Capitalism – the Real “Third Way”

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Conventional understanding views economic history as some kind of big battle between unfettered capitalism on the one hand (as supposedly demonstrated by the late nineteenth to early twentieth century United States) and full blown socialism on the other (as the Soviet Union was supposed to have been). Allegedly, both extremes have their positive aspects but are, individually, weighed down by their supposed negative ones. So capitalism, for example, is able to raise the standard of living by several-fold in a person’s lifetime and showers us with more goods than we could possibly imagine. On the other hand, so this conventional belief goes, it promotes a consumerist, materialist and greedy “sink or swim” society that has no regard for the unfortunate and the least well off. Hence the vision of the US as the kind of place where you can buy whatever you want but if you happen to be poor or become afflicted with an illness then you are on your own. Socialism, however, stagnates and reverses the standard of living to the extent that nothing ever works and the population is mired in permanent poverty. On the other hand, so this conventional wisdom dictates, everyone is apparently more equal and the goods that they do manage to produce are distributed “fairly” across society. (Curiously this understanding of economic history seldom tends to acknowledge the tyrannous nature of socialism which, in the Soviet Union, resulted in the deaths of tens of millions of people – one might ask whether this negative feature is so off the scale that it would completely obliterate the chance of socialism being taken seriously as an ethical proposition at all?). Thus, in order to create the best society, we allegedly have to try and combine the economic growth of capitalism with the supposed equality and fairness of socialism, discarding the negative aspects of those two systems in order to arrive at we have today – a social democracy, the “third way”, an economic order that is “somewhere in the middle” between greed and need.

The first problem with this conventional thinking is that neither of the two polar opposites have ever really existed, or at least not in the manner that their proponents imagine them. Capitalism has never existed because government interference in the economy has always been present, simply in lesser or greater quantities at different points in history. Often the interferences at lesser points have provided the catalyst for more intense government activity in later periods, such as the booms and busts and the stop-start flirtation with centralised banking in the last half of the nineteenth century paving the way for the Federal Reserve System that dawned in 1913 just in time to print enough money to pay for World War One. Socialism has never existed because, as Ludwig von Mises so convincingly told us nearly one hundred years ago, it is, quite literally, impossible to build a socialist commonwealth without economic calculation. The Soviet Union survived to a large extent because it could refer to international markets for prices for the factors of production which enabled it to provide at least some kind of functioning economy, albeit at a vastly reduced rate of output compared to the rest of the world.

The real polar opposites that we have endured in the post-Renaissance era are not unfettered capitalism and unfettered socialism at all, but, rather, state corporatism and state socialism. State corporatism, the alignment between government and business, has its epitome in fascist economies such as Nazi Germany and Fascist Italy, but it describes also the imperialism of nineteenth century Britain and the evolution of the United States, which received corporatist boosts during the War between the States, World War I and the New Deal, the latter of which, modelled on Fascist Italy, has successfully sealed the fate of the US as a permanent “corp-tocracy”. State socialism, on the other hand, is not the ownership and use of the productive assets by all for the benefit of all. Rather, it is their ownership by the government and the bureaucracy with productive capacity devoted to their ends, such as missile parades in Red Square, rather than the ends desired by the people, with the people themselves treated as expendable public slaves whose disobedience warrants a one way trip to the gulag.

Second, the blend that has actually been achieved in modern government is not between capitalism on the one hand and socialism on the other. Rather, it is between state corporatism and a democratised form of state socialism. On the state corporatist side, we have central banks printing massive quantities of money, dishing it out to Wall Street which expands credit, creating artificial booms and busts and lining the pockets of the financiers. At the same time large swathes of industry are subject to government patronage and privilege to the extent that in sectors such as energy, transportation, finance, healthcare, and so on there is no genuine free competition. To top it all off, armaments manufacturers profit from the continued proliferation of invented and unjustified foreign wars. On the state socialist side, however, we have politicians bribing voters with other people’s money, and demands for social justice, fairness and equality, anti-discrimination are met through the forced redistribution of wealth and income.

The fissure between these two extremes has not produced any kind of successful mixed economy that selects the best aspects of each system at all. Rather, it has resulted in some kind of bifurcated system that is based on antagonism and resentment. Those clamouring for state corporatism, fake privatisations and government support for business simply want to line their pockets while leaving everyone else to foot the bill. Those wanting state socialism, noting that state corporatism seems to do nothing except make the rich richer and the poor poorer, want to end the anti-democratic structure of state corporatism and return key industries to “public ownership”.

Third, if the two dominant social systems have been state corporatism and state socialism and the postulated “third way” of blending the two has failed, then what, we might ask, is the real third way? There are only three possibilities. First, unfettered socialism; second, unfettered capitalism; and third, a mixed economy of genuine socialism and genuine capitalism (what we might call “interventionism”).

The first option, socialism, is clearly a non-starter as its inability to perform economic calculations means that it is suitable only for bringing chaos out of order. A socialist economic order is no order at all; it is a disaster that would quickly relegate the human race to the Stone Age. The third option, interventionism, is also a non-starter as it produces distortions that must either lead to further interventions or to a complete abandonment of the intervention altogether. For example, if the government intervenes to set a price ceiling on a certain good that is below the market price the result, all else being equal, will clearly be a shortage of that good. The government therefore has one of two options in order to restore supply – to intervene further and take over the supply chain; or to abandon the price control. If it takes the first option, this requires further interventions in other industries which will create similar distortions and disarrays which will breed further interventions all the way until there is full government control over everything – i.e. socialism. Socialism, however, is impossible as so will collapse almost immediately. If it takes the second option, then capitalism is simply restored. In the opinion of the present author we are now reaching the apex of the so-called mixed economy where this decision will have to be made. Decades of excessive money printing and perpetuated malinvestment through the resulting credit expansion has driven financial markets to a zombie-like existence bathing in a sea of insolvency. We are now close to the point where governments will either have to completely socialise financial markets or abandon their policy of cheap credit and restore sound money and credit.

This leaves, then, only capitalism, the genuine free market, as the only prospective and sustainable economic order. Only capitalism, based upon voluntary trade resulting from each individual peacefully pursuing his purposes, is able to avoid the pitfalls of socialism, of the pseudo-capitalism in state corporatism, and of the pseudo equality and fairness of state socialism, all of which are based on force, fraud and antagonism. As we discussed before, all of the alleged pitfalls of capitalism – inequality, greed, selfishness, and so on – are not part of the capitalist system at all and are more appropriately assigned to one of the other systems where everyone attempts to live at the expense of everyone else. Only the restoration of a genuine free market capitalism can therefore lead to a peaceful and prosperous society.

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Social Democracy

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The author responded to a lengthy article, posted online, that advocated strongly social democracy. Unfortunately the original link has broken but the text below quotes the article in its entirety, interjected by responses.

“Democracy is a form of government in which all citizens take part. It is government of the people, by the people, and for the people. Socialism is where we all put our resources together and work for the common good of us all and not just for our own benefit. In this sense, we are sharing the wealth within society.”

Socialism is the abolition of private property in the means of production, i.e. no individual owns the physical entity of or is entitled to the capital value of any capital or producer good. Once this has been accomplished there remains the problem of how to direct these resources to the most highly valued ends. Contrary to the tacit assumption of many socialist thinkers there is no separate, conscious entity who feels and knows what the “common good” is; there are only individual humans who each value different ends independently; they may agree, in some cases, on what are valuable ends but they still hold these values as individuals and they are liable to change. Further, there will be disagreement on how these ends are to be achieved and precisely which of the scarce means are to be allocated to them. So how is a) the most valuable ends and b) the most suitable means for those ends to be determined under Socialism? How is disagreement on these matters to be reconciled?

All valuable ends are confronted by the same problem – scarcity of the means of production. Hence the economic problem is how to direct scarce means to the most highly valued ends. You can advocate that this can be done either through socialised property or private property but you cannot argue in favour of both together – they are entirely different solutions to the same problem. If you start from the premise that “certain industries” may be socialised you are already advocating that at least some of the factors of production should be allocated to these industries, but this can only be arbitrary. How do you know? And if you know how do you know which factors should be allocated and in which proportion? How do you compare one set of allocations with another set?

A system of private property in the means of production answers this through pricing, profit and loss. For private property gives way to exchange which creates supply and demand which produces prices which produces profit and loss. Hence costs and revenue can be reduced to a single common denominator, the unit of exchange (money), that allows resource allocation to be compared across the entire economy.

In the absence of private property, however, there can be no exchange. There are therefore no prices in the factor of production and no profit and loss. How are the factors of production to be compared? How is the electorate or its democratically elected caretakers of the means of production to compare the cost of 5 tonnes of steel, 3 tonnes of wood, 40 labour hours, 500 sheets of paper, 6 billboards of advertising, 30 hours of telephone calls if it cannot reduce these inputs to a common denominator?

“Of course when people hear that term, “Share the wealth” they start screaming, “OMG you want to rob from the rich and give it all to the poor!”  But that is NOT what Democratic Socialism means. To a Democratic Socialist, sharing the wealth means pooling tax money together to design social programs that benefit ALL citizens of that country, city, state, etc.”

If a person is wealthy in a pure private property society (where trade is entirely voluntary) it is because he has produced a comparatively high quantity of goods that other individuals are willing to purchase. A poorer person has produced comparatively less. The wealth of the rich can only grow if they abstain from consumption of their income and invest it in order to increase the number of goods they can produce. Most of the wealth of the rich consists of, or is derived from, real valuable assets – factories, commodities, plant, shops and inventories. They continue to be rich because these assets are productive – other people are willing to exchange them for another valued good, i.e. money. If they cease to be productive their capital value will decline and so will the wealth of the owner.

If the amount of pooled wealth available for government programs is to increase these real resources have to be liquidated from their current uses and the workers have to be laid off and transferred to Government employment. For every resource that is consumed in a government program that is one resource less that can be used for something else. By which method do you calculate whether the resources are being put to their most valuable ends in the hands of private entrepreneurs or in government programs?

“The fire and police departments are both excellent examples of Democratic Socialism in America.  Rather than leaving each individual responsible for protecting their own home from fire, everyone pools their money together, through taxes, to maintain a fire and police department. It’s operated under a non-profit status, and yes, your tax dollars pay for putting out other people’s fires. It would almost seem absurd to think of some corporation profiting from putting out fires. But it’s more efficient and far less expensive to have government run fire departments funded by tax dollars.”

This is no different from insurance. Individuals pool their premiums together with a private provider in order to provide the resources for extinguishing fires in an emergency and/or compensating the unfortunate victims of fire damage. The only difference is that each individual can choose whether to pool his premiums with one particular provider or not (or at all). The insurer therefore has to act in a way that will retain its customer base, one of which is to keep premiums lower than those of its competitors. The primary method of accomplishing this is to minimise the amount that has to be paid out in compensation and the only way to do this is to prevent and control fires as much as possible. The insurer may, therefore, specify that your home be fitted with some basic fire-fighting equipment such as fire extinguishers or fire blankets and that all of your equipment is electrically tested, for example. If the cost of this is less than the saving you make on a lower premium then you are likely to do this. They may charge higher premiums in cases where flammable substances are stored on a property, or refuse to insure you altogether because the risk would be too great, thus discouraging the accumulation of dangerous materials. The result of this is that each person pays according to the amount of risk he is willing to bear and everyone, consumer and insurer, is equally interested in taking steps to minimise the number of fires as much as possible.

If a fire does start, however, the longer they burn the more the insurer has to pay in compensation to a covered individual. They are therefore likely to respond with the utmost urgency with their own, privately owned, fire fighting equipment or privately contracted fire fighting supplier in order to minimise the amount of damage.

All of these incentives are lost when fire-fighting is managed by the Government. The Government does not need to be concerned about losing your premium to a competitor – you have to pay it in taxes or it will incarcerate you regardless. Hence it is less bothered about minimising the amount of damage. Fewer homes will therefore be installed with preventive equipment and less electrical testing will take place. There will therefore be more fires. Further the tax paid towards fire-fighting services is not adjusted to your individual level of risk; rather it is determined by your income. There is therefore less incentive to avoid the accumulation of risks that contribute towards fire. Every preventative measure you take is an extra cost but there is now no added benefit – you still have to pay the tax and you are still entitled to the same service as everyone else. The result will be less prevention and more fires, more destruction of property and consequently less overall societal wealth.

And finally, once a fire starts, the Government is not going to lose any money if your house burns. Even if it has to pay you compensation the Government will not go out of business if it has to pay too much, unlike a private firm. The Government-employed fire-fighters know that, regardless of what happens to your house, they will, in principle, still be employed and paid tomorrow regardless of the cost to the Government of compensating you for your house. This is not to suggest that Government fire-fighting will always be slow, shoddy and negligent. But given these facts what is the likelihood that a Government fire service will respond more efficiently to a case of fire than a private fire service?

This is a typical case of Government having carried out a particular function for so long that everyone forgets what it looks like when it is carried out privately. Yet the above should demonstrate how it would most likely be done and to a higher degree of efficiency than by the Government.

“Similarly, public education is another social program in the USA. It benefits all of us to have a taxpayer supported, publicly run education system. Unfortunately, in America, the public education system ends with high school.  Most of Europe now provides low cost or free college education for their citizens. This is because their citizens understand that an educated society is a safer, more productive and more prosperous society. Living in such a society, everyone benefits from public education.”

No one denies that education is a beneficial and indeed a good and beautiful thing. But for every resource spent on education there is one less resource to be spent on something else. How do you know that education is the most productive use for these resources?

We could devote the entire productivity of the world to a huge and glorious education system where everyone pops out as smart as Einstein. But there would be no cars, no shops, no food, no computers, no houses, no offices, no factories etc. because all resources are devoted to the education system.

The problem faced by an economic system is not to determine what is valuable in the abstract – it is how to direct the scarce means to their most highly valued ends before all others.

“When an American graduates from college, they usually hold burdensome debt in the form of student loans that may take 10 to even 30 years to pay off. Instead of being able to start a business or invest in their career, the college graduate has to send off monthly payments for years on end. On the other hand, a new college graduate from a European country begins without the burdensome debt that an American is forced to take on. The young man or woman is freer to start up businesses, take an economic risk on a new venture, or invest more money in the economy, instead of spending their money paying off student loans to for-profit financial institutions.  Of course this does not benefit wealthy corporations, but it does greatly benefit everyone in that society.”

But the cost has to be paid by someone. If the graduate has to pay for his own education then yes he has less money to “start up businesses, take an economic risk on a new venture, or invest more money in the economy”. But if everyone else has to pay for his education through taxes then everyone else has that little bit less to do all of those wonderful things. The graduate has only gained what everyone else has lost.

“EXAMPLE  American style capitalistic program for college: If you pay (average) $20,000 annually for four years of college, that will total $80,000 + interest for student loans. The interest you would owe could easily total or exceed the $80,000 you originally borrowed, which means your degree could cost in excess of $100,000.”

If the cost of $80 000 tuition is paid back by the graduate without the interest of, say, $20 000 then that is $20 000 less that can be loaned to another student. There will therefore be fewer funds available to loan to more students for their education. Fewer students will therefore be educated. That is presumably not the intended outcome of this author. Governments, of course, could simply raise taxes to make up the shortfall. But again, all this will mean is that what the graduate has gained the taxpayer has lost.

“EXAMPLE  European style social program for college: Your college classes are paid for through government taxes.  When you graduate from that college and begin your career, you also start paying an extra tax for fellow citizens to attend college. Question – You might be thinking how is that fair? If you’re no longer attending college, why would you want to help everyone else pay for their college degree? Answer – Every working citizen pays a tax that is equivalent to say, $20 monthly.  If you work for 40 years and then retire, you will have paid $9,600 into the Social college program.  So you could say that your degree ends up costing only $9,600. When everyone pools their money together and the program is non-profit, the price goes down tremendously. This allows you to keep more of your hard earned cash!”

The cost of $20 monthly is arbitrary and no proof of this being the real cost under such a system is offered. The conclusion that “the price goes down tremendously” is, therefore, a non-sequitur. If anything, the cost of education is likely to go up as relieving every individual of the cost of his tuition will cause an increase in demand which causes prices to rise.

This is the reason, in the UK, for the recent “outrages” over higher education tuition fees. Government sanctioned loans systems artificially stimulate demand while the Government also caps the number of students, hence leading to a reduction in supply. Increasing demand and suppressed supply equals spiralling costs.

It is therefore Government interference with the higher education system and not private finance that makes bearing the costs of higher education so intolerable to graduates.

“Health care is another example: If your employer does not provide health insurance, you must purchase a policy independently.  The cost will be thousands of dollars annually, in addition to deductible and co-pays. In Holland, an individual will pay around $35 monthly, period.  Everyone pays into the system and this helps reduce the price for everyone, so they get to keep more of their hard earned cash.”

Healthcare premiums are so expensive in the US precisely because of Government interference in the insurance industry (and the only reason that insurance is the preferred method of funding healthcare is an anomaly that originates in The Great Depression). If Governments legislate so as to compel a provider to insure risks which are perceived by the latter as higher and more costly then the latter is forced to take on the burden of paying more than it would like when these risky events transpire (an almost guaranteed certainty if the insured event is something over which the policyholder has control. This is simply compensating individuals for their deliberate actions). Costs, therefore, rise.

Socialised healthcare under Medicare and Medicaid under which the healthcare consumption of an individual is divorced from its cost to the individual, the ease of malpractice suits, and lengthy and bureaucratic drug approval processes mandated by the FDA all contribute to the rise in healthcare costs in the US. None of these are phenomena of the free market.

Holland also operates on an insurance-led basis. One should investigate whether the lower cost allegedly associated with this is because of less and not more Government involvement.

“In the United States we are told and frequently reminded that anything run by the government is bad and that everything should be operated by for-profit companies.”

This is a list of Federal Government departments and agencies. Just a brief glance will reveal Government involvement in commerce, transport, housing, education, broadcasting, agriculture, labour, security, energy, healthcare, environment and engineering. Even if America is “frequently reminded” by somebody “that anything run by the Government is bad” no person can look sensibly at this list and conclude that Government does not already control or regulate vast areas of the US economy.

“Of course, with for-profit entities the cost to the consumer is much higher because they have corporate executives who expect compensation packages of tens of millions of dollars and shareholders who expect to be paid dividends, and so on.”

Executive compensation cannot determine market prices of consumer goods. Every good purchased by you is evaluated on its merits alone, not on the costs that went into producing it. If you deem the merchant’s asking price to be less valuable to you than the utility you will gain from the good then you will make the purchase. Otherwise, you will not make the purchase. It is therefore because an entity’s goods are so highly valued and consequently sell so well that companies are willing to pay more to hire the best employees. Not so if their sales are less successful.

Profit (and loss) is revenue minus costs. In order to make a profit you must increase your revenue as much as possible but what is forgotten is that you must reduce your costs also. Employee compensation is a cost and the higher it is in relation to revenue the lower the profit of the entity will be; the lower the profit, the less it will be able to invest in growth and the sooner it is more likely to stumble in meeting the needs of consumers which is the first step to insolvency.

In 2011, total executive compensation at Tesco plc was £21.7m against a turnover £60.9bn, approximately 0.0356%. Even if executive compensation did drive up consumer prices one has to wonder how such a small percentage could make much of a difference.

Finally, regarding very large corporations one might wish to investigate the effects of monopoly and regulatory privilege granted by Government and the effects of Government–granted limited liability in generating a preference for the large, publically-traded entity before implying that these beasts are creations of the pure pricing, profit and loss system.

“This (and more) pushes up the price of everything, with much more money going to the already rich and powerful, which in turn, leaves the middle class with less spending money and creates greater class separation. This economic framework makes it much more difficult for average Joes to ‘lift themselves up by their bootstraps’ and raise themselves to a higher economic standing.”

You cannot leave the general population with less spending money and push up the price of everything simultaneously. If the population was left with less money then it would have less with which to bid for goods and services. The latter would therefore remain unsold until prices were dropped. If prices were dropped, profits for vendors would drop. If profits drop then costs have to be cut. One of those costs is executive compensation.

If a firm, however, is able to continue to raise its prices without affecting sales and this increases profit margins beyond that experienced in other industries, resources are diverted away from the less profitable industries and into the profitable both by the existing entity and by new competition. Supply is therefore increased and prices consequently decrease.

It is therefore very difficult for an entity to raise its prices to increase profits without a) choking off sales or b) attracting competing investment.

The most effective way for the latter to be avoided is for the entity to induce the Government to regulate the industry. Compulsory licensing, planning permission, Government imposed trading standards, health and safety standards, employment regulation, etc. all serve to deter competition. For every extra regulation that must be complied with is an extra cost that a new competitor must meet and, by virtue of its status as a start-up, must consist of a larger portion of its costs that those of an incumbent provider. There is therefore a tendency for larger firms to become entrenched and for the “Average Joes” to be unable to “lift themselves by their bootstraps” – all because of Government intervention.

“So next time you hear the word “socialism” and “spreading the wealth” in the same breath, understand that this is a serious misconception.”

That is precisely what the effect of socialism is. In a capitalist society wealth accumulates to each person according to his productivity. If another system is adopted then the wealth must be distributed in a different way with a different result; otherwise implementing socialism would be pointless. Hence socialist writers devoted part of their theory to the problem of distribution of goods in a socialist society, i.e. to “spreading the wealth”.

“Social programs require tax money and your taxes may be higher.”

Correct.

“But as you can see everyone benefits because other costs go down and, in the long run, you get to keep more of your hard earned cash!”

What has been demonstrated, in fact, is that costs rise under socialism. If an individual does not have to pay for his consumption, all else being equal he consumes more. Hence demand rises and so do costs.

“Democratic Socialism does NOT mean taking from the rich and giving to the poor.”

It means taking from the productive to fund the unproductive. This can be the only logical outcome of a system other than private property, where the fruit of production accrues to the producer.

“It works to benefit everyone so the rich can no longer take advantage of the poor and middle class.”

It benefits the unproductive ahead of the productive. The unproductive are able to take advantage of the productive. Productivity therefore becomes less valuable and decreases whereas un-productivity becomes more attractive. Societal wealth therefore declines.

POSTSCRIPT: The main error of the author of the original article (apart from providing blatant examples of Bastiat’s famous “broken window” fallacy) is the belief that a market economy provides benefits only for some whereas “democratic socialism” provides benefits for all. Precisely the opposite is true. Under the free market all exchanges are voluntary. If A exchanges a good with B then it must be because they each value what they receive more highly than what they give up. Both therefore benefit from the transaction and we can say that social utility is increased. A system of “democratic socialism” however would necessarily involve violently enforced transactions (taxes). If an individual has to be coerced into a transaction then it necessarily means that he values abstaining from the transaction more than entering it (otherwise he would have entered it voluntarily). The recipients of Government spending may gain (as does the Government itself) but here, in contrast to a market economy, some have gained at the expense of others. As we cannot make interpersonal utility comparisons (i.e. we cannot “measure” utility) it is impossible to say that the gain to one is greater than the loss to another. But even if this wasn’t true the fact remains that the coerced individuals would have gained greater utility from not being taxed and to them the transaction is very much a loss; hence a system of “democratic socialism” does not provide “benefits for all”.

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