From Adam Smith
(1776) to Leon Walras (late 19th and very early 20th century), an astonishing
case was made for market-based systems. The mathematics is deep and
extensive, the theory massive, and the assumptions strong. The argument
in favor of markets was made by thousands of political economists. There were detractors, of course, and some of
them quite serious. (Marx thought
capitalism would replace feudalism but be replaced by socialism, and thought
this a good thing while Schumpeter, much later, thought Marx was right that
socialism would win out but thought that result terrible.) But it is fair to say that the result of all
that work was A CASE FOR CAPITALISM.
The gist of it was that IF a
nation or global market system met certain essential assumptions, markets
allocate labor, products and services better than any other system. That
is rather extraordinary, as it involved a deep and complex set of assumptions
and then follow-on proofs about how people think and behave, and how production
is organized and marketed most efficiently, and finally how resources are
allocated across products, firms, markets, sectors and even nations.
I suppose in our current milieu
in which millions of ignorant people argue for capitalism and against
socialism, communism, fascism, etc., for essentially random reasons, the idea
that there might be a case for capitalism over the others is not considered
remarkable. But this feat of logic and mathematics is a Mount Everest in
the history of scholarly efforts, as it was not just ideological puffery, but
honest, brilliant argument.
A few of the key assumptions
are:
1.
Markets are competitive (no firms have large market shares and
thus market power over pricing of inputs, including wages, and output prices)
and in so doing set their private marginal costs equal to the private marginal
benefits,
2.
Everyone is equally and perfectly well informed (suppliers do
not know that their products will break down and hide it from buyers, for
example),
3. Governments understand and are
effective at properly regulating businesses, taxing and subsidizing them so
that when they set their after-regulatory private marginal costs equal to their
after-regulatory private marginal benefits, they choose to set social marginal
costs equal to social marginal benefits.
This last maximizes social economic well being and is absolutely
fundamental to the case for capitalism.
4. The alternative – social
planners directly set social marginal costs equal to social marginal benefits
(central planning at the root of socialism) – in theory an easier system – is
too hard because the informational demands of complex economic systems will
overwhelm even the best social planners.
(Note that this theory was worked out long before super-computers and
massive data processing power.)
Let’s stop with these big four.
1. First, we all know that markets
are not perfectly competitive. Some have
tried to salvage the case for capitalism by arguing that it is “workably
competitive.” In theory, this is not a
save, because of something called the theory of the second best, in which it
was shown in the 50s that capitalist systems are theoretically chaotic, so
small deviations from perfection in one variable can disturb all the other
variables, and the results, in unpredictable ways.
2. Second, we know that information
is not perfect and not perfectly shared.
This appears to be another breakdown in the case for capitalism.
3. Third, regulators have not always
shown themselves to be up to the task of regulating business well – and the
very ideologues who shout to the hilltops that capitalism is the best of all
possible worlds actually make it much harder for regulators to do their
jobs. (Because our policy is now
woefully incoherent.) Thus, some of the
most vocal supporters of capitalism actually do it grave harm, making both regulation and capitalism itself less effective.
4. Fourth, in an age of
supercomputers the case for central planning is surely stronger than it once
was.
The bottom line is that the case
for capitalism – which requires at a minimum competitive markets, perfect
information, and excellent regulation – is weaker because we fail to deliver on
those requirements and because central planning is theoretically a better
option than it was before the modern information age. (Some find the idea that the case for
capitalism rests on excellent regulation surprising because they have failed to
understand that markets cannot optimize the social marginal conditions without
help.)
Does this mean that socialism is
to be preferred? No. The case for socialism – one I will not make
here, but is, in summary, dependent upon the good will of extraordinary social
planners and astonishing information processing technology – is also quite
problematic.
What do we do about it if we are
honest?
1. We stop lying about the economic
case for capitalism versus socialism. We
just don’t know which, in the imperfect forms we now experience them, is the
economic system with the most promise. (Although a strong case can be made
against the more extreme forms of socialism the 20th century
experienced.)
2. We do what we can to make
whatever system is in place work as well as possible for the people it is
supposed to serve. The European model of
democratic socialism, which is more a market-based capitalist system than a
socialist system, seems to perform best, especially when labor is organized,
legally protected, and is a true partner (sharing authority but also
responsibility for corporate and policy outcomes). But, once again, the proof is
inadequate. Economic theory describes
models that do not exist in the real world.
3. Educated people acknowledge that
both those asserting the superiority of capitalism and those asserting the
superiority of socialism are doing so without adequate proof, and usually at
the behest of ideological compatriots. The unfortunate truth is that despite a century of economic theory, for practical purposes we
are in the dark – the reality is too complex for current human understanding – and
we must do our best to muddle through without hope of anyone turning on the
lights when it comes to these issues. Picking a system is not a practical course of action. Picking and refining workable policy, even radical policy, is far more promising.
