Capitalism

Capitalism is a way to come up with goods and services and get them to people. Every society that doesn’t want its people to starve or die of exposure has to accomplish this task; capitalism is simply one approach to doing it. The important features of this approach are:

  1. Profit-seeking companies. Under capitalism, most goods and services are produced by for-profit companies rather than nonprofits, the government, or individuals. Companies can be owned by only a few people (such as the partners in a law firm) or a great many (publicly traded companies have shareholders all over the world) and are assumed to last over time; they don’t have a predefined end date.
  2. Free market entry and competition. Companies can go after one another’s markets and customers; there are few if any protected monopolies. It might not be legal to completely copy a rival’s patented product, but it’s perfectly legal to try to come up with something better. In economist-speak, markets are “contested.” Similarly, people can take their skills from one market to another; they’re not tied to a single geography or job.
  3. Strong property rights and contract enforcement. Patents are a form of intellectual property. They can be bought and sold just as other kinds of property—from land to houses to cars—can. Laws and courts ensure that none of these kinds of property can be stolen or destroyed, even by large, powerful entities such as billionaires, giant corporations, or the government. Similarly, if a small company and a big one sign a contract to work together, neither party gets to unilaterally walk away from the agreement without fear of getting sued.
  4. Absence of central planning, control, and price setting. The government does not decide what goods and services are needed by people, or which companies should be allowed to produce them. No central body decides if there is “enough” volume and variety in smartphones, caffeinated beverages, steel girders, and so on. The prices of these and most other goods and services are allowed to vary based on the balance of supply and demand, rather than being set in advance or adjusted by any central authority.
  5. Private ownership of most things. Smartphones, cups of coffee, steel girders, and most other products are owned by the people or companies that bought them. The companies that produced these things are also owned by people. Many shares of Apple, Starbucks, US Steel, and other public companies are held by mutual funds, pension funds, and hedge funds, but all these funds are themselves ultimately owned by people. Most houses, cars, land, gold, Bitcoin, and other assets are also owned by people rather than the government.
  6. Voluntary exchange. The phrase most closely associated with capitalism is “voluntary exchange.” People can’t be forced to buy specific products, take a certain job, or move across the country. Companies don’t have to sell themselves if they don’t want to. They also don’t have to make some products and not others or stay within specific markets.

There are a couple of things to highlight about this definition. First, capitalism is not without oversight. The government has clear roles to play in establishing laws and settling disputes (to say nothing of setting tax rates, controlling the money supply, and doing other things of critical economic importance). Every sane advocate of capitalism also recognizes that while voluntary exchange and free market entry are great, they don’t create utopia. Some important “market failures” need to be corrected by government action.

The second thing to point out is that all of today’s rich countries are capitalist, but this definition. This is not to say that all capitalist countries are alike. Denmark, South Korea, and the United States are very different places. They have dissimilar trade policies, tax systems, social safety nets, industrial structures, and so on. But they all have all of the things listed above; they are all inherently capitalist.

Today’s poorer countries, in sharp contrast, reliably do not have all of the things listed above. Their governments tend to run such things as airlines and telephone networks that are run by private companies and rich countries. It’s generally much harder to start a company in less affluent countries, so free market entry and competition are constrained. In poorer countries, it’s also often not clear who owns what. Things that are taken for granted in the rich world, such as unambiguous land registries and clear title to houses and other property are problematic in many developing countries.

The biggest difference between rich and poor countries might be whether laws are clearly and consistently enforced. Poorer countries don’t lack laws; they often have extensive legal codes. What’s in short supply is justice for all. Officials are corrupt; the elite get special treatment and rarely lose in court; police, regulators, and inspectors can expect bribes; and contested markets, property rights, and voluntary exchange suffer in countless other ways. It’s not that these abuses don’t occur in rich countries, but they occur much, much less often.

Capitalism is not popular these days. Many people feel that this system for producing goods and services is no longer working well or that the flaws it’s always had have finally become unignorable. Many others believe it’s the main reason why we’re seeing an unprecedented global rise in prosperity, health, and other critical aspects of well-being. So, which is it?

Even though he never used the word “capitalism,” Adam Smith—the eighteenth-century Scottish economist and political theorist—was its first great analyst. He figured out many things over two centuries ago that economist keep going over, without adding much (if anything) new. He recognized both capitalism’s great strengths and its weaknesses and discussed both at length. So, with Adam Smith as a guide, let’s look at three valid critiques of capitalism, and three invalid ones.

First, the valid criticisms:

  1. Capitalism is selfish. Yes, it absolutely is. But as Smith points out, this is a good thing. One of the most quoted passages from his 1776 masterpiece, The Wealth of Nations, is “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” The profit motive is an extremely powerful incentive for people and companies to create goods and services others will want to buy. Self-interest is not a flaw of capitalism, it’s a central feature. In most societies and religious traditions selfishness is held to be a vice, so the notion that the profit motive is beneficial fights against long traditions and deeply ingrained assumptions. The New Testament, for example, holds that “the love of money is the root of all evil.” This view is persistent. Yet nothing works better. As Smith observed, “Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow-citizens.”
  2. Capitalism is amoral. This is also true, and it’s a much harder criticism to dismiss than selfishness. “Will somebody buy this?” (or even worse, “Can we convince somebody to buy this?) is one of a producer’s most frequently asked questions, and it’s bad for society if it’s the only one that gets asked. People will buy child pornography, the feathers of desperately endangered birds, stolen goods, and many other things that are malum in se—bad in and of themselves. Countless other popular goods and services occupy moral gray areas: such offerings include foods full of sugar, fat, and salt; cigarettes; powdered infant formula marketed to mothers in regions where it’s unsafe to drink the water; assault rifles; and so on. People will readily buy these too. Capitalism is not going to host the debate about which of these offerings are to be permitted. That essential debate needs to happen elsewhere in a society. Smith got right the fundamental principle we should apply: “The interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer.” We also need to attend the interests not only of the producer or the consumer but also of the people (such as slaves or children) and the animals that are used in production but don’t want to be.
  3. Capitalism is unequal. Without question, it is. As Smith observed, “Wherever there is great property, there is great inequality.” Land, mineral rights, and shares in a company are all forms of property under capitalism, and ownership of most of these is far from equal in most societies. The dominant belief among American economists in the decades after World War II was that inequality in capitalist countries would decrease as prosperity spread, but that view is now shifting. Both current trends and newly available historical data indicate that high levels of inequality might well be the norm. Smith was very insightful about one of inequality’s most serious consequences: a feeling of not belonging and not participating, of being shut out of larger communities. Smith was right to stress that this aspect of falling behind is of great concern. As he wrote in his other great work, The Theory of Moral Sentiments, “The poor man goes out and comes in unheeded, and when in the midst of a crowd is in the same obscurity as if shut up in his own hovel.”

Now here are three invalid critiques of capitalism, each refuted by Smith long ago:

  1. Capitalism is cronyism. Smith knew that competition was essential for capitalism to function well. He also knew that companies don’t want real competition because it drives down profits. Another of his most famous observations is “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Smith saw that government had a role to play in making sure that competitors don’t become cronies—close friends who collude to all get rich together by simultaneously raising prices. Many of the complaints about our current economic system aren’t complaints about capitalism. Instead, they’re complaints about perversions of it. Collusion and crony capitalism, as described by Smith above, are dangers. So is corporatism: favors done for large, established companies by the government. Smith also realized the danger of what is now called regulatory capture—where instead of acting in the best interests of the public, regulators or elected officials instead take care of incumbent companies. As he wrote, “The member of parliament who supports every proposal for strengthening [a] monopoly, is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance.”
  2. Capitalism is anarchy. No, it’s not. Yet another of Smith’s most famous observations, taken from a lecture he gave more than twenty years before The Wealth of Nations appeared, is that “little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice.” Capitalism will cause great prosperity to blossom, but only in a properly tended garden. Laws and courts are needed to protect the rights, property, and contracts of society’s weaker members; violence and the threat of violence can’t be tolerated; and taxes are necessary even though they’re unwelcome. Taxation needs to be done carefully (it needs to be “easy”) because it can (and often does) distort incentives. But it does need to be done. Taxes are what we pay for civilized society. We need them to pay not only for armies and courts but also, as Smith realized, for infrastructure that improves both daily life and the economy. He wrote about the government’s “duty of erecting and maintaining certain public works and certain public institutions, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain.”
  3. Capitalism is oppression. Perhaps the single most unfair, inaccurate, and ignorant critique of capitalism is that it is bad for the workers who help create it. Karl Marx was confident that workers under capitalism would be trampled and impoverished until they threw off their shackles and embraced communism, but this is not what happened. Despite its many flaws, the Industrial Era increased the prosperity and quality of life for average people more quickly than ever before. Progress in many important areas has sped up in recent decades as capitalism and tech progress have both spread around the world. Adam Smith realized that capitalism’s greatest virtue was that it improved the lives of not only the elite but also of people born into modest circumstances. He saw much more clearly than Marx or Malthus what the future held as long as capitalism was allowed to operate properly. And throughout his writing, he’s concerned with what we might today call social justice. Smith believed deeply that workers deserved a high and rising standard of living. As he wrote in The Wealth of Nations, “They who feed, clothe, and lodge the whole body of the people, should have such a share of the produce of their own labor as to be themselves tolerably well fed, clothed, and lodged.” He believed that capitalism is the best means to accomplish that goal.

Another common criticism of capitalism is that it doesn’t provide a social safety net for everyone. This is true, but it’s like complaining that a ship doesn’t fly. And just as a transportation system can have both ships and airplanes, a society can have both all of capitalism’s elements and a social safety net. All of the rich countries that meet the above definition of capitalist have welfare systems that include support for the poor and unemployed, subsidized health care for at least some groups, child and elder care, and so on. Advanced capitalist countries have tremendous variations in their social safety nets—Norway’s, for example, is very different from America’s—but all such countries have one.

Much of the confusion stems from a caricature. Market fundamentalism describes the belief that capitalism alone is sufficient to ensure well-being of all members of a society, and that social safety nets are wasteful and unnecessary. Or, even worse, that they’re counterproductive because they reduce people’s incentive to work. The term is associated with the writings of the mid-twentieth-century novelist and political theorist Ayn Rand. The investor and philanthropist George Soros and others have used. The term in connection with the policy agendas, initiated around 1980 of Ronald Reagan and Margaret Thatcher.

But while Reagan and Thatcher clearly worked to shrink and change the welfare systems in their countries, they never sought to completely eliminate them. Market fundamentalism is a theoretical condition—a society with capitalism, but without welfare—that doesn’t exist in reality. And few people think that it should.

Market fundamentalism is still a useful concept, though, because it anchors one end of the spectrum of belief about how much a government should rely on capitalism to ensure the well-being of its people. Market fundamentalists believe that capitalism by itself is enough. Social democrats, who occupy the next position on the spectrum, believe that it’s not. They believe that government should play an active role in helping out people who are temporarily or permanently left behind by capitalism, and in reducing its inequalities. The more people identify as social democrats, the more they tend to favor high tax rates, more regulation, and larger welfare systems. Scandinavian countries are often held up as the clearest examples of social democracies, while America almost never is, since the safety net in America is smaller and less elaborate than in Sweden or Denmark. However, Sweden, Denmark, and America are all clearly capitalist countries.

The real difference comes when we take the next step along the spectrum, from “social democracy” to “socialism.” Socialism rejects just about all the pillars of capitalism. Under socialism, most companies and industries are owned or controlled by the government, and much economic activity—who makes what, who gets what, who works where, what the prices are—is centrally planned. Property rights are fewer because there’s less private property; the state owns more of the things that matter. When socialist governments come to power via an election rather than a revolution, the result is “democratic socialism.” Which only deepens the confusion around the labels.

The far end of the spectrum, past socialism, is communism. Communism, as envisioned by Marx, was a kind of self-organizing, egalitarian utopia for workers. There would be no inequality, no money, no private property, no companies, no bosses, no governments, and no borders between nations. Marx provided few details on how a planetary communist economy would work—how goods and services would be produced and allocated to people—but he was sure that it would arise. He considered communism a historical inevitability, and socialism a kind of stepping-stone on the way to it.

Market fundamentalism and communism are as different as it’s possible to imagine, but they do have one important thing in common: neither has ever existed in the real world. Countries that adopted Marx’s ideas never reached full communism; they instead remained at socialism (the full name of the Soviet Union—the Union of Soviet Socialist Republics—acknowledges this). North Korea still has money, private companies are allowed to operate in Cuba, and many sectors of the Chinese economy have a great deal of competition.

So as regards how capitalistic a country is, all the action seems to be in the middle of the spectrum. The real fault line is right down the center: between social democracy and democratic socialism. The historical record, written from Moscow to Beijing to Havana, was quite clear on the point that Social is fine, but Socialism is a catastrophe. We don’t need any more demonstrations of socialism’s too-numerous-to-list shortcomings. We don’t even need to keep debating whether a socialist economy could work in theory (regardless of what had happened in practice) because the great Austrian British economist Friedrich Hayek laid that issue to rest.

Hayek realized that fluctuating prices for such things as aluminum and wheat are signals about scarcity and abundance. These signals cause people who buy and sell to take action (to slim, swap, optimize, evaporate, and so on). So free-floating prices in capitalist economies do an important double duty: they provide both information and incentives. Prices fixed by a socialist government do neither of those things. Hayek used this insight to shoot down the idea of socialism in 1977: “I’ve always doubted that the socialists had a leg to stand on intellectually . . . Once you begin to understand that prices are an instrument of communication and guidance which embody more information than we directly have, the whole idea that you can bring about the same order . . . by simple direction falls to the ground . . . I think that intellectually there is just nothing left of socialism.”

But in some quarters, socialism is cool again. The good news is that even as this is happening, we’re getting a detailed look, aided by all the technologies of modern media, at yet another socialist experiment as it unfolds and falls apart. The bad news is how much the people of Venezuela are suffering as they provide this lesson.

Venezuela, South America’s richest country as recently as 2001, elected the ardent socialist Hugo Chavez in 1998. He was succeeded after his 2013 death by his vice president, Nicolas Maduro. Both men gained and held on to power via elections rather than military coups or popular revolutions. For twenty years, then, the country has been a clear example of democratic socialism.

Both Chavez and Maduro closely followed the Socialism 101 playbook. They nationalized companies in industries from oil services to fertilizer production to banking to glassmaking. Instead of relying on markets to bring goods and services to the poor, the government established and ran misiones that provided meals and groceries. The state also bought food on international markets then sold it internally at subsidized prices (in other words, at a loss). Currency controls were put in place for most businesses, which meant the end of free markets for other moneys such as the US dollar. A set of “fair price” laws set not only prices but also acceptable profit margins on products. And so on.

Chavez and Maduro thus chipped away at or knocked over all the pillars of capitalism within their country. A team of economic researchers could hardly have created a better field experiment on the effects of socialism. However, no ethical team would have tried to run such an experiment because of the damage it would likely cause. Any economist or historian who wasn’t a committed Marxist could have predicted at least some of the results of Venezuela’s plunge into socialism. However, few would have predicted the actual scale of the economic catastrophe and the accompanying human suffering.

Socialism can be slow-acting poison, and the first of “Chavism” wasn’t too bad (at least in comparison to what came later). Along with much of the rest of the world, Venezuela entered a recession in 2009. It recovered by 2011, however, mainly because of the strength of its oil industry, which accounts for 95% of its total exports. Venezuela has the largest proven oil reserves in the world and so benefited greatly from oil prices that largely stayed above $100 per barrel. High oil prices allowed the government to subsidize many other things and kept its socialist experiment going.

Oil prices plummeted in 2014, however, and things began to fall apart quickly. Food became scarce because the government could no longer afford to buy as much of it on international markets. Many private companies had stopped making food products that were being given away for free by the state. Other producers had been crippled by currency and price controls or were badly mismanaged after nationalization.

The grim consequences of bungling a nation’s food supply were quick to appear. By mid-2017 Venezuelans were referring to being on an involuntary “Maduro diet”; adults lost an average of nearly twenty pounds in a year. Malnutrition among children was already widespread in 2016; but according to one doctor, “In 2017 the increase in malnourished patients has been terrible. Children arrive with the same weight and height of a newborn.”

In early 2016 oil prices more than doubled from their low point, leading many to hope that Venezuela could recover. The price rise did little good, though, because the country had lost the ability to produce oil. Total output dropped by 29% in 2017, a decline greater than that experienced by Iraq after the American invasion in 2003. A former director of the state-run oil company explained, “In Venezuela, there is no war, nor strike. What’s left of the oil industry is crumbling on its own” because of incompetence and corruption.

Other industries didn’t fare much better. The IMF estimated that the country’s GDP dropped 35% between 2013 and 2017. According to economist Ricardo Hausmann, this is the largest economic collapse ever seen in the history of not only Latin America but also Western Europe and North America. It dwarfed even the Great Depression. The government tried to make up for this huge fall in output by printing a great deal of money. As is always the case, this did nothing except cause prices to spike. By November 2018, the annual inflation rate was 1,290,000%. Three months later, the IMF estimated that it was 10 million percent.

As economic mismanagement at every level intensified, so did human misery. Crime skyrocketed; by 2016 Venezuela had the second-highest homicide rate in the world after El Salvador. The government resorted to increasingly brutal measures to fight crime and shore up support in the poor neighborhoods that had been the base of Chavism. One investigation tallied more than eight thousand extrajudicial killings by Venezuelan police and soldiers in less than three years.

As socialism inflicted massive damage on societal infrastructure, Venezuelans fled their country in ever-larger numbers. By early 2018 at least 5,000 people a day were streaming into Columbia and other neighboring countries. Unable to find work and desperate to feed their families, many women turned to prostitution. “We’ve got lots of teachers, some doctors, many professional women, and one petroleum engineer,” reported a brothel owner in a Colombian border town.

Back in Venezuela conditions continued to worsen. The country was increasingly referred to as a war zone, but that comparison is in some ways too kind. The government went to great lengths to hide the true magnitude of its health crises, but even official statistics put its infant mortality rate higher than that of Syria in 2016.

In a May 2018 election that was boycotted by the main opposition party and widely regarded as far from free and fair, Maduro was reelected with 68% of the vote. By early 2019, though, his presidency was in trouble. More than 80% of Venezuelans wanted him to resign, in large part because of his government’s terrible mismanagement of the economy. Hyperinflation and other self-inflicted wounds had reduced almost 90% of the population to poverty. Opposition leader Juan Guaido declared himself the interim president of the country on January 23, 2019. By mid-February more than fifty countries had recognized him as the rightful president of Venezuela.

UK prime minister Margaret Thatcher famously observed in 1976, “The trouble with socialism is that eventually you run out of other people’s money.” Maduro eventually faced a related crisis: his country ran out of food and other goods because its money and just about everything else related to its socialist economy ran out of credibility.

economics

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