The fall of the Berlin Wall in November 1989 was the defining economic event of our lifetime. It marked the end of the largest controlled experiment in the history of social sciences – the division of Germany into two economic zones, one centralised and planned, the other a market economy. After 40 years, the gap in living standards between the two was so extreme that the experiment terminated.
But why? A popular caricature of the market economy sees greed as the dominant human motivation. Economic progress is best achieved by acknowledging that reality and imposing as few restrictions as possible. This is the economy of Nigeria and Haiti, and it does not work. It is also the commercial environment of the Ik mountain people described by anthropologist Colin Turnbull, and Lehman Brothers as written up by former vice-president Lawrence McDonald. It did not work in these cases either.
A more thoughtful account of the success of markets has three elements. Prices act as signals – the price mechanism is a guide to resource allocation rather than central planning. Markets are a process of discovery – an economy adapts to change through a chaotic process of experimentation. The third element is the capacity of the market to bring about diffusion of political and economic power. This is the most effective way to protect society from rent-seeking – a culture in which the principal route to wealth is not creating wealth, but attaching oneself to wealth created by others.