Before You Blame Capitalism…

Or talk about how terrible capitalism is…

The world we live in isn’t perfect. And if that wasn’t enough, this world is far from fair. It’s so unfair that I can guarantee you that there is someone who’s got it 10 times worse than you and there’s someone who’s got it 10 times better than you—and this applies to pretty much everyone (including those “filthy” billionaires you might hate).

Maybe Mars will be different after Elon finds a way to get us there. However, we’re stuck on Earth, and because Earth has so many problems, it’s easy to find blame for Earth’s—or for your local or regional—problems. For anyone that chooses to spend time in any non-Western country (and some Western countries too) for an extended period of time, it’s easy to become skeptical of big governments and the promises they make. However, for many who live in the US, I see people easily blaming Capitalism on their problems.

Now, don’t get me wrong, Capitalism isn’t perfect. Also, I’m not here trying to pretend like those problems you might complain about don’t exist. It’s clear that we need to protect the environment and use it carefully before it’s too late. It’s clear that the prices of higher education is skyrocketing to a level that’s unbearable. It’s unfair that big businesses often get bailed out when small businesses don’t. It’s clear that the police is too brutal. It’s obvious that healthcare is far from perfect. However, before you blame capitalism for your problems…

Understand What Capitalism Is

I’m gonna use various definitions just to make sure we are on the same page on what Capitalism is:

• From the Oxford English Dictionary: “an economic and political system in which a country’s trade and industry are controlled by private owners for profit, rather than by the state”
• From Wikipedia: “Capitalism is an economic system based on the private ownership of the means of production and their operation for profit. Central characteristics of capitalism include capital accumulation, competitive markets, a price system, private property and the recognition of property rights, voluntary exchange and wage labor.”

I want to give another definition based on my reading of the book Basic Economics by Thomas Sowell. First, in that book, economics is defined as “the study of the use of scarce resources which have alternative uses”. Keywords:

• Scarce → scarcity: This means “that what everybody wants adds up to more than there is”. Nothing fancy here, just that not everyone can get what they want.
• Alternative uses: Not only these resources are scarce, they can be used for different things. A very simple example: some people use sugar to make doughnuts, and some other people use sugar to make cakes. Both of those are alternative uses of sugar.

With that economics definition out of the way, capitalism is a system where the use of scarce resources which have alternative uses is fully privately coordinated. That means that you are free to use your own sugar to make cakes or doughnuts—or even sell it to someone else who would want to make cakes or doughnuts. No one will force you.

I know the example above is absolutely ridiculous, but I just want to make a point that the above is really all that capitalism is. These are dictionary definitions of capitalism, and if you hear anyone say that capitalism is anything else, then they are not talking about capitalism.

With that said, when you hear someone who supports capitalism talk about it, they are indeed talking about this system in addition what was said in the Wikipedia definition. Particularly, voluntary exchange, competitive markets, wage labor, and private property and the recognition of property rights.

Voluntary Exchange

This means that when you go out there and exchange a resource (like your money) for another resource (like doughnuts or cakes), you are doing so voluntarily—no matter what forces are pushing you to participate in these exchanges. That is, you have the full power without fear of repercussions to say, “no, I will not exchange my money for this doughnut”. Another word for this is: freedom, which is reflected in the definition of capitalism.

Competitive Markets

What competitive markets implies is that if two people are selling the same resource, the better resource will win and the worse one will go out of business. If you lived in a city where no one wanted doughnuts and everyone wanted cakes, all the doughnut businesses would go out of business because no one wants them.

One key thing about competition in a fully textbook definition of capitalism is that the winning resource wins 99% of the time because it is a better resource—better in the sense that more people voluntarily choose to purchase that resource over the competition’s resource.

• This means, if your favorite doughnut business goes bankrupt, it was 99% because it just wasn’t as good as the cake business. I.e., the cake business didn’t do some crazy “non-competitive” practice to make the doughnut business go bankrupt.
• This is going to sound like a jump, but if you don’t believe me, just read Basic Economics by Thomas Sowell: Monopolies are practically impossible to exist in a capitalist economy. But wait, aren’t there technically some monopolies in the U.S.? Not really. Some of those “monopolies” are just not monopolies, and the ones that are close to being monopolies exist because the U.S. is not fully capitalistic. Maybe I’ll write about this topic in the future to further explain why.
• Finally, another aspect of competition is that consumers dictates what happens based on what they purchase. In other words, consumers kind of vote with their money. By choosing to buy things from Amazon (vs. eBay or target), consumers are voting with their money that Amazon is the better online retailer (which is a form of supporting everything that Amazon entails).

Wage Labor

Something you have to understand about capitalism is that labor, just like every other resources, is just another resource. Just like water can be used to shower or drink or other alternative uses, labor can be used for just as many if not more alternative uses.

This sounds harsh, but the reality is that no matter what system you use (socialism, democratic capitalism, democratic socialism, etc), labor is still just a resource like everything else.

This implies that your labor compensation is just the price of that labor. Saying “compensation” here because it doesn’t have to be money. Certainly under different systems, you could be compensated differently. Under capitalism, it’s usually in the form of money, and again because capitalism has that voluntary exchange component, your compensation is something that you agree with with whoever is compensating you—be it a salary, stocks, shelter, benefits, or anything else.

Depending on what kind of labor you are arguing for, you may have more or less bargaining power to demand more. If more isn’t provided to you because your labor is that valuable, then you would simply go to the competition and exchange your labor for their compensation instead (if they are willing to make such an exchange). On the flip side, if a company has 50 people trying to exchange the same type of labor for compensation, then that company has more bargaining power and can choose to provide the compensation to the person who will demand the least amount of compensation.

Yep, in capitalism, the labor market is brutal like that, and what people can do about it is find a way, either in the short term or long term, to be able to provide labor that doesn’t have as high of a supply so as to drive up their bargaining power and demand a higher compensation.

Private Property and the Recognition of Property Rights

What this means is that in capitalism, you have private property that fully belongs to you, and that somehow in this system it is recognized and respected that it belongs to you. That means, someone can’t just take your property from you.

In other words, all people would recognize that you cannot take something away from someone else without them voluntarily exchanging it or giving it to you. How that’s ultimately achieved is through some form of incentives, which conventionally is done through some sort of government police or court. Other ways could be via social stigma against stealing someone else’s property.

Understand Core Implications of Capitalism

There are many implications of capitalism. However, the most important one is efficiency, so I want to focus on that.

In the words of Thomas Sowell from Basic Economics:

While capitalism has a visible cost—profit—that does not exist under socialism, socialism has an invisible cost—inefficiency—that gets weeded out by losses and bankruptcy under capitalism. The fact that most goods are most widely affordable in a capitalism economy implies that profit is less costly than inefficiency. Put differently, profit is a price paid for efficiency.

If you were the ruler of a country and you were deciding what economic system to go with, your key lever would be how efficient you want things to be. Do you want people to get what they want as quickly as they want, or do you want them to sometimes have to wait before they can get what they want?

In fact, you don’t have to be a ruler. You can be a legislator trying to vote on a bill. The same exact question applies. Let’s say you want to add a bill about “affordable housing”. I will assume that you’d be a smart legislator and come up with something way better than this, but let’s say the bill was “in the City of New York, a landowner cannot charge people more than $1000/month for rent”. What happens when such a bill gets enacted?

• On the tenant side: Imagine you live in Boston and you find out the average rent for a one bedroom apartment in NYC dropped from >$2.5K to ≤ $1k. If you were thinking of moving to NYC, this is great news! How many people would decide to now try to move into the city? A lot of people. This means that the number of people wanting to live in NYC increases by a lot while the number of apartment buildings available stays the same or gets lower. On the flip side, if you lived in NYC and were thinking of moving to Boston, then you would have second thoughts now that your rent has lowered. In fact if it lowered enough, you might even decide to continue paying for that rent even if you didn’t live there (say it dropped from $9000 to $1000). You may find this article on the topic interesting.
• On the landowner side: Would any landowner want to make people stay on their land anymore? Well, no. They would pretty much all turn their property into commercial rental places or try to sell it to another business for office space. The only ones that will keep renting are the ones that are capable of making a profit at $1000/month. All in all, they might decide to not fix up the place anymore because it’ll be less worth it to maintain.
• On the legislative side: Now that you realize that this legislation isn’t working, you decide to lift for newly constructed buildings—or allow developers to build what’s considered “luxury housing” which may charge super high prices. This leads to having more options for the rich and extremely high cost for the newly built apartments (because you can’t just raise everyone’s rent or otherwise you won’t get reelected so the old places with low rent costs will have to stay low and their tenants will hoard them to maintain their low rent statuses).

The result of such a poorly thought out legislation is not more affordable housing, it’s less housing, more low quality housing, more bargaining power to the landowners, and probably later down the road more homelessness. Such a bill makes housing less efficient because more people will be waiting in line to get their housing.

The above is simply to serve as an illustration of this spectrum of efficiency that capitalism provide; it’s not meant to pick on affordable housing policies (I do think there are better policies for affordable housing—like having the equivalent of food stamps but for housing—which maybe the government doesn’t do often because it can’t afford it).

Another example of lack of efficiency is the DMV. I don’t have to say much here: everyone knows how slow and inefficient the DMV is. If instead such an entity was made by a privately owned business, competition would drive down the waiting time and improve the efficiency of the provided service.

Understand What The Alternative Systems Are

Knowing the textbook definition of capitalism isn’t enough. It’s also important to understand what the other systems are. Now, here I could go on about socialism or all the other systems that could be used instead of capitalism. But I want to keep things simple and talk about what happens when some central authority dictates the allocation of scarce resources which have alternative uses (remember: in capitalism, private individuals and businesses dictate the allocation of scarce resources which have alternative uses by trading them at a given price voluntarily).

When a central authority dictates the allocation of scarce resources, the central authority is not only bound to make errors but also bound to make biased decisions that could easily favor one person over another.

• Errors will be made because there is just no way that the central authority has access to all the necessary information to correctly coordinate prices. Also, they can easily fall for the trap of confusing demand and “need” (see below).
• Biased decisions are also easy to make and probably will be made intentionally. Some biased decisions could be good ones: for instance, choosing to allocate more resources for a group that has been badly hurt in the past or to which recent calamities happened. However, bad ones are also possibles: politicians easily listen to those who have money more than those who don’t, or for instance, you often hear about how in some countries, politicians prefer listening to the ethnic group where they came from.

Another important issue with central authority allocating scarce resources which have alternative uses is that this process is much more inefficient and takes away one major thing that makes people produce things: incentives. What incentives does one have if they know that working more will not give them more? Or even if they did, how properly would a central authority correctly evaluate how hard everyone worked and try to compensate them properly? It just becomes impossible to motivate people. Once enough people are demotivated to work, everything else will become of lower quality and the entire system usually ends up falling.

Obviously, in this example I took it to the far opposite of what capitalism is, but this is just to show that the opposite of capitalism is worse than capitalism, and the closer you get to that far end, the worse things get. At the same time, it doesn’t necessarily mean that things should be full on capitalistic. There’s a spectrum here, and often being somewhere in the middle might be the better option.

Avoid Making Common Confusions

Understand the Difference Between Demand and “Need”

I learned this one also from Basic Economics (note: if you haven’t gotten the memo yet: you should read this book).

Obviously, if you go to the far extremes, there are things that people really need: you cannot survive without water or food. However, when we’re not in the extreme, there is no such thing as “need”. For instance, do you “need” electricity? If you really “needed” electricity, then you would pay for it no matter the cost. However, as soon as that cost increases enough, enough people would start using it sparingly (see below for what I mean by “cost”—I do not mean “price”).

This is where demand kicks in. I’ve previously wrote about supply and demand, and I think this is something people often confuse too (or at least I used to be confused about it). The gist of it is that “demand” is like a commitment to buy something given a price. That is, if doughnuts cost $6, you would “commit” to buying only 1 but if they cost $4.5, then you’d buy 2. This commitment is kind of implicit and can change from one moment to another. The gist of it is that it helps coordinate prices. For instance, a company can accurately evaluate (1) whether they’d make profit selling a given product and (2) how much they expect to make if enough people would buy at any given price they set. This prevents them from charging too much or charging too little.

In this case, you might “need” electricity, but only if it costs so much (thankfully right now it doesn’t seem to be costing too much for the average person).

Understand the Difference Between Cost and Price

Out of the many confusions people make, mixing up cost vs. price is by far the most common one. It’s very important to understand the difference between the two:

• Price is the amount needed to purchase something. The price is often set (more often than not based on careful calculations and, in capitalism, regulated by competition), and it is tied to some given currency. Price is very easy to grasp. If you pay $3 for doughnuts, the price of those doughnuts was $3.
• Cost, on the other hand, is sort of like the “actual work” needed to produce or do something. In this case, the cost of the doughnuts is how much actual labor was needed to produce it.

As you can infer from the above two definitions, cost is much more difficult to evaluate. A simple way that economists like to think of cost is this term “opportunity cost”, which is what other thing you could do if you chose to do something else instead. For instance, if you take into account all the time, preparation and labor that went into making those doughnuts, you could use all of this time, preparation, and labor to do something else (maybe make cakes instead!).

Cost is always there, no matter the system. No matter whether we’re in a socialist or capitalist or fascist economy, there will always be cost to making doughnuts. What is really different between these systems is that this cost can change. In a centrally planned economy (as discussed above), things can easily cost a lot more because everyone would be working a lot less or producing lower quality labor. In addition, the cost can also change within a single system. For instance, John Stossel said, “Rockefeller got rich selling oil… He found cheaper ways to get oil from the ground to the gas pump.” By finding a cheaper way to get this oil, Rockefeller was able to reduce the cost of oil even though the economic system he was in didn’t change, and that is an example of how innovation can help reduce the cost of things.

Understand the Difference Between Intentions and Incentives

I want to bring up the example of the $1000/month rent in NYC again. The intention of the legislators was to make rent cheaper for people—make it “affordable”. Instead, they made rent nearly impossible. The reason for that is because intentions often don’t matter. What really matters are the incentives created.

That legislation gave people incentives to squat their current apartment or move to NYC and it gave landlords the incentives to look for other means of supporting their businesses by turning it into commercial property. It doesn’t matter what the legislators intended to do, the incentives created is what mattered at the end.

Another example for where this discussion of intentions vs. incentives matters is on minimum wage laws. The intentions of minimum wage laws is generally to give people enough money to support themselves. However, it changes a lot of things for society. Focusing on those jobs that currently pay below the desired minimum wage (say below $15/hour):

• Businesses now have an incentive to hire less people (note: every dollar increase in salary results in $1*40*52 = $2,080 less in yearly revenue for the business).
• Businesses now have an incentive to demand more from their employees, or alternatively, hire those employees that have more experience. This means that the low skill workers now have less of a chance to start gaining the skills they badly need in order to improve their finances. Who are the low skill workers? Usually young people who are probably living with their parents and don’t need to fully support themselves.
• People now have more of an incentive to work a job they previously didn’t want to because it didn’t pay as much, creating even more supply for the job. In capitalism, that increase in supply (people wanting this specific job) happens when the price for the resource (salary) is expected to be higher. Such increase in supply doesn’t necessarily make sense here because the demand hasn’t increase (McDonald doesn’t all of a sudden need to hire more people). This creates a surplus on the supply, which just happens to be called unemployment.
• Businesses might also have an incentive to raise their prices to make up for the loss in profit. If all businesses increase their prices, then that leads to higher cost of living for everyone.
• Finally, what kind of business can really afford to pay the higher minimum wage? Obviously the business that makes enough profit to swallow the cost or has enough resources to quickly adapt. The kind of business that can do this are big businesses; small businesses can’t. When small businesses go out of business, guess who has more market share? The big businesses. Do you think Amazon doesn’t know this when it claims that it supports an increase in the minimum wage?

If you support increasing the minimum wage, just be sure to acknowledge that some people will inevitably lose their jobs, some people in the future will inevitably not be able to get a job (increasing the level of unemployment), the cost of living will likely increase for everyone, and the winners will be big businesses (which people often complain about that they’re too big). It’s the brutal trade off of increasing the minimum wage—helping some people at the expense of other people. Personally, I am somewhere in the middle of this just like I am on most issues.

Understand Where and When Capitalism Fails

I may have sounded like one of those absolutists about capitalism. The truth is, from all the strong evidence I’ve seen so far, capitalism is the system that seems to work best to lift nations out of poverty. However, capitalism fails at a great many things and often it’s in those things that the government needs to step.

Image courtesy of Investopedia.com

The places were capitalism fails often have the following in common:

• Highly costly resources that benefit everyone
• Resources that have externalities

Highly costly resources that benefit everyone

If we go back to the very beginning, the Wikipedia definition of capitalism mentioned Personal Property and the Recognition of Personal Property. That component is extremely important to capitalism. Without it, you could just steal stuff from people (or do very bad things to coerce people into giving you their stuffs). This is an example of a resource that is costly but that benefits everyone. That is, if you go with the safer route of having a government run police / court, it will cost money to properly train and hire those people and run the system it powers and prevent corruption, but doing so is very costly. I want to give other examples of highly costly resources that benefit everyone:

• Military
• Police
• Court
• Roads, highways, streets, and everything that powers them
• Water (if you lived in a place that doesn’t get much water you’d feel this one)
• Education
• Raising of children
• Healthcare
• Environment

(note: I don’t want to sound insensitive by calling these things “resources”. The reason I use that terminology is so to maintain the idea that from the standpoint of economics, pretty much everything is a scarce resource that has alternative uses—including me and my labor!)

Some of these resources are borderline or more complex—like education or healthcare. However, for most of them, it’s not hard to see that everyone would be better off if those resources were kept at a high quality even though a single person wouldn’t endeavor to try to pay for them themselves.

Resources that have externalities

There are resources that have externalities; either in producing them or in using them. What I mean by externalities is that there is a cost associated in producing or using them that the person doing the production or usage is not the person paying the cost.

For instance, if you drove a car recklessly (e.g., while drunk), it will be almost guarantee that you will run into another car or run into people. Either ways, you make the roads less safe for everyone else and if you were to cause something to happen and die, other people would have to bear the costs of your actions.

In cases like this, it’s important for the government again to step in in some ways. With cars, the government does it by forcing everyone to pass the driver’s license test and forcing everyone to pay for car insurance. Other examples of things with externalities:

• Oil drilling rigs
• Roads, highways, streets, and everything that powers them (if poorly constructed, they could hurt a lot of people)
• Produce (people selling them)
• Medicines

You might notice that if you really think about it, almost everything has externalities, and that makes figuring out the right level of government involvement difficult. Some things are just plain obvious (like cars), but other things less so (like someone buying a Samsung phone that historical have been of high quality but that started exploding in 2017).

I haven’t read up enough about how to solve that dilemma, but I would guess that one should evaluate the level of risks and make policies accordingly—which I’d admit is a terrible solution because it’s easy to have non-standard ways of evaluating risks (like using a crisis to one’s political ends—like how Churchill said, “never let a good crisis go to waste”).

Other Places Where Capitalism Seems Like It’s Failing

Other critics of capitalism are that capitalism creates a lot of wealth inequality. Depending on the person, this can be a bad thing. Personally I don’t think it’s a bad thing as long as those who got wealthy didn’t do so unfairly.

• In capitalism, no one should be able to “cheat”. That is, for example, getting government bailouts. To me that sounds like a form or rewarding bad businesses that should have failed in the first place.
• In addition, things like tax benefits for a big company to move into some city is also technically a form of “cheating” because in capitalism, they wouldn’t be able to do so.
• Other forms of cheating, which I consider discredited (please read Basic Economics to see why) are things like predatory pricing or business malpractices (lying to customers or making products that don’t live up to their promises), which are all things that just don’t work.
• Finally, I don’t think it’s cheating if some people start out with a lot of money because as mentioned at the beginning of this article, life is already unfair. On that note, 88% of millionaires are self made.

Outside of that, a critic that I consider a good one is that capitalism doesn’t really lead to taking better care of our environment. For that, think the government needs to somewhat step in because going back to intentions vs. incentives, no matter how much people care there’s just not many incentives to take care of the environment in a substantial way (or like the cost of discovering that incentive is very high).

Now You’re Ready to Blame Capitalism… or Are You?

I hope that I have convinced you to think differently about capitalism. At the very least, you know more about capitalism now to know when a criticism is valid and where it’s not. Finally, you know not to blindly listen to people blaming capitalism for the problems of the world—like how people blame capitalism for government bailouts when bailouts would never happen with capitalism.

At the end of the day, my hope is that we all become more critical about what politicians say and more critical about what the media wants us to believe. My hope is that you see that things are more complicated than saying “capitalism is all bad” or that “we need small government”. It’s all a balance, and a lot of things involves making tradeoffs in efficiency and tradeoffs in resources. The fact that capitalism is the only system that has really lifted nations out of poverty should say a lot about its merits. At the same time, the fact that today’s society has so many problems should hint that what we have—whatever it is (because it’s not full on capitalism but has components of it) isn’t perfect and isn’t working well for everyone.