We the Individuals - "The Economic Butterfly Effect: and the myth of market failure"


art-butterfly-fly-jar-photography-Favim.com-132143_largeBy Thomas J. Michie VII

Swift economic downturns; bankruptcy; increased scarcity of a good or service; rising prices; falling wages; pollution; unemployment; none of these economic and social ailments are congruent with any claim or argument of a total market failure or an irrational market. This is particularly true today more so than ever. This is due in absolutely no small part to state intervention in the market places from Federal, State, Provincial, Regional, and local levels. We must also take into account economic and social interventions in other nation-states that the U.S. actively trades with, or simply send tourists to, or receive tourists from, as well as government policies overseas and at home which influence immigration and emigration here and abroad. The basic premise of the Economic Butterfly Effect, which will be outlined in greater detail below, is there are immeasurable and incalculable amounts of government interventions, directly and indirectly, small and large, rendering any claim of market failure fallacious. It is also recognized by this author that this leads to the distasteful conclusion, by default, that any claims of market success (independent of the state) are equally fallacious. This will be addressed as well. The Economic Butterfly Effect will be outlined first with a simplistic case study to show its ever-present existence in the market system, and second by showing the readers how complex and pervasive it is. The objective of this article is to persuade any readers that any empirical or historical evidence they may have to prove the existence of market failures or market irrationality is fallacious.

Adam Smith, considered the father of modern capitalism and industrialism, told us of an invisible hand guiding society towards its overall betterment within a laissez-faire economy in his masterwork, The Wealth of Nations. In it he writes:

Every individual… neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.[1]

This eloquent assertion, also accompanied by the story of the humble butcher, brewer, and baker who are pursuing their own self interests, paradoxically making society better, is the cornerstone of laissez-faire liberalism. This, however, even in Smith’s times, was not feasible. Though an invisible hand may have been present, there was a more powerful hand interfering with the market processes; thus making a laissez-faire market nonexistent to begin with because any government influence whatsoever makes a market inherently unfree. To suggest otherwise is contradictory.

One cannot argue without causing their own argument to be rendered impotent that a free market exists so long as there is a single chain restricting the markets, or that this illusion of an existing free market has failed. There is a butterfly effect within the sphere of economics. The butterfly effect is a term applied to general physics, used in chaos theory, that any influence regardless of how small can make a significant difference to the state of a physical system (e.g. wind currents, water currents, weather) later in time. The popularized version of this is the suggestion that a butterfly in flight over Rio de Janeiro causes an outside influence on the wind patterns, affecting the weather in Chicago later in time. This is better known as a ripple effect.

This effect can be applied to the global economy; we will call it the Economic Butterfly Effect (EBE). Let us suppose there are no borders, no nations, no centralized monopolies on force whatsoever in the entire world; truly the anarchists paradise. This situation sets us up for an absolute laissez-faire global economy, except there is one singular nation in the entire world which occupies the geographical territory of modern day Brazil. This territory, being the largest producer of coffee[2], levies a tax on their largest export in order to raise revenue for the basic governmental functions needed to maintain their status as a nation-state. For the sake of argument, and to demonstrate how even the smallest disturbance in the economy can offset it by a larger proportion later in time, we will even assume it is a miniscule tax, say, a 1 percent tax on the income of coffee producers. We will also assume the nation-state of Brazil is completely laissez-faire aside from a 1 percent tax being levied. There are no other regulations in the nation-state of Brazil.

A 1 percent tax would, in turn, cause the producers of coffee to attempt to hedge their losses on the consumers by raising their prices by a reasonable enough amount to still remain competitive in the coffee trade while also not suffering a loss of 1 percent income. Let us suppose, in this almost completely laissez-faire global economy the average price for a bag of coffee (60 Kg) is 2 widgets. Assuming Brazil would still produce roughly the same amount of coffee as they do today (~38 million bags of coffee per year[3]) the total income before taxes, labor, production, etc., etc., would be about 76 million widgets per year. A 1 percent tax would cut into this by 760,000 widgets per year. This tax will cause a number of market distortions that not only affect the coffee trade, but also have spillovers into the general global economy.

The producers could raise their prices for a bag of coffee. This will have one of two effects. Either consumers start buying from other areas which produce coffee, or they continue buying Brazilian coffee at a higher price. The first effect would cause obvious distortions in the global economy. Brazilian coffee producers would lose income even more, and would be forced to lay off employees. Some producers may even be forced to shut down completely. This would result, no doubt, in an economic recession for the Brazilian territory, while other coffee producing areas (e.g. modern day Vietnam, Columbia, Indonesia, Ethiopia, India, and Mexico) would receive higher revenues. The sudden influx of sales would cause prices of coffee to temporarily rise overall because the supply of coffee for a sudden shift in market demand in these areas is relatively inelastic. Prices would fall shortly after supply is adjusted for market demand though. Nonetheless, those other coffee producing areas would enjoy higher revenues, higher employment, less competition with the Brazilian nation-state being put at a competitive disadvantage, and greater overall wealth.

Producers in the Brazilian territory could also respond to the 1 percent tax by cutting costs instead of raising prices (i.e. layoffs) and increasing quantity while reducing quality. This would also cause of distortion in the global economy. Coffee prices in this case would likely drop, causing more people to purchase coffee from this region. Or people would outright reject Brazilian coffee because of its poor quality. We have already demonstrated the economic consequences of reduced demand for Brazilian coffee, but what about increase demand because of its remarkably lower prices? This would seem like a good thing to most people, one would think. Surely Brazil would enjoy greater overall income for coffee production, but at a cost. The only producers who could afford to make their production more efficient while cutting employment are those with better financial means. Essentially, the only producers who could survive in this atmosphere are the wealthy. The less affluent would be eliminated from the market because they would not be able to compete. A dramatic decrease in competition would create an atmosphere of big-business, and with it comes lower wages and greater exploitation for the Brazilian people.

Not only would it create the origins for big business in Brazil, it would do so at a cost to the other regions which produce coffee. They would be less capable of competing with the lower prices as well, so they would be forced to continue to produce better quality coffees for those who can afford it, while the Brazilian, big business coffee industry markets to the less affluent coffee consumers. This may not seem like the end of the world, and indeed it isn’t, but it is nonetheless an episode of the Economic Butterfly Effect.

As stated earlier, all of these possibilities not only effect the coffee industry, but they also have spillover effects on other markets. Say coffee prices rise as a result, and consumers purchase it regardless. Consumers will then have less widgets to spend elsewhere, effecting other markets. Say the price of coffee falls overall, or people decide the price of coffee is too high so they don’t purchase it at all, only then would consumers have more money to spend elsewhere, effecting other markets in a positive manner. Say prices rise and consumers still continue buying it, but also continue buying everything they would have been purchasing anyways. Now the distortions are cutting into savings and investments. This means less money is going into savings, which means less money is going into investments, which means economic expansion is thwarted to a degree. Remember, it is only a 1 percent tax in the beginning which causes all of this which means economic expansion would not be brought to a complete halt by any means. Notwithstanding, it is becoming more clear how influential the Economic Butterfly Effect truly is.

When we take all of this into account it becomes impossible to claim there is an unshackled free market, even in this anarchist world except Brazil, when there is even the slightest intervention in the global economy. Outlined was a small, minute intervention, now imagine how remarkably distorted markets are with a world riddled with nation-states and economic interventions. There are multitudes of taxes on the Federal, State, Provincial, Regional, and local levels. There are trade barriers, sanctions, embargoes, and tariffs worldwide. Governments spend trillions worldwide on war machines, dropping bombs, military personnel, spreading “democracy,” and exacting revenge. There are permits required for businesses which reduce competition. Moral hazard is on the rise as well, thanks to corporate welfare. Because of this risk is essentially nationalized in most western countries. Governments also restrict or prohibit immigration and emigration in most places. They also outright prohibit the sales and possession of some substances creating black markets (some of the worst and most deadly consequences of a distorted market). Most governments even blur the lines of what is and what is not your property. Many other government outright own the means of production for some goods and services. And almost all of these nation-states specifically prohibit the private production of money, while the governments debase their own currencies, causing shockwaves through the world (i.e. the 2007 meltdown).[4] The Economic Butterfly Effect is undeniably present; so much so that markets are far to distorted to blame any economic cycles or disasters on the markets alone. Markets react to price incentives, supply, demand, and competition. When all of these are distorted by government intervention it causes mal-investment and market reactions which never would have occurred in a freed economy.

What then do we say to those who respond by arguing we must then accept all successes be owed to the governments of the world since markets are too distorted to be blamed for failures? Surely markets can’t be free from blame, but be thanked for successes. This seems like a reasonable argument on the front, but holds no water after taking a brief look into it.

Real economic growth does not occur because of government, rather it occurs despite government. It is important to note that “real growth” is not comprised of artificial growth spurred by government lending, spending, subsidies, special tax breaks, credit expansion, inflation, or regulatory legislation. Big business in the oil industry, healthcare, banking, and housing owe their success to governments, but at the price of sacrificing competition and smaller business. Entrepreneurs, venture capitalists, and your run-of-the-mill business men and women will always continue to create, innovate, produce, and succeed regardless of government policies. The Economic Butterfly Effect may cloud the markets, even to the point of near blackout, but it is the butchers, the brewers, and the bakers of our time who are leading the way through the thicket. They will survive; it is a basic human instinct to do so. Success, real genuine success, in the markets is indeed because of what remains of the markets, not because of governments. Governments take from the productive individuals and firms, and gives to the corporations. In what way is this considered aiding market success?

The Economic Butterfly Effect is real. It is present in every transaction in the global economy. Imagine, instead of one butterfly over Rio de Janeiro, hundreds of millions of massive butterflies throughout the entire world, and the effect they would have upon the weather. Governments, however, are not  beautiful butterflies flapping their wings, instead they are monstrously ugly creatures responsible for millions of changes at specific points in time throughout the world to an already complex economic system. The distortions and mal-investments resulting are so numerous and ever-present that no mildly thoughtful person could possibly conclude economic downturns are the failure of markets. Indeed they are the failures of government interventions.

[1] Smith, Adam. The Wealth of Nations. London: J.M. Dent, 1910. Print. Pg 456
[2] http://www.bloomberg.com/news/2011-08-19/world-s-top-10-coffee-producing-countries-in-2010-2011-table-.html
[3] http://www.worldmapper.org/posters/worldmapper_1037_coffee_production_ver5.pdf
[4] It would also be encouraged to read into the theory of Regime Uncertainty by Dr. Robert Higgs, which is also a heavy distorter of markets.

Courtesy of We the Individuals.