Freeman

ARTICLE

Capitalism & Socialism

MAY 01, 1985 by JOHN L. CHAPMAN

Mr. Chapman, an economics major in college, is a marketing representative for IBM in Louisville, Kentucky.

My purpose here is to extol the virtues of a social system based on the precepts of private enterprise, limited government, and maximum individual liberty. This system, known as “capitalism,” will first be defined, and its major features will then be highlighted. Additionally, the primary competing social system, known as “socialism” or “interventionism,” will be defined, and compared or contrasted where appropriate. Finally, key features of current public policy debates will be addressed where they relate to points under general discussion.

One of the most intriguing of all intellectual debates concerns the most optimal method of organization of human society. More specifically, from the time of Aristotle onward a great debate has raged concerning the proper form, scope, and role of government in society, in order to effectuate the “good life.”

Most people would agree that two polar-opposite kinds of society have evolved through the ages, and the aforementioned debate centers around which society is superior. Using the analogy of a continuum or spectrum, at one pole we have what is commonly referred to as “capitalism,” and at the opposite pole is the system known as “socialism.” All nations reside along this continuum, and none is at either absolute extreme. Closest to the theoretical pure capitalism is the United States; closest to pure socialism is the U.S.S.R. All other nation-states lie in between. A definition of each social system and a look at some of the major fundamentals of each will help us determine why capitalism is clearly the superior form of social organization.

Market Allocation

Capitalism is a system of social organization whereby capital is allocated and distributed via market-based channels. More simply capitalism is a system where private individuals or organizations determine the production, distribution, and ownership of all goods and services in an economy. “Capital” may be defined as any entity used in the production of goods and services. Examples of capital would include raw materials, equipment, buildings, money, and machines. In a capitalistic society, all the above-mentioned examples are owned and utilized by private individuals or organizations for the attainment of the owner’s ends.

Socialism is a system whereby capital is owned, allocated, distributed, and utilized by the collective society as a whole, rather than by private people or groups. The concept of private property and use of capita] for private ends is replaced instead by public ownership and collective employment of capital. Government bureaus, acting in the name of “the public” as a whole, replace private organizations as the main actors in an economy. For example, in socialist Great Britain, the steel industry has been nationalized, and there is one government-run computer company as well. Both enterprises thus avoid the rigors of marketplace competition facing such United States firms as U.S. Steel and IBM in these respective industries.

A final level-setting point of importance concerning capital is the undisputed fact that the only way a country is able to increase its wealth is to experience an increase in capital per worker. The only method of increasing “output per worker”meaning either (a) more work in the same amount of time, or (b)the same amount of work accomplished in less time—which is commonly referred to as productivity, is to increase the amount of capital invested in that worker. For example, factories with automated machinery today produce thousands more articles of everything, from widgets to automobiles, than in previous times.

Another example of capital invested in a worker to increase his productivity—and thus his wealth—is the pocket calculator. A student utilizing a calculator to do his math homework will finish earlier than the student computing the same problems in his head or with pencil on paper; the resultant time savings may either be used as leisure time—an economic good—or to increase income, with either choice representing a net increase in wealth. Therefore, any economy, socialistic, capitalistic, or mixed, has to invest in capital in order to increase output and thus wealth, and thereby improve living standards.

Government or Market?

The key question all concerned human beings must answer is this: which institution, the “government” or the “market” (an intangible consisting of freely acting individuals or groups), is better equipped to solve the problems confronting society today? All rational men and women, whatever their political and philosophical leanings, would like to see a world at peace, fully employed, with equality of opportunity for all, and the eradication of poverty. Which kind of society, the command economy or the market economy, will generate the capital wealth necessary to eliminate social ills?

The answer, it would seem, is self-evident. Yet the debate rages on, because the illiteracy and lack of knowledge of the general populace with regard to economics is rampant in our world. Lacking the intellectual tools to correctly analyze problems or interpret relevant data, most people, whether they be commoners of the street or members of the United States Senate, misinterpret the causes of a problem, and subsequently then advocate solutions which usually will tend to make the problem worse! Let us then analyze briefly the workings of capitalism, and expose the shortcomings of government interventionism, whether total (as in socialism) or partial (as in a mixed economy, such as the United States today).

Capitalistic institutions had their latent beginnings in the periods of Greece and Rome, disappeared during the Dark Ages, and reappeared during the Reformation. During most of this time, from primitive tribal cavemen through to the rise of civilizations in the Middle East, the Far East, and then Greater Europe, societies were authoritarian in nature. A ruler-king or ruling class devised several rationales for their subjection of others (“divine right,” position of birth, wealth, or ancestry, for example), but the end result was the same.

It is obvious but important to note that throughout the thousands of years of human history, up to the present day, the fundamental economic problem of “scarcity” has persisted; that is to say, man’s wants (for scarce goods and resources) have not been, and never will be, satiated. It is of further fundamental importance to note that through the ages, up until just a few hundred years ago, man’s material condition, or standard of living, was relatively constant. It rose briefly with the advent of Greek and Roman civilization, but receded as those societies died. Authoritarian structures may have resulted in pyramids or great cathedrals, but life continued mostly to be “nasty, brutish, and short.”[1]

Only with the advent of free enterprise capitalism was the standard of living for all to suddenly realize a dramatic improvement. This is important only because of the widespread but fallacious notion that material progress is merely a function of the progression of time (i.e., the quality of life in the 1980s is an improvement from the 1880s, but not as good as it will be in the 2080s). In fact, the standard of living is a function of the prevailing social and economic institutions of any given society.[2] Indeed, only when such capitalistic institutions as private property, limited government, and liberal trade were developed, did the quality of human life show marked improvement from the relative stagnation of the preceding centuries.

Social Contract

As Locke, Hobbes, and others have observed, individuals form a “social contract” (or government) to protect individual life, liberty, and property. Capitalism developed as individuals began to withdraw from the yoke of authoritarianism, and instead desired individual liberty to order their lives. The “social contract,” or government, entailed a delegation of fundamental rights of individuals to protect themselves. Thus, early government was an “umpire” rather than an active participant in day-to-day affairs, and as such treated each individual neutrally (or equally). This was an important development because the private property order and individual liberty allowed for the first time a “long-run view” of life, rather than a preoccupation with immediate concerns. In economic terms, the individual could now save and accumulate goods for future use (i.e., “investment”), because of societal guarantees of life and property.

The resultant saving and capital accumulation led directly toward increased specialization and a productive division of labor, and the “Industrial Revolution” quickly ensued. Most Marxian analysis of this period focuses on the horrors and exploitation, but the facts were otherwise. People flocked to the urban centers of Europe and then America as capital investment steadily increased worker productivity and thus raised the living standards of the masses.[3] More recently, South Africa has experienced a tremendous influx of immigrants seeking improved opportunities.

The functioning of this emerging market society was brilliant to behold. As Adam Smith first so eloquently described, a market- based economy was driven by an “Invisible Hand” which promoted order out of seeming chaos. Each individual laborer in a capitalist society seeks to acquire a marketable skill in order to trade with others. Thus, increased specialization (with all its attendant productive efficiencies) is promoted. As literally thousands of specialties are developed, relative prices (which are nothing more than the collective monetary votes of the masses of consumers) point the use of scarce eco nomic resources toward their most highly-valued ends.

Consumers in Charge

The Invisible Hand of the market directs capital to wherever consumers desire. For example, in recent years the demand for improved decision support and analysis tools (leading to improved professional productivity in business) has led to an explosive growth in low-cost personal computers and software that is easy to use. Market signals prompted data processing companies in this direction, and market competition has resulted in steadily lower prices and improved quality. Conversely, the market signaled to Ford Motor Company several years ago that its production of the Edsel was a waste of scarce resources (because Ford was not realizing a profit on this auto), and consequently Ford ceased Edsel production.

A few significant points should be noted here. First, the Invisible Hand, when allowed to operate unhampered by government, serves individual consumers by catering to the satisfaction of their wants. This is a monumental development; throughout most of human history, the masses toiled for the king, the pharaoh, or the oligarchical elite. Under capitalism the reverse is true; the captains of industry seek to serve the consuming masses.

Secondly, resources are most efficiently allocated, and production most effectively coordinated under capitalism. The free movement of prices signals capital and labor (the two main ingredients of production) to migrate to their highest-valued marginal uses. The production of the most desired goods and services ensues, and this obviously promotes social welfare in the best possible way, by satisfying the most urgent wants.

Thirdly, the private property order engenders a spirit of peaceful, harmonious coexistence and cooperation among individuals and groups. Permitting and protecting the natural right to property encourages saving and capital accumulation (and of course as capital invested per worker increases, standard of living and quality of life increase), fosters a climate of production by encouraging labor, and encourages individual self-reliance and responsibility (through the growth of personal assets).

Of course, what is true for individuals can scarce be folly for nations as a whole.[4] International specialization and division of labor lead to increased production of goods and services worldwide. Increased production, enhanced by full and efficient employment of labor, capital, and land, leads to generally lower goods prices, and market competition improves quality. Where active trade across borders occurs, the living standard is improved and war will never occur; Canada and the United States have no need for armies and border guards. In fact, there has never been an armed conflict between two capitalistic societies, because the bonds of free trade and peaceful noncoercive coexistence are too strong.

Economic Progress

Under capitalism, then, the engines of production turn at full speed. Individuals are free to pursue their own interests, and the consumer is king. Any individual who seeks employment finds it, because wages are not distorted by any intervention and compensation is based on marginal contribution to needed production (labor is always in demand, as wants are insatiable). It is talent and merit, and not birth or wealth, that propel the individual up the economic ladder. And of course, it is absurd to deride those individuals who amass great wealth; no one is any poorer because of them, and they attained such rewards by serving the rest of us!

Peace and prosperity prevail among individuals and nations, and poverty is eradicated through full employment. Additionally, and most importantly, the individual leads a free, uncoerced life and has complete sovereignty over his own existence, as long as his actions are peaceful and create no negative externalities for others. As long as the spirit and responsible attitudes engendered by capitalistic institutions are promulgated, the happy state of affairs such liberty fosters will never break down.

In the short span of a few hundred years, capitalism has delivered an improvement in the general quality of life unparalleled in the previous thousands of years of human history under the ancien regime of authoritarianism. It would thus seem self-evident that capitalism is the most superior form of social organization (even more so if one travels to and observes the two Berlins, or the two Koreas, or the two Chinas). A brief look at the underpinnings of socialism shows, however, why it is still so prevalent, just as its functional workings expose its false glamour.

Most socialists (and I use the term here to apply to any individual favoring an active, interventionist government) claim to be altruistic, compassionate people professing concern for and a desire to help others. They view the market economy as an impersonal, cold institution promoting crass material gain, and chastise its instability and always- changing chaos, brought about by the “animal spirits of investors.”[5] They seek to bring order and security to society by instituting a certain amount of control over economic activity, through fiscal, monetary, and even social policy. Through legalized intervention (“legalized” in the sense of a law being passed) government seeks to ameliorate social conditions.

Alleged Examples of the Failure of Competitive Enterprise

Adherents of interventionism see various failings of the market economy. Among those heard most often are the charges that capitalism causes a rather widespread distribution of income, and that unequal income distribution consigns some to a permanent “underclass.” Further, most members of this underclass are from minority groups, and since such groups historically have been the victims of racial discrimination, collective government action is required to right earlier wrongs and raise these groups’ living standards, argue the socialists. This argument, incidentally, is merely a variant of the old Marxian critique of the bourgeois exploitation of proletarian labor.

Another failure of the marketplace pointed to by collectivists is the “misallocation” of resources. How can funds be properly sourced, say these social well-wishers, when professional athletes, for example, command astronomical salaries when compared with public school teachers? After all, education is a far more noble and socially useful profession than basketball or football. Additionally, defense contracts, say, are a terrible waste, when such money should really be spent to feed the poor.

More examples could be cited, but the key point to understand is that policies of social welfare seek to redress inequities and social ills allegedly caused by an unhampered market economy. Conscious collective efforts are made to redistribute resources toward women, minorities, and other institutions and special interests. Again, to paraphrase Marxian analysis, the “problem of production” has been solved—distribution is now the focal point for interventionists.

The policies of socialism are so alluring (especially to the idealists often found in graduate schools, universities, the arts, and the media) precisely because of the appeal to altruism, and the exhortation to exhibit concern and compassion for others. Government interventionism (all of society supposedly working together for the common good) may be used to achieve a better society for all, and to root out the incessant competition, change, and chaotic insecurity of the market society, replacing these with the tranquil, orderly security of the collective command society.[6]

Sadly, the appealing rhetoric that always lies behind the well-meaning policies of active government interventionism does not shield the false premises on which such actions are based, or the unfortunate consequences that ensue. A brief look at the background and general structure of a few of these programs and their consequences will suffice to point to socialism’s broader failings.

The Transfer Society

Policy-makers in government possessing a socialistic orientation seek to redress market failings, as previously stated. In the United States, this process began in earnest with the advent of Roosevelt’s New Deal. Social Security was set up to aid the aged. Agriculture and various small businesses then received subsidies. Later, benefits were drawn up for veterans (and then other groups) for housing, education, and vocational training. By the administration of Lyndon Johnson, vast health care, public works, and anti-poverty schemes had come into being. The result of all this is the existence today of a plethora of public laws showing favor to select groups, industries, or institutions, and of course organized lobbies representing hundreds of special- interest pressure groups.

This system of interwoven welfare programs constitutes what Hans Sennholz and others have aptly named “the transfer society.” In the transfer society that the United States is fast becoming, there are classes of beneficiaries receiving government largess in the form of entitlements, subsidies, grants, or generous pensions flowing from the just-mentioned social programs and hundreds of others as well. Less visible to the public, however, are the classes of victims that are paying the bills for such largess. The very progressive and high marginal taxes (not to mention chronic inflation) levied on the victims to pay for the subsidies and benefits flowing to the targeted beneficiaries has had a highly negative effect on the level of production and output (and a concomitant rise in taxpayer cynicism and disgust, as their work efforts grow increasingly futile).

Since approximately 1960, defense spending as a proportion of the Federal budget has dramatically decreased, from 53 per cent of total spending to less than one-fourth. At the same time, “social spending” has exploded. One would hope, at the very least, that this would have resulted in less poverty, better job opportunities and lower unemployment for the poor, rebuilt cities and highways, and improved international conditions. Unfortunately, the general living standard for minorities and underclasses has in relative terms not seen improvement.[7] The inner cities are as decayed as ever, and foreign aid and agricultural and technological subsidies have not aided the Third World—Africa, a net exporter of food in the 1950s, is today the site of massive famine. Benevolent socialism has failed.

Rational Behavior

The transfer society, as are all forms of socialism, was destined for failure for a few key reasons (which, I would argue, one could have determined a priori, without ever bothering to gather comparative statistics),[8] First and foremost, man is a praxeological being. That is to say, man behaves purposively, utilizing various means to arrive at chosen ends. As such, he responds in a generally predictable manner to changing incentives; as the incentive structure in the economy has changed, so has the behavior of economic agents. This again is a seemingly self- evident tautology, but it is mentioned because the proponents of Big Government constantly ignore the inexorable laws of human action through policies which carry perverse incentives. Incentives to produce are replaced by incentives to receive statist handouts.

The economic distortions these handout programs cause is truly massive. What kind of sense, for example, does it make to pay farmers not to produce food? Agricultural price supports are a related absurdity. By setting maximum prices (ostensibly to help the poor) government artificially pumps up demand for a product at the same time it curtails the incentive of the producer to supply the commodity. Increased shortages result.

Minimum wage laws and union wage floors, again designed to aid certain targeted groups, have the same effect. The employer’s demand for labor is reduced (labor, like everything else, is a cost phenomenon) at the very time the higher wages guarantee an increase of job applicants; the end result is a certain amount of unemployment. Those lucky enough to obtain the artificially high-wage jobs benefit at the expense of the unemployed; this is the collectivist’s idea of “compassion” (of course, in a free market, all who wished work and the opportunity to acquire skills and advance would have a job at market wage rates). It is unnatural to be unemployed, and anywhere and everywhere this condition occurs, it is a sign of market interference of some sort.[9]

Benefits of Deregulation

All government interventions in the domestic economy, and international protectionism as well, have a common denominator: restricted supply and higher end-prices to the consuming public. Where government backs off, immediate positive effects are realized. Airline and trucking deregulation has led to a flourishing of new carriers offering better services at lower prices to the consuming public. Of course, the Teamsters Union and executives at Eastern Airlines may be less than happy, but the masses benefit.

Confiscatory tax rates and inflation are perhaps the most insidious interventions of all, however, for they lead literally to the destruction of civilized society (as Lenin once observed). Taxes are a direct disincentive to produce, and the phenomenon of “capital flight” is a direct result of high progressive rates. Is there any doubt as to why Bjorn Borg left his native Sweden for Monaco? Trying to grab ever more income, the Swedish government lost it all. This is but one example of a widespread phenomenon—tax avoidance and outright evasion are dramatically increasing, as luxury goods boom and the “underground economy” grows perhaps beyond 15 per cent of Gross National Product.

Inflation is a surreptitious tax caused directly by government mismanagement of the money supply. By continually inflating the money stock, the FED adds high uncertainty into longterm contracts, stifling business investment. Why would any creditor loan to a debtor when the payback will result in cheapened dollars? As money loses its unit of account and store of value functions, this relationship is ruined, and further impedes vital trade. Fixed-income pensioners are devastated by real wealth transfers away from them, yet “compassionate” government officials scoff at attempts at monetary reform.

The worst aspect of inflation, however, is undoubtedly that it is a key ingredient of boom-and- bust business cycles. By falsifying interest rates, flows of investments into capital goods industries are stopped as inevitably project costs rise, and resources flow into consumer and service sectors only later. Malinvestment and misallocation of scarce resources, with attendant hardship and disruption for human beings, is always the end result.[10] This is best exemplified by the current situation in the United States, where certain sectors and geographic areas have enjoyed a sparkling recovery, while other sectors, such as agriculture and certain import-export businesses, are lagging. Inflation and intervention always combine harmfully, with grave human costs.

The Unseen Effects

In addition to the foregoing distortions, socialism’s toll must be viewed in terms of opportunity cost. What would have been built, produced, and delivered in lieu of the inefficient profligacy of government? What would each individual and group have done with their extra income? We of course will never know. Certain individuals or groups benefit from subsidies or direct transfers in the short run, and these positive effects are seen by all (a public housing project is of course highly visible, for example). The aggregate costs which burden the rest of society will in the longer term far outweigh the short run visible benefits, however. These costs are currently widespread and diffuse, but they are growing rapidly, and will come due.

In addition to economic distortion and curtailed production, interventionism leads to expanding powerful bureaucracies. Groups no longer motivated to produce and serve the consuming public instead lobby for a larger portion of government handouts (colloquially, grab a larger portion of a redistributed pie rather than grow the whole pie). Senators and Congressmen, looking only toward winning the next election, set up large bureaus to visibly transfer resources to privileged groups. Such an environment, geared toward redistribution rather than production of wealth, is highly conducive to the waste, fraud, and corruption so often found.

This is another predictable consequence of interventionism, because government bureaus are not subject to the rigor and discipline of the free market; where there are no pricing signals or competition, there will be tremendous inefficiency and waste. Does anyone really know the pur pose of the Department of Energy? Has it produced any oil? Has the Department of Transportation produced any autos, or run transit systems effectively? What do the Labor, Commerce, and Education Departments really do? Would the free market have granted thousands of dollars to study insect sex lives, or the effect of pornographic literature on children?

Obviously there is tremendous waste in a system where groups are encouraged to spend productive time trying to obtain grants from government bureaus. The masses who are not beneficiaries are big losers. Innovation will always be stifled under such a system. Can anyone see a self-serving Federal Department of Railroads, under heavy pressure from railroad industry lobbyists, granting a government permit to the Wright Brothers to test their airplane? How fortunate socialism was not well developed in the United States in 1903.

Legal Plunder

Perhaps the worst effect of socialism, however, is that the transfer society is tantamount to legal plunder.[11] Leaving aside the obvious disincentives, what is “fair” about taking differing percentages of income from different laborers? The United States once had the highest taxpayer compliance in the world, but the increasing perversity of the transfer society has caused millions to enter the underground economy. People fight the government’s unfairness by becoming corrupted thieves and tax-cheats.

Additionally, the transfer society promotes true Marxian “class warfare,” as several special interests compete for government handouts. Beneficiaries and victims, agriculture and small business, black and white, and young and old are but a few of the many groups fighting each other for privilege. In fact, the conflict has many levels; within the agricultural lobby, for example, tobacco interests are surely in contention with dairy farmers for agricultural price supports. Socialism breeds violence and warfare, as competing entities vie for what is “fairly” theirs.

In summary, then, the command economy has proved to be a failure because it is based on a false theory of human nature. To understand this one need only observe masses of people seeking freedom and opportunity, “voting with their feet” worldwide (Southeast Asia and Cuba are recent examples of a popular flight from socialism), or talk briefly with the likes of Lech Walesa to know why: government programs take away the incentive to work and produce.

Seeds of Conflict

Capital formation, the necessary prerequisite to an increased standard of living and improved quality of life, is stifled as government bureaucrats and politicians wield power which rightfully should fall to consumers. Strife and conflict replace the peaceful coordination and exchange of goods and services that capitalism provides. Once this is discerned, it is easy to see why the bil lions spent on “social programs” in the last 20 years have done nothing to end poverty in the aggregate.

It is no coincidence that socialism’s most ardent supporters are relatively wealthy, and are often found in academia or the media. Coming from a controlled and comfortable environment, these people seek only to lift the living standards of the poor. Their aims and concerns are commendable, but their intellectual arrogance is unseemly. They wish to order society after their own fashion, and impose their own designs and standards on the rest of us, thinking they know best. Having no knowledge of economics, they pursue policies which in the end cause misery to the unemployed, condemn millions to poverty, stifle innovation and production, and in the long run lower us all. In their ignorance, they disparage the very system that has brought them several amenities of life and the time to deride capitalism, and they vote for politicians and policies which will come to hurt them, ironically. The road to hell is, after all, paved with good intentions.

However, ideas rule the world, and the human spirit burns to be free of all man-made fetters. Those who understand the free market must undertake to explain the adverse consequences of interventionist policies to the well-meaning but misguided proponents of collectivism, and re- turn again to freedom, prosperity, opportunity, and peace for all individuals. The alternative is too sad to contemplate.


1.   See Thomas Hobbes.

2.   See Ludwig von Mises, The Anti-Capitalistic Mentality.

3.   Mises makes reference to the blatant fallacies of Marxist interpretation on this point several times in his various works.

4.   See Adam Smith, The Wealth of Nations.

5.   Keynes, of course, felt government could ingeniously temper these animal spirits, and his General Theory prescribes the formula.

6.   Clarence B. Carson gives an excellent rendition of socialism’s soothing rhetoric and appeal in The World in the Grip of an Idea (New Rochelle, NY, Arlington House Publishers, 1978).

7.   A growing body of literature, exemplified by George Gilder in Wealth & Poverty and more recently by Charles Murray in Losing Ground, points to the harmful social effects of bad economics. For example, the number of single-parent black families and illegitimacies has risen steadily over the last twenty years.

8.   This is the traditional analysis of the Austrian school of thought, which makes use of the tenets of praxeology and methodological individualism to arrive at valid conclusions.

9.   Hans Sennholz, “The ‘Natural’ Rate of Unemployment” (The Freeman, November 1984, pp. 644-650).

10.   Only Austrian business-cycle theory adequately explains concurrent inflation and recession. The reader should look to authors such as Mises, Hayek, Rothbard, Sennholz, and others.

11.   Dean Russell, “The Source of Rights” (The Freeman, November 1984, pp. 661-668).


Government is not capable, by nature, of being productive or constructive. In its capacity as government, it acts to restrain and restrict. When it uses these powers against those who would disturb the peace in one way or another it enables peaceful men to produce and construct. When it uses them to restrain peaceful men, it inhibits the constructive. Thus it is that limited government is the requirement for releasing the energies of men.

Clarence B. Carson

ASSOCIATED ISSUE

May 1985

comments powered by Disqus

EMAIL UPDATES

* indicates required

CURRENT ISSUE

November 2014

It's been 40 years since F. A. Hayek received his Nobel Prize. His insights, particularly on the distribution of knowledge and the impossibility of economic planning, remain hugely important today. In this issue, we look back on the influence of his work. Max Borders and Craig Biddle debate whether liberty must be defended from one absolute foundation, further reflections on Scottish secession, and how technology is already changing our world for the better--including how robots, despite the unease they cause, will only accelerate this process.
Download Free PDF

PAST ISSUES

SUBSCRIBE

RENEW YOUR SUBSCRIPTION