Symposium

A Softhearted Defense of Capitalism

By From the March 1972 issue

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Mention the word “capitalism” and someone is sure to make the association “inequality.” With some justice the relationship between the two concepts is generally thought to be close. Consequently defenders of capitalism are often suspected of being hardhearted defenders of the privileges of the rich.

A routine defense of capitalism, if it does not positively extol the ever- lasting moral virtues of a system which allows the ambitious and productive to thrive, while the slothful and indolent are impoverished, is at least expected to point out that tampering with the mechanism that produces these results will inevitably tend to destroy the initiative and ambition of the whole society.

I find such moralizing unconvincing. I propose instead to give a softhearted (albeit hardheaded) defense of capitalism. I will point out the importance of the institutions of private property and limited government in preserving individual freedom and also suggest the advantages of prices and markets over central planning in the efficient production of goods and services. Finally I will point out that the inequality produced by a capitalist economy can be greatly reduced without killing the goose that lays the golden egg.

Now the almost immediate objection raised to virtually any proposal to redistribute income is that it would reduce the incentive to work, compete and innovate.

But our whole tax and welfare system is so shot through with loopholes (such as the provisions of the capital gains tax), special privileges (e.g., the oil depletion allowances), and sheer irrationalities (e.g., the present welfare system) that there are many opportunities to implement reforms which would increase both efficiency and equity in our economy.

Private Ownership and Individual Freedom
It would be difficult to deny that in the modern world today there is a strong association between anthoritarian political systems and nearly complete state control over the means of production. Almost all the world's parliamentary democracies have a large private sector responsible for generating at least half and more usually two-thirds of the total national income. The nations with the most complete state control of the economy, the Communist regimes of Eastern Europe, the Soviet Union and China, are all characterized by their lack of respect for individual rights and the absence of meaningful elections.

Not many sensible people would object to these observations I should think -- but their proper interpretation is more controversial. Is a statified economy really infertile soil in which to cultive a political freedom, or is the association between state ownership and tyranny merely coincidental, due, in fact, to some third factor such as the revolutionary origins of many statified economies, Leninist ideology or centuries of peculiarly Russian political tradition?

There is no need to deny that the factors nourishing individual freedom are numerous and complex in order to maintain that a large, autonomous private sector is an important bulwark of a free society.

The importance of a powerful private sector was impressed upon me quite vividly in the deep South (of all places) when I worked for CORE in the middle 1960s trying to persuade black citizens to vote. In three summers of door-to- door canvassing in Mississippi and Louisiana I was surprised by the consistent timidity of the black school teachers. Teachers were almost invariably reluctant to sign petitions, participate in organizational activity or even register to vote. One did not have to look far to discover the cause of this trepidation. School personnel were hired and fired by an all-white school board elected by a mostly white electorate bitterly hostile to civil rights activity. In one of the nastier towns I was in the school board even made a practice of faithfully attending civil rights meetings in order to make sure that none of "their" people showed up.

The systematic enforcement of orthodox behavior on school board employees (who constituted the vast majority of local government employees in the black community) contrasted sharply with the rarity of pressure from private employers, except in cases where their interests were directly threatened. It was not, for instance, advisable for someone to encourage a sit-in at a luncheonette where he worked, but with only occasional exceptions, militant general political activity was not punished.

These experiences illustrate the following general rule: a reasonably competitive private sector ensures that most employers most of the time will be concerned exclusively with his employees' performance on the job and will avoid indulging his tastes for conformity in matters not directly related to business performance. It could hardly be otherwise since the decision to indulge personal tastes in favor of, say, segregation, or anti-communism by firing an efficient employee (or by hiring an inefficient one) is an added business cost. Businessmen who voluntarily incur unnecessary costs tend to be businessmen whose enterprises grow more slowly or decline more rapidly than their colleagues who ruthlessly avoid any costly indulgences in personal whims. The competitive process thus contains a naturally selective mechanism which tends to weed out employers who incur unnecessary costs and reward single-minded devotion to minimizing costs and maximizing value of output. At any given point in time this mechanism is not 100 percent effective. There exist private employers who are needlessly arbitrary, unfair and discriminatory. But a reasonably free competitive economy ensures that such employers will be at a competitive disadvantage.

This selective process accounts in large measure for the natural antipathy which intellectuals seem to feel toward successful businessmen. The intellectual's stock in trade is his scope, his daring, and often his idiosyncratic ideas or behavior. The businessman may display daring in matters concerned with cost cutting or production innovation but elsewhere all instincts tell him to keep his principles, or peculiarities strictly out of his business affairs. This soulless timidity and single-minded pursuit of profit tends to strike the intellectual as unappealing at best.

All this stands in sharp contrast to the situation in the public sector. State enterprises are generally monopolies. Their political bosses can afford to indulge their (or their constituency's) personal preferences without effective constraint. Indeed politics largely consists in the attempt to satisfy the preferences of as large a part of one's constituency as possible. And in addition a person blackballed by the government in a statified economy has nowhere else to turn while arbitrary action in the private sector at least has the consolation that alternatives exist.

One is reminded of the Soviet Secret Police (K.G.B.) practice of warning managers in state enterprises not to hire dissidents who are then arrested on charges of "social parasitism." Although the situation is vastly worse in the Soviet Union than it would likely to be in a parliamentary democracy, one still remembers with a shudder Richard Nixon's intrusion into the New Jersey governor's race in 1966 when the main issue was whether the state-supported University should fire a history professor (Eugene Genovese) for a pro-Viet Cong speech. The campaign cry then was that our tax dollars should not be used to pay someone who supports our nation's enemies abroad. Fortunately the Republican candidate lost and Professor Genovese retained his position, but the incident should serve as an ominous reminder that in a statified economy the right to dissent depends on the transitory tolerance of a majority of the electorate.

It seems unlikely that any mere statutory protection for a man's livelihood in a socialist state monopoly will be as effective a barrier to popular intolerance as the centuries old tradition of private property. During the 1950s, for instance, New York provided for the mandatory revocation of the driver's license of any motorist convicted under the Smith Act of advocating the overthrow of the government. The District of Columbia even denied a married man in his forties a permit to operate a taxi because, when he was a young man in his twenties, he and a woman had been discovered making love in his car. It is not difficult to imagine a private home or business being confiscated for similar reasons.

Even when businessmen appear to bow to popular intolerance and dismiss unpopular employees, the pressure to covertly purchase their services is sometimes irresistible. As Milton Friedman reminds us in Capitalism and Freedom, when about 150 script writers were blacklisted by Hollywood studios for their suspected Communist connections, they went right on selling scripts to the industry. The studios simply attached pseudonyms to the scripts and when caught in the act one producer explained, "We have an obligation to our stockholders to buy the best script we can."

Capitalism and Efficiency
The primary task which any economy must cope with is the problem of choice. Which goods and services should scarce resources be used to produce? What techniques should be used in their production? The complexities involved multiply madly as an economy becomes richer and more diversified. A developed economy will have tens of thousands of distinct "products" with several competing production techniques feasible for each.

A particularly crucial set of choices involves selecting the best investments society should make with its scarce savings. No society uses all the resources available to it for current consumption. Some resources must always be set aside to provide the tools to maintain or increase future consumption. A primitive fishing society, for instance, would employ some of its scarce labor repairing, replacing and augmenting its supply of fishing nets (capital) so that future consumption of fish could be maintained or increased. In a modern economy the alternative capital investments are vastly more complex. Some efficient mechanism must be established which chooses the investments which will yield the greatest future economic benefits.

Capitalist economies typically rely on private capital markets in order to make investment decisions. It would be difficult to think of a more thoroughly "capitalist" institution than the network of stock exchanges, bond markets, banks and other financial intermediaries which channel money from savers to investors. Yet this institution performs a crucial social function. A successful stock broker, for instance, is one who knows which sectors of the economy are going to grow most rapidly and which particular firms within those sectors have the resources and entrepreneurial skills to take advantage of such rapid sectorial growth. A stock broker who can spot such firms before the rest of the market will enrich both his clients and himself; those who cannot will eventually be forced to turn to some less ruinous trade.

A capitalist style capital market, then, relies on competition at both ends in order to channel private savings to the investors who are capable of earning the highest possible returns. Competition between firms gives investors maximum possible choice of methods, managements and products in which to invest their savings. Competition between brokers and other financial intermediaries means only those with the requisite talents to channel their clients' money to the firms best able to use it will prosper.

What is the socialist alternative to competitive private capital markets? Clearly, any economy must choose which investments to make with its scarce savings and any socialist worth his salt ought to have a pretty good idea what he would like to see replace competitive capital markets.

The true radical (and the one whose faith has been unshaken by a half century of economic history) would nationalize investment planning entirely. A government agency (say the Bureau of the Budget) would be empowered to decide how many dollars would be invested in nail production, how the money should be divided up between little nails and big nails, and which production techniques should be used. Such an administrative monstrosity (an American equivalent to the Soviet Gosplan) is the logical outcome of rhetoric which denounces capitalist investment criteria (i.e. maximizing rate of return on invested capital) as "'production for profit instead of to satisfy human needs." If indeed profits and consumer satisfaction have nothing to do with each other, then the only sensible course of action is to scrap the market altogether in favor of complete central planning.


I would suggest that anyone who is in danger of succumbing to this reasoning or to any species of enthusiasm for central planning come up to Cambridge and have lunch at Elsie's restaurant near Harvard Square. Elsie's is a tiny eating place, generally jammed to far more than capacity and featuring the largest sized meat sandwiches available anywhere around. The relatively poor, and extremely hungry students who eat most of the sandwiches are more than willing to consume their lunch in a proximity to their fellow eaters that a more normal cross-section of the population would consider outrageous.

Now imagine, if you will, a completely nationalized restaurant system, with a central planning authority making all the decisions concerning investment and pricing. The New England Branch of the National Restaurant Authority would no doubt be staffed by hundreds of the best dieticians and economists money could buy. No doubt all these wise men would have worked out formulae showing the desired distribution of restaurants and the optimal amount of floor space for each expected customer.

But what about Elsie's? It is inconceivable that any central planner would even consider the ridiculous trade-off between expenditure on space and food to which Elsie's customers pay tribute every lunch-time.

Elsie's restaurant is worth mentioning because it is an example of the flexibility which markets allow people in expressing their preferences. Any producer in a competitive market who can figure out how to combine existing inputs into a more valuable output (or to produce the same output with less inputs) will wind up making extraordinary profits. In contrast, production goals in a central plan are generally stated in terms of maximizing some relatively crude measure of aggregate output such as tons of steel, pounds of butter, etc.

This is why the constant innovation which many view as a sign of waste in capitalist economies is, in fact, an indication of the constant experimentation which alone can provide the feedback producers need to discover how to provide maximum consumer satisfaction at minimum cost.

Inequality
Still the nagging problem of inequality remains. The distribution of income in all capitalist societies is highly skewed and the distribution of wealth much more so.

Now many people have advanced various cogent arguments in favor of a certain amount of inequality: need for incentives, concentrations of wealth produce patrons for the arts and for dissident political views, reward for hard work and thrift, etc. These justifications all contain a certain amount of merit. They perhaps constitute a sound argument against exact equality of income or wealth. What they do not do, what they do not even attempt to do, is to refute the proposition that there is too much inequality in capitalist society. The opinion that, "the gap between the rich and the poor is too wide," or that "Hugh Hefner should not be allowed to ride around in his own personal eight million dollar airplane while children go hungry," cannot be refuted by proving that "a certain amount of inequality is a good thing."

As the English economist, J. E. Meade, reminds us in his excellent little book, Efficiency, Equality and the Ownership of Property, the relative shares of national income going to labor and capital is the outcome of an intricate web of economic forces, and to expect the result to manifest any special moral virtue is unreasonable. To illustrate, consider two countries, identical in all respects but one. Both countries would have the same natural resources, the same capital stock, the same number of capitalists, and equally sober and industrious workers. The only difference would be that country A will have more workers than country B. Then the wage rate in country A will be lower and the return to capital (and the average income of the capitalists) will be higher than in country B.

If one believes that country B, the more egalitarian of the two, has the right amount of inequality it is difficult to see how one can justify the greater inequality imposed on the equally meritorious workers in country A. Even if one is a hard-hearted believer in inequality and believes that country A has the appropriate gap between the rich and the poor, it is hard to see how the more egalitarian economy of country B is to be justified.

There seems to be no sensible reason why a species of moral and political animal should be content to allow the essentially random (or more properly, morally random) forces which determine the market clearing prices of labor and capital to also determine the distribution of economic resources among men.

Indeed, I have not seen a single modern, cogent, moral argument for accepting the distribution of income which a free market presents us with. Even so uncompromising a defender of the free market as Milton Friedman is forced to admit (in Capitalism and Freedom, p. 165) that the degree of inequality imposed by a market economy "cannot in and of itself be regarded as an ethical principle; that it must be regarded as instrumental or a corollary of some other principle such as freedom." Those of us who are not persuaded that the freedom to keep all one is able to earn on the market is an essential human right are thus free to remain skeptical about the sanctity of our present distribution of income.

Yet implicit in the positions taken by many conservative spokesmen is a deep antipathy to any measures designed to redistribute income. It is difficult to understand why else the Buckley brothers, for instance, would be so disturbed about the Family Assistance Program's proposed extension of benefits to the working poor. The instinctive reaction of ritualistic conservatives is extreme reluctance to extend "'welfare" to large numbers of additional families while reluctantly agreeing to continue paying minimal benefits to keep the really destitute non-working poor afloat. The idea of extending progressively diminishing benefits to working families as their income rises rankles, even though such an extension is necessary to eliminate the incentive-killing 100 percent marginal rate of taxation presently imposed on welfare recipients. Thus the conservative antipathy to redistribution gives us the worst of both worlds, inequality without incentives (at least for the poor).

What Is To Be Done?
I remain convinced that an economy in which at least half the incomes are generated in the private sector is desirable both because it makes a large contribution to the maintenance of individual freedom, and because a market economy remains the best means of efficiently and flexibly producing goods and services.

But there is no reason why free men in a parliamentary democracy must accept all the inequality which a true laissez-faire economy produces. Vigorous policies ought to be pursued aimed at equalizing the distribution of income and wealth. To some extent they already have. FHA guarantees of long-term loans to homeowners have made possible a substantial increase in the wealth of middle-income people. This must certainly be ranked as one of the most successful federal programs ever undertaken. Similar increases in wealth can be encouraged among lower income groups by generous programs of interest subsidies (which can half the payments on a long term mortgage) to low income families. In addition, efforts should be made to encourage and subsidize other forms of wealth accumulation by the bulk of the population. Workers should be encouraged to purchase stock and other paper assets possibly at reduced prices.

Such “spread the wealth" programs are to be encouraged for a variety of reasons; property gives people a sense of security and independence which is very desirable in our over-wrought, urbanized civilization, property ownership gives people a stake in the society and aversion to violent change which certainly should be welcome in America, and finally, wealth earns income and thus a more equal distribution of wealth automatically results in a more equal distribution of income.

In addition, much greater effort must be made to redistribute income directly through tax reform, more generous family assistance and other programs. I am convinced that such policies are indeed compatible with both a high level of economic incentives and with a free society--but that is a whole new essay.


Michael Clurman received his B.S. in economics from the University of Wisconsin in 1965, his M.A. from Harvard in 1968. He is presenty doing an economic study of the computer industry for a firm in Boston.

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Michael Clurman received his B.S. in economics from the University of Wisconsin in 1965, his M.A. from Harvard in 1968.