This is a response to a brochure that was circulated on the Stony Brook University campus entitled “SOCIALISM - AN OUTLINE”, which I wrote in 2014-2015. The idea was to make it into a tri-fold brochure. I was disenchanted with other attempts to promote capitalism on college campuses, such as done by Turning Point USA. While my thinking on these issues has evolved since this was written, I am leaving this post exactly as it was written as a snapshot of my thinking at the time.

For thousands of years the vast majority of people lived day to day, producing just enough to subsist off the land. Most of what they produced was confiscated by feudal lords. Life expectancy hovered around 30 and modern medicine was nonexistent. Land, education and political power could only be obtained by birth into the aristocratic class. This state of affairs persisted for thousands of years. Then, in a small stretch of time between ~1650-1750 everything changed. It is no coincidence that this sweeping social revolution began in Britain, one of the few countries where property and voting rights were extended to greater segments of the population. It was also the place where philosophers such as John Locke advocated for greater liberty for all. It was during this time that both the theory and practice of free market capitalism emerged, leading to dramatic increases in standards of living and human freedom across the globe.

Capitalism is an economic and political system based on private property and free exchange of goods and services. Capitalism requires rule of law in order to function. Private property rights must be protected so people feel the fruits of their labor are secure. A court system must be in place to handle breach of contracts. Banks must be properly audited. Borders must be defended from foreign invaders. At the same time however, the influence of government power must be kept out of the market. Individuals and companies must compete in a free market and not receive special favors or subsidies from the government, as is now commonplace in the United States. Innovation must be allowed to thrive, which means allowing “creative destruction” of old businesses that have become outmoded. To function best and best allocate resources, capitalism requires sophisticated financial markets, including many sophisticated financial instruments. In order for these financial markets to function, financial technologies must be carefully regulated to prevent fraud and the regulator itself must also be regulated to prevent corruption. Democracy can help achieve this by holding politicians accountable to the people. Capitalism and democracy therefore go hand in hand, although capitalism can function under different forms of government. It is important to recognize one can argue for capitalism without arguing for minimization of government to only serving the role of a “night watchman”. The government also has an important role to play in ensuring equal opportunity. This means providing education to all citizens and special services for the disabled. Welfare programs can also exist alongside capitalism and such programs (in a limited form) have been endorsed by great free market thinkers such as F.A. Hayek and Milton Friedman.

The 2008 financial crisis

Many people blame the 2008 financial crisis on free market capitalism. Some see the crisis as evidence that free markets are wild and out of control and that more government intervention in the market is needed. The causes of the 2008 crisis are numerous and complexly intertwined. The underlining causes were all due government interventions. First, during the 2000’s the Federal Reserve dropped the key interest rate to 1%. Borrowing money became incredibly cheap. In this economic environment, banks became over leveraged. Stock prices soured and people borrowed money to pay for their mortgages. The value of bonds and treasuries fell, so banks took money out of such investments and put them in mortgage-backed securities. Meanwhile, politicians and government officials began a campaign to get people into houses, even if they could not afford them. The role of “Fannie Mae” (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) cannot be under emphasized here. Fannie Mae and Freddie Mac are Government-sponsored enterprises. They were created by government and completely funded by government. During the 2000’s they were charged with selling mortgages and mortgages backed securities to banks. Banks bought these in great quantity under the assumption that in the event of a failure of either enterprise, the government would bail them out. Indeed, this is essentially what happened in September 2008 when the federal government took over Fannie Mae and Freddie Mac and bailed them out.

This brief (and admittedly vastly incomplete) historical account highlights the key role that government intervention played in causing the housing bubble and the resulting financial crisis. Of course, there were also many failures on the part of some private businesses and private rating agencies, but these failures cannot be said to be the cause of the crisis. Less discussed in the popular discourse are international factors, such as the formation of the Eurozone and the financial services bubble that resulted from it. Even less discussed are the international banking regulations known as “Basel I” (1988) and “Basel II” (2004). Basel I defined the amount of minimum equity a bank must hold relative to their debts , which is a sensible type of regulation to ensure people’s money is safe. However, because of holes in this regulation, it was very easy for banks to circumvent it. Some have argued that these regulatory failures were an even bigger contributor to the financial crisis as the aforementioned factors.

Capitalism and the environment

It is a mistake to think that capitalism is inherently destructive to the environment. The private property laws which are the foundation of capitalism protect the environment from pollution. For instance, under free market capitalism, if someone dumps a chemical into a stream, this causes property damage downstream and the perpetrator must pay a hefty penalty. One also hears discussions of externalities, which are societal costs not passed on to the consumer, but are spread out, such as air and water pollution. Externalities such as air pollution effect each individual only slightly but collectively over time can have a negative effect on the environment. It is interesting that externalities are not inherent in capitalism. In fact, assuming a functioning market with low transaction costs, the famous Coase Theorem says that externalities always tend to zero while economic efficiency is maximized. In practice, however, some externalities do exist because of finite transaction costs. Just as with the example of pollution in a stream, externalities can be dealt with using property rights. It is precisely the parts of the environment which are not codified into property belonging to individuals or groups such as air and oceans, that are currently experiencing the most environmental calamity. In each case, a tragedy of the commons results.

As an example of this, one of the most important environmental issues today is the warming of the planet caused by the anthropogenic emission of greenhouse gases. Private property rights reasoning provides a solution - a revenue neutral carbon tax. A carbon tax makes corporations pay for the damage they do to property via global warming. A carbon tax also signals markets to find more environmentally friendly ways of producing energy. By utilizing markets in this way, alternative energy technologies can be developed faster and more efficiently than through top-down centralized planning. Two examples of the failure of centralized tax-payer planning are ethanol subsidies and Solyndra, both of which have led to massive waste of tax payer money.

To close out this section we note that there is no reason to believe that other systems of social organization, such as communism, or socialism would be better at protecting the environment than capitalism. The terrible environmental legacy of the USSR suggests otherwise.

The long tail of Marx’s ideas

The historical importance of Karl Marx (1818-1883) can not be underestimated. While acknowledging that capitalism had brought millions out of poverty, Marx attacked the capitalism on both moral and economic grounds. Most of Marx’s economic ideas have fallen by the wayside long ago. One crucial problem with Marx’s arguments against capitalism is that they rely on the labor theory of value. This was no fault of his own as the labor theory of value was used by all economists of that period, including Adam Smith. The labor theory of value posits that the value of goods can be quantified in terms of the number of hours of labor that went into the producing them. While being able to quantify value in this way obviously has appeal , it’s shortcoming can easily be seen by considering the case where someone invests many hours producing a product which then nobody wants to buy. For this reason all of modern economists use the subjective theory of value. In the subjective theory of value the value of a product depends on subjective factors which vary from consumer to consumer and over time and space. Without the labor theory of value, Marx’s central theory of exploitation - the idea that the capitalist (owner of a company) ‘extracts’ a certain amount of value from his employees - falls apart. Additionally, Marx’s contemporaries were quick to point out a devastating technical objection to his of exploitation theory called the “transformation problem” - a problem which even left wing scholars acknowledge has never been solved. Despite these problems (among others), Marx’s thought had great appeal to the people of his time and even continues to attract attention today. One appeal of Marx’s thought is that it posits that those who are poor are poor largely due to actions of the rich, and therefore the rich should be punished - an idea which resonates with the human emotion of envy. A second appeal of Marx’s thought is that he predicted that the capitalist system would be overthrown in a glorious revolution leading to communism and then some form of utopian socialism.

A separate problem with Marx’s thought, which we can only touch on briefly here, is that he viewed human beings as infinitely malleable (also called the “blank slate fallacy” by Stephen Pinker, as discussed in his book The Blank Slate). Under this view, with sufficient conditioning, people’s individuality can be eliminated so they will work for the greater collective. According to Marx, socialism can only be realized if “capitalist man” is supplanted with a “communist man” who is content with a life of servitude to the collective. The need for a totalitarian state, such as that in George Orwell’s 1984, is essential to realizing Marx’s vision. Of course, in Marx’s world, the leaders of this state are also perfect communists. There is reason to believe that even if such a perfect totalitarian state was formed, people could not be conditioned to the extent required by Marx. Modern psychology, biology and neuroscience largely reject the idea of an “infinitely malleable” blank slate, and instead show there are some aspects of human nature that can not be changed. In the words of the biologist E.O. Wilson, “Karl Marx was right, socialism works, it is just that he had the wrong species.”

How Lenin mutated Marx’s ideas to demonize capitalism and justify tyrannical state socialism

It was Lenin (1870-1924) much more than Marx who promulgated the false equivalence of colonialism and imperialism with free market capitalism. Imperialism is “state policy, practice, or advocacy of extending power and dominion, especially by direct territorial acquisition or by gaining political and economic control of other areas.” (Encyclopedia Britannica). Imperialism is a problem coming from governments either attacking other countries or failing to enforce laws against foreign aggressors. Imperialism exists independent of capitalism although historically there is a correlation. Due to stronger governments and better rule of law throughout the world, imperialism is not as common as it once was.

Marx predicted the communist revolution was inevitable and would occur first in Germany. Instead it was in Russia that communism was born in 1917. Lenin distorted Marx’s thought, advocating that the communist state be run by a “vanguard party” which must brutally eliminate all dissent. Lenin is still idolized in Russia and held by many as more ethical than Stalin. However, in numerous documented cases Lenin ordered dissidents to be hanged or sent to work camps. Sadly, Lenin’s ideas were copied all over the world, leading to the preventable deaths of at least 90 million under communism. Even though since the collapse of USSR people have proclaimed that communism and state socialism are dead forever, the follies of communism and socialism are just as true and just as dangerous today as they were then. As F.A. Hayek warned in his book The Road to Serfdom, socialism inherently necessitates centralized planning, which inevitably leads to a totalitarian state.

The economic calculation problem

The fundamental problem faced by any society is coordination. F.A. Hayek and Ludwig von Mises were among the first to explain how it is impossible for centralized planning to adapt to changes in supply or demand the way that the free market can. The “economic calculation problem” is a deathblow to the centralized planning that is central to communism and exists to varying degrees in all varieties of socialism. Economic coordination is exceedingly complex, to use a famous example, consider how many people it takes to make a pencil. A pencil requires wood, which requires trees. Cutting down trees requires chainsaws and chainsaws which require steel. The eraser contains rubber from Brazil and the graphite was likely mined in China. Altogether, thousands or hundreds of thousands of people from vastly different cultures and backgrounds have to work together in intricate coordination to create a pencil, which is then sold for pennies. In the free market system such coordination is automatically orchestrated through price signals. Prices contain valuable information about supply and demand which, as pointed out by Hayek, cannot be obtained in any other way except through the price system. When price signals are absent, economic devastation results. In Maoist China for instance, tens of millions died needlessly because food could not be properly distributed and the news of famine did not reach the right people at the right time. In retrospect, it is amazing that the economies in communist countries did as well as they have. According to Robert Schiller and other economists, the only reason the USSR’s economy did not collapse completely was that their leaders had access to price information from capitalist countries, otherwise, they would have been flying blind.

Further reading

Websites

www.learnliberty.org

Articles

  • “The Use of Knowledge in Society” by F.A. Hayek
  • “The origins of the financial crisis: a crash course” - The Economist, 2003.

Books - academic

  • Economics in One Lesson by Henry Hazlitt
  • The Road to Serfdom by F.A. Hayek
  • The Constitution of Liberty by F.A. Hayek
  • Human Action by Ludwig von Mises
  • The Law by Fredrick Bastiat
  • Economic Sophisms by Fredrick Bastiat
  • A Conflict of Visions by Thomas Sowell
  • The Blank Slate by Stephen Pinker
  • The God of the Machine by Isabel Paterson
  • Anarchy, State, and Utopia by Robert Nozick

Books - lighter fare

  • Economic Facts & Fallacies by Thomas Sowell
  • Atlas Shrugged by Ayn Rand
  • Give Me a Break by John Stossel