Capital, Capitalists and Capitalism (Part IV)

0130-money_full_600Editor’s note: The following is the fourth installment of the FrontPage series “Capital, Capitalists and Capitalism” by Dr. Mark Hendrickson. Click the following for Part IPart II and Part III

In the earlier installment about “Capitalists,”  we discussed how capitalists raised the standard of living of their employees. While the pace of past economic progress seems agonizingly slow to us from our vantage point of mass affluence, the Age of Capitalism (starting in the 1700s) inaugurated a new era in which the pace of wealth production, and therefore, standards of living, improved in every succeeding generation.

The Age of Capitalism dawned in the 18th century. Since then, capitalism has liberated the majority of human beings from the bondage of chronic poverty in which they had been trapped for thousands of years. By lifting billions out of poverty, it has produced a new phenomenon in the history of the human race: Entire countries now have affluent middle classes numbering in the millions. Perhaps most wonderfully, capitalism’s superior productivity has resulted in a great increase in human longevity, enabling the human population to multiply far beyond the cramped limits which pre-capitalist production had mercilessly imposed from time immemorial.

Since most people prefer prosperity to poverty, few leftists are so audacious as to criticize capitalism for its unprecedented ability to generate wealth (although some of the more radical greens advocate economic de-development). Indeed, even such an arch-enemy of capitalism as Karl Marx acknowledged capitalism’s superior economic performance. He cited its “low prices,” its creation of “enormous cities,” and that, “during its rule of scarce one hundred years, [it] has created more massive and more colossal productive forces than have all preceding generations together.”1

Contemporary critics of capitalism focus on its alleged unfairness. That claim will be analyzed in the next installment of this series. First, though, it is important to understand why capitalism produces more wealth than any other system of economic organization, and thus to comprehend the unavoidable fact that replacing capitalism with any known alternative will come at a stiff price: It will make people poorer.

Despite capitalism’s demonstrated ability to lift the masses out of poverty, anti-capitalists of various stripes claim that they have a better deal for “the people.” They assert that government planning and control can make economic production more rational and efficient, and so make society more prosperous, than can unplanned free markets. This is an enormous intellectual error.

The theory of centralized economic planning overlooks the fact that there is plenty of planning involved in free markets. The difference is that, in a free market, the planning is diffused among virtually the entire population in which everyone shapes production in their role as “the sovereign consumer,” whereas under government control, economic planning is shifted away from everyone to a relatively small number of government-appointed planners.

It is a delusion to believe that government-appointed experts are capable of arranging production to maximize economic value, wealth creation, and standards of living for “the people.”  Even if that were the planners’ goal (in practice, it never is) and even if the government appointed the world’s most brilliant, fair-minded, kind-hearted geniuses to plan and oversee production, those experts are doomed to fail. They can never know what Joe Lunchbucket wants as well as Joe knows. (Even if we concede the impossible—i.e., that a committee of planners could figure out what everyone wanted in real time, thereby replicating the flow of economic information that free-market prices transmit—the overhead costs of such a bureaucracy inevitably would make the society poorer, because the people would be paying for a service that market prices render for free.

The anti-capitalists haven’t grasped that government intervention inevitably makes economic planning less rational. This is so because, in a market economy, the economic rationality (that is, his hierarchy of preferences about what he wants) is communicated through ever-adjusting market prices reflecting the ever-changing constellations of supply and demand. This economic information guides producers to produce what is most highly valued—that is, to meet consumers’  most highly valued needs, which is another way of saying “to maximize wealth.” To the extent that government intervention suppresses, censors, and replaces the economic information communication through free-market prices, the rational input into, and hence the value of, national production is reduced. In other words, people are made poorer when government intervention prevents them from getting what they most value, and instead forces producers to produce things that people value less.

The most irrational economic system of production is socialism. Under socialism, there is no private ownership of the means of production; thus, the bulk of economic production has been taken from producers who must compete to serve the most highly valued needs of consumers. Instead, the state allows a small elite to determine what gets produced, and in support of the official plan, the state has the power to continue diverting scarce resources from the production of goods more highly valued by the people to goods less highly valued. Socialism, therefore, lacks markets whereby supply and demand can help participants discover the market-clearing price (the price where supply meets demand). Consequently, instead of prices being economically rational and communicating what the people value most highly, the central planners have to set prices by guessing what they think they should be.

My friend Dr. Yuri Maltsev, an economic adviser to Soviet leader Mikhail Gorbachev, once worked in the Soviet price-setting council. There, a staff of 328 bureaucrats was in charge of setting 23 million different prices.2 This caused at least two major problems. First, that council had to set prices of consumer goods without knowing what consumers wanted most. This rendered Soviet prices arbitrary and irrational, insofar as they were divorced from the economic realities of supply and demand. Second, unlike market prices that can fluctuate moment by moment in response to changes in supply and demand, the council’s “guestimated” prices remained inflexible for protracted periods of time, since the council could only revisit and adjust prices at multi-year intervals due to the sheer number of prices they were supposed to manage.

As anyone who has taken Economics 101 knows, if the planners set prices too high, they produced unwanted surpluses; if too low, then there were painful shortages. The common citizen in the Soviet Union suffered from both. It doesn’t take a degree in economics to understand that if a system wastes precious resources by producing some things that people don’t want and not enough of other things that they do want, that those people will have been made poorer by the very system that was supposed to prosper them.

Another insuperable defect of not having economically meaningful prices (that is, prices that reflect what people value most highly) is that it is impossible to measure profit and loss. There is no way to tell whether individual enterprises are increasing or decreasing wealth. Socialists mistakenly believe that profits are wasteful; in fact, profits are essential for the economic well-being of society. Regardless of the economic system under which one lives, if factors of production with a total value of A are arranged in such a way that they are now worth A+1, then there is more wealth in society. Profits, then, represent newly created wealth and the economic progress of a society.

Conversely, if factors worth A are arranged to produce something worth A-1, then society has less wealth than before. Under capitalism, money-losing enterprises either mend their ways or go out of business. For a money-losing business to close its doors is economically beneficial to society. It curtails uneconomic, wealth-destroying activity and releases misallocated scarce economic resources to be redeployed to more rational (i.e., profitable) uses. Government intervention, by contrast, often props up and subsidizes wealth-depleting enterprises for years, making a society poorer.

The profits generated by capitalism are of great historical significance. In the pre-capitalist systems of feudalism and mercantilism, the system was rigged to prosper the elite at the expense of the masses. Capitalism, by contrast, doesn’t guarantee economic success. Instead, it forces entrepreneurs to earn profits by out-competing others in serving consumers, and punishes those who don’t serve consumers well. Socialism claims to be a step in advance of capitalism, but it rejects profits (i.e., new wealth) categorically and so guarantees the impoverishment of the masses much as the pre-capitalist systems did.

Besides misunderstanding profits, the opponents of capitalism also misunderstand monopolies. They accuse capitalism of promoting rapacious monopolies that devour the economic substance of the people. There are a couple of very serious holes in this argument.

In his classic essay, “The Phantom Called ‘Monopoly,’” economist Hans Sennholz described capitalism’s natural defenses against monopoly3: 1) The sovereign consumer may substitute other goods; 2) demand is, in varying degrees, elastic (that is, as prices rise, more and more buyers simply do without; 3) in a market economy, the ever-present invisible threat of new competitors entering into markets with unusually high profit margins restrains would-be monopolists from engaging in price gouging.

In actuality, monopolies have been exceedingly rare in the United States. Two of the most famous—the post office and, until the 1980s, “Ma” Bell, the AT&T long distance telephone monopoly—were established by government decree, not by market forces.

Of course, some private corporations have become gigantic and highly profitable while achieving dominant market shares. However, the leftist assertion that such firms obtained their fortunes at the expense of consumers does not withstand scrutiny. As Dominick Armentano documented so ably in Antitrust and Monopoly: Anatomy of a Policy Failure,4 his classic study of many of the landmark antitrust cases in American history, the government found itself in the peculiar position of prosecuting firms that not only were not monopolies, but which had been charging consumers lower prices than their competitors had been charging rather than exploiting their dominant market share to charge the kind of high, rapacious prices for which monopolies are feared.

It is a strange jurisprudence that punished companies for being the benefactors of consumers and key agents of rising standards of living. The only beneficiaries of prosecuting and penalizing corporations for having served consumers well have been the less efficient competitors who were given a reprieve from the consumers’ “thumbs down”  verdict—a form of cronyism amounting to a government rescue or bailout.

There is great irony (and more than a little hypocrisy) in people insisting that socialism is preferable to capitalism on the grounds that capitalism spawns monopolies: Under socialism, the state establishes monopolies as the normal mode of organization. Far from providing a refuge from monopolies, socialism is, in fact, an entire system of monopolies. Under socialism, political elites forbid economic competition and charge whatever price they want. Henry Ford and the other hugely successful entrepreneurs that emerged under capitalism never came close to holding the kind of power over consumers that socialist central planners exercise.

Naively, many people believe that monopolies under socialism are benign, because socialists don’t try to make profits—that is, they forsake the creation of new wealth while focusing on redistributing and subsidizing the consumption of society’s existing wealth. What eludes the apologists of socialism is that monopolies insulated from potential competitors by the government always have a tendency to lapse into undesirable monopolistic practices. Soviet monopolies, for example, were notorious for producing goods of shoddy quality and for offering poor service to consumers. Indeed, clerks often treated citizens standing in lines rudely, because the consumers had nowhere else to go (except for risky forays into black markets).

In short, socialism simply can’t match the economic productivity of capitalism. Mises figured this out nine decades ago. In his book, Socialism, Mises demonstrated logically, from an economically scientific perspective, that socialism inevitably cripples economic production because of its monopolistic inefficiencies and its absence of a tool (i.e., market-based prices) with which to make economic calculations.5 Even the socialist intellectual and economic historian, Robert Heilbroner admitted, when the Soviet Union collapsed seven decades after Mises’ prescient analysis, “Mises was right.”6

Despite the overwhelming historical evidence of socialism’s inherent defectiveness, many American intellectuals remain determined to find an alternative to capitalism. They are convinced that government intervention into the economy is better than genuine, untrammeled capitalism. They seek “a middle way” between capitalism and socialism, a mixed economy that will combine the best features of both systems.

The problem is, the hoped-for “middle way,” the seductive vision of a system that combines the supposed virtues of both capitalism and socialism, is a chimera. Both the avowed enemy of capitalism, Karl Marx, and the unwavering champion of capitalism, Ludwig von Mises, agreed that government economic intervention breeds additional intervention, inexorably pushing society toward socialism by increments.7  Multiple studies show that the greater the degree of government economic intervention—that is, the greater the percentage of Gross Domestic Product consumed by government—the slower the rate of economic growth in that country.8

In sum, the argument that socialist planning can improve upon capitalism’s unprecedented productivity is fallacious. That is why most proponents of greater government control of economic activity emphasize the fairness angle. Those arguments, too, are problematical, as we shall see in the next installment.

Read Part V of this series in the next issue of FrontPage Magazine.

Notes:

1 See Chapter One, “The Communist Manifesto.”

2 Yuri N. Maltsev in conversation with Mark Hendrickson February 14, 2012.

3 Hans F. Sennholz, “The Phantom Called ‘Monopoly,’” The Freeman, March 1960, pp. 39-52. www.thefreemanonline.org/features/the-phantom-called-quotmonopolyquot/.

4 Dominick T. Armentano, Antitrust and Monopoly; Anatomy of a Policy Failure, New York: John Wiley & Sons, 1982.

5 Mises, Socialism, pp. 95-103.

6 Robert Heilbroner, “After Communism,” The New Yorker, September 10,  1990, p. 92.

7 Cf. Karl Marx, “The Communist Manifesto,” Chapter Two; Ludwig von Mises, “Middle-of-the-Road Policy Leads to Socialism,” in Planning for Freedom and sixteen other essays and addresses, 4th enlarged edition, South Holland IL: Libertarian Press, Inc., 1980, pp. 18-35.

8 Cf. Mark W. Hendrickson, “Country Economic Policies: What the U.S. Could Learn From Other Countries,” forbes.com, March 12, 2012, www.forbes.com/sites/realspin/2012/03/12/country-economic-policies-what-the-u-s-could-learn-from-other-countries/2/; Alan Reynolds, “Countries That Cut Debt, Taxes And Spending Are Thriving,” posted April 3, 2013 on ibdeditorials.com. www.news.investors.com/ibd-editorials-viewpoint/040313-650293-nations-that-lower-debt-cut-taxes-reduce-spending-thrive.htm?ref=SeeAlso&p=2

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