JEFF SUZUKI – SEPTEMBER 15TH, 2020
EDITOR – RAINA ZHAO
Across the United States, economics groupies, usually young, white, and male, saunter around college campuses with Ayn Rand’s Atlas Shrugged in one hand and Friedrich Hayek’s The Road to Serfdom in the other. According to them, one should read about “Austrian Economics” to understand that the government is inefficient. One who advocates for stronger welfare policies should read some Hayek, lest the moral and economic costs of brutal totalitarian communism be forgotten. The magic of the “free market”—a market devoid of government intervention—is considered the ideal for many of these libertarian and conservative economist types.
Embedded in this free market ideology is an unshakeable skepticism in government, a trust in the individual’s genius to reap the fruits of their labor, and a faith in the collective knowledge of the market communicated via price signaling. To quote Milton Friedman, “there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by the free-enterprise system.” Or to quote Ayn Rand, “capitalism was the only system in history where wealth was not acquired by looting, but by production, not by force, but by trade, the only system that stood for man’s right to his own mind, to his work, to his life, to his happiness, to himself.”
Those who advocate for free market capitalism often hold beliefs that can be reduced to two main arguments. First, government intervention in the economy tends to be inefficient and, for that reason, the government should leave the market alone. Those with this sentiment often champion the DMV as a chief example of government inefficiency, extrapolating its purported inefficiency to other sectors of the economy, such as health care. The second argument is that capitalism is the most moral economic system because it promotes individual liberty by minimizing state intervention. That is, free markets promote free people.
However, these arguments are often idealistic, using unrealistic assumptions to advocate for a small non-interventionist government that leaves the free market alone.
Argument 1: Government Intervention is Always Inefficient
This argument is true in most introductory microeconomics courses. Indeed, in the hypothetical world of infinite firms with no market power to set prices, complete and symmetrical information between producers and consumers, and a lack of any transaction costs, maximizing welfare in the society is simply the government doing absolutely nothing— no taxes, subsidies or quotas. Otherwise, the government creates a deadweight loss, a cost to society that results from inefficiency in the market, as implied by the First Fundamental Theorem of Welfare.
However, this deadweight loss argument promptly fails in almost every successive development of the most basic microeconomic theory. First, the argument’s assumptions are heroic. The real world has a limited number of firms that have market power to set prices. For example, Comcast is often the only provider of high speed internet in huge swaths of the United States, while having some of the worst customer service and satisfaction ratings of any industry. Large firms like Comcast can engage in unscrupulous practices toward customers, such as overcharging and price discrimination. Furthermore, in the real world, externalities generate market failures. Externalities are the impacts of a good on society not reflected in its price. Externalities in the real world come in the form of the smoke belched from coal, pestilential noise from manufacturing or even the pollination that beekeepers provide.
Image source: NRDC
The negative effect of this river pollution on society is not reflected in the price of the good produced
Including externalities in a model of the market leads to an unavoidable conclusion: both negative and positive externalities cause market failures, or a failure of the market to maximize welfare. In the case of negative externalities, an absence of government intervention will lead to the overproduction of a good or service, as the profit-maximizing producer does not personally have to pay the social costs of production. For example, the price of a smartphone may reflect the cost of machinery, labor, and transportation, but it wouldn’t reflect the social cost of greenhouse gas emissions. A government response to increase social welfare may then be a carbon tax to increase marginal costs and limit production to a more socially optimal level. In this case, government intervention, far from being inefficient, is necessary to maximize welfare.
For positive externalities, the good is actually underproduced—society would benefit from more of it being provided. However, this benefit is not reflected in the price of the good and, therefore, the producer provides less of it to maximize profit. For example, assuming that consumers are self-interested and only trying to protect themselves, vaccines have more value than their actual price. This extra value in contributing to herd immunity is not accounted for in the price. Perhaps, if vaccines are cheaper, more people would be willing to get vaccinated. Here, a government response to increase social welfare might be to subsidize the production of this good.
In short, in an imperfect world with externalities and a limited number of firms with market power, unregulated capitalism will lead to inefficiencies. As I argue in the following paragraphs, the idea of “withdrawing the government” from the market to attain true free market capitalism is also suspect.
Argument 2: Capitalism Promotes Liberty
Proponents of the free market often moralize capitalism as the only economic system that is free of coercion—the only system standing “for man’s right…to himself,” as Rand said. Perhaps the most instrumental piece of literature popularizing this argument was Friedrich Hayek’s The Road to Serfdom, which posited the following:
- Markets are democratic because they involve everyone in voluntary transactions. Government bureaucrats, a minority of society, serve to intrude in the business of the market and are thus inherently coercive. Through the government, the few impose their will on the many.
- Increasing the role of government intervention in the economy endangers the liberty of the individual. As he writes, a poor individual has more freedom under a market economy than a planned economy.
There are two main issues with Hayek’s arguments. The first is that he does not define what liberty is. Secondly, he assumes that free market capitalism is the absence of government intervention.
In reality, capitalism and the state are inseparable; a functioning market relies on a set of rules defined and enforced effectively by the state. Specifically regarding capitalism, protecting capital rights often requires coercion or the threat of coercion.
The Illinois National Guard Firing on Striking Workers | Source
For example, the labor movements in the US from the 1880s through the 1910s were often bloody. In one such instance, over 250,000 railroad workers went on strike, demanding better living conditions from the Pullman Company. The government had a choice between two visions of capitalism. They could either side with the striking workers, upholding the right to strike and force employers to the negotiating table, or choose to protect the business’ right to ignore the strike and operate as usual through the employment of strikebreakers. The government chose the latter in a decisively coercive manner. In what was a largely peaceful strike prior to government intervention, President Grover Cleveland deployed 12,000 soldiers to break the strike and resume the trains. Violence quickly escalated, 30 strikers were killed, and the strike dispersed with its leaders arrested. This is a clear example of how the state enforces a capitalist economic order in a coercive manner.
Even in the counterfactual where Cleveland chooses not to intervene, the state would have chosen to enforce a different set of liberties (i.e. labor rights). And rights associated with capitalism require coercion, or the promise of coercion, to enforce. Whether it be the right to buy back stocks, the right to collective bargaining, or, historically, the right to commodify and enslave humans as a means of production, capitalism has relied on the state to enforce these rights.
Therefore, categorical rejections of government intervention in the economy are misguided. The government already intervenes through the enforcement of rules that structure and uphold the market. The practical question that should be asked is “which set of rules would most promote the general welfare?” Should corporations have the right to buy back their stock? Should workers have the right to unionize and strike? Is there a right to slavery, as the Confederate states outlined in their in their Ordinances of Secession? The state’s role in the market is to provide working definitions of these liberties and enforce them for better or for worse.
Hayek’s idea of liberty is a lack of government intervention in the markets. However, capitalist markets cannot exist without this intervention. There is no property without police. The protection of private property is the reason the oft-cited (and highly misunderstood) Adam Smith proclaimed that paying taxes was “a badge, not of slavery, but of liberty.” Unless a free marketeer’s idea of “true” capitalism is one of the informal markets during the Somali Civil War when the state was ineffectual, then Hayek’s argument is impractical in almost every area of political discourse except for in one domain—ideology.
Whether it is Bill Clinton’s proclamation that “the era of big government is over” during his State of the Union address or Rand Paul’s argument that big governments promoting a right to health care is literally promoting “slavery” for doctors, this line of rhetoric is common in American politics. However, the smothering foot of big government is seldom depicted in the forms of agricultural subsidies, strike-breaking, or the protection of patents on cheaply manufactured and expensively sold medication like insulin (not so fun fact: roughly 25% of Americans with diabetes ration their insulin). Rather, many conservatives frame lower taxes, financial deregulation, and privatization of public enterprises as shrinking the size of an oppressive government.
Even though in the past four decades the government has lowered taxes, legalized stock buybacks, and fostered the boom of the private prison industry, the state has actually increased in size relative to the economy it manages in terms of government spending as a percentage of GDP, military spending, and percentage of population in prison. In other words, “freeing up the markets” has not shrunk the American state or made it less inherently authoritarian; it has merely restructured market institutions.
Perhaps the best example of how capitalism does not necessarily lead to a less authoritarian society is China. Even as shares of Alibaba can now be bought from an exchange and owned privately, China heavily controls its media, jails political dissidents, and arguably has a stronger surveillance state with more resources at its disposal than it had with a communist regime.
Ultimately, arguments depicting free market capitalism as setting people free from the shackles of big government ought to be greeted with skepticism. The state is indeed coercive. But it protects capital and defines the very economic and social rights that Hayek values. On February 6, 2020, Royal Canadian Mounted Police smashed open the window of a truck and dragged out a naked woman who had locked herself inside, one of six Wet’suwet’en land defenders attempting to stop the construction of the Coastal GasLink Pipeline in their territory. “Shame on the RCMP! Shame on the colonizer!” land defenders screamed as they were arrested during the police raid.
A land defender arrested | Source
With the full support of the Canadian government, TC Energy has been given the right to construct and own the pipeline through these lands, while Wet’suwet’en have been given the right to suffer the consequences.
Featured Image Source: Spiked
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