Saturday, February 22, 2014

In Praise of (Fettered) Capitalism, AKA Freedom

Opposes Unregulated Capitalism

Language in the first Apostolic Exhortation of Pope Francis, "Evangelii Gaudium," ("The Joy of the Gospel"),  has fueled the never-ending debate about the relative merits of alternative economic systems.  In particular, commentators on various parts of the political spectrum have critiqued or praised the Holy Father's supposed condemnation of "unfettered capitalism."   From the Right, Walter Williams has taken issue with the Pope's supposed claim that "unfettered capitalism" is "a new tyranny."   From the Left, John Nichols of the Nation has praised this supposed claim, asserting that the Pontiff has given an articulate voice to the Occupy Wall Street movement, which the Pope did not mention.  Numerous other commentators have also weighed in about the Pope's supposed comments.  (See here, here and here for examples).  One pundit even declared that "Liberation Theology is Back."   None of these pundits, so far as I am aware, has actually defined "capitalism" or "unfettered capitalism."
Ironically, as others have pointed out, the document does not include the word "unfettered" or "capitalism."  Instead, the Exhortation refers to the "absolute autonomy of the marketplace," which it blames for a widening income gap between rich and poor.  (See Evangelii Gaudium, 2.I.56 and 4.II.202).  Nonetheless, the term "unfettered capitalism" has taken on a life of its own and will likely play a significant role in our public discourse.  It therefore makes sense to develop a working definition of the phrase so as to facilitate a useful public discussion of the merits and demerits of "unfettered capitalism" and various alternative economic systems.  As will be seen, most proponents of free markets support some "fetters" on such freedom, fetters that help channel individual initiative in socially useful directions.  Thus, instead of deciding between a world with "fetters" or "no fetters," societies that wish to advance economic justice must choose among various possible fetters, some of which help create wealth and opportunity and some of which destroy both.

But first, it should be noted that the term "capitalism" is itself a misnomer that often adds little to public discourse.  (Perhaps this explains why the Holy Father, pictured above in a photo taken by the official Brazilian press agency (see here), does not employ the term.)  As Frank Knight once explained, the free market is the natural result of society's recognition of private property, including each individual's ownership of his or her own labor.  Such ownership, Knight said is "a synonym for individual freedom," freedom that includes the right to exchange such property with a willing buyer.  See Frank H. Knight, Risk, Uncertainty and Profit, at 56-57 (1921).  Thus, what pundits call "capitalism" is often just a synonym for "freedom" or "liberty."  This is not always true, however.  In some cases systems that pundits call "capitalism" entail significant intrusions on liberty and property inconsistent with any plausible conception of freedom or liberty, as seen below.

With this caveat in mind,  here are several possible definitions of "capitalism," fettered and unfettered.

1.  Capitalism as State of Nature.  Under this model, there is no State.  Each individual is entirely free to acquire as much property as he or she can, whether by manual labor, trade, invention, or theft from others.    Having acquired such property, an individual can only retain it if he or she can ward off others who seek to acquire it by force. 

2.  Capitalism as the Common Law Baseline: Under this model, individuals reject the State of Nature and form a State so as to enhance the security of their persons and property.  The State, in turn, employs coercion (jail time, criminal fines and monetary damages) to deter and prevent individuals from harming others or invading others' property.  The State may also allow individuals to employ reasonable private force to defend their persons and property from invasion by others.   Such a society may entail less liberty in some sense than the State of Nature, as individuals are not "free" to injure others or steal others' property and suffer state-backed coercion if they do.  However, individuals may still prefer such a society to the State of Nature, because what liberty and property they do possess can be more secure and result in more prosperity, assuming, of course, that the State respects the Rule of Law and avoids arbitrary and selective enforcement of this baseline.   

3.  Capitalism as Wealth Maximization:  Under this model, the State employs coercion to enforce the common law baseline described in Model 2, above.  The State also employs coercion when necessary to overcome market failures that may arise because transaction costs prevent a wealth-maximizing allocation of resources.  Examples include contract law, which reduces the cost of transacting and thus facilitates wealth creation, corporate law, which facilitates the creation of large scale enterprises,  patent law, which ensures that individuals who invest in innovation can reap the rewards of doing so, and antitrust law, which prevents market actors from exercising market power that is not necessary to achieve efficiencies.  Such regulations steer individual conduct and initiative in wealth-creating directions.  This model also justifies expenditures on public goods such as national defense and education, because private actors will not be able to capture the benefits of investments in such goods and thus will under invest in their production.  This model also justifies state expenditures on public works such as highways and harbors, projects that private enterprises may not undertake because transaction costs make it difficult to employ the private market to amass property from numerous individual owners.   Finally, this model would empower the State to conduct macroeconomic stabilization policy, e.g., raising taxes and/or reducing public spending to slow an overheating economy and cutting taxes and/or increasing spending to stimulate a slow one. 

    It should be noted that the distributional consequences of Model 3 will depend upon how the State raises the revenue to pay for various public goods and public works, for instance.  The State could simply divide the cost of such expenditures equally among all of its adult citizens, in which case the distributional consequences could be neutral, depending upon how the State distributes its expenditures.  If, however, the States relies upon a sales tax or an income tax, for instance, Model 3 will redistribute income from rich to poor.  (An individual who pays the State 10 percent of a $100 million income will pay for a much larger share of the State's expenditures than one who pays 10 percent of a $10,000 income.  Unless the State spends 10,000 times more on public goods for the former individual than the latter, reliance on this "flat tax" to fund the State will redistribute income to individuals of modest means.  In the same way, so long as wealthy citizens spend more on consumption than those who are poor, the wealthy will pay more taxes under a sales tax regime, thereby resulting in possible redistribution.)

4.  Capitalism as Utility or Welfare Maximization.  Under this model, the State enforces the common law baseline and also employs coercion when necessary to overcome market failure, as in Model 3 above.  Operating within such a framework, individuals may, alone or in association with others, create great wealth.  Under Model 4, the State also relies upon coercive taxation to redistribute a portion of such wealth from well-to-do individuals to those who are less well off.   While the taxation necessary to accomplish such redistribution will reduce incentives to create wealth in the first place, the result might be an increase in overall welfare, i.e., society's total utility, assuming there is a diminishing marginal utility of wealth.    For instance, redistributing $100,000 from the annual income of a wealthy individual to ten poor persons could increase society's overall utility, if one assumes that these persons collectively derive more utility from that $100,000 than the wealthy individual would forgo because of the redistribution.   Model 4 is truly a "Welfare State," insofar as the State employs its legal and regulatory machinery with one goal --- enhancing society's overall welfare --- in mind.

5.  Corporatism Confused With Capitalism.  Under this system, the State enforces the common law baseline, employs coercion to overcome market failure and spends resources on public goods.  The State may also  engage in redistributive taxation in an effort to increase society's total welfare.  In addition, however, the State also structures taxes, subsidies and regulations so as to encourage particular industries and/or firms within such industries.  Often such rules might favor large, capital-intensive firms over smaller, labor intensive firms, thereby raising barriers to entry and fortifying the market power of incumbents.  See generally Oliver E. Williamson, Wage Rates as Barriers to Entry: The Pennington Case in Perspective, 82 Q. J. Econ. 85, 91-98 (1968) (explaining how imposition of minimum wages industry-wide can disadvantage smaller, labor-intensive firms).   The State may even reserve to itself the authority to approve entry into particular markets, consulting marketplace incumbents before allowing such entry.  The requirement that new entrants into the hospital market obtain a so-called "certificate of need" is one such example, discussed previously on this blog.      The State may also adopt rules, including exemptions from antitrust laws, that encourage the formation and operation of labor cartels known as unions, cartels that seek to obtain a portion of any market power that their employers possess.  Such cartels can rarely thrive, however, unless the State also prevents free entry into the industries subject to such labor cartels.  See generally Michael L. Wachter, Labor Unions, A Corporatist Institution in a Competitive World, 155 U. Penn. L. Rev. 581, 601-604 (2007) (describing NIRA’s support for collective bargaining).   Indeed, once society recognizes as legitimate legislation that bestows economic benefits on some at the expense of others, consciously picking economic winners and losers, economic actors will rationally invest scarce resources attempting to influence political decision makers to enact more and more such legislation.  Such "rent seeking," of course, diverts valuable economic resources away from productive economic activities that would otherwise increase society's overall wealth.   As previously explained on this blog, James Madison claimed that societies that consistently allow such legislation are akin to the State of Nature, given that both such societies allow the strong to united to oppress the weak.

* * * * *

The United States is perhaps best described as a mix of Models 4 and 5, with some Socialism thrown in "to boot."  For instance, the Constitution, at least as interpreted by the Courts and the political branches, empowers states and the national government to restrain economic liberty for the sole purpose of enriching some industries or groups of individuals at the expense of others.  (But see here for a discussion of a recent decision in the United States Court of Appeals for the Fifth Circuit rejecting such rent seeking as a valid basis for interfering with economic liberty.)     Certificate of need laws and unions are quintessential examples.  Ditto for the regulation of taxi cab markets, of all things.  In addition, states and the national government sometimes own the means of production themselves, the very definition of Socialism.  For instance, all states own and operate one or more colleges or universities, ownership that is not necessary to ensure an appropriate investment in education.  (States could, instead, simply provide their college-aged citizens with vouchers, as explained here with respect to primary and secondary schools.)  Moreover, the national government once owned General Motors, after an ill-advised bailout of two automobile manufacturers whose products have failed in the marketplace.         At the same time, governments do not always exercise their power to restrain economic liberty or own the means of production, partly because of a political culture that values competition, and partly because competitive federalism deters individual states from adopting policies that drive capital and productive citizens to migrate to other states.

Of these five models, only Models 1 and 2 can be characterized as "unfettered capitalism."  Model 3 empowers the State to impose any number of harm-reducing regulations ("fetters") and to "tax and spend" so as to produce various public goods, including education.    Moreover, Model 4 expressly empowers the State to employ additional coercion to redistribute wealth from some individuals to others.   Model 5 empowers the State to favor some industries or firms over others, favoritism that necessarily restricts the liberty of those firms and individuals not favored.  Model 5 also empowers the State to compel firms to recognize and bargain with labor cartels also known as unions. 

Very few individuals advocate Models 1 or 2 as organizing principles for an economic system.   Instead, most individuals, including most who support "limited government" or some synonym thereof, embrace Model 3 or even Model 4.  For instance, most prefer a world in which the State imposes the "fetters" necessary to protect individuals from others' harmful exercise of property rights and vice versa.  Most also prefer a world in which the State expends the resources necessary to produce public goods, using coercive taxation to raise the necessary revenue.  As noted above, States that rely upon a flat income tax, for instance, to fund such goods will redistribute income from the wealthy to the less well-to-do.  Finally, many proponents of limited government also endorse expenditures to provide the poor with basic services, education and even enough income to lift such individuals out of poverty and into the middle class.  For instance, Milton Friedman (pictured above at a White House ceremony), always a proponent of limited government, advocated both a negative income tax and school vouchers, both of which redistribute income from some to others.   See e.g. Milton Friedman, Capitalism and Freedom, 191-94 (1962) (advocating the negative income tax) id. at 85-100 (discussing proper government role in education).  See also this discussion of the negative income tax between Milton Friedman and William F. Buckley. 

In short, most members of society, whether they be Progressive, Conservative or even Libertarian, agree that Capitalism or individual freedom should be fettered in some way.  The much harder question is how many and what sort of fetters the State should impose.  It should also be clear that "not all fetters are created equal."  Some coercive regulations clearly enhance society's welfare, while others plainly reduce it.  Moreover, we must never lose sight of the fact that robust free markets produce the very wealth that many wish to redistribute to the less fortunate.  A society of "haves" and "have nots" may well be more just than a society in which everyone is (equally) destitute, particularly if the State uses its powers of taxation to redistribute some income from rich to poor.  As previously explained on this blog, individuals who create massive fortunes for themselves often do so by simultaneously enhancing the welfare of countless others, even before the State imposes redistributive taxes.   Finally, the existence of significant poverty in a nation such as the United States that allows some economic freedom does not thereby justify any and all additional restrictions purportedly designed to reduce poverty.  Instead, such poverty may be the predictable result of fetters already in place, the removal of which may actually increase wealth, opportunity and employment.  Labor cartels, minimum wages and state-protected monopolies are obvious examples of such wealth-destroying fetters that reduce opportunity and increase poverty.