Somehow the “no government/free market capitalism” that is touted by many as the solution to our economic problems bears no resemblance to the capitalism that Adam Smith described in his book The Wealth of Nations.
Real capitalism – Adam Smith
The real Capitalism of Adam Smith was harsh and unforgiving; a competitive system designed to be efficient. It used the raw self-interest of people competing in the market to create the most output from limited resources. Efficiency required that the end consumer pay the minimum possible; just enough to ensure availability of the resource.
In his book The Theory of Moral Sentiments, Adam Smith reasoned that humans were essentially self-centered, and that a system that could create wealth in a nation must depend on channeling that self-interest into competition where it would be neutralized in the best interests of society. This is often called “the invisible hand”.
In practical terms this meant that in a free market a person could move seamlessly between being a provider of natural resources (land), human capital (labor), technology (capital either embodied in machinery or in applied knowledge like design or logistics) and ownership (skills managing the other resources to maximize output at the least cost). The rate of return of engaging in each activity would be equalized because people would move from one to another with the highest return until each activity had equal value. This is a process called factor price equalization. In this case, all resource owners dance to the tune of the consumer. I call this real capitalism.
In this model markets are highly regulated by the rule of law to ensure that competition reigns supreme, and that public goods that the market cannot create are purchased through government, but produced by the private sector. The government operates on democratic principles responsive to the public. The government regulates commerce to ensure competition and equal protection under the law. In this capitalist world consumers understand that their self-interest as consumers coexists with their collective interest in the health of the economy as a whole.
Rich Dude Capitalism – Modern Republicans and The Tea Party
The current free market (or Rich Dude Capitalism as I call it) that modern Republicans and Tea Party advocates of capitalism currently endorse looks nothing like Smith’s competitive capitalism. Their free market is a place for entrepreneurs to earn extraordinarily high incomes relative to anyone else in the economy because they are termed “job creators”. They don’t face competition, only risk, and risk is actually minimized by bankruptcy laws (usually written by the companies) allowing companies to vanish and reemerge when creditors become annoying. A great many other risks are covered by government-insured bank accounts; the ability to buy risk-free government securities, government disaster relief programs, and litigation through the courts to name a few. So uncertainty is really the only risk. But even when uncertainty comes along in the form of slow economic growth the really big corporations and major entrepreneurs expect to be protected, or bailed out because they are job creators.
Rich Dude Capitalism requires that companies are allowed to operate in anyway they deem appropriate, free from consumer or governmental meddling. Their simple goal is profit, which proves that they are superior to anyone who provides any other resource. In Rich Dude Capitalism consumers and the other resource owners dance to the tune of the capitalists who suposedly create jobs for everybody else.
Competition is redefined to mean that they are competing for the dollars spent by consumers, rather than against other companies producing the same product. All products are different because they are branded, and that brand is protected by patents, copyrights, and other restrictions on entry to the market.
Laws governing commerce are set by entrepreneurs and corporations to ensure that their best interests are protected. Consumers are expected to pay a premium on goods and services to ensure that the job creators don’t have below expected returns, which would risk that they would quit investing in new branded products and hiring people. The government is seen as the enemy of consumers and entrepreneurs because through taxes and regulation it restricts their freedom to buy branded products and to operate without that old-fashioned competition promoted by a dead white guy named Adam Smith.
Rich Dude Capitalism is not harsh for those that play the game. Whenever anything goes wrong the answer is make it easier for the rich dude capitalists to do job creation by giving subsidies, tax breaks, less exposure to litigation from consumers in particular, and preventing old-fashioned competition by relaxing regulation like antitrust laws, and diluting consumer protection and environmental protection laws.
In Part 2 of this blog entry I will examine the idea of raising or lowering marginal tax rates in these two economies. This might tell us a lot about the way in which the two parties view incentives and solving the problem of unemployment and slow growth. Stay tuned…