In the previous posts I explained what the market economy is and how it works. I also described how, in the next few decades, disruptive technologies can bring the global economy to a total collapse. In this series I will show what can be done to prevent such collapse and how to put the economy on a path to prosperity. But first we need to look at some of the problems of the market economy.
Now, before I go on I need to ask you – and this is particularly directed at all the Free Market Libertarians out there – to be patient and keep an open mind. The reason I ask this is that the knee-jerk reaction of free market advocates, whenever they see any criticism of capitalism, is to say: “what is your alternative? more regulations? more government? socialism?” My answer to that is: “no, no, and no.” The purpose here is not to see how capitalism stacks up against socialism, communism, or any other existing economic system – in that case capitalism wins hands down. Rather, the purpose here is to judge capitalism on its own merits. Only then, can we offer solutions to the problems we face. So before I offer my solution, let’s have a frank discussion about the shortcomings of the current economic system.
#1 – The Fallacy of Laissez-Faire Capitalism
In a true free market economy no non-market forces of any sort – whether they are government regulations, subsidies, taxes, workers’ unions, or any other organizing or correcting mechanisms – are allowed to interfere with market forces (supply and demand). Even free market purists, however, agree that government has a role in the economy, and that is to protect private property and prevent fraud (ie. enforce contracts). Nevertheless, in a free market property rights laws cannot be static or absolute. Government has to modify these laws to prevent market failures or economic stagnation, and to allow technological progress. This means that true laissez-faire capitalism cannot work – neither in theory nor in practice – since active government intervention in the economy is indispensable to a well functioning economy.
#2 – Consumers Are Not The Bosses
The real bosses [under capitalism] are the consumers. They, by their buying and by their abstention from buying, decide who should own the capital and run the plants. They determine what should be produced and in what quantity and quality. Their attitudes result either in profit or in loss for the enterpriser. They make poor men rich and rich men poor. They are no easy bosses. They are full of whims and fancies, changeable and unpredictable. They do not care a whit for past merit. As soon as something is offered to them that they like better or is cheaper, they desert their old purveyors. (Bureaucracy, ”Profit Management,” p. 227)
Claiming that the consumer is the boss is very convenient… if you’re a corporation. After all, if the consumer is the boss then everything a corporation does must be in the best interest of the consumer. Low-wages for workers? Polluting the environment? The consumer wants cheap products! Producing foods low in nutrients and high in fat, sugar and calories? That’s what the consumer wants! Spending $250 billion per year on advertising to sell products? All in the name of consumers.
How much influence do consumers really have in determining ”what should be produced and in what quantity and quality”? As it turns out, not that much.
Today, an ever-growing body of research shows that human decision making is anything but rational. Standard economic theory and the law of supply and demand do not tell the whole story of what is happening in the marketplace. Consumers do not determine what should be produced and in what quantity. Instead, they can be easily swayed by clever marketing strategies. Corporations are spending hundreds of billions of dollars every year to influence public perception and induce consumer demand for their products. Consumers are not the bosses, despite what they may be told by free market advocates and corporate interests.
For more see: Capitalist Myth #2 : Consumers Are Not The Bosses
#3 – The Pie Grows, But Many Still Get Crumbs
A free-market economy creates wealth. For one person to make a dollar does not mean that another needs to lose one. There is not just one dwindling pie to be divided up among the population, but rather a proven recipe to grow the pie to serve everyone. All the talk about the rich “grabbing” too large a share of the national income therefore rests on a flawed understanding of this basic truth of free-market economics.
While on the surface this may seem reasonable and even reassuring, reality says otherwise. So let’s look at the data:
According to the Economic Policy Institute: the bottom tenth of the wage distribution earned less in 2011 than the lowest earners did in 1979, accounting for inflation. Meanwhile, the real wages of the median worker rose only 6 percent between 1979 and 2011.
On average, hourly pay has not grown at all since 2002 for workers with a college degree or with only a high school degree. Wages have not grown for college graduates in nearly every occupation, and college graduates in the 70th income percentile or lower have had stagnant or falling wages since 2000.
Worker productivity grew 11 times more quickly than worker pay between 1979 and 2011. While worker productivity rose 69 percent, median hourly compensation rose just 6.5 percent.
CEO pay today is more than 200 times that of a typical worker, up from 30 times that of a typical worker in the late 1970s.
The top one percent captured 60 percent of total income growth between 1979 and 2007, while the bottom 90 percent was left with just 9 percent of the total. Moreover, the top one percent’s incomes rose 241 percent, in contrast to 11 percent growth for the bottom fifth and 19 percent growth for the middle fifth.
What is evident from the data is that while the pie used to serve everyone in the 1970s, this isn’t the case anymore. The growing pie doesn’t necessarily serve everyone – let alone everyone equitably. It allows a few to enjoy fantastic prosperity, while many struggle to make ends meet (according to a survey by Wider Opportunities for Women around 45 percent of Americans say they don’t have enough money to cover basic expenses like housing, food, or healthcare).
For more see: Capitalist Myth #3 : Dividing The Pie
#4 – Capitalism Isn’t Moral, It Is Nihilistic
Free market libertarians claim that capitalism is a moral system. They argue that “[t]he capitalistic social order . . . is an economic democracy in the strictest sense of the word” because “all decisions are dependent on the will of the people as consumers.” They further argue that “inherent in the nature of the capitalistic economy that . . . the employment of the factors of production is aimed only toward serving the wishes of consumers.” Therefore, they argue that “every dollar that an entrepreneur accumulates is evidence that the entrepreneur has provided value to someone.”
Based on this moralistic view of capitalism, free market libertarians argue that the role of government in the economy should strictly be to protect private property and prevent fraud (enforce contracts). They argue that any other interference in the workings of the free market would only produce an inferior result. That is because imposing regulations on the market, such as consumer protection or occupational health and safety standards, supposedly interferes with the market mechanism by which consumers and producers make cost-benefit tradeoffs, and by which scarce resources are efficiently allocated in the economy.
They argue that ”[o]n the unhampered market there prevails an irresistible tendency to employ every factor of production for the best possible satisfaction of the most urgent needs of the consumers. If the government interferes with this process, it can only impair satisfaction; it can never improve it.” Therefore, “the economy works best when individual risk-takers are free to innovate and to allocate their resources as they please, and consumers are free to spend their money as they please.”
This means that not only should the products and services currently available in the market be unregulated, but also that any product or service whatsoever - including things such as hard drugs, prostitution and gambling - be legally traded, as long as the exchange between the buyer and seller is voluntary.
What is evident from this line of reasoning is that capitalism is nihilistic - it conflates subjective value with objective value. When free market libertarians say that “every dollar that an entrepreneur accumulates is evidence that the entrepreneur has provided value to someone” they suggest that the drug dealer who sells heroin to a drug addict is in fact “employing the factors of production for the best possible satisfaction of consumers,” and is no different from a doctor who saves the life of a patient. But why stop with the drug dealer? What if a person wishes to be hunted and killed for a price? What if a person volunteers to be killed and eaten? As long as someone values such services free market libertarians would have to argue that the provider of such services is “serving the wishes of consumers” and government intervention would “produce an inferior result.”
#5 - Capitalism Is Inherently Exploitative
Many free market advocates cringe when they hear the words “capitalism” and “exploitation” in the same sentence. Yet, the inconvenient truth is that capitalism is exploitative in its nature.
Economic theory stipulates that all transactions in a free market economy are voluntary, and therefore by definition must be beneficial to both parties. The problem here is that, in reality, not all exchanges in the free market are truly voluntary. To give an extreme example, if I demand your wallet at gunpoint, and you “voluntarily” give me your wallet it can be said that this was a mutually beneficial voluntary exchange - I got your money, and you didn’t get shot. Therefore, the dynamic of the situation dictates whether the exchange is truly voluntary or not. Generally speaking, the fewer alternatives one party in a transaction has (or the more desperate it is) relative to the other the less voluntary is the exchange, and the more exploitative is the relationship.
But that is not the reason why capitalism is exploitative in its nature. The real reason is this: the capitalist system forces the individual to see no value in anyone or anything except as means to making a profit for himself. Who (or what) does capitalism exploit? The answer is: anyone (and anything) it can – starting with the environment itself and ending with those who are most vulnerable - women and children.
#6 – Big Corporate Bonuses Do Not Improve Performance
Do big bonuses improve the performance of corporate executives? Duke Professor of Behavioral Economics Dan Ariely examined this question in a series of experiments. Here are the results:
We presented 87 participants with an array of tasks that demanded attention, memory, concentration and creativity. We asked them, for instance, to fit pieces of metal puzzle into a plastic frame, to play a memory game that required them to reproduce a string of numbers and to throw tennis balls at a target. We promised them payment if they performed the tasks exceptionally well. About a third of the subjects were told they’d be given a small bonus, another third were promised a medium-level bonus, and the last third could earn a high bonus.
We did this study in India, where the cost of living is relatively low so that we could pay people amounts that were substantial to them but still within our research budget. The lowest bonus was 50 cents — equivalent to what participants could receive for a day’s work in rural India. The middle-level bonus was $5, or about two weeks’ pay, and the highest bonus was $50, five months’ pay.
What would you expect the results to be? When we posed this question to a group of business students, they said they expected performance to improve with the amount of the reward. But this was not what we found. The people offered medium bonuses performed no better, or worse, than those offered low bonuses. But what was most interesting was that the group offered the biggest bonus did worse than the other two groups across all the tasks.
We replicated these results in a study at the Massachusetts Institute of Technology, where undergraduate students were offered the chance to earn a high bonus ($600) or a lower one ($60) by performing one task that called for some cognitive skill (adding numbers) and another one that required only a mechanical skill (tapping a key as fast as possible). We found that as long as the task involved only mechanical skill, bonuses worked as would be expected: the higher the pay, the better the performance. But when we included a task that required even rudimentary cognitive skill, the outcome was the same as in the India study: the offer of a higher bonus led to poorer performance.
If our tests mimic the real world, then higher bonuses may not only cost employers more but also discourage executives from working to the best of their ability.
#7 – For Motivation, Money Isn’t Everything
What motivates us? Standard economic theory states that the primary reason people engage in business or productive activity is for the profit motive. – ie., for money. It also states that people will always choose to maximize their reward while minimizing their effort. As we’ve already demonstrated before, however, there is a significant gap between what standard economic theory says and empirical reality. Why is that?
The simple truth is that social science knows more about human motivation than economic theory, and social science says that there is more to human motivation than just money. Namely, once people earn enough money to satisfy their basic needs, they become motivated by having a sense of autonomy (ie. the desire to be self-directed), mastery (ie. the urge to get better at things), and purpose in their work and life. Money is just not a good enough motivator.
We’ve already discussed the fact that giving people large monetary rewards for their work can result in poorer performance. Now let’s look at a few more cases that clearly demonstrate how money isn’t everything for motivation:
Altruism: an intrinsic motivator
In the 1990s, Swiss government officials wanted to build a nuclear waste facility outside the village of Wolfenschiessen. After a robust public awareness campaign, a bare majority of villagers—51 percent—supported the project. In hopes of bringing more people on board, payments of up to $8,700 per person was offered; instead, support plummeted to 25 percent. Villagers said they considered the money a bribe and felt belittled that their moral quandary had become a financial transaction. “The message was clear: People are much more altruistic than standard economics claims,” says Bruno Frey, an economist at the University of Zurich who studied the Wolfenschiessen case. “The challenge is for economists to nurture this intrinsic motivation instead of crowding it out.”
Contrafreeloading: preferring to earn something over getting it for free
The concept of contrafreeloading – a term coined by the animal psychologist Glen Jensen - directly flies in the face of standard economic theory, which states that organisms will always choose to maximize their reward while minimizing their effort.
In 1963, Jensen observed in an experiment that, given a choice between eating pellets from a dish and pressing a bar that dispensed the same pellets, albino rats preferred to “earn” their food by pressing the bar. Subsequent experiments demonstrated that contrafreeloading – the preference for an indirect route to obtaining food over a shorter, more direct approach - was prevalent in many other species, including fish, birds, grizzly bears, maned wolves, monkeys and chimpanzees. In fact, the only species tested that did not exhibit this phenomenon was, not surprisingly, the domestic cat.
When similar experiments were conducted with human participants, the preference to earn something over getting it for free decreased with age from nearly 100% in preschool children to only 50% in adults.
What these findings suggest is that the need for meaning and purpose in what we do is not only an important aspect of our being, but indeed seems to be an innate quality of all life. Yet, the current economic system drives out our innate desire for meaning and purpose and replaces it with cynicism and greed.
#8 – Market Value Distorts Intrinsic Value
There are certain things that the free market does exceptionally well; it makes people industrious and productive, it is responsible for the incredible abundance of products and services we have, and for our high standard of living. Yet, when it comes to providing many essential products and services the free market fails. Why does this happen? Imagine the following two scenarios:
In the first case a scientist is researching a cancer that affects 100,000 people every year. After years of research the scientist discovers that there are two chemical compounds that can effectively treat and cure the cancer. The scientist develops a drug and sells it in the market for $500 per pill.
The second case is very similar to the first. A scientist researching the same cancer discovers two compounds that can effectively cure the cancer. The only difference is that in this case these chemical compounds occur naturally in oranges and pecans.
Though the intrinsic value in both cases is the same – curing a cancer that affects tens of thousands of people every year, the market value is different. In the first case the scientist can expect to make millions, if not billions, of dollars by selling the drug in the market. In the second case the scientist cannot profit from selling any drug when natural substitutes are readily available, so she can at best expect to make a modest income. That is, if she doesn’t first go broke from repaying the loans for the research.
The reason for this great disparity is clear: the market economy does not reward people for their hard work or contribution to humanity. It only rewards people for selling commodifiable, marketable products or services.
What makes something commodifiable is the excludability principle; when it is impossible (or impractical) to exclude a non-paying consumer from using a product or service, that product or service is said to be non-excludable. In the example above, the scientist cannot profit from her discovery because she cannot exclude non-paying people with cancer from benefiting from her discovery. What cannot be excluded cannot be properly commodified, and what cannot be commodified will not sell in the market. The result is that there is great societal investment in commodifiable products and services that benefit some, and great societal disinvestment in non-commodifiable products and services that benefit all. Unfortunately, these are often the things that are essential for society to prosper, let alone function.
What this means is that there is less investment in art and education, which makes it more difficult to raise children. It also means that there is less investment in public infrastructure, which our cities and communities depend on, and in basic research, which made things such as satellite technology, the computer chip, the internet, and mapping the human genome possible.
#9 – The Highest Ideal Under Capitalism: Cynicism
When John Donne wrote No Man Is An Island he probably was not thinking of a capitalist society. Because in a capitalist society every man is an island – an island of self-interest and profit maximization. And though It is true that capitalism is not exactly a zero-sum game, the system is such that the interests of people – as consumers, producers, workers or simply human beings – perpetually come in conflict with one another.
Under capitalism one company’s success may be another’s loss. Less emissions may be good for the environment, but they are bad for business. Higher wages may benefit workers, but not the employer. Technological progress benefits everyone, except for those who get laid-off because of it.
Corporations are not interested in well informed customers. Fast food chains and soft drink companies do not want people to eat healthy. Credit card companies do not want people to be responsible or pay their bills on time.
The prison-industrial complex is not interested in public safety or reducing crime, it wants more prisoners. The military-industrial complex is not interested in peace, it wants to sell more weapons.
The average young person is bombarded with thousands of ads per day. Commercials telling her what she should eat and wear, how she should look like, and what she should want. Very little of this will actually benefit her wellbeing. In fact, the opposite is much more likely. That is because every year $11 billion are spent on cigarette advertising and $5.7 billion on alcohol advertising. According to the American Academy of Pediatrics:
“Advertisers spend more than $2.5 billion/year to promote restaurants and another $2 billion to promote food products. On TV, of the estimated 40,000 ads per year that young people see, half are for food, especially sugared cereals and high-calorie snacks. Healthy foods are advertised less than 3% of the time.”
#10 – Under Capitalism There Is No Dignity In Labor
There is a certain absurdity about the way capitalist society is organized. The reality is that those who are at the top are treated best, and those who are at the bottom are treated worst. Therefore, everyone has the incentive to strive to get to the top. Yet, no matter how hard we try – no matter how much education or skills we have – we cannot all make it to the top. It is simply a logical impossibility.
At the same time, there are certain lines of work that are simply indispensable for the economy and for society to function – in agriculture, construction, manufacturing, education, healthcare and so on. Though the work itself is indispensable, in a capitalist society the workers are not. And though these workers labor for long hours, doing physically and mentally exhausting work, they receive low pay and few if any benefits. That is because in a free market economy the intrinsic value of their labor does not matter. The only thing that matters in a free market is the market value of their labor – and it is generally low. Thus, when the people who do indispensable work for society are motivated by desperation and are treated the worst, there can be no dignity in labor in a free market.
#11 – There Is No Such Thing As A Self-Made Man
Let’s make this perfectly clear: there is nothing wrong with people being confident in their abilities. There is also nothing wrong with people being proud of their achievements and success. No one is denying their initiative. No one is denying their talent or their hard work. However, there is something very troubling about people who believe they are self-made men. Because what’s implicit in their belief is the denial of the role of others in their success, and ingratitude for their contribution.
The truth is that, in modern society, no noteworthy achievement - and in particular in the realm of business – is possible without collective effort. The myth of the self-made man is just that - a myth. The achievements of these so-called self-made men would not have been possible without the support of mentors, parents, friends, partners or workers. Their achievements would not have been possible without the infrastructure of modern legal, political and economic institutions and government. Their achievements would not have been possible without the cumulative contribution of men and women to scientific and technological progress. Finally, their achievements would not have been possible without a stable economic environment, which was made possible by the heroic sacrifices of men and women in defense of our country.
Now, contrast the words of those who diminish the efforts of others to this:
“If I have seen further it is by standing on the shoulders of giants.”
~ Sir Isaac Newton
What’s evident is that the mark of a truly great man or woman is not in arrogance or self-aggrandizement at the expense of others, but in humility.
#12- Greed Is Not Good
“What human motivation gets the most wonderful things done?” The answer is that human greed is what gets wonderful things done. I wasn’t talking about fraud, theft, dishonesty, special privileges from government or other forms of despicable behavior. I was talking about people trying to get as much as they can for themselves. (In Greed I Trust, Walter E. Williams)
…We don’t give second thought to the many wonderful things others do for us. Detroit assembly-line workers get up at the crack of dawn to produce the car you enjoy. Farm workers toil in the blazing sun gathering grapes for our wine. Snowplow drivers brave blizzards just so we can have access to our roads.
Do you think these people make these personal sacrifices because they care about us? My bet is they don’t give a hoot. Instead, they along with their bosses do these wonderful things for us because they want more for themselves. (Economics 101, Walter E. Williams)
Despite what Professor Walter E. Williams and other Libertarians would like you to believe, greed is not good. Greed means doing whatever you can get away with to get more for yourself. Greed does not motivate people to do the most wonderful things. It motivates people to do the least to get the most. It is the reason why so many of our best and brightest - 47 percent of Harvard University seniors in 2007 – head to Wall Street, and not to science, medicine or engineering. It is the reason why banks sold subprime mortgages to families who could not afford them. It is the reason why in 2006 financial sector profits constituted 27% of all corporate profits in the United States. And it is the reason why the New York State Comptroller’s Office in 2006 had this to say about Wall Street traders:
“Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their firm. The whole system – from mortgage brokers to Wall Street risk managers – seemed tilted toward taking short-term risks while ignoring long-term obligations.”
And that is the essence of greed. It is about thinking of short-term gains for ourselves, without considering long-term consequences for everyone. Unfortunately, this line of thinking is not unique to Wall Street, it pervades every aspect of our society. It is why our food is high in calories but low in nutrients. It is why our movies are high on action but low on substance. And it is why our politicians constantly over-promise and under-deliver. The most wonderful things are not done by the greedy, but by those who can get past the cynicism and narrow self-interest - to contribute to something greater than themselves.
To sum up: our current economic system is far from perfect. It rewards marketability over merit, it is driven by corporate-induced consumerism, it overcompensates those at the top (without regard for performance) and disparages those at the bottom, it is inherently exploitative, its highest ideals are cynicism, nihilism and greed, and the economic theory behind it is based on flawed assumptions, such as the premise that humans behave like profit maximizing automatons. What is more important though is that regardless of what you or I think about our economic system – if it is not fundamentally altered in the next few decades - disruptive technologies will bring it to a total collapse.
In the next posts in the series I will show what can be done to prevent such collapse, and explain how a more sensible economic system can effectively address all of the issues above (and much more).
The End of Capitalism Series:
- The End of Capitalism, Part I : Disruptive Technologies
- The End of Capitalism, Part II : What Is Capitalism?
- The End of Capitalism, Part III : 12 Capitalist Myths
- The End of Capitalism, Part IV : Toward a Flow Economy
For more about Capitalist Myths see:
- Capitalist Myth #1 : The Fallacy of Laissez-Faire Capitalism
- Capitalist Myth #2 : Consumers Are Not The Bosses
- Capitalist Myth #3 : Dividing The Pie
- Capitalist Myth #4 : Capitalism Isn’t Moral, It Is Nihilistic
- Capitalist Myth #5 : Capitalism Is Inherently Exploitative
- Capitalist Myth #6 : Corporate Bonuses Don’t Improve Performance
- Capitalist Myth #7 : For Motivation, Money Isn’t Everything
- Capitalist Myth #8 : Market Value Distorts Intrinsic Value
- Capitalist Myth #9 : Highest Ideal Under Capitalism: Cynicism
- Capitalist Myth #10 : No Dignity In Work
- Capitalist Myth #11 : No Such Thing As A Self-Made Man
- Capitalist Myth #12 : Greed Is Not Good