Performance Criteria: Foundations of Free Enterprise

The Foundations of Free Enterprise
by Allen, Armstrong, and Wolken

Performance Criteria
Just as people are different, so too are economic systems. The world has scores of economic systems, no two of which are identical. All have different blends of traditions, commands, and markets. Even though they deal with the same economic problems, each system does so in a unique fashion. As we have noted before, these differences occur because economic systems are more than simply means of turning resources into goods and services. They are ways of life, and they reflect the differences in the social values and objectives of each nation.

 

Because there are many different economic systems in the world, it is natural to want to compare performances and to decide which is the best. Unfortunately, such comparisons are difficult to make. Which is best depends on one’s point of view. To identify the best, we would have to establish a single standard against which all systems can be evaluated. But there is no single standard or ideal acceptable to everyone. People around the world have a wide variety of values, opinions, and ideals and have set different goals for their economic systems. These ideals are ultimately matters of individual opinion, and one cannot be proved superior to another. So we need to change the question to “which economic system is best for us?”

Though this is a difficult task, it is important. It encourages us to be more precise and helps us to better understand our own economic system. Only by making comparisons do we learn who we are and what we really want.

When making comparisons of performance we must remember one of the most basic principles of economics. Namely, economic systems are set up to serve people, not the other way around. Economic systems should assist people in improving their quality of life.

Definitions of quality of life vary from person to person. Most of us would agree that it includes both material and non material aspects of life. Our spiritual and psychological desires are just as important as our standard of living. Our initial impulse might be to link economic systems solely with material well-being. But we must realize economic systems also affect the non material aspects of our lives. The following seven performance criteria were developed with this in mind. Such things as standard of living and economic growth are materially oriented, while freedom and equity are more non material in nature. Thus, the performance criteria cover different parts of the overall quality of our lives.

Let’s look at each of these criteria individually.

Standard of living
One obvious way our economic system can help us attain a higher quality of life is by providing continually rising standards of living. To determine how well a system is doing this, we want to know how much the system is producing. This indicates the amount of goods and services available for use, or what is usually called consumption. This reflects the general standard of living.

We can use a statistic called per capita GNP (Gross National Product) to measure this. Per capita tells us how much, on the average, each person in that society can have. Gross National Product is a measure of the total value of output of a society during a one-year period.

Economic growth
By growth we mean an increase in the amount of goods and services produced and available for consumption. This growth simply means a larger pie is available to the members of society. Only when the pie grows from year to year can a society hope to raise the general standard of living. To determine if an economy is growing, we look at its per capita GNP. If this statistic is larger each year (after accounting for inflation), the country is experiencing economic growth.

But a growing pie does not guarantee an increasing standard of living for all. This depends on how goods and services are divided among the people. One group in society can always raise its standard of living at the expense of another. But the only way everyone can have more is if the pie gets bigger. Thus, economic growth is essential if the general standard of living is to increase from one year to the next.

Efficiency
Since resources are scarce, and since it is not possible to satisfy all of our wants and desires, it is important to be efficient. We want to avoid wasting resources. We do not want to use a whole tree to make just one board with a lot of scrap wood to be thrown away. We want to make as many wooden products from each tree as possible.

To be efficient also means that the economy should be operating at its full potential or capacity. This is usually called the goal of full employment. Also, an economy is efficient only if it is producing those goods and services that people want. We want to produce those goods and services that are valued most by individuals.

Being efficient in each of these ways simply means that the size of the pie is as large as possible.

Equality
Increasing the size of the pie only increases the average standard of living possible. That is why it is important to see how an economic system answers the “how to divide” question. We want to observe the actual distribution of goods and services (GNP) among individuals. Is the distribution fair or equitable? Who can say? Once again, what is equitable depends on one’s point of view.

This is a difficult criterion to evaluate, but we can find some help by looking at two types of equality — equality of opportunity and equality of results. Equality of opportunity means we are free to pursue a higher quality of life on an equal footing with each other. No artificial barriers block the efforts of individuals to make the most of their resources and capabilities. This does not imply any guarantee of success, just an equal opportunity to strive for a higher standard of living.

Equality of results has a quite different meaning. For example, consider equality of results in the classroom. Suppose a teacher decides that the grades on the next test will be based on a policy of equal results, everyone receiving the class average. The high scores will be lowered to the class average, and the low scores raised to the class average. This would certainly make everyone equal. But what effect would such an announcement have on the incentive to study for the test? Would any of us like to be tested under such circumstances?

Equal results in an economy means the pie is divided into equal slices and given to all members of society, regardless of the effort they contribute to making the pie. Everyone receives exactly the same income.

Equality is an extremely emotional issue. Ideally, we might like to have both equality of opportunity and equality of results. But it is impossible to have both at the same time. We must decide which one we prefer, and then determine which economic system does the best job of providing it.

Stability
Economic stability is concerned with both prices and employment. Prices tell us the cost of an item and the value of the resources we own. They are an important factor in any economic decision. Wide fluctuations in prices are generally considered undesirable because they cause a high degree of uncertainty when we are making economic decisions. During a period of inflation it is difficult to decide whether we should continue to save for that major purchase or buy it on credit immediately before the price goes up. These fluctuations also change the value of our wealth in an erratic fashion. Consider our savings. During a period of inflation, dollars in a savings account lose purchasing power. They will not buy as much when we withdraw them as they would have when we deposited them.

Price fluctuations also tend to lead to instability in economic growth and employment. Unemployment is undesirable for economic as well as social reasons. From a purely economic standpoint, we are wasting a scarce resource ñ labor — as long as people are unemployed. Only if we are using our resources to their fullest extent can we produce the largest pie possible. Thus, we would like our economic system to provide stable prices and high employment.

Security
Security, like equality, is widely desired, but must be looked at from different points of view. Webster defines security as “freedom from danger, freedom from fear or anxiety, freedom from want or deprivations.” With this in mind, the first thing we must determine is the types of security we want our economic system to provide for us.

It is widely recognized that in every society there are individuals who, through no fault of their own, cannot provide for their own well-being. For example, some children are born with birth defects that make them incapable of ever taking care of themselves. Most of us would agree that our economic system should provide some way of taking care of such people. But it is not always easy to determine which people are truly unable to take care of themselves.

In addition, we must decide who should provide security, the government or individuals. Consider the following example. In any community, during a year’s time, some homes will be destroyed by fire through no fault of the owners. It’s simply an “act of nature,” but it causes financial, emotional, and physical problems for those involved. To protect ourselves we can voluntarily purchase household insurance which provides us with security from financial loss. Fire is just one of the dangers or uncertainties we face during our lives. What about illness, unemployment, and old age? Should the government, through our economic system, provide us with security from these uncertainties? Or should we, as individuals, voluntarily put aside some of our savings to provide for old age and to tide us over in case we are temporarily unemployed?

The government can attempt to provide us with security from a wide variety of life’s risks. But it cannot provide this security for free. Someone must pay the bill, and usually, the ones paying are not those who receive the benefits. After all, that’s the reason for the program in the first place. It was decided that the recipients of these benefits could not provide that type of security for themselves. But there is another, more important, cost to such programs. Every time the government provides another type of security, we all lose some of our freedom.

Thus, when we use security as a performance criteria, we must answer two questions: (1 ) What dangers should we be secure from? (2) Should the government provide these securities for us or should we provide them for ourselves? Only after these questions have been answered can we begin to determine how well an economic system is providing security.

Freedom
Earlier we noted that freedom was an important feature of the free enterprise system. Here we see it as an important dimension of the performance of an economic system, for freedom is perhaps the most cherished of man’s goals.

Freedom is defined as the absence of constraint in choice or actions. However, in a world of many people, total freedom is not possible. One

person’s freedom of action must be constrained by the rights of others to be free. Therefore, all societies establish laws outlining what people can and cannot do. Since such laws are man-made, people ultimately control the extent of their freedoms.

There are many types of freedoms. We have already looked at the economic freedoms of businesses and individuals in our discussion of the foundations of a free enterprise system. We should also be concerned with the extent to which the economic system contributes to, or conflicts with, other types of individual freedom — political, religious, press, and others. All of these freedoms contribute to both the material and non material aspects of the quality of our lives. And, it is important to realize that our freedoms are closely related. If we lose any one of them, we are likely to lose them all.

Freedom means different things to different people. Like security and equality, it is an emotional issue and extremely difficult, if not impossible, to measure. While the importance assigned to this criterion varies widely throughout the world, it is a dimension of performance that should be considered.

Conclusion
In conclusion we must keep in mind that these criteria are related to each other. Some conflict with each other, some complement each other. For example, efficiency is clearly consistent with growth. Also, economic freedom is consistent with efficiency. However, equality of results conflicts with freedom, and security may very well be inconsistent with both freedom and efficiency. Clearly, some trade-offs have to be made. When evaluating economic performance it is necessary that we establish priorities among these criteria.

This brings us back to the beginning of our problem. The evaluation of economic performance is a multidimensional problem. The importance assigned to each criterion varies among individuals and cultures. Nevertheless, we must face up to the problem. We must continually make judgments about what we want from our economic system. In the final analysis these are judgments that should be made by people.

As Thomas Jefferson said,
I know of no safe depository of the ultimate powers of society but the people themselves;
and if we think them not enlightened enough to exercise their control with a wholesome
discretion, the remedy is not to take it from them, but to inform their discretion by education.

Only by educating ourselves about the advantages and disadvantages of the alternatives available can we hope to make informed decisions. It is hoped this discussion will help us to view the problem clearly and to approach it in a systematic and rational fashion.

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