I am sometimes surprised by the reactions I get to my posts. For example, one (very progressive) reader said my post on state lotteries was moralistic (I guess it’s the Puritan in me). Another suggested my post on the unemployment report was unfair to President Biden. But by far, the strongest reactions have related to my post about billionaires and why they are bad for the economy. Not surprisingly, conservative readers felt that I was advocating socialism. But another (progressive) reader said that if we got rid of billionaires, we would destroy capitalism. What he meant was that unless people can make a lot of money (in some cases, more money than they or their children or grandchildren could ever spend in their lifetimes), capitalism will cease to exist. But I would argue that the exact opposite is true: an economic system that allows for such an extreme accumulation of wealth by a handful of individuals is not capitalism. Our capitalist economy is broken, and billionaires are a symptom – not a cause – of its failures.
An economy is a system for allocating the means of production (i.e. resources) and providing for the production, distribution and consumption of goods and services. Translated to English, it means an economy is the way we decide who gets access to limited resources, and who benefits from the production of goods and services. Most Americans believe that a market economy, that is, capitalism, is the best way to provide the maximum economic benefits to the largest number of people. Under capitalism, the means of production are owned by private individuals who are motivated to produce in order to make a profit. By inference, the more profit they can make, the more they will produce, so if there are a lot of billionaires, the system must be working. Except the profit motive is only one pillar of capitalism, and if the other pillars are either damaged or missing, capitalism will not work as intended. Hence, billionaires.
Pillars of capitalism
The International Monetary Fund (IMF) defines six pillars of capitalism[i] that ensure the system works properly. Unfortunately, in our modern version of capitalism, the pillars are not providing the support they should. I’ve summarized each of them below, along with my assessment of how well they support capitalism in the U.S.
1. Private ownership of the means of production
Private ownership of the means of production – land, labor and capital – is essential to capitalism because it gives owners the right to personally benefit from what they produce. If you own the land you farm, you can sell your crops; if you own a factory, you can sell your products, and individuals can sell their labor for wages. Most property in the United States is privately owned, with some important exceptions.
Much of the land in the United States is owned by federal and state governments. The federal government owns about 28% of the total,[ii] primarily to promote preservation, recreation and development of natural resources. Federal land can be leased by private companies, including mining and petroleum companies for exploration, and ranchers for cattle grazing. State and local governments own about 9%[iii] of the U.S. land area, including interstate highways, airports and schools. Each of these publicly owned resources should be managed for the common good, but often powerful interests are able to arrange sweetheart deals that let them use public resources at a cost far below the market value. For example, ranchers, pay less today to graze livestock on public lands (which taxpayers pay to maintain) than they did 40 years ago.[iv] This, despite the fact that some of the ranchers receiving subsidies are among the wealthiest Americans, such as the Koch Brothers, Ted Turner and the Hilton Family. Annually, an estimated $1 billion in taxpayer subsidies ends up in the pockets of wealthy ranchers.[v] Yes, factories, farms, and businesses are generally privately owned, but important infrastructure used in the production of goods and services is publicly owned. Unfortunately, government-owned resources are often managed in a way that transfers wealth from taxpayers to a small group of wealthy capitalists.
Bottom line: The public sector subsidizes the private sector to the detriment of the vast majority of taxpayers.
2. Self-interest, properly understood
One of the most fundamental precepts of capitalism is the notion that individuals making uncoordinated decisions will, through the “invisible hand of the market,” produce what is in demand and fill gaps when they occur. Thus, the self-interested decisions of individuals maximize benefits for everyone. Businesspeople often conflate the pursuit of their own self-interest with the profit motive, as if the only interest they could possibly have is making money. But the singular focus on making money, rather than building profitable businesses, has skewed the profit motive in two ways.
First, while Adam Smith wrote in his seminal work, Wealth of Nations, that the greater good is best served when people are free to pursue their own self-interest, he made it clear that self-interest is not the same as selfishness. Smith’s self-interest, properly understood, requires individuals to view the interests of the greater community as part of their own self-interest.[vi] The pursuit of profits at the expense of the community as a whole is not compatible with capitalism. If businesses acted in their properly understood self-interest, they would treat their employees as stakeholders to be valued and rewarded, not as assets to be acquired at the lowest possible cost. They would also avoid activities that damage the environment or the economy.
Second, the profit motive provides incentives for people to produce goods and services that are in demand. That’s what makes it essential to the economic system. But over the past few decades, the profit motive has been replaced by the “stock price motive,” the idea that a company’s management should focus on increasing the stock price rather than producing profitable goods and services. The two are not the same, and in fact are often incompatible. Stock buy-backs are one of the easiest ways to quickly boost the price of a stock – the company’s profits are now divided among fewer shareholders, and thus the price of each stock goes up accordingly. But the profits used to buy back the stock are no longer available to reinvest in the company, or to produce new goods and services. Over time, repeated stock buybacks will reduce the overall productive capacity of a firm. Considering that in 2022 stock buybacks in S&P 500 companies totaled $1 trillion,[vii] that’s a lot of lost production, and a lot of money funneled into the pockets of shareholders.
Bottom Line: The profit motive has been contorted beyond recognition, leading to less, not more, economic growth.
3. Competition
In a competitive market economy, firms are free to enter and exit markets, and competition is the key to keeping prices down and markets efficient. As I wrote in my last post, when someone “builds a better mousetrap” and makes a lot of money, the high profits will create incentives for someone else to produce the same, or similar, product. Competition will eventually eliminate “excess profits,” and over time the price of a product will reflect the cost to produce and deliver it to market. In economic theory, there are several natural impediments to competition. Two of the most important are product differentiation and monopolies/barriers to entry.
Products that are highly unique or specialized will have less competition than a new product that is similar to others on the market. Additionally, U.S. patent laws protect unique inventions for up to 20 years. However, many U.S. businesses abuse patent laws to extend patent protection far beyond the original 20 years, stifling competition and keeping prices high for everyone (see my post on the pharmaceutical industry).
The number of firms offering the same product will also affect competition. Natural monopolies are common in industries with high barriers to entry and start-up costs that make it prohibitive for competitors to enter the market. When those monopolies provide essential services, such as electricity, telecommunications, and waste management, governments usually regulate them to protect consumers and ensure that everyone can access services at a reasonable price. Other firms, while not technically monopolies, exercise such dominance in their markets that they are able to restrict competition merely because of their size. Companies such as Alphabet (Google), Microsoft, Meta (Facebook) and even Altria (tobacco) have no meaningful competition, in large measure because of their anti-competitive practices. Other industries, such as automobiles and airlines, are dominated by a handful of companies that each have enough market share that they can squash competitive challenges.
Bottom Line: The competition pillar is crumbling.
4. Price mechanism
A market economy sets prices based on supply and demand. When more people want to buy a product, the price will rise, providing incentives to producers to increase supply, so prices will then either stabilize or go down. However, customers must be able to compare prices efficiently and accurately in order to make informed decisions and limit the ability of firms to set prices. The price mechanism breaks down when there is a lack of price transparency.
Although the mechanism works well for most consumer goods, where it easy to compare prices, many essential services, such as insurance and healthcare, have such convoluted pricing structures that it is virtually impossible for the average person to compare prices. A couple of years ago I was deciding whether to have a routine medical procedure, and wanted to know how much it would cost. The medical provider said the cost depended on my insurance company. The insurance company said it depended on the diagnostic code. The doctor’s office then said the diagnostic code was set by the insurance company. I had to speak with twenty different people in order to find out what my out-of-pocket cost would be. How can consumers make informed decisions if they don’t know what something costs?
The price mechanism applies not only to goods, but also to labor. A low unemployment rate should lead to higher wages, and vice versa. However, there is a tremendous lack of price transparency in the labor market. Many firms have policies against discussing or divulging pay levels, leading to wide discrepancies in pay and causing some people to sell their labor for less than it is worth.
Bottom Line: The price mechanism doesn’t work in several key sectors of the economy.
5. Freedom to choose
When both producers and consumers have the freedom to choose among competing options, dissatisfied customers can buy different products, investors can seek out more profitable companies, and workers can leave their jobs for better pay. Again, this mechanism works well in certain industries, and less so in others. Many industries, such as healthcare and public services, are either outright monopolies or are so highly concentrated that consumers have no meaningful options. Those businesses can set prices as high as they want, resulting in excess profits. Additionally, with regard to healthcare, most individuals are covered by health insurance plans selected by their employers, and those plans often limit the employees’ options. Finally, many employees are forced to sign non-compete agreements, which prevent them from working for another company in the same industry.
Bottom Line: The freedom to choose is restricted in important segments of the economy.
6. Limited role of government
In capitalism, government has a limited, but essential role to protect the rights of private citizens and maintain an orderly environment that facilitates proper functioning of markets. Although the U.S. has highly regulated markets and private citizens have access to the courts, in many respects the role of government is both too limited, and too intrusive.
“Regulatory capture” occurs when regulatory agencies are dominated by the industries they regulate, resulting in lax oversight. In many cases, the industries themselves write the regulations, limiting their scope and effectiveness. On the other hand, the government is also a market participant. In addition to its ownership of land and key infrastructure, the government also buys goods and services with taxpayer money. Government spending is often impervious to price signals – think Medicare and defense spending – and government policies restrict its ability to negotiate with private industry. Finally, many industries receive substantial government subsidies, including agriculture, energy, healthcare, among others.
Bottom Line: Government participation in the economy distorts prices and results in a transfer of wealth from taxpayers to millionaires and billionaires.
Fixing Capitalism
In a normal market economy, the pillars of capitalism would promote general well-being and allocate resources to their highest and best use, while ensuring the production of desired goods and services and promoting general well-being. Real innovators and companies providing high-quality products would make a lot of money, but robust competition would eliminate excess profits limiting how much money any one company – or individual – could accumulate. It’s clear that our current system is broken, but not irretrievably so.
Back in the day, miners would take canaries with them into the coal mines to alert them to the presence of dangerous gases, which would kill the canary before the miner. Stretching the analogy, the presence of so many billionaires – and the related extreme concentration of wealth – should alert us to the fact that capitalism is broken. We need to do something before we are all (metaphorically) killed by it. In my next post I’ll discuss the measures that we can take to repair the pillars and restore a functioning market economy.
[i] https://www.imf.org/external/pubs/ft/fandd/2015/06/basics.htm
[ii] https://sgp.fas.org/crs/misc/R42346.pdf
[iii] https://www.perc.org/2018/03/13/state-owned-lands-in-the-eastern-united-states/#:~:text=State%20governments%20own%20and%20manage,is%20found%20in%20the%20East.
[iv] https://www.motherjones.com/environment/2022/02/inflation-cattle-livestock-ranchers-free-ride-federal-grazing-fees/
[v] http://dailypitchfork.org/?p=698
[vi] https://www.adamsmithworks.org/documents/self-interest-rightly-understood
[vii] https://advisor.visualcapitalist.com/rise-of-stock-buybacks/