Lifting all Boats

Friday, October 26, 2012

The financial crisis and recession have led to a backlash against the profit motive and private enterprise. Left-of-center political parties have gained power and influence in France, Mexico, Greece, and other lands with the promise of much greater regulation of banks and other businesses, the renationalizing of some companies, and the constraint of profits through higher taxes and other ways.

It is easy to sympathize with the hostility to banks that behaved (in retrospect) so foolishly, damaging everyone else as they took on excessive risk in their quest for greater profits. One can also understand the general reaction against capitalism and “market failures” because 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 class should resist the temptation to attack competitive private enterprise and capitalism. (Monopolies and crony capitalism should always be deplored, of course.)

Government failures also contributed in an important way to the financial crisis, as regulators failed to rein in the asset explosion of banks and households. Indeed, regulators often encouraged lending to lower-income families so they could buy houses with low down payments and assume large mortgages and ballooning interest payments.

But the main reason to defend competitive capitalism from the current attacks is the benefit it has bestowed over the past 150 years to every stratum of society, including the poor.


For example, China thirty years ago was among the poorest countries in the world. It had just gone through the Cultural Revolution and the Great Leap Forward, which contributed to tens of millions of deaths. In desperation, a few farsighted leaders decided to allow private enterprise and capitalism to gain a toehold in the agricultural sector. To the great surprise of many political leaders, farm output exploded, even though farmers had only tiny plots to work with. Seeing the success of the liberalization of farm output, China extended the incentive system to industry, encouraging the growth of private enterprises in some sectors. Again, the results far exceeded expectations. These private companies, many owned by residents of Taiwan and Hong Kong, not only were far more efficient than state-owned enterprises but also became the leaders in the rapid expansion of exports from China to the United States and other countries.

The most significant result of this radical shift toward a more market-oriented economy was the lifting of hundreds of millions of Chinese out of dire poverty. No longer living on the equivalent of a couple of dollars per day, they now had decent and growing standards of living.

Competitive capitalism helps societies blunt the effects of racial discrimination.

Many critics attack globalization as the source of the world’s economic problems. The opposite is much closer to the truth: competitive private enterprise and the profit motive, acting through a globalized economy, have eliminated the most abject poverty among more than a billion people in China, India, and other parts of Asia.

Another way that competitive capitalism helps people is how it undercuts biases based on race, gender, religion, or other characteristics. Capitalism and the profit motive help erode discrimination. Companies, in their quest for greater profits, try to hire minority group members whose lower pay has yet to reflect their productivity. Even when discrimination persists, the growth in incomes and productivity induced by private enterprise raises the standard of living of minorities.

Private enterprise has eliminated the most abject poverty among more than a billion people in China, India, and other parts of Asia.

When South Africa was an apartheid state, the system of racial discrimination was maintained by government laws but opposed by many private companies. South African blacks suffered immensely under apartheid, and its overthrow was one of the great events of the past several decades. But even during the apartheid era, the government had difficulty controlling the migration of black people into South Africa from other parts of the continent. The explanation obviously was not that blacks liked apartheid, but rather that the private enterprise system in South Africa had raised the incomes of black people there, despite the widespread government-orchestrated discrimination against them. Black people from elsewhere wanted the higher incomes available to them in South Africa.

Something similar happened in the United States. African-Americans suffered from discrimination until recent decades. Nevertheless, black incomes continued to grow along with white incomes as the United States experienced sizable, continuing economic growth after the end of the Civil War in 1865.


Finally, consider the growth in U.S. gross domestic product. America is recognized as the country that has had the most open, vigorous, competitive private enterprise system over the past 150 years. And over the long stretch from 1870 to 2007, per capita American incomes grew at the rate of about 2 percent per year, despite vast changes in institutions and regulations. The result was a severalfold 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, when GDP in the United States rejoined its long-term growth line.

The Great Recession once again pushed GDP below this line, although it sank a lot less than during the Great Depression. I would expect that barring any catastrophic government policies, GDP in the United States will 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, people are concerned about inequalities and about pollution and other externalities that often require government regulation and control, although the limits of what government can do must also be recognized. In their anger at banks and investors, voters and governments have to be careful not to kill the goose that has laid so many golden eggs.