Thursday, January 29, 2009

Three Faults with Capitalism

Well, yesterday I looked at three flaws with socialist solutions to a nation's problems.

(1) Decisions are made by people other than those who are the best informed.

(2) Decision makers are motivated by a number of concerns other than the public good.

(3) Political systems respond slowly (way too slowly) to changes circumstances.

So, let's look at three significant problems with capitalist solutions to social problems.

(1) The wealth effect. In a capitalist system, those with money have the power to bid resources away from the more valuable uses to which the poor people would put them.

Capitalists often boast that its system allows for the most efficient allocation of resources because, if you want something more than somebody else, you simply pay more. Resources always go to the person who will pay more, so resources always are given to the person who values them more.

This is false.

Differences in wealth mean that those people who have wealth can outbid those who have significantly less wealth, even if the wealthy person has a trivial interest in those resources.

I have illustrated this in previous posts with the case of a woman with $20 in a drought-infested land wanting to buy water for her sick child, while another woman with $20 million wanting that water to shampoo her poodle. If the two people had equal wealth, the woman with the sick child would certainly outbid the woman with the poodle for that water. Unfortunately, because of differences in wealth, the water is allocated to its socially least valuable use.

The world is filled with wealthy people bidding resources away from poorer people who, nonetheless, would put those resources to more highly valued use.

It takes about nine pounds of grain to produce a pound of meat. If poor people had the means, they would buy that grain to feed themselves and their families. Instead, wealthier people literally bid the grain off of their table and demand that it be used for what merely amounts to an increase in flavor.

The same thing is now happening with ethanol production. Wealthier people are bidding the food away from poorer people to produce energy that they can then continue to use for purposes, many of which are substantially trivial.

(2) Capitalism is a regulatory system.

Capitalists often market the distinction between them and their competitor as a conflict between "regulation" and "no regulagion".

The fact of the matter is that this is a conflict between two different types of regulatory systems.

What is the difference between an action that imposes a legitimate cost on other people, and one that violates their rights? I lower prices in my store, taking your customers, lowering the value of your business. Did I violate your rights? What is the difference between that and letting my property deteriorate, when you live next to me, lowering the value of your property?

What if I build a dam on my property that breaks, causing a rush of water that destroys your house and kills your wife and daughter? Is this a violation of your rights?

How do we define what risks you voluntarily adopt, and what risks I wrongfully impose upon you?

Even in a purely capitalist system, it would take a mountain of legislators, judges, and lawyers to sift through the minutia of what capitalists call “voluntary exchange”. It is no different then the effort that we must also go through with respect to any other type of regulatory system that we choose to set up.

Capitalism is not regulation free. It is, itself, a system for regulating the ownership and transfer of property.

(3) Capitalism is expensive.

I originally entitled this section, "Externalities and the Free Rider Problem." However, externalities are not a problem with capitalism. Externalities occur where capitalism does not exist. Externalities are costs or benefits that are imposed on other people that are not imposed on the people who cause them.

In order for resources to be perfectly allocated, a person who produces benefits for others needs to be compensated for every single benefit provided – and a person who imposes costs on others has to be made to pay those costs.

If he produces benefits where he does not capture any rents, then others are “taking from him” that which is rightfully his. In the economic realm, it means that people are not going to put as much effort into those activities as they would if those benefits could be properly captured.

If he produces costs that others are forced to pay, this is the equivalent of buying things on somebody else’s credit card without their consent. Activities where people can force others to pay the bill are activities that people are likely to perform even when the social benefit of their actions is negative.

Imagine what it would cost to have a system where every single benefit that one produces for others is captured in terms of rents or payments, and one is forced to pay for every single cost that one imposes on others.

At some point, we have to say that the marginal cost of additional capitalism simply is not worth the marginal benefits. At that point, we say, "We're just going to stop capitalism right here and allow the "thefts" in capitalist terms beyond this point to stand without worrying about them."

Ultimately, we are forced into a choice - to not use capitalism when it does not pay to do so, or to institute some very expensive systems of property rights that cover absolutely every externality produced both positive and negative.

Conclusion

So, capitalism has its problems. It allows for the gross misallocation of resources, it is a regulatory framework that is subject to all of the abuses of any regulatory abuses, and it can be fully extended and applied only at very great expense.

Socialism has its problems.

The question of whether to adopt capitalist or socialist solutions to our problems is not an either or question. It is a question that requires taking seriously the benefits and the problems that exist in each system and then trying to choose which tool is best for a given job.

Sometimes, that is not going to be an easy question to answer. Sometimes, morally reprehensible people are going to get in and muddy the waters as much as they can because they see an opportunity to gain personal benefit by generating confusion and manipulating us into choosing poorly.

These are facts that we simply have to include in our decision making.

24 comments:

.C. said...

With regard to both posts: you highlight exactly the reason why it's often so difficult to discuss these issues with people: they assume that you either fall on one side or the other - a true socialist or a true capitalist should understand that these are not polar opinions but merely descriptive semantics to a plethora of potential scenarios. And should defnitely never be staunch (even though pride often becomes the main antagonist in a debate).

Dave said...

I just finished reading a "The Victory of Reason" on the rise of capitalism by Rodney Stark, a sociologist whose thesis is that capitalism only arose in the West because of a view of property rights and human equality that was grounded in beliefs of a Judeo-Christian God. His negative argument is that in any other world view/political system the elite will tax or sieze property and create other disinentives for production. An interesting read. I haven't sufficiently processed it yet, but the history of the rise of capitalism, banking, lending, etc in Italy and Denmark was very new and unexpected to me, and I would expect to many others

Janus said...

Alonzo,

I think the first analogy makes a horrible error: why should the wealthy woman want to pay $20 million, or even $2 million, or even $200 dollars, when the wealthy woman need only pay $21 dollars?

In your three-person universe of poor woman, wealthy woman, and water-seller, the situation looks unfair because you've stacked the deck against both the water-seller and the wealthy woman to begin with.

But what if there were two water-sellers, or three? You've constructed a monopoly on water, where the water-seller can charge what he chooses. You also give omniscience to the water-seller, so he knows the perfect personal price to ask the wealthy woman, yet in a market of, say 100 people, we do not know an individual's personal price they're willing to pay.

What if, after selling some water to the wealthy woman for $21 dollars, for that's what she's willing to pay to outbid her neighbors, the water-sellers want to remain in business? Won't they find a perfect market in the poor woman who is willing to buy water - for only one less dollar?

My analogy is grossly simplified, of course, but at least it reflects reality a bit more.

faithlessgod said...

Janus

You completely misunderstood the water/child/shampoo scenario, Alonzo said that the rich woman could outbid the poor woman, that is all. Given this misunderstanding, none of your points in your response are irrelevant.

anton said...

Sometimes, morally reprehensible people are going to get in and muddy the waters as much as they can because they see an opportunity to gain personal benefit by generating confusion and manipulating us into choosing poorly.

. . . and if the morally reprehensible also go to "your church", invoke nationalism in their cause, or cry that their "freedoms" are being attacked, it is unlikely that those who should know better will raise their voices against them -- out of fear as being labeled a capitalist, a socialist . . . or an atheist!

Janus said...

faithlessgod,

The situation Alonzo builds only takes place within a monopoly, which is, if I remember correctly, due to a state in control of part of the economy.

Alonzo Fyfe said...

The situation that I build is one that illustrates the fact that the person who is willing to spend the most money for something is not necessarily the person with the highest valued use.

The test for whether a person has a higher valued use requires that both participants have the same amount of wealth.

I also gave two real-world cases in which this effect applies - the bidding of food away from poor people to produce meat (feed grains), and the bidding of food away from poor people to produce fuel (via ethanol).

Neither of these involve any type of monopoly. The only thing they require is increasing marginal costs for additional units of production (e.g., the assumption that the best land will be put into production first).

Poor people would likely be more than happy to bid the food away from the meat eaters and fuel consumers if they were able. But to bid the food away they need money, and they do not have any.

Or, to describe the situation another way, the fact that the rich person is willing to spend $21 for something the poor person is willing to spend $20 for does not imply that the rich person values the item more than the poor person. Because $20 to the poor person is more valuable than $21 to the rich person.

Justus Hommes said...

I enjoyed the last several posts, Alonzo. I agree that there are faults with both socialists and capitalist utopias, and am a fan of Röpke third way. You would not like his faith, but putting that aside, I think you would agree there is the ability to find common ground in economics.

I have been keeping up with your desire utilitarianism discussions, and may have a couple of questions to pose when I get a moment.

Janus said...

Alonzo,

Excellent point. I understand what you meant now.

Some entrepreneurs are trying to provide food and goods to the poor on the cheap. After all, if food can be produced cheaply enough, sellers might enter a new market.

Capitalism can be directed towards most things. People might need a few incentives to get there; it isn't perfect; we aren't omniscient. A 'fault'? Perhaps.

Janus said...

P.S.

For instance, this is a good example.

anton said...

To faithlessgod:
"very few people till the land today"

And that, my fellow non-believer, is the problem. Many in the world see progress as never having to get your hands dirty! Why should they grow cabbages when they get their cabbages from some other poor slob in a foreign country? Or, if US America grows the cabbage, it wants the freedom to "temporarily" bring in foreign farm hands to pick them! Why would a US American demean himself by picking cabbages? Its somewhat like when UK municipalities in the early 1990s contracted out their garbage collection to Portugal!

If you study history, the "cabbage growers" eventually topple the "intellectuals" because the intellectuals still need to eat but have forgotten how to fend for themselves. Those big lawns, yards and golf courses of the wealthy could be better served growing "cabbages" but most municipalities have very strict rules that discourage, or eliminate, vegetable gardens and have legislated against the use of "chemicals" unless them are being used to maintain a golf course.

Imagine if an Asian nation gains financial control of the US -- they might "appropriate" all of the tillable land in the US and force US America to grow produce. Don't forget, US America has paid farmers a lot of money NOT to grow crops. Why? The answer to that one explains more about US America's economic policy than most citizens are prepared to acknowledge -- or repair!

Eneasz said...

Anton - why would you want to force someone who would be ineffecient at cabbage-plucking, but is highly effecient at engineering, to waste his labor-hours on a task that produces less value, and can be better done by someone else? This seems like a great way to cripple an economy.

And the foreign cabbage-pickers come here by choice, because the wages we pay them far exceed those they could make at home. Both my parents and my ex-wifes parents are immigrants who came precisely for this reason, and have made a much better life than they could have achieved in their home countries.

Why would the cabbage-pickers want to overthrow the intellectuals? The intellectuals provide goods and services to the cabbage-pickers as well. Things like better & cheaper goods, new innovations (Hooray for Air Conditioning!), all sorts of entertainments, etc. It's not like they are simply a Master caste sitting around watching the Slave caste do all the work.

And yes, farm subsidies are a bad thing. You'll get no arguement from me there.

anton said...

And yes, farm subsidies are a bad thing. You'll get no arguement from me there.

How can you separate the deleterious effect of US America's farm subsidy program from US American economic philosophy?

In the following example you can claim that it was ignorance on Canada's part for going along with the "agreement" but there is also the case of morality.

"The US was producing more wheat than it required in the 1950s. In what was claimed to be an effort to stabilize the world trade in wheat, the US entered into agreements that fixed the price of wheat. The ignorance comes into play when the "other" countries failed to notice the fine print that fixed prices on the "current years growth". The US stockpiled its wheat for a year, and then sold it on the world market at unbelievably low prices, subsidized, or course, by the US government. That created great financial distress for countries like Canada who had "trusted" US America. Since the Canadian economy was largely based on its trade of wheat to the world, Canada was "forced" to enter into further agreements with US America that were primarily of advantage to US America. Over time, this led to NAFTA. And while US Americans may have some complaints, you should hear what happened to Mexico and Canada!!!

Protectionist? Maybe! Holding the US accountable for its actions? Definitely!

faithlessgod said...

Anton

I agree with everything Eansz said in reply to your question to me.

anton said...

Faithlessgod and Eansz:

Millions would agree with you -- but then again, millions voted for George the Shrub and Maggie Thatcher.

Both of you have too narrow of a view to be advocating solutions. I agree that your approach appeals to those who would prefer not to accept their global responsibilities . . . but then again, neither of you are likely to expand your vision to witness the atrocities created by your kind. I would hope that neither of you ever run for political office and are elected -- it would mean that your electorate are really dumb!!!!

anton said...

The situation Alonzo builds only takes place within a monopoly, which is, if I remember correctly, due to a state in control of part of the economy.

Monopolies can be found everywhere . . . all you have to do is look!!!

Was Bell Telephone state controlled? If I can remember, it was the state that forced Bell Telephone to break up its monopoly! Or are you old enough to remember?

Eneasz said...

Anton,
How can you separate the deleterious effect of US America's farm subsidy program from US American economic philosophy?

I wasn't trying to. I am not a blind cheerleader for American economic philosophy, there are things wrong with it. Primarily the corporate feudalism Alonzo recently wrote about (love that term, hope it spreads).

I'm a bit confused about your opinions tho. In a different post, the one regarding steel-restrictions in the stimulus package, you advocated strongly for protectionism. Here you are railing against farm subsidies and citing a few examples of their disasterous effects. But farm subsidies are just another form of protectionism. I don't understand how you can be both for and against protectionism this strongly.

anton said...

Uneasz, I was NOT advocating protectionism! But, if US America is going to invoke protectionism, I said that, as a punishment for US America, it should be deprived of Chinese products and forced to get its running shoes, t-shirts, Christmas decorations, etc. from US American manufacturers operating in US America and employing US Americans! If US America is going to close its borders to some products, it could help the world by closing its borders to ALL products. Mind you, Walmart, the world's largest retailer might be forced into bankruptcy. I don't think the world will miss Walmart, especially with its anti-union and anti-rights philosophy!

faithlessgod said...

Anton

"Millions would agree with you -- but then again, millions voted for George the Shrub and Maggie Thatcher."
I would never have voted for either and disagreed with them both. Do not put words into my mouth.

"Both of you have too narrow of a view to be advocating solutions."
There you go again nothing I have implied any such thing. I can only conclude that it is you who are looking at the issue too narrowly and note that this is the basis on which I have been engaged in debate here, to get beyond the narrow and false dichotomy of "socialism" versus "capitalism".

"I agree that your approach appeals to those who would prefer not to accept their global responsibilities . . . but then again, neither of you are likely to expand your vision to witness the atrocities created by your kind."
Now you are beginning to look like a bigot classifying me into a group that I have not voluntarily elected to be in and ascribing to me features of this group which is nothing to do with me. Or you are looking in the mirror. Which is it?

"I would hope that neither of you ever run for political office and are elected -- it would mean that your electorate are really dumb!!!!"
That has decided it, you are definitely looking in the mirror. You still might be a bigot though.

anton said...

Faithless God:

"If it looks like a duck . . . if it sounds like a duck . . . if it quacks like a duck . . . "

"Millions would agree with you -- but then again, millions voted for George the Shrub and Maggie Thatcher."
I would never have voted for either and disagreed with them both. Do not put words into my mouth.

If you interpret that comment about George and Maggie as an accusation that you voted for them, you may suffering from a persecution complex.

"Both of you have too narrow of a view to be advocating solutions."

I stand to be corrected for making this comment. I should have noticed that you really have not contributed any solutions . . .

Now you are beginning to look like a bigot classifying me into a group that I have not voluntarily elected to be in and ascribing to me features of this group which is nothing to do with me.

My opening "duck" statement covers this one!

Alonzo Fyfe said...

Some recent comments are not productive, I'm afraid.

Try a post that states a proposition and then offers evidence for either accepting or rejecting that proposition.

neoclassical_libertarian said...

Regarding the drought example:

I wonder how that is a *fault* with capitalism, since the constraints on the choices of the mother of the poor child have more to do with the--I suspect, deliberate--geographical isolation of the three-person economy, something that is in sharp contrast with a true laissez faire economy like Hong Kong, Singapore, or Great Britain after 1846, when the protectionist Corn laws were abolished.

Something can only be a fault of capitalism if and only if it is unique to capitalism and some other system of economic organization can make things less worse in the situation you put forward.

Ask the following questions:

How can an interventionist state make things better in this situation--is it through redistribution of access to the scarce resource?

If yes, then:

Why should the interventionist state ignore the rent seeking tendencies of the woman with $20 million in wealth and redistribute utility to the poor woman--why not, as is usually the case in the real world, allow state power to help the rich woman be the sole monopsony of the scarce resource?

What kinds of societies have been the most successful in lifting millions of people out of poverty? Take a look:

http://mysite.verizon.net/alankh/akhblog/FreedomGDP.gif

In a laissez faire economy in which the state is restricted to its core functions of protecting property rights, maintaining a strong judicial system, etc., and one in which free trade flourished and there are no barriers to entry into any markets, there would be lot of competition on the supply side for the market for the scarce resource. Even if local supply were to be scarce, international free trade will drastically increase the supply of clean water to the local economy. Through free trade, both women are made better off.

In fact, here's a real world example: my dad buys Aquafina bottled water when he visits drought-ridden southern India. There are numerous other brands, both domestic and international, which vigorously compete with Pepsi inc. to supply clean water at an affordable price.

By deliberately restricting your scenario, which purports to demonstrate the short comings of capitalism, to an arbitrary, isolated three person-economy, you have effectively failed at your task of erecting a valid critique against capitalism.

I could go on about the myriad other flaws in economic reasoning you have so generously churned out. However, the opportunity costs of doing so are humongous.

Alonzo Fyfe said...

neoclassical_libertarian

The problem in the drought example is not that there is not enough water. It is the fact that differences in wealth allows a person to bid resources away from a person who has a more highly valued use for those resources.

The capitalist claim that we can know who values something more by looking at who is willing to pay the most is false. The case illustrates the fact that wealth differences creates a situation in which people bid more for something that they actually value less than other (but less wealthy) bidders.

That is a fact about capitalism.

Anonymous said...

The author declared the wished to make the world better in his childhood,like Jews(but they want just to repeare it collectivly).
I see this desire as the result of some arrogance that is peculiar to left ideologists.These people understand well that the united masses need the fuhres,and they desire.This pseudo-atheists uses the philosophy as the Islamists use Islam.Their sympathy is evident!