Reshaping the ‘ism’ debate

Constructive debate needs a better understanding of economic systems.

by Derek Olson

One can hardly think of two more contentious words in the American political lexicon than socialism and capitalism. Neither can I think of two words as highly misused and misunderstood. In the aftermath of the recent financial crisis, just as in the aftermath of every deep recession, there is heightened discussion of these concepts. If these concepts were understood more clearly, perhaps we could have more constructive conversations about the size and scope of government.

There is some confusion surrounding the meaning of socialism. In the economics discipline, these colloquial “isms” are generally not used. Economic systems are described as market economies or command economies, roughly analogous to capitalism and communism, respectively. In the former, prices are determined by markets and capital is privately owned. In the latter, prices are determined by a planning board and capital is publicly owned.

From time to time I hear befuddling discussion about the socialist economies of Europe. Many Americans seem to consider much of Europe, especially Scandinavian countries, as socialist because of their expansive programs for wealth redistribution. However, these are economies with private capital, successful corporations and prices determined by markets. If Norway, Sweden or Denmark were socialist economies, it would not be a stretch to say the same of the U.S. Among Americans, there is some ambiguity surrounding the term socialism, but for most of the world, and for much of history, the varieties of socialist theory have been recognized as roughly synonymous with communism.

This ambiguity resulting from conceptual discussion points to the second major flaw in the debate between capitalism and socialism. These are theoretical concepts. They do not actually exist in reality.

Since the Constitution was written, the U.S. has operated a publicly financed post office. Milton Friedman even referred to the military as a socialist activity because the capital is owned by the state and proposed that the U.S. is 45 percent socialist. These examples illustrate how the United States’ economy has never consisted of complete private ownership of capital. In the 20th century, with the surge of entitlement programs, the economy shifted much further from strict capitalism. We must recognize the inadequacy of simply labeling the U.S. with capitalism.

For real world observations, it is necessary to imagine a spectrum. Consider a pure market economy on one side and a pure command economy on the other, from complete private ownership to complete public ownership, from markets to collective planning as the sole mechanism to determine prices. Like the U.S., there are no pure market economies among developed nations. At no point in the history of the Soviet Union or any other planned economy was capital ever 100 percent publicly owned or markets completely abolished. What we must recognize is that there are no examples in modern history of an economy at either extreme end of these spectrums. In other words, all developed economies of the world consist of some mix of capitalism and socialism.

Has capitalism failed? Is capitalism in crisis? These are not constructive questions. Pure capitalism is not the economic system of the U.S., or any country for that matter. The real question we need to ask is this: Where is the optimal place on the spectrum between private and public ownership, between free markets and planned controls?

So how do we determine the optimal place? Economics is a relatively young science, and it is still clouded with some theoretical subjectivity. Additionally, scientific experiments are impossible. It is not feasible to instruct two countries into a situation where all but one variable is held constant. However, data collection methods are improving, available data is expanding and every day we have more history to analyze.

For example, modern empirical evidence supports the incentives argument of neoclassical economics. Edward Prescott, a former University of Minnesota professor and Nobel Prize-winning economist, has done substantive research comparing the tax rates of G-7 nations. Americans now work more than Germans, French and British, when this was not the case in the 1970s. Prescott’s findings show that the large disparity in marginal tax rates that has arisen between the U.S. and other G-7 nations since the 1970’s accounts for the decreased productivity in Europe, Canada and Japan. Prescott’s studies show that even relatively small moves along the spectrum from private to public ownership of capital can have large, disincentive effects on the productivity of workers. Workers are most motivated when they earn the reward for themselves.

While increasing equality is a noble goal, we must not forget the adverse effects of redistribution. When you try to cut the economic pie more evenly, the pie gets smaller, and there’s less to share.

Americans need to change the way they talk about capitalism and socialism. The appropriate discussion is not a debate of alternatives. It’s a question of balance. The next time you hear someone say capitalism has failed or advocate socialism, remind him or her that those economic systems don’t truly exist.