Risk-value relationship

This post was a response to a student's comments about the freedom to contract.

I like your point that anyone in a free market society can enter into an agreement with anyone else. In a free society, the individual is the basic unit of society. The role of government is to facilitate individual freedom by ensuring safety, stability and providing the basic infrastructure required by society, such as the legal system. However, government is very much in the supporting role, and not the focal point of a free society.

This is in stark contrast to other types of societies, be they totalitarian, theocratic or authoritarian. In such systems, government is the basic unit of society. Authority flows from the top down, in contrast to the bottom up flow of authority in a free society. Like you said, in a free market society, anyone can enter an agreement with anyone else. In a free society, you do not need government’s permission to do so.

So why has this difference translated historically into free societies being wealthier societies? I think that it is understandable when you consider how wealth is created in a free market system. To start, think about what we mean by “value.” Value is a subjective concept. Only I can judge the value of something in my hands. In fact, because of my own unique circumstance a particular good or service in my hands may be much more valuable than the same good or service in the hands of another person. Of all the people on the planet only I see can the world from by particular perspective, and thus I am the best judge of value in my own particular situation.

When I meet with someone and we discuss a possible transaction, I will only agree to the transaction if I believe that I am better off for having entered the transaction. Likewise, the potential counterparty to the transaction is making the same judgment. He also believes that he will be better off for having agreed to the transaction, or we will not reach an agreement. Assuming that we a working with accurate information, the miracle of the free market is that we will both be correct. We will both be better off for having entered the transaction. Thus, the hallmark of a free market system is that it is dominated by win-win transaction. With each transaction economic resources move to a higher value and the wealth of the system as a whole is increased.

Consider the strategies that we use to accomplish this result. All of you who are here in school are here because you want to obtain skills and knowledge, which you believe others will see as valuable. You will then enter into transactions with people who believe that what you can provide is more valuable to them than the money that they will give you in return. You will take that money and use it to obtain goods and services from others, which you judge will be more valuable to you than keeping the money in your hands. In other words, the incentive is for each individual to continuously develop skills and abilities, which others will find as valuable, and which will continuously increase the overall wealth of the society.

Now consider the basic transaction model in a command society. It is not based on judgments made by those who have the best knowledge concerning the value of economic resources in the society. It is based on decisions made from a distance. Decisions in a command system are forced. Such transactions tend to be zero sum transactions. One person's gain is another person's loss. There was no mutual agreement that the transaction was in the best interest of those involved. Rather transactions are compelled by one side. In a free society, innovation and efforts to increase the value you offer to others is rewarded. In a command system, the name to the game is usually survival. In a free society the individual is rewarded for taking risk and playing to win-win, but in a command society taking risk can mean imprisonment or death. Being different is bad. Being the same is safe. So, you play not to lose. It is no wonder that free societies have been the most innovative and wealthiest societies.

		October 12, 2007 *Free to Win-Win*
	This post was a response to a student's comments about the freedom to contract. I like your point that *anyone* in a free market society can enter into an agreement with *anyone else. In a free society, the individual is the basic unit of society. The role of government is to facilitate individual freedom by ensuring safety, stability and providing the basic infrastructure required by society, such as the legal system. However, government is very much in the supporting role, and not the focal point of a free society. This is in stark contrast to other types of societies, be they totalitarian, theocratic or authoritarian. In such systems, government is the basic unit of society. Authority flows from the top down, in contrast to the bottom up flow of authority in a free society. Like you said, in a free market society, anyone can enter an agreement with anyone else. In a free society, you do not need government’s permission to do so. So why has this difference translated historically into free societies being wealthier societies? I think that it is understandable when you consider how wealth is created in a free market system. To start, think about what we mean by “value.” Value is a subjective concept. Only I can judge the value of something in my hands. In fact, because of my own unique circumstance a particular good or service in my hands may be much more valuable than the same good or service in the hands of another person. Of all the people on the planet only I see can the world from by particular perspective, and thus I am the best judge of value in my own particular situation. When I meet with someone and we discuss a possible transaction, I will only agree to the transaction if I believe that I am better off for having entered the transaction. Likewise, the potential counterparty to the transaction is making the same judgment. He also believes that he will be better off for having agreed to the transaction, or we will not reach an agreement. Assuming that we a working with accurate information, the miracle of the free market is that we will both be correct. We will both be better off for having entered the transaction. Thus, the hallmark of a free market system is that it is dominated by win-win transaction. With each transaction economic resources move to a higher value and the wealth of the system as a whole is increased. Consider the strategies that we use to accomplish this result. All of you who are here in school are here because you want to obtain skills and knowledge, which you believe others will see as valuable. You will then enter into transactions with people who believe that what you can provide is more valuable to them than the money that they will give you in return. You will take that money and use it to obtain goods and services from others, which you judge will be more valuable to you than keeping the money in your hands. In other words, the incentive is for each individual to continuously develop skills and abilities, which others will find as valuable, and which will continuously increase the overall wealth of the society. Now consider the basic transaction model in a command society. It is not based on judgments made by those who have the best knowledge concerning the value of economic resources in the society. It is based on decisions made from a distance. Decisions in a command system are forced. Such transactions tend to be zero sum transactions. One person's gain is another person's loss. There was no mutual agreement that the transaction was in the best interest of those involved. Rather transactions are compelled by one side. In a free society, innovation and efforts to increase the value you offer to others is rewarded. In a command system, the name to the game is usually survival. In a free society the individual is rewarded for taking risk and playing to win-win, but in a command society taking risk can mean imprisonment or death. Being different is bad. Being the same is safe. So, you play not to lose*. It is no wonder that free societies have been the most innovative and wealthiest societies.