From our esteemed contributing editor, Dr. Leonard Carrier, comes this provocative post.
Free-market capitalism has come to dominate our economic thinking. It has even led to the mistaken view that there is no other variety of capitalism than the free-market kind. Capitalism is the view that a nation’s economy, for the most part, is better left in private hands rather than being centrally planned by government. In this respect it differs from socialism or fascism, where, though private industry is allowed, it is in all respects directed by government decree or regulation. It is thus necessary to distinguish capitalism from “statism,” recognizing that there might be different varieties or degrees of capitalism, some in which private business is monitored carefully by the state, as in China, and other varieties in which government regulation is either stronger or weaker–stronger in the case of Germany and weaker in the United States and Russia.
A free-market capitalism would then be capitalism without any government regulations or restraints. It would constitute a free market in which property rights are exchanged voluntarily by mutual consent of buyers and sellers, without coercion or constraint, where prices are determined solely by supply and demand, and where government does not directly or indirectly regulate prices and supplies.
Obviously, there is no such thing as free-market capitalism in the world today, especially not in the United States; for even those who champion free markets make exceptions for patents and copyrights, which constitute government regulations that favor publishing companies and pharmaceutical companies.
Free-market economists might agree that no free market actually exists, but that (1) if not for government interference free markets would exist naturally, and (2) that it would be better for all if we strived to approximate free-market capitalism in the real world. A defense of (2) is usually called laissez-faire economics, in which government is confined to intervene in economic matters only to regulate against force and fraud among market participants, and perhaps to raise taxes to fund the maintenance of the free market. I contend that (1) and (2) constitute the myth of free-market capitalism and that both of them are demonstrably false. I shall argue first against (1).
Those who support (1) confuse free-market capitalism with globalization. Globalization is the view that ongoing technical innovation has led inexorably to a global capitalistic economy. It is then further assumed, as Thomas L. Friedman does in The World is Flat, that globalization leads inexorably to free markets. Such an assumption is ill-founded. Karl Marx believed in globalization, but he thought that it would inevitably lead to a communistic society. Accepting the view that we live in a period of increasing technological progress does nothing to show that this leads to one worldwide economic system. Globalization may be unstoppable, but the economic systems it creates do not necessarily merge into one.
John Gray’s book, False Dawn: The Delusions of Global Capitalism, forcefully shows that governments have engineered every case of a free market. Historically, state intervention has always been involved in the economic development of Great Britain, Japan, Russia, Germany, and the United States. Only recently in the United States has our government, under the influence of Friedrich Hayek and Milton Friedman, flirted with the notion of creating a global free market. According to Gray, such free-market thinking in the United States is really a relic of the Enlightenment, belonging to John Locke’s world and not to ours. This is Enlightenment utopianism that has no basis in reality. Consequently, there is no empirical basis for asserting (1).
The foundation for free-market thinking embodied by (2) is that rational human beings, each by selfishly seeking his own good, will promote the good of all. Adam Smith’s “invisible hand” has been cited to support this. But a careful reading of The Wealth of Nations, in which the notion of an invisible hand is mentioned only once, shows that Smith used that notion to support domestic markets over foreign ones and not to support global free markets. Smith, like Joseph Butler before him, thought that humans were mainly governed by their emotions, and so if everyone were really to look after his own self-interest it would usually produce a better outcome for all. It has been assumed by free-marketers that emotional distortions can be corrected by the use of reason. But it is precisely this assumption that appears to be false.
Free marketers assume that in the ideal situation agents are well-informed, that their preferences are well-ordered and stable, and that their actions are controlled, self-centered, and calculating. Psychological research, beginning with Kahneman’s and Tversky’s 1979 article, “Prospect Theory: An Analysis of Decision under Risk,” shows instead that people’s judgments are biased, and their preferences are changeable and unstable. More recently, J. D. Trout’s book, The Empathy Gap: Building Bridges to the Good Life and the Good Society, lists several cases in which the use of reason is no antidote to the way we make decisions, suggesting that emotional bias is hard-wired into our central nervous systems and cannot be removed easily, if at all. Such things a “base-rate neglect,” “over-confidence bias,” “anchoring bias,” and “loss aversion” are all ways in which our reason is over-powered by our ingrained biases.
There is also further empirical evidence to show that even when individuals act selfishly from perfect economic freedom they rarely enhance the good of others, or even themselves. One such bit of evidence is known as “the tragedy of the commons.” Jared Diamond, in his book, Collapse: How Societies Choose to Fail or Succeed, shows how the tribes of Easter Island, each seeking its own good, brought about the failure of their society.
A second sort of counterexample to (2) is the phenomenon known as “the race to the bottom,” which is a special case of “the prisoner’s dilemma.” Here, the optimal outcome for an entire group of participants results from cooperation of the participants, whereas the optimal outcome for each individual is not to cooperate while others do cooperate. An example is tax competition among nations. Each nation may benefit from having a high tax on corporate profits to promote income equality. But nations can benefit individually with a lower corporate tax rate to attract business from other nations. This hurts all but the one that lowered the tax rate. To be competitive, each of the other nations would have to lower its tax rate, thereby “racing to the bottom” with a result less favorable in promoting income equality and the good of all.
I conclude that both (1) and (2) are false, and so free-market capitalism is simply a myth that needs to be relegated to the dustbin of economic theory.