Why Capitalism Works (and What Other Systems Must do to Compete)
(Part 5 of a series on Political Economy I am writing on this blog. See the series Introduction here. See Part 1 here. See Part 2 here. See Part 3 here. See Part 4 here. I recommend reading all prior posts, especially Part 4, in the series before reading this piece)
- In Part 1, we provided a novel post-liberal grounding of political economy and, especially important for this and future pieces, we explained the difference between private and personal property
- In Part 2, we examined our ideas of “what a market is” and understood why our typical ideas are misguided, culminating in a new, more accurate understanding of markets and how they function
- In Part 3, we laid out the true set of the means of production and examined different ownership criteria and frameworks that can exist in economic systems
- In Part 4, we proposed the crux of this series: the set of foundational questions that all systems of political economy must answer to function properly
What we’re answering today
Let’s return to the fifth and final question in the “Five Questions” part of the introduction to this series:
Why has capitalism succeeded while non-capitalist systems have largely failed? In other words, what does capitalism do that other systems do not? And, by extension, what must other systems accomplish to provide functional alternatives to capitalism?
As we have seen in the previous post, the true determinant of whether or not an economic system succeeds is whether or not it can provide a solution (or solutions) to the foundational problems of political economy. Capitalism does just that, using a system that is simultaneously ingeniously simple and mind-numbingly complex: Money and Prices.
Restating our Definition of Capitalism
As noted in the introduction post of this series, capitalism is a system defined by
- the production of commodities (production for exchange and to maximize exchange-value, not necessarily use-value),
- the accumulation of capital (through production for exchange and profit),
- And the primacy of the capitalist-laborer relationship (in which there are those who own the means of production and those who do not) and the wage-labour system that co-exists with it.
Capitalism is not to be defined as a system of markets, as other systems use markets and yet are not capitalist. Capitalism is not to be defined as a system of “freedom” in opposition to “authoritarian” “socialism” (as such a concept of “freedom” incoherent/nonsensical for many reasons). When I refer to capitalism, I am referring to the above definition and its three parts in totality.
That means, of course, it is a system of markets that rely on a moral-political framework of private property with an ownership framework typically composed of some combination of Ownership by Mere Fiat and Ownership by Initial Productive Use with some marginal uses of Ownership by Persistent Productive Use. (Note: capitalism is not necessarily wedded to subjective theories of value)
So How Do Money+Prices Solve the Foundational Problems?
A brief note on my approach: I am going to take as fundamental (or “basic”) approach to this as I can. What I mean is, I’m not going to consider advanced financial instruments or things like that, as they are merely abstractions of the underlying basic processes that answer these problems.
The Information Problems
As noted in the previous post on foundational problems, information problems are the most common point of criticism by economists against “planned” economies. In other words, a system wherein a group of nerds in the capital city decide how much each product costs based upon reports from tens of thousands of firms and individuals regarding supply and demand is just not going to work well. Or, it is not going to work as well as firms setting their own prices based on local information. Sure, even within individual firms, there’s nerds (or an algorithm built by nerds) setting that firm’s prices, but they can do so with greater autonomy than a single central entity doing it for everyone. And as we noted in our post on markets:
Consider it a single point of failure: even if everyone is an idiot, chances are at least a few people will accidentally get something right and run successful firms so this colloquial “market economy” seems to beat a system where a small group of nerds (who may also be idiots and/or delusional) try to manage everything.
Prices are the basic solution to information problems. Look at all of these questions we laid out in yesterday’s post that we consider to be information problems:
How do we make sure that enough goods and services get produced? How do we know how many goods and services need to be produced? How do we know we are using our resources in the most efficient manner? How do we know that people’s preferences are being satisfied (or utility maximized, etc.)?
Money and prices (and, more importantly, the profit motive) provide an answer to all of this. Most importantly relative to typical economic calculation problem arguments in favor of capitalism is the question of using our resources in the most efficient manner. One example of how prices does this extremely simply is presented by Alex Salter:
For example, if a railroad company wants to build a new branch line, should it use steel or titanium rails? Both projects are technologically feasible, but only a working price mechanism conveys that, at the margin, titanium is much more expensive than steel, meaning titanium should be saved for more urgently desired (and thus higher-yield) investment projects.
(Salter, “Economics and the Calculation Problem,” Foundation for Economic Education. https://fee.org/articles/economics-and-the-calculation-problem/)
In an extremely simple way of looking at it, I can find the optimal production of any good or service by looking at where I can maximize my profits (this, of course, gets infinitely more complex the more you delve into both economic theory and the real world with its various competing objectives, some economic and others non-economic). If there is a shortage of a product, I can raise prices (or just produce more if I can do that in a cost-efficient manner). If there is a surplus of a product, I can lower prices or cut production.
And this still holds up with other decisions such as how much I should save versus how much I should consume. Different kinds of “prices” (interest rates, in this example) will direct my actions in order to satisfy my personal preferences, but the pricing system remains intact. From the consumer point of view, she is maximizing utility subject to a budget constraint (just stick with the basic modern microecon model for now). From the firm point of view, it is maximizing profitability subject to its own constraints (how much is it possible to produce, at what price will it start losing money, etc.). The money+prices system works to generate the universal drive to maximize profits which ultimately resolves information problems.
The Defector Problems
Oh, you want to be a free rider? You don’t want to work, so I guess you’ll have no money. You’re starving now? Tough shit, get a job. Brutally simple and effective. Same concept applies to the “Every Man an Artist” variant of the Free Rider problem (if you want to be an artist but no one wants your artwork, you’re gonna have to get a different job or decide to starve). Capitalism doesn’t actually have built-in ways to resolve other self-interested defections, so it turns to the political system it exists within in order to resolve these (ex: protections against fraud, regulations, criminal actions, etc.).
The Innovation/Efficiency Problems
Want to get people to innovate? Positive innovation creates new products and markets, decreases costs of production, and does many other things that can lead to greater profitability. The built-in desire to maximize profits pushes firms to constantly innovate and attempt to become more efficient. And because this drive to maximize profits is built in to the entire system of money+prices in a capitalist system, every single person is affected by it, distributing innovation across the system (in theory, of course).
How do Other Systems Compete?
Capitalism’s basic money+prices system seems to work extremely well. The only foundational problem it doesn’t resolve internally is a subset of the defector problems, and those are largely political issues anyways (it’s not clear any system could resolve these internally). So, is capitalism the most perfect system we can achieve? Not necessarily the perfect system, but perhaps the best one we can build? Is there no better alternative?
Well, I would disagree that capitalism is the best system we can build. It certainly answers the foundational questions, but it has a large number of its own problems (market failures and, depending on your moral viewpoint, inequality, amongst others). The profit motive doesn’t necessarily answer some of the information problems well, and can struggle to maximize the utility of persons both rationally and empirically (we will go into this more as we begin building our own post-capitalist system). And there are arguments to be made that some proposed socialist systems with centrally “planned” economies could overcome the economic calculation problem amongst other information problems; however, I personally find those arguments to be largely dubious. One point the capitalists have going for them: their’s is the only system that has a clearly defined system that answers the foundational problems of political economy.
So, the gauntlet has been laid down. For a post-capitalist system to compete against capitalism, it must also answer these foundational questions of political economy at least as well as capitalism does. In order to do this, we will provide a clearer understanding of the distinction between “market” and “planned” economies, using points we raised in our earlier piece on markets as well as a further analysis of the money+prices system we discussed here.