What makes the American capitalist system, as opposed to the “capitalism” practiced in other countries, work so well? If your answer includes flexible prices or relatively low taxes, secure property rights or efficient capital markets, you would be woefully misguided. According to Thomas Friedman in the July 28 New York Times (“In Oversight We Trust”), what makes our system the “envy” of foreigners from Argentina to China is “the FAA, the FDA . . . the EPA,” and yes, “the IRS, the INS, and the FBI.”
Friedman writes, “[O]ur federal bureaucrats are to capitalism what the New York Police and Fire Departments were to 9/11-the unsung guardians of America’s civic religion . . . that says if you work hard and play by the rules, you’ll get rewarded and you won’t get ripped off.” The analogy suggests that capitalism without a huge regulatory apparatus would be a disaster of 9/11 proportions. He explains his strange, but probably not untypical view by arguing that “fear and greed are built into capitalism. . . . [W]hat distinguishes America is our system’s ability to consistently expose, punish, regulate and ultimately reform those excesses.”
In one sense Friedman is right, the system does “expose, punish, regulate” and ultimately lead to reform. But he is confused when it comes to identifying the part of the system that gives rise to this process. It is not the bureaucracy, not the alphabet soup of regulatory agencies mentioned above, but the market itself that punishes bad behavior, rewards good behavior, and leads to change. The regulatory agencies he credits for the success of capitalism cannot improve on the market, but only make it worse.
Friedman’s view demonstrates almost no understanding of the nature of capitalism or government. This is reflected in several comments. As noted, he says “fear and greed are built into capitalism,” and therefore the importance of the heroic bureaucracies is that they keep “excesses” in check. Of course “greed,” that is, self-interested behavior, is part of capitalism. Indeed, it is part of human nature and therefore of all economic systems. What distinguishes capitalism is that it channels “greed” into activities that benefit society as a whole. The same cannot be said for the SEC, EPA, and the rest. In fact, as “public choice” analysis has demonstrated, most of what these bureaucracies do can be viewed as attempts to maximize their own power and budgets. His comment about fear is truly bizarre, considering that he praises the IRS, INS, EPA, and FBI. These agencies pursue much of their agenda by instilling fear.
A second comment suggests that Friedman really knows nothing about what goes into a capitalist system. He states that while “Mexico or Argentina, Russia or China . . . have . . . the hardware of capitalism . . . they don’t have all the software-namely, an uncorrupted bureaucracy.” The hardware of capitalism is its basic institutions. Foremost among these are defined and enforced property rights that include the right to exchange property on any mutually agreeable terms-in other words, an unencumbered and flexible price system. To suggest that those countries have institutional “hardware” anything like this, and that their main problem is corrupt bureaucracy, shows no understanding of either capitalism or the civil and economic institutions there.
This lack of understanding leads Friedman to his erroneous conclusion about the importance of regulatory agencies and presumably the laws they enforce. In a free market, businesses do not have the freedom to pursue greed wherever it takes them. Both the rules of the market and the market process itself put severe constraints on business behavior. Free-market activity demands respect for other people’s property. For example, under laissez-faire capitalism, where property rights are clearly defined and enforced, constraints on the polluting activities of industry would exist without a massive and intrusive EPA bureaucracy. If a firm’s pollution harmed others, it would be held responsible for all damages. Likewise fraud and misrepresentation would also be recognized as illegitimate conduct.
Bureaucracy Not Necessary
Prohibiting pollution and fraud is not an intrusion into the capitalist system but part of what it means for the system to exist. Ensuring that people abstain from those offenses does not require the large bureaucratic apparatus consisting of the SEC, FTC, EPA, and DOJ to regulate business activity. It requires an efficient civil-court system where contract disputes and claims of fraudulent advertising and cooked books can be adjudicated and, if proven, compensation awarded to victims.
Perhaps most egregious of all is Friedman’s failure to understand how the market process itself checks harmful behavior. Unlike the government agencies he praises, when businesses are abusive to their customers, or corporations deceive their stockholders, they are penalized. And if they do not reform they are driven out of business-just ask Enron, Arthur Andersen, or WorldCom. While the officers of those companies may eventually be punished for alleged wrongdoings, which may or may not have involved actual violations of other people’s rights, the market’s punishment has already occurred. It was swift and severe. One need only ask what the market consequences would be for any business that treated its customers the way the IRS treats taxpayers or that managed its books the way, for example, the Pentagon does. The company would be bankrupt in no time. The marketplace is much swifter and harsher in doling out justice than any political agency. Indeed, abuses by government agencies, even when exposed, often go unchanged indefinitely.
Friedman apparently has infinite faith in human beings as bureaucrats with power to impose arbitrary rules, confiscate property, and transfer wealth-and almost no trust in free individuals. This blind faith in government, held by more and more people since 9/11 and the recent corporate scandals, is not only naïve but also betrays the principles on which America was founded. Ultimately it is dangerous to a free society.