Self-Interest at Work
MARCH 01, 1981 by DALE M. HAYWOOD
Dr. Haywood is professor of business and finance at Northwood Institute, Midland, Michigan. He is co-au-thoring with Mr. Lawrence Reed a textbook, When Men Are Free, from which this chapter is published by permission,
There is no need to apologize for the self-interest of human beings and the desire to earn a good living that follows from it. This is simply the way we are.
In a free enterprise system based on private property and the profit and loss system, earning a good living very frequently translates into efficiently performing a service or manufacturing a product which others value and for which they are willing and able to pay.
This was pointed out by Adam Smith more than 200 years ago in An Inquiry Into the Nature and Causes of the Wealth of Nations: “Every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it . . . 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.”
In sum, most, if not all, new businesses start with someone motivated by self-interest being alert to some problem that others face. A new business then requires someone with imagination, ability, and courage to follow through with practical solutions to that problem. This was precisely the case with Roger and Mary Lou MacGregor’s business.
The MacGregor Yacht Corporation
The time was about twenty years ago. The place was Costa Mesa, California. The “problems” that Roger MacGregor saw were rising sailboat prices and rising docking rentals.
For most of his life, Roger had been around sailboats—building them and sailing them. Sailboats were his hobby. While a student at Stanford University, he conceived a new kind of cruising sailboat with a retractable keel. The boater who owns a cruising sailboat with a re tractable keel can tow his boat on a trailer behind his car. Thus, he can store his boat in his own back yard, thereby saving the cost of docking and slip rentals.
Starting a new business requires capital, money with which to buy (or rent) a building and machinery. The MacGregors started their business with $5,000 of their own savings. It is significant that the initial investment was their savings. In a private property, profit and loss system, the owners of private property at risk normally tend to look after that property very closely. Investors proceed cautiously when it is their savings that are at stake, for any losses will be their losses.
There was no guarantee that prospective cruising sailboat buyers would actually buy the kind of sailboat that Roger conceived and that the MacGregors’ firm manufactured. As long as consumers are free to patronize whomever they please, there cannot be any such guarantee. In a free enterprise system, it is the consumers who are the ultimate judges of goods and services. Through their buying or not buying a particular product or service, consumers determine which businesses will earn profits and which businesses will suffer losses. The consumer is king. It is not the producer, it is not the wealthy who guide the economy. Rather, it is the consumer who is in the driver’s seat.
A Better Product at a Lower Price
The MacGregors knew there was competition in the sailboat manufacturing business. They knew that the way to woo customers was to come up with a superior boat at a lower price. And they understood that if a firm is to sell its products for less than the competition, it must have lower costs.
The MacGregors believed that the retractable keel feature of their boat made it a better boat than the competition’s. They sought to cut costs, and thus to cut the selling prices of their boats, through the application of assembly line techniques and the standardization of parts in the fabrication of their sailboats. Neither the assembly line process nor the standardization of parts is new, of course. But the MacGregors made a new application of these familiar techniques, for historically the cruising sailboat manufacturing business has been a custom work business.
Reflect on what is happening here. In pursuing their own interests, the MacGregors were quietly transforming, in a small way, an industry geared to serving a select few to an industry geared more toward serving a less-select larger group. Characteristically, this is how many businesses and industries get started and grow in a free enterprise system.
Division of Labor
Initially, only Mary Lou devoted full time to Roger’s hobby that was turning into a business. Roger kept his job at Ford Aerospace and Communications Corporation. But the MacGregors had correctly judged the demand for less expensive cruising sailboats with retractable keels. Consumers bought more and more of their boats. When production reached ten boats per week, Roger quit his job at Ford Aerospace and joined his wife full time. His hobby was no longer a hobby. It became a full-fledged business—the MacGregor Yacht Corporation.
As their business has grown, the MacGregors have split up some of its major functions. Roger has responsibility for production and sales. Mary Lou is responsible for finance and administration. Economists call this a division of labor.
The basis for a division of labor is the difference in the abilities and the interests of the individuals involved. Each individual does what he or she is relatively more interested in and better able to do. Such specialization usually leads to each specialist becoming even more proficient in handling his part of the business. The greater proficiency leads to greater productivity. And relatively high productivity is what it takes to survive in a competitive free market.
Retained Earnings Finance Growth
The MacGregors’ business is profitable. Thus, it has survived. The profits retained in the business have provided much of the financing for the growth of the firm. This is typical of many businesses.
The bulk of the profits of business do not go for the owner’s personal consumption. Rather, most of those profits go to finance the growth of business. And it is thus that the wealth of many wealthy people gets tied up in assets that provide jobs, in assets that multiply the productivity of the people who use them, in assets that help generate still more goods and services for consumers. In the free enterprise system, much of the wealth of wealthy people is in forms that serve the masses. And the wealthy person who wants to preserve or increase his wealth has an ongoing obligation to see to it that his wealth continues to be in forms that serve the masses.
But relatively high profit margins are short-lived in a system where there is private property, a free market, and a profit and loss system. The top of the heap is a precarious position. For example, as competitors also adopt the assembly line and standardization of parts techniques that the MacGregors pioneered in the sailboat manufacturing business, the competitors will be able to cut their costs too. Then, they also can cut their selling prices. And so the MacGregors will lose whatever competitive advantage they had because they were the first to apply these cost-cutting techniques to the cruising sailboat manufacturing business.
Thus, to hold, to say nothing of increasing, their share of the market for cruising sailboats, the MacGregors are continuously “under the gun.” To maintain relatively high profit margins in a free market, it is not enough to come up with one or two new products. It is not enough to come up with one or two new ideas or new applications of ideas for cutting costs. No, to maintain above average profit margins in a free market, a businessman must repeatedly come up with new products that solve problems or in some other way appeal to consumers. The businessman must repeatedly come up with cost-cutting techniques. And he must do all of this ahead of the competition. Thus we see why the free enterprise system is such a powerful engine for economic progress.
The Uncertainty and Insecurity in Freedom
The MacGregor Yacht Corporation has had a healthy birth and infancy. Will this business continue to prosper and grow? As long as consumers are free to buy someone else’s boats (or other goods altogether), no one can say for sure. The MacGregor boats with retractable keels may inspire another generation of sailboats. Who will have the inspiration? There is no way of knowing in advance. The MacGregor cost-cut-ting techniques may spark another round of cost- cutting. Who will have this spark? There is no way of knowing in advance.
Clearly there is a large element of uncertainty about this firm’s future. In a free society, there is uncertainty about the future of all businesses. But this uncertainty and attendant insecurity are simply the consequences of freedom—freedom of the consumer to buy or not to buy from a given business; freedom of existing or potential producers to begin, expand, or halt the production of any item they believe there is a market for.
Not knowing exactly when or where or from whom the next idea for a new or improved product or new cost-cutting technique will come has been the source of both much mischief and of much good.
Not knowing the source of the next surge of progress tempts some individuals to call for central planning, for government planning of our economic affairs. Some individuals seem to think that not knowing exactly how the next spark of progress will come makes life unnecessarily chancy. Isn’t it, they contend, more rational to “improve” on this chancy situation by methodical central planning? This line of reasoning is the source of much mischief.
History has repeatedly shown us what happens when government central planning is substituted for planning by individual consumers and producers. Central planning stifles the self- interest motive. It constricts the spirit inside us that urges us to strive for the “good life.” This kind of planning is at odds with the nature of man. Although on the surface it appears that in theory political central planning should eliminate some of the uncertainty in freedom and accelerate economic progress, history clearly shows that in fact it is a source of instability and that in fact it retards progress.
Those among us who are tempted to endorse central planning, because it appears to be the more methodical way to progress, might profitably reflect on the life insurance industry. For there is an element of uncertainty in the life insurance industry that is in some ways like the uncertainty of the origins of progress in a free society.
The most capable actuary cannot specify which particular sixty-year-old men will die next year. But the actuary studies history. Specifically, he studies the history of male deaths. He learns from history. He develops mortality tables. Equipped with the information in these mortality tables, that actuary can very accurately forecast the percentage of sixty-year-old men in a large population who will die next year. Knowing this percentage for sixty-year-old men and the corresponding percentages for men and women of all ages, he can help his company confidently proceed with its business of insuring the lives of men and women whatever their ages.
Similarly, a study of the history of free men and women enables us confidently to proceed in freedom. Although we cannot accurately forecast details of how the free society will progress, we can confidently forecast that it will progress. Free men and women will progress because of the good feature of insecurity.
The good feature of insecurity is that it is a powerful stimulus. For the best way to cope with insecurity is to become competent. By ably serving consumers day in and day out, productive individuals can do much to reduce insecurity. Then, in a society in which there are large numbers of individuals busy trying to become more competent and more productive, the average level of ability and the average output of the individuals in that society rises tremendously. Indeed, the average ability and output can rise to the point where the “poor” person in a free society is much better off than the “rich” person in a society that is not free.
Can the MacGregors, specifically, sustain their “track record?” Time will tell. But as for the record of free men and women generally, time has already told. That record is decisive. Freedom is a condition required for maximum human progress.