Capitalism

Recently, two excellent articles about capitalism.  The first is from the Wall Street Journal and about ending welfare for banks; a critical component in helping capitalism to work as best it can.

I have a proposal to strengthen the U.S. financial system by simplifying its structure and making its institutions more accountable for their mistakes. Put simply, my proposal would help prevent another 2008-style crisis by prohibiting banking organizations from conducting broker-dealer or other trading activities and by reforming money-market funds and the market for short-term collateralized loans (repurchase agreements, or repos). In other words, Glass-Steagall for today.

My proposal seeks to return to capitalism by confining the government's guarantee to that for which it was intended—to protect the payments system and related activities inside commercial banking. It ends the extension of the safety net's subsidy to trading, market-making and hedge-fund activities. This change will invigorate commercial banking and the broker-dealer market by encouraging more equitable and responsible competition within markets. It reduces the welfare nature of our current financial system, making it more self-reliant and more internationally competitive.

Capitalism will always have crises and the recent crisis had many contributing factors. However, the direct and indirect expansion of the safety net to cover an ever-increasing number of complex and risky activities made this crisis significantly worse. We have yet to correct the error. It is time we did.

Then, Judge Richard Posner has some wise commentary elucidating what capitalism is - and is not.

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.

Then, Posner accurately pinpoints how some seem to think we can perfect our human activity:

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.

We can't.  All we can do is do our best to improve it.  We must never forget that at any moment, human foibles may send us off track - and dangerously so.  Although we must aim at "nirvana" - thinking that we can actually reach it is a wrongheaded and destructive notion.

Comments

[nick ohnell]

Peg - The teaching of Capitalism in schools is all but forgotten and considering this economic system has been the vital engine of America's success this is scary. Even worse it is sometimes trashed. I am supporting a terrific program of giving teachers free CD's and guides about Capitalism by John Stossel called "Stossel in the Classroom". Over the last couple of years thousands of teachers have started to use these CD's. We all have a
responsibility to see that our Capitalist system survives.

[Peg]

Nick - sadly, I have one disagreement with you. Capitalism is taught in school - but it is taught inaccurately and dishonestly. Way too many teachers do not understand how it works. It is called evil and selish and inhuman.

Those of us who do understand how different economic systems work appreciate that, despite all its flaws - it's still the best system available.

So - what needs to be taught is the truth about capitalism. Your suggestions are excellent; I agree wholeheartedly.