The Myth of the ‘Capitalist System’

One of the indices that mark the retrogression of public discourse since the 1970s is the fact that we now take it for granted that the United States and other, similar nations have a “capitalist system” or a “market economy” instead of a “mixed economy,” the term preferred by mid-century American thinkers for the typical blend of public good provision, social insurance, and private enterprise in advanced industrial nations. Equally misleading is the idea that the Cold War, rather than being a great-power struggle, was an ideological battle in which “capitalism” won and “socialism” lost. To the extent that economic models were involved, state socialism was discredited by comparison with the economic performance of variations of the mixed economy in which government typically accounts for 40-50 percent of national GDP.

The very term “mixed economy” itself may be misleading, if it is defined too simply, in terms of two components: the public sector and the market. In my view, it is useful to think about the modern mixed economy in advanced technological societies in terms of five sectors: the household sector, the nonprofit sector, the government sector, the competitive market sector, and the imperfect market sector.

The household sector is the realm of domestic production—making a meal at home, with ingredients and appliances purchased in the market, rather than eating out at a restaurant. For generations economists have tried but failed to quantify the unmeasured labor and value added in household production. It is clear, however, that it is significant and that all existing measures like GDP underestimate the actual size of economies by failing to measure the “dark matter” of household production of goods and services that are both produced and consumed by individuals and their families.

The nonprofit sector includes not only religious and secular charities and philanthropies, but also institutions of higher learning, particularly research universities, which play a central role in technological innovation and economic growth.

The public sector has many and various components, including pure public goods like defense, income maintenance transfer payments like Social Security and unemployment insurance, and a range of tax incentives and credit enhancements which influence corporate and individual behavior in ways that are hard to quantify.

What is usually called “the market” or “the private sector” is usefully divided into two different kinds of markets. In the competitive market, where there are constant or diminishing returns to scale, competition among numerous, mostly-small producers ensures that firms are “price takers” rather than “price makers.” In imperfect markets, identified and described as early as the 1930s by Joan Robinson and others, increasing returns to scale, network effects or others produce a tendency toward “natural” monopoly or oligopoly—that is, monopoly or oligopoly produced, not by political or legal manipulation, but by the genuine efficiencies that result from larger facilities, firms or production runs. The steel industry is an example. A big, expensive blast furnace is genuinely more efficient than the tiny steel mills which Mao ordered Chinese peasants to construct in their backyards during the Great Leap Forward in which nearly thirty million Chinese starved.

This five-sector map of the mixed economy allows us to perceive a number of mistakes made by most libertarians and conservatives and many neoliberals.

The Misreading of Economic History as the Progressive Substitution of the State for the Market. It is usually assumed that “once upon a time” most economic activity took place in competitive markets, and that the growth of government has come at the expense of older market activities. This is not the case.

In pre-industrial agrarian societies, the two major economic sectors were the rural household and the government. Most people were farm laborers—slaves, serfs, debt peons or free peasants, depending on the society. They grew their own food and made their own clothes, tools and houses, mostly from local raw materials, and mostly without market transactions. They paid either money or tribute in kind such as pigs, chicken and wheat sheaves to parasitic warlord and landlord upper classes. Markets were minor, peripheral, and limited mostly to long-distance trade in luxury goods, like precious metals, spices and fine fabrics, that were purchased by the landed aristocracy. Anybody who talks about “flourishing global commerce” before the modern industrial era is ignorant or confused. Almost all economic activity before the industrial revolution took place outside of the miniscule pre-modern market sector.

What has happened, as the result of industrialization and urbanization, is primarily the out-sourcing of what were once purely household functions—manufacturing of clothes, appliances, and furniture, care for the young, old and sick, and education—to non-household sectors, including government and the non-profit philanthropic sector, as well as for-profit firms in both competitive and imperfect markets. In other words, in industrial societies all of the non-household sectors of the mixed economy have ballooned simultaneously, even as the contribution to economic activity of the household, as a productive unit, has shriveled.

Far from displacing pre-modern market-based welfare systems (which did not exist for the majority of people), government-based and nonprofit-based welfare systems have replaced family-based, in-household care, to the benefit of businesses, which do not have to pay workers the full wages that would be necessary to keep them and their relatives alive and healthy and educated if there were no welfare state. In effect, the welfare state (including tax-favored institutional charity) socializes the cost of subsistence not only for the workers but for the worker’s non-working children and elderly relatives, while allowing employers to privatize most of the benefits of the worker’s labor, particularly in recent decades, when proportionately more profits have gone to CEOs and shareholders than to workers. Business elites should be thanking the modern welfare state for providing a huge and permanent windfall for them and their shareholders, while “pro-family conservatives” should logically be denouncing all institutions to which former family functions have been outsourced—not only governments but also for-profit corporations that make and sell things that could be made by hand at home and tax-favored megachurches that provide food, day-care and elder-care.

The Mistaken Belief that Free Trade in a Global Market Will Lead to Lower Costs Through Greater Competition. This is a mistake because it assumes that trade liberalization can reduce local monopoly or oligopoly rents by replacing limited national markets with larger regional or global markets in which there are many producers. In some countries, that might be the case. However, most of the technology-intensive industries in the “traded sector,” such as steel, automobiles, aerospace, and information technology products, are industries with increasing returns to scale, which are natural monopolies or oligopolies. In such industries, a truly free, global market, if it were to exist (as it does not now) might lead a single company to dominate each of a number of major industries, not because it cheated, but because it was genuinely more efficient than smaller enterprises. For example, the global aerospace industry is a duopoly dominated by Boeing and Airbus, and in a truly free global market a single company formed by their merger, if it did not exploit its monopoly status to gouge customers, might very well produce airplanes even more cheaply, by exploiting economies of scale.

To be sure, this might be a different, plausible argument for a free global market, from the efficiencies of natural global monopolies rather than from cost-lowering competition among multitudes of producers, but it is not the argument that champions of free trade usually make. In any event, because no great power is ever going to allow a free global market to determine whether it had a minimal share of militarily-relevant industries, this is a purely hypothetical example.

The Mistaken Belief that Competitive Markets are Primarily Responsible for Innovation. The greatest mistake that arises from a failure to understand the modern mixed economy is the error of grossly over-rating the contribution of competitive markets to technological innovation. Of the five sectors of the mixed economy—the household sector, the nonprofit sector, the public sector, the competitive market sector, and the imperfect market sector—the three most important, when it comes to R&D and long-term technological innovation, are the nonprofit sector (research universities), the public sector (as a funder of R&D and as a first purchaser of scalable infant technologies) and creative monopolies and oligopolies, which plough back some of the rents their positions as price-makers rather than price-takers enable them to extract in further innovation (as AT&T did in Bell Labs when it was a monopoly, and as Google does in some cases today, using rents from search engine advertising revenue to fund, for example, robot car research). In contrast, in hyper-competitive markets with many relatively small producers, profits are driven down nearly to the level of costs, sparing few or no resources that a company can use for significant product or process R&D, much less basic, long-term R&D.

Photos by: Scout Tufankjian for Obama for America