Capitalism vs. the Free Market

I've posted here an article, written by one of my fellow commentators on one of my favorite economics/politics blogs, that beautifully illustrates the differences between the American economy (known by many as "crony capitalism") and a free market. I'm shamelessly thieving this piece because it's so well-written. Enjoy.

Viva Co-operation!
Or, why 20th century ideological discourse missed the point.
By David Chaplin

During the 20th century, the term ‘capitalism’ became a crude synonym for the ‘free market’, even by enthusiastic proponents of liberty and free choice. This is a pity, because the term was originally coined by Karl Marx as a pejorative. Rightly so, but not for the reasons he would have had in mind.

Capitalism and free markets are not the same thing.

The fundamental characteristic of a free market is that participants are free to engage in transactions willingly, without coercion or impediment by the State, and without the interference of any other parties who are not involved in or affected by that transaction. Capitalism is something different (except when it suits any individual capitalist to present himself as a free market proponent): where Capital, as one of the factors of production, engages the legal and coercive powers of the State to advance its particular interests at the expense of any other factor of production, or at the expense of consumers. Or where it engages with the State to capture tax revenues(1) .That’s Capitalism, and it is in ideological terms no different to the labourist Marxist prescription, which seeks to advance the narrow interests of Labour at the expense of the other factors of production, for example landowners or investors.

This crucial distinction is rather subtle, not at all obvious to either the Left or the Right – thus both sides of the bipolar debate have happily come to conflate free markets with capitalism. This is probably because most capitalists rhetorically endorse the broad principles of the free market, having recognised that their earnings and profit generation are at root dependent on the willingness of consumers to buy their products ( which I suppose puts them one step closer to enlightenment than socialists). However, it is a rare capitalist who will pass up an opportunity to boost his earnings through rent-seeking (2) , whether through protectionist tariffs, or restrictions on imports, or monopoly licensing, and this tendency is utterly at odds with the very idea of a free market.

The United States of America is widely regarded as the poster-child of Capitalism, and this is popularly equated to it being the prime example of the Free Market - by its detractors and supporters alike. However, like many others, the US is not a free market. Its tax code, body of Law, and the very way its political system is structured, is characterised by a thickly entangled complex of regulations, interventions, restrictions, and other forms of government interference, each strand calculated to protect and entrench the narrow interests of one or another special interest grouping – thousands, millions of them. Many of which, incidentally, are fundamentally incompatible with one another, generating wasted costs while mutually negating the very benefits they are aimed to secure. Thus, America may indeed be the home of modern Capitalism, but it is hardly more than an insult to the pure concept of the free market. Granted, the American market might be relatively free, and arguably freer than those in many other countries, but ‘free market’ is no longer its defining characteristic – how could it be with a Federal government share of GDP of some one-third?

In short, Capitalism in practice makes no distinction between profits gleaned from rent-seeking and those earned from the productive exchange of value, and it actively develops political institutions which entrench that vice. The Free Market, properly constituted, has no room for rent-seeking at all and naturally disincentivises it. The misunderstanding of this distinction is the central flaw which invalidates the broad socialist thesis: By and large, all of the Western social ills the Left has blamed on the ‘unfettered’ free market ever since Marx, arose out of the rent-seeking behaviour that inevitably follows Capitalists getting into bed with the State.

It’s not competition, it’s co-operation.

There is another, deeper, misconception associated with the free market. This is partly due to the way elementary (neoclassical) economics is taught in schools and universities, and Capitalists simply love it: the Doctrine of the Virtue of Competition. Companies everywhere regard their mission as some sort of sports match against their perceived competitors, some treating it as all-out war. (And some even extend the concept of competition to their trading partners, customer or supplier alike, regarding them as opponents to be beaten down as much as possible, stopping just short of the deal-breaker). The free market is defined by competition, they say, it’s dog eat dog out there, you gotta be the toughest, the biggest, meanest, leanest fighting machines to get your slice of the pie, ‘cos if you don’t, somebody else will steal your lunch. And that’s Good! Equally, and citing more or less the same words, communists and other pink-tinted ideologues bemoan the implicit violence in this view of competition , regarding it as a sad loss of compassionate human values, once again erroneously conflating the ugly elements of capitalistic rent-seeking with the purity of the free market.

Both sides of this view of competition missed the point completely. This misconception arguably does more to entrench economic illiteracy across the spectrum than any other factor, (except perhaps the undead labour theory of value which I won’t go into here). And it makes companies, CEOs and entrepreneurs everywhere lose their way in optimising the performance of their enterprises in their quest to generate value in the hands of their customers where none existed before. Furthermore, it has, in Western, capitalist economies, given rise to the most absurd forms of legislative State intervention to somehow enforce competition through the barrel of a subpoena, backed by the threat of jail or other violence against person and property. Whatever that is, it is not a free market.

Granted, competition in a free market does indeed have a structural role in assuring the productive and allocative efficiency of a market. But it is a subtle and indirect form of competition, completely unlike a sporting match, or a war, where the competitors square off and battle it out directly until a winner emerges and the losers fade behind a cloud of disgrace. Let me let you in on a little secret: The defining characteristic of a free market is not competition, but co-operation. All economic activity, however or wherever it takes place, is defined by the fact that each participant in any given transaction does so willingly, because each expects to gain from having done the transaction. Absent the jackboot force of compulsion from the State or any other party with guns, any party to a transaction is free to choose not to do it if he believes he’ll be worse off for having done it. That’s freedom. You do the same every time you pick up an item in the supermarket and then put it back on the shelf because you have better things to buy with your earnings. In a free market, the interaction between any buyer and seller, in every transaction, represents a friendly, voluntary, mutually-beneficial act of co-operation, with millions upon millions of them every single day making up an economy that accumulates wealth among its participants, each gaining in direct proportion to the value he places in the hands of others. That’s a free market, and it works.

The competition in the free market economy is of an indirect, second-order nature, a residue. If I and my customer are co-operating between ourselves to mutual benefit, that means other suppliers in the same line as I am have lost the opportunity to sell him something similar to what I am selling him. But I need never meet this competitor directly, still less fight with him. That’s neither a war nor a sports match. If I rip my customer off by charging him too much or by supplying shoddy goods, he is more likely to do business with someone else next time. The customer chooses where he gets the best value, and its up to me to offer better value than what others do. Modern corporates and CEOs would do well to remember this: If your mission is focussed on beating your competitors at all costs, what does this say about the importance of your customers? Focus your attention on your customer, your partner in co-operation, keep him happy with your product, service and pricing. And likewise, keep your supplier happy with his co-operative relationship with you. Do this, and everything else falls into place naturally.

Strange bedfellows.

We have seen that the ideological debate that characterised the 20th century, simplistically polarised into capitalism vs communism, free market vs socialism, or simply Left and Right, was based on several economic misconceptions. Indeed, the simplistic bipolar nature of the debate led to some very strange bedfellows: Conservatives on the right, who by and large supported economic freedom, also tended to support the regulation of private moral choices through State force, and of course censorious suppression of dissent. And yet on the Left, those who favoured State intervention in markets also tended to support personal liberties, free moral choices, and free speech ( But only in so far as they didn’t get to actually run a country, when the tune inevitably changes to despotism overnight). It is ironic that either side of this polarity contained half of the Libertarian prescription, strapped to a fundamentally incompatible other half. It seems hardly more than an accident of history that Libertarianism found itself popularly lumped in with the conservative Right. This despite Murray Rothbard’s brief attempt to align the Libertarian movement with the New Left of the 60s. It seems this failed because it proved too difficult to get the Left to understand economic fundamentals and see Marx’s Big Mistake for what it was.

Conclusion – what a waste of ink.

That observation aside, there is rich irony in the observation that the ideology of the Left, while full of the rhetoric of mutual co-operation, egalitarianism, freedom, and compassion for the less fortunate, required nothing less than totalitarian coercion, and the wholesale removal of freedom from all citizens, to advance its aims, simply because the ideology required human beings to behave in fundamentally non-human ways, and of course, it has failed fairly rapidly in every known case.

Likewise, on the ‘right’, the mainstream capitalist ideology of the West based its ideological case on the rhetoric of competition and self-sufficiency, both of which narrow values are completely at odds with the co-operation and mutual benefit that characterises free market trade. Indeed, co-operation and mutual benefit are the defining features of reciprocal altruism, itself deeply embedded in human society: it comprises the very essence of what it means to be human. And yet, behind the rhetoric of ‘life, liberty and the pursuit of happiness’, or ‘freedom and democracy’, the capitalist State has stealthily and relentlessly increased its activity in regulating and constraining just about all areas of human activity and individual choice. Regrettably, this capitalist despotism takes longer to fail than socialist despotism, because within its framework, there is a larger scope for citizens to engage in free, voluntary economic activity among themselves, and this permits them to build value, which blunts their outrage, even as their State confiscates some of that value to fund the perpetuation and entrenchment of its coercive powers.

Thus it was that the polarised 20th century debate between left and right turned out to be a colossal waste of breath – the real issue wasn’t collectivism vs individualism, or communism vs capitalism, or even workers vs bosses. It was always State vs liberty, coercion vs free choice. Barring a few marginalised visionaries who kept the spark of classical liberalism (3) alive, hardly anyone in the 20th century even noticed.

(1) Consider Halliburton, whose core competency is hoovering up tax dollars. That company could not exist without the State as its primary customer.

(2)‘Rent-seeking’: the use of political power or force to capture value from other people without yielding value in return. Not to be confused with mutually-agreed hiring of property between the owner and the user.

(3) ‘Classical liberalism’ as distinct from ‘liberalism’. The distinction is important, because the term ‘liberal’ had been hijacked by the Left by the 1960s, by which time it had come to label the mildly pink part of the ideological spectrum. This forced the successors to the classical liberal tradition find another name – libertarian