Why Capitalism?

Editor’s note: Allan Meltzer, a visiting scholar with the American Enterprise Institute for Public Policy Research and a noted author on the history of the Federal Reserve, delivered on Mar. 9 a lecture titled, “Why Capitalism?” This is the first part of a three-part series summarizing his lecture.

In his opening comments as part of the 2008-2009 Bradley Lecture series,  Allan Meltzer said headlines proclaiming the end of American-style capitalism “greatly overstated” the economic situation, and further noted that capitalism has “weathered many more serious problems.”

“Capitalism as a guiding system for economic activity has spread over the centuries to now encompass most of the world’s economies,” according to Meltzer. “This spread occurred despite almost continuous hostility from many intellectuals and, in recent decades, military threat from avowedly Communist countries.”

Meltzer explained that capitalism is the “only system that increases both growth and freedom,” and places the means of production and the economic choices in the laps of individuals. He said the arrangement is built upon a foundation held firm by the rule of law that protects property rights and preserves the connection between risks and rewards.

He said critics of capitalism always emphasize the “unequal distribution of income” from the free market system, the recessionary periods and a focus on rewards for the individual rather than for the larger population.

“Critics of capitalism emphasize the unequal distribution of income generated by the market system … They talk about equity and fairness, but it is mainly wealth redistribution that they seek,” Meltzer noted.

NOT A MORAL SYSTEM
However, Meltzer opposes the defense of a capitalist system on the grounds it is a moral system. He said a moral defense fails to acknowledge that not all actors in a capitalist system are honest. Also, Meltzer argues that not all moral principles are generally accepted; meaning not everyone agrees on what is right and wrong.

“The rule of law is the principal partial substitute for a moral code. To function efficiently or even to function at all, a capitalist system requires rules. The law must protect individuals and property, enforce contracts, sustain belief in systemic stability over time, and respond to political and social pressures,” Meltzer explained.

Capitalism survives and spreads because it recognizes that people are different. In fact, Meltzer argues, the reason capitalism survives when other alternatives fails is because it “permits choices” so that the differences between people are accommodated easily.

Meltzer observed: “Socialism and other utopian systems are more rigid. They represent someone’s belief in the aims that ‘good people’ should embrace. Movies are too violent. They must change. Television is too banal. It must improve. But the change is always from individual choice to an imposed choice. Freedom allows people choices that violate someone’s idea of social norms or right conduct; Socialism restricts choice to those that officials permit. Capitalism accepts that some dislike the outcomes resulting from choice in a market economy. … A good society permits markets to accommodate differences.”

DEMOCRATIC CAPITALISM
Meltzer acknowledges that capitalism does not efficiently solve all problems. He noted that a public service — police — suggests that society agrees that collective action is necessary to improve the common good. This action grants a government the power to intervene with administration and taxation, resulting a what Meltzer calls a “mixed capitalist system.”

Further, Meltzer notes that true capitalism does not exist in America; it is democratic capitalism in that voters have the authority to choose “the tax rate and the size of government.”

Voters typically have two choices in democratic capitalism, according to Meltzer: “Elections often require a choice between one party that favors economic growth achieved by lower tax rates and less government regulation and another that emphasizes programs for redistributing income and expanding government’s role and size.”

Voters also can restrict actions deemed socially undesirable. Anti-smoking laws and cigarette taxes are an example.

“Despite past and current failure to outlaw alcohol and narcotics, the public chose to restrict cigarettes,” Meltzer wrote.

REGULATING CAPITALISM
Regulating capitalism often fails because the markets “learn to circumvent costly regulations,” Meltzer said.

Meltzer explains further: “The object of campaign finance reform was to remove the allegedly noxious influence of money in politics and limit presidential candidates to an amount of spending decided by regulators. As the recent presidential election demonstrated, it failed. The election was more costly, and only one of the major party candidates accepted taxpayer money and a limit on spending. The legislation limited spending by candidates and parties but not by interest groups. One result was to further weaken political parties and increase the influence of single-issue groups. Parties work to harmonize divergent interests. Specialized groups often work to magnify differences, making policy compromise more difficult. This was not the outcome that proponents of McCain-Feingold or similar legislation promised.”

Meltzer said regulation is useful only when it aligns private and social costs. He provided the example of a society agreeing to share the cost for a police force as an alignment of private and social interests.

Unfortunately, most regulations are inefficient and survive beyond the initial reason for their implementation.

“Often they (inefficient regulations) reward a group powerful enough to sustain them. Think of agricultural subsidies for high-income farmers as one of a multitude of programs that persist and grow,” Meltzer explained.

At the end of the day, however, the regulations and their good and bad results are the responsibility of citizens in a democratic capitalist society.

Meltzer explains: “Democratic government introduces a separate way to allocate resources. Generally, those who succeed in the marketplace favor market allocation. Those who do not succeed favor allocation at the polling place. They are joined by those who dislike capitalism or prefer more emphasis on ‘social justice’ and less on market efficiency. Actual social outcomes are a compromise between the two aims.”

Part II of this series will summarize Meltzer’s thoughts on alternatives to capitalism and the history of economic growth and progress.