Monday, February 10, 2014

Capitalism v. Democracy: Why The Free Market Needs Government To Work

I didn't study economics, but I've always scratched my head over what seemed to me glaring contradictions in capitalism.  Milton Friedman, in Capitalism and Freedom (which I've pointed out on here before) identified three gaps in the market that led to three legitimate  roles for government.  Friedman actually had four, but he grouped two and three together as one.  I'll treat them separately.

1.  Rule-maker and umpire - The market works only if the rules are fair and people fulfill follow them.  A business cannot function if it pays for supplies that are never delivered.    Our homes and our lives lose significant valued if someone can  build a noisy, stinky factory right on the property line.   Without a government to create rules - not just zoning laws, but rules for establishing a currency, for safety, for prohibitions against slavery and against fraud - and to enforce and adjudicate those rules, we have nothing but a free-for-all, where no one is secure. 

2.  Externalities - Friedman called these neighborhood effects back then: the costs that society as a whole, not the company that creates them, bears.  Costs such as pollution, resource depletion, social disruption, health care, loss of life, etc. that result from production (ie, the water use in fracking, water and air pollution in most manufacturing, habitat destruction to build factories); from sales and distribution (pollution caused by transportation of people and goods); and consumptions of products (injury, illness, and death from smoking, from automobile crashes, from gunshots).  Because these costs aren't captured in the price of the product, the efficiency that is supposed to be the hallmark of the market doesn't work.  Goods are sold for less than their actual cost and society as a whole, in effect, subsidizes the business.

3.  Natural Monopolies - These are often infrastructure and utilities, where the cost of multiple systems (such as sewers, electric lines, bridges) is so high that competition is not efficient.

4. Paternalistic Role - Taking care of those who cannot take care of themselves.  Friedman's example was 'madmen and children."  He's not comfortable with saying that government should step in, but he acknowledges that there are people who cannot take responsibility for themselves.

But there are lots of issues with the market system that Friedman doesn't mention in that classic book.  I was always confused, for example, when capitalism was equated to democracy (or freedom in Friedman's book title) and communism was declared undemocratic.  It seemed to me that communism and capitalism were economic systems and should be compared to other economic systems, not political systems.   Communism isn't inherently undemocratic.  Israeli kibbutzim seemed to be both communistic and extremely democratic.

Capitalism doesn't seem any more a guarantee of democracy than communism.  Capitalism thrived on slavery.  I don't think I thought about this connection between economics and freedom until people like Tom Hayden, in the 1970's, were talking about economic democracy,. Without economic equality, they said, you couldn't have democracy, because wealth could buy elections and politicians and then get laws that favored their interests.   Not only could money buy politicians, it could also buy voters, or at least, buy sophisticated marketing to sway voters.

More recently and specifically, as I watched salaries of corporate executives go up and up and up, I figured the only way to end the growing disparity in income and wealth was to put progressive taxes back on income with high earners taxed significantly.  They had been in the past, and when those taxes got cut severely, it seemed that they raised their salaries indecently on the hopes of amassing as much of a fortune as possible before new taxes were imposed.

Except, somehow, the Republicans have been able to block such taxes - not that the Democrats were asking for very much.

And now there's a French economist, Thomas Piketty’s  who has put all those ideas (and more) into a book, Capital in the Twenty-First Century.  As I say frequently here, we are prone to believe what we want to believe.  And judging from the review of this book by Thomas B. Edsall in the New York Times, this book says what I believe to be true.

. . . He contends that capitalism’s inherent dynamic propels powerful forces that threaten democratic societies.
Capitalism, according to Piketty, confronts both modern and modernizing countries with a dilemma: entrepreneurs become increasingly dominant over those who own only their own labor. In Piketty’s view, while emerging economies can defeat this logic in the near term, in the long run, “when pay setters set their own pay, there’s no limit,” unless “confiscatory tax rates” are imposed.

There's a graph showing 'pure rate of return to capital (after tax and capital losses)' and the growth rate of the world output. There's only a short period in the the 20th Century where the return on capital got lower and economic growth rose, and inequality decreased.

[Video from Harvard University Press Website]

Did I grow up in a golden period that was just a temporary blip and now the power of wealth, liberated from strict government regulations, works to accumulate more and more wealth for fewer and fewer people?  Piketty seems to think so.

Edsall's review tells us that conservatives won't like the book and some liberals think his predictions are too harsh, that less than a world wide progressive income tax can stop the trend to economic inequity.   But one scholar Edsall cites, "Branko Milanovic, an economist in the World Bank’s research department" is effusive:
“I am hesitant to call Thomas Piketty’s new book Capital in the 21st Century one of the best books in economics written in the past several decades. Not that I do not believe it is, but I am careful because of the inflation of positive book reviews and because contemporaries are often poor judges of what may ultimately prove to be influential. With these two caveats, let me state that we are in the presence of one of the watershed books in economic thinking.”
The NY Times article only quoted Milanvic's first paragraph.  A little further into the paper, he talks about Piketty's earlier work and the influence it has already had on economics and every day language.
The prominence of the work of Piketty and his associates has also been helped by the revived interest in inequality which coincided with the onset of the Great Recession and the realization that in the United States incomes around the median have been stagnant in real terms for almost 40 years while the top 1%, or even more narrowly top 0.1 %, have dramatically increased their share of total income . The confluence of the rise in the political importance of inequality, best exemplified in the Occupy movement and the 99% vs. 1% slogan, had its empirical basis in the work done principally by Thomas Piketty and Emmanuel Saez (2003) . Their famous graphs of the income shares of US top decile, top 1% and top 0.1% , showing that at the turn of the 21st century rich’s income shares approached the extremely high values from the roaring twenties, are now found all over the Internet and in many magazines and newspapers. But their origin goes back to Piketty’s 2001 book on top incomes in France.
The new book is nearly 700 pages.  The English translation doesn't come out until April, and I don't read French.  So I can only repeat what a few others have said about the book.  But what they describe him to be saying makes perfect sense to me.  It's not that the market doesn't make significant positive contributions to humanity.  It's just that blind faith in the market to solve all human problems has become part of the patriotic mantra of the right, and these market zealots fail to acknowledge that capitalism isn't perfect or that there is any legitimate role for government.  

I'm hopeful this book is as good as the reviewer and Milanovic think. But I hope the predictions of increasing inequality do not pan out.  And I think there is reason to believe they won't.  Not because he's wrong about the dynamics of capitalism, but

1.  Predictions about social behavior can often change that behavior.  As people become aware of their behavior, even collective behavior, they can change it.

2.  Unexpected events can intervene.  Just as Piketty cites the Great Depression and two World Wars of the 20t Century as interrupting the trend toward greater inequity, I would argue that other unexpected events can interfere in the future.  I hope these don't have to be wars or depressions.

3.  I do believe that there is a push toward balance in most things.  Systems theory talks about equilibrium.  As things go too far out of economic balance, people will find ways to bring things back.  Unfortunately, it may include serious violence if those in power resist any sort of balancing.  While we may have had severe imbalance in the past, now that we have seen the possibility of more political and economic equality, it will be harder to take it away.  Only through a minimal standard of living, can this be prevented.  But the systems in place now to destroy labor and the gains of labor - secure jobs, decent wages, pensions - will eventually lead to a backlash if not moderated.

But, from the hints I got from the reviews, Piketty would say that the wealth will be able to control people's thinking through control of media.  If  the recent rejection of net neutrality in court decisions continues, this period of unprecedented dissemination of ideas, could end.

But why should we bother ourselves with such gloomy topics when the Winter Olympics are on?  

For those who might want to bother, here's a link to lectures Piketty has given recently in English mostly, as well as French. 


  1. To answer your question, because money matters any time of the year.

    Thanks for discussing this thinker, as I've made a point of reading economic writing over the years. It's a fascinating field and well worth the time labouring with its struggle to create modelling for our behaviours around money and its consequences. That effort is certainly rewarded when what we read is shown to influence the very world it observes.

    Picketty appears to have contributed toward this end; I went and reserved a copy of his book today.

    1. Jacob, does this mean we'll be getting a guest post on the book by the end of the year?

    2. Steve, that's an idea, maybe even a good idea. Too bad I happened to catch your query (I was going back to delete these this morning).

  2. I just came across your blog...I'm glad I did.

  3. Wait. The recent court decision on net neutrality didn't 'reject' the principle of net neutrality, that decision only banned the FCC from using a prescribed method to enforce net neutrality. Net neutrality is still enforceable, just not in the manner it once was. We have to wait and see how the FCC addresses the issue in the future.


    1. Thanks for the clarification and the link. Looking at the piece, I don't feel so bad about thinking it was a big setback, because the headlines it mentions certainly give that impression.

      And do try the link below on how to put a link in a comment. It's not the easiest thing to do, but it's pretty straightforward and if you put in the link, more people are likely to use it.


Comments will be reviewed, not for content (except ads), but for style. Comments with personal insults, rambling tirades, and significant repetition will be deleted. Ads disguised as comments, unless closely related to the post and of value to readers (my call) will be deleted. Click here to learn to put links in your comment.