savings, favoring consumption (spending) as the key driver of the economy.

Young people often don’t learn about the importance of savings. When I participated in a seminar on finance for high school students, my fellow panelists, who were bankers, stressed that students should achieve a high credit rating. They made no mention of savings. Today the average student-debt load of college graduates is the highest in history—nearly $30,000. These debts will take years, even decades, to pay, which will make it much more difficult for young people to form families, buy homes, and so on.

9. Leisure

One of the most overlooked prerequisites for a prosperous, well-functioning society is leisure. The vast majority of Americans today scarcely know what the term means and why it is essential to the development of any healthy economy.

Leisure is not simply time away from work. It involves moving beyond the workaday world to the world of contemplation. Leisure is not the same as entertainment or diversion. It is an activity—an activity of the mind and soul. Leisure is in many ways akin to play, especially the kind of children’s play that lacks any specific plan, rule, or timeline. Leisure offers the entrepreneur and the manager the opportunity to think about new and better products, services, and ways of doing business, especially in light of collected information and knowledge.

The social commentator Eric Hoffer wrote of leisure in The Ordeal of Change: “Archimedes’ bathtub and Newton’s apple suggest that momentous trains of thought may have their inception in idle musing. The original insight is most likely to come when elements stored in different compartments of the mind drift into the open, jostle one another, and now and then coalesce to form new combinations.”

10. Decentralization

The smallest, least centralized units of society are best equipped to handle most of the work society does. Local institutions understand their communities and the people in them in a way that large, far-removed governments and institutions simply cannot. As Hayek put it, “We need decentralization because only thus can we insure that the knowledge of the particular circumstances of time and place will be promptly used.”

In crafting the Bill of Rights, the Founders tried to ensure decentralization. The Tenth Amendment states: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.” Unfortunately, today’s federal government all too often ignores this stricture, usurping what local governments and/or individuals, families, and the private economy could and should do.

A market economy represents the best means of bringing prosperity to the many. But it is crucial to understand the essential cultural, political, and legal preconditions that allow an ­economy—and a society—to flourish.

For a tree to grow to its full height, it needs to be nurtured in a certain environment—one with sunlight, water, mineral-rich soil, room to spread its roots, and so forth. Society functions much the same way: when crucial preconditions are not met, it will not grow to its potential.

Harry C. Veryser teaches economics at the University of Detroit Mercy and is the author of It Didn’t Have to Be This Way: Why Boom and Bust Is Unnecessary—and How the Austrian School of Economics Breaks the Cycle (ISI Books), from which this essay was adapted.