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?

Monthly Proposal No.5: agree on an uniform corporate tax rate for Europe

Not only is the prisoners’ dilemma a well-known example in game theory. It is also a central issue in political negotiations. One of these negotiations that has to be conducted concern corporate taxes.

It was one of our past ministers of finance, Karl Heinz Grasser, who meant that he loves competition and that it was a good idea to compete with other countries by means of reducing the corporate tax rate. The incentive is clear: Lower corporate tax rates attract firms and firms crucially determine economic growth and employment. Business administrators and politicians might think that this indeed is the end of the story and so far it seems to be a reasonable plan.

However, economists know it better. Following the logic from above, any other country has an incentive to lower their corporate tax rates too. Furthermore, if they love competition as much as Karl Heinz Grasser and exhibit the same lack of information, they will continually underbid one another. Economists call this process the race to the bottom.

Theoretically, this race only ends as the public budget is not able to refinance the gifts anymore, which they handed to enterprises in terms of low tax rates or even subsidies. The burden of this policy has to be borne by households.

While this issue alone can already be criticized, it does not even take the instability and the transition costs that have to be avoided into account. So, for just a moment ignore whether the mistakes occurred in Austria or Ireland or elsewhere. Maybe in the short run even abandon the determination and enforcement of the so called efficient corporate tax rate. Just ensure that it is uniform, at least within Europe.

Monthly Proposal No.3: extend compulsory education for the sake of freedom and wealth

A democratic market economy theoretically achieves the highest possible level of freedom and wealth. Focussing on our country, this concept indeed worked out not too badly. However, we are still far away from the perfect world stated by the theory. Furthermore, for a few years we seem to be stuck in an economic as well as a democratic crisis. Though, when the theoretical conclusions are derived by the compelling logic of mathematics, how can they fail?

The answer is pretty simple: They don’t. The differences between theoretical and empirical outcomes are caused by the differences between the models’ underlying assumptions and real social and political conditions. In this regard, one important assumption for efficient democratic as well as economic behaviour is sovereignty. It can be understood as the power and possibility to make a rational choice and force its proportional consideration by others.

Among others, in the real world sovereignty therefore requests sufficiently informed and well educated people as consumers, voters and all kinds of democratic and economic agents. Therefore, it is not just about merit goods and external effects when a government establishes compulsory education. It rather is an essential foundation for the successful operation of a democratic market economy.

In the younger past the quality and effectiveness, or at least the average outcome of our educational system seems to be decreasing. Simultaneously, our youth possesses more and more self-determination. To this effect, teenagers have to make decisions about their path-dependent future, while they just do not know how strong the latter will depend on their capability to acquire and use knowledge. For knowledge itself is power. A certain proportional amount of power definitely is a necessary condition for sovereignty. Finally, sovereignty determines individual and aggregate outcomes in a democratic market economy.

Therefore, besides several other arguments from labour market and institutional economics, already the basic theory of democracy and the market economy justifies an extension of compulsory education. The empiricism finally recommends it for today. Of course, there will be costs in the short run, financially as well as politically. However, the alternative upcoming social costs arising in the long run would be many times higher. So be paternalistic today, in order to save democratic and economic freedom in the future!

Monthly Proposal, No.1: charge consumption instead of income

I’ve chosen to start with this topic, because even right after the election several parties still talk about the necessity of a tax reform in favour of the tax payer. Maybe they expect every tax payer to cheer up on that. But even if we ignore the so called debt crisis for a moment, a promise like this one still leaves crucial questions. What can be understood by a tax reform in favour of the tax payer? The easy and myopic answer could be: a tax reduction. But then we still need to know who this favoured tax payer is. And it is clearly not a homogenous everybody, because we individually pay different taxes in different heights. In this sense every serious politician would honestly tell us which voter is overreached and who is getting discriminated in comparison to the status quo. Such concrete information can of course not be found on posters during the election. And the announcement of a flat tax on income in favour of hard working people shows us that they either not know what the word “favour” means, or what a flat tax ceteris paribus would imply for the relative tax burden of “hard working” people. So I rather focus on declaring my own proposal:

I want affordability for the necessities for living at the expense of unnecessary comfort and wealth. That means I do not hesitate to admit that in return to the relief for poor and sparing households I have to tax wastefulness, abundance and excessive luxury. One way to do that is to charge individual consumption instead of income. And this is only one of the reasons why I want a big scale reform towards a direct progressive expenditure tax.

Another reason is that by charging just the purchase of consumables we would expect savings to rise. If these savings are used for investments this should imply economic growth. Of course such investments have to be correspondingly triggered but the first impression leads to the thought that the individual decision process is nudged in a sustainable direction.

In this sense also other forward-looking expenditure for like family, health or education should get even more attractive because they would reduce and avoid taxes. Thereby people could still decide day by day which lifestyle is worth the corresponding burden and are not principally charged for being productive or having a well-paid job.

This raises the topic of another advantage which would be the non-existing discrimination of production factors. It would be irrelevant whether the income is earned out of labour or capital. Once more: Instead of charging the source we would focus on the use. And latter seems to be a pretty good base to estimate what a person is able to give as well as obviously taking from society. So tax it!