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  Praise for Free Our Markets

  “Central to economics is the study of how people deal with the scarcity of resources. Unfortunately, among humanity’s scarcest resources are crystal-clear, compelling, and correct explanations of how economies work. With this truly outstanding volume, Howard Baetjer makes that vital resource much less scarce.”

  —Donald J. Boudreaux, professor of economics, George Mason University

  “Howard Baetjer takes a new look at economics – neither from the left nor from the right, but from the heart. Baetjer takes a refreshingly holistic approach in exploring how joyously talented and frustratingly limited humans interact to better their lives. You won’t find the graphs and equations that unnecessarily alienate so many economics students from this wonderful discipline. Instead, you’ll find a story of how people can come together to form a civil society – a story that will resonate with anyone who believes that, for all their shortcomings, humans are fundamentally good.”

  —Antony Davies, professor of economics, Duquesne University

  “In Free Our Markets Howard Baetjer demonstrates clearly that increased liberty, not government, is the way to improve our standards of living. Making his case with beautifully explained economic reasoning and a careful and unbiased examination of real-world examples ranging from the housing crisis to education markets, Baetjer has succeeded in producing that wonderful rarity – a book that is both so clear and so important that it really should be read by everyone. If we take the humane lessons of Free Our Markets to heart we will undoubtedly make our lives – and the lives of our children – far, far better.”

  —James Stacey Taylor, professor of philosophy, College of New Jersey

  “Howard Baetjer has produced a marvelous introduction to economics that will have great appeal to those who want to understand why economics matters both for making sense of our world and for improving it. In the tradition of the great communicators of sound economics, Baetjer makes complex economic ideas simple, and uses great storytelling and numerous effective examples to illustrate the productivity and humanity of the market. His final section on the housing boom and bust is particularly effective in showing the economic waste and human toll that arise even from the most well-intentioned attempts to intervene in the market. This book is a great place to start in understanding why we need markets that are more free, not less.”

  —Steven Horwitz, Charles A. Dana Professor of Economics, St. Lawrence University

  “Free Our Markets enables the educated layman to understand the fundamental reasons why economic liberty is the foundation for prosperity and societal flourishing.”

  —John Allison, CEO and President, Cato Institute, Washington, DC.

  “It’s no accident that Howard Baetjer is a highly sought-after speaker far beyond his home institution: few economists – few thinkers in any discipline – are as effective at communicating ideas. His explanations and examples of core economic principles and how they inform our understanding of a free society are clear and vivid; his writing is engaging and uplifting. Baetjer’s gifted ability as a lecturer translates nicely to the printed page. Readers of this book will not only come to a better understanding of economics, they will also come away with a better understanding of human freedom.”

  —Aeon J. Skoble, professor of philosophy, Bridgewater State University

  “Howard Baetjer, one of America’s great classroom teachers, has now written the definitive introduction to free-market economics for the twenty-first century. Clear, logical, and principled, Free Our Markets ranks with Henry Hazlitt’s Economics in One Lesson as one of the very best books on free-market economics ever written. This book should be read by all Americans who care about prosperity and a free society.”

  —C. Bradley Thompson, Executive Director of the Clemson Institute for the Study of Capitalism

  “We are at this moment in time confronted with the consequences of the perpetuation for decades of economic fallacies that captured the political elite and popular imagination and now have come to threaten the economic future of Europe and the US. We need at this time a massive intellectual correction to defeat popular fallacies and to spread economic literacy. Howard Baetjer is a master teacher of the economic way of thinking, and Free Our Markets: A Citizens’ Guide to Essential Economics is the perfect antidote to the fallacious reasoning that dominates political speech on the left and the right in DC and Brussels (and everyone in between).”

  —Peter Boettke, University Professor of Economics, George Mason University

  Free Our Markets is that rare treasure—an illuminating book about a complex and important subject that is so clear, so persuasive, and so inspiring that it is an absolute pleasure to read. Professor Baetjer makes the case for economic liberty with a masterful combination of show and tell that leads inexorably to his conclusion: that the way to prosperity, security, and abundance is freedom, not the coercive power of government.

  —Clark Neily, Senior Attorney, Institute For Justice

  An instant classic… Howard Baetjer’s vivid explanation of key economic principles stands out as not only sound and incisive but also humane and generous. Free Our Markets makes a clear and compelling case for the restoration of Thomas Jefferson’s vision for “a wise and frugal government, which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned.”

  —Robert M. S. McDonald, Associate Professor of History, United States Military Academy

  The microeconomic sections of Howard Baetjer’s Free Our Markets, which are most of the book, are magnificent. He takes you on a voyage of discovery as he reveals the power of free markets to make our lives better. Whether he discusses corn row braiding, how to protect elephants in Africa, why central economic planning doesn’t work, or why price controls on water cause people to do without, Baetjer brings fresh energy to his subject. His enthusiasm is infectious. Read, learn, and enjoy.

  —David R. Henderson, author of The Joy of Freedom: An Economist’s Odyssey.

  One of the major failings of the economics profession is not making our subject comprehensible to the ordinary person. Free Our Markets: A Citizens’ Guide to Essential Economics comes to the rescue. Professor Howard Baetjer does a yeoman’s job in addressing that problem whilst proving that economics is not only exciting, it’s mostly plain common sense. Readable and fun, Free Our Markets provides valuable insights and possible solutions to many of the nation’s problems.

  —Walter E. Williams, John M. Olin Distinguished Professor of Economics, George Mason University

  Free Our Markets

  A Citizens' Guide to Essential Economics

  Jane Philip Publications

  New Views, New Beginnings tm

  Copyright © 2013, by Howard Baetjer Jr. All rights reserved.

  Cover and book design by Jordan Zane Brownstein

  Grateful acknowledgement is made for permission to excerpt from copyrighted works:

  Leonard Read’s “I, Pencil.” Copyright © 1958, by the Foundation for Economic Education, 260 Peachtree St. NW, Suite 2200, Atlanta, GA 30303.

  Russell Roberts’s “Gambling With Other People’s Money.” Copyright © 2010, by Russell Roberts, Mercatus Center, George Mason University.

  Publisher’s Cataloging-In-Publication Data

  (Prepared by The Donohue Group, Inc.)

  Baetjer, Howard.

  Free our markets : a citizens’ guide to essential economics / Howard Baetjer Jr. -- 1st ed.

  p. : ill. ; cm.

  Includes bibliographical references.

  ISBN: 978-0-9844254-2-6

  1. Free enterprise. 2. Austria
n school of economics. 3. Intervention (Federal government) 4. Economics. I. Title.

  HB95 .B34 2013

  330.12/2 2013941977

  First Edition: July, 2013

  Published by Jane Philip Publications, LLC, New Hampshire, USA

  For my mother,

  Katharine Finney Baetjer Hornady,

  in admiration, gratitude, and bottomless affection

  Contents

  Acknowledgements

  Introduction

  Part I. Principles of Spontaneous Economic Order

  Introduction

  1. Prices Communicate Knowledge

  2. Profit and Loss Guide Innovation

  3. Free Market Incentives Foster Service to Others

  Conclusion

  Part II. Regulation by Market Forces Outperforms Government Regulation

  Introduction

  4. Ownership Matters

  5. Government Regulation Gets Captured by Special Interests

  6. Market Forces Regulate

  7. Special Interests versus Democracy

  Conclusion

  Part III. The Housing Boom and Financial Crisis

  Introduction

  8. Mortgage-Making in a Free Market

  9. Boom, Bust, and Turmoil

  10. Why Housing Boomed

  11. Why the Boom Got So Big

  12. Why the Housing Bust Led to a Financial Crisis

  Conclusion

  13. Hope for the Future

  Appendix A. How the Fed Alters the

  Money Supply and Thereby Interest Rates

  Appendix B. Bank Capital and "Leverage"

  Notes

  About the Author

  Acknowledgements

  My primary debt of gratitude for this book is to the Institute for Humane Studies (IHS) at George Mason University. IHS helped me pay for my graduate work at George Mason; IHS sponsored the public policy course in which I first gave shape to the ideas presented here; and for the last seventeen years IHS has given me the opportunity to teach at its summer seminars—invariably the high point of my teaching year—where with the help of fellow faculty and many wonderful students I have developed the lectures on which this book is based. In particular I thank my long-time IHS faculty and staff teammates Brad Birzer, Susan Love Brown, Andrew Cohen, Antony Davies, Jerry Ellig, Beth Erber, Christy Rhoton Horpedahl, Mark LeBar, Chris Martin, Rob McDonald, Clark Neily, Aeon Skoble, Frank Stephenson, James Stacey Taylor, Mario Villarreal-Diaz, and Marty Zupan, for their wisdom and friendship.

  For explanations of and information on particular policy matters I thank Karol Boudreaux, Urs Kreuter, Jerry Ellig, Sallie James, Bruce Yandle, John Baden, Russ Sobel, and particularly Steven Horwitz, who generously answered questions and also read and commented on early versions of the chapters on money and banking. For helping me better understand mortgage-backed securities and other aspects of the financial crisis of 2008 I thank Alison Granger, Arnold Kling, Joe Pomykala, and Jeffrey Friedman. For information on Children’s Scholarship Fund Baltimore I thank Paul Ellis and Beth Harbinson. I thank Alex McCoy for insight into the consequences of the No Child Left Behind Act.

  I thank my friends and colleagues who read all or parts of the first complete draft and made many useful suggestions: Jim Dorn, Cheryl Finney, Vin Broderick, Scott Reinhardt, Kerry Brown, Tom Rouse, Jim Vinoski, Art Carden, Greg Muth, and Mike Hanrahan. Tim Stonesifer gave me the benefit both of comments on the manuscript and feedback, over a number of years, on my evolving plans for framing the content. I am particularly grateful and indebted to Ted Winstead for his painstakingly thorough markup of the entire first draft, giving me the benefit of his eye as a professional writer, and his frank criticism as a true friend.

  For help with research I thank former students Kathryn Sandstrom, Chad Henson, and Charlie Wieprecht, and also Kai Filipczak. Thanks to Craig Hammond for helping me think through my approach to the education chapter, and to Dr. Alexandre Padilla for identifying the origin of the term “the knowledge problem.”

  To my colleague and former department chair George Georgiou I am grateful for allowing me to teach money and banking so that I could learn it, even though I had never had a course in it.

  For moral support and encouragement in keeping the writing moving I am particularly indebted to Aeon Skoble and Christy Rhoton Horpedahl.

  All the graphs in the book were put together by my IHS teammate Antony Davies. He found the data, created the graphs, and altered them in any way I asked, all with astonishing quickness. For that and for his professional and personal friendship I am extremely grateful.

  My editor, Deborah Brownstein, has been a joy to work with and a source of constant encouragement and support; I am lucky and grateful we got to team up. Thanks also to Barry Brownstein for his encouragement and insights and the book’s title.

  I thank all of those who have taught me economics in the Smith-Hayek tradition, a tradition committed to demonstrating that on-going increases in economic well-being for all depend on liberty. These include the great thinkers whose ideas form the foundation of the discipline for me: Adam Smith, Ludwig von Mises, F.A. Hayek, and Israel Kirzner; the great explainers whose lucid prose has clarified for me the essential principles: Frederic Bastiat, Leonard Read, Walter Williams, Henry Hazlitt, Milton Friedman, and Thomas Sowell. They include as well Russ Roberts, via his novels and EconTalk, and (here I hesitate to name names for fear of forgetting some) my teachers at GMU, especially my dear friend and mentor Don Lavoie, Jack High, Dick Wagner, George Selgin, and Don Boudreaux. For a subtle but strong contribution to my intellectual development I thank the trio of inseparable, irrepressible, inspiring grad students in the “class” ahead of me at GMU, who showed me what it was to be immersed in ideas and who continue to teach me through their writings and lectures: Steven Horwitz, Peter Boettke, and David Prychitko. I thank Peter Boettke further for giving me the idea (at an IHS seminar) to write this book.

  For intellectual and personal companionship that have helped me develop as a teacher I thank Emily Chamlee-Wright, Mark Steckbeck, Steven Miller, Ben Tisdale, Jonas Merrill, John Ross, Solomon Stein, Jim Vinoski, and other classmates, students, and teachers too numerous to mention. My goal in this book is to pass on to others some of the understanding I have been privileged to gain from all of these.

  Not least, I thank my wife, Susan, for putting up with “No, I have to work on the book” and for help with grammar, but mostly for the emotional support of our happy companionship. It sweetened the writing as it sweetens life.

  Introduction

  This book had its origin at 30,000 feet in March of 1977. I was a young English teacher and football coach at St. George’s School in Rhode Island, assigned to teach an overflow section of a colleague’s popular “Utopian Literature” spring elective. During the spring vacation before the term began, on an airline flight with my sister Betsy, I was getting ahead on the course reading. Having finished The Communist Manifesto, I opened up the title essay from For the New Intellectual, by Ayn Rand. A few pages into it, I turned to Betsy and said, “This is good stuff.”

  After a few more pages, I turned to her again and said, “This is really good stuff.” As I drew toward the end of the essay, my eyes opening for the first time to the right and wrong of government intervention in the economy, I turned to her a third time and said, “This is going to change my life.”

  Up to that time, my philosophical interests had been limited to a concern about ethics; I had had no interest in economics or political philosophy. But I was intrigued by the idea that business owners have a right to the profits they earn in voluntary exchange with others; that government interference with people’s productive activities violates their right to pursue happiness (peacefully) as they wish; and that these peaceful pursuits increase the well-being of others as well as the business people themselves.

  Excited by this new perspective on human relations, I looked for other writings from the individual-liberty-is-important perspectiv
e. I discovered The Foundation for Economic Education (FEE) and went to one of their seminars. Waiting for me in my room when I arrived was Leonard Read’s “I, Pencil” (with which we’ll begin Chapter 1) and its exhortation to “leave all creative energies uninhibited.” Also waiting for me was Frederic Bastiat’s The Law. I opened it and read,

  See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime.

  Then abolish this law without delay… (p. 21)

  I was struck by the dignity of principle followed to its logical conclusion. Why had I never thought that before?

  I embraced classical liberal (or libertarian) principles easily because they suit my ethics. I had learned at summer camp that one should leave the other guy’s tennis balls at his bunk unless one has permission to use them. I believed, and believe still, that a generous concern for others means, first of all, not forcing our will on them by preventing them from peacefully pursuing happiness in their own way.

  This ethical belief led me logically to a belief in limited government: minimum taxation, no forced transfers of wealth from some people to others, and no regulatory restriction of voluntary exchange. It meant people should be free to do “anything that’s peaceful” (the title of one of Leonard Read’s books), that no one may justly initiate the use of force on others, and that governmental force should be used only to secure people’s rights to life, liberty, and property.

  In short, I found myself to be a liberal, in the classical sense. On principle, I believed in unrestricted freedom of enterprise, free markets, capitalism.