How Capitalism Will Save Us (3 page)

That’s how growth occurs in a free-market economy. No one “orders” it to take place. It happens spontaneously, almost by accident. But it always happens. That’s what people who buy into capitalism’s bad rap don’t get. When there is a need, entrepreneurs will step in to fill it, appearing seemingly out of nowhere.

Take, for example, what happened in the mid-1980s, after budget cuts forced the U.S. Coast Guard to scale back some services. The guard could no longer provide nonemergency marine assistance to recreational boaters.
Almost immediately, small entrepreneurs took up the slack. In Southold, New York, Joseph J. Frohnhoefer founded Sea Tow, an AAA for boats. His small business grew from a single vessel into a thriving franchise network with 121 locations in the United States, Asia, Europe, the Bahamas, and Puerto Rico.

Before Frohnhoefer and other entrepreneurs appeared, government was thought to be “needed” to assure nonemergency boater safety. But Frohnhoefer’s private-sector business filled the need for this service as well as, if not better than, government. Frohnhoefer is called on by the Coast Guard to assist in finding lost boaters and major emergencies; his operation aided in the recovery of victims of the crash of TWA Flight 800. But his business is more than a private version of the Coast Guard. It offers a variety of other services such as boat financing and insurance.

Of course, there will be criminals and greedy individuals in a freemarket economy. That is where government is critical to a free market—to enforce contracts, protect property rights, and maintain order, as it does in the rest of society.

However, most of the time, democratic capitalism’s self-interest compels people to act responsibly and predictably, to work together in networks of cooperation based on trust. After all, it is in people’s self-interest to act reliably if they want to succeed in the marketplace.

These roots in a voluntary, open market are what make democratic capitalism more moral than a state-dominated economy—even if the state-run economy is a democracy. Why? Because state-imposed economic solutions reflect the interests of a group of bureaucrats or politicians who are currently in power.

You may happen to agree with those government solutions. And the designers of those solutions may have good intentions. But when you get down to it, their ideas reflect the wishes and interests of a relative few more than they reflect the broad-based needs of people.

In many ways, a market is an ecosystem. There is no way to know all the forces and factors that propel it forward. Just as no one person can fully fathom all the people and processes that go into making a pencil, no
one individual—including the smartest policy wonks and bureaucrats—can have complete knowledge of why a market for any product works as it does.

We are not the first to point out that if government were charged with creating a pencil, bureaucrats at the Department of Pencils would probably order up too many logs in order to please their lumber-industry constituents. (Or they might order too few because of demands from environmentalists.) The graphite miners would be overpaid as a result of political pressures. People involved in the manufacture of pencils would have to comply with an assortment of government rules and regulations, some sensible but many arbitrary. They’d have to spend hours filling out forms to show compliance. Costs would spiral out of control, as they do on so many government projects. Pencils would be priced to reflect those spiraling costs. No one would be able to afford them. You’d have a surplus. Or maybe pencils would be priced too low by the Department of Pencils. Demand would be excessive and there’d be a shortage.
¹³

As this book will show, efforts by politicians to manage markets have consistently produced similar consequences. You see this in the government-dominated economies of nations such as Venezuela, North Korea, Cuba, and, years ago, the Soviet Union—as well as in heavily regulated sectors of our own economy, such as health care. Bureaucrats and politicians don’t realize that the market has already allocated resources in the most broadly beneficial way possible, based on existing conditions of supply and demand. Thus, their attempts to make markets work according to how people think they should work generally never succeed.

Hugo Chávez, the increasingly dictatorial president of Venezuela, a socialist and ardent believer in the Rap, imposed price controls on hundreds of goods to make food and other essentials more affordable for low-income people—an admirable goal and one that has endeared him to some critics of capitalism in the United States. But what he didn’t understand is that the price of a product reflects the costs of the countless transactions and processes required to make it. The prices that he imposed may have pleased his political constituencies and won him votes, but they did not reflect the Real World costs of making those products. As a result, they threw the markets for these products, and his nation’s economy, out of whack.

The only place where many food staples can be obtained in Venezuela
today is on the black market—where they are now many times more expensive than before price controls. That’s typical of the economic solutions devised by people who dislike free markets. They almost never remedy perceived problems or, to use the economists’ lingo, the “market failure” they were supposed to correct. Instead they create even worse market failure.

A friend who emigrated from Bulgaria to the United States recently described government-controlled health care in his former country: “Health care is free,” he said. “But you can’t get it.”

As we will see throughout this book, government intervention rarely solves economic problems, because it
politicizes
them. The solutions it imposes to promote fairness are designed primarily to satisfy the desires of those in power, not the Real World needs of people in a market.

What could be a better illustration of this than the Detroit bailout and government’s takeover of GM? We discuss in
chapter 2
that GM would probably have been able to cut its staggering labor costs and plot out a recovery strategy had the Obama administration allowed the market to work; GM would have taken the usual route and restructured in bankruptcy court. But with the government taking control, GM has been prevented from making the kind of tough Real World decisions needed to bring about a true turnaround.

Wall Street Journal
columnist Holman W. Jenkins Jr. wrote in the spring of 2009 that the true priority of GM’s new government-appointed CEO, Ed Whitacre, was not the needs of the marketplace but “first and foremost, making sense of GM’s relationship with Washington.” Whitacre’s decisions are likely to be driven not by what will succeed with customers but by what will please his political bosses, as well as the people who
they
need to please, the labor unions.

We explore the unintended consequences of government micromanagement in our chapters on government policy: “Don’t Regulations Safeguard the Public Good?” and “Isn’t Government Needed to Direct the Economy?”

Overbearing regulations by bureaucrats—from price controls to draconian accounting rules—produce damaging economic distortions that hurt people. The foremost example, which we explore in detail, is health care. In our chapter “Is Affordable Health Care Possible in a Free Market?”
we show how government participation in the health-insurance market and layers of regulation have produced a tangled market with runaway costs that benefits fewer and fewer participants.

Efforts in the United States and other nations to make health care more available and affordable have helped only to drive up prices and lead to rationing. Sadly, the economics of health care remain the least understood of any market.

Almost as poorly understood is the process of wealth creation in democratic capitalism. That is the focus of our chapter “Isn’t Capitalism Brutal?” which explores the disruptive and often painful dynamic change that is part of economic growth. Economist Joseph Schumpeter, as we have mentioned, called this process “creative destruction.” The very technologies and businesses that produce new industries and jobs can also devastate old industries they render obsolete.

Think about personal computers. They wiped out demand for typewriters, and no doubt thousands of jobs. This is why, even in good times, there will be disturbing stories of corporate layoffs. Businesses and jobs created in a capitalist economy don’t always spring up in the sectors where you expect them.

Take a more recent product spawned by the growth of personal computers: the iPod. Apple’s revolutionary innovation (which includes not only the iPod but the iTunes software that works along with it) has become a cultural icon. It has created, by one count, more than 40,000 jobs; and that number does not include those related to selling its countless accessories. The technology has brought numerous benefits: It enables consumers to buy single songs instead of pricier CD compilations, making their music dollars go further. It allows smaller artists access to the market without having a record label. And it has generated opportunities beyond the music industry, providing a new way to sell or distribute video content—such as movies and informational “podcasts.”

Yet there’s no question the iPod has been destructive. It helped accelerate the boom in music downloading that devastated music retailers,
forcing many to close down or dramatically alter their businesses. Record labels and recording artists are increasingly having to make their money from the sales of singles rather than more profitable CD compilations. The iPod has also presented challenges for makers of traditional stereo equipment that had to tailor their offerings to the new technology.

For those negatively affected, these changes are unquestionably painful. But does that mean we would have been better off had Apple’s innovation never been developed? When all of the benefits are taken into account, most people would probably agree that the iPod has been a plus, not only for the economy but for the broader society. Even well-known recording artists admit that the changes, though disruptive, also offer opportunities, like the ability to be financially and artistically independent.