June 3, 2012
Capitalism
Capitalism—Posner
I agree wholeheartedly with Becker that capitalism is a superior economic system to any other that has been tried, the others being mainly socialism and communism. The best evidence for this is that out of the 194 countries in the world, I can think of only two that are not capitalist—Cuba, which however is moving slowly in the capitalist direction, and North Korea, the greatest economic failure on the planet.
But this statistic indicates that capitalism is a necessary condition of economic success rather than a sufficient condition. Many of the world's countries, though capitalist, are basket cases—not as badly off as North Korea, but plenty badly off. Per capita incomes in rich capitalist countries such as the United States, Canada, Germany, Britain, and Japan greatly exceed per capita incomes in poor capitalist countries, which are the majority of countries.
So the big question is, given capitalism, what else does a country need in order to prosper? We know that it doesn't need abundant natural resources or a large population. But it needs a legal and political system that protects property rights, allows a large degree of economic freedom, minimizes corruption, controls harmful externalities (like pollution) and subsidizes beneficial ones (like education), distinguishes between equality of opportunity (which it promotes) and equality of incomes (which it promotes only to the extent of combating poverty), welcomes and assimilates skilled and wealthy immigrants, and (related to protecting economic freedom) avoids public ownership or control of economic enterprises. To create and maintain such a legal and political system a country also requires a culture of respect for business success, of competition and risk-taking, and of consumerism—since, as Keynes argued, consumption drives production.
Such a combination is difficult to achieve; no nation has achieved it. The variance across nations in culture and in institutional structure is very great, and determines the relative economic success of the different nations.
Since there is so much variance across capitalist countries—so much that can go wrong with a capitalist system because of the complex institutional structure and social culture that capitalism requires if it is to be maximally successful in contributing to social welfare—we need to avoid complacency. Complacency was a major factor in the surprising economic collapse that began in September 2008, a collapse the consequences of which are still very much with us.
When I started teaching in the late 1960s, the economist Harold Demsetz was talking about the "Nirvana Fallacy." He defined that as the belief of many economists that any market failure, such as monopolization or pollution or underproduction of public goods, could be rectified at little cost by government intervention. If that were true, it would indeed enable "Nirvana" (in the sense of heaven—which isn't actually what the word means; it's nearer to "oblivion") to be attained. But as Demsetz pointed out, it isn't true. There are government failures as well as market failures, and they have to be taken into account in deciding whether and what the government should be asked to do about market failures.
Over time, however, a reverse Nirvana Fallacy took hold of many economists, most famously Alan Greenspan. This was the idea that capitalism was a self-regulating system; market failures were, with few exceptions, either self-correcting, or less harmful than regulation aimed at eliminating them. Such thinking influenced the regulatory laxity that contributed (decisively in my view) to the financial collapse of September 2008 and the ensuing worldwide depression, and to the disbelief until then of many economists that there would ever again be a major depression. Greenspan and other like-minded economists and political leaders were wrong to think capitalism self-regulating; they neglected the need for an institutional structure, and a culture, that differentiate successful from unsuccessful capitalist economies.
The institutional structure of the United States is under stress. We might be in dangerous economic straits if the dollar were not the principal international reserve currency and the eurozone in deep fiscal trouble. We have a huge public debt, dangerously neglected infrastructure, a greatly overextended system of criminal punishment, a seeming inability to come to grips with grave environmental problems such as global warming, a very costly but inadequate educational system, unsound immigration policies, an embarrassing obesity epidemic, an excessively costly health care system, a possible rise in structural unemployment, fiscal crises in state and local governments, a screwed-up tax system, a dysfunctional patent system, and growing economic inequality that may soon create serious social tensions. Our capitalist system needs a lot of work to achieve proper capitalist goals.
Profits, Competition, and Social Welfare-Becker
The financial crisis and the resulting recession have led to a strong reaction in many countries against the profit motive and private enterprise. Left of center political parties are gaining office and power in France, Mexico, Greece, and elsewhere with the promise of much greater regulation of banks and other businesses, renationalizing some companies, and constraining profits through higher taxes and other ways.
It is easy to sympathize with the hostility to the many banks that behaved (in retrospect) so foolishly in ways that damaged everyone else as they took on excessive risk in their quests for greater profits. One can understand also the general reaction against capitalism and "market failures" since commercial and investment banks were in the past a leading example of capitalism at work. Yet anyone concerned about the welfare of the poor and middle classes should resist the temptation to attack competitive private enterprise and capitalism- monopoly or crony capitalism should be deplored. This is only partly because "government failure" also contributed in an important way to the financial crisis as regulators did not rein in the asset explosion of banks and households. Indeed, regulators often encouraged lending to lower income families to buy houses with low down payments, large mortgages and ballooning interest payments.
The main reason to be concerned about the attacks on competitive capitalism is that it has delivered during the past 150 years so much to all strata's of society, including the poor. I will try to demonstrate this not with a general analysis, but with several rather impressive examples.
China in 1980 was among the poorest countries in the world. It had just gone through the Cultural Revolution and the Great Leap Forward that contributed to the deaths of tens of millions of rural and other Chinese. In desperation, a few farsighted Chinese leaders decided to allow private enterprise and capitalism to gain a toehold in its agricultural sector. To the great surprise of many Chinese political leaders, the result was an explosion in farm output, even though farmers had only tiny plots of land to work with. Seeing the success of the liberalization of farm output, China extended the incentive system to industry by encouraging the growth of private enterprises in some sectors. Again, the results far exceeded expectations as these private companies, many owned by Taiwanese and Hong Kong residents, were not only far more efficient than state owned enterprises, but they also became the leaders in the rapid expansion of exports from China to the US and other countries.
The most significant result of this radical shift of China toward a more market oriented economy has been the lifting of hundreds of millions of Chinese out of dire poverty-living on the equivalent of only a couple dollars per day- to having decent and growing standards of living. Many critics attack globalization as the source of the world's economic problems. Yet the opposite is much closer to the truth as competitive private enterprise and the profit motive acting through a globalized economy has eliminated the most abject of poverty for over a billion persons just in China, India, and other parts of Asia alone.
My second example deals with the interaction between capitalism and discrimination against groups based on their race, gender, religion, or other characteristics. Capitalism and the profit motive help to erode discrimination because companies in their quest for greater profits try to hire minority group members who are getting paid less than their productivity. In addition, the successful growth in incomes and productivity induced by private enterprise raises the standard of living of minorities even when they continue to suffer from substantial discrimination.
A prime example is South Africa under apartheid that was maintained by government laws but was opposed by many private companies. South African blacks suffered immensely under apartheid, and its overthrow is one of the great events of the past several decades. Nevertheless, one main problem during the apartheid period was not to prevent many blacks from leaving South Africa, but rather to control the in migration of blacks from other parts of Africa. The explanation is obviously not that the incoming blacks liked apartheid, but rather that the private enterprise system in South Africa had raised substantially the incomes of blacks there -despite the widespread government-orchestrated discrimination against them-and blacks from other countries in Africa wanted to benefit from the higher incomes available to them in South Africa.
Something similar happened in the United States. African-Americans suffered greatly from discrimination until recent decades. Nevertheless, black incomes continued to grow along with white incomes as the US experienced sizeable and continuing economic growth after the end of the Civil War in 1865 (see my book The Economics of Discrimination, 1971).
My final example deals with this growth of US GDP. America has been recognized as the country during the past 150 years that has had the most open and vigorous competitive profit-oriented private enterprise system. And for the almost 140 years from1870 to 2007, per capita American incomes grew rather constantly at the rate of about 2% per year, despite vast changes in many institutions and regulations. The result was a several fold increase in per capita income that raised the incomes of the poor by about as large a percentage as the incomes of the upper middle class and even the rich. To be sure, GDP suffered a serious shortfall during the Great Depression of the 1930s. Yet even that was made up for by the 1940s as US GDP then joined its long-term growth line. The Great Recession once again pushed US GDP below this line, although by a lot less than during the Great Depression. Unless government policy messes things up badly enough, and that is a real possibility, I would expect before very long that US GDP would join up with its long-term growth potential.
I do not claim that the profit motive under competitive capitalism always produces ideal results. Aside from the need for greater capital requirements for banks, there is concern about inequalities, and pollution and other "externalities" that often require government regulations and controls, although the limits of what government can do also have to be recognized as well. However, over the long haul capitalism has delivered big time. In the anger at banks and the financial crisis, voters and governments have to be careful that they do not kill the goose that has laid so many golden eggs.