I agree wholeheartedly with Becker that capitalism is a superior economic system to any other that has been tried, the others being mainly socialism and communism. The best evidence for this is that out of the 194 countries in the world, I can think of only two that are not capitalist—Cuba, which however is moving slowly in the capitalist direction, and North Korea, the greatest economic failure on the planet.
But this statistic indicates that capitalism is a necessary condition of economic success rather than a sufficient condition. Many of the world’s countries, though capitalist, are basket cases—not as badly off as North Korea, but plenty badly off. Per capita incomes in rich capitalist countries such as the United States, Canada, Germany, Britain, and Japan greatly exceed per capita incomes in poor capitalist countries, which are the majority of countries.
So the big question is, given capitalism, what else does a country need in order to prosper? We know that it doesn’t need abundant natural resources or a large population. But it needs a legal and political system that protects property rights, allows a large degree of economic freedom, minimizes corruption, controls harmful externalities (like pollution) and subsidizes beneficial ones (like education), distinguishes between equality of opportunity (which it promotes) and equality of incomes (which it promotes only to the extent of combating poverty), welcomes and assimilates skilled and wealthy immigrants, and (related to protecting economic freedom) avoids public ownership or control of economic enterprises. To create and maintain such a legal and political system a country also requires a culture of respect for business success, of competition and risk-taking, and of consumerism—since, as Keynes argued, consumption drives production.
Such a combination is difficult to achieve; no nation has achieved it. The variance across nations in culture and in institutional structure is very great, and determines the relative economic success of the different nations.
Since there is so much variance across capitalist countries—so much that can go wrong with a capitalist system because of the complex institutional structure and social culture that capitalism requires if it is to be maximally successful in contributing to social welfare—we need to avoid complacency. Complacency was a major factor in the surprising economic collapse that began in September 2008, a collapse the consequences of which are still very much with us.
When I started teaching in the late 1960s, the economist Harold Demsetz was talking about the “Nirvana Fallacy.” He defined that as the belief of many economists that any market failure, such as monopolization or pollution or underproduction of public goods, could be rectified at little cost by government intervention. If that were true, it would indeed enable “Nirvana” (in the sense of heaven—which isn’t actually what the word means; it’s nearer to “oblivion”) to be attained. But as Demsetz pointed out, it isn’t true. There are government failures as well as market failures, and they have to be taken into account in deciding whether and what the government should be asked to do about market failures.
Over time, however, a reverse Nirvana Fallacy took hold of many economists, most famously Alan Greenspan. This was the idea that capitalism was a self-regulating system; market failures were, with few exceptions, either self-correcting, or less harmful than regulation aimed at eliminating them. Such thinking influenced the regulatory laxity that contributed (decisively in my view) to the financial collapse of September 2008 and the ensuing worldwide depression, and to the disbelief until then of many economists that there would ever again be a major depression. Greenspan and other like-minded economists and political leaders were wrong to think capitalism self-regulating; they neglected the need for an institutional structure, and a culture, that differentiate successful from unsuccessful capitalist economies.
The institutional structure of the United States is under stress. We might be in dangerous economic straits if the dollar were not the principal international reserve currency and the eurozone in deep fiscal trouble. We have a huge public debt, dangerously neglected infrastructure, a greatly overextended system of criminal punishment, a seeming inability to come to grips with grave environmental problems such as global warming, a very costly but inadequate educational system, unsound immigration policies, an embarrassing obesity epidemic, an excessively costly health care system, a possible rise in structural unemployment, fiscal crises in state and local governments, a screwed-up tax system, a dysfunctional patent system, and growing economic inequality that may soon create serious social tensions. Our capitalist system needs a lot of work to achieve proper capitalist goals.