Confusingly you can have free markets or Capitalism, but not both, here's why:
This is a slightly more involved blog post than usual because this is a slightly confusing topic, not least because the terms āfree marketā and ācapitalismā both have multiple meanings.
Perhaps a better description would be that because of the multiple meanings of both words you end up needing to separate āfree market capitalismā into two distinct ideas. I was reluctant to split the term capitalism in quite the way I've ended up doing in this essay and I've resisted doing so for a long time but I think the logic here forces the distinction to be made in the way I end up doing here.
Before we get into all that though we need to get into some of the reasoning used to justify free markets and how that ultimately forces you to accept two distinct ideological systems and make a choice between them.
The reasoning comes from a tool in economics called a supply/demand graph. The way they are usually described is like this:
There is a line representing the cost to produce each additional unit of whatever product you're talking about. Usually this is draw sloping upwards as ultimately if you try and produce an infinite amount of something it will become infinitely expensive.
Then there is a second line sloping the opposite way- when only a small amount of the stuff is produced the people who want it the most will pay a lot for it, then as more is produced you must sell to people who want it less and so will pay less for it. Eventually you'll come to people who will pay for the product, but only if the price is less than it costs to produce that much of it, and so the producers won't bother making any more.
At the point where producers can afford to make one more product for the same price that one more person will buy one more of the product you have the market price. All of the previous products are sold to people who would have paid more, but don't have to, and each of the previous products sold cost less than the market price to produce. That extra value that people don't have to pay is called consumer surplus and the difference between how much a product is sold for and the cost of making it is profit for the producer. Over time in a perfectly competitive market (those don't exist in real life but just imagine for a moment) the line representing the cost to supply the product will alter so that the producer profit falls to zero but the consumer surplus will remain.
If you hold all that as true then it isn't hard to see why people would argue that free markets are unambiguously good! Free markets will find a spot where enough of what people want is produced, but no more, so everyone gets as much of what they want as is technically possible with zero waste. Unsurprisingly the problem is that this doesn't all hold true.
People often point out that markets are never perfectly competitive so I'm not going to deal with that here. Suffice to say you might still justify free markets by saying that even if profits never fall to zero markets still maximise consumer surplus, plus producers are ultimately people too and so the profit isn't a problem. What I want to concentrate on is the problems that flow from this point onwards.
To see the problem we have to do two things: 1. look at how free market capitalism is described by its advocates and 2. (Unfortunately) get a little philosophical.
When describing free markets the people advocating for them usually lean quite heavily on the idea that markets reward people such that people get what they deserve. This isn't actually what the theory we've just described says! What we've said so far is that producing a new product can be profitable but that will eventually fall to zero profit. You aren't rewarded for skill or effort as such, you're rewarded for switching from something we already have plenty of to a new thing that we don't.
Well that's not so bad, it's actually quite useful, BUT that's only true in perfectly competitive markets, which don't exist, so actually you're also rewarded for being in a market where people can't properly compete with you and so you get money that nobody else could ever hope to get, not terribly fair. Before we untangle this though we have to add one more complication, which is wages. In a perfectly competitive labour market wages will fall to a āprofitā of zero, which is a confusing concept so let me reword it- in a perfectly competitive labour market wages will fall such that everyone is paid enough to survive and continue to work/pay the costs of training for work and no more.
That's a little grim but luckily labour markets aren't perfectly competitive either so it's only people working the worst jobs that are paid only enough to survive and no more. The problem is that even if we could fix labour markets such that everyone could switch to any job (which would lead to equal wages/hour minus the costs of training and how unpleasant the job was to do) AND we somehow kept that equal wage above the bare minimum needed to survive, so that people were making a genuine choice between working more hours and having more money to spend and working fewer hours and having less to spend, we still hit a couple of problems.
Because now, even if we ignore the unfair monopoly payments people get in real markets AND assume people are only ever richer if they work more hours, work a more unpleasant job or move to are new industry that needs people to switch over to it, even though we're very close to what sounds like a really good system we've just screwed up our measuring system.
Well we said it was worth rewarding people in this way because it maximized consumer surplus... but we measured consumer surplus using the demand line we talked about. We said, as most microeconomics courses do, that the demand line represented how much people wanted something, but it doesn't, it represents how much people are willing to pay and if some people have more money they can be willing to pay more not because they actually want the product more but because they're simply richer. That distorts the consumer surplus away from how we originally described it and the bigger the wealth inequality the bigger that distortion becomes.
Now you can decide this doesn't matter, that's fine, but you have to acknowledge that the reasoning has now changed. Now, in fact, the defence of markets has become a little circular- the people who are rewarded deserve to be rewarded because they are maximising happiness for the people who have been rewarded who deserved to be rewarded because they maximised happiness for the people who were rewardedā¦ etc.
Luckily in perfectly competitive markets it's hard to earn more than the average for longā¦ but perfectly competitive markets don't exist. So on top of this problem as it would exist in perfect markets its actually worse because there's also all of the unearned income on top of inequality due to earned income. This is what forces us down two alternative paths-
Accept this logic loop and roll with it.
People do this to a greater or lesser degree. Some (originally referred to as the ālaissez-faireā doctrine or āleave it aloneā, now usually referred to as right-Libertarianism) prefer to roll with it all the way, no exceptions. Some prefer to argue that the logic loop is OK if we ensure everyone has an equal start in life and/or a minimum standard that no one falls below. Some take a sort of mix of this and Conservatism and argue that this is OK but like to mildly regulate things to achieve a more stable society than you get in laissez-faire.
All of these, I think, fit into what we often term āneo-Liberalismā. Where as Liberalism was originally not terribly unified on economic policy, was arguably broadly agnostic on economics and was more of a social and political philosophy than an economic one, neo-liberalism seems to be a synonym for one of the two meanings of the word Capitalism. It seems to be the meaning where we deregulate the market such that it works as is described in this first option and those that do well, do well and those that do not, do not. It varies between the attempt at meritocracy, via minimum standards of living and as close to an equal start for all as possible, to the true laissez-faire. This is the Marxian definition of Capitalism (and I think the original usage of the term?). It's the version I've always resisted but I think the term is so necessary for describing this first approach that I'm conceding the ground on that issue. In this essay I use the capital C āCapitalismā to mean this system. I.e. a system where Capitalism is the ideology rather than just being a policy tool.
2. The second choice is to concentrate on the original aim rather than the original method.
Here we care about the consumer surplus as originally described- the aim is to maximise what each person gets as much as possible without worrying about merit as such. Here you might accept that some level of inequality is not just necessary but vital for encouraging people to turn their efforts to whatever society needs them to but you also recognise that for the market to accurately measure those needs we MUST redistribute income and minimise inequality. If you accept this option redistribution isn't optional, it's a requirement. In fact you would want the maximum level of redistribution possible that doesn't slow the economy (we know from empirical data that this is actually quite high) and you'd preferably want to raise the revenue for redistribution from monopoly rents whenever possible BUT as the very rich, definitional, can only get very rich via monopoly rents then any tax that hits the very rich is OK.
This is actually fairly well in line with original advocates of free markets, like Adam Smith, who clearly assume that it will be very hard to stay rich without someone else jumping in and the payment for that activity being eroded. Where they did see and acknowledge that there would be monopoly rents (as in Land, for example) they favoured taxation. Smith also favoured taxes that hit the wealthy generally. They just didn't realise that market distortions would be as big as they are. So none of this is a betrayal of free markets, we just now know from observation that redistribution is required to achieve that original aim!
Indeed if you think about the implicit logic of markets this all fits in quite well- the aim is to pay the minimum possible cost required to get a product produced. The idea of paying more than the minimum required is alien to markets. The logic of this is that we should pay what is required to get people to switch from producing something we have enough of to something that is underproduced but the profit they make should fall over time as new production comes online. Profits in all industries should equalise and fall to zero. Wages should equalise and fall to the minimum required to persuade workers to do the work. The end result doesn't include any provision for some people to have higher life satisfaction than others in the long run. This means that if we CAN tax and redistribute without reducing production of things people want then we MUST do so. Otherwise we would be overpaying for the same level of production, something free markets aren't supposed to have happen! This second option is much more attached to the free-market idea and far less to the capitalism part, here capitalism (small c) isn't an ideology but just an incidental acknowledgment that individuals can own capital (the means of production) but that this should, on average, yield zero profit.
These two viewpoints both use markets and both have individuals owning capital but their underlying reasoning and end results are quite different.
I would argue option 1. is rather circular and somewhat contradicts the logic inherent in free markets, that costs should be minimised and utility equalised for all. (Although markets do accept that some people may achieve that utility with more labour exchanged for more goods and some may achieve it with less labour but more leisure.) This circular logic of the people being rewarded deserve to be rewarded because they are maximising happiness for the people who have been rewarded could, frankly, apply equally well to Feudalism- rich land owners deserve to be rich because they're maximising the happiness of rich landowners, which is themselves. It's just switching from the Feudal system of picking those at the top to a Capitalistic (big C) one. They both risk justifying Plutocracy. I therefore personally find it unsatisfying as a system, but I acknowledge its existence as a real political philosophy. (Although it probably requires subdivision into Meritocratic Capitalism, Laissez-faire Capitalism and Conservative Capitalism.)
I infinitely prefer option 2, the free-markets as a tool to complete a different task, maximising utility for all equally, approach. Here Capitalism isn't the ideology driving decision making but instead capital ownership (I.e. small c capitalism) and free-markets are allowed to exist but are used to achieve that purpose. That purpose being utility maximisation for everyone equally, where utility is defined by the individuals themselves based on their own personal preferences. This is what I would call Liberalism. What this implies, however, is that providing equality of opportunity simply isn't enough, you must aim for equality of utility and that requires redistribution of wealth.
A brief acknowledgment- just as not everyone who falls in the āCapitalismā camp has the same views this other camp is also split. Some are less focused on individuals defining their own utility and think we need society to guide us- Social Democrats, some are focused on self definition of utility but acknowledge that human beings aren't always good at maximising this by themselves and we need a little help- Social Liberals. Then there is one final group that cares about utility maximisation chosen by individuals and let's them do it themselves. This is ideologically where I would like to be but I think the evidence suggests that we do need a little help so I'm a (somewhat reluctant) Social Liberal. This last group doesn't really have a well defined name but I like to use āradical Liberalā as the best placeholder. It's important to stress the difference from neo-Liberalism though, radical Liberalism isn't (big C) Capitalist and by definition it requires the absolute maximum amount of wealth distribution that is possible, that's not an optional extra, it's a core requirement.
Finally I know I haven't talked about Socialism but that's a different question for a different time.
So I accept it has taken a little wordplay to get to this endpoint but I hope I've now shown that free-markets and (big C) Capitalism don't mix!
