Market economy and private capitalism – two pairs of shoes!

Critics of our social and economic system often lack in accuracy when it comes to argumentation. At the same time defenders of the status quo sweepingly prejudge those critics and ignore the details of their argumentation in the first place. In order to advance the discussion it may be helpful or even necessary to capture and explain the most important institutions defining market economies and private capitalism in a metaphor about their evolving:

There was a tribe. Every year the eldest of the tribe decided about the roles of the individual members. In principal they spilt up the tribe into hunters and farmers. All food produced was collected by the eldest and then distributed equally among all members of the tribe.

Some members of the tribe were not quite satisfied with the mixture of meat and vegetables. Some of them preferred meat, others preferred vegetables. So they had the idea to exchange their goods in order to increase satisfaction. The institution called market was born and provided the possibility to bilaterally increase individual as well as total welfare. Every sensible economist has to acknowledge the basic potential trade principally offers to a society which is institutionalized by the markets thereby created.

The members of the tribe also acknowledged the improvement, but at the same time recognized that even after the goods were exchanged some still were not perfectly satisfied with their mixture of goods but perceived a shortage in meat. So these members asked the eldest, whether he may adapt the allocation of productive efforts in order to produce more meat. The eldest considered the request and reallocated some members from farmers to hunters. However, he overestimated the demand for meat and soon they observed a shortage in vegetables. Members preferring vegetables now asked the eldest to reallocate some hunters in order to increase the production of vegetables again. Members preferring meat, though, feared that the eldest once again fails to estimate correctly. So they proposed that the tribe votes about the aspired mixture of meat and vegetables. The eldest agreed and to some extent direct democracy was implemented in terms of indirect consumer sovereignty.

After having achieved two big reforms some of the members considered to go further. They proposed to also vote about the type of meat and vegetables. The eldest, though, declined and argued that the allocation would become far too complex considering an increased variety of goods. He neither had the capacities nor the information to centrally plan their production in such a detailed way.

The members however did not give up. Instead they proposed to delegate the allocation of effort to the individual members. They should know best about their preferences and skills. So why should they not decide individually whether and how they want to react when facing a shortage. Finally, the eldest agreed. He provided a sufficient amount of tools and then let the members of the tribe coordinate themselves. Following the argument of efficiency, from now on both consumption and production were decided decentrally.

The improvements in total as well as in individual welfare made the idea of self-organization well-accepted. At the same time the idea also sensitized the tribe with regard to productivity. Soon, some members started to complain about those that, in their opinion, contributed less to the output collectivized so far. So they proposed that it should not be equally distributed anymore. Instead, members should have the right to directly trade based on the output individually produced. The eldest was skeptical about such a big change but feared the dissatisfaction of the most productive and influential members. So he agreed again and the tribe finally headed towards a meritocratic market economy.

As their ambition increased further discussions evolved. All wanted to be the first when tools were allocated. Hunters argued about who has seen or shot an animal first. Farmers could not agree about who has sowed and groomed which acre of land. The fight about rights and resources had begun. Again some members came to the eldest for the sake of a proposal. They suggested to allocate the available resources to the members once for all. From then on, every member should have the property rights with regard to these resources as well as to all that is produced with, by or on them. Then the welfare of any member of the tribe should finally lie entirely in its individual hands. Everyone would have the incentive to make the best out of its own resources and thereby also the tribe in total benefits. The eldest had to admit the logic consistent to the previous reform and agreed. This is the point where private capitalism came on the board.

However, the eldest obviously did not consider that the consistency with previous reforms depends on the assumption of a stationary state. Once the resources are fixed on the individual level, the praised flexibility of members is at least partly lost. Threats and potentials implied by changes in preferences, changes in the variety of goods or changes in the set of available technologies are not shared equally or fairly any more. Instead, members are affected differently depending on the resources originally allocated to them. Some may benefit from changes which may imply losses for others. In contrast to the previous argumentation, the welfare of individual members does not entirely lie in their own hands but strongly depend on developments determined by all the others. In addition, this lack of self-determination is inherited to future generations. When born they face an allocation of resources as well as a distribution of output they so far could not determine at all. They may have the incentive to make the best of what they possess, but this may be not much or even nothing.

What this metaphor finally shows is that decentralized democracy, efficiency and meritocracy are not the result of the institution of private capitalism but may even be threatened by it. Therefore, critics of private capitalism are not necessarily critics of market economies, neither do they necessarily argue in favour of an equal distribution. They rather just address the lack of self-determination implied by the once and for all privatization of productive resources. Who dares to fundamentally contest this very liberal perspective?

6 thoughts on “Market economy and private capitalism – two pairs of shoes!

  1. „critics of private capitalism are not necessarily critics of market economies“
    — not necessarily, but there is a high correlation. Anyway, I guess it is in principle possible to have a market economy without private property of productive resources, i.e. a system where a government agency owns all land and all machines and allocates them somehow, but in which people are free to use the land and machines for whatever purpose they like. But wouldn’t such a system look an awful lot like normal communism? Wouldn’t it suffer from very serious public goods problems (people neglect the machinery, overuse land, consume to much, invest too little etc.)? Wouldn’t it suffer from the same kind of nepotism and corruption like the normal kind of communism?

    “the welfare of individual members does not entirely lie in their own hands but strongly depend on developments determined by all the others. In addition, this lack of self-determination is inherited to future generations. When born they face an allocation of resources as well as a distribution of output they so far could not determine at all.“
    —- I am afraid there is no system in which the welfare of individuals only depends on their own actions. If you compare capitalism to the actual systems it replaced (feudalism and communism), instead of your hypothetical tribal world, I think you would agree that capitalism is more nearly meritocratic than those other systems. Under feudalism, the luck of birth determined pretty much everything. Under communism, your life chances depended on the arbitrary will of some party bureaucrats (or the luck of being born into a family of communist leaders, see Kim Jong Un). We could of course redistribute inherited wealth through taxation without completely abolishing private ownership, but this would come at the cost of lower incentives to save and invest. It would equalize life chances to some extent (some inherited inequality, for instance in intelligence, would still persist), but probably reduce the long-term living standards by reducing growth.

    At some points in your post you make it sound as if capitalist institutions were deliberately designed (presumably by some „elders“) and that the now existing distribution of property was the result of some initial privatization of hitherto public property. If that is what you mean, it’s just incorrect. The way I understand economic history, capitalism arose from the urban merchants and manufacturers outperforming the rural farmers and eventually even their landlords. Nothing of that was planned or even foreseen. It didn’t require any kind of conscious effort by anyone. There was nobody who ever said „Let’s create a new economic system based on private property and markets“. It just happened. And it brought a fantastic improvement in the lives of ordinary people (average income increased by a factor of 30 in only two centuries!). Critics of capitalism usually neglect to mention that, of course, because it would destroy their narrative.

    • I think the main message of the blog post is not questioned by your comments. Partly they even seem to be proceeding – even if slightly contesting – thoughts, once the critical perspective is taken. In that sense:

      Yes, it seems hard to imagine a world without private property. Not only due to incomprehensibly failed trials in the past, but also due to my personal appreciation I am not in favour of such an extreme position.

      At the same time I disclaim to break down the discussion to the obsolescent debate about capitalism and communism. It was even one motivation of my blog post to bring critical discussions on a more constructive, detailed and forward looking level. I prefer reformative times over revolutionary ones and I fear the emergence of the latter, if we are still not able to adequately address the inadequateness of our actual social and economic system.

      That you mention feudalism, though, brings some irony to the discussion. Not least because capitalism as we observe it today exhibits an alarming tendency towards distributions of wealth and power similar to feudal ages. I say tendency and I talk about distribution intentionally because of course you are right: the absolute improvements in wealth and democracy we observed in the most western countries can and should not be neglected. At the same time, as I mentioned, the observed progress may be caused by several institutions which are not necessarily related to private capitalism. The causalities between past development in western countries and the institution of private capitalism – which refers to the allocation of productive resources only – are at least not much stronger than the causality between private capitalism and the misery of large parts of world’s population as well as climate change.

      Finally, you know what is meant by a metaphor? There was no eldest and our world was not a tribe. Although I did not aim on a discussion about private capitalism’s evolving it now has to be remarked that it at least was not introduced by a fully democratic, perfectly free and bottom up decision. It still could have been the right one at that time and maybe it still is. I would be fine with that conclussion and somehow even relieved as long as we are open for critical discussions about additional and accompanying institutions that may help us to find back on track towards a better, more equal and still liberal world.

  2. Let’s be clear about economic history: It’s not just Western countries who benefited greatly from capitalism. China’s real GDP per capital has increased by a factor of 8 since they abandoned central planning after Mao died in 1976. India’s by a factor of 4 during the same time (starting from a higher level than China). South Korea’s and Taiwan’s each by a factor of 5. (All data from the Madison database) The record of history is as clear as daylight: wherever private property was relatively secure and markets were allowed to work relatively freely, people saw unprecedented increases in living standards. Those parts of the world in which misery and poverty ruled were precisely those in which private property was insecure and markets were destroyed. Of course, it’s just correlation. But sometimes, correlation is a pretty good indicator of causation.

    “the observed progress may be caused by several institutions which are not necessarily related to private capitalism” — like what? I mean that as an honest question. Which institutions do you have in mind? Democracy? No, that can’t be, because the increase in living standards predated democracy in most countries. Rule of Law? Look at China!

    “I disclaim to break down the discussion to the obsolescent debate about capitalism and communism” — There are only two kinds of property: public and private. The more you replace private property with public property, the closer you approach communism. The way I understand your post (which is not necessarily correct), you suggest to eliminate private property with regard to productive resources like land and capital. You may not like to call that “communism”, but I don’t see much of a difference. (or maybe what you have in mind is closer to “market socialism” as developed by Oskar Lange and others in the 1930s:

    I am no stranger to the art of the metaphor. But there are good and bad metaphors. Insofar as your metaphor suggests, and it does if I read it correctly, that private property and markets were institutions deliberately designed by someone, it’s a bad metaphor.

  3. How many percent of world’s population were involved in the decision about their social and economic system at the time of its evolving? If the eldest in my metaphor is one of fifty members, I probably even was too kind in democratic terms… however, I accept your critique. I did not aim to suggest a deliberately decision, although I would not dare to call it a truly liberate one either.

    Anyway, you have a rather suggestive way of reading. You should know from mathematics that my statement about western countries is not sufficient to derive a conclusion about my opinion about countries in the east or elsewhere. With regard to your examples: yes, I do not contest improvements. I even do not want to argue against private capitalism in general. I just wrote about the confusing of institutions and provided some clearity.

    Referring to your question with regard to beneficial institutions I repeat my self: Market economies and their decentralized decision process are not institutions implied by private capitalism. The same can be said about democracy and meritocracy. As an employee I do not own any noteworthy productive resources (beside skills and knowledge) and still make the best of what is provided to me by my employer. As long as my remuneration depends on my performance (in contrast to some CEO salaries) I have a strong incentive to perform in a satisfying way independent of whether I use my own tools or tools provided to me. As I wrote in the blog post, private property on productive resources simply is not a necessary condition for a rather efficient and meritocratic society.

    Finally, no, I was not and I am not arguing in favour of an elimination of private property. I am just aware of the challenges implied by privatization of productive resources and I am in favour of corrective institutions – like heritage tax for example. Both, though, was not implied by my blog post, because it is rather a personal position. The blog post instead is just a metaphor about the factual difference between institutions calles market economy and private capitalism and argues that critics of the latter may take a very liberal perspective.

  4. “As long as my remuneration depends on my performance (in contrast to some CEO salaries) I have a strong incentive to perform in a satisfying way independent of whether I use my own tools or tools provided to me.” — That’s wrong on two counts. 1) Tools, like all capital goods, need to be maintained, repaired and replaced. People are usually much more careful with their own property than with someone else’s. They are especially careless when using common property — that’s where the term “tragedy of the commons” comes from. In a world where all capital goods are common property, this problem would be rampant. 2) Under a normal work contract you don’t need your wage to depend on your performance at all — you just need the wage to be at least as high as your marginal disutility of labor. Only when your work effort cannot be directly observed do you need an “incentive contract”, i.e. wage depending on output — this is exactly one of the reasons CEO’s salaries are high (bonuses are a way to make wages dependent on output).

  5. “People are usually much more careful with their own property than with someone else’s.” Are you suggesting to reallocate property rights towards employees? I know you do not, but you should be aware that your argument is not in favour of the status quo.

    “Under a normal work contract you don’t need your wage to depend on your performance at all.” You seem to have a distorted view on companies producing for the market. There your wage is not a continous function of your performance, but generally depends on your performance just like your job in the first place. The institution providing that circumstance is called competition, which once again is not implied by private capitalism.

    I will grant you the last word in this line of comments but please consider the fact: the institution of private capitalism is just about the allocation of private property on productive resources – neither about efficiency, nor about meritocracy and especially not about democracy!

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