How Capitalism Will Save Us Read online

  We explore the unintended consequences of government micromanagement in our chapters on government policy: “Don’t Regulations Safeguard the Public Good?” and “Isn’t Government Needed to Direct the Economy?”

  Overbearing regulations by bureaucrats—from price controls to draconian accounting rules—produce damaging economic distortions that hurt people. The foremost example, which we explore in detail, is health care. In our chapter “Is Affordable Health Care Possible in a Free Market?” we show how government participation in the health-insurance market and layers of regulation have produced a tangled market with runaway costs that benefits fewer and fewer participants.

  REAL WORLD LESSON

  Efforts to impose political constraints on market forces end up producing unintended consequences that hurt those they were supposed to help.

  Efforts in the United States and other nations to make health care more available and affordable have helped only to drive up prices and lead to rationing. Sadly, the economics of health care remain the least understood of any market.

  Almost as poorly understood is the process of wealth creation in democratic capitalism. That is the focus of our chapter “Isn’t Capitalism Brutal?” which explores the disruptive and often painful dynamic change that is part of economic growth. Economist Joseph Schumpeter, as we have mentioned, called this process “creative destruction.” The very technologies and businesses that produce new industries and jobs can also devastate old industries they render obsolete.

  Think about personal computers. They wiped out demand for typewriters, and no doubt thousands of jobs. This is why, even in good times, there will be disturbing stories of corporate layoffs. Businesses and jobs created in a capitalist economy don’t always spring up in the sectors where you expect them.

  Take a more recent product spawned by the growth of personal computers: the iPod. Apple’s revolutionary innovation (which includes not only the iPod but the iTunes software that works along with it) has become a cultural icon. It has created, by one count, more than 40,000 jobs; and that number does not include those related to selling its countless accessories. The technology has brought numerous benefits: It enables consumers to buy single songs instead of pricier CD compilations, making their music dollars go further. It allows smaller artists access to the market without having a record label. And it has generated opportunities beyond the music industry, providing a new way to sell or distribute video content—such as movies and informational “podcasts.”

  Yet there’s no question the iPod has been destructive. It helped accelerate the boom in music downloading that devastated music retailers, forcing many to close down or dramatically alter their businesses. Record labels and recording artists are increasingly having to make their money from the sales of singles rather than more profitable CD compilations. The iPod has also presented challenges for makers of traditional stereo equipment that had to tailor their offerings to the new technology.

  For those negatively affected, these changes are unquestionably painful. But does that mean we would have been better off had Apple’s innovation never been developed? When all of the benefits are taken into account, most people would probably agree that the iPod has been a plus, not only for the economy but for the broader society. Even well-known recording artists admit that the changes, though disruptive, also offer opportunities, like the ability to be financially and artistically independent.

  Contrary to what is commonly perceived, the iPod did not magically spring from the mind of Steve Jobs. Like YouTube, CC Patton’s iport, the pencil, and countless other innovations, it emerged from people looking to fill a perceived need. In 2003, journalist Rob Walker noted in the New York Times Magazine that the iPod came not from “a specific technological breakthrough” but from the innovations of other companies. Jobs himself acknowledges in the article that he basically brought the pieces together.14 That’s typical of the process of creation that takes place in a free market—it’s spontaneous and unpredictable. You’ll never know where it will take place.

  The widespread inability to perceive the full picture of freemarket wealth and creation has encouraged many of the beliefs that are part of capitalism’s bad rap. For example, it drives opposition to free trade. As we discuss in our chapter on globalization, commentators who bemoan “outsourcing” and “trade deficits” fail to see that trade with other nations also results in billions of dollars coming back to the United States in the form of foreign investment—producing jobs in other sectors of the economy. Our trade with China, for example, is what generates all those dollars that the Chinese plow back into U.S. Treasury bonds—the investment that the Obama administration now seeks to help underwrite its massive spending and keep our government financially afloat.

  What capitalism’s critics ignore is the fact that until the current recession, U.S. unemployment in the last three decades had gone down, not up. America’s unemployment rate through most of this decade has been substantially lower than during the years of the 1950s and early ’60s—hovering between 4 and 5 percent. And this is true even though “labor force participation”—the proportion of adults in the workforce—is higher than it was forty years ago.

  That’s right, over the past thirty years, despite all the millions of jobs destroyed by the rise and fall of companies and industries in our democratic capitalist economy, over forty million net new jobs have been created. Overall personal incomes have increased from $2 trillion to $12 trillion. The net worth of American households (that is, assets minus liabilities such as home mortgage debt) has increased dramatically, from $7.1 trillion to $51.5 trillion. The economy as a whole has expanded mightily. Our standard of living has soared.

  Yet unlike government programs that are launched with press releases and media fanfare, there is usually no “official” announcement of the jobs and standard-of-living improvements produced by capitalism’s invisible hand. No speeches or bill signings in the Oval Office. Most of the time, things simply just happen.

  REAL WORLD LESSON

  It is easier to see the “destruction” that takes place in democratic capitalism than it is to recognize the creation and growth that also occurs.

  Still, there’s no getting around the fact that business failure, the downside of risk-taking and innovation, is part of the process of wealth creation in dynamic capitalism. No one denies it can be painful. Yet, as we discuss in this book, the consequences of not allowing it—a lower standard of living and even greater joblessness—are far worse.

  Some people who have lost jobs in the recession may be feeling hot under the collar about now. However, as we will show repeatedly, the financial crisis and recession was anything but a case of normal freemarket creative destruction. It was exactly the opposite. History’s most devastating economic upheavals have never been caused by the normal cycles of free market; they have been caused by catastrophic distortions that occur when government doesn’t allow markets to work.

  In a healthy, open economy, when there is an imbalance—too much or too little of something—the market eventually corrects it. Take cell phones. They were once rare and exceedingly expensive. Now everyone has them. Consumers no longer faint at the sight of their cell-phone bills. Prices have come way down, and many companies are struggling to make a profit.

  Because a market is about serving the needs and wants of others, it will eventually do so—if people are given sufficient economic freedom. However, when government imposes artificial constraints, through regulation or through its own direct participation, it creates an imbalance—a distortion—that market forces aren’t permitted to correct.

  The result can be severe dysfunction, as we have with today’s government-dominated health care. Or in the case of the larger economy, it can produce the meltdown we experienced in the past two years.

  Distortionary federal policies have played a role in every historic economic disaster. This was the case with the Great Depression, the disastrous consequence of the Smoot-Hawley Tariff. That
levy, intended to save American jobs, ignited a trade war between the United States and other nations, killing global employment. And it is the case today, with the subprime-mortgage mess and subsequent financial-sector meltdown. Both began with the massive distortion of the mortgage market engineered by misguided federal policies and the giant government-created mortgage corporations Fannie Mae and Freddie Mac.

  These two behemoths were created with the worthy goal of boosting home ownership. Their immense size—larger by far than all private-sector competitors—and their ties to the federal government enabled them to create massive distortions in the mortgage, housing, and financial markets that brought the nation’s financial system to near collapse.

  A still bigger role was played by the Federal Reserve System, which lowered interest rates to boost the economy after the dot-com bust of the early 2000s—but ended up keeping them too low for too long. Without this error in monetary policy, the housing bubble never would have reached the catastrophic size that it did.

  Rather than free markets betraying Alan Greenspan’s faith, it was the other way around. Greenspan’s low-interest, weak-dollar policies as head of the Federal Reserve Bank undermined free markets. Ayn Rand would not have succumbed to the temptation to believe that a government agency like the Fed could fine-tune the American and global economies. Nor would she have forgotten that a key component of a free market is a strong, stable, and reliable currency.

  REAL WORLD LESSON

  Bad economic policy can cause economic upheaval far more brutal than any disruption caused by the normal operation of markets.

  There’s another misunderstanding that’s common to believers in the Rap. Just as they tend to see freemarket destruction and ignore the bigger creation that’s simultaneously taking place, they also tend to see certain government activities as fostering “creation” and prosperity—when in fact they’re doing exactly the opposite by destroying wealth and jobs.

  Job programs and other government spending may create some employment. But they do so by siphoning off tax dollars from countless individuals and corporations—resources that would have otherwise provided the capital for new job-creating ventures. What happens when there isn’t enough capital? Companies can’t expand—and often can’t stay in business. New ventures remain on the drawing boards. Jobs that would have grown the economy can’t be created—and in many cases are destroyed.

  Thus, the massive public-works programs of the 1930s created some temporary employment, but not enough to end the Great Depression, which eventually faded with World War II. Nor did some ten economic stimulus programs, which created infrastructure-building jobs in Japan throughout the 1990s, succeed in pulling the nation out its decade-long economic slump, despite almost quadrupling the national debt.

  In 2009, people of all political stripes decried the massive government spending of the Obama administration on the grounds that it would create an enormous debt to be paid for “by the next generations.”

  Actually, they’re wrong. Government spending is not some green-eyeshade accounting matter to worry about in the future. It has immediate impact in the here and now—by producing increased taxes and borrowings that drain the economy of private-sector capital.

  Chapter 3, “Aren’t the Rich Getting Richer at Other People’s Expense?” explores common misconceptions surrounding “the rich” and the role they play in driving a democratic capitalist economy, creating wealth not only for themselves but for everyone else.

  What if people like Steve Jobs and Bill Gates—or for that matter, Henry Ford and Thomas Edison—had been prevented from amassing the capital they needed to expand their businesses or bring their innovations to the world? Millions of jobs and livelihoods never would have come into existence. Throughout history, countries that have punished or banished their commercial class have discovered what happens—the economy stagnates or actually collapses.

  Our chapter on taxation, meanwhile, asks the question, aren’t higher taxes the price we pay for a humane society? Of course we need to pay taxes. But contrary to the claims of politicians, they’re not an “investment.” Government initiatives rarely deliver a return like a private-sector investment. Even government bonds that repay investors divert capital that likely would have been better invested in growth-creating businesses.

  Taxes make work and other transactions more expensive. Thus, fewer of them take place. As we discuss, the best way to generate tax revenues is through policies that encourage a growing tax base by allowing entrepreneurs and businesses to generate the capital to expand. And the best way to do this is to keep tax rates reasonable—or through a low flat tax.

  Some may recognize the ideas in this book as freemarket economics. We call them Real World Economics because we believe that is a more accurate term. The U.S. economy, after all, is not a totally free market. It is made up of many markets. Some are freer than others. The markets that are freer, that give the greatest latitude to entrepreneurs and innovators, that let buyers and sellers work out price and supply solutions, create more wealth for more individuals than any controlled by government.

  Real World economics is beyond partisan politics. Presidents and politicians on both sides of the political spectrum have shown both understanding and ignorance of Real World economic principles. John F. Kennedy’s tax cuts ignited the booming economy of the 1960s. Kennedy also understood the need for a strong dollar, declaring, “The dollar should be as good as gold.”

  Unfortunately, Richard Nixon didn’t feel the same way. Nixon’s abandonment of the gold standard, combined with his wage and price controls, ushered in the stagflation of the 1970s. He failed to heed the market-based policies that have been associated with his party. Bill Clinton also defied political stereotypes—with better results. Unlike his party, he believed in reducing international trade barriers. He successfully enacted the North American Free Trade Agreement. And he understood the dangers inherent in a weak dollar.

  On the negative side, like Jimmy Carter and George W. Bush, Clinton pushed banks to make uneconomical mortgages. When he first took office, he raised income taxes, nearly aborting the recovery that was under way. He made amends for that error early in his second term, supporting a big capital gains tax cut that helped produce a vibrant economy and stock market.

  Clinton’s successor, George W. Bush, got it right on taxes with his 2003 rate cuts, which convincingly pulled the United States out of the 2000–2001 recession. But his weak-dollar policy and other mistakes made in 2008 produced the worst economic disaster since the 1930s.

  Ronald Reagan slashed income-tax rates and, working in tandem with Paul Volcker at the Federal Reserve, killed the devastating inflation that had pockmarked the 1970s. Together these achievements—not to mention winning the cold war—set off a great, long boom in America and the world that didn’t end until the crash of 2007.

  Real World economics isn’t about “left” or “right.” It’s based on tried-and-true principles that offer the best explanations of how the economy—and daily life—really works.

  Ironically, as many in the U.S. question capitalism, nations that have been held up as models of “Third Way” democratic socialism are increasingly embracing Real World free market principles. Prime Minister Fredrik Reinfeldt of Sweden openly blames high taxes and welfare state policies for the problems of his nation’s economy. As he noted in a speech in 2008, his country’s much-vaunted affluence was built before the nation turned to socialism.

  At the beginning of the 1970s Sweden also had the fourth highest GDP per capita measured in purchasing power parity. Sweden was blooming.15

  Thanks to Swedish socialism, Reinfeldt said, the wealth that “took a hundred years to build was almost dismantled in twenty-five years.” As he recounts, “Growth fell off. Unemployment rose. The quality of welfare declined.”

  Between the 1970s and the 1990s, Sweden fell from fourth to eighteenth place among nations belonging to the Organisation for Economic Cooperation and Development (O
ECD). As we discuss in chapter 2, not only Sweden but other Nordic nations have a lower material standard of living than many people think, with dramatically less disposable income and fewer basic necessities. Reinfeldt’s government, elected in 2006, is working to turn things around with initiatives like tax cuts, smaller government, and privatization—Real World promarket policies.

  Whole Foods founder John Mackey confesses he once thought that “business and capitalism were based on exploitation: exploitation of consumers, society and the environment.” At one time an ardent believer in capitalism’s bad rap, Mackey admits, “I believed that ‘profit’ was a necessary evil at best, and certainly not a desirable goal for society as a whole.” However, when he founded Whole Foods, his view of the world began to evolve.

  Becoming an entrepreneur completely changed my life. Everything I believed about business was proven to be wrong. The most important thing I learned about business in my first year is that business wasn’t based on exploitation or coercion at all. Instead I realized that business is based on voluntary cooperation. No one is forced to trade with a business; customers have competitive alternatives for their labor; investors have different alternatives and places to invest their capital. Investors, labor, management, suppliers—they all need to cooperate to create value for their customers. If they do, then any realized profit can be divided amongst the creators of the value through competitive market dynamics. In other words, business is not a zero sum game with a winner or loser. It is a win, win, win game—and I really like that.

  Mackey’s transformation was helped along by exposure to freemarket thinkers: “I stumbled into reading Milton Friedman, Friedrich Hayek, Ludwig von Mises, Ayn Rand—I read all of them. I said to myself, ‘Wow, this all makes sense. This is how the world really works. This is incredible.’ ”16