The Myths and Misperceptions of MarketsJames P. Davenport, Rose State College

“No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable.” – Adam Smith

Capitalism

This session relates to the following content standards for Social Studies:

• High School Economics– Content Standard 2: The student will evaluate how societies answer the

three basic economic questions: what goods and services to produce, how to produce them, and for whom are they produced?• 1. Compare the world’s basic economic systems of market (free enterprise), command,

and missed market economies identifying countries that have adopted each and comparing and contrasting the results those economic systems have produced in those countries as measured by GDP, national prosperity, and individual income and wealth.

– Content Standard 5: The student will describe the role of economic institutions including banks, labor unions, corporations, governments, and not-for-profits in a market economy.• 1. Evaluate the impact of government ensuring the protection of private property rights

and the rule of law in a market economy.

Content Standards

– Content Standard 9: The student will evaluate the economic role of government in a market economy.• 1. Explain the role that government has in dealing with issues such as poverty, pollution,

and medical research.• 2. Describe the costs and benefits of government assistance programs, education, and

other government funded services and projects.

• High School World History:– Content Standard 4: The student will evaluate the global transformation

brought about by the Industrial Revolution and the World Wars• C. Summarize the impact of massive social and economic changes as a result of

industrialization including Marxist criticisms of capitalism – U.S. History

Content Standards Continued

A Brief History of Economics

Capitalism is an economic system predicated on:• Private Property– Locke: The right to property predates government– Smith: The ability to develop, improve, & exchange

property creates wealth•Voluntary Exchange– Attempts to force certain exchanges or unnecessarily

limit exchanges are “anti-capitalist”•Absence of Coercion or Fraud

Defining Capitalism

Capitalism is not:

• “Pro-Business”– Adams Smith: Any collection of business interests will try to distort the

market to their benefit– Dr. Jeffrey Miron: Capitalism requires businesses to compete with one

another, which they would prefer to avoid. Benefit goes primarily to consumers more than producers

• “Anti-Government”– Dr. Greg Mankiw: Need a government that can develop a system of clearly

identified property rights– Dr. Greg Mankiw: Need government to enforce contracts

Un-Defining Capitalism

• Capitalism is not opposed to helping the poor – nor is it opposed to the government helping the poor.– Adam Smith

• As the wealth of society grew, the resources collected by the government would also grow

• As wealth in society increased, so would benevolence– Friedrich Hayek, Milton Friedman, Charles Murray: All proposed some form

of basic guaranteed income provided through the government– Capitalism does require the consideration of trade-offs for various means of

providing assistance• Work Incentives• Efficiency (least market distortions)• Effectiveness (provides needed resources to the people who need them)

Un-Defining Capitalism Continued

Prices Communicate Information

Markets Spur Innovation

Markets Create Wealth

Markets Reward Those Who Most Benefit Society

• Unlocking the Power of Markets– Hayek: Prices rapidly

communicate information that is widely dispersed in society

– Schumpeter: Markets constantly require producers to improve

– Locke: The use and development of private property improves its value

– Smith: Markets direct self-interest to socially beneficial endeavors and create positive social behaviors

• Smith: Markets cannot provide many of the things needed by a modern society– National Defense– System of Justice– Infrastructure

• Hayek: Markets allow for significant disparities in wealth as some will be more “resourceful” than others.

• Hayek: Because capitalism is rooted in human nature, as long as human nature is flawed, capitalism will be flawed.

• Schumpeter: The “creative destruction” of capitalism – what modern economists might call innovation – tends to make skills and industries obsolete.

The Limits of Markets

• Dr. Jerry Muller has identified five areas in which versions of capitalism differ from one another.– Democratic or non-democratic

• All liberal democratic societies have had capitalist economies, but not all capitalist economies have been liberal and democratic

– Welfare-State Capitalism (all systems that combine democracy with capitalism have developed into welfare-state capitalist systems)• Conservative – stresses job protection, high wages, and the ability of a male to be the

sole breadwinner of the household (many Catholic countries)• Social Democratic – stresses government provision of social services and income

supports for greater income equality for men and women (Nordic countries)• Liberal – Offers government support to those who can’t work in the market. Has less

stringent labor laws making it easier to hire/fire employees. (Anglo-Saxon countries)

Variations of Capitalism

– Strategies for National Development• Smithian – Combines competitive free markets with international free trade• Hamiltonian – Stresses protectionist policies (high tariffs, subsidies, etc.) in the

transition from agrarian to industrial economy – Types of Businesses and Relationship to Government*

• State-guided Captialism – government attempts to guide the market; offers support to favored industries

• Oligarchic Capitalism – The bulk of wealth and power is held by relatively few individuals, families, or clans with close ties to the government

• Big-firm Capitalism – Most significant economic activity is performed by established, large enterprises

• Entrepreneurial Capitalism – small, innovative firms play a major role in economic activity

(U.S. is a combination of Big-firm and Entrepreneurial Capitalism)

* Taken from the Book Good Capitalism, Bad Capitalism, by William Baumol, Robert Litan, and Carl Schramm

Variations of Capitalism Continued

– Extent of equality or inequality in society• Variations can be explained in part by:– Ethnic Homogeneity– Size (population)– Cultural Traditions

• National differences are reflected in the variety of welfare states

Variations of Capitalism Continued

• There have been many non-democratic capitalist countries, but no liberal democratic, non-capitalist countries.– Most Western nations became capitalist before becoming

democratic– Some liberal thinkers worried that democracy would lead to the

destruction of capitalism (John Stuart Mill)– Three ways democracy supports capitalism

• Elections tend to make people more accepting of government• Democracy tends to reduce the more extreme elements of capitalism• Democracy provides an informational feedback mechanism

Capitalism’s Tensions with Democracy

• Rising standards of living produced by economic growth is conducive to democracy– Modern democracies derive much of their legitimacy from their ability to

provide increasing standards of living– Growing economies tend to minimize political conflict– Democracy without economic growth tends to exacerbate distributional

conflict

Capitalism’s Tensions With Democracy Continued

• With economic stagnation occurring during the 1970s, with increasing government expenditures and inflation, led some to rethink the relationship between democracy and capitalism.– James Buchanan – Public Choice Theory

• Focused on “government failure” rather than “market failure”• Key Insight: Politicians pursue their own self-interest and appeal to voters’ self-interest

while doing so– Revisiting Keynes in light of democratic processes– Elected officials get more support when they spend money that yields benefits to constituents

than when they cut back on spending– This leads to ever larger deficits

Capitalism’s Tensions with Democracy Continued

– Mancur Olson – Logic of Collective Action• Politicians and other government officials are self-interested actors• Well organized small groups have an advantage in lobbying the government for policies

that benefit them at the expense of the rest of society.• Each group seeks protection from market competition for the commodity or service it

produces. As protection is gained, efficiency and production in the market are reduced.

According to Dr. Jerry Muller, the stagnation of economic growth in the 1970s, coupled with these powerful criticisms turned both capitalist and non-capitalist countries toward more market oriented policies beginning in the late 1970s and early 1980s.

Capitalism’s Tensions with Democracy Continued

• Many institutions and practices that work well in one national context may not be easily produced in another because of cultural and historical factors– Different societies have different preferences for risk versus security,

mobility versus stability, and equality of outcomes versus inequality of achievement

– These differences can be difficult to change by deliberate policy which can limit the options available to policymakers

Limits to Comparison and Analysis

• Questions?

• Comments?

Questions or Comments

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