Why is capitalism not what you think it is?
Learn why unrestrained market capitalism isn’t all it's cracked up to be!
Most economic gurus on television or in newspapers adhere to the same theory: free market economics. With so many individuals holding the same viewpoint, you can be misled into believing there is only one economic path to adopt.
But you'd be wrong; there's a lot wrong with free market economics. Far from being a perfect, scientific approach, it involves numerous incorrect assumptions about how the economy and society function. There are additional approaches to consider. However, they should be more noticed by the media.
In this summary, you will learn precisely what is wrong with free market capitalism and what we can all do to find better alternatives. After reading the following arguments, your knowledge of economics will be forever altered.
In these summaries, you will learn:
Why government planning does not always lead to Soviet Russia,
Why economists believe you should avoid paying your cab fare
You need to discover why earning the Nobel Prize in Economics does not make you a financial expert.
1. Regardless of what free-market economists claim, their subject is not objective natural science.
You are undoubtedly familiar with the global financial crisis that occurred in 2008. You may also recall that in the following months, economists were the most distrusted professionals in the world, except bankers. However, this backlash was not unfair to economists; it was an appropriate response to their haughty attitude in past years. Quite simply, economists had outgrown their boots.
One indication of economists' overconfidence was their idea that only they could fully comprehend the complexity of economic theory. This led them to ignore criticism of their ideas as overly simplistic.
However, this was and is simply not the case. Instead of being overly complicated for outsiders, 95 percent of economics is straightforward common sense.
You can think about it this way. Even if you are not a skilled epidemiologist, you know what hygiene standards you want while dining out. The same is true for economics; the fundamental concepts may be understood by everybody. After all, you don't have to be the head of a central bank to know that a government shouldn't spend all its money on hazardous ventures.
This arrogance also caused mainstream economic education to dismiss any alternative hypotheses.
One economic theory has dominated the past few decades: neoclassical free market theory. This concept holds that every member of society behaves rationally and selfishly, making financial decisions solely to benefit themselves. The economic profession began to see this hypothesis as almost a natural science. As a result, they became overly focused on a normative theory rather than its practical application.
However, unlike physics, economics is a social science. This means numerous potential alternative hypotheses exist, each of which is equally demonstrable as the free market method.
The following overview will reveal the main flaws in free market economic theory.
2. Individuals cannot make entirely rational economic decisions, contrary to popular belief among free market economists.
In 1997, two economists, Robert Merton and Myron Scholes, received the Nobel Prize in their respective fields. Their views were primarily based on the belief that when making economic decisions, such as where to put their money or which product to purchase, humans made entirely logical choices.
After receiving such a prestigious award, the two economists implemented their theories in the actual world. However, instead of making tremendous sums of money, they found their companies bankrupt twice in less than a decade!
The failure of Merton and Scholes offers us an important lesson. You can't expect humans to always behave rationally.
Why?
To make sensible decisions, people must analyze every piece of information. For example, while determining where to spend our life savings, we must consider every possible scenario, alternative option, etc. We can make the right decision only once we have all of this information.
However, in today's environment, it is impossible to comprehend all of the information before making a decision; thus, our choices cannot be rational.
However, this does not imply that we behave wholly irrationally. Instead, we are restricted to constrained rationality. We try hard to be sensible but need more intellectual aptitude to make the best decision. But how can we adapt our economic thinking to reflect this?
To assist us in making the most significant judgments possible, the government must intervene in the marketplace to limit our economic options. If we are only presented with options whose consequences we understand, we can begin to make better judgments. The government already operates in this manner in other sectors. For example, the authorities prevent us from obtaining pharmaceuticals with unknown adverse effects or vehicles with low safety standards. Why shouldn't they follow the same rules in the business world?
3. Humans are not entirely selfish; we frequently behave out of altruistic motivations.
Have you ever felt tempted to leave without paying for your taxi ride? Assuming the driver is not Usain Bolt, you should be able to get away with it. Even though the thought occurs to you on occasion, you always dismiss it and pay your fare.
However, as rational as paying for your cab may appear, free market economists will argue that you are doing unreasonably. They say we are all programmed to act selfishly; hence, we should always flee without paying.
To explain why we don't appear to follow their theory, free market economists point to the hidden rewards and sanctions of our behavior. These are the expenses and advantages that, while not immediately apparent, will have an influence in the long run.
So we pay for cabs to avoid creating a reputation as fare dodgers. A person with such a reputation would be absolutely avoided by taxi drivers and would never be able to catch a ride again.
However, the hidden costs and consequences principle does not apply in a selfish society.
Let us return to the taxi case. If we ran away, the taxi driver would be responsible for punishing us. He would have to follow us down, collect our fare, and photograph us to show other taxi drivers in the area. And while he was doing this, he would leave his cab fully unattended, putting it in danger of theft or damage.
If he merely thought of himself, there would be no value to him: the fare he'd reclaim would be minimal, and why should he aid other taxi drivers by finding us down?
We pay for our taxi journey because we have other priorities, such as honesty, honor, and respect, rather than pure selfishness.
4. The economy needs to pay individuals what they deserve.
Would you agree that "we should all earn what we deserve"? That sounds sensible. However, if you are from a wealthy country, you should think twice about wanting this. If paid what the market believes you deserve, your income would likely fall alarmingly. How could this be?
This is because workers' wages in the industrialized world are sheltered from market pressures; thus, they remain high regardless of how valuable the work is.
For example, whatever work you have, people in other nations will be willing to do it for less money. You are not susceptible to this competition because the government safeguards your job. They impose tight immigration regulations to keep people from impoverished nations out of the workforce. Your wages remain artificially high while you are safe from these workers.
This example also demonstrates how much you earn is determined by the society in which you live rather than your skills. Living in a prosperous, productive society will increase everyone else's wages. Even if you are the laziest and most unproductive worker, you will earn more than a hard worker in a poor country.
Wage disparities can also be evident within particular societies.
Those with higher earnings will earn far more than they deserve than those at the bottom. For example, in the early 1990s, top executives discovered that their pay climbed by 100 times that of the typical worker. This gap has grown to 400 times its original size after 20 years.
Is this because the executive earns more than the worker each year? The evidence suggests otherwise; the average executive is not 400 times as productive as the average employee. Thus, in commercial terms, their increase is unjustified.
5. A strong manufacturing sector is more crucial to economic growth than a vital service or tech industry.
What do you think when you drive past an abandoned, deteriorating factory? If you live in the developed world, you may associate it with media coverage of the demise of domestic industry. These facts may lead you to believe that manufacturing is almost extinct in the West, but you would be mistaken.
People frequently believe that industry is in decline because they misinterpret statistics.
For example, people have noticed fewer people working in manufacturing than in the past. However, this does not imply that the industry is shrinking; it is becoming more efficient.
Nonetheless, many politicians have urged developing countries to consider transitioning from manufacturing to the service and knowledge industries. However, this action would hurt the entire economy.
Take services as an example. Over the last few decades, the service economy has expanded to include retail and information technology industries. However, it would be risky to become overly reliant on this sector.
One issue in the service sector is the slow rate of productivity growth. In most circumstances, increasing a service's output will result in a worse quality end product. For example, Macbeth's ten-minute performance would be more productive, but the quality would suffer significantly. Therefore, an economy reliant on services will find itself growing very slowly.
Then, there's the knowledge economy, built on the development and dissemination of information. Since the birth of the internet, people have proposed that the knowledge economy has immense potential.
However, this needs to be more accurately estimated. Significantly from being a revolutionary invention, the internet has had considerably less influence than past advances in communication. The telegraph, for example, lowered the time it took to transmit a message from two weeks to 7.5 minutes, a factor of 2,500.
However, the internet only increased efficiency from ten seconds (from a fax machine) to two seconds, a mere five-fold decrease.
6. The financial crisis was created by a deliberate accumulation of risk in the system.
The 2008 financial crisis had a severe impact on the worldwide economy. It halted more than a decade of economic development and dragged some of the world's largest financial institutions to their knees.
However, many of the corporations most affected by the catastrophe — for example, the insurance giant AIG or the investment bank Lehman Brothers – played a significant role in their downfall.
How?
The financial system had become more sophisticated in the years before the crisis. Bonds, called financial derivatives, were invented to develop new goods to trade. Although they were first quite profitable, their sheer complexity concealed significant risk.
Pools of securities, such as home loans, were utilized to produce an ever-increasing variety of financial derivatives. And as more of these were generated using the same security, the risk increased.
Imagine constructing a house on a little plot of land. Because you cannot build outward, you opt to build upward and add story after story to the house. What do you think will happen? With each extra floor added, the house loses stability and becomes increasingly unsteady.
In addition, there was another issue. Each new financial product generated was of lower quality than the last. Let's return to our narrow but towering residence. Consider making each new level out of progressively inferior materials like paper or plasticine. Such a construction would only last for a while before collapsing.
Although the crash affected countries worldwide, the most brutal hit was those that had liberalized their markets.
For example, Ireland and Latvia, which had both opened up their markets in the years preceding the crash, suffered severely; the Irish GDP shrank by 7.5% and the Latvian by 16.5%.
7. Despite economists' fears, government economic planning is already taking place and doing well.
Should the government ever intervene in the operation of the economy?
Free market economists would quickly say no. They would say that when the state intervenes in the economy, the outcome is invariably anarchy. These economists refer to the complete failure of regulated economies, such as those in the Soviet Bloc, and claim that this inevitably happens when the state intervenes.
Despite what free-market theory claims, governments can and do play an essential role in economic progress.
For example, the state frequently understands the overall economy more than individual businesses. And this knowledge can be used in the most profitable sectors.
This is what occurred in South Korea. LG, a major electronics company, had planned to focus on the textile sector, but the government objected. They felt the firm would be more successful if it focused on electronics, so they pushed it into that industry.
This is not limited to government policy in underdeveloped countries. The US government also carefully fostered the early development of the now-dominant internet, biotechnology, and aerospace industries.
But why did government planning work in these scenarios, not in Soviet Russia? The goal is to avoid trying to exert too much control.
If the state attempts to dominate all aspects of the economy, as it did in the communist era, it will fail. However, it can succeed if it only helps to guide the system by establishing broad objectives, such as inflation targets and interest rate management.
In doing so, the state functions similarly to a firm CEO. A CEO's goal is to establish strategic objectives to ensure the company continues growing in the right direction. The purpose of the state is to accomplish the same thing for the entire economy.
8. Social welfare is critical for sustained economic progress.
Across the developed world, free-market economists are calling on governments to reduce their social welfare benefits. They claim that providing benefits such as unemployment insurance or holiday pay promotes people for not working.
Despite what their theories claim, data from the real world demonstrates that, far from being a drain, social welfare is critical to economic success.
We can observe this when we look at labor markets. Countries that provide generous assistance to the unemployed have more dynamic economies than those that limit assistance.
The reason for this is apparent. People in countries with limited unemployment benefits are scared about losing their jobs. As a result, individuals seek employment in sectors of the economy where they perceive the most safety. They frequently gravitate toward solid professions like healthcare and law. While these may be socially important, they do not generate significant economic growth.
To achieve growth, encourage people to enter the economy's riskier, more entrepreneurial sectors. It is not a surprise that nations that help individuals who try but fail outperform those where the cost of failure is poverty.
While data demonstrates that social assistance aids growth, the converse of the free market alternative, called the trickle-down effect, may be argued.
Free market advocates argue that if the government spent less money on welfare, it would not have to collect it in taxes. Wealthy people could then invest their money directly into the economy. This money would flow into the economy as investments generate additional growth and jobs.
However, the theory has yet to yield the expected outcomes where it has been tested. Growth slowed in countries that adopted free market policies in the 1980s, including the United States and the United Kingdom. And as growth slowed, money stopped trickling down and remained at the top.
For example, between 1979 and 2006, the wealthiest one percent of incomes in the United States more than doubled their proportion of national income, rising from 10% to 22.9%.
9. We must stop fixing emerging countries with the wrong tools.
Many Western politicians, economists, and pop singers believe they know what measures will assist in eradicating poverty in developing countries.
Despite their confidence, most of the developed world's thinking on poor countries appears to be based on incorrect assumptions.
One common misunderstanding among Western policymakers is that the causes of poverty in developing countries are structural. Inhospitable climates, landlocked locations, and challenging terrain are examples of structural factors. However, wouldn't Austria and Switzerland, which are landlocked and hilly, struggle economically if this were the case?
Another common Western misconception is that emerging countries need to gain the dynamic business spirit of the developed world. However, this is not the case; in emerging countries, self-employed people account for 30-50 percent of the workforce. In the prosperous West, just 10% of the workforce is self-employed. You cannot claim that non-Western countries lack business spirit.
Westerners who wonder why developing countries stay poor should look for answers closer to home. The fact is that Western free-market policies pushed on developing nations contribute significantly to their poverty.
For example, in the 1960s and 1970s, Sub-Saharan African countries were growing steadily. This was due to their governments' protection of their economy, which included subsidies for home businesses and protection from outside competition. However, when Western governments compelled them to open their markets in the 1980s, their internal economies collapsed.
If we wish to reverse this pattern and move developing countries forward, we must first recognize how the West became wealthy in the first place. It happened because, in the nineteenth century, Western countries shielded their economies from foreign competition. For example, foreigners were barred from becoming financial directors in the United States, and customs taxes on imported goods were 50%.
Wouldn't it be better to let underdeveloped countries choose this path?
10. The problem is not capitalism but how we build it.
After reading these summaries, you may be getting upset about capitalism. However, before joining the Communist Party, you need to understand that it is not capitalism itself that is to blame, but rather a specific sort of capitalism: free market capitalism.
In truth, capitalism may be a highly effective method of managing the economy.
For example, the profit motive, or the desire to make money, is an effective motivator. People's desire to start a successful business has led to numerous ideas and advancements.
Capitalism is also an effective means of coordinating the economy.
The market is an excellent approach to ensure that labor and capital are swiftly directed to the most needed regions. With the market to guide individuals where they are needed, we could wind up with hundreds of music stars but more plumbers!
However, despite capitalism's benefits, it can be extremely harmful if not properly governed.
We should think of the capitalist economy as a car. If you build a car without any safety equipment, such as brakes or seatbelts, there is a reasonable risk that the vehicle will crash and cause injuries.
Unfortunately, the current prevalent view of capitalism implies establishing a primarily unregulated economy. However, there are alternatives. It is conceivable to abandon the free market and create a better, more equitable, safer economic system.
One approach would be to use the concept of bounded rationality, which holds that we make better decisions with limited alternatives.
We need to give the government more economic influence to pursue this strategy. It would then use this power, for example, to limit bankers' capacity to make dangerous investment decisions. This would help society to make better-informed and safer decisions.
Final Summary
Refrain from accepting expert economists who claim that the free market is the only way to govern the economy; we have alternative, more equitable options. We must all prioritize these options to create a better, more stable, and equitable world.
Actionable advice: Be careful who you vote for.
Politicians frequently try to attract voters by promising tax cuts. Although this may appear to be a favorable statement at first, consider what must be removed to pay this rebate. If you appreciate public services, consider voting for someone else.
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