Current economics: Robert C. Lieberman, “Why the Rich Are Getting Richer: American Politics and the Second Gilded Age”

What? You missed this, on February 20, 2011? Well, here it is again. Please pay attention this time.

The U.S. economy appears to be coming apart at the seams. Unemployment remains at nearly ten percent, the highest level in almost 30 years; foreclosures have forced millions of Americans out of their homes; and real incomes have fallen faster and further than at any time since the Great Depression. Many of those laid off fear that the jobs they have lost — the secure, often unionized, industrial jobs that provided wealth, security and opportunity — will never return. They are probably right.

Cover of Winner-Take-All Politics, by Jacob Hacker and Paul Pierson

Cover of Winner-Take-All Politics, by Jacob Hacker and Paul Pierson

And yet a curious thing has happened in the midst of all this misery. The wealthiest Americans, among them presumably the very titans of global finance whose misadventures brought about the financial meltdown, got richer. And not just a little bit richer; a lot richer. In 2009, the average income of the top five percent of earners went up, while on average everyone else’s income went down. This was not an anomaly but rather a continuation of a 40-year trend of ballooning incomes at the very top and stagnant incomes in the middle and at the bottom. The share of total income going to the top one percent has increased from roughly eight percent in the 1960s to more than 20 percent today.

This what the political scientists Jacob Hacker and Paul Pierson call the “winner-take-all economy.” It is not a picture of a healthy society. Such a level of economic inequality, not seen in the United States since the eve of the Great Depression, bespeaks a political economy in which the financial rewards are increasingly concentrated among a tiny elite and whose risks are borne by an increasingly exposed and unprotected middle class. Income inequality in the United States is higher than in any other advanced democracy and by conventional measures comparable to that in countries such as Ghana, Nicaragua, and Turkmenistan.

Robert C. Lieberman, reviewing the book Winner-Take-All Politics: How Washington Made the Rich Richer — and Turned Its Back on the Middle Class, by Jacob S. Hacker and Paul Pierson, Simon and Schuster, 2010, 368 pages. $27.00.; review appears in Foreign Affairs, January/February 2011, pp. 154-158.

More:

Two years later, even more:

This post is borrowed, with express permission, from Millard Fillmore’s Bathtub.

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Black Friday economics

Every economics teacher knows that old Leonard Read piece, “I, Pencil.” It’s a good, practical demonstration of the concept of Adam Smith’sinvisible hand,” free markets, and the way economies put stuff together for sale without a government agency issuing instructions, written by Read in 1958, for the Foundation for Economic Education, a once-free-market economic think tank that recently made an unexpected (by me) lurch to the radical right.

English: A standard number 2 pencil, unsharpen...

A standard number 2 pencil, unsharpened. Made by Sanford. (Photo credit: Wikipedia)

The essay is dated, though, for high school kids today. Most of the stuff Read properly assumed people knew something about, is left out of modern curricula in elementary and middle school, so a high school teacher must do remedial work in mining, international trade, lumbering, manufacturing, chemistry and metallurgy, just to make the thing make sense. Where we used to learn about pencils in first or second grade, my students in recent years labor under the misconception that pencil leads are made out of lead, and I have to explain to them that graphite is a form of carbon. They don’t know cedar from pine, or mahogany, they don’t know copper from tin from zinc from steel, and they think rubber has always been synthetic.

Imagine my surprise on this: I got an e-mail touting an animated, YouTube update of Read’s essay. It’s not bad, even though it’s from the Competitive Enterprise Institute, which is neither competitive, nor an institute, but is instead a propaganda arm of crazy right-wing wackoes.

Whoever made this film appears not to have had much interference from the CEI poobahs.

Am I missing something? Is this film more right-wing than I see?

I worry that I missed something, or that the producers of this movie wove a spell over the usual radical near-fascist groups. This movie has been touted in recent days by almost all of the usual crypto-black-shirt think puddles, American Enterprise Institute, the unreasoning Reason magazine from the so-called libertarian view, the cartoonish Glen Beck effluent pipe The Blaze, the Coors family’s Heritage Foundation, the offensively-named Lexicans, the biased Cafe Hayek (which is often a good read anyway, so long as you don’t take them seriously on any science issue), the sanctuary for authoritarian-leaning victims of lobotomy Hot Air, and even that publication from the propaganda organization, The Daily Capitalist — in short, it’s been plugged by organizations covering the entire political spectrum from Y to Z, the far right end of the alphabet.

Maybe they didn’t watch it?

For today’s teenagers, someone should do a couple of updates. “I, SmartPhone” and “I, Tablet Computer” could include lessons in government regulation of radio spectrum and how such regulation allows public safety functions and air traffic control to exist alongside great profit-seeking groups, and how such developments would be impossible without government regulation. There would also be a section on the mining and milling of rare Earths, of ores like Coltan, which would introduce the concept of blood or conflict diamonds and ores, the collapse of order in unregulated areas like Congo and Somalia, slave labor as in Pakistan and China. “I, Fast Food Breakfast” could include side lessons in importing of orange juice from Brazil and other nations, artificially-flavored syrups from China and the threat from climate change to U.S. maple tree farmers, and meat from Australia and Argentina, along with the ideas of food safety regulation on eggs and egg products by USDA and FDA. “I, Burrito” could include lessons in cultural diffusion and migrant farm workers who pick the tomatoes . . .

Colored_pencil

Colored pencils (Photo credit: Wikipedia)

By the way, the fact that pencil leads are graphite (and clay), and not lead, should not be taken to mean that pencil manufacturers came up with a kid-safe product on their own; lead in the paint on pencils was enough to worry the health officials, until regulation got different paints used.

We need a classroom guide on Read’s piece and this new movie that seriously discusses the need for regulation in pencil manufacture, from the safety of the saws used to cut the trees, and in the mills, to the anti-child labor provisions of the graphite and rubber import agreements, to the forest regulation and research necessary to keep the incense cedar wood in production, through the anti-deforestation requirements on rubber plantations and the regulation of lead in the paint. The movie is good, much less right-wing than those groups who fawn over it, but still in need of some real-world economic reality.

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‘Commanding Heights’ home page

For economics research, to find example of economics principles and to understand economic history, there are few better sites than the home page of the PBS series based on Daniel Yergin‘s history of economics in the 20th century, “Commanding Heights.”  Go see.

Image for Commanding Heights video series

You may view segments, or the entire series.

You can read up on the people, or the countries.  You can follow specific ideas.

There is a good glossary of economic terms There are essays on key concepts, in addition to the material in the book and the series.

One might wish all websites were so thorough.

Quote of the moment: Robert Kennedy on what really matters in economies

Found this at the blog (on economics!) of Harry Clarke (made a few minor corrections in the text):

Robert F. Kennedy speech at the University of Kansas, Lawrence, March 18, 1968

Robert F. Kennedy speech at the University of Kansas, Lawrence, March 18, 1968 - Photo by George Silk, Time-Life Pictures/Getty Images

RFK said this in 1968. In a speech I heard today it was quoted and it stirred me.

Too much and for too long, we seem to have surrendered personal excellence and community value in the mere accumulation of material things. Our Gross National Product, now, is over eight hundred billion dollars a year, but that GNP — if we judge the United States of America by that — that GNP counts air pollution and cigarette advertising and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and it counts nuclear warheads, and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children.

Yet the Gross National Product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.

Then-Sen. Robert F. Kennedy delivered these words in an address at the University of Kansas, Lawrence, Kansas, on March 18, 1968, near the beginning of his too-short run for the presidency, and a few days before President Lyndon Johnson announced he would not be running for another term.  This was just more than two weeks before the assassination of the Rev. Dr. Martin Luther King, Jr.

Here’s a video production from the Glaser Progress Foundation which includes an audio recording of the speech:

More resources:

This post originally appeared at Millard Fillmore’s Bathtub.  It is used here with express permission.

What is a stock? How do I know what to invest in?

From Thinkquest, “What is a stock?”

A stock is a certificate that shows that you own a small fraction of a corporation. When you buy a stock, you are paying for a small percentage of everything that that company owns, buildings, chairs, computers, etc. When you own a stock, you are referred to as a shareholder or a stockholder. In essence, a stock is a representation of the amount of a company that you own.

Read more about what stocks are, and how to pick them, at ThinkQuest.

How to pick a stock?

Here’s a primer in stock picking, from Investopedia, a good site for general information.

In this tutorial, we examine some of the most popular strategies for finding good stocks (or at least avoiding bad ones). In other words, we’ll explore the art of stock-picking – selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market’s overall average.

Before exploring the vast world of stock-picking methodologies, we should address a few misconceptions. Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! If you are reading this tutorial in search of a magic key to unlock instant wealth, we’re sorry, but we know of no such key.

This doesn’t mean you can’t expand your wealth through the stock market. It’s just better to think of stock-picking as an art rather than a science. There are a few reasons for this:

1. So many factors affect a company’s health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant.

2. A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company’s staff, its competitive advantages, its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process.

3. Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they’ll do. Emotions can change quickly and unpredictably. And unfortunately, when confidence turns into fear, the stock market can be a dangerous place.

The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory – a “best guess” of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits your personal outlook, time frame, risk tolerance and the amount of time you want to devote to investingand picking stocks.
Read more: http://www.investopedia.com/university/stockpicking/#ixzz1c11JYrS9

Hope that helps.  Happy stock picking!

More information:

World population: 7 billion and counting

Exponential growth’s potential to rapidly change the numbers of a situation tends to fall out of the thoughts of most people, who don’t see such things occur in daily life.

You should stop and think about this one for a minute: World population will tip to over 7 billion people soon, maybe in the next week, but most assuredly by next spring.

A very large crowd in a stadium

Seven billion people? Really? Are the concessions adequate? The restrooms?

Joel E. Cohen wrote about the event in Sunday’s New York Times:

ONE week from today, the United Nations estimates, the world’s population will reach seven billion. Because censuses are infrequent and incomplete, no one knows the precise date — the Census Bureau puts it somewhere next March — but there can be no doubt that humanity is approaching a milestone.

The first billion people accumulated over a leisurely interval, from the origins of humans hundreds of thousands of years ago to the early 1800s. Adding the second took another 120 or so years. Then, in the last 50 years, humanity more than doubled, surging from three billion in 1959 to four billion in 1974, five billion in 1987 and six billion in 1998. This rate of population increase has no historical precedent.

Can the earth support seven billion now, and the three billion people who are expected to be added by the end of this century? Are the enormous increases in households, cities, material consumption and waste compatible with dignity, health, environmental quality and freedom from poverty?

(Joel E. Cohen, a mathematical biologist and the head of the Laboratory of Populations at Rockefeller University and Columbia University, is the author of “How Many People Can the Earth Support?”)

We’re in for some dramatic shifts in concentrations of people, if not shifts in how we think of the world (thinking is always slower than reality).

While the bulge in younger people, if they are educated, presents a potential “demographic dividend” for countries like Bangladesh and Brazil, the shrinking proportion of working-age people elsewhere may place a strain on governments and lead them to raise retirement ages and to encourage alternative job opportunities for older workers.

Even in the United States, the proportion of the gross domestic product spent on Social Security and Medicare is projected to rise to 14.5 percent in 2050, from 8.4 percent this year.

The Population Reference Bureau said that by 2050, Russia and Japan would be bumped from the 10 most populous countries by Ethiopia and the Democratic Republic of Congo.

Are you ready?

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Borrowed with express permission from Millard Fillmore’s Bathtub.

Annals of entrepreneurship: Edison’s improved lightbulb works! October 21, 1879

GE cartoon on Edison's light bulb, by Maki Naro

Cartoon by Maki Naro, for GE - Click for larger image

GE’s release said:

Perhaps there should be a bumper sticker: “If you love doing stuff at night without a kerosene lantern, thank Edison.” Okay, it doesn’t roll trippingly off the tongue. Still, today is the anniversary of Thomas Edison’s 13-and-a-half-hour test of the carbon filament lightbulb that made electric light a practical reality for the world. As we’ve discussed before, Edison was one of many inventors of the lightbulb, but his designs proved to be transformative for the technology. Maki Naro marked the occasion with a short comic (replete with Alexander Graham Bell, who’s hoppin’ mad).

GE may be a biased source on this history, but the cartoon seems quite straightforward to me.

On the whole, is the light bulb a boon to society, or a bane?  More specifically, does a 24-hour/day society produce more angst and dysfunction than productive work? 

See more history of Edison’s work on the lightbulb, including the patent drawings, at Millard Fillmore’s Bathtub, a history blog:

What is socialism?

Robert Heilbronner says he was a socialist for most of his life, but eventually became enlightened.

He has a bias, but it’s a bias honestly arrived at.  This article on socialism presents the capitalist’s case against it.  Heilbronner defines and describes socialism well, however, and it is very useful despite its slant.

This article can be found at the Library of Economics and Liberty, sponsored by the Liberty Fund.

Heilbronner wrote:

Socialism—defined as a centrally planned economy in which the government controls all means of production—was the tragic failure of the twentieth century. Born of a commitment to remedy the economic and moral defects of capitalism, it has far surpassed capitalism in both economic malfunction and moral cruelty. Yet the idea and the ideal of socialism linger on. Whether socialism in some form will eventually return as a major organizing force in human affairs is unknown, but no one can accurately appraise its prospects who has not taken into account the dramatic story of its rise and fall.

 

The Birth of Socialist Planning

It is often thought that the idea of socialism derives from the work of Karl Marx. In fact, Marx wrote only a few pages about socialism, as either a moral or a practical blueprint for society. The true architect of a socialist order was Lenin, who first faced the practical difficulties of organizing an economic system without the driving incentives of profit seeking or the self-generating constraints of competition. Lenin began from the long-standing delusion that economic organization would become less complex once the profit drive and the market mechanism had been dispensed with—“as self-evident,” he wrote, as “the extraordinarily simple operations of watching, recording, and issuing receipts, within the reach of anybody who can read and write and knows the first four rules of arithmetic.”

In fact, economic life pursued under these first four rules rapidly became so disorganized that within four years of the 1917 revolution, Soviet production had fallen to 14 percent of its prerevolutionary level. By 1921 Lenin was forced to institute the New Economic Policy (NEP), a partial return to the market incentives of capitalism. This brief mixture of socialism and capitalism came to an end in 1927 after Stalin instituted the process of forced collectivization that was to mobilize Russian resources for its leap into industrial power.

The system that evolved under Stalin and his successors took the form of a pyramid of command. At its apex was Gosplan, the highest state planning agency, which established such general directives for the economy as the target rate of growth and the allocation of effort between military and civilian outputs, between heavy and light industry, and among various regions. Gosplan transmitted the general directives to successive ministries of industrial and regional planning, whose technical advisers broke down the overall national plan into directives assigned to particular factories, industrial power centers, collective farms, and so on. These thousands of individual subplans were finally scrutinized by the factory managers and engineers who would eventually have to implement them. Thereafter, the blueprint for production reascended the pyramid, together with the suggestions, emendations, and pleas of those who had seen it. Ultimately, a completed plan would be reached by negotiation, voted on by the Supreme Soviet, and passed into law.

Thus, the final plan resembled an immense order book, specifying the nuts and bolts, steel girders, grain outputs, tractors, cotton, cardboard, and coal that, in their entirety, constituted the national output. In theory such an order book should enable planners to reconstitute a working economy each year—provided, of course, that the nuts fitted the bolts; the girders were of the right dimensions; the grain output was properly stored; the tractors were operable; and the cotton, cardboard, and coal were of the kinds needed for their manifold uses. But there was a vast and widening gap between theory and practice.

Problems Emerge

The gap did not appear immediately. In retrospect, we can see that the task facing Lenin and Stalin in the early years was not so much economic as quasi military—mobilizing a peasantry into a workforce to build roads and rail lines, dams and electric grids, steel complexes and tractor factories. This was a formidable assignment, but far less formidable than what would confront socialism fifty years later, when the task was not so much to create enormous undertakings as to create relatively self-contained ones, and to fit all the outputs into a dovetailing whole.

Through the 1960s the Soviet economy continued to report strong overall growth—roughly twice that of the United States—but observers began to spot signs of impending trouble. One was the difficulty of specifying outputs in terms that would maximize the well-being of everyone in the economy, not merely the bonuses earned by individual factory managers for “overfulfilling” their assigned objectives. The problem was that the plan specified outputs in physical terms. One consequence was that managers maximized yardages or tonnages of output, not its quality. A famous cartoon in the satirical magazine Krokodil showed a factory manager proudly displaying his record output, a single gigantic nail suspended from a crane.

As the economic flow became increasingly clogged and clotted, production took the form of “stormings” at the end of each quarter or year, when every resource was pressed into use to meet preassigned targets. The same rigid system soon produced expediters, or tolkachi, to arrange shipments to harassed managers who needed unplanned—and therefore unobtainable—inputs to achieve their production goals. Worse, lacking the right to buy their own supplies or to hire or fire their own workers, factories set up fabricating shops, then commissaries, and finally their own worker housing to maintain control over their own small bailiwicks.

It is not surprising that this increasingly Byzantine system began to create serious dysfunctions beneath the overall statistics of growth. During the 1960s the Soviet Union became the first industrial country in history to suffer a prolonged peacetime fall in average life expectancy, a symptom of its disastrous misallocation of resources. Military research facilities could get whatever they needed, but hospitals were low on the priority list. By the 1970s the figures clearly indicated a slowing of overall production. By the 1980s the Soviet Union officially acknowledged a near end to growth that was, in reality, an unofficial decline. In 1987 the first official law embodying perestroika—restructuring—was put into effect. President Mikhail Gorbachev announced his intention to revamp the economy from top to bottom by introducing the market, reestablishing private ownership, and opening the system to free economic interchange with the West. Seventy years of socialist rise had come to an end.

Socialist Planning in Western Eyes

Understanding of the difficulties of central planning was slow to emerge. In the mid-1930s, while the Russian industrialization drive was at full tilt, few raised their voices about its problems. Among those few were ludwig von mises, an articulate and exceedingly argumentative free-market economist, and friedrich hayek, of much more contemplative temperament, later to be awarded a Nobel Prize for his work in monetary theory. Together, Mises and Hayek launched an attack on the feasibility of socialism that seemed at the time unconvincing in its argument as to the functional problems of a planned economy. Mises in particular contended that a socialist system was impossible because there was no way for the planners to acquire the information (see Information and Prices)—“produce this, not that”—needed for a coherent economy. This information, Hayek emphasized, emerged spontaneously in a market system from the rise and fall of prices. A planning system was bound to fail precisely because it lacked such a signaling mechanism.

The Mises-Hayek argument met its most formidable counterargument in two brilliant articles by Oskar Lange, a young economist who would become Poland’s first ambassador to the United States after World War II. Lange set out to show that the planners would, in fact, have precisely the same information as that which guided a market economy. The information would be revealed as inventories of goods rose and fell, signaling either that supply was greater than demand or demand was greater than supply. Thus, as planners watched inventory levels, they were also learning which of their administered (i.e., state-dictated) prices were too high and which too low. It only remained, therefore, to adjust prices so that supply and demand balanced, exactly as in the marketplace.

Lange’s answer was so simple and clear that many believed the Mises-Hayek argument had been demolished. In fact, we now know that their argument was all too prescient. Ironically, though, Mises and Hayek were right for a reason they did not foresee as clearly as Lange himself. “The real danger of socialism,” Lange wrote, in italics, “is that of a bureaucratization of economic life.” But he took away the force of the remark by adding, without italics, “Unfortunately, we do not see how the same or even greater danger can be averted under monopolistic capitalism” (Lange and Taylor 1938, pp. 109–110).

The effects of the “bureaucratization of economic life” are dramatically related in The Turning Point, a scathing attack on the realities of socialist economic planning by two Soviet economists, Nikolai Smelev and Vladimir Popov, that gives examples of the planning process in actual operation. In 1982, to stimulate the production of gloves from moleskins, the Soviet government raised the price it was willing to pay for moleskins from twenty to fifty kopecks per pelt. Smelev and Popov noted:

State purchases increased, and now all the distribution centers are filled with these pelts. Industry is unable to use them all, and they often rot in warehouses before they can be processed. The Ministry of Light Industry has already requested Goskomtsen [the State Committee on Prices] twice to lower prices, but “the question has not been decided” yet. This is not surprising. Its members are too busy to decide. They have no time: besides setting prices on these pelts, they have to keep track of another 24 million prices. And how can they possibly know how much to lower the price today, so they won’t have to raise it tomorrow?

This story speaks volumes about the problem of a centrally planned system. The crucial missing element is not so much “information,” as Mises and Hayek argued, as it is the motivation to act on information. After all, the inventories of moleskins did tell the planners that their production was at first too low and then too high. What was missing was the willingness—better yet, the necessity—to respond to the signals of changing inventories. A capitalist firm responds to changing prices because failure to do so will cause it to lose money. A socialist ministry ignores changing inventories because bureaucrats learn that doing something is more likely to get them in trouble than doing nothing, unless doing nothing results in absolute disaster.

In the late 1980s, absolute economic disaster arrived in the Soviet Union and its Eastern former satellites, and those countries are still trying to construct some form of economic structure that will no longer display the deadly inertia and indifference that have come to be the hallmarks of socialism. It is too early to predict whether these efforts will succeed. The main obstacle to real perestroika is the impossibility of creating a working market system without a firm basis of private ownership, and it is clear that the creation of such a basis encounters the opposition of the former state bureaucracy and the hostility of ordinary people who have long been trained to be suspicious of the pursuit of wealth. In the face of such uncertainties, all predictions are foolhardy save one: no quick or easy transition from socialism to some form of nonsocialism is possible. Transformations of such magnitude are historic convulsions, not mere changes in policy. Their completion must be measured in decades or generations, not years.

What is capitalism?

What is capitalism?

Here’s the Wikipedia short entry, from Robert Heilbroner:

Capitalism is an economic system in which the means of production are privately owned and operated for profit, usually in competitive markets.[1] Income in a capitalist system takes at least two forms, profit on the one hand and wages on the other. There is also a tradition that treats rent, income from the control of natural resources, as a third phenomenon distinct from either of those. In any case, profit is what is received, by virtue of control of the tools of production, by those who provide the capital and utilize it so successfully that revenue from resulting products exceeds the costs of production. Often profits are used to expand an enterprise, thus creating more jobs and wealth. Wages are received by those who provide a service to the enterprise, also known as workers, but do not have an ownership stake in it, and are therefore compensated irrespective of whether the enterprise makes a profit or a loss. In the case of profitable enterprise, profits are therefore not translated to workers except at the discretion of the owners, who may or may not receive increased compensation, whereas losses are not translated to workers except at similar discretion manifested by decreased compensation.

At greater length, and with more polemic and cheering, we hear from Robert Hessen writing at the Concise Encyclopedia of Economics:

“Capitalism,” a term of disparagement coined by socialists in the mid-nineteenth century, is a misnomer for “economic individualism,” which Adam Smith earlier called “the obvious and simple system of natural liberty” (Wealth of Nations). Economic individualism’s basic premise is that the pursuit of self-interest and the right to own private property are morally defensible and legally legitimate. Its major corollary is that the state exists to protect individual rights. Subject to certain restrictions, individuals (alone or with others) are free to decide where to invest, what to produce or sell, and what prices to charge. There is no natural limit to the range of their efforts in terms of assets, sales, and profits; or the number of customers, employees, and investors; or whether they operate in local, regional, national, or international markets.

The emergence of capitalism is often mistakenly linked to a Puritan work ethic. German sociologist Max Weber, writing in 1903, stated that the catalyst for capitalism was in seventeenth-century England, where members of a religious sect, the Puritans, under the sway of John Calvin’s doctrine of predestination, channeled their energies into hard work, reinvestment, and modest living, and then carried these attitudes to New England. Weber’s thesis breaks down, however. The same attitudes toward work and savings are exhibited by Jews and Japanese, whose value systems contain no Calvinist component. Moreover, Scotland in the seventeenth century was simultaneously orthodox Calvinist and economically stagnant.

A better explanation of the Puritans’ diligence is that by refusing to swear allegiance to the established Church of England, they were barred from activities and professions to which they otherwise might have been drawn—landownership, law, the military, civil service, universities— and so they focused on trade and commerce. A similar pattern of exclusion or ostracism explains why Jews and other racial and religious minorities in other countries and later centuries tended to concentrate on retail businesses and money lending.

In early-nineteenth-century England the most visible face of capitalism was the textile factories that hired women and children. Critics (Richard Oastler and Robert Southey, among others) denounced the mill owners as heartless exploiters and described the working conditions—long hours, low pay, monotonous routine—as if they were unprecedented. Believing that poverty was new, not merely more visible in crowded towns and villages, critics compared contemporary times unfavorably with earlier centuries. Their claims of increasing misery, however, were based on ignorance of how squalid life actually had been earlier. Before children began earning money working in factories, they had been sent to live in parish poorhouses; apprenticed as unpaid household servants; rented out for backbreaking agricultural labor; or became beggars, vagrants, thieves, and prostitutes. The precapitalist “good old days” simply never existed (see industrial revolution and the standard of living).

Nonetheless, by the 1820s and 1830s the growing specter of child labor and “dark Satanic mills” (poet William Blake’s memorable phrase) generated vocal opposition to these unbridled examples of self-interest and the pursuit of profit. Some critics urged legislative regulation of wages and hours, compulsory education, and minimum age limits for laborers. Others offered more radical alternatives. The most vociferous were the socialists, who aimed to eradicate individualism, the name that preceded capitalism.

Socialist theorists repudiated individualism’s leading tenets: that individuals possess inalienable rights, that government should not restrain individuals from pursuing their own happiness, and that economic activity should not be regulated by government. Instead, they proclaimed an organic conception of society. They stressed ideals such as brotherhood, community, and social solidarity and set forth detailed blueprints for model utopian colonies in which collectivist values would be institutionalized.

The short life span of these utopian societies acted as a brake on the appeal of socialism. But its ranks swelled after Karl Marx offered a new “scientific” version, proclaiming that he had discovered the laws of history and that socialism inevitably would replace capitalism. Beyond offering sweeping promises that socialism would create economic equality, eradicate poverty, end specialization, and abolish money, Marx supplied no details at all about how a future socialist society would be structured or would operate.

Even nineteenth-century economists—in England, America, and Western Europe—who were supposedly capitalism’s defenders did not defend capitalism effectively because they did not understand it. They came to believe that the most defensible economic system was one of “perfect” or “pure” competition. Under perfect competition all firms are small scale, products in each industry are homogeneous, consumers are perfectly informed about what is for sale and at what price, and all sellers are what economists call price takers (i.e., they have to “take” the market price and cannot charge a higher one for their goods).

Clearly, these assumptions were at odds with both common sense and the reality of market conditions. Under real competition, which is what capitalism delivered, companies are rivals for sales and profits. This rivalry leads them to innovate in product design and performance, to introduce cost-cutting technology, and to use packaging to make products more attractive or convenient for customers. Unbridled rivalry encourages companies to offer assurances of security to imperfectly informed consumers, by means such as money-back guarantees or product warranties and by building customer loyalty through investing in their brand names and reputations (see advertising, brand names, and consumer protection).

Companies that successfully adopted these techniques of rivalry were the ones that grew, and some came to dominate their industries, though usually only for a few years until other firms found superior methods of satisfying consumer demands. Neither rivalry nor product differentiation occurs under perfect competition, but they happen constantly under real flesh-and-blood capitalism.

The leading American industrialists of the late nineteenth century were aggressive competitors and innovators. To cut costs and thereby reduce prices and win a larger market share, Andrew Carnegie eagerly scrapped his huge investment in Bessemer furnaces and adopted the open-hearth system for making steel rails. In the oil-refining industry, John D. Rockefeller embraced cost cutting by building his own pipeline network; manufacturing his own barrels; and hiring chemists to remove the vile odor from abundant, low-cost crude oil. Gustavus Swift challenged the existing network of local butchers when he created assembly-line meatpacking facilities in Chicago and built his own fleet of refrigerated railroad cars to deliver low-price beef to distant markets. Local merchants also were challenged by Chicago-based Sears Roebuck and Montgomery Ward, which pioneered mail-order sales on a money-back, satisfaction-guaranteed basis.

Small-scale producers denounced these innovators as “robber barons,” accused them of monopolistic practices, and appealed to Congress for relief from relentless competition. Beginning with the Sherman Act (1890), Congress enacted antitrust laws that were often used to suppress cost cutting and price slashing, based on acceptance of the idea that an economy of numerous small-scale firms was superior to one dominated by a few large, highly efficient companies operating in national markets (see antitrust).

Despite these constraints, which worked sporadically and unpredictably, the benefits of capitalism were widely diffused. Luxuries quickly were transformed into necessities. At first, the luxuries were cheap cotton clothes, fresh meat, and white bread; then sewing machines, bicycles, sporting goods, and musical instruments; then automobiles, washing machines, clothes dryers, and refrigerators; then telephones, radios, televisions, air conditioners, and freezers; and most recently, TiVos, digital cameras, DVD players, and cell phones.

That these amenities had become available to most people did not cause capitalism’s critics to recant, or even to relent. Instead, they ingeniously reversed themselves. Marxist philosopher Herbert Marcuse proclaimed that the real evil of capitalism is prosperity, because it seduces workers away from their historic mission—the revolutionary overthrow of capitalism—by supplying them with cars and household appliances, which he called “tools of enslavement.”1 Some critics reject capitalism by extolling “the simple life” and labeling prosperity mindless materialism. In the 1950s, critics such as John Kenneth Galbraith and Vance Packard attacked the legitimacy of consumer demand, asserting that if goods had to be advertised in order to sell, they could not be serving any authentic human needs.2 They charged that consumers are brainwashed by Madison Avenue and crave whatever the giant corporations choose to produce and advertise, and complained that the “public sector” is starved while frivolous private desires are being satisfied. And having seen that capitalism reduced poverty instead of intensifying it, critics such as Gar Alperovitz and Michael Harrington proclaimed equality the highest moral value, calling for higher taxes on incomes and inheritances to massively redistribute wealth, not only nationally but also internationally.3

Capitalism is not a cure for every defect in human affairs or for eradicating all inequalities, but who ever said it was? It holds out the promise of what Adam Smith called “universal opulence.” Those who demand more are likely to be using higher expectations as a weapon of criticism. For example, British economist Richard Layard recently attracted headlines and airtime with a startling revelation: money cannot buy happiness (a cliché of song lyrics and church sermons).4 He laments that economic individualism fails to ensure the emotional satisfactions that are essential to life, including family ties, financial security, meaningful work, friendship, and good health. Instead, a capitalist society supplies new gadgets, appliances, and luxuries that arouse envy in those who cannot afford them and that inspire a ceaseless obsession with securing more among those who already own too much. Layard’s long-range solutions include a revival of religion to topple the secularism that capitalism fosters, altruism to obliterate selfishness, and communitarianism to supercede individualism. He stresses the need, near-term, for robust governmental efforts to promote happiness instead of the minimalist night-watchman state that libertarian defenders of capitalism favor. He argues that low taxes are harmful to the poor because they give government inadequate revenue to provide essential services to the poor. Higher taxes really would not harm the well-to-do, he says, because money and material possessions are subject to diminishing marginal utility. If such claims have a familiar ring, it is because Galbraith made the same points fifty years ago.

Virtually all the new criticisms of capitalism are old ones repackaged as stunning new insights. One example is the attack on “globalization” (the outsourcing of service, manufacturing, and assembly jobs to foreign sites where costs are cheaper). It has been denounced as union busting, exploitative, and destructive of foreign cultures, and is damned for the loss of domestic jobs and the resulting erosion of local tax revenues. Identical complaints were voiced two generations ago when jobs began flowing from unionized New England textile factories to nonunionized southern textile mills, and then to offshore sites such as Puerto Rico.

Another “new” line of attack on capitalism has been launched by law professors Cass Sunstein and Liam Murphy and philosophers Stephen Holmes, Thomas Nagel, and Peter Singer.5 They lament that in societies based on self-interest and private property, wealth earners oppose rising taxes, preferring to spend their money on themselves and leave inheritances for their children. This selfish bias leads to an impoverished public sector and to inadequate tax revenues. To justify governmental claims for higher taxes, these writers have revived an argument—attacking the legitimacy of private property and inheritance—that was advanced by institutionalist economists during the New Deal era. Government, they assert, is the ultimate source of all wealth, and so it should have first claim on wealth and earnings. “Is it really your money?” Singer asks, citing economist Herbert Simon’s estimate that a flat income tax of 90 percent would be reasonable because individuals derive most of their income from the “social capital” provided by technology and by protections such as patents and copyrights, and by the physical security afforded by police, courts, and armies rather than from anything they personally do. If the “fruits of capitalism” are merely a gift of government, it is an argument that proves too much. By the same logic, individuals might be enslaved if they were not protected by government, so conscription (servitude for a brief period) would be entirely unobjectionable, as would the seizure of privately owned land to turn it over to new owners if their uses would yield higher tax revenues—exactly the basis of a 2005 Supreme Court ruling on “eminent domain.”

Another persistent criticism of capitalism—the attack on corporations—harkens back to the 1930s. Critics like Ralph Nader, Mark Green, Charles Lindblom, and Robert Dahl focus their fire on giant corporations, charging that they are illegitimate institutions because they do not conform to the model of small-scale, owner-managed firms that Adam Smith extolled in 1776.6 In fact, giant corporations are fully consistent with capitalism, which does not imply any particular configuration of firms in terms of size or legal form. They attract capital from thousands (sometimes millions) of investors who are strangers to each other and who entrust their savings to the managerial expertise of others in exchange for a share of the resulting profits.

In an influential 1932 book, The Modern Corporation and Private Property, Adolf A. Berle Jr. coined the phrase “splitting of the atom of ownership” to lament the fact that investment and management had become two distinct elements. In fact, the process is merely an example of the specialization of function or division of labor that occurs so often under capitalism. Far from being an abuse or defect, giant corporations are an eloquent testimonial to the ability of individuals to engage in large-scale, long-range cooperation for their mutual benefit and enrichment (see corporations).

As noted earlier, the freedoms to invest, to decide what to produce, and to decide what to charge have always been restricted. A fully free economy, true laissez-faire, never has existed, but governmental authority over economic activity has sharply increased since the eighteenth century, and especially since the Great Depression. Originally, local authorities fixed the prices of necessities such as bread and ale, bridge and ferry tolls, or fees at inns and mills, but most products and services were unregulated. By the late nineteenth century governments were setting railroad freight rates and the prices charged by grain elevator operators, because these businesses had become “affected with a public purpose.” By the 1930s the same criterion was invoked to justify price controls over milk, ice, and theater tickets. One piece of good news, though, is that a spate of deregulation in the late 1970s and the 1980s eliminated price controls on airline travel, trucking, railroad freight rates, natural gas, oil, and some telecommunications rates.

Simultaneously, from the eighteenth century on, government began to play a more active, interventionist role in offering benefits to business, such as tax exemptions, bounties or subsidies to grow certain crops, and tariff protection so domestic firms would devote capital to manufacturing goods that otherwise had to be imported. Special favors became entrenched and hard to repeal because the recipients were organized while consumers, who bore the burden of higher prices, were not.

Once safe from foreign competition behind these barriers to free trade, some U.S. producers—steel and auto manufacturers, for example—stagnated. They failed to adopt new technologies or to cut costs until low-cost, low-price overseas rivals—the Japanese, especially—challenged them for their customers. They responded initially by asking Congress for new favors—higher tariffs, import quotas, and loan guarantees—and pleading with consumers to “buy American” and thereby save domestic jobs. Slowly, but inevitably, they began the expensive process of catching up with foreign companies so they could try to recapture their domestic customers.

Today, the United States, once the citadel of capitalism, is a “mixed economy” in which government bestows favors and imposes restrictions with no clear or consistent principles in mind. As the formerly communist countries of Eastern Europe struggle to embrace free-market ideas and institutions, they can learn from the American (and British) experience about not only the benefits that flowed from economic individualism, but also the burden of regulations that became impossible to repeal and trade barriers that were hard to dismantle. If the history of capitalism proves one thing, it is that the process of competition does not stop at national borders. As long as individuals anywhere perceive a potential for profits, they will amass the capital, produce the product, and circumvent the cultural and political barriers that interfere with their objectives.


About the Author

Robert Hessen, a specialist in business and economic history, is a senior research fellow at Stanford University’s Hoover Institution.


Further Reading

Berger, Peter. The Capitalist Revolution. New York: Basic Books, 1986.
De Soto, Hernando. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. New York: Basic Books, 2000.
Easterbrook, Gregg. The Progress Paradox: How Life Gets Better While People Feel Worse. New York: Random House, 2003.
Folsom, Burton W. Jr. The Myth of the Robber Barons: A New Look at the Rise of Big Business in America. 3d ed. Herndon, Va.: Young America’s Foundation, 1996.
Hayek, F. A., ed. Capitalism and the Historians. Chicago: University of Chicago Press, 1953.
Hessen, Robert. In Defense of the Corporation. Stanford: Hoover Institution Press, 1979.
Landes, David S. The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor. New York: Norton, 1999.
McCraw, Thomas K. Creating Modern Capitalism. Cambridge: Harvard University Press, 1997.
Mises, Ludwig von. The Anti-capitalistic Mentality. Princeton: Van Nostrand, 1956.
Mueller, John. Capitalism, Democracy, and Ralph’s Pretty Good Grocery. Princeton: Princeton University Press, 2001.
Norberg, Johan. In Defense of Global Capitalism. Washington, D.C.: Cato Institute, 2003.
Pipes, Richard. Property and Freedom. New York: Alfred A. Knopf, 2000.
Rand, Ayn. Capitalism: The Unknown Ideal. New York: New American Library, 1966.
Reisman, George. Capitalism. Ottawa, Ill.: Jameson Books, 1996.
Rosenberg, Nathan, and L. E. Birdzell Jr. How the West Grew Rich: The Economic Transformation of the Industrial World. New York: Basic Books, 1987.
Seldon, Arthur. The Virtues of Capitalism. Indianapolis: Liberty Fund, 2004.

Footnotes

Herbert Marcuse, “Repressive Tolerance,” in Robert Paul Wolff, Barrington Moore Jr., and Marcuse, A Critique of Pure Tolerance (Boston: Beacon Press, 1969).

John Kenneth Galbraith, The Affluent Society (Boston: Houghton Mifflin, 1958); Vance Packard, The Hidden Persuaders (New York: D. McKay, 1957).

Gar Alperovitz, “Notes Toward a Pluralist Commonwealth,” in Staughton Lynd and Alperovitz, Strategy and Program: Two Essays Toward a New American Socialism (Boston: Beacon Press, 1971); Michael Harrington, Socialism Past and Future (Boston: Little, Brown, 1989).

Richard Layard, Happiness: Lessons from a New Science (New York: Penguin Press, 2005).

Stephen Holmes and Cass Sunstein, The Cost of Rights (New York: Norton, 1999); Liam Murphy and Thomas Nagel, The Myth of Ownership (New York: Oxford University Press, 2002); Peter Singer, The President of Good and Evil (New York: Dutton, 2004).

Ralph Nader and Mark Green, Taming the Giant Corporation (New York: Norton, 1976); Charles Lindblom, Politics and Markets (New York: Basic Books, 1977); Robert Dahl, A Preface to Economic Democracy (Berkeley: University of California Press, 1985).

Now you know.