The Uncompromised Case for Capitalism
Yaron joins Amy Peikoff on Don’t Let it Go Unheard to discuss wealth redistribution, the Nanny State, socialism vs. capitalism, and more. This interview was recorded March 10, 2013.
Note: I know the recording isn’t working for some reason. Should have it fixed shortly. Let’s just consider it an April Fool’s joke. -DW
Update: Fixed!
Washington Post writer Steven Pearlstein recently published a thoughtful piece on the morality of capitalism that has gotten a lot of attention. I have a lot to say about it, and I want to start with one of the more intriguing questions raised by Pearlstein.
After going over what he calls “the moral case against redistribution,” he raises “one glaring problem”:
For implicit in the imperative to let the productive keep what they earn is an assumption that the markets distribute income in a way that accurately reflects everyone’s relative economic contribution—and therefore is fair. But is that true?
Pearlstein goes on to say that in a simple barter economy, the connection between what a person contributes to production and his wealth is clear. But in a complex division of labor economy? “[T]he connection between what is produced and who is responsible for producing it is not so obvious.”
Can you see where Pearlstein is going with this? If the connection between what a person gets paid on a market and what he contributes to production is fuzzy, then that person has no moral grounds for objecting when the government confiscates and doles out his income.
But Pearlstein is wrong. Dead wrong. On a free market, the connection between what a person contributes to production and his income is as clear as day: what he makes is what he produces—as judged by those who voluntarily pay him.
When Pearlstein raises the question of whether pay reflects productive contribution, he is adopting a central planner’s perspective. Implicit in his question is the idea that under capitalism, resources start out as some collective pie, markets then distribute those resources “somehow,” and now we have to stand back and look at market outcomes and divine if they “fairly” reflect each individual’s contribution.
But wealth is not a tribal product which some disembodied “market” “distributes.” What actually happens is that, under capitalism, individuals create and trade wealth. There is no “distribution” of income. Instead every dollar a person gets comes from the voluntary judgment of each individual who chooses to deal with him.
What makes your income “fair” is not that it matches some arbitrary economic benchmark (e.g., some fixed “share” of income going to capital and labor, as Pearlstein seems to endorse)—what makes it fair is that it is the product of an objective process: the free, uncoerced, voluntary judgment of market participants.
Contrast that with the approach implied by Pearlstein’s argument: a group of bureaucrats will get together, decide those voluntary decisions are “unfair,” and coercively seize and distribute people’s wealth so that it conforms to theirs, the bureaucrats’, feelings about what is “fair.”
What’s especially revealing about this argument is Pearlstein’s concession that if a person could claim to have earned his income, then it would be a moral travesty to take it and hand it over to people who didn’t earn it. And on that point he is absolutely right.
But Pearlstein aside, there is a legitimate question: how do market participants assess others’ productive contribution in a complex, division of labor economy? How does a board of directors assess the contribution of the CEO and other high level executives? How do managers assess the productive contribution of their employees?
It ain’t easy. They have to have a lot of knowledge about their company, all of the people involved, how many others in the labor market have the skills and aptitudes necessary to do the various kinds of work, to name just a scant few factors.
Do they always get it right? Of course not. But what’s unique about capitalism is that market forces reward people for good decisions and punish them for bad decisions: companies that pay people too little see good employees head for greener pastures; companies that pay people too much see their resources depleted relative to competitors. As a result, there is a tendency in a market for income to reflect productivity.
And if it is challenging for someone to assess the productive contribution of people within his own company, it is virtually impossible for a complete outsider to do so. What does Larry Ellison contribute to Oracle? How much value does he bring to the table? That’s a Herculean question for Oracle’s board of directors to answer, and it’s ludicrous to expect—as critics of market outcomes such as Pearlstein often do—that someone not deeply familiar with Oracle and its industry should be able to answer it.
The majesty of capitalism is that it doesn’t matter. Why not? Because “we” aren’t the one’s paying Ellison’s salary. Oracle’s shareholders are, and if an individual shareholder thinks Ellison is overpaid, he is free to sell his shares. The fairness of Ellison’s pay is not anyone’s to decide but his and those who voluntarily choose to pay him (or not).
Nobel Prize-winning economist Joseph Stiglitz has been beating the “income inequality” drum for some time now. So have many others on the left, of course, but Stiglitz’s argument is unique: inequality is not simply a moral problem, in his view, but an economic one. As he put it in a recent New York Times blog post:
Politicians typically talk about rising inequality and the sluggish recovery as separate phenomena, when they are in fact intertwined. Inequality stifles, restrains and holds back our growth.
In other words, even those who don’t regard inequality is a moral issue—count me among them—should oppose inequality because it’s making everyone worse off economically.
What’s Stiglitz’s argument? He supports his claim with four reasons:
Now set aside the last point. Stiglitz doesn’t offer any support for the causal role of inequality in boom-and-bust severity. He merely asserts that “it is no coincidence that the 1920s—the last time inequality of income and wealth in the United States was so high—ended with the Great Crash and the Depression,” while conceding that “inequality did not directly cause the [2008] crisis.” (It is true that financial crises are associated with a rise in inequality, but it is an effect of government policies, not a cause contributed by the market.)
That said, notice anything funny about the first three reasons? None of them has anything to do with “inequality.” They are all about the (alleged) weakness of the middle class.
We can argue about the details of what’s actually happened to the middle class (the evidence I’ve seen indicates that, to the extent it has been “hollowed out,” it’s because many Americans have moved up the economic ladder). And we can also argue about the causes of any economic stagnation (I would attribute it to a lack of economic freedom).
But the one thing that’s 100% clear is that Stiglitz is conflating economic stagnation with inequality. Sure, he could argue that the same forces that are causing recent inequality are preventing a recovery. But that is very different from arguing that inequality itself—the sheer disparity of U.S. incomes—is “holding back the recovery.”
Inequality can increase (1) because those with lower incomes are stagnating, or (2) because they are prospering, but at a slower rate than people with higher incomes. By treating (1) as an “inequality” problem, Stiglitz is implying that inequality per se is a problem. He’s denying the possibility of (2).
But that makes no economic sense and it doesn’t mesh with history. I haven’t studied the matter in depth, but my understanding is that during almost every era in American history, economic growth at the highest levels has outpaced economic growth by people with lower incomes. (If anyone has the relevant stats at hand, please let me know.)
Getting Americans worried about income inequality is hard. Most of us are not envious of others’ success. To sell its egalitarian agenda, the left needs to appeal to our desire for prosperity. That explains Stiglitz’s approach. But the approach—and the motive behind it—are unjustifiable.
I’ve been thinking a lot lately about the idea of “opportunity.” Some on the right have tried to defend capitalism on the grounds that it promotes “equality of opportunity.” That’s a bad argument, as I’ve talked about before. But that still leaves open: Just what is opportunity?
My dictionary defines “opportunity” as “a set of circumstances that makes it possible to do something.” So, for example, having a talent scout watch you play ball gives you an opportunity to go pro. Getting into a particular school may give you the opportunity to study with a great professor. Inheriting a million dollars gives you the opportunity to invest in a new business.
Here’s what I find striking. It takes a certain kind of person to capitalize on those opportunities: it takes a person who adopts the skills, practices, and habits that lead to success in a given area of life.
A talent scout wouldn’t benefit a couch potato—because he’s not in the game, and even if he were in the game, he would be completely awful because he didn’t spend years practicing. Getting into a particular school wouldn’t benefit a lousy student—because chances are he wouldn’t get in, and even if he did get in through some accident, he wouldn’t be able to benefit from the professor unless he made the effort to become a better student. Even inheriting a million dollars wouldn’t benefit the kind of person who can’t spend $10 responsibly.
I like to think of Bill Gates. Some have argued that his success was due mostly to luck, such as the luck of having gone to one of the few high schools of the era to have a computer. But Gates was not the only student at his school. He made the opportunity valuable by choosing—day after day—to spend his time learning about the computer rather than watching TV or partying.
An opportunity is only valuable to someone who prepares himself to take advantage of it. And, what’s more, that kind of person creates many if not most of the opportunities he encounters in life. It doesn’t matter how many opportunities you pour into the lap of a James Taggart—he won’t be able to make use of them. A Dagny Taggart, on the other hand, will turn virtually every circumstance she encounters into an opportunity.
No, you aren’t responsible for all of your opportunities in life. And of course some external circumstances can be favorable and others unfavorable. But those who say we have to redistribute wealth to create opportunity are wrong. To the extent a country is free, what matters is fundamentally not how many opportunities a person is given, but whether he chooses to become the kind of person who can take advantage of—and create—opportunities.
The great virtue of capitalism is not that it provides people with “equal opportunity,” whatever that means. It’s that capitalism provides the best possible environment to capitalize on opportunity—for those who choose to do so.
If you would like to ask me a question, you can submit it here.