Page 3  ---  Economics Commentary

Pillars of Prosperity:  The 4 P's

 by  James P. West

The U.S. Chamber of Commerce is launching an educational campaign designed to save capitalism. Chamber President, Thomas Donahue saying, ‘…enough is enough’, sees government bailouts, industry takeovers, and deficit driven stimulus programs, as dangerous to our prosperity and ultimately our freedom. Perhaps the last straw was the irony of China and Russia giving the United States economic advice. Donahue says he is prepared to spend $100 million of Chamber of Commerce 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 task this will not be easy.  First, there is the growing supply of critics that blame market capitalism for the current state of affairs in the U.S  economy.  Second, the counter intuitive nature of many economic concepts, such as comparative advantage, opportunity cost, and marginal analysis, are not easily digested. The Chamber would do well to stick to the basics.

In this spirit, I offer my opening freshman lecture on the  ‘Four ‘P’s  of Prosperity’.  Like educators returning to the three ‘R’s, reading, (w)riting and (a)rithmetic,  the 4 ‘P’s focus on the foundation principles of capitalism .  The ‘P’s  are: Production, Property, Prices and Profits. Each of these is a pillar in the edifice of capitalism. Each is also widely misunderstood resulting in poor 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.  As one astute economist noted, we could create full employment tomorrow by simply outlawing agricultural machinery. Motivating private production that creates sustainable employment is the key to prosperity.  Adam Smith, in his aptly named 1776 book, ‘The Wealth of Nations’, made exactly this point.

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 moral imperative of property rights, which is to respect the property of others. Failure to respect property rights is where the path to prosperity takes a bad turn.  If a person seizes another’s property that is, of course, theft. To misuse the power of the state to legitimate the taking of property is also theft.  Property rights need to be clearly defined and enforced by the rule of law. State coercion to reallocate property, while at times necessary, must be exercised with prudence. Eminent domain, taxation, 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 against 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 new products, services and explore new frontiers. Suffering the consequences of the failure to make profits i.e. bankruptcy, is likewise, a part 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 ‘Ps’ are not really new. They are the same principles that the father of modern economics, 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 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 economic and ethical questions raised by the four ‘P’s loom large in the current economic debate.  The pendulum balancing private and state action appears to be swinging heavily toward the state.  As the U.S. Chambers of Commerce takes up its campaign, which it  has called ‘one of the most important and necessary initiatives in our nearly 100 year history’, these core principles should be at the center of the syllabus. Perhaps, when this is accomplished they can turn to the ethical issues raised in Smith’s other great work, “The Theory of Moral Sentiments”.  This is another ‘must do’ lesson. (The Chigago Tribune and The Morning Call, September 3, 2010).

More than meets the Eye: The Macro environment

Economists are trained to see what is invisible as well as what is visible.   While accounting focuses on the tangible costs and benefits of a transaction, economists consider the broader and more abstract concept of opportunity cost. This requires a keen sense on the part of the analyst to see those costs (or benefits), that may arise from the alternative use of resources, side effects caused or the long-run versus short term ramifications of decisions. This is of particular importance when considering economic impacts of production activity on the environment as these have great and lasting influence.

The spiritually perceptive person is likewise aware that the unseen exists along with that which is seen, i.e. the material world. The spiritual, or moral reality, is an integral part of the creation and it influences the outward material forms. Knowledge of and adherence to spiritual laws ( honesty), like physical laws,(gravity), can help us avoid painful situations and give us the means for a solid foundation of a good life as well as an advancing civilization.

For much of the last two centuries the world has been sharply divided over economic ideologies. The split between east and west, and more particularly between capitalism and socialism, has been a topic of great controversy and bloody conflict. The ascendance of market-based systems, while generating remarkable wealth, has not removed some of the fundamental inequalities that plague the planet, nor has it produced stability conducive to human prosperity. Socialist systems, with their tendency toward mediocrity, bureaucracy and authoritarianism offer a poor alternative.

Finding a balance between the material and spiritual, as well as between command and market based systems is a challenge and one on which the Baha’i teachings, may shed some light. Consider the Law of Huququllah, which while encouraging individual wealth creation, conditions property ownership on the morally obligatory, but practically voluntary and secret,  payment of a prescribed percentage on acquired wealth. This ‘spiritual’ law also seems to strike a balance between the free enterprising nature of man and the need for the accumulation of funds to support centralized activity. 

The drawing below shows how prosperity rests on three institutional pillars: the private sector that creates new products and services, distributes income and makes tax and voluntary payments. The public sector, supported by taxes of the private sector, is the government (national, state and local), which provides public goods and the administration of law. The final pillar, philanthropy, depends on voluntary support of individuals, largely in the private sector, to support a myriad of humanitarian activities. These pillars in turn rest upon the philosophical foundations of the society, that is, its culture, religion and social norms.  For example, a society that promotes honesty and trustworthiness will support stable institutions in the private, public and philanthropic sectors. Societies that rely too heavily on one sector as the former communist nations, which had only a public sector, have stagnated. The United States, with strong pillars in each of the areas, has done much better.

The proper functioning of each sector rests on its component philosophy. Again, how many countries have been destroyed by a culture that does not support honesty, for example?

THE MACROECONOMIC ENVIRONMENT -insert diagram

Prosperity

3 Pillars 1. Public 2. Private 3. Philanthropic

Philosophy

Figure 1 – The Macroeconomic Environment   (©J. West 2009)

More than meets the Eye: The Micro environment

 One of my opening lectures in freshman economics is on the ‘Four ‘P’s of Prosperity’.  Like educators returning to the three ‘R’s, reading, (w)riting and (a)rithmetic,  the 4 ‘P’s focus on the foundation principles of capitalism .  The ‘P’s  are: Production, Property, Prices and Profits. Each of these is a pillar in the edifice of capitalism. Each is also widely misunderstood resulting in poor public policy.

THE MICROECONOMIC ENVIONMENT

 Diagram insert--- Prices, Producton, Prices, Profits

Figure 2- The Microeconomic Environment (© J. West 2009)