Profits, Competition, and Social Welfare-Becker

 

The financial crisis and the resulting recession have led to a strong reaction in many countries against the profit motive and private enterprise. Left of center political parties are gaining office and power in France, Mexico, Greece, and elsewhere with the promise of much greater regulation of banks and other businesses, renationalizing some companies, and constraining profits through higher taxes and other ways.

It is easy to sympathize with the hostility to the many banks that behaved (in retrospect) so foolishly in ways that damaged everyone else as they took on excessive risk in their quests for greater profits. One can understand also the general reaction against capitalism and “market failures” since commercial and investment banks were in the past a leading example of capitalism at work. Yet anyone concerned about the welfare of the poor and middle classes should resist the temptation to attack competitive private enterprise and capitalism- monopoly or crony capitalism should be deplored. This is only partly because “government failure” also contributed in an important way to the financial crisis as regulators did not rein in the asset explosion of banks and households. Indeed, regulators often encouraged lending to lower income families to buy houses with low down payments, large mortgages and ballooning interest payments.

The main reason to be concerned about the attacks on competitive capitalism is that it has delivered during the past 150 years so much to all strata’s of society, including the poor. I will try to demonstrate this not with a general analysis, but with several rather impressive examples.

China in 1980 was among the poorest countries in the world. It had just gone through the Cultural Revolution and the Great Leap Forward that contributed to the deaths of tens of millions of rural and other Chinese. In desperation, a few farsighted Chinese leaders decided to allow private enterprise and capitalism to gain a toehold in its agricultural sector. To the great surprise of many Chinese political leaders, the result was an explosion in farm output, even though farmers had only tiny plots of land to work with. Seeing the success of the liberalization of farm output, China extended the incentive system to industry by encouraging the growth of private enterprises in some sectors. Again, the results far exceeded expectations as these private companies, many owned by Taiwanese and Hong Kong residents, were not only far more efficient than state owned enterprises, but they also became the leaders in the rapid expansion of exports from China to the US and other countries.

The most significant result of this radical shift of China toward a more market oriented economy has been the lifting of hundreds of millions of Chinese out of dire poverty-living on the equivalent of only a couple dollars per day- to having decent and growing standards of living. Many critics attack globalization as the source of the world’s economic problems. Yet the opposite is much closer to the truth as competitive private enterprise and the profit motive acting through a globalized economy has eliminated the most abject of poverty for over a billion persons just in China, India, and other parts of Asia alone.

My second example deals with the interaction between capitalism and discrimination against groups based on their race, gender, religion, or other characteristics. Capitalism and the profit motive help to erode discrimination because companies in their quest for greater profits try to hire minority group members who are getting paid less than their productivity. In addition, the successful growth in incomes and productivity induced by private enterprise raises the standard of living of minorities even when they continue to suffer from substantial discrimination.

A prime example is South Africa under apartheid that was maintained by government laws but was opposed by many private companies. South African blacks suffered immensely under apartheid, and its overthrow is one of the great events of the past several decades. Nevertheless, one main problem during the apartheid period was not to prevent many blacks from leaving South Africa, but rather to control the in migration of blacks from other parts of Africa. The explanation is obviously not that the incoming blacks liked apartheid, but rather that the private enterprise system in South Africa had raised substantially the incomes of blacks there -despite the widespread government-orchestrated discrimination against them-and blacks from other countries in Africa wanted to benefit from the higher incomes available to them in South Africa.

Something similar happened in the United States. African-Americans suffered greatly from discrimination until recent decades. Nevertheless, black incomes continued to grow along with white incomes as the US experienced sizeable and continuing economic growth after the end of the Civil War in 1865 (see my book The Economics of Discrimination, 1971).

My final example deals with this growth of US GDP. America has been recognized as the country during the past 150 years that has had the most open and vigorous competitive profit-oriented private enterprise system. And for the almost 140 years from1870 to 2007, per capita American incomes grew rather constantly at the rate of about 2% per year, despite vast changes in many institutions and regulations. The result was a several fold increase in per capita income that raised the incomes of the poor by about as large a percentage as the incomes of the upper middle class and even the rich. To be sure, GDP suffered a serious shortfall during the Great Depression of the 1930s. Yet even that was made up for by the 1940s as US GDP then joined its long-term growth line. The Great Recession once again pushed US GDP below this line, although by a lot less than during the Great Depression. Unless government policy messes things up badly enough, and that is a real possibility, I would expect before very long that US GDP would join up with its long-term growth potential.

I do not claim that the profit motive under competitive capitalism always produces ideal results. Aside from the need for greater capital requirements for banks, there is concern about inequalities, and pollution and other “externalities” that often require government regulations and controls, although the limits of what government can do also have to be recognized as well. However, over the long haul capitalism has delivered big time. In the anger at banks and the financial crisis, voters and governments have to be careful that they do not kill the goose that has laid so many golden eggs.

 

Comments

[Terry Bennett]

Thank you, Dr. Becker. Whatever its imperfections, capitalism is necessarily senior to communism. If there were no capitalism, there would be no rich people to tax, and communist idealism - by which I mean the impulse to make things better by taking things from some people and giving them to other people - would not arise at all.

Some collective action is appropriate: national defense is surely a better approach than individual defense. However, this fundamental anger at individuals who produce more than they consume, and thus become rich, is so obviously flawed that its manipulation by certain politicians who should know better can only be explained as offensive pandering.

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[Tim Worstall]

Re China.

My favourite example is from Angus Maddison's figures. In 1978 (the real start of the change) the country's GDP per capita was the same as the UK's in 1600 AD. By 2010 it was the same as the UK's in 1948.

350 years of economic development packed into 32 years.

[NEH]

When we talk "CAPITALISM" are we talking Capitalism with a Capital "C" or capitalism with a lowercase "c". It all comes down to the harmonizing of interests. "Financial/Commercial, Industrial, Agricultural and Societal". No Harmonization, Capital "C", Harmonized, lower case "c".

As for the "China" example, Instead of classifying it as a "Capitalist" system I would prefer to see it classified as a "Statist" economy covered over with a veneer of "capitalism" all controlled by the Communist State. They have learned their lessons well. Something we could do well to relearn...

[TANSTAAFL]

The conceit that government can orchestrate a "harmonizing of interests" runs contrary to the principle of economic liberty on which America was founded. And Hayek, too.

[ezra abrams]

your opening is a straw herring.
It is not just the awful econ situation that has galvanized the left; it is
a) the lack of any prosecution of the wealthy. The poor and middle class have paid - in foreclosures (which affect neighbors) broken homes, divorces suicides etc
and the wealthy ? poor things, they had to down grade from a Bentley to a Mercedes S class
As you know, not one - not one- banker or wall street exec under crimminal indictment.
b) the bizarre logic of the right wing extremists, like Bachmann, calling for the EPA to be shut down. I suppose, I could list a long list of similar things.

But enough of this silly theory; in a country (ours) where kids go to bed hungry, while the VCs get low tax rates via carried interest exemption, the idea that we are attacking the capitialists is silly; it is they, like a cancer, that are attacking us.

surely you know of the ratio of worker/ceo pay, from Mitt Romney (who didn't create any jobs - he used financial shenanigans to destroy jobs and recreate them at min wage, pocketing the diff) back to his father, what a change.

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But enough of this silly theory; in a country (ours) where kids go to bed hungry, while the VCs get low tax rates via carried interest exemption, the idea that we are attacking the capitialists is silly; it is they, like a cancer, that are attacking us.

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[NEH]

affl, Before passing off a euphemism for "Anarcho-capitalism ("Economic Liberty")as a two second sound bite on the history of American Political Economy, may I suggest you peruse and study closely the following:

First Secretary of the U.S. Treasurey to the U.S. Congress:
"First Report on Public Credit"
"Operations of the Act Laying Duties on Imports"
"Second Report on Public Credit"
"Report on the Establishment of a Mint"
"Report on Manufactures"

American Political Philosopher Raymond:
"Elements of Constitutional Law"
"Thoughts on Political Economy"
"Elements of Political Economy"

Theorists on the American School of Political Economy, Matthew and Henry Carey:
"Essays on Political Economy"
"The Harmony of Interests"
"And others"

German Political Economist List's responses to A.Smith:
"The National System of Political Economy"
"And others"

That's the problem with "Free Speech", every uneducated buffon is allowed their two seconds on the "Soap Box". No matter what kind of poison comes out of their mouths... ;)

[Ben]

"The result was a several fold increase in per capita income that raised the incomes of the poor by about as large a percentage as the incomes of the upper middle class and even the rich."

Evidence?

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[Oliver Holloway]

The root problem with America's competitive capitalism is that currently it's not all that competitive. Is it reasonable to consider the possibility that progressive redistribution can keep competition high and fair, thus ensuring the benefits of capitalism for all participants? As an example, consider that every major sports leagues implements progressive redistribution so as to keep the competition high and the product ever-improving.

[Steve Beebe]

What might be equally instructive about the China example is to look at the degree of government orchestration of the growth and exercise of competitive private enterprise. China's success was not from an unfettered approach to capitalism such as advocated by Greenspan et al, but a managed approach.

If we weren't so proud, we could perhaps learn something.

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