Is Capitalism Worth Saving?

Any social system must coordinate production and cooperation, and must also implement a system of distribution that participants perceive as sustainable, which often means morally fair. As Nobelist Elinor Ostrom demonstrated, there are many and widely varied social systems that can be found in settings where there are small groups and long-term, indefinitely repeated interactions.

But at scale—meaning in groups of 10,000 or more—there are only three social systems available:

1. Some form of authoritarianism, sometimes with a legitimating creation myth based on religion or tradition, and sometimes simply based on the threat of violence. In these systems, production and distribution are idiosyncratic. In some, such as Singapore, the results may be pretty good. In others, such as Zimbabwe or North Korea, the results are catastrophic.

2. Capitalism, using markets for production and input prices, asset prices, and profits and losses for distribution. To the extent that the violent powers of the state are put up for sale, distribution may be skewed toward wealthy elites

3. Democratic Socialism, where the means of production and most prices are decided by majority rule, or by some technocracy to whom authority is delegated by law. The system of distribution is often egalitarian in concept, but skewed in practice toward those who have political power.

I will say no more of authoritarianism because it is hard to be systematic about idiosyncrasy. And I will note that zealous defenders of capitalism, or socialism, might object to my characterizations of their “tendencies.” But there is a tradition, dating back at least to Aristotle, to mention both the ideal system and its corrupted form. And it is clear that in capitalist systems there is the possibility for wealth to metastasize into political power, and that in socialist systems there is the possibility that political power expands to command unearned material wealth. This problem, of placing constitutional limits on power, is the core of the “limiting Leviathan” approach of “constitutional political economy,” an offshoot of public choice pioneered by James Buchanan.

The reason to include both the ideal types and their corrupted forms is to avoid a common mistake, a kind of ideal type bias. We all want to compare the actual form, and pathologies, of systems we dislike with the ideal form, as we can imagine it, of systems we admire.

The Pretty Pig

I call this the “pretty pig” problem. The snag is that while some pigs may be less ugly than others, no adult pigs are pretty. Nonetheless, imagine that there is a beauty contest of adult pigs. The judges were ready, and the first pig was brought out.

“Holy smokes! What an ugly pig!” The judges gag in disgust. The old boar is muddy, smelly, fat, and hairy; it grunts and blows snot as it walks.

The judges conferred, and announce their decision: That first pig is so ugly that they will simply give the second pig the prize. Members of the audience protest, saying that they hadn’t even seen the second pig. “Yes, that’s true. But we have seen the first pig. And it is not pretty. The second pig wins!”

This real/ideal comparison is common for almost everyone. People on the left note the problems with market processes, and then conclude “therefore the state should step in.” But that’s not obvious, unless the actual actions of the state are an improvement. The reverse is also true: highlighting (legitimate) problems with democracy or the state does not automatically imply “and therefore the market is the best option.”

The Argument for Capitalism

But then, what is the argument for capitalism? It is simple: wealth and prosperity is the result of the division of labor. If a group of people can cooperate by carrying out different specialized functions, then everyone can have more. In fact, they can have a lot more, of almost everything.

The difficulty is that division of labor makes each of us dependent on the delivery of all the many things we need, in exchange for the very small number of things we know how to make, or do. This kind of specialization is reflected in many of our last names:  Coopers made barrels, Smiths made iron items, Bakers were bread makers, Mongers sold things, and so on.

Adam Smith illustrated the benefits of division of labor using his “pin factory” example: 18 people making pins as artisans could make only a few pins per day. But if the 18 people divide up the tasks in what we would now call a production line, those same 18 workers could make thousands of pins.

Of course, that’s a lot more pins than they could use. As Smith pointed out, the division of labor is limited by the “extent of the market.” This is great for consumers, but it can be hard on workers.

Smith gives a clever example: the woolen coat. For centuries, artisans had made a living by making crude clothing out of skins and rough fabrics. Even quite early in the Industrial Revolution these thousands of artisans were replaced by processes that were far more efficient and also produced better quality clothing. A few dozen people working on a production line could produce a coat that was such high quality that only royalty could have obtained such an item just a few decades earlier.

Capitalism, in short, is about consumer sovereignty, not about creating jobs. Capitalism finds ways to create new products, better versions of existing products, and cheaper prices for products that are also much more widely available. Capitalism creates a complex, voluntary mutual dependence, and the only way one person can consume things is by creating things other people want to consume. It’s actually a kind of sharing, except that we don’t need to know much about the people we are depending on.

The creation of this huge amount of wealth—and notice that wealth is stuff, things to consume and use, not money or gold—went a long way toward curing poverty, in much of the world. But some people would say that curing poverty came at a price: a big increase in inequality.

At least, that’s the most sensible form of the argument. For the least sensible opponents of capitalism, the only consideration is inequality. But poverty and inequality are completely different things. And they have very different solutions:  The way to end poverty is to enable the poor to enrich themselves, so there are no poor people. The way to end inequality is to destroy wealth, so there are no rich people.

It is tempting to think, “Why not both?” The problem is that it appears doing both at the same time is not easy. Since the pro-market reforms of Deng Xiaoping, beginning in 1978, China has seen two enormous changes.

1. The largest decline in poverty in history. More than 500 million people were lifted out of extreme poverty as China's poverty rate fell from 88 percent in 1981 to 6.5 percent in 2012. Poverty defined as living on the equivalent of US$2.00 or less per day in 2011 purchasing price parity terms

2. An enormous increase in income inequality. China has by far the greatest income inequality of any nation or region in the world.

If you ask the poor people of China who have seen a dramatic increase in their living standard, in many cases an increase of 1000 percent or more in PPP terms, many are likely to say that the increased inequality from using market systems was easily worth it, because of the dramatic decline in poverty. The point is that if you care mostly about inequality, you have to admit you are indifferent to the plight of the poor.

Or perhaps you want a different system that simultaneously reduces inequality and reduces poverty. The problem is that there is no such “other system.” The idea that there is an alternative is an illusion. There are no examples of a socialist system managing a system that is either prosperous or egalitarian. Much less both.

I should be careful. Remember, by socialism, I mean a system that relies on state ownership and control of the means of production, state direction of production decisions, and direct state control of education and employment decisions of individuals. If one does not mean those things, then that would require a little more thinking about what “socialism” means.

1. Ownership solves the problem of the commons. But political incentives are very short-run. Presumably we are talking about “democratic socialism.” But then it is not clear that state ownership is better than private ownership. In fact, the environmental record of socialist nations in the Soviet bloc and in China is not very good.

2. Using prices gives useful signals about relative scarcity, and incentives for decentralized but highly organized individual action. A socialist system sets prices, rather than allowing prices to adjust to reflect the dynamics of fast-moving events.

3. Without prices, we must either rely on desires of individual dictators or state control. Without prices in the form of salaries,there's no way to direct people toward job shortages except coercive force.

If we want the form of state control to take the form of democracy—and presumably we do want that—then we have to confront a difficulty. That difficulty is at the core of the “ugly pig contest” I discussed above, and it’s deceptively simple.

The difficulty is this: Every flaw in consumers is worse in voters.

Voters and Irrationality

Take the individual consumers, the ones who are too dumb, ill-informed, or easily misled to make choices about what size Coke to buy. It may be, as my Duke colleague Dan Ariely—author of Predictably Irrational and other books on behavioral economics—has argued, that people just don’t have all the information they need to be able to carry out the role of a fully “rational” consumer in the standard economics model.

But think about it: if we take a large number of such dim bulbs, and gather them together into a mob, are they suddenly able to solve the problem that no one of them understands?  Absolutely not. All the problems that Ariely and behavioral economists list, including an undue focus on free stuff, an inability to consider the future, and choices contingent on the set of alternatives, are even worse in voters.

So, there is a real problem for the democratic socialist who starts with the idea that consumers need help. If you think we can use democracy as a replacement for prices, deciding what the “true” value of wages, commodities, and assets should be, you would have to explain that voters are smarter than consumers. Not only are they the same people, but the institution of democracy provides less information and gives less responsibility to the individual.

After all, if I buy a bad car, I have to drive a bad car and I’m likely to think about it more next time. But my vote for President, or a referendum such as Brexit, has no impact on the outcome, and I am free, as Bryan Caplan has pointed out, to have no connection to rationality at all.

Of course, many people who advocate for socialism don’t really think voters are capable of making such choices, and would entrust power to a secular priesthood of experts and bureaucrats. But such a “solution” would have to pursue its own logic to the conclusion that the power of experts must be placed beyond the control of voters. That is simply a recipe for authoritarianism, an unelected and unaccountable oligarchy that rules for its own purposes and with its own goals.

Unsurprisingly, it has been exactly that outcome that all real experiments in socialism have ended up reaching. If you accept that democracy is no better, and is often much worse, in solving problems of information and incentives than markets, than you recognize that democratic socialism is not desirable. If your solution is to suspend democratic accountability, you are conceding that democratic socialism is not possible.

Either way, that first pig, the capitalist pig, is looking pretty good. A clear-eyed comparison of the alternatives actually available to us reveal why all the world’s developed nations use some version of capitalism. The only people who advocate socialism are those who don’t know how it actually works.

(Note: This is a revised version of an opening statement given in a debate on Capitalism vs. Socialism at Middlebury College, February 28, 2019)

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Michael Munger

Michael Munger is Professor of Economics at Duke University and Senior Fellow of the American Institute for Economic Research. His degrees are from Davidson College, Washingon University in St. Louis, and Washington University.