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Saturday, October 22, 2016

Allergic to “Capitalism”? Call It “Trade-Tested Permissionless Innovation”

Young people think they don't like capitalism. They should think again.

A recent survey of millennials reveals some results that should be of interest to those of us who care about free enterprise and the market economy. Slightly more 18-29 year olds (58% vs. 56%) had a favorable view of socialism than of capitalism. That’s a disturbing result.

There’s some evidence that the term “capitalism” is getting in the way of communicating effectively with millennials.However, if the wording was changed to a comparison of a “government managed economy” to a “free market economy,” the results change dramatically with 64% viewing a “free market economy” favorably and 32% viewing a “government managed economy” favorably. There’s some evidence that the term “capitalism” is getting in the way of communicating effectively with millennials.

Our Word Problem

Many of us have long thought that the term “capitalism” is problematic for a variety of reasons. This is not just a modern concern either. In Law, Legislation, and Liberty in the early 1970s, Hayek argued that capitalism is a misnomer for the system he wished to defend:

“Capitalism” is an appropriate name at most for the partial realization of such a system in a certain historical phase, but always misleading because it suggests a system which mainly benefits the capitalists, while in fact it is a system which imposes upon enterprise a discipline under which the managers chafe and which each endeavors to escape.

For Hayek, as for many of us, the problem with the term “capitalism” is twofold:  1) it suggests that it is “capital” that is central to how the system works; and 2) it suggests that the owners of capital are the system’s primary beneficiaries. The first is misleading and the second is just wrong.

A System for Everyone

The monarchies and churches of ages past had plenty of capital, but they lorded over impoverished worlds.In a market economy, it’s helpful to have capital of course, but the motor of economic progress is the ability to put your ideas out into the world and to have them tested by profit and loss as indicators of value creation for others. Doing so requires that capital be privately owned and that those owners are able to reckon the value of their capital in terms of profit and loss so that it can be deployed in ways that generate wealth.

But doing that requires the freedom to act and the respect for profit and loss as a way of organizing economic activity. The monarchies and churches of ages past had plenty of capital, but they lorded over impoverished worlds.

It is “everyone else” who has benefitted the most from “capitalism.” Capitalism brought, and markets continue to bring, to the masses goods and services that were at first only accessible by the rich. As Schumpeter argued decades ago:

The capitalist engine is first and last an engine of mass production which unavoidably also means production for the masses. . . . It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within reach of factory girls.

A hundred years ago, accessing the libraries of the world in one place was even beyond the reach of the wealthiest. Today, we all carry the world’s libraries in our pockets. “Capitalism” did that, and the primary beneficiaries have been the world’s poor and middle class, not the 1% or the owners of capital.


Accuracy in Nomenclature

I am not a marketer, so my proposed alternative is not something that rolls easily off the tongue. However, it does have the advantage of accurately describing how the system works and can at least be a phrase we use when we talk about how “capitalism” generates its good results.

In her most recent book, Deirdre McCloskey raises some similar concerns about the term capitalism and decides instead to write of “trade-tested betterment.” This is a useful term for describing what she calls The Great Enrichment of the last 200 years. And I like the phrase “trade-tested” as it captures the way in which the discovery process of the market and its system of profit and loss indicate to us whether our actions have created value for others.

What’s missing from McCloskey’s term is the other key aspect of that discovery process: the freedom to put our best ideas forward. Other recent economic literature emphasizes the idea of “permissionless innovation” as being key to economic growth. When people can put their ideas out there without requiring permission from any authority, or when no one seller can obtain a monopoly that legally excludes competitors, we have the possibility of “permissionless innovation.”

Why not blend this with McCloskey’s term?  I would argue that what best describes the discovery process of competitive capitalism is that it is a process of trade-tested permissionless innovation.

It is a system in which people are free to deploy their property as they see fit (with equal respect for the right of others to do the same), to innovate, to contract, and to engage in labor on terms they find acceptable. And they can do this all without the permission of others. It is the profit and loss system that tests whether or not their ideas have created value for others.

A Discovery Process

A permission-driven economy becomes what Rand called “an aristocracy of pull” or what we call “crony capitalism.”Where there are no barriers to people trying out their ideas, we get the maximum range of possible ways of improving people’s lives. Again, markets are a discovery process, like the search for knowledge in science and academia. It’s why we value academic freedom and freedom of speech, and the freedom to pursue the scientific research we think is valuable. We don’t know the answers ahead of time and discovery processes like markets enable us to figure that out, first by allowing anyone with an idea to take a shot.

We also know that when you have to ask permission to try something new, there’s no way that those who are granting the permission can know if your idea is good or bad ahead of time. And we also know that once in possession of that power, the dispensers of permission will inevitably favor their friends and those who make it worth their while to say “yes.” A permission-driven economy becomes what Rand called “an aristocracy of pull” or what we call “crony capitalism.”

It’s one thing to have the freedom to innovate but then how do we know which ideas are valuable and which are not? This is the role of prices and the profit and loss system. This is what it means to be “trade-tested.”

Profits and losses inform and incentivize us. Profit means what you sold was more valuable than what you made it out of, and losses mean the reverse. If your invention is profitable, it’s an innovation and lives are improved. It’s easy to have new ideas, and in a permissionless economy you’re free to put them into play. But that’s not enough to ensure human betterment. That requires a process to figure out which inventions are true innovations.

Everyone Wins

Only a society that does not require permission for people to innovate, tests those innovations by trade via profit and loss, and, as McCloskey continually reminds us, views profit-seeking through trade as ethical behavior and accords dignity to those who engage in it, will deliver the dramatic human betterment we have seen in the last 200 years.

Trade-tested permissionless innovation. It doesn’t roll off the tongue, but it’s the source of the human betterment of the last 200 years. We fail to recognize it, and we fail to help others recognize it, at our own collective peril.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.