The 20th Century Debate of Economics

The great economic debate that has been going on here in the United States and elsewhere has been between free-marketers and collectivism. In one sense we can assume that free-markets have won, in another sense, capitalism is far from vanquishing collectivism. Two great events have had a major impact on the rise of collectivism during the 20th century, the First World War followed by the rise communism, state facism, Nazism and even the rise of Islamic facism that we face today. These events gave focus to many who believe that a handful of people in government can manage affairs better than free people. This has given rise to a massive increase in government power. Huge tax increases gave bureaucrats the idea that they could achieve massive increases in production by commandeering the financial resources of society.
The second event that gave rise to collectivism was the Great Depression. Because this event was seen by many as a failure of the free-markets it became ammunition in the hands of the mis-guided. But it was actually the intervention of government that exacerbated the depression.

The Smoot Hawley Tariff act dried up capital flow into the United States, at precisely the wrong time, tracking the movement of this act we find that it parallels the fall of the stock market. Another factor involved was the huge tax increase by President Hoover in 1931. Despite all of the evidence that the great depression was caused by bad policies, many came to believe that the economy would implode without the intervention of the government. This gave rise to Keynesian theories, the guiding light behind New Deal economics. Put money in here, take money out here and you could drive the economy like an automobile, a machine if you will, which is how Keynes saw our economy, like a machine and by following this logic you could achieve equilibrium. This idea would have tremendous and serious consequences. Our economy is not a machine where equilibrium came be achieved simply by following Keynesian theory, it is too diverse, made up of movement up and down, new enterprises start up and fall, old ones decline only to be replaced by new ones, a healthy economy is made up of all kinds of activities that are constantly changing. In other words our economy is full of constant disequilibrium. The ideas of John Maynard Keynes remained in force until the 1970’s and some believe in the case of the “Fed” even longer. With the election Ronald Reagan, the United States stepped back from Keynesian theory and after the devastation of the economy by high inflation, high taxes and interest rates, the economy began to recover.
Meanwhile in the same period Western Europe has stagnated and fallen behind in all categories of growth. The United States has seen an economic revival but even so democratic capitalism is still on the defensive and seen as “bad”. Because capitalism is somehow seen as being less than moral, even amoral, capitalism is depicted by Hollywood as being selfish and greedy (kind of ironic). Charity and capitalism are seen as opposites. This kind of thinking about capitalism is wrong. To succeed in business and capitalism one must meet the needs and wants of others, giving back is also inherent our system, the system itself demands that there be cooperation between many diverse groups for a business to succeed. Misers do not succeed in successful businesses, one must take risks. The United States is both the most commercial AND philanthropic nation in history.

In recent decades, collectivists have also hijacked the cause of environmentalism to promote their agenda. I’m not talking about the desire to have clean water; we’re all in favor of that. Or clean air; one of the great things we’ve done in the last century is getting lead out of the air. Saving tigers and elephants is also a good thing. I’m talking about those who use the mantra of environmentalism to try to control the economy the way the old-time socialists wanted to, breathing hellfire and damnation on those who don’t subscribe to their new, post-Christian religion. The fact is, if our goal is to improve the environment, increasing government regulation and destroying manufacturing is counterproductive. Affluence is the friend, not the enemy, of the environment. As people become better off, they want a higher quality of life, including environmental improvements. And new technology drives such improvements. Consider the east coast of the U.S. Even though its population has more than doubled—in some areas, it’s tripled—and even though there are more developments, malls, and urban sprawl, there are more trees today than there were 80 years ago. Why? Because of technology that allows us to grow more food on less land. Technology is a friend of the environment.

Democratic Capitalism leads to progress and an increase in our standard of living, this progress leads to change, Collectivists play on people’s natural and inherent fear of change. With the rise of industrialism in the 19th century we see paintings depicting the agricultural , pastoral past being disrupted by the railroads, cars came along to disrupt the railroads. Buggy whip makers and blacksmiths were done for. One can imagine CBS’s 60 Minutes investigating 100 years ago, the plight of the poor blacksmiths being put out of business by Henry Ford. During the 40’s and 50’s TV came along and most movie theaters went broke. Now the internet is doing the same thing to newspapers and network news shows. (For me, I gave up on network news before the internet)

Let me mention three additional myths that are used to promote collectivism. One is the idea that demand is the key to economic growth. Collectivist economists often talk about means to increase “aggregate demand,” as if that would ensure that the economy will grow. Following Keynes, they assume that the economy is like a machine. But again, the economy is an aggregate of tens of millions of people, millions of businesses, millions of technologies. We don’t know how it interacts on a day-to-day basis. We don’t know what’s going to work or not work. Who could have conceived of eBay ten to twelve years ago? But today, 400,000 people make their livings on eBay. When Google was launched, there were ten other search engines. Who would have thought another one was needed? Isn’t that how you get so-called “bubbles”? But Google found a way to do it better and ended up on top. Innovation is the key. Whether it’s railroads, cars, computers, the Internet, or iPods, risk-taking is messy. It is often irrational, and seemingly wasteful. But it’s the only way to determine what works best and what doesn’t.

Another collectivist myth concerns trade. If I were dictator of the world—even though I believe in the First Amendment—I would ban trade numbers, especially merchandise trade numbers. They just lead to mischief. We are given the impression that a trade surplus is like a profit and a trade deficit is like a loss. But trade is not a transaction between countries. It takes place between parties. For example, Forbes magazine buys paper. For all of the 88 years that we’ve been in existence, we’ve run a trade deficit with our paper suppliers. If you look just at that trade deficit, you might think we are doing poorly. But if you look at the two parties involved, that turns out to be an illusion. The paper supplier thinks he’s going to make money selling his paper. We think we’re going to make money by taking the paper and putting print on it, with value added. So it’s a mutually profitable transaction, even if it looks like a trade deficit. Or consider a book printed in Taiwan. Looking at the trade number alone, it appears there is a two dollar trade deficit with Taiwan. Yet the book comes back here and retails for $24.95. The value added is in the U.S. The author gets a cut, the publisher gets a cut, booksellers get a cut, distributors get a cut, and remainder stores get a cut. Something similar happened with iPods: A lot of its parts are made overseas, but where is most of the value added? Here in the United States. North America has had a merchandise trade deficit for 350 out of the last 400 years, and we have done very well, thank you.

The final myth I’ll mention concerns budget deficits. Milton Friedman said several years ago that if he had a choice between a federal budget of $1 trillion that was in the red and a federal budget of $2 trillion that was balanced, he would take the former. Deficits, in and of themselves, are not evil. Deficits must be put in context, because Washington’s inability to curb spending is often used as an excuse to raise taxes.

Now let me turn to five basic principles of economic growth. First and foremost is the rule of law: Without individual equality before the law, entrepreneurs cannot challenge already existing businesses. Alliances between the latter and government regulators who place barriers before entrepreneurs must be guarded against.

The second essential principle is property rights. We take it for granted in this country that if you buy a piece of property, everyone acknowledges that you own it. Most countries don’t have that kind of uniform property system. A few years ago, Hernando DeSoto, a great economist from Peru, saw that in countries like his, although there is entrepreneurial activity, there isn’t the corresponding prosperity found in the U.S. And he wondered why. In his recent book—The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else—one of the key factors he cites is the absence in so many other countries of a legal foundation for property rights. In Brazil’s shanty towns, an individual may know that he owns the house in which he lives, and his neighbors may know it, but the fact is not recognized elsewhere.
Mr. DeSoto was asked by the Egyptian government a few years ago to determine who owns the businesses and residences in Egypt. His finding was that 88 percent of the businesses in Egypt are illegal. Why is that? Here in the U.S., it is possible to set up a business legally in a matter of days. In Egypt, it takes a couple of years. It requires going through numerous bureaucracies, doling out numerous bribes, etc. So it makes sense to proceed “informally.” On the other hand, running a business outside the law limits its growth. Most “informal” enterprises never grow beyond the level of family enterprises, because if they get too big, they might attract the attention of the tax collector. DeSoto’s group also reported that 92 percent of Egyptian housing is illegal. People living in residences may have deeds; but only a few miles away, those deeds are not recognized. In Egypt, as in so many other places, there is no uniform system of establishing and protecting property rights. As a result, four billion people around the world own $9 trillion of assets that amount to dead capital.
What do I mean by “dead capital”? Remember that here in the U.S., the most important source of capital for new ventures is not Wall Street, the local banker or the venture capitalist. It is the mortgage market. People either increase their mortgage or take out a second mortgage in order to start businesses. This is not possible in countries like Egypt. Understanding this was the key to Japan’s post-World War II economic boom. General MacArthur reformed a feudalistic property system, in which the peasants had only an informal system of property exchange, into a system with formalized property rights. Immediately, the Japanese economy took off. The importance of property rights is not sufficiently recognized by those of us who take them for granted.
The third principle of economic prosperity is low taxes. Taxes are not just a means of raising revenue for the government. They are also a price. Income taxes are a price paid for working; taxes on profits are the price paid for being successful in business; taxes on capital gains are the price paid for taking risks. In light of this, the importance of low taxes is easy to see: When you lower the price of good things—things like work, success and risk-taking—you tend to get more of them. Raise the price of these good things and you get less. In 2003, we lowered tax rates in the U.S. and the economy started to grow again. As we’ve seen time and again, tax cuts do not mean a loss of tax revenue. By increasing incentives, the government comes out ahead. Washington’s revenues in the last fiscal year were up 15 percent—$100 billion above expectations. Washington’s problem is not revenue, but spending.
The fourth principle I would mention is making it simpler to launch legal businesses. Getting bureaucracy out of the way will inject a new vibrancy into the economy. The fifth and final principle is free trade. Expanding markets and creating greater opportunity for trade benefits us all.

I will remind you of a point I made earlier: The reason that the great economic debate continues into the 21st century, despite the proven superiority of free markets in terms of delivering prosperity, is because of the misperceptions that keep democratic capitalism from capturing the moral high ground. Dispelling these misperceptions should be our priority as we carry on that debate in the years ahead.

My thanks to the brilliant Steve Forbes of Forbes magazine
“Reprinted by permission from IMPRIMIS, the national speech digest of Hillsdale College, www.hillsdale.edu.”