During the first hour of Final Word last week, Nihilist in Golf Pants' Paul Happe interviewed me in a switch of roles. I was a little nervous about this, but his first question allayed any of my concerns: he asked what creates wealth in an economy?

The simple answer is trade. Whenever I exchange with someone else, I give up something I value less for something I value more. Same is true for the other person to the trade, when the trade is voluntary. I emphasize that point for something I want to say below, but let's deal with the basic idea first.

I could quote any number of economists to make that point, and I'll choose in this case Murray Rothbard from his (timely!) "What Has Government Done to Our Money?"

Clearly, a voluntary exchange occurs because both parties expect to benefit. An exchange is an agreement between A and B to transfer the goods or services of one man for the goods and services of the other. Obviously, both benefit because each values what he receives in exchange more than what he gives up. When Crusoe, say, exchanges some fish for lumber, he values the lumber he "buys" more than the fish he "sells," while Friday, on the contrary, values the fish more than the lumber. From Aristotle to Marx, men have mistakenly believed that an exchange records some sort of equality of value�that if one barrel of fish is exchanged for ten logs, there is some sort of underlying equality between them. Actually, the exchange was made only because each party valued the two products in different order.

Why should exchange be so universal among mankind? Fundamentally, because of the great variety in nature: the variety in man, and the diversity of location of natural resources. Every man has a different set of skills and aptitudes, and every plot of ground has its own unique features, its own distinctive resources. From this external natural fact of variety come exchanges; wheat in Kansas for iron in Minnesota; one man's medical services for another's playing of the violin. Specialization permits each man to develop his best skill, and allows each region to develop its own particular resources. If no one could exchange, if every man were forced to be completely self-sufficient, it is obvious that most of us would starve to death, and the rest would barely remain alive. Exchange is the lifeblood, not only of our economy, but of civilization itself.

This really is key, and it's something I picked up in graduate school -- what we really trade are values, and we are motivated to trade because we expect to get more value from the trade. It's that insight that solves the diamond-water paradox and my Twilight Zone story I try to solve with my class as a way to teach marginal analysis. (My view was shaped largely by the writings of James Buchanan, particularly here and here.) Because we are different, trade allows us to specialize in that which we do better than we do anything else; the more we can exchange that good or service with others, and with more people, the wealthier we become.

This provides insight to our post last week about potholes, which seems to have irked one side of the debate. A private exchange increases wealth in part because the two parties to it have all the information needed to assure this is so. Government does not exchange values; it moves goods from one person to another without knowledge of the values each person attaches to them. It seldom can do better than voluntary exchange, and often does worse. When it does worse, it destroys wealth.

When I trade a Mickey Mantle baseball card for a Tony Conigliaro baseball card, I know what I value, and so does the other person. You, standing outside, may say "what the heck? Mantle was such a better player! Beckett's price guide says that Mantle card is worth four times the Conigliaro card! That guy is ripping you off!" But you don't know Tony C, and how kids of New England of the mid-1960s loved him and cried for him when he was hit by a fastball in 1967 and never was able to play again with the same power and elan he had before. I was one of those kids; that card has value to me, and it would be nigh impossible for a government bureaucrat to know this.

That is one reason government harnesses businesses in those NGOs. The money that philanthropists give to a hot breakfast program in D.C. are dollars that those charities value more as breakfasts than other uses. The tax dollars collected from a D.C. shopper who earns $15,000 a year, perhaps not. The government cannot know that. Markets provide information that governments cannot obtain without them. The company that makes potholes trades a value called profits today for advertising today that hopefully becomes greater profit tomorrow.

Critics rail that transactions are riddled with "behind-the-scenes extortion" and that my thinking is an apologetic for firms to "set rivers on fire, exploit labor, fill your chicken with hormones and then declare bankruptcy if too many people squawk." But this is exactly what Milton Friedman said the social responsibilty of business is not. A corporate leader is the employee of his or her shareholders, and has a responsibility to maximize the lifetime profits of the firm. For her or him to pollute, exploit, poison and then declare bankruptcy is highly immoral, as any classical liberal would argue. The critics erect a strawman born of ignorance with this example. From Capitalism and Freedom,

There is one and only one social responsibility of business�to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

That men are not angels, and that some will run businesses in reckless and irresponsible ways, is not a secret, nor is it a secret that those same people would rather run government than business, if you give government more power.

Labels: economics