Knowledge And Decisions

Perhaps the greatest achievement of market economies is in economizing on the amount of knowledge needed to produce a given economic result. That is also their greatest political vulnerability. The public can get the economic benefits of such systems by judging results without understanding processes. But in their political behavior, the public must judge processes — including economic processes of which they may be ignorant or misinformed. Public misunderstandings can lead not only to misinterpretations of economic benefits as harm, but to actual harm resulting from policies designed to “correct” perceived problems. Once the process is underway, every perceived problem — whatever its reality or origin — calls for political solution, and these “solutions” tend to create a never-ending supply of new problems to be “solved.”

Lenin said that “Anti-Semitism is the socialism of fools.” In other words, Jews were being singled out for criticism on the basis of arguments which would more logically apply as a general indictment of the whole capitalist economy. That is the argument here as well — that both have been criticized on the basis of the physical fallacy. Not only Marxism or socialism in general, but a wide variety of other revolutionary or reform movements incorporate a belief that those who directly handle physical objects are “really” the producers of economic benefits. Even Adam Smith said such things at times,⁸ though it was inconsistent with the rest of his message. The physical fallacy has a long and varied pedigree.

Since man does not create physical matter, those who handle material objects in the production process are not producers in that sense. Economic benefits result from the transformation of matter in form, location, or availability (intellectually or temporally). It is these transformations that create economic benefits valued by consumers, and whoever arranges such transformations contributes to the value of things, whether his hands actually come into contact with physical objects or not.

The physical fallacy typically has temporal blinders as well. The production process is arbitrarily conceived to begin at a point after many prerequisites have already been assembled, and only those people actively involved beyond that arbitrary point are conceived to be involved at all (or “really”) in causing the result desired by the consumer. Those involved earlier, before the arbitrary point at which the story was begun to be depicted, then appear at the end — as if for the first time — as recipients of unearned proceeds. Aside from ethical questions about using such a depiction, intellectually it is essentially a linear picture of a circular process.

In the full circle, the consumers’ desires as to physical characteristics and location in time and space must be ascertained by someone who is able to assemble the human and other resources necessary to produce that combination of material and temporal results. Only after the subjective intangibles of consumer evaluation and producers’ costs in risks and time preferences have been balanced and resolved prospectively can the mechanical portions of the physical process proceed. Once the process has gone full circle, it can continue and repeat only insofar as the actual valuations of the end results by the consumers prove sufficient, in retrospect, to cover costs incurred on the basis of prospective estimates. It is a knowledge process, based on estimation and feedback. The physical process is only an intermediary consequence of these intangible estimates, and can continue only insofar as the estimates of some are subsequently validated by the subjective evaluations of others. The risky nature of this process is evidenced not only by the vast numbers of business bankruptcies each year, but by the fact that even such successful giant businesses as the Chrysler Corporation or U.S. Steel have operated at millions of dollars’ losses in some years. But these risks are inherent in a situation where some produce for others, rather than being artifacts of a particular set of institutions. Other kinds of economic systems may resolve or conceal these risks in various ways, but the risks and the costs they entail will not go away.