The Vision of a Real Free Market Society: Re-Imagining American Freedom [1 ed.] 1138228974, 9781138228979

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The Vision of a Real Free Market Society

Free market capitalism has created a divided American society. Conservative economic and social policy thinking drove the Right’s Project from 1980 to its collapse in 2008, leaving the world in ruins and fascism on the march. The Vision of a Real Free Market Society challenges the Left to create new forms of the market economy that promote efficiency and equality while permanently thwarting concentrated power. Many recent commentators have offered policy recommendations based on existing economic institutions. By contrast, this book calls for root-and-branch changes to the inherent structure of American capitalism. The Vision of a Real Free Market Society: Re-Imagining American Freedom presents a Left-egalitarian case for limited government that overcomes the failures of conservatism while rescuing economic justice from the weaknesses of tax and transfer liberalism. The book explains why the system fails so many Americans in so many different ways, and outlines how we can build a better economy that simultaneously promotes freedom and social justice while crippling the powers of America’s oligarchs. Exploring the idea of a left-wing case for strong but small government, the book makes the case for fundamental reforms that will lead to a truly free and fair society. This provocative book will be of great relevance to anyone with an interest in politics, philosophy or economics, and will challenge readers to rethink their assumptions concerning the prospects for combining justice with fairness in the modern world. Marcellus Andrews is Professor of Economics at Bucknell University, USA, with research and teaching interests in: economic theory; economics and philosophy; inequality; complex adaptive systems; and macroeconomics. After earning a PhD in Economics from Yale, Andrews has taught at Wellesley, the City University of New York and Barnard College.

Routledge Focus on Economics and Finance

The fields of economics are constantly expanding and evolving. This growth presents challenges for readers trying to keep up with the latest important insights. Routledge Focus on Economics and Finance presents short books on the latest big topics, linking in with the most cutting-edge economics research. Individually, each title in the series provides coverage of a key academic topic, whilst collectively the series forms a comprehensive collection across the whole spectrum of economics. 1 International Macroeconomics for Business and Political Leaders John E. Marthinsen 2 Ethics and Responsibility in Finance Paul H. Dembinski 3 The Vision of a Real Free Market Society Re-Imagining American Freedom Marcellus Andrews

The Vision of a Real Free Market Society Re-Imagining American Freedom Marcellus Andrews

First published 2017 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business  2017 Marcellus Andrews The right of Marcellus Andrews to be identified as author of this work has been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN: 978-1-138-22897-9 (hbk) ISBN: 978-1-315-39098-7 (ebk) Typeset in Times New Roman by Swales & Willis Ltd, Exeter, Devon, UK

Contents

1

A map of the terrain

1

The predicament  4 Recipe for a real free market society  6 First argument: Principles  6 Second argument: Policy  8 Basic income and analytical economics  9 2

Real freedom versus American freedom

10

A really free society  10 Libertarianism: Right and Left  11 Liberty requires equality  16 3

What do markets do?

22

The market at work  22 Markets and knowledge  23 A Hayekian Left?  25 The case against raw capitalism  27 Market failure  29 Incentives and information  29 Efficiency wages  29 Mass unemployment  31 Risk and insurance  33 Monopoly and Big Business  35 Joining the debate  39 4

Taking conservative capitalism seriously The Chicago School  42 In defense of capitalism  42

42

vi Contents The problem with “social justice”  44 Incentives 47 The equality problem  50 Merit 52 The problem with capitalism  56 5

Conservative failure and the next capitalism

59

Quackery 59 Defining supply-side economics: Some unpleasant facts  60 Basic economics to the rescue  62 Reverse Robin Hood  63 “Public choice” and conservative failure  64 Progressive supply-side economics  67 Schumpeter’s world  69 A street-smart Left  71 6

Universal capitalism and economic justice

75

Labor and wealth  75 Universal capitalism versus socialism  76 Universal capitalism: Pedigree and history  78 Basic income  81 The Social Trust Fund: A variant on the basic income theme  84 Incentives and the trust fund  85 Work 85 Savings 87 Getting from here to there  89 International aspects of endowment-based justice  92 Conclusion: The road to real freedom Bibliography Index

97 101 104

1 A map of the terrain

This little book proposes a radical alternative to contemporary American capitalism—a species of left-libertarianism—as an unorthodox yet pragmatic reform of the American economic system, moving beyond the dead-end squabbles between a failed conservatism and an exhausted liberalism. My goal is to open a new front in the fight about the proper balance between the State and the market in economic life. This book shakes up the economic imagination of citizens of liberal democracies everywhere, especially Americans, by exploring how to combine markets with the public ownership—but not management— of a large share of the nation’s private capital stock which is the antithesis of socialism as usually understood. This seemingly crazy idea is venerable, smart, and entirely practical. In 1964 Nobel laureate James Meade—an outstanding member of the orthodox economist guild and an ardent liberal socialist—proposed a scheme for what he later called “Topsy-Turvy nationalization” to create a new kind of free market society, a property-owning democracy.1 Meade hoped that the collective wealth of the working- and middle-class majority would provide a decent income for everyone, not just those who owned great wealth or had elite degrees. Meade also harbored a deep political desire, buried in an appendix filled with complex mathematics, that a common capital fund owned by the people might one day reclaim democratic control of economic and political life in an otherwise private enterprise society.2 The time for Topsy-Turvy nationalization has arrived. The following pages are written in a strong belief that economics can be used in the service of social revolution, to diminish one of the scourges of our times: vertiginous degrees of economic inequality. If this sounds crazy, consider the inspiring example of an economist who changed the world by using economics to shake up the status quo. In 1960, Nobel laureate Milton Friedman wrote a feisty little tome, Capitalism and Freedom, challenging the then reigning New Deal liberalism of his day by showing how orthodox economics supports a strong case for limited government

2  A map of the terrain and lightly regulated markets. The current book follows Friedman’s example, while completely overturning his prescription by proposing a better form of capitalism that is much fairer and more efficient than incumbent conservatism or the welfare state. Conservatism is a nightmare; liberalism is a mess; and “socialism” as we know it is a quaint relic of the past. Time to try something better. The key move is to use a seemingly “conservative” budget policy approach—a small but steady federal structural budget surplus—to save on the behalf of the American people, thereby building a substantial common capital fund that pays each citizen a guaranteed dividend income. This capital fund—here called the “Social Trust Fund”—is not a form of ordinary redistribution wherein the rich and well-off are taxed in order to benefit the poor. The Social Trust Fund is, instead, a common mutual fund, or set of funds, that throws off its dividend and interest earnings to every adult citizen in the form of a regular capital-income check. The Social Trust Fund is not a method for Government to control the economy by having Uncle Sam employ workers and tell people what to do in the marketplace. Ordinary, everyday, profit-based business decisions in competitive markets will still determine employment, wages, prices and products in our economic lives under the Social Trust Fund concept. Indeed, this change in the nature of American capitalism—or, for those who prefer a different name, a model of competitive free market socialism—might, in the long term, cut the size of the Federal Government in the economy while, at the same time, aggressively promoting equality. Radical problems usually require radical solutions. If you, dear reader, think this is just more weird, leftist pie-in-the-sky daydreaming, let’s look at some numbers. As these words are being written, the total level of income generated by the US economy is roughly $17 trillion, earned by and spent by a population of roughly 321 million people, or a bit over $53,482 per family (as of the most recent data in 2015) by 82.199 million families.3 The top 1 percent of the income distribution—the top 1 percent of persons that earn the highest incomes—earn 20 percent of all income generated by production, and the top 10 percent of the distribution earns 50 percent of all income, leaving the remaining 90 percent of the population with the other half of the economic pie. Worse, Thomas Piketty’s Capital in the TwentyFirst Century4 tells us that the top 10 percent of wealth-holders own 50 percent of American wealth, whereas the bottom 50 percent of people at the other end of the wealth spectrum possess nothing at all once we subtract the value of what they own from the value of what they owe. Arithmetic tells us what this means. If the economy in 2015 had grown by 2.5 percent over the course of the year—the historical average for the US—then the total increase in the nation’s income would have been about $340 billion.

A map of the terrain  3 Table 1.1  How economic growth is not shared (1980–2015) Population 1980 2015 1980 2015 Percentage Ratio Ratio share distribution distribution income income difference 1980 2015 (%) (%) gain ($) gain ($) Top 5% Fifth quintile Fourth quintile Third quintile Second quintile First quintile

14.6 41.1

20.8 48.9

12,078 8,500

17,202 10,113

42.42 18.98

2.92 4.16 2.06 2.45

24.4

23.2

5,046

4,798

-4.91

1.22 1.16

17.6

15.1

3,639

3,122

-14.21

0.88 0.76

11.6

9.2

2,399

1,902

-20.72

0.58 0.46

5.3

3.5

1,096

723

-34.03

0.26 0.17

However, the gains from this bounty will be doled out in a very doleful fashion. Table 1.1 shows how economic growth was shared among the top 5 percent of the income distribution, as well as across all other families, in 1980 and in 2015, if we divide the population of families into five equal groups (quintiles) and arrange them from the highest to lowest level of income.5 Had the distribution of income and wealth in 2015 been more like that in 1980, when the conservative movement in the United States gained power in politics and the public mind, that it then wielded for at least a generation, the same 2.5 percent increase in real GDP would have had a very different impact on society, as shown by the last three columns in Table 1.1. The table tells us that the bottom 80 percent of all families have a much smaller claim to the economic bounty that they created collectively in 2015 than they would have had in 1980. In particular, the majority of families in the bottom 60 percent of the income distribution lost more the 14 percent of the benefits they would have garnered from growth had distribution of well-being only been as skewed as it was in 1980, compared to the even greater degrees of inequality present in 2015. Further, inequality among the very well-off has increased considerably over time: the top 5 percent of families in the income distribution now claim more than 42.5 percent of income earned by the richest families, as compared to only 35.5 percent of income. Another way to understand how much inequality has grown between 1980 and 2015 is to consider how much a family in each category will earn for every dollar that average family income grows. The last two columns of Table 1.1 show the ratio of the average rise in income for families in each category in 1980 and 2015 to the average rise in income across all families if the economy in 2015 had grown by 2.5 percent, after adjustment

4  A map of the terrain for inflation. Had the distribution of income and wealth in 2015 resembled its counterpart in 1980, a family in the lowest quintile would have earned roughly $0.26 for each dollar rise in average family income, whereas a family in the most well-off quintile would have earned $2.06, and a family in the richest top 5 percent would have earned $2.92. These glaring disparities are in and of themselves cause for concern, since social cooperation is undermined when the benefits of cooperation are so badly skewed. But contemporary inequalities across families are so much worse than they were more than three decades ago. Now the poorest family only earns $0.17 on average for every $1 rise in average family income, whereas those in the top 20 percent of families earn more than $2.45, and those in the top 5 percent earn about $4.16. The richest 5 percent of families would have gained more than 11 times as much from growth on average than the poorest family, instead of an obscene multiple of 24 under contemporary economic arrangements. In the intervening years the fable of “supply-side economics,” explored and exposed as the lie it is below, was the guiding principle of economic policy for the dominant American Right, which recommended this approach to the voting public, based on the claim that making the rich even richer would benefit everybody else, especially the poor. Alas, the bottom of society gains even less from growth than it did in 1980, and more than 60 percent of us see less-than-a-dollar increases in our own family’s well-being as the system grows for each dollar of family income growth, with the lion’s share sucked up by the very richest families in society. The supply-side fable told us that we can spur growth by making sure that the rich got an even bigger slice of the expanding economic pie through lower taxes, looser regulations, and a deliberate turn away against economic justice—for the poor’s own good, of course. And so Americans were seduced by the fable, and the results have been just nasty for most of us, especially the people trapped at the bottom of the system. What happened?

The predicament The reason for this dreadful state of affairs is simple: the wages and incomes of ordinary workers, both those without college degrees as well as many of the college-educated, did not and do not rise in step with the growth of the economy, thereby leaving most Americans with smaller gains from economic expansion, even as our combined efforts are required to generate national well-being. This state of affairs is due to the fact that capitalism has changed in ways that necessarily harm the well-being of the working majority of Americans, so long as we stay with stale conservative or liberal approaches to economic policy. Economics tells us that a market economy is a special

A map of the terrain  5 type of cooperative. Markets are effective devices for getting people to cooperate with each other to produce what they need and want by tapping the drive for individual gain. A market system is a subtle (and cleverly hidden) cooperative wherein we help each other to have our needs met through competition under the rule of law, on the promise that participation in the system is the most reliable road to well-being. The statistics cited on pp. 3–4 tell us that there is simply no way for an economy or society to avoid escalating bitterness, anger, and social strife when the lion’s share of growth accrues to those who are already earning astounding incomes and own absurd stocks of concentrated wealth.6 The American capitalist cooperative has broken down because technology, trade, bad policy, and social change have undermined all of the old deals that held the system together. Although capitalism and modernity have always been a violent “gale of creative destruction” that render all occupations, ideas, and forms of business vulnerable to obsolescence, the speed and reach of change threatens the vast majority of Americans right now, even though the same instability and vulnerability threatens every worker, everywhere. Some people in the American system are lucky enough to have skills and property that protect them from the corrosive effects of changing technologies and economic competition, allowing them to earn high and growing incomes. Others among us are vulnerable to being ejected from our place in the system when our employer leaves for another shore where labor is cheaper or better educated, or new software can direct a machine to do what once required human intelligence, skill, judgment and craft. Then we are tossed out of the capitalist cooperative because we are inefficient and therefore disposable people that cost too much, or do not do things the rest of society values. As I write these words, after the American presidential election of 2016, the incumbent American model of democratic capitalism is unraveling because it is failing the people—particularly the modestly educated workingclass majority and the young. Donald Trump—seen by some as a clownish, racist, vindictive but clever media star with dictatorial ambitions—says that America can somehow remake the blue-collar road to middle-class prosperity, defeating a mild social democrat in Hillary Clinton, who promised to improve on the middling achievements of the Obama presidency. The mixture of nationalism and protectionism urged by Trump defies economic good sense, but speaks to a frustrated working majority left behind by the dramatic shift in the balance of power between owners and workers. Neither Trump nor the weak Democratic program dismissed by the voters can address the central problem of our era: people who own capital or receive elite schooling thrive, while the rest of us flail about and fail. This book advocates a radical restructuring of American capitalism along lines that permanently undermine concentrated private power, by widening

6  A map of the terrain wealth ownership beyond the small circle of plutocrats who buy and then break democratic politics. I am proposing a method for paying the common man and woman a decent basic income that is free of all the flaws of “welfare,” because it is not a payment for being poor but is, instead, the income from property we collectively own. In short, this book calls for an economic revolution that is well within our grasp if we can just pause long enough to heed basic, even orthodox, economics. The idea that orthodox economics might actually contain the seeds of revolution, and be a blueprint for how to get from where we are to a much better place, may seem ridiculous. Doesn’t economic theory recommend the old conservative program of limited government, low taxes, and weak regulation, or the Clinton–Obama variations thereof? Sure, but only in the same way that a cookbook or culinary tradition has many recipes for, say, meat, fowl, fish and vegetables. What and how we cook depends on what we want to eat, in the kitchen and in political economy. Economic theory is an endeavor that tries to discover how economies work and fail, making it a recipe book for how we can make our lives better by adjusting our economies to better fit our needs. Economies are created by people, not ordained by Nature. There are no economic “laws,” only regularities that are associated with different ways of organizing our common economic lives. Economic regularities are based on what people want and need and can make compromises about, in that way making them the exact opposite of physical laws, which are written into the fabric of space and time. Economic theory is a sprawling recipe library about how we can make our lives better, or worse, by crafting one set of deals with each other as against another. This book uses economics in the service of peaceful social revolution, showing how we can make the United States a freer and fairer society.

Recipe for a real free market society The argument for the economic theory recipe is divided into: (1) a Principles section that presents the philosophical case for left-libertarianism, albeit in an informal but analytically respectable fashion, to an audience too busy with living to pay attention to developments in philosophy or analytical economics; and (2) a Policy section that explores the nature of economic and social policy in a left-libertarian society. First argument: Principles This section presents a sketch of a genuinely free society, where each man or woman is free to do what he or she wants to do, and has the means to make reasonable and responsible choices. The style of this section is

A map of the terrain  7 reminiscent of a rollicking, at times loud, even lightly bawdy, but goodnatured bull session between thinkers who respect each other as persons, but who are truly perplexed about how their intelligent, good-hearted and honest opponents could be so wrong. Readers are first introduced to the fundamental fight between leftlibertarians and their conservative adversaries by a review of the conservative case against equality, based on the ideas of the dominant theorists of contemporary limited government conservatism: Milton Friedman, Friedrich Hayek, and Richard Epstein.7 The point of this review is to show why ideas matter in politics and policy, even if politicians and pundits do such bad job of making sensible arguments in public. This review goes to great lengths to show why the Left must pay close attention to the best part of the conservative mind if social justice is to have a future. This first section makes the conservative case for a free society, scrubbing the argument clean of the taint flowing from the practical compromises that conservative intellectuals have made with predatory capitalists, racists, theocrats and sexual bigots that have soiled the intellectual Right over the past four decades. Readers are next introduced to left-liberal and left-libertarian thinkers whose critiques of conservative thinking, though largely unknown to the general public, have effectively destroyed the case for conservatism. This portion of the book shows why conservatism fails by not understanding the link between means and choice in its analysis of freedom, with the consequence that the Right ignores the ways in which poverty and concentrated private power—both private monopoly power and the tyranny of social majorities in markets and politics—can turn free market societies into systems of oppression, and the persistent degradation of the poor and social outcasts. Readers are introduced to the ideas of Amartya Sen, Ronald Dworkin, and Phillipe van Parijs, among others, who have slowly and carefully undermined the intellectual case for conservatism over the past four decades. This exploration demonstrates why substantive freedom for all—the capacity to be self-supporting and make responsible choices— is impossible in a conservative order. The final arguments of the Principles section explore why a consistent left-libertarian approach to freedom should make the Left an enemy of Big Government. The key concept here is that the core functions of Government—policing, education, national defense, law and the judiciary, public health, sustainability, and other public functions in a complex, technology-driven society—are threatened by the twin evils of bureaucracy and concentrated public power. This section of the book explores the common interests of conservatives and left-libertarians in limiting the reach of the State in a diverse society, where Government can be captured by powerful economic minorities, or intolerant and abusive social majorities.

8  A map of the terrain Second argument: Policy This section takes a left-libertarian look at the old and tough question about the functions of Government in a free society. Two overarching operating principles guide public policy under the left-libertarian banner. First, governments should arrange public policies to promote maximum equal opportunity for all children to develop their capacities, thereby minimizing the hold of inherited wealth and social, as well as caste position on the young. Second, Government should enlist competitive markets to provide important public goods wherever possible—including health care, education, and housing—in order take full advantage of the power of directed self-interest to meet the needs of all citizens, not just those with inherited wealth or high incomes. A key point of the Policy section is to show why a commitment to radical equality is perfectly consistent with markets, provided that Government policy is carefully designed to undermine the hold of class and caste inheritance on the life chances of each generation. A left-libertarian political economy would supplement, and if possible supplant, the modern welfare state with a social endowment system that grants each member of society, upon maturity, a financial claim on the collective wealth of society. This claim can take a number of forms, from a guaranteed basic income paid to each citizen as a matter of right—so long as each member participates in economic life through work, study, or a few other sanctioned economic activities—or a citizen’s stake, wherein each person is granted a sum of money, say $50,000, once he or she reaches the age of 21, that can be used to purchase a home, start a business, or finance college. Left-libertarians seek to maximize real equal freedom for all; to promote maximum effective individual autonomy for everyone. But rights mean nothing without the means to exercise those rights. The right to free speech means nothing to someone who cannot express themselves, just as contract rights mean nothing to people who cannot make or keep promises. In the same way, the right to freely choose one’s course in life is without much value unless one is able to make choices and has the means to make choices. The economic foundation for equal real freedom in society requires a substantial degree of economic redistribution to support the prospect of equal real opportunity for each child to learn enough, be healthy enough, and safe enough to develop the skills he or she will need to exercise their freedom when adults, no matter their gender, race, color, religion, or the economic resources of their parents. Left-libertarians dispute the right-libertarian’s claim that freedom can exist without means. Indeed, the left-libertarian argument against the rightlibertarianism is devastating because the critique takes seriously the real brutality that poverty and inequality inflict on human beings, whereas the conservative, in the end, is a daydreamer who wishes away the bloodiest

A map of the terrain  9 aspects of the real world. Yet the left-libertarian is not a socialist, if by that we mean a person who seeks to use the State to provide permanent protections for all against the risks to life and limb posed by the economy and the rough facts of life. Left-libertarians, being egalitarians and realists, are all in favor of protecting the young from the risks of the soul-crushing poverty and hierarchy that is the lot of those born to the bottom of society. Left-libertarians are also good enough economists to see why collective protections against life’s risks are sensible and just, though the modern form of welfare systems can be much improved upon if we move toward either a basic income or stakeholder system of the sort noted above and developed fully later on. But left-libertarians do not seek to protect people from the nasty consequences of their own choices, since each of us really is free to harm ourselves. What we are not free to do is harm the well-being of children, because the young are future citizens whose prospects for liberty need to be guarded against the silliness, stupidity, cupidity, and bad choices of adults, including an economy crafted by adults deluded by misguided public policy.

Basic income and analytical economics The concept of a basic income is quite controversial, in part because it smacks of the claim that people will get “something” for “nothing,” thereby ruining their character, or at any rate twisting economic incentives. A full technical analysis of the economic consequences of a basic income as an alternative to more traditional approaches to social protection is quite beyond the scope of this little book. However, an extensive and analytically rigorous test of the ideas proposed here is developed in a companion website, which uses neoclassical and heterodox mathematical and computational models, including complex adaptive systems, to explore the benefits and pitfalls of left-libertarianism in general, beginning with the basic income/social endowment scheme. Interested readers should visit the companion website (www.darkeconomist.com).

Notes 1 Meade (1993) and (1995). 2 Ibid. 3 US Census Bureau. 4 Piketty (2014). 5 US Census Bureau and Piketty (2014). 6 Piketty (2014). 7 The most important works include Milton Friedman’s Capitalism and Freedom, Friedrich Hayek’s The Constitution of Liberty and Richard Epstein’s The Classical Liberal Constitution: The Uncertain Quest for Limited Government.

2 Real freedom versus American freedom

A really free society A left-libertarian approach to economic policy seeks a market-based road to equality and social justice that promotes efficiency, equality, and fairness more effectively than existing welfare states. More, this free and fair society can be realized without an intrusive, clumsy, wasteful bureaucracy, but instead by a small, smart, nimble State. The well-known right-libertarian commitment to individual liberty and faith, in the capacity of ordinary people to manage their affairs through mutual self-interest, is based on a powerful critique of concentrated and therefore unaccountable State power. A comprehensive left-libertarian critique of authority extends to all forms of concentrated power—public and especially private. The term “left-libertarian” will seem an oxymoron to many, even though there is a long and venerable line of thinkers whose views on the connections between equality and liberty put them on the Left side of the political spectrum. A brief meditation on the nature of a free society from a right- and left-libertarian perspective might make matters a bit clearer. A free society is not simply an arrangement where people can use their property, including their bodies, in whatever way they choose, unencumbered by Government or the Church or a populist mob bent on imposing its will. Limitations on the power of Government and “the people” to force individuals to act against their own judgment are preconditions for genuine liberty that must be protected against the theocrats, bureaucrats, and other busybodies who love to tell other people what to do. But no society can be really free if many of its members are unable to read, or work, or protect themselves from the hatred of others because they are the “wrong” color or gender, or pray to the “wrong” god, or make love to the “wrong” people. A really free society knows that freedom can exist only if everyone has substantive liberty in equal measure, which means that everyone has the

Real freedom versus American freedom  11 economic means to act on their own ideas of what is best. As Phillipe van Parijs notes in his path-breaking Real Freedom for All: What (If Anything) Can Justify Capitalism?, “One is really free, as opposed to formally free, to the extent that one possesses the means, not just the right, to do whatever one might want to do.”1 Does real freedom require that everyone have the same economic means; the same level of income; the same amount of wealth? Of course not. A really free society promotes equal liberty, not equal welfare. Human diversity in manners, morals, and desires is far too great for any simple or even single standard or measure of equality. The best that we can hope for is a society that allows each of us to pursue our dreams without the fear that our beliefs or values put our lives, or our independence, at risk because we are out of step with the crowd. Equal liberty means the equal right to make choices. Classical liberals, including Nobel economists Milton Friedman and Friedrich Hayek, as well as philosophers Robert Nozick and John Tomasi, have made a powerful case for capitalism and markets as crucial economic institutions for the preservation of individual liberty, as well as the creation of wealth.2 These thinkers see freedom as the purpose of political and economic life. For them, a good society allows each person to realize their own goals and pursue their own understanding of their good, unfettered by the coercion or interference of others. Many right-libertarians, especially the economists among them, also see capitalism as the best way to create wealth and thereby enhance liberty; in that way, limiting conflict over scarce goods. Governments, in a right-libertarian society, are supposed to only provide those public goods that individuals or groups cannot provide for themselves through voluntary exchange in markets, or through voluntary organizations. Further, governments are specifically enjoined from favoring one set of values, social groups, or social classes over another because such favoritism will inevitably enhance the well-being of some by undermining the liberty of others.

Libertarianism: Right and Left For right-libertarians, a competitive market economy is an ideal social arrangement because economic outcomes are the unplanned result of the free choices of millions of people on the basis of self-interest. Some people are rich because they own valuable resources that other people value: skills, ideas, money, land, or especially capital. The pattern of prices and wages resulting from the free exchange and bargaining of millions of people reflects the balance between a population’s desires and the realities of limited resources, as well as the ownership patterns of these resources.

12  Real freedom versus American freedom Bill Gates is rich because he created products that vast numbers of people want to use and are willing to pay for, just as many professional athletes or film stars are rich because they are beautiful, provocative, or have special skills that others want to witness. Other people are poor because they do not have labor, capital, or other assets that can command high or even adequate prices and therefore incomes. For right-libertarians, poverty and inequality may be a regrettable circumstance that society should try to remedy through charity, or by some other voluntary means, rather than using Government to transfer income or wealth from the rich to the poor. The right-libertarian approach to the distribution of income and wealth can be summarized by the phrase “from each according to his or her wishes; to each according to his or her market value.” If we assent to the right-libertarian’s theory of justice, which gives priority to social relations based on freedom from coercion, self-ownership, and voluntary exchange, then there is no coherent idea of “equity” that can be consistent with the principles of liberty. First, the State-based redistribution of income and property, on the basis of a politically determined idea of social equity or merit, takes the property of some people and gives it to others by virtue of their identity as “poor,” whatever that means, without compensation. Second, the political determination of merit or desert is, in a democratic society, based on the decisions of the majority of voters, or more likely, the majority vote of their representatives in the legislature, which may have little bearing on any intellectually or philosophically coherent concept of desert that can earn the support of those whose property is confiscated and redistributed to the “poor.” This is a clear case of the “tyranny of the majority” that defines both the objects of social charity, as well as the people who are forced to finance “societal” beneficence, in ways that ride roughshod over the rights of those designated as better-off. The most important matter at hand is not whether the well-off eventually benefit from policy programs aimed at improving the condition of the badly off —such as public health programs that reduce the incidence of communicable diseases in society, or public education policies that improve the economic capacities of all children, thereby boosting the pool of highly skilled workers. The primary point is that the democratic use of public power to pursue redistributive aims invariably sets aside the material freedom of the well-off at the behest of any politically popular claims to desert in favor of the poor, despite the fact that sharp disagreements about social justice in society argues against any commonly supported idea of desert being more important than liberty.3 Consider a very difficult case. Suppose poor children regularly suffer terrible illnesses because their parents cannot afford to live in environmentally safe places. The illnesses require immediate medical attention and then

Real freedom versus American freedom  13 long-term care if recovery is to be possible. The children’s parents have little by way of family or community resources: everyone they are related to, or know, is as a poor as they are, and the required medical procedures cost too much. Medical providers are quite sympathetic but severely hamstrung by cost considerations. What should Government do in this case? A logically and ethically consistent right-libertarian would, after taking a couple of very stiff drinks, insist that governments should not tax anyone to provide medical care for these children, based on the claim that they “deserve” care by virtue either of their youth or their “innocence.” The issue here is not whether poor kids “deserve” to die because their parents can’t buy medical care, or afford to live away from deadly risks. A decent classical liberal order would rely on compassion, or a sense of religious duty, or even a sense of anarchist justice to create institutions to take care of these kids. But governments cannot, at the same time, minister to the needs of sick poor children and protect the property rights of all on the basis of equal treatment before the law. According to the classical liberal stance, a government using redistribution to offer solace or support to suffering people by taking from the rest of us is erasing the freedom of some at the behest of others. The State in a free society cannot be allowed to weigh these rights against each other on the basis of its own calculations, or even on the basis of democratic procedures, without the Government becoming a tool by which the majority takes from the minority—even if the majority’s ethics are commendable, and the minority’s wealth is so immense as to be obscene. Classical liberals are extremely wary of States for the simple reason that Government is an incredibly powerful social agent that can slip free of the people’s leash, and even place the leash upon them. Governments are mechanisms with extraordinary powers beyond the capacity of individuals or private organizations, because the State can transfer property from some citizens to others without the original owners’ consent, on the basis of the collective’s judgment about the best use of resources. Further, Government is granted the power to block mutually beneficial commercial, social, intellectual, recreational, or sexual activity on the basis of its authority, as the agent of the people charged with enforcing their will. These powers are exercised through the State’s presumed monopoly on the use of force; power that can be used on the basis of the Government’s discretion to accomplish the collective’s goals as established by a political process. But this concentration of authority and overwhelming power makes Gov­ ernment an unreliable agent of the people; one that can pursue its own purposes. Hayek’s most famous single work, The Road to Serfdom, is a dire warning about how modern States present an extreme version of the principalagent problem to their publics that he feared would lead to totalitarianism.

14  Real freedom versus American freedom Hayek’s mid-twentieth-century warnings about the weakness of democracy and capitalism, and the tendency for governments to turn citizens into subjects, written soon after the wreckage of fascism in Europe and in the shadow of socialist collectivism in central Europe and the Soviet Union, seems extreme now that State socialism has collapsed in ignominious failure. And Hayek’s writings on the incompatibility of human freedom with redistribution wrongly assumes that democratic and constitutional controls on State power will always fail. The legitimate Hayekian claim, that markets are the most effective means for the creation and dissemination of knowledge to solve the problems of practical life, does not in any way justify the further claim that redistribution invariably leads to centralized State economic control and the end of freedom. Many right-libertarians also claim that an unregulated capitalist economy is the best-known system for creating wealth, and eliminating poverty and want over the long span of history, if we have the patience and foresight to let self-interest work. These thinkers claim that a market society without a welfare state or a government that imposes regulations on business to promote a phantom “common good,” or take money from the better-off in the interest of the “deserving” others, will eventually be very wealthy. In fact, many of these writers claim that economic inequality is a necessary part of wealth creation, so much so that attempts to reduce inequality will only result in reducing the average standard of living for everyone. One purpose of this book is to show why this claim is almost totally wrong, to the extent that one wonders how so many otherwise intelligent and decent people keep saying this sort of thing. For the moment, though, we should note that the right-libertarians make an important intellectual leap that has, until relatively recently, gone unchallenged by the Left to the detriment of decency in politics and policies. The right-libertarian argument for capitalism as the primary instrument for promoting freedom limits the idea of freedom, as we’ve noted, to the formal right of a person to use their property as they see fit. Yet, the old leftist claim that formal freedom is meaningless if individuals lack the capacity to make choices has gained renewed meaning in modern times, where millions of men and women lack the means to be effective agents in economic life, by virtue of low levels of education, poor health, or unemployment. It is sad but correct to say that one of the “benefits” of the mass unemployment and extreme inequality of the past few years is the reevaluation of the meaning of the word “freedom” in our political and moral lexicon. Consider the “freedom” of the homeless as an example of the emptiness of the right-libertarian vision of liberty without means. Someone who is without a regular address, shelter, or a place to receive mail is “free,” if we mean that he or she does not pay the rent or mortgage. They are without so many of the small annoyances that go with maintaining a clean and

Real freedom versus American freedom  15 comfortable living space, or living in some degree of harmony with one’s neighbors. The homeless are “free” from the worry that their home may burn down, or that the ceiling or roof may leak, or so many other mundane things. On the other hand, it is hard to choose to work, or be clean, healthy, or safe in body and one’s property without an address. Of course, someone might object to this example by noting that so many of the homeless in our cities are wounded people, who are unable to make reasonable choices for themselves by virtue of mental or emotional illness, which in turn requires the compassionate among us, no matter our philosophical commitments, to respond to the plight of these people. But this sort of response to the fictive liberty of the homeless gives the game away by acknowledging that the problem for so many homeless people is that they do not have the means to make reasonable choices. A person who has been denied access to adequate schooling is barred from making responsible choices in a technology-driven economy—and can be as economically inert as the homeless. For right-libertarians to say that a badly educated man or woman is “free,” and should therefore live with the poverty that is the unplanned outcome of competitive markets, is ethically obscene. A person who deliberately chooses to not attend school in favor of, say, play and partying is someone who we might say is responsible for his or her later poverty if the choice results in a lack of income—though only if we take a very restricted view of personal responsibility. A middle-aged adult who is poor, or even destitute, because of bad choices made when they were young is, in a very real sense, a prisoner to another person: their former, frivolous self. A feckless person who deliberately chooses to bear a child without the capacity to then raise the child in a way that promotes that child’s wellbeing is attacking the child’s future liberty by depriving him or her of the means to act in his or her own interest. The left-libertarian stance on economic policy begins with the observation that the capacity to choose is as important as the right to choose, with the consequence that a really free society is one where its members are able to make reasonable choices. Left-libertarian approaches to economics acknowledge one of the core strengths of the right-libertarian argument— that markets, and therefore some forms of capitalism, are effective devices for promoting the growth of wealth and a wide range of choices in employment, as well as lifestyles—while insisting that freedom is the result of material investments in each person’s capacity to choose. The subject matter of economics—the creation and distribution of wealth—matters because freedom is only possible if the material needs of men and women can be satisfied. We are free beings—persons capable of creating and acting upon plans that are rooted in our desires and imagination—only to the extent that we can fashion reliable sources of food, shelter, and protection from

16  Real freedom versus American freedom the ravages of disease, as well as from the savage side of human nature. An economy is an expression of our collective determination to assert control over fate by guaranteeing the necessities of life, thereby liberating us from the pain, toil, and drudgery associated with grinding destitution that reduces all thought to the urgent task of survival. The anarchist thinker Peter Kropotkin entitled one of his works The Conquest of Bread, because the creation of abundance is among the most important creative acts in human history. The freedom that we all cherish is born only after we have found a way to release ourselves from the coercion inherent in penury. The sin of the Right, from a left-libertarian point of view, is that the poverty and underdevelopment of some is seen as the necessary price for the wealth and freedom of others. This sacrifice of the well-being of some in the interest of others is just as objectionable as the use of Government power to favor some groups at the expense of others. Markets, like governments, are social creations wherein rules of property, contract, and law are established in the hope that society may achieve certain objectives and diminish suffering. The rules of the market game dictate the broad pattern of wealth and poverty, growth, and decline that are the framework for individual fortunes and failures in economic life. We are intelligent enough to know, at least in broad outline, how one set of institutions fares relative to another, in terms of the capacity of individuals to develop and exercise reasonable choice, with the result that different patterns of income and wealth distribution are a social choice (otherwise, economics is a completely worthless discipline). Many on the Right sometimes claim that there is no choice to be made in this matter: if one wants freedom, choose raw capitalism, and accept life with a certain amount of poverty and suffering as the price of freedom. Left-libertarians insist that there are many forms of the market economy, some of which are better at promoting real freedom for all in the context of competition and innovation than the radical and blood-stained version of market capitalism that Americans live with. The naivety of the right-libertarian is as curious as it is dangerous, because he or she actually believes that liberty and equality are opposed. A brief meditation on the nature of American freedom, informed by a realist understanding of human need, and the connections between social hierarchy, poverty, and violence, shows why right-libertarianism is either a delusion or a commitment to social warfare.

Liberty requires equality Libertarians, no matter their flavor, are, at the end of the day, liberals of a sort.4 Liberals insist that the purpose of economic and political life is to promote the well-being of individuals by gradually developing social rules

Real freedom versus American freedom  17 and institutions that expand the range of individual autonomy to more and more aspects of a person’s life. A liberal society sees individuals as the best judge of their own well-being, because the incredible diversity of desires and ideas among large groups of people makes it impossible for concentrated private or public power to promote the well-being of all, or even the majority of, citizens at any point in time. No institution with concentrated power can ever know the minds of millions of individuals. Individuals, pursuing their own ideas of what is best for themselves and their companions will organize their efforts and resources to reach their own goals, whether those goals are as mundane yet sublime as creating a meal, writing a novel, fixing a car, building a house, cleaning dirty babies, driving a bus, preventing crime, putting out a fire, teaching a child to read, easing the pain of the dying, or cleaning an office building at midnight. Each of us cooperates with some people, competes with others, and either ignores or retreats from contact with hated others, because that is the best way we know to realize our own goals, on the basis of negotiations and exchanges of property—whether in material or money form. Liberals of all flavors understand that a society is a vast and complex network of individuals bound together by their self-interested choices. Economists study the ways that this network of choices improves well-being, by fostering cooperation, innovation, and production to overcome mass poverty and scarcity at the same time that the network also elevates some people into positions of nearly limitless material wealth, while also locking others down into nearly bottomless forms of avoidable suffering. This network will be the source of great prosperity and connected misery if the rules governing property, work, deal-making and the limits on individual and concentrated power in private and public life help each of us realize our goals, without deliberately reducing the well-being of some in the interests of others The right-libertarian’s insistence on the reign of property and contracts over all else in society is an egalitarian demand; that the law of the land treat all citizens equally, without favor to any one type of person, region, belief or opinion, so that individuals can make whatever deals they want to make on the basis of self-interest. The idea that right-libertarians are egalitarians is going to shock some people because the term “equality” is usually reserved for discussions about how income, wealth, or opportunity ought to be distributed, in order to alleviate profound disparities in economic well-being. But equality is, first and foremost, a principle that applies to the rights of citizens in a free society, in the specific sense of a set of rules governing the exercise of autonomy in personal and economic life, as well as the exercise of power and influence in politics. A liberal society is based on the idea of an equal zone of autonomy for each citizen, where every person lives under the same rules as

18  Real freedom versus American freedom any other. Individual property rights cannot exist if some citizens can own property and others cannot. The deals between property owners must be subject to the same rules, and similar cases before the courts must result in similar outcomes on the basis of well-known rules, or else the protections of property rights depends on the identity of property owners. Equality in matters of civil and political rights is just as vital to the right-libertarian case as equal property and contract rights. If a government that can choose its voters, use police surveillance and brutality against some parts of the population with impunity, and limit the right to free speech in politics, then liberty does not exist. But once right-libertarians have acknowledged that equality before the law is an essential requirement for liberty, the claim that liberty and equality are forever enemies becomes impossible to sustain. Equal treatment before the law requires an equal capacity to understand and act within the parameters of the law. A society’s legal code, from an economist’s point of view, is not just a list of rules that tells citizens what they can and cannot do in the face of a vast system of punishment that inflicts penalties on those who violate the rules. Such a system is both literally impossible and a principle enemy of freedom. Liberty cannot live in an order that is so cynical and corrupt that it must constantly threaten people if the rule of law is to exist. The law is the skeleton of society, the structure that defines and protects individual liberty by establishing the rules that govern our dealings with each other. In a way the law puts a legal price on the violation of property, civil, and political rights that inform citizens of the relative importance of transgressions against the autonomy and property of others.5 A free society is only possible if each person understands and consents to the purpose of the law, as well as the legal rules themselves. Ignorance about the purpose of the law is the gateway to cynicism and chaos, because the rule of law will be seen as the hammer the privileged and the powerful use against the poor and powerless. Equality before the law has a further, far-reaching demand that directly undermines the right-libertarian’s insistence that substantive economic equality is the enemy of freedom. American freedom is based on the principle of the Democratic–Republican determination of the law. The people of the nation, through their representatives, establish and enforce the rule of law to create and protect vast zones of individual freedom and initiative, against the incursions of concentrated private or public power that whittle away at a person’s desire to live life as he or she sees fit. The process of selecting, supervising and, when need be, replacing our representatives through the political process requires an intellectually acute citizenry that not only understands the Constitution that establishes the machinery of Government but, more importantly, understands the way that our economy

Real freedom versus American freedom  19 and society emerge out of our individual efforts and, in turn, is the environment in which our pursuit of happiness takes place. The ordinary business deals that are the basis of our economic lives are not just trades of money for goods, labor, and assets, but are parts of a complex web of connections that makes our shared prosperity possible. The routines of scientific investigation, based on the principles of free inquiry, free speech, and competition via the scientific method, are the basis for our ever-growing capacity to know about the physical universe and to act upon it (and to protect ourselves when it acts upon us), both building on and, in turn, enhancing our economic well-being. But our robust scientific culture depends on a system of law that protects speech and inquiry from the claims of religion and politics to forbid certain forms of knowledge. We can only understand the law once we learn the language of the law, which thus requires us to not only understand the meaning of the words of the Constitution and the language of politics but to also comprehend the human world that both defines, and is defined by, the law. Law and Government—what we called above the “scaffolding of freedom”—can only protect and expand liberty if the people understand how power works and fails to work for them, which in turn requires citizens to be very well educated, and to be capable of absorbing the new knowledge created by scientific advance and social innovation in a free society. The right-libertarian’s insistence on equal property and contract rights brings with it a powerful demand for equal political rights in our democratic republic that, in turn, requires each citizen to have an equal capacity to participate in choosing and supervising the activity of the Government, by being well informed about all aspects of our common life—particularly the areas of life affected by the use of Government power. The American principle that individuals are equally free from the coercion of others and have equal rights to own property and to participate in politics not only requires citizens to be equally capable of exercising rights, but further requires an equal opportunity to acquire these capacities through education and the basic needs of human development. Right-libertarianism completely dies once the demands of American freedom are combined with a basic fact of human life: citizens are made, not born. We are not born with knowledge of how our society works and fails, much less of the interconnections between our laws and rules, and the collective, and frequently unintended and unwelcome, consequences of our individual actions. Our capacities to act on our own behalf, in accordance with the rule of law, as well as to act as self-governing citizens competent to shape our common life through politics, is the work of parents, neighbors, and teachers over many years. In turn, our minds and hearts can only accept the lessons about the world of human understanding—from art, history, and mathematics to physics and Government—if we are granted access to decent food, housing, and

20  Real freedom versus American freedom opportunities for safe play as children; if we are protected from the threat and actuality of soul-shattering violence and most forms of illness that destroy our capacity to learn; if our parents and guardians can earn a good enough living, and are themselves sufficiently secure that they can care for us in ways that promote our well-being and therefore our capacity to be future citizens. The right-libertarian’s picture of the world ignores all of these facts of human development, particularly the basic fact that citizens are human beings whose capacities to govern themselves, to recognize and act on their interests, and to cooperate with others under the rule of law are all the end result of an ongoing cycle of care and growth, wherein adults literally tend to the growth of the young in the interests of the young. In this way the analytically consistent right-libertarian is pushed, against his or her will, to become a strong proponent of the idea that equality is the foundation for liberty. The system of liberty we have described as American freedom brings with it a very strong commitment to economic equality of the chance to develop a real equal opportunity for good schools and decent health for all children, reasonable levels of parental and guardian care, and protection against violence, as well as natural and industrial pollutants (and perhaps cultural pollution as well; the unintended but very damaging effects of materials and ideas that are intended for adults but which spill over onto the young). This is a complete disaster for the utopian rightlibertarian—the sort that pretends that Ayn Rand is something other than a monster—because he or she must bend before the developmental needs of children and find ways to engage in economic redistribution in the name of equal real freedom for all. The fact that the young must be schooled and fed and cared for if freedom is to exist, and the rule of law is to be possible, pushes the right-libertarian to be a radical egalitarian in certain matters, so much so that he or she must have complete disdain for any argument against redistribution that begins with the claim that liberty is inconsistent with any form of redistribution. To be sure, the right-libertarian is still a determined enemy of concentrated public power and therefore of Government, and will try to find ways to meet the basic requirements for the creation of citizens in a free society, without resorting to the use of public power. The worldly right-libertarian (a rare breed in this country), particularly an American who has lived in the shadow of poverty and violence in American cities, knows that a regime where a privileged class can become ever better at beating the bottom into submission will, in time, destroy itself. The use of prisons and police to manage the poor only turns the law into the enemy of the poor, thereby creating the conditions for permanent social warfare, killing off freedom in favor of control. At that point the right-libertarian has a choice: support the use of Government as a weapon that society wields against the bottom of the system, or admit that equal real freedom requires

Real freedom versus American freedom  21 a commitment to marrying some degree of economic equality with realist American liberty—a vision of liberty tempered by the realities of human development and schooled by the blood, broken bones, and shattered lives of the poor. The fight between right- and left-libertarians then gets very interesting, precisely because the rightist gives up on the defense of privilege and social hierarchy in favor of the defense of real freedom.

Notes 1 Van Parijs (1995), pp. 32f. 2 Tomasi (2013). 3 Hayek (1978b), pp. 231–233. 4 Sen (1979). Sen’s analysis points to the complicated connections between a person’s zone of authority as a matter or rights, as recognized by the law and social convention, against their capacity to convert rights into actions, developed further in his analysis of capability justice, which then requires us to make connections between capability and means. 5 Lawrence Friedman’s Crime and Punishment in America contains a brilliant history of criminal law and punishment policy in the United States since the Founding, that makes the vital point that the idea of freedom brings with it the companion idea of un-freedom and punishment. Law is not just the codification of the social contract, but also a sort of price list that shows the value of different infractions of the rules, in that way guiding the behavior of both citizens and the State. The Introduction to Friedman (1993) is worthy of careful study all by itself.

3 What do markets do?

One of the most dangerous and damaging intellectual mistakes left-leaning people make is to confuse capitalism and markets. It is easy to see how these ideas are conflated, but we must be mindful of the difference if we want to promote economic, and especially social, justice in a free society. One reason for the American public’s acceptance of the deplorable record of poverty, inequality, and suffering under capitalism is that too many on the Left believe that existing American capitalism is the only kind of capitalist market society. This belief has diminished the intellectual energy of the Left in the face of a once-triumphant Right, whose insistence that capitalism, freedom, and inequality are of a piece once induced resignation in the face of what looked like fate. So much of the modern Left’s intellectual weakness is due to its acceptance of the claim that freedom and equality are incompatible, despite an impressive body of argument and evidence to the contrary. The next two chapters present arguments about the compatibility, even the necessity, of combining markets with genuine equality, in order to shake up the Left’s economic imagination.

The market at work One of the most important lessons that economists teach is that all societies must coordinate the brains and brawn of millions of people in ways that lead to the satisfaction of as many needs as possible. Societies must find ways to produce food, shelter, medicine, clothing, culture and knowledge by using the resources of nature, as well as the power of our minds and bodies. If each of us can achieve our individual goals by making something that someone else values, we just might have our needs met. If we each become adept at performing a few tasks and trading with other people to get what we need, then we are collectively better-off than we would be if we had to make everything we needed by ourselves. A market economy is just a system of trades between people who try to produce as much as they can at the lowest

What do markets do?  23 cost possible. Competition between rival producers in any field forces each seller to cut costs, by working smarter or finding cheaper materials or locations, or moving to a new field of endeavor. Success in the market means giving buyers what they want at a price that they are willing to pay. Failure comes when players do not meet the needs of others at a price that permits producers to meet their own needs or even survive. There is an important sense in which economics is the study of the material consequences of a particular idea of liberal freedom, based on the claim that a wise and just society understands how freedom and prosperity are connected. This insight was first outlined clearly by Adam Smith’s argument for markets in his classic The Wealth of Nations: that long, wordy, yet shrewd and subtle tome, which demonstrated how individual self-interest can result in societal wealth and the end of mass poverty.1 Much of the history of economics is a fierce debate about the material consequences of freedom of choice in work and play, when ordinary men and women own themselves and their property. The evidence in favor of markets is overwhelming: societies which permit competition, selfinterest, and individual initiative to operate over a wide range of activities can become wealthy communities, offering their members a rich array of opportunities for well-being.2 Economists try to understand the mechanics of this tendency by developing “models” of the underlying processes— analytical and mathematical descriptions of the essential features of a market society that result in prosperity—to find a recipe for how a people can escape mass poverty through self-interest and markets. Markets and knowledge The creativity and energy of self-interest that is a market economy is a dense, highly adaptable web of relationships between people that responds to changes in the public’s needs or wants, expressed in the form of prices. One of the most penetrating analyses of the role of prices and markets in turning the seemingly divided and separate decisions of millions of selfcentered men and women into a sensitive mechanism that meets human needs is that of Nobel laureate Friedrich Hayek, whose work on markets and liberty forms a crucial part of the modern right-libertarian critique of government in general and of socialism in particular.3 Hayek’s big point is that markets create and distribute knowledge in ways that solve the most pressing practical problems in society. For example, a software manufacturer has no idea who needs the company’s existing line of products, much less who might benefit from the company’s development skills. Further, the vast majority of software users have no idea how the software that they use works, but rely on manuals telling them how to get

24  What do markets do? things done. Yet, (most) software firms make sure that their customers have sophisticated software and good instructions at their fingertips. Computer users do not need to know how their machines or software works, nor how to write new programs or fix flaws that may plague existing programs, because software firms have powerful incentives to meet customer needs. All customers need to do to get a software firm’s attention is purchase a copy of an existing product, or hire the firm to develop a new product, or even hire a rival firm. Complex, abstract knowledge dispersed across a number of different people, regions, nations, and cultures is recruited to solve the practical problems of particular people through markets, because prices place a value on the tasks to be performed. A complex market economy is a network of fragmented and dispersed knowledge and skills that can nonetheless deliver the relevant information to particular places at specific times—including the creation of new technologies and new forms of knowledge—because otherwise unconnected people can get what they need by virtue of the profit motive, which will mobilize talent, knowledge, and resources to solve problems, so long as all parties to the transaction have something to gain. Hayek’s analysis vindicates the much maligned profit motive as an essential aspect of creating and disseminating knowledge in society. This point is distinct from, but related to, Smith’s point in The Wealth of Nations, about how the pursuit of wealth motivates otherwise self-interested men and women to serve the needs of their neighbors. Our software maker provides products and services that solve other people’s problems, because that is how to make money, not because of any special interest in the particular problems. However, software makers have to know what kinds of skills and knowledge to bring to bear on new problems that may be beyond their own experience. Hayek’s point is that a market society, where goods and services are allocated in response to prices and profits, will not only meet existing needs, but will also encourage individuals to search for ways to respond to new needs, or to change more generally.4 The upshot of all of this is that liberty is both a means and an end in itself. Nobel laureate Amartya Sen—a leading light of the intellectually vibrant portion of the Left—has succinctly summarized the case for markets and, to a large extent, capitalism. Freedom is the point of all economic activity, since the capacity to live in accord with one’s own values and interests depends on the extent to which we can each get what we need. But freedom is also a means of economic activity, because self-interest is a powerful motor that drives the growth of wealth.5 Societies get rich, sooner or later, when individuals develop and use their talents in ways that promote their own well-being by engaging in mutually beneficial exchanges with others, in vigorous competition with rivals, thereby forcing everyone to do their best. The independence of each person is therefore a prerequisite for

What do markets do?  25 competition and development, since buyers and sellers must be able to pursue their own ideas of what they want, or what they want to do, without interference from powerful social majorities or political authorities, who would dismiss the tastes and knowledge of particular participants in favor of external criteria. Indeed, one of Hayek’s most subtle but crucial points is that a market society creates and disseminates knowledge by encouraging a diverse population, dispersed over a wide physical, cultural, and social landscape, to share information, because everyone can benefit from the exchange. A professor of physics shares their knowledge of the physical world with their students, who then go forth and share this knowledge with their customers and clients in a distant part of the nation or the planet, because each person’s material well-being is enhanced in the process. Private property is an essential part of this process of knowledge creation and information exchange, because each person has the means to carry out his or her plans without the need to seek the permission of others. The intellectual whose unpopular ideas eventually become conventional wisdom is better able to resist criticism when he or she can make a living without needing the approval religious or Government authorities charged with protecting the community’s official morality. An innovative entrepreneur is better able to bring a new product or service to the market when he or she can use their own wealth to build a business organization that can compete for the dollars of buyers. Most importantly, a political and social radical or outcast can survive the scorn and disdain of the majority when he or she has an independent source of support, either by working for those who care less about deviant opinions and more about competence and performance, or by virtue of having money in the bank. In each of these cases, independence from the group requires that individuals have some way to earn a living that allows them to pursue their own ideas, without having to surrender to the will of the majority. Private property is, in this sense, an essential precondition for the existence of substantive liberty, because it provides each person with the means to carry out their plans. A Hayekian Left? Hayek’s analysis of knowledge and markets is part of a critique of the oncepopular socialist claim that eliminating private property and competitive markets in favor of Government planning and income redistribution could produce a just society. Hayek’s central point is that no government could ever know enough about people’s tastes, talents, ideas, or needs to substitute the judgment of a set of distant experts for the specific and local insights of self-interested people. One cannot simply replace the activity of millions of buyers and sellers in competitive markets with a Government bureau

26  What do markets do? that would take over producing goods and services with existing technologies, while distributing income and products on the basis of need, or some criteria of justice. How would technology advance in the absence of competition, where innovation is rewarded with riches and lethargy is punished by losses? How would buyers make their needs known without signaling their needs through their buying decisions? How would workers and managers know whether they were doing a good or bad job without earning high incomes when they satisfy customers, or facing low incomes and unemployment when they fail? The economic bounty of modern capitalism, according to Hayek, is the unintended consequence of millions of men and women creating technologies, organizations, and products to satisfy the evolving needs of buyers, who are also workers that create wealth through their labor. The socialist dream of a society— where, according to Marx’s famous aphorism, “from each according to his ability, to each according to his need”6—is an impossibility in Hayek’s eyes, precisely because knowledge and work can only happen if people directly receive the material benefits from cooperation on the basis of individual liberty. By this argument, the traditional idea of socialism, as the collective ownership of the means of production, fails because it assumes away the most pressing problem in any society: how to get an irreducibly diverse population to cooperate with each other in ways that promote the growth of wealth while respecting each person’s liberty. If people are not free to do what they want to do, then there will not be any wealth for a government to redistribute. Hayek’s insight has gradually become the accepted wisdom of a large part of the analytical Left, which has fully acknowledged that there is no viable alternative to markets, or to private property, as basic building blocks for a modern economy.7 The collapse of State socialism has been a powerful force for eliminating daydreams about Government owning and running the economy in the interests of the citizenry, quite apart from the obvious horrors that come when Government control of economic life is matched with the Governmental monopoly on the means of violence. Yet, the Left’s acceptance of Hayek’s insights concerning the weaknesses of State socialism and the powerful role of incentives in economic life is not a vindication of capitalism per se, much less contemporary American capitalism. To say that competitive markets create wealth by coordinating the activities of millions of independent people in no way overlooks the avoidable brutality and unfairness of private enterprise economies. Nor does the recognition of the market system’s virtues compensate for the fact that competition and innovation are also sources of profound social and economic inequality, unemployment, unnecessary suffering and environmental degradation. There is a powerful case against American capitalism in its current form,

What do markets do?  27 and in favor of better forms of both markets and capitalism, that can achieve most of the Left’s goals of a free and fair society. However, all members of the liberal Left who want social justice are in Hayek’s debt for showing why markets, and even capitalism, can be essential tools for the development of liberty and equality.

The case against raw capitalism Hayek’s insight into the strength of markets is all too frequently and wrongly used to argue that raw, unregulated capitalism is the best form of capitalism, or at any rate, the only form consistent with maximum individual freedom. Hayek is especially prone to make this extreme claim, which is why so many on the Left have ignored the wisdom that is buried in his work.8 We will return to this point a bit later. One of the benefits of a leftist interpretation of Hayek’s main point is that we can retain the idea that markets are powerful but far-from-perfect devices to promote development, while dispensing with the flatly wrong claim that extreme forms of capitalism along the American model are the only way to protect liberty. Hayek’s subtle argument in favor of markets cannot overcome what most economists know: markets are unreliable. The most important market in an economy, the labor market, is lousy at matching jobs and workers. Labor markets are supposed to establish the price of labor, wages, on the basis of competition between employers and workers, so that the demand for workers is roughly equal to the number of people seeking work. In an ideal world, unemployment is a temporary condition that is corrected by wages rising or falling to erase the gap between jobs and workers. If the market for labor worked like the idealized bargaining arena of textbook lore, the only persistently “unemployed” persons in an economy would be those people who choose against work because wages are too low relative to the value of other uses of their time, like child care or the pleasure of nonwork, or even the financial returns from criminal activity. Of course, this picture of the labor market assumes that the unemployed have a viable alternative, including a source of support aside from work. People without property, aside from their capacity to work for others, are in no position to leave the labor market when wages are very low, but are all too frequently inclined to seek out more than one job—whether legal or not—in order to support themselves and their families. But relying on wages to establish a balance between jobs and workers, or, in the language of economists, to “clear” the labor market, ignores the fact that wages are both a cost to businesses and the primary source of income for the vast majority of workers. The typical economics student learns that individual enterprises hire more workers when wages fall, because lower

28  What do markets do? costs will lead to higher profits, thereby boosting a firm’s incentive to take on more workers in anticipation of selling a greater volume of goods at lower prices. However, lower wages also mean that workers earn lower incomes, with the consequence that men and women face a fall in their buying power. Even worse, the children of workers who face falling wages are often affected by their parents’ bad fortune when they become adults, because low incomes block access to decent schooling, health care, or housing. The labor market not only allocates labor to different uses across the economy, but also distributes opportunity to the goods and services that future generations need to survive and develop, thereby creating tight links between the economic fortunes of parents and their children. Raw capitalism’s capacity to create wealth through competition and profit is matched by its tendency to distribute the bounty of cooperation in ways that undermine the well-being of populations with the bad luck to be born without skills or valuable property. The links among income, wealth, and opportunities for individual development are largely the result of accidents of birth and history that have no moral legitimacy. At best, the institutions of private property and inheritance promote economic development by providing incentives for saving and risk-taking, thereby spurring greater rates of business development and innovation. However, the economic and political inequalities associated with private property and inherited wealth count heavily against capitalism. In the absence of public policies to weaken the hold of class on the fortunes of the young, morally indefensible economic and social inequalities will be passed from generation to generation, thereby conferring unearned privileges to some parts of the population and unearned burdens upon others. The Left’s attack on raw capitalism, and on markets as a whole, is based on the observation that the labor market is inconsistent with the needs of the working majority, who must rely on work to make a living. In the early and middle periods of industrial capitalism, during the nineteenth and early twentieth centuries in the United States, the vast majority of workers had few alternatives other than to either work in newly emerging industrial cities, or to cling to agricultural life at a time when the growth in the productive power of farm labor reduced the need for farm labor. The growing capacity of farmers to produce more food on each acre of land, or more livestock per bushel of feed, meant that the supply of food grew by leaps and bounds relative to the demand for food, thereby putting downward pressure on food prices, which only intensified the drive for greater productivity in agriculture. Those farmers and rural workers who could not survive the decline in agricultural prices were forced to abandon the land and move to the cities and industrial towns in search of work. Most industrial work required little by way of formal schooling, and even those jobs that did require some degree of literacy

What do markets do?  29 and numeracy were easily filled by the vast army of workers, both from the American hinterland and those arriving from Europe during the great migrations of the late 1800s and early 1900s. The Left’s critique of raw capitalism under these conditions denounces society’s reliance on the market mechanism in the face of a vast supply of unskilled labor. Contemporary knowledge- and trade-driven capitalism might seem a far cry from this picture of masses of poor workers crowded into industrial cities by the relentless push of peasants from the farms to the factories under the pressure of growing productivity. Yet, a moment’s reflection on why markets do not and cannot work well shows that the Left’s critique of raw capitalism is of even greater contemporary relevance. Market failure The term “market failure” is a bit misleading because it suggests that economic problems happen when markets do not work as they should. Indeed, economists mimic physicists by comparing the real world, where “market failure” is everywhere, to an ideal world where markets work perfectly— according to the law of supply and demand—just as physicists compare the friction-filled world we live in to a frictionless one. Although this is a very helpful teaching device, it sometimes suggests that there can be an economy where markets work, when, in fact, markets generally do not and cannot “work” in the way suggested by the textbooks and by the utopians of the libertarian Right. A key problem with the market system is that prices are frequently not “right,” in the specific sense that prices do not and cannot carry out the information function that the Hayekian visions for a capitalist society requires. Economic theory has long noted that though the Hayekian critique of traditional socialism is right, the insistence that unchecked capitalism leads to the best of all possible worlds is a fantasy, because prices cannot coordinate the activities of millions of self-seeking people in the most effective ways. Incentives and information Efficiency wages One especially important and ubiquitous form of market failure, or better coordination failure,9 is due to the fact that many economic transactions are marred by the problem that either buyers or sellers, or both, must make decisions without all of the relevant information, thereby turning an ordinary purchase into a lottery that might have life-altering consequences. In particular, prices are frequently “wrong” in the specific sense that the deals

30  What do markets do? people make are so flawed and destructive that economic well-being is harmed on a vast scale. For instance, an ordinary hiring decision is often an investment decision because employers spend time, effort, and money training a new employee, as well as integrating them into the work force. Employers garner information about a potential employee through interviews, resumes, references from past employers and teachers, to determine if they will be worth more than their wage. Once someone is hired, trained, and put to work, employers want to keep an employee long enough that their investment pays off; the last thing an employer wants to do is train and develop workers only to have that person leave to work for someone else. Further, an employer has to design jobs to entice employees to make the organization’s goals their own, thereby encouraging greater cooperation. Employers and employees are entangled in a principal–agent relationship in the parlance of economists: both employers and employees have interests that partly mesh and partly conflict. And though the employer controls the pay and promotion prospects of the employee, the employee actually does the work that, if successful, will redound to the benefit of the employer. One especially effective method that employers use to align workers interests with those of managers is to pay an “efficiency wage” or “incentive wage” that rewards effort by giving employees something to lose if they slack off. This efficiency wage works because employers will usually pay good workers a premium over what they could get in other enterprises, in order to keep them on the job and working at peak efficiency. For instance, how can a law firm or financial enterprise be fairly sure that lawyers and analysts will keep secrets when their activities cannot be monitored very well? Pay them a premium to keep their mouths shut and their minds on their business, which in and of itself gives employees something to lose. Since most work in most industries is never under the complete control of managers because the costs of supervising labor are high, smart employers make a point of paying experienced workers enough of a premium to ensure worker loyalty and peak performance. The portrait we have just painted of the labor contract is a far cry from the fantasy portrait that fills so many textbooks and, unfortunately, the minds of politicians and the public. As noted before, the textbook law of supply and demand suggests that enterprises will hire more workers when wages are low and vice versa, with the consequence that persistent unemployment in an economy happens when wages do not fall enough to encourage firms to hire more workers in the face of an otherwise temporary fall off in job offerings. Indeed, one of the most oft-repeated arguments against minimum wages is that this move kills jobs by preventing wages from falling in situations of unemployment, thus blocking a decline in labor costs that could

What do markets do?  31 boost the profitability of employing more people. But the phenomenon of efficiency wages, in theory and practice, means that employers will generally not cut wages in situations of unemployment because lower wages will reduce labor effort, as well as encourage the most effective employees to seek jobs elsewhere. Businesses have very little incentive to cut wages and hire seemingly cheap labor from the pool of unemployed people because the costs of training new workers may be high and firms need to pay workers a premium in order to elicit high levels of effort and loyalty. This analysis of efficiency wages means that the law of supply and demand cannot work in job markets in the way textbooks and right-libertarian utopians suggest because of the problems of risk, information, and effort that are inherent in any workplace. One of the best-known phenomena in economics—that wages do not generally decline in periods of substantial unemployment— occurs because wage cuts are actually too costly compared to maintaining the status quo.10 Mass unemployment The upshot of the idea and reality of efficiency wages is that wages cannot balance the supply and demand for labor, with the consequence that unemployment is a regular feature of a market economy. However, mass unemployment of the sort that occurs during every major recession, and especially the large-scale unemployment associated with financial crises like the Great Recession, or better, Little Depression of 2007–2009, happens when the demand for labor collapses in the system as a whole. The basic idea of the multiplier from Economics 101, brought into economics by John Maynard Keynes’ The General Theory of Employment, Interest and Money, tells us how this process works. Every purchase by one person is necessarily another person’s sale. In turn, any person’s spending is financed in one of two ways: (1) either by income earned through work, or the sale of something to someone else; or (2) by using money saved up in the past. Note that using money from savings can mean that I use my own savings to buy what I want, thereby drawing down my own wealth, or I use someone else’s savings, thereby borrowing that person’s savings on the promise of repaying those debts later. The volume of spending in an economy at any point in time must depend on: (1) the income workers and owners earn by making and selling goods and services to each other; and (2) the amount of borrowing the buyers do to buy goods now, on the promise of repaying debts later. Since spending is the source of income and is based on either earnings or borrowing and lending, the number of jobs in an economy at any point is due to people spending money they earned in the recent past, or money

32  What do markets do? (their own or others’) earned in the more distant past, and kept in the form of savings or some other form of wealth. But the idea is that current spending depends on past income, or borrowing means that current spending and therefore current employment depends on past employment and borrowing: people have jobs this month because most of them had jobs last month (that is one source of their spending power), and some of them (perhaps most of them) can also borrow and spend more than they earn now because they expect to have jobs next month, so that they can repay their debts. In turn, most people can only spend if they earn income from work, which means most of us have a job because someone else can spend because they also have a job, or can borrow from someone else. The source of mass unemployment is quite clear: a drastic decline in spending in an economy will lead to further jobs cuts because of the links between current and past employment. For instance, the enormous US housing boom from 2002 through 2007 was a primary source of job growth and economic well-being for Americans as a whole, because homeowners and contractors borrowed enormous sums of money to buy and build homes, which in turn led to the creation of millions of jobs in every area of the system. In turn, the collapse of the financial system from 2007 onward led to a collapse in employment, because less lending means less spending, which in turn generates an extended cycle of declining spending and further job losses that spread throughout the system. But this makes banking and finance the erratic heart of a capitalist society: if just the right types and scale of borrowing, lending and therefore spending are taking place, then employment can rise at just the right pace so that new workers can find jobs, incumbent workers can advance in their careers, and business people have every incentive to hire and promote workers. However, if the banking and financial systems push out too many loans, and buyers borrow more than they can repay, then an economy will experience a cycle of boom and bust. Overextended borrowers become debt-crippled borrowers, who are unable to repay loans, in turn leading to bank failures and a general collapse of lending, spending, and employment. Unregulated capitalist economies favored by right-libertarians and conservatives are doomed to cycles of boom and bust.11 Bankers and Wall Street traders will and must, in the rational pursuit of profit, invariably end up lending too much to the wrong people, whose subsequent failure to repay loans will, in turn, cripple lenders and create cascades of joblessness, bankruptcy, and suffering. Again, mass unemployment is the awful stepchild of unregulated self-interest. One of the greatest intellectual and moral scandals facing economists, especially American economists and those who pay their salaries, is that the sources of mass unemployment have been well known for a very long

What do markets do?  33 time, but were deliberately ignored in favor of a free market fairy tale that counseled governmental and social indifference to the sea of joblessness that engulfed the US after the mini-Depression of 2007–2009. A whole generation of academic economists at our finest universities, including Nobel laureates, taught each other and the world that mass unemployment was not a regular feature of capitalist life, because free markets cannot generate vast joblessness, since anyone who wants a job can find a job if they are willing to work for a low enough wage, and if the Government does not prevent wages from falling. This line of thinking claimed that Government regulations tend to keep wages too high, thereby reducing the profitability of employing workers and, not surprisingly, resulting in lots of jobless adults. Indeed, one very well respected scholar even claims to show that the long echo of the 2007–2009 crash, in terms of long-term unemployment well past 2010 and later, is because generous social benefits mean that the unemployed have an alternative to working when times are tough.12 Worse, other forms of Government interference end up pushing banks to lend too much money to the wrong people, thereby precipitating financial booms and busts that lead to the collapse of spending and mass joblessness, which is then made worse by the fact that regulations dissuade business people from hiring the unemployed. In other words, the Devil of Government is the source of mass unemployment! Risk and insurance Protection against risk is, like all things in economic life, a cost of doing business. Unsafe products and dwellings, incompetent medical care, unreliable accounting information, or tainted food are cheap relative to clean and safe goods and services, both because the poor will be outbid by their better-off counterparts for these goods and because, as noted, safety is costly. Further, so many goods and services in the modern world are technically complex, designed and produced by specialized skilled workers using sophisticated procedures. Most buyers have little if any of the technical knowledge required to judge the quality or reliability of the goods or services, whereas the accidents or malfunctions associated with the use of complex goods can inflict considerable injury or even death on their user. Though consumers can be trusted to evaluate the risks and rewards associated with goods or services that are easily understood, or where information is readily available and relatively inexpensive, customer ignorance or catastrophic loss, if things go wrong, are serious problems that markets cannot usually handle. The market failure here is that information is expensive, perhaps so expensive that many buyers are unable to know the true risks associated

34  What do markets do? with their purchases. Of course, the free market solution to this problem is for private agents to collect and sell information to consumers, thereby permitting buyers to make informed choices based on an accurate assessment of the relevant risks. Those information specialists who do a good job of supplying accurate information will develop a loyal customer base that can make competent decisions, whereas specialists who make mistakes or lie will gradually lose business by virtue of their bad record. Yet, many buyers cannot afford the services of the most reliable information specialists for the same reason that poor people frequently end up with rotten food in urban markets: good information, like fresh food, is costly, whereas bad information and bad food are cheap. Economists divide the problem of information into two overlapping categories that go by the unlovely names of “adverse selection” and “moral hazard.” Adverse selection is the problem of inadequate or inaccurate information that leads to bad choices, while moral hazard is the perverse situation where people make risky choices because they are protected from the consequences of their actions. Problems with health insurance are a classic example of adverse selection. Sick people have an incentive to downplay the extent of their physical problems in order to get coverage; at the same time, insurers are wary of covering the sick because they are expensive and unprofitable. Health insurers deal with the problem of choosing high-cost clients by spending money and time to divide potential clients into low- and high-cost groups, and discriminate against those groups with a high chance of generating high claims. The flip side of health insurance, or most other types of insurance, is that people who are protected from risky situations may behave as if risk has disappeared, thereby taking fewer precautions and engaging in increasingly risky behavior. Of course, the problems of adverse selection and moral hazard lead to the perverse situation where insurers are very happy to insure people who do not need insurance—because they are low-cost populations that will not make claims—but turn away people who face lots of risk and need protection. Left to themselves, markets for very important forms of insurance would dwindle or even disappear because the people who need insurance are either too expensive for companies to provide protection for, or are too poor to afford the proper degree of protection, whereas the low-cost populations that insurers desire have little reason to buy much insurance because they do not need (or at least think they don’t need) protection. But insurance markets are never left to themselves for the simple reason that an economy cannot function well (or at all) without insurance against risk. Imagine a world where homeowners cannot buy insurance to protect themselves against the many and varied risks associated with living in a home bought with money borrowed from banks. Or consider a world where

What do markets do?  35 health insurance does not exist for any but a small population of relatively healthy and, in any case, well-off individuals and families, leaving the rest of us to fend for ourselves as best we can when we get sick. Or consider a world with very little private auto insurance so that drivers must find some other way to cover their own costs and recover damages in the event of accidents. A world with very limited homeowner insurance would see very little home building and buying, and even less mortgage lending by bankers, for the simple reason that insurance protects the loans the banks make to home buyers. A world without auto insurance would be a hellish place, where accidents would lead to endless litigation in courts clogged with competing claims by drivers disputing who was responsible for harm associated with a crash, as well as who should bear the burden of the deaths and injuries associated with those calamities. And a world without sufficient health insurance is one where millions of people would only see doctors when they were in severe distress, frequently well past the capacity of medicine to help, when earlier visits could have detected and treated conditions easily. Indeed a world with insufficient health insurance would be one where public health would be undermined, because medical professionals could not perform the surveillance function of gathering the information necessary to track the spread of disease, in that way preventing, or at least reducing, the scope of epidemics. The problems of imperfect information, adverse selection, moral hazard and efficiency wages combine to destroy the capacity of unregulated capitalism to be a self-correcting system, of the sort described by naive textbook economics and praised, at our peril, by utopian right-libertarians. No sane society can rely on property rights and the profit motive alone to generate jobs and incomes, or to provide protection against the many risks to life, health, and wealth. The trick is to find ways to overcome the fact that prices are usually “wrong,” in ways that do not introduce other and perhaps worse problems. Monopoly and Big Business Markets work best, though not well, when there are so many buyers and sellers that each person or business has a virtually unlimited number of potential customers or sources of supply. We have already noted that Hayek’s dream world of freedom in a capitalist society rests on the presumption that vigorous rivalry between sellers will push entrepreneurs to cuts their costs and improve product quality, just as fierce competition among buyers puts products in the hands of those who are willing to pay more than everyone else. The constant push and pull of the competitive marketplace is an arena of freedom precisely because buyers and sellers have such a large number of

36  What do markets do? potential partners that no one has any power over anyone else. Power in the marketplace is fragmented and disbursed among a vast number of players. Contrast this near-utopia of free choice with the dreary situation of a market dominated by a single buyer or seller, or at best a few big businesses. A single buyer—a monopsonist in the ugly parlance of economics—in a job market or a market for produce, or even medicine, has a strangle hold on the prices and incomes that sellers can earn, because suppliers have no one else to turn to. The monopsonist, like any buyer, wants to pay the lowest possible price for whatever they buy. But since sellers have no other customers willing and able to buy what they offer, they are forced to fight each other in order to complete deals with the single buyer, thereby driving the prices they charge down to a bare minimum. So a giant buyer like Walmart in the market for fresh fruit, or McDonald’s in the youth labor market, has every incentive to push suppliers to drop their prices as much as possible, pushing down the incomes of farmers and fast-food workers at the same time that the costs of goods offered by these behemoths to their own buyers can be driven down too. In the same way, a single seller in the marketplace can squeeze customers to pay a much higher price than might otherwise reign if there were a much larger number of rival sellers, each of whom could undercut the exorbitant prices that the monopolist imposes on buyers. The monopoly seller traps buyers by destroying alternative sources of supply, thereby forcing buyers to either resign themselves to high prices, or to do without the things they wish to purchase. Few of us really worry about a monopoly in frivolous items aimed at the obscenely wealthy—say designer fashions of one kind or another—because the high prices and limited supplies of the luxury goods have no bearing at all on the health and well-being of most citizens, or on the distribution of political and economic power in society. Indeed, the example of luxury goods points to a significant aspect of monopoly that is sometimes missed by the Left, and that makes us vulnerable to a shallow but still persuasive right-libertarian rebuke. A single producer of a set of glamorous (at least to some) brand-name trifles has achieved their station by snookering a portion of the public into believing that their goods are somehow better than the rest, thereby stripping the anxious, gullible, and status-obsessed of a bit of their income and wealth in exchange for . . . whatever. This “monopoly” is not a social menace because no one’s life or well-being depends on the price and availability of the particular brand of fluff, even if many hundreds of thousands of young, poor and working people waste their money on these trifles. More, the high prices, low supplies, and high profits associated with these trinkets will encourage the creation of other brands of expensive trash, as clever business people find ever-new ways to prey on the psychological weakness of fashionistas of all forms, in every area of life. The apparent “monopoly” in bling turns out to be nothing of the kind, so long as savvy

What do markets do?  37 business people can find ways to create similar sorts of brands that can siphon away customers by offering alternatives, thereby gradually diminishing the power of any one brand in the marketplace, and squeezing the profits of any single producer. But Big Business is dangerous when incumbent firms are able to stifle competition in socially important areas of economic life. For instance, a private monopoly, or cartel in water, or any other essential good or service—from medical care and housing to insurance, banking, and food—is terrible because the single seller or small groups of sellers have every reason to charge high prices and restrict supplies in the interest of maximizing profits. In each case, a monopoly or cartel in a vital good or service can pin buyers down, stripping them of income and well-being by forcing them to buy goods and services that they either must have, or can only do without at great cost to their health and quality of life. We can gain insights into the links between various forms of market failure by exploring the problem of health insurance further. The health-insurance cartel in the US, though rarely talked about in these blunt terms, has managed to undermine the well-being of tens of millions of workers and families by restricting the availability, and lifting the price of health-care coverage far beyond what is required for the provision of care. We have already noted that an unregulated health-insurance sector would fail to provide enough insurance for the population because sick people—especially the old, the poor, and those with costly chronic conditions or risky situations (many pregnant women)—are not reliable sources of profit. Health-insurance providers, whether monopolies, cartels, or competitive market participants, all face the common problem of wanting to provide insurance to profitable clients while evading high-cost people, with the nasty consequence that the logic of capitalist health insurance is that a substantial proportion of the population will by abandoned by the private market. But health-insurance cartels can drive the price of health care beyond the cost of providing health care, because no alternative sources of protection exist. The basic mathematics of probability suggests that smart insurers will offer a wide range of policies to different pools, thereby offsetting the high costs of some groups with the high profits from others—but only if insurers are forced to accept everyone who needs coverage, and if they must use their considerable mathematical and computational capacities to craft systems that have profitable populations to subsidize unprofitable groups. If private insurers are forced to provide coverage for everyone—which is the basic plan of the much reviled and deeply conservative health-care plan proposed by and implemented under Governor Mitt Romney in the state of Massachusetts and later proposed by and implemented under President Barack Obama (at great political cost to the latter)—Government carefully

38  What do markets do? designs the marketplace for insurance because the private market would, if left to itself, fail. The point of the program is to force members of the cartel to compete with each other by requiring all companies to sell insurance to everyone who can afford to pay, while using the Government’s power to tax, as well as companies’ considerable skill in setting prices, to subsidize buyers whose incomes would otherwise be too low to purchase coverage. Of course, the cartelization of the health-insurance market allows a few large enterprises to resist Government’s efforts to design a better and fairer insurance marketplace. A few players—owned primarily by a very small coterie of very rich individuals and families—pool a portion of the profits they derive from their dominant position to purchase politics (hence the curious and quite vociferous “conservative” opposition to a market-friendly, health-insurance reform that guarantees insurers a much larger customer base), and to derail the reform of health-insurance markets. Indeed, monopoly buyers and sellers in every sector of the economy have incentives to use their power and profits to prevent competitors from challenging their position in the marketplace, thereby turning markets into semi-permanent fiefdoms. Big incumbent firms might, in a popular right-wing fairy tale, protect their dominance of markets by continually pushing the frontiers of technology, customer service, and workplace management, thereby blocking their competitors by making better and cheaper products and, at the same time, improve job quality and worker productivity. However, this sort of forward-looking and progressive strategy is unlikely to be favored by most monopolists, precisely because the point of dominating a market is to extract maximum profits at the least cost, for the longest period of time. If progressive business practices are the most effective means of maintaining market dominance, then there would be little reason for any economist to complain about the economic costs of monopoly and monopsony, since Big Business would constantly find ways to make more and better goods and services at ever lower prices, while creating a wider array of better jobs at higher pay for workers who, in turn, are so grateful for their excellent work situations that they work harder and better. Alas, these sorts of business practices only make sense in sectors where innovation in design, technology, and services is the lifeblood of the marketplace: the knowledgeintensive sectors, where highly educated and technology-savvy buyers and sellers solve difficult problems in areas as diverse as computer design, biotechnology, and very complex financial and insurance services. But most of us will never benefit from the activity of a progressive single buyer and seller, whose market dominance just happens to make our lives better. In the real world, a single buyer or seller, as well as buyer and seller cartels, will squeeze money from buyers, as well as crush the prices and profits of their suppliers, in order to maximize the profits of their shareholders.

What do markets do?  39 This sort of economic exploitation can be dressed up in a number of ways: modern advertising is a marvelous arena for experiments in private-sector propaganda that sweetens up the foul smell of domination and abuse in the economy. And these advertising techniques are bleeding over into the art of propaganda we politely refer to as “political campaigns” and “the news.” Still, the consequences of concentrated private power in the marketplace are what they are: buyers are robbed, small business is crushed, and the bounty from domination can be used in all sorts of nasty ways, from blocking competition to buying politics. In turn, concentrated private power in markets not only undermines democracy by granting cartels the capacity to purchase and destroy democratic politics, but actually recruits the unorganized portions of society—the customers and suppliers who are the frontline victims of buyer and seller cartels—to participate in their own oppression and abuse. Consider this bitter but ordinary example: working-class customers of a powerful Big Business, say Walmart in a small depressed town like Salisbury, Maryland, have far more access to all sorts of goods and services than they otherwise might have, because Walmart can drive down the prices it pays to its suppliers, which allows the company to sell cheaply. Of course, Walmart earns a handsome profit despite its low prices, because it is also able to drive out many alternative sources of supply in small towns like Salisbury, thereby effectively using its power as a larger buyer to create power for itself as a dominant seller. These buyers are in the sad position of buying from a company owned by a family that finances conservative politicians with an agenda downplaying worker and consumer rights, as well as policies promoting genuine equal educational opportunity for all, thereby making life harder for people of modest means. Of course, any company owned by politically active and conservative American shareholders will finance a policy regime that attacks the lives and well-being of working-class people. However, these sorts of companies in a competitive industry would find it hard to earn the favor of their customers, who would naturally refrain from spending money in enterprises whose owners support policies that tend to destroy the lives and fortunes of their customers. Yet, the cartelization of American life makes it impossible for abused people to escape financing their own oppression, thereby turning the marketplace into one more whip cutting into their well-being.

Joining the debate Our brief explorations of market failure show that unregulated capitalism is a dangerous form of economic life that threatens the well-being of ordinary citizens. Yet, our indictment of capitalism cannot dodge the powerful

40  What do markets do? intellectual response of the rational right, represented by Hayek and others considered in Chapter 4, who do not deny that free markets can be a menace to the well-being of millions, but instead claim that the usual left-liberal remedies to the disasters visited on the people by capitalism are far worse than the very real suffering imposed by the barely constrained American market system. Their argument is that the demand for safety in the face of capitalism’s many disasters will only make our economic problems worse, and perhaps kill off liberty too. Our sophisticated right-libertarian adversaries (alas, too few in number) do not call on us to deny the permanent misery that capitalism delivers to some—the poor, racial outcasts, and ordinary working people—but to instead to face up to the fact that life is hard, that there are no easy or effective ways to protect ourselves from suffering, and that a stoic’s insistence on personal responsibility and dignity in the face of unavoidable and necessary pain is the only respectable path for free people. The rational right does not engage in the revolting spectacle of denial and racist calumny against the victims of the system so popular among members of the contemporary American “conservative” movement, but instead demands a clear-eyed understanding of the necessity of suffering born by the poor and working folks among us. Of course, one cannot help but note how those who do not suffer insist on the nobility of suffering borne by others. In any case, the fight between left- and right-libertarianism is over whether, and to what extent, economic suffering is required in a free society, as well as who is best equipped to bear these burdens while preserving and promoting human dignity.

Notes   1 Smith (1994).   2 Daron Acemoglu and James Robinson’s Why Nations Fail: The Origins of Power, Prosperity and Poverty (2013) is an excellent account of how the institutions of the rule of law, sensible forms of limited government, self-interest and competition combine to generate wealth and overcome mass poverty, as well as a warning of how concentrated private as well as public power can undermine prosperity.   3 Hayek (1978b), pp. 231–233.   4 One of Hayek’s most concise yet complete discussions of these points is “The Use of Knowledge in Society” (1945); a short and dense meditation on the role of prices and competition in channeling economic resources to their best uses in an evolving society. This article, though more than 70 years old and sadly neglected by a generation of technically trained economists who value mathematical and statistical approaches over literary analyses, still repays study by mathematically oriented economic theorists and curious non-specialists alike.   5 Sen’s Development as Freedom (2000) is a masterful summary of his lifelong analysis of the connections among development, equality, and liberty. Chapters 1 and 2 of Development as Freedom—“The Perspective of Freedom” and

What do markets do?  41 “The Ends and Means of Development”—explore the necessary links among freedom, equality, and prosperity, thereby equipping the Left to respond sensibly to the challenge of the Right after the demise of socialism. Sen’s book makes use of both Smith’s and Hayek’s understanding of the power of markets to make a powerful anticonservative point about free societies: a viable liberal order must promote its members’ capability to realize their legitimate life plans, through participating in markets and politics. The capacity to compete, in turn, has a material foundation that cannot be set aside in the interest of an abstract concept of liberty that ignores the fact that the freedom to act, trade, produce and think requires that the most basic human needs of all be met, as part of the regular metabolism of economic life.   6 Marx (1938), Critique of the Gotha Programme, Part I.   7 Roemer (1994).   8 For instance, Hayek’s The Constitution of Liberty (1978b) is a smart attack on the welfare state that presents a powerful but flawed challenge to the Left and Right alike. The book presents a comprehensive argument about why the rule of law in a free market society is superior to the use of public power to pursue the objective of “social justice” and social protection. While The Constitution of Liberty is, in many ways, a far subtler and sadder defense of the right-libertarian position than Milton Friedman’s far more popular Capitalism and Freedom, Hayek’s work overstates the extent to which the use of public power in the interest of redistribution and the regulation of markets is the first step on the (very) slippery slope to the gulag. It is important to note that Hayek’s argument has nothing in common with the racism, nationalism, and homophobia of American conservatism. For example, an addendum to The Constitution of Liberty, “Why I am not a Conservative?” elegantly rehearses the right-libertarian argument against theocracy, social conservatism, and any other marriage of public power and religious authority. Hayek’s argument is a strong rebuke to any social movement—racial, religious, ethical—that seeks to use public power to promote its claims, precisely because concentrated public power will invariably benefit some persons and identities at the cost of the lives of outcasts and freedom as a whole.   9 Bowles (2012), pp. 2f. 10 Bewley (2002). 11 Minsky (2008) and Kindleberger and Aliber (2011). 12 This truly incredible idea is fully developed in Mulligan’s The Redistribution Recession: How Labor Market Distortions Contracted the Economy (2012), complete with a sophisticated theoretical and econometric analysis that purports to show why social generosity keeps economies from recovering after recessions. Of course, the theoretical apparatus the Mulligan uses has the unfortunate implication that recessions and depressions cannot happen in the first place, but that detail does not seem to hinder the author’s determination to show that the problems of a weak recovery are, once again, due to the law of unintended consequences—where liberal do-gooders make matters worse than they might otherwise be if we all just left the free market alone.

4 Taking conservative capitalism seriously

The Chicago School The rational Right’s two-part response to the Left’s indictment of capitalism is simple and almost perfectly devastating. By rational Right we mean a diverse collection of scientifically minded classical liberals who favor individual liberty on Hayekian lines. The dangerous coalition of racists, theocrats, fascists, and other horribles comprising the political Right are banned from these pages. The rational Right has crafted a set of ideas to meet the challenges that modern life and the Left have posed to the reign of unregulated capitalism and nearly unlimited property rights. This tendency in economics over the past 40 years is ably represented by a brilliant set of intellectuals and Nobel laureates centered around the economics department at the University of Chicago, usually referred to as (unsurprisingly) “the Chicago School.” Leftists should always remember that the many intellectual achievements of the Chicago School cannot, and should not, be treated as crude apologies for the inequality and brutality of contemporary capitalism. A great deal of the writing of the Chicago School combines subtle analyses of the logic of markets and Government policies with an uncompromising commitment to the sovereignty of the individual in economic and political life, giving the works of these thinkers a distinctly right-libertarian flavor at odds with a substantial portion of populist “conservatism.” The Chicago Nobel laureates—Milton Friedman, George Stigler, Robert Lucas, and especially Gary Becker—have contributed important ideas to economics and social policy that have provided conservatives with an analytically rigorous, if ultimately flawed, political economy that has been the intellectual architecture of center-right governments at home and abroad over the past 40 years.

In defense of capitalism Economists of the rational Right would yawn at the indictment of capitalism offered in Chapter 3 as an example of why reason is superior to compassion

Taking conservative capitalism seriously  43 in important areas of social policy. Would these economists be bored by the suffering resulting from the lightly regulated capitalism that the Left decries? No; intellectually acute conservative economists doubt that the problems noted by the Left are really public problems at all or, at any rate, problems that can or should be addressed by the use of Government power. The rational Right of the Chicago School, or of the caliber of Hayek, would answer the indictment of capitalism with a series of seemingly simple questions. •• •• ••

•• •• •• ••

What is an economy for? Is an economy supposed to guarantee that everyone has everything they need or want, without risk or suffering? Is everyone supposed to be equal, in the sense of earning the same level of pay, no matter what type of work they do, despite differences in the degree of difficulty or effort, risk or pain, boredom or time spent learning a trade, developing a skill, or mastering a subject? If so, how would any hard work ever get done? How is a society supposed to create all of this bounty for all of the people who need or want, in a world where nature is stingy and the creation of wealth is hard? How does a society resolve the competing claims between individuals and groups when there is only a limited amount of land, labor, and raw materials to go around at any one time? Why would anyone spend time and effort to invent new machines that can ease our labors, or boost our productive powers, if there is no extra reward for expending extra effort?

The thinkers on the rational Right answer this long list of questions by first noting that an economy in a liberal society is, in the end, a device for the protection of individual liberty from the tyranny of the mob. Private property grants each property owner a zone of authority where his or her will is sovereign, with the consequence that the use of one’s body and property are beyond the reach of anyone else, so long as others are equally free to live without interference from nosy snoops and meddlers. Individual liberty is protected when each person has an outfit of property that they can use as they see fit, so that each of us can do what we want on the basis of self-interest and mutual advantage. In such a setting, the right to property in one’s own body and mind, as well as to articles, objects, or ideas (like a corporation or a copyright) acquired in ways that respect the freedom and property of others, insures that the benefits of whatever improvements or innovations that arise from the labor or thought of the owner accrue to the owner rather than to someone else. Private-property arrangements of this sort are an essential bulwark against the tendency for majorities or powerful

44  Taking conservative capitalism seriously social groups to wipe out the liberty of others, by making it hard for social outcasts to survive except by knuckling under the whims of the powerful. The Right’s nearly devastating argument in favor of capitalism, and the basis for its critique of the ideas of the Left, is based on the insights of economics about the power of free markets to create wealth and mass prosperity. A free society, in which the vast majority of men and women have the means to live according to their own plans, is only possible if the material scarcity that is the source of so much conflict is replaced by material abundance, thereby lessening the need for people to fight in order to satisfy their needs. Liberty is a deal that a group of people make with each other in order to give each person the space to live life as they see fit. But liberty is also fragile to the extent that mass poverty will sow the seeds of resentment and anger at those who have achieved wealth and security. The deal breaks down when desperate and jealous people try to grab whatever they can from those who have more, forcing the well-off to defend themselves against the violence of the mob. The only way to prevent the descent of society into a war of all against all—where individuals, families, tribes, and regions fight with each other to acquire what they need through an unstable mix of production and plunder—is for society to somehow arrange its affairs so that liberty can become the source of a widening circle of wealth. The argument between the Left and the rational Right boils down to a bruising battle over whether markets “work” or not. The liberal Left suggests that conservatives rely on markets to do what markets simply cannot do, thereby leading to avoidable suffering that only public action can overcome. The rational Right denies the problem of market failure by claiming that the Left doesn’t understand what markets are for. Further, the Right claims that collective action to solve “social problems” gives rise to Government failure, where public policy does the wrong thing because governments cannot fix certain problems, or are inevitably tainted by the dirt of politics, particularly by the cynical, special pleading of the so-called “victims” of capitalism.

The problem with “social justice” The rational Right insists that the protection of liberty requires the State to abstain from using public power to promote “social welfare” or “social justice.” Protecting people or institutions from the insecurity and loss associated with capitalism is a tricky business because competition, though a painful process for the losers in economic life, imposes an impartial type of social discipline, which breaks down when political claims play a role in economic matters. Part of the problem is that the losers in the struggle for riches rightly complain that they are the victims of circumstance, harmed

Taking conservative capitalism seriously  45 for reasons that may have nothing to do with their personal behavior. A low-income worker struggles to find decent housing when rents in New York or Los Angeles skyrocket because legions of young, highly educated workers from around the globe descend on those cities in search of work and excitement. Another worker loses her job because software makers develop programs that can control the process of production in her industry, rendering years of training obsolete. A third person is disgusted by the content of the Internet, especially the prevalence of pornographic images that offend his or her sense of decency. Each of these people is upset because markets are responding to changing economic circumstances in ways that reduce their well-being, while improving the well-being of others. These aggrieved people are unable to change their situation on their own, either because they are poor, or because they are only individuals with little power in a vast impersonal market. If unemployed workers, low-income renters, or offended social conservatives can persuade Government to use its power to alter market outcomes in their favor—through the provision of unemployment insurance, or rent controls, or restrictions on the distribution of pornographic materials—then Government is necessarily redistributing opportunity and resources in favor of some people and ideas at the expense of others. This is a dangerous exercise for two reasons. First, the losers in the economic struggle will make appeals to “social welfare” or “social justice” that amount to nothing more than the claim that their losses are more important than the gains of the winners. In democracies, the losers of the capitalist competition can frequently rally a sizable plurality of voters to favor politicians willing to use public power to overturn the results of free markets, even though the market outcome is the unplanned consequence of the interaction of a great many people with a range of opposing interests that were reconciled through free exchange. Second, the successful capture of Government by the economically agg­ rieved threatens liberty by undermining Government neutrality when it comes to the particular projects of different groups. Liberty requires Government to treat each of its citizens with equal respect, and to refrain from endorsing or blocking the projects of its citizens, so long as these projects do not undermine equal liberty for all. For example, Government in a free society has to be indifferent to the religious identities of the citizens in order to protect freedom of religion. Any acts that favor particular faiths, or that favor religion at all, undermine religious liberty by placing public power in the hands of the faithful at the expense of the rest of us. Similarly, Government support for the claims of unemployed workers, low-income renters, or social conservatives takes resources away from some groups for the benefit of others, thereby cutting into the principle of equal freedom for all.1

46  Taking conservative capitalism seriously This political distribution of opportunity and resources turns politics into a competition between contending social groups and classes to use Government for their narrow economic or ideological interests. Government becomes a device that the politically powerful use to garner resources for themselves at the expense of others, who in turn take whatever actions they must to defend their interests from what they see as Government-sponsored thievery. Low-income renters enlisting Government in their quest for rentcontrol gain at the expense of landlords, whose property rights have been restricted and whose rental incomes have been cut, as well as high-income renters who must now look elsewhere for housing. Social conservatives who succeed in restricting access to pornography on the Internet have achieved their goals at the expense of consumers whose freedom to view sexually oriented material has been reduced, as well as entrepreneurs who face a smaller market for their wares. The use of politics to displace markets also undermines the capacity of markets to create wealth by preventing the losers in competitive struggles from responding effectively to market signals. A low-income worker facing high rents in New York is told by markets that she should: (1) get a higher paying job if she wants to live in the City; (2) move to a lower cost part of New York, or move to New Jersey if she cannot get a better job; or (3) leave the region entirely in order to secure a better quality of life where people with her skills can have a higher standard of living. Rent control in New York causes prices to “lie” by suggesting that apartments on Manhattan are available to low-income renters when they are not. Worse, the cap on rents reduces the profitability of building and managing apartments in the City, even when a substantial number of people are willing to pay rents far in excess of the upper limit imposed by the rent-control regulations. The problem with using Government to distribute opportunity and resources is that the beneficiaries of political forms of distribution have little incentive to improve their capacity to compete in markets, whereas the victims of redistribution have substantial incentives to evade regulations and taxes. The most extreme example of this process is communism, where Government ownership and management of the economy so distorts incentives that the economic implosion of these regimes erased State socialism from the political lexicon of the Left. However, the rational Right’s key point is that the difference between the incentive effects of rent controls, on the one hand, and the State ownership and operation of all of the means of production, on the other, is a difference in degree rather than kind. A society that values freedom and economic efficiency is bound by reason and history to support capitalism and resist the political distribution of economic resources, if it seeks to create wealth and widespread opportunity.

Taking conservative capitalism seriously  47

Incentives The Right’s emphasis on the role of incentives in economic life has become a standard theme in public policy debates over how Government policy must strike the correct balance between economic efficiency and equality concerns. One unfortunate formulation of this outlook that has become a part of conventional wisdom is encapsulated in the phrase “supply-side economics,” which has become a fuzzy sort of shorthand that hides much more than it reveals. The phrase came into popular discourse during the presidential election campaign of Ronald Reagan in 1980, when his economic advisor Arthur Laffer introduced the now famous “Laffer Curve” as a convenient visual aid for showing why the tax and spending policies of the broad liberal Left had become a barrier to economic prosperity. Many economists would snigger at the claim that Arthur Laffer is an important conservative intellectual, whose influence on practical politics in the United States and beyond approaches that of Hayek, or members of the roster of Nobel Prize winners from the Chicago School. Yet, the ideas summarized by Laffer’s curve have had such a profound influence on the nation’s view of economic policy that any serious attempt to understand the challenges faced by the Left must treat this famous diagram with the respect it has earned by virtue of its popularity, if nothing else.2 Figure 4.1 presents the Laffer Curve in all its brilliant—and misleading— simplicity. The horizontal axis of the diagram represents the average incometax rate that the citizens of a nation face, whereas the vertical axis represents 4000

Output per worker

3500 A

3000 2500 2000 1500 1000 500 0 0

0.1

0.2

0.3

0.4

0.5 Tax rate

Figure 4.1  The Laffer Curve

0.6

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48  Taking conservative capitalism seriously the size of total tax revenue that the Government can expect to receive for each level of the tax rate. Note that a zero income-tax rate is associated with a zero level of tax revenue but that the income-tax take of Government rises with increases in the average tax rate that citizens face, up to a maximum tax rate (70 percent in the diagram).3 Two opposing forces determine the shape of the curve. First, higher income taxes may lead some portion of the workforce to reduce their work effort in response to lower take-home pay. In addition, the public may choose to save a smaller portion of their incomes because the after-tax rate of return to saving falls when income taxes rise, thus reducing the supply of new capital resources pumped into the economy. Second, extremely low levels of taxation are usually associated with very poor-quality public services that cripple an economy’s performance: bad roads; crowded and dilapidated schools; overwhelmed public-safety forces; crumbling transport, sewage, water and power-generation systems; as well as badly paid and low-quality public-sector workers. Increases in tax rates permit society to spend more on all of these public goods, so improving the capacity of workers and managers to get things done that the negative effect of higher taxes on work effort or saving is more than offset by higher levels of production associated with superior public services. However, a rise in the tax rate beyond 70 percent is actually associated with a decline in the total tax take, because the negative effect of higher taxes on work effort and saving more than offsets any further increases in economic efficiency associated with higher levels of public spending. Indeed, very high levels of public spending may be counterproductive, especially if some forms of public spending—welfare benefits or child-benefit payments are the usual examples cited—discourage work incentives among some segments of the population. High levels of taxation that redistribute income from the most skilled and high-earning segments of the population to far less skilled, lowwage segments will reduce the level of output for two reasons. First, highly skilled workers have reduced incentives to work in the face of lower aftertax rewards for additional effort. Second, low-income populations have less reason to work since they can get some of what they want and need without having to work for it. Of course, a 100 percent tax rate will remove all incentives for work and saving in society, since the fruits of all productive activity are confiscated by the State, reducing the population to the status of serfs, who are dependent on the benevolence of their master—Government—for whatever portion of their own creation they are permitted to enjoy. Laffer’s ingenious diagram has a very important message: intelligent public policies of any kind must pay close attention to the effect of taxing and spending on the incentives of citizens to work, save, invest or take risks. Taxes affect behavior by changing the reward for various economic activities.

Taking conservative capitalism seriously  49 Different types of government spending also affect behavior by providing access to goods and services in ways that can reduce incentives to look for work, study hard, delay childbearing (particularly among the young and poor), or save. Government actions aimed at ameliorating poverty or deprivation can actually make things worse if the negative incentive effects of taxing and spending policies are so large that the total level of economic activity actually shrinks. There is nothing particularly startling or original about the Laffer Curve’s message about the need to pay attention to the effect of Government policy on incentives. Some of the most important intellectuals of the liberal Left in the twentieth century have insisted that egalitarians be sensitive to the effect of their proposals for reform on the “supply side” of the economy. One example from among many will serve to dispel the canard that the liberal Left is hopelessly misguided because it wishes away the hard realities of incentives as it dreams of a world without inequality. The late liberal philosopher John Rawls’ Theory of Justice (1971), arguably the most important work in modern political philosophy in the second half of the twentieth century, outlined a complete analysis of the nature and scope of justice in a free society that has revolutionized the Left’s approach to capitalism and equality. One important principle that Rawls develops in Theory of Justice, that will play a leading role in the analysis of the reform of capitalism in a later section of this book, is the famous difference principle: the claim that economic inequalities in a free society are justified only so long as they are to the benefit of the least advantaged members of society.4 Rawls is careful to make the difference principle less important than what he calls the liberty principle, which requires that society be arranged so that individuals have the maximum degree of freedom consistent with equal freedom for all people.5 Indeed, the whole point of Rawls’ difference principle is to remind us that freedom, real freedom, requires men and women to have the material means to act, in addition to formal rules which protect each person from the unwarranted intrusion of public and private collectives. However, Rawls is also careful to note that there are many situations where economic inequality might benefit the least advantaged members of society, particularly when this inequality enhances economic efficiency so the poor can get a larger, though perhaps slimmer, slice of a growing economic pie. Incentives play a crucial role in Rawls’ approach to justice precisely because liberal-Left approaches to justice, like that of Rawls, as well as other thinkers considered later, are rooted squarely in a profound appreciation of the capacity of market economies to create wealth and therefore opportunity. Indeed, Rawls’ Theory of Justice was explicitly singled out by Hayek as an example of approaches to justice that are consistent with his right-libertarian view of things exactly because Rawls is careful to put

50  Taking conservative capitalism seriously liberty first (much to the surprise of everyone).6 In fact, Hayek, of all people, has endorsed the idea of a guaranteed minimum income—an idea that is anathema to the contemporary American populist Right, but one that is worth exploring in some detail as a viable and liberty-enhancing alternative to the modern welfare state—that fits nicely into new liberal-Left thinking.7 The battle between the Left and the Right over incentives is not a skirmish between people who think incentives don’t matter and people who think that they matter a lot: no one with a brain and some basic economic literacy doubts that incentives matter. The tough question is this: how much do incentives matter? The Laffer Curve suggests that incentives are so important that even seemingly modest tax rates wipe out work, saving, and risk taking, thereby rendering Government policy to improve well-being counterproductive. Many on the Left doubt that contemporary tax and spending policies have run into this incentive barrier, accusing the rational Right of overstating the extent to which people in the economy are sensitive to taxes or to welfare benefits, in order to bolster their case for low taxes and very limited Government involvement in economic affairs. The rational Right has one more argument in favor of capitalism that matters a great deal in a diverse society, particularly one with a long and disgraceful history of racial oppression and antagonism like the United States. If we believe that human beings are ultimately self-seeking creatures who will pursue their own interests with great passion and energy—including the interests of their own families, tribes, clans and religious communities— then one of the great problems that any society faces is how to harness these energies in ways that promote the well-being of the majority of the people at the smallest cost, in terms of violence. This is a very tough problem in very diverse societies comprised of individuals and groups with antagonistic beliefs, and perhaps lethal hatreds. A market system can encourage cooperation across all sorts of social dividing lines by reducing social interaction to the exchange of goods and services for money, thereby diverting some of the passions that might otherwise go into racial and religious warfare into a more benign struggle for wealth through competition.

The equality problem Well-educated workers, in the US and elsewhere, earn much higher wages than their poorly schooled counterparts. We can get a sense of the importance of education in the economic well-being of ordinary people by considering: (1) the median earnings of American workers, 25 years or older, by level of educational attainment in 2015; and (2) unemployment rates by educational attainment in 2015. Table 4.1 is based on data from the Bureau of Labor Statis­ tics, which is in turn a division of the US Department of Labor (www.bls.

Taking conservative capitalism seriously  51 gov/emp/ep_table_001.htm). These charts offer irrefutable evidence that more schooling is not only a road to higher earnings, but is also an excellent road to economic security because the probability of being unemployed drops dramatically as educational attainment rises. The high wages of welleducated workers are the return to a scarce asset—knowledge—that an individual possesses by virtue of their own efforts, as well as efforts on their behalf. Workers in high-wage industries had the good fortune to be born to families and communities who provided them with good schools and other opportunities that allowed them to acquire the skills and habits of mind that the market values. Their efforts to succeed in the competition for grades and places in the better colleges are built on the advantages that they inherited from their parents and communities, on the basis of family and communal altruism. The fact that children inherit wealth, knowledge, skills, social contacts and their place in the social matrix from their parents and communities of origin means that the distribution of economic well-being in society is the combined result of effort and luck. While a very poor young man or woman may achieve great riches by dint of supreme effort in the face of good fortune, most statistical analyses of social mobility strongly suggest that the children of the poor in the US are likely to be poor themselves, while the children of well-off parents are likely to inherit their parents’ good fortune.8 Economic opportunities, in the sense of access to skills, health, and other ingredients for success, are commodities in a capitalist society that are purchased by those who can afford them, shutting out others whose incomes are too low to give their children what they need. A particular adult’s portfolio of financial and human-capital assets is as much a product of a long chain of investments by many prior generations of descendants as it is of that adult’s effort, with the consequence that a person’s high incomes and accumulated wealth is properly treated as the return on a prior generation’s foresight. Table 4.1 Median earnings and unemployment rates by level of educational attainment, 2015 Education attained

Median weekly earnings ($)

Unemployment rate (%)

All workers No high school diploma High school diploma Some college, no degree Associate’s degree Bachelor’s degree Master’s degree Doctoral degree Professional degree

860 493 678 738 798 1,137 1,341 1,623 1,730

4.3 8.0 5.4 5.0 3.8 2.8 2.4 1.7 1.5

52  Taking conservative capitalism seriously Yet, any liberal society, no matter its political economy, insists that its members take responsibility for the results of their own actions, so that free choices are made with proper attention to their consequences. Whereas it is surely true that the majority of poor children cannot be held responsible for the poor roster of choices that they face, it is also true that each of us, no matter our circumstances, is required to make the best of our options, even if our predicament is quite lousy. Most Americans do not seriously believe that a young child in the poorest section of New York City or Chicago deserves exclusion from good schools or health care, by virtue of their parents’ poverty. But a poor young man or woman who chooses to commit crimes is rightly condemned for his or her hurtful actions. The choice to commit crimes may be explained by the fact that crime may be the most lucrative choice among the list of available alternatives, but the community condemns antisocial behavior as a violation of the social contract that makes individual liberty possible. Similarly, a young woman’s choice to bear a child that she cannot properly care for is rightly assailed on the grounds that she has damaged the life chances of her child by tying that child to a person—his or her mother—who cannot provide the necessary emotional or economic support required for a good start in life. The difficult question that any free society must face is the extent to which it will allow accidents of birth to dictate economic well-being. There is no real disagreement between the Left and Right about whether a lazy person is entitled to be supported at someone else’s expense: the liberal Left, as well as the Right, insists that a lazy person cannot legitimately complain about being poor if they have refused to study or to work. We will usually say that people who refuse to make an effort to support themselves do not deserve to be supported by others because they lack merit, though the concept of merit is trickier than common usage might suggest. The difficult cases are where the children of poor people, or lazy people, or depressed people have little in the way of skills, or wealth, or economic prospects by virtue of their bad luck in the birth lottery. What do we do about those who inherit few resources or a bad place in the social matrix? In particular, what do we do when the bad choices of one generation become the accidents of birth that injure the life chances of the next generation?

Merit Common sense tells us that merit is, in the first instance, the reward that accrues to all those who possess talents or property that can fetch a high price in markets. High returns are the incentive required to induce talented people to exercise their skills or property owners to use their resources in particular ways. Further, high returns are also necessary to induce men and

Taking conservative capitalism seriously  53 women to invest time and toil, in order to develop and hone their knowledge and skills through study in school or extra effort on the job. Yet, as Amartya Sen has noted, the high prices and resulting high incomes received by those persons who own scarce resources or skills are not in and of themselves measures of merit—in the sense of just or morally appropriate compensation for the use of personal or impersonal assets.9 Instead, high incomes simply reflect the underlying balance of supply and demand in different markets at different points in time. Capitalism’s much heralded capacity to mobilize talent and resources, in order to direct resources to their most valuable uses, does not entitle property owners to high incomes. Economic efficiency is a morally empty though practically important criterion enhanced through competition that can be set aside when other, morally superior criteria, call for a policy, even at the cost of limiting or abrogating the free exercise of property rights in some cases. The owners of highly valued property and skills “merit” their high incomes and high social positions because the larger society values the high levels of output and productivity resulting from competition and initiative. In turn, high levels of economic activity and rapid economic growth are socially beneficial, and therefore are acclaimed to be meritorious, because most of us believe that wealth and income contribute greatly to human well-being. By the same token, we condemn economic incentives whenever the consequences of self-interest undermine our collective wellbeing by encouraging pollution, crime, or socially destructive behavior. It is important to note that Hayek’s own analysis of justice specifically downplays the idea of merit.10 Recall that justice in Hayek’s view is the equal application of rules to all persons, as well as the enforcement of property rights so as to secure the maximum degree of liberty for each person. Merit has an instrumental place in capitalism because the economic rewards or burdens that emerge from vigorous competition are an unintended consequence of the price mechanism’s alchemy rather than the design of a conscious agent. As per Sen, people with high incomes “merit” their good fortune only because that is what is required to induce them to use their skills or property for the benefit of others. But if “merit” is ultimately based on other things that we value, like output or freedom, then the argument between the Right and Left about equality is ultimately a fight over the meaning of freedom and its connection to equality. Under the Hayekian vision of a free society the outcomes of free market competition are the unplanned results of people’s choices on the basis of their own desires and plans, with the result that the distribution of income and wealth emerging from the civic war for riches is the outcome of a game whose rules apply to everyone equally. The fact that this game may mean that the children of poor people inherit their parents’ poverty is not in and of

54  Taking conservative capitalism seriously itself an unjust social outcome, so long as it is the result of free competition between individuals in a society enforcing the rules equally. Conservative political philosopher John Gray broke with the Hayekian Right precisely because its public philosophy forgets that markets serve more profound purposes than wealth accumulation, or even the promotion of the maximum degree of individual liberty. Gray reminds the Right, in vain, that the market is valuable because it is an institution that contributes to human well-being by promoting autonomy which is: the condition in which persons can be at least part authors of their lives, in that they have before them a range of worthwhile options, in respect of which their choices are not fettered by coercion, and with regard to which they possess the capacities and resources presupposed by a reasonable measure of success in their self-chosen path among these options.11 [emphasis added] Autonomy has definite material preconditions that are all too frequently ignored by those free market enthusiasts proclaiming the efficiency properties of competitive capitalism, without also acknowledging the horrendous distributional patterns generated by lightly monitored markets. One of the great advances in modern economic theory, particularly theories of income distribution and economic growth, has been the development of analytically rigorous accounts of the intergenerational transmission of class status, and therefore, the dynamics of economic and social inequality.12 A primary insight of this branch of economics is that the capabilities of each generation of men and women in society are the result of deliberate investments of time, attention, and resources on the part of families, communities, and governments. One consequence of this fact is that the capacity for men and women to act autonomously—to devise and act competently on their plans, in competition and cooperation with others—is largely the product of the decisions that societies make. Modern conservatism is an abysmal failure because it has permitted markets to allocate resources in ways that necessarily undermine the intellectual, social, and personal development of the weak in the interests of the strong as a matter of policy. So what is the proper balance of choice, merit, incentives, and justice in a market society where economic inheritance matters? This question is brought into sharp relief in debates over public policies that try to reduce poverty through redistributive taxation and spending. There are two fundamental questions here. First, what is the effect of public policies on the incentives of poor people to work, stay in school, delay childbearing and form stable parenting arrangements; i.e. to make the economically effective

Taking conservative capitalism seriously  55 choices? Second, what is the proper role of public policy in creating genuine equality of opportunity within each generation, so that the good or bad outcomes of each person’s choices are tied more tightly to their own decisions than they are to their economic inheritance? If one thinks that everyone in society, including the poor, acts on the basis of narrow self-interest, then providing food, housing, health care, and money to people on the basis of their low incomes may reduce their efforts to improve their condition through work, education, and delayed reproduction. One particularly clear and classic statement of the Right’s perspective, Charles Murray’s Losing Ground, notes that the issue here is not whether poor people are lazy or feckless, but rather whether well-intentioned Government help for people with low incomes, lousy employment prospects, and few skills will lead them to opt out of labor markets and self-discipline, because measly Government benefits are better than any conceivable alternative.13 There has been a tremendous amount of research and debate over whether antipoverty policies generate large or small changes in behavior, as well as whether these changes in behavior create more social harm than they prevent. The rational Right won the latest round of this debate by convincing the American people, and especially the dominant sector of the Democratic Party, that the social costs of welfare programs, prior to 1996, far outweighed the social benefits of poor relief, despite the inability of the nation’s finest social scientists to reach a consensus on this issue. The lack of consensus is due partly to the incredibly complex nature of the economic issues involved, which require substantial investments of time, money, and mathematical ingenuity to discern the statistical significance and strength of the incentive effects of public policies. However, part of the lack of consensus is clearly due to the fact that each side in these debates has strongly held views about the role of Government policy in providing poor relief that colors the interpretation of the results of even the most careful and disinterested technical studies. The Welfare Reform Act of 1996, signed into law by a politically adept conservative Democrat, William Jefferson Clinton, and passed by a conservative Congress, reshaped the relationship between the poor citizens of the US and the rest of us. These reforms imposed time limits, work requirements, and other restrictions in the hope that incentive problems associated with welfare might be overcome. The public and their representatives in Congress believed that the pre-1996 system of poor relief, with its guarantee of public support for families with children without time limits, as well as support without a work requirement, undermined a person’s self-respect and self-reliance by severing the link between work and reward that comes from participation in the labor market. But the focus of public debate on the presumed bad choices made by poor people misses the far more basic problem of poor people inheriting such

56  Taking conservative capitalism seriously a bad roster of choices that some rationally choose to live off the labor of others whenever they have the chance. All of the loud arguments about the disincentive effects of welfare policy on the behavior of poor people gloss over the harsh facts of the tight links between parental resources and the economic well-being of children in a raw capitalist economy. The ultimate goal of welfare reform was to push poor people back into the labor market in order to reduce their dependence on public support, thereby encouraging self-reliance among low-income populations. Yet, this goal makes little sense unless the nation also addresses the problems associated with growing wage inequality and reductions in social mobility. The low earnings of poorly educated men and women are ultimately due to the fact that millions of people have been denied the opportunity to develop skills and capabilities that might command a high wage by virtue of being born to the wrong parents, in the wrong communities. Pushing people into a labor market that has little room for their skills just converts a welfare-dependency problem into poverty, unemployment, and crime problems, unless the larger society chooses to guarantee employment and make work pay. Though the American Federal Government has implemented a number of promising policies designed to increase the incomes of low-wage workers with children—particularly, the earned income-tax credit that is considered in some detail later—the fact remains that the only way for poorly educated people to escape poverty is if the rest of us redistribute income and resources to them.

The problem with capitalism The Left’s indictment of capitalism is long, detailed, and damning in its insistence that most of the inequality and suffering that is plaguing free market arrangements can be overcome if public power is used to counter the harm done by lightly monitored markets. The Right counters that the Left’s indictment is based on a fundamental misunderstanding on the nature of freedom, as well as a failure to acknowledge that governments can fail even more disastrously than markets when public policy ignores the power of incentives. By this logic, we have no choice but to accept free market outcomes—messy, ugly, and lethal though they may be—as the best we can do in an imperfect world. The Left’s rejoinder is that the decision to accept free market outcomes is an ethical outrage and social nightmare that abandons the idea of real equal opportunity and genuine freedom for all, on the dubious claim that freedom is threatened whenever public policy seeks to promote equality. From the Left’s point of view, real freedom includes the capability to make responsible choices, which requires society to weaken the chains of economic inheritance from one generation to another lest the promise of freedom turns into a vicious joke.

Taking conservative capitalism seriously  57 In contemporary times, when the Right’s indictment of Government and public policy is faltering in politics and culture, the Left must somehow show why freedom requires the use of public power to intervene in markets, taking full account of the problem of Government failure in a new brief against raw capitalism. Conservatives have, until recently, had the advantage in the argument over economic policy in a free society because they have been allowed to pretend that freedom is a state of unlimited property rights and unrestricted bargaining between property owners, with the role of Government reduced to providing those few public goods—like courts, police, national defense, and arguably education—that are essential for the operation of capitalism, but which cannot be provided reliably by raw capitalism. It is time for the Left to challenge the Right on the grounds that raw capitalism undermines real freedom, as well as the well-being of the majority of the population. The past couple of decades have seen the emergence of a tough-minded liberal-Left argument against raw capitalism, on the grounds that it chews up individual freedom by creating and sustaining persistent inequalities that lock the poor into permanent caste-like positions of poverty and social disrespect. These emerging liberal-Left insights can be combined with the older indictment of capitalism, by synthesizing the analyses of both market and Government failure into a new egalitarian program to pursue economic justice.

Notes   1 Hayek (1978a).   2 Blinder (1981).   3 The Laffer curve shown in Figure 4.1 is based on the usual neoclassical microfoundations in the context of continuous market clearing, of the sort that ruins a fine weekend of most first-year graduate students in economics. The utility over consumption and leisure for the representative agent in the system is represented by U = 1nct + 1nLt + Ω1nbt + 1 where U is the level of utility, ct the level of consumption, 0 < Lt < 1 the proportion of time in each period taken in the form of leisure, and bt + 1 the level of wealth in the next period. The intertemporal budget constraint of the representative agent is bt + 1 = [1 + r (1 − τ )][(1 − τ )bt + (1 − τ )ωt (1 − Lt ) − ct ] where 0 < τ < 1 is the single tax rate on both income and wealth, rt is the rate of return to capital, and ωt is the level of the real wage. If the level of output per worker (y) is represented by the usual Cobb–Douglas production of function of the form yt = Abtθ (1 − Lt )1 − θ where 0 < θ < 1 is capital share, then we know (from basic economics) that the real wage and the rate of return to capital are the marginal products of

58  Taking conservative capitalism seriously labor and capital, respectively, with the consequence that the economy’s state at any point in time can be reduced to a (rather complex) first-order difference equation in b. The long-run level of the capital–labor ratio is just the level of steady-state capital holdings by the representative agent. Once the expressions for the steady-state levels and consumption and labor supply have been derived, the level of total tax payments is the product of the tax rate and output per worker; i.e. τtt, with the consequence that the revenue-maximizing tax rate is defined by the condition d (τ t yt ) dτ t

= yt + τ t

dy = 0. dτ t

The Laffer curve in Figure 4.1 of the text presumes the baseline parameters A = 1000, Ω = 0.95 and θ = 0.3.   4 Rawls (1971), pp. 60–65.   5 Ibid.   6 On p. 100 of Hayek’s sulfurous attack on the idea of “social justice,” Law, Legislation and Liberty, Volume 2: The Mirage of Social Justice, the reader is confronted by Hayek’s explicit endorsement of Rawls’ approach in A Theory of Justice, precisely because Rawls condemns the attempt to engineer the specific distribution of income and wealth in accord with some external vision of the correct distribution of economic rewards.   7 It is best if we quote Hayek directly, lest a conservative reader accuse us of distorting the master’s words: There is no reason in a free society government should not assure to all protection against severe deprivation in the form of an assured minimum income, or a floor below which nobody need to descend. To enter into such an insurance against extreme misfortune may well be in the interest of all; or it may be felt to be a clear moral duty of all to assist, within the organized community, those who cannot help themselves. So long as such a uniform minimum income is provided outside that market to all those who, for any reason, are unable to earn in the market an adequate maintenance, this need not lead to a restriction of freedom or conflict with the Rule of Law. (Hayek, 1978a, p. 8)   8 Bowles and Gintis (2002) and Chetty et al. (2014).   9 Sen (2000). 10 Hayek (1978a), pp. 97–99. 11 Gray (1995), p. 78. 12 The last 25 years have seen the development of rigorous models of economic growth and income distribution connecting aggregate economic growth to the distribution of income and wealth. These models demonstrate how investments in knowledge and skills among workers—human capital—drive economic growth by creating a positive feedback loop among the spread of knowledge within a population, development of labor productivity, and the rate of return to capital and investment in new capital equipment. Some of the canonical writing in this field includes Galor and Zeira (1993) and Benabou (1996 and 1997). Aghion and Howitt (1998) provide a masterful summary and extension of this literature. 13 Murray (1984).

5 Conservative failure and the next capitalism

Quackery Economic reality has not been kind to the conservative rollback of the welfare state that began in the 1980s. When the Right came to power in the US, Britain, and elsewhere in the late 1970s and early 1980s, the liberal welfare state seemed to be in crisis everywhere. American conservatives confidently offered a new approach to economic policy—supply-side economics—with promises of lower taxes, smaller government, and economic prosperity that captured the public’s imagination and eclipsed the Left for more than a generation. The Right’s program of smaller government and greater prosperity has turned into the sour realities of financial instability, growing poverty, and deepening inequality that we have reviewed in previous chapters. The extravagant promises and dismal failures of conservative economic policy has turned the phrase “supply-side economics” into a sick joke for many who remember the now-embarrassing claim that the further enrichment of the richest among us would somehow “trickle down” the economic ladder to everyone else. The calumny attached to the phrase “supply-side economics” is unfortunate, because there is a good case to be made for a sensible economic policy marrying the expansion of a nation’s economic potential to a far fairer distribution of income and wealth. The economic failure of the Right’s supply-side program contains valuable clues for how the Left can build a new road to social justice that overcomes the problems with welfare capitalism in a global economy. Conservatives are right when they say that the welfare state has run into trouble, but they are dead wrong when they suggest that our only alternative is to return to the brutalities of raw capitalism. Contrary to conservative assertions that redistribution reduces economic growth, the Left can take concrete steps along a new market-based road to justice—“universal” or Trust Fund capitalism—that marries the strengths

60  Conservative failure and the next capitalism of markets to the just distribution of wage and profit income in society. The Left can join competition, innovation, and security together in new ways that benefit everyone, in fact as well as theory. In one of history’s many ironies, the political success and economic failure of the conservative attack on the welfare state clears the way for new forms of progressive economics that can boost productivity and fairness at the same time. The abject failure of supply-side economics is by now so well-established among most economists and serious policymakers, and substantial portions of the general public, that readers may wonder why we are talking about it at all. Sad to say reason and evidence have not dislodged this lie from the public mind, in part, because too few people understand why conservative supplyside economics must fail. So the following pages are a brief excursion into sensible supply-side economics for the Left, in the hope that we can learn from the Right’s destructive and dangerous intellectual follies.

Defining supply-side economics: Some unpleasant facts More than 30 years of conservative dominance in economic policy matters has taught us to think of supply-side economics as the proposition forever symbolized by the Laffer curve, discussed in Chapter 5: that tax rates can become too high, to the point where tax revenue can actually rise if tax rates are cut. We have already noted that the economics of the Laffer curve are quite uncontroversial if all we mean is that societies with stupidly high rates of tax can depress the return to work and saving, thereby creating an avoidable scarcity of labor and capital. The Laffer supply-side argument against redistributive taxation stresses the depressive effects of progressive taxation on work and savings. Under progressive tax schemes, the percentage of income taken in taxes from earners rises as the level of income earned increases. In turn, the progressivity of the income-tax system can be represented by the highest marginal tax rate. If the highest marginal tax rate is, say, 91 percent, as it was as late as 1963, then a very rich person will pay 91 cents of every extra dollar they earn to the Government. So a very highly paid athlete, movie star, or Wall Street banker that earns an extra $1 million would have paid an additional $910,000 in taxes. Right-wing supply-siders tell us that this level of taxation will so depress the return to investment that the rich will refrain from creating new businesses or improving their existing enterprises, thereby reducing the rate of job growth and therefore economic opportunity for everyone else. If this crude version of supplyside economics is correct we should therefore see a negative relationship between high tax rates and the national private savings rate (the proportion of income that is used to buy assets): when tax rates go up, savings rates should fall, and vice versa.

Conservative failure and the next capitalism  61 Table 5.1 Relationship between average highest marginal tax rate and the average US personal savings rate, 1960–2012 Period

Highest average marginal income tax rate (%)

Average savings rate (%)

1960–1969 1970–1979 1980–1989 1990–1999 2000–2009 2010–2012

80.33 70.18 48.36 37.02 36.18 35

8.29 9.6 8.6 5.49 3.33 4.95

Table 5.1 completely refutes the claims of crude conservative supplyside enthusiasts, for it shows that there is no particular relationship between the average highest marginal tax rate for each decade between 1960 and 2012, and the associated average personal savings rate. Of course, there are many determinants of personal savings rates, including the relative proportions of young, middle-aged, and elderly persons in the population, unemployment rates, and the rate of return on all sorts of financial assets, among others. Unfortunately for crude supply-side enthusiasts, economists who have studied this question using the most sophisticated mathematical and statistical techniques have been unable to say whether, and by how much, changes in marginal tax rates affect personal savings.1 One might think that the advocates of Laffer-ish supply-side economics would at least try to have some evidence for their claims. Then again, who wants to subject their deepest religious beliefs to the evidence? Table 5.1 is just one of a multitude of examples of how the economic record of the supply-side experiments is very unimpressive, to say the least. The absence of a connection between the personal savings rate and the highest marginal tax rate is matched by the lack of any strong connection between marginal tax rates and the extent to which people choose to work. The supply of capital and labor have not responded to low taxes and reduced progressivity in the way that Laffer curve enthusiasts had hoped. What went wrong? Part of the problem is that the Laffer curve is based on a very important, but frequently unexamined assumption that experience has shown to be completely wrong. The mistaken assumption is that work and savings behavior is very sensitive to tax rates, so much so that small changes in tax rates will lead to very large changes in labor supply and savings. Tracking down the source of this mistaken assumption leads us straight to a piece of basic economic reasoning that will help us see why the Laffer supplyside approach is completely consistent with orthodox economic theory, but ignores a couple of important economic facts.

62  Conservative failure and the next capitalism

Basic economics to the rescue The next couple of pages are a little dry as they take up an important but technical piece of economic reasoning. The reader should nonetheless stay with it, because the logical case for crude supply-side economics hinges on a single assumption that is not supported by any evidence. Indeed, right-wing economics in the United States is based largely on a strong assertion—or better, a fervent wish, despite our parents’ patient teaching that “wishing does not make it so.” A rise in tax rates has two effects—an income effect and substitution effect—on a person’s decisions to work and save. Higher taxes reduce the return to work and saving. However, higher taxes, by cutting after-tax income, also make it necessary for workers and savers to supply more capital and labor in order to reach their economic goals, whether to pay next month’s rent or save for college. If I have to pay my rent and my after-tax income is cut because taxes are higher, I will be mad at the politicians, but I will have to find a way to earn more money so that I don’t have even more problems—like being homeless. The prospect of higher taxes and lower after-tax incomes pushing people to work more or save more, in order to reach certain goals, is an example of the income effect of taxation. Note that the ultimate effect of higher taxes on work effort or savings depends on the balance between income and substitution effects. If income effects are stronger than substitution effects, then a rise in taxes might actually lead to an increase in labor supply or savings (this is unlikely in the case of savings, but not impossible). Similarly, if substitution effects are more powerful than income effects—the hidden assumption behind the Laffer curve—then a rise in taxes will lead to lower work effort and savings. Most statistical studies of savings and labor supply in the US strongly suggest that the substitution effect and income effect of changes in either wages or interest rates effectively cancel each other out, with the consequence that changes in tax rates have negligible effects on the supply of labor or capital in society. For example, the creation of special savings incentives like 401(k) retirement accounts did not lead to a burst of additional savings when they appeared during the Reagan regime. Instead, the emergence of these plans reshuffled savings into this new vehicle and out of other savings vehicles, without any appreciable effect on the national savings rate. In addition, there is some evidence that high tax rates do reduce the level of saving and investment among the very richest individuals and families in the US, though the size of this response is subject to intense debate, with the preponderance of the evidence suggesting that this effect is positive but small.2 This last piece of evidence is the basis for the loud calls for cuts in the tax rates on capital and interest income—the bulk of this earned by the very rich—on the claim that low taxes will create more capital and more jobs for the rest of us, suggesting a gargantuan substitution effect.

Conservative failure and the next capitalism  63 Yet, while we know that the distribution of income and especially wealth in the US is very skewed in favor of the wealthy, the small real-life response of savings to lower taxes suggests that the incentive effects of tax-rate changes are much too small to be the basis of policy.

Reverse Robin Hood The idea that American conservatives would base major economic policies on the dubious claim that the substitution effects of lower taxes on work effort and savings are very large, compared to income effects, is a bit baffling. Economist Laurence Kotlikoff of Boston University has suggested that conservative supply-side policies are a good example of the triumph of quasi-religious zeal over good economic sense.3 This may be true of some of the more zealous members of the conservative movement, but one has to wonder how otherwise sober people could have repeated the Reagan mistake on a grander scale since then. Perhaps a sage said that history is a mystery, but I cannot place the name of this wise person. The most notable and dubious accomplishment of supply-side economics was to shift the burden of taxation toward labor and away from corporate profits. The proportion of federal taxes paid by corporations has fallen from approximately 17 percent in 1970 to 9.5 percent by 2012, whereas the proportion of federal taxes coming from Social Security and other retirement programs has risen from 23 percent to 34 percent over the same period.4 Employment taxes have risen steadily because many programs financed by payroll taxes, especially Social Security and Medicare, have such large long-term deficits that taxes are raised in order to rectify the fiscal imbalances. The rise in employment taxes reduces the progressive nature of the US tax system in two ways: first, we have already noted that payroll taxes are a problem because they increase the cost of labor, thereby putting downward pressure on employment and after-tax wages; second, payroll taxes underwrite social protection for workers at the cost of a lower consumption, without enhancing economic equality by redistributing the burden of social protection down the economic ladder. This shift in the burden of taxation from capital to labor increases the cost of the welfare state to workers at the same time that lower rates of corporate taxation raise the rate of return to capital. This fits well with the conservative supplyside claim that the lower capital taxation is a key to reviving long-term economic growth. However, there is a far less benign aspect of this shift in the structure of taxation that is revealed by the failure of the conservative supply-side program. I will return to this point in the next section. It is important for leftists to remember that reducing our reliance on corporate income taxes does not require us to shift the burden of taxes onto

64  Conservative failure and the next capitalism lower-income workers. There are good progressive reasons for reducing taxes on corporate income—which are themselves shifted to consumers in the form of higher prices and reduced output, as well as onto workers in the form of lower wages and reduced levels of employment—in favor of a more progressive tax system that increases the burden of taxation on high personal incomes. Indeed, a standard topic in intermediate economics courses—and the bane of many students at mid-semester in countless classrooms—are the efficiency costs associated with taxing corporate profits in a competitive capitalist economy.5 The usual analysis goes something like this: taxing corporate income reduces the rate of return to capital invested in the corporate sector, thereby reducing the flow of capital into corporate enterprises. The net result of this sort of taxation is a reduction in the amount of capital invested in the corporate sector relative to investment in the non-corporate sector: the world of smaller and less sophisticated enterprises that are frequently less efficient. Therefore, according to standard economic reasoning, taxing corporate profits reduces output and employment in the corporate sector. In turn, lower levels of output must lead to higher prices for goods produced by corporations and a lower standard of living in society as a whole. The loss of jobs, output, and profits associated with taxing corporate profits must be set against the presumed increase in fairness, along with the benefits connected to the use of corporate tax receipts in financing public sector projects. Things get a bit trickier when we move from the textbook portrait of an intensely competitive market economy, dominated by small corporate enterprises, to one where corporations are so large that they can exercise significant monopoly power. In this latter situation—one closer to the real world—corporate income taxation has a much smaller negative effect on output and employment, because corporate profits are a return to the use of monopoly power to keep output down and prices up. In an economy where large corporate enterprises collude with each other to maintain control of markets, the primary efficiency problem is the absence of vigorous competition rather than corporate income taxes. Of course, a corporate income tax can still be a problem for consumers if firms simply raise their prices to offset the effect of taxation on profits, particularly in industries where consumers have few alternatives. But arguments about the efficiency consequences of corporate taxation are less important than demands for vigorous antitrust enforcement in an economy dominated by large, market-spanning corporate enterprises.6

“Public choice” and conservative failure The tax-cutting efforts of the supply-siders are part of a strategy for reducing the size of Government, popularly known as “starving the beast” of

Conservative failure and the next capitalism  65 Government by depriving it of its food—tax revenue. The “public choice” approach to economics and politics has propounded an influential analysis of the connections between taxation, Government spending, and democratic politics that sheds light on conservative economic policy in the aftermath of its supply-side failures.7 The public choice approach to economics and politics begins with the seemingly innocuous claim that a voter will choose one candidate’s or political party’s program over that of another when the balance between costs and benefits of the policy package exceeds that of all relevant alternatives. For example, a worker choosing between two presidential candidates will tally up all of the benefits that he or she will receive from each candidate’s program—including the value that the voter puts on the well-being of the poor—as well as the costs associated with each program, particularly the cost in terms of taxation or other foregone opportunities (such as restrictions on the use of one’s property associated with proposed environmental, antipollution, or antidiscrimination regulations). Once this cost-benefit calculation is made, voters choose those candidates and parties whose program offers the largest difference between benefits and costs. Whereas many important political questions resist being reduced to dollars and cents, the economic approach to politics only asks us to believe that the balance of tangible costs and benefits associated with competing public policies is an important component in the political choices of voters. In a democratic society relying on simple majority rule, the middle or median voter—the voter whose balance between benefits and costs is in the middle of the spectrum of citizen evaluations of public policy—is the decisive political actor in electoral politics. By definition, half of all voters will have a more favorable view of a policy situation than the median voter, whereas the other half is less favorably inclined. Political competition attempts to sway the median voter’s view of the balance between costs and benefits in order to win power, with the consequence that voters toward either end of the spectrum of opinion are largely ignored. In particular, economic policy arguments try to persuade the median voter that the balance of benefits and costs associated with one program outweigh those associated with another. A candidate is more likely to gain the support of the median voter—usually a middle-class voter—if their program promises voters more in benefits than it extracts in costs, particularly in terms of tax costs. But if democratic politics leads to public policies that provide more benefits than costs to voters on the winning side of the election, isn’t there a possibility that democracy could lead to inefficient or excessive government? One of the important insights of the public choice approach is the observation that winning policy platforms in a democracy may be “efficient” from the perspective of the median voter—in the limited sense

66  Conservative failure and the next capitalism of the benefits exceeding the costs for the middle voter—despite being inefficient from the point of view of society as a whole. For example, a politician and party may win office by promising poor and middleclass voters all sorts of benefits while imposing the costs of programs on higher-income voters through progressive taxation. In a society where poor and working people are the vast majority of voters, this formula for political success forces the well-off and the rich to become “forced riders,” who must pay the costs of policies that they do not support. If the costs of policies to the well-off exceed the benefits derived by those who vote for the winning party’s program, then popular government policy is economically inefficient in the strict sense that the overall costs exceed the benefits. Similarly, another politician and party may propose to cut taxes in ways that lead to ballooning deficits that impose a ruinous financial burden on future generations. If contemporary voters do not think about the future costs of current policies to themselves or their children then the balance of costs and benefits for the median voter may support a fiscal policy program that is a long-term economic nightmare. In this case, future generations are “forced riders” who must bear the burden of policies that provided benefits for current voters. Many conservatives argue that progressive taxation and redistribution increase the size of Government in democracies, by skewing the distribution of economic benefits toward the bottom half of the voting population in terms of income and wealth, while imposing the costs on voters in the upper half of the distribution. If the conservative supply-side argument were right, this sort of political economy would be bound to suffer from slow rates of growth and wasteful government spending, because society’s most productive members would be burdened with taxes and regulations that discouraged work effort and savings, while the community’s less productive members were offered subsidies that undermined initiative and economic independence. In this case, the long-term costs of progressive taxation and redistribution, as well as social protection, can exceed benefits for the economy as a whole, at the cost of both upper-income citizens now and all citizens in the future. According to this argument, tax reforms that impose a large portion of the cost of government policy on poor and middle-class people can reduce the support for redistribution and social protection. The shift of taxes from capital to labor that has occurred over the past 30 years can be seen as part of the Right’s program to reduce public support for economic justice, by increasing the costs of government services to middle-income workers, while lowering the burden of taxation on high-income citizens. Higher payroll taxes to support social insurance programs, along with lower taxes on capital income, are devices for shifting the burden of taxation down the income and wealth ladder toward those who benefit most

Conservative failure and the next capitalism  67 from social-protection policies—the poor and middle class—because they the lack financial wealth and knowledge capital that yield high returns under current economic conditions. The American Right has snatched political success from the jaws of economic failure because the liberal Left has not come up with a viable alternative to the crumbling welfare state. The center of the voting public— an insecure middle class—is no longer willing to underwrite welfare-state protections in a world where jobs and incomes are insecure. The suffering public, still an economic minority comprised of poor, low-skilled workers and those who have recently been ejected from the middle class by virtue of depression, international trade, and technological change, is left to fend for itself. The Right’s shift of the burden of taxes toward labor, as well as its successful attack on the welfare state, has come at the cost of astonishing levels of debt, growing economic insecurity, and inequality that are the residue of unparalleled intellectual and policy failure on the rational Right. Future median voters will punish American conservative parties for the dreadful costs of the supply-side program that is being passed off to them. The silver lining in all of this is that many of the economic institutions of the old liberal Left have been carefully dismantled by conservative activists intent on cleansing the nation of any hint of leftist taint. This offers an opportunity for the Left to develop a new program for prosperity and social justice in a very different world from the one that gave birth to New Deal liberalism. What would a liberal Left supply-side program look like?

Progressive supply-side economics Supply-side economics, properly understood, is the sensible claim that the state of a single market, or an entire economy, depends on the balance between demand and supply in any given situation. For example, we know that the price of beef is low when the supply of beef is high relative to the demand for beef, with the consequence that buyers of beef will benefit from low prices, whereas suppliers of beef suffer low profits and possible business failure. Beef suppliers in this example have two options when faced with low beef prices and low beef profits: reduce their supply of beef to the market, either by cutting back on future production plans or quitting beef production altogether; or reduce the cost of producing beef in order to make it possible to sell beef at a lower price and still turn a profit. The immediate or short-run response of most beef producers to low beef prices and low profits will be to cut back on beef production, thereby leading to a rise in the price of beef in a later period if the demand for beef doesn’t change. However, the choice of whether to leave beef production entirely

68  Conservative failure and the next capitalism or to make beef production more efficient—the supply-side response of the beef industry to low prices and low profits—will depend on the profitability of each of these moves. Beef producers will invest in the capital and new production routines required to reduce their costs and regain profitability, instead of selling out if they can afford to do so. In turn, beef producers can improve their profitability by either: (1) improving the productivity of labor and other inputs in the production process, thereby cutting the cost of production; or (2) finding cheaper inputs that can replace expensive inputs. Firms in most markets of a competitive capitalist economy will, like our hypothetical beef producer, search out the least-cost methods of production, or create more efficient methods in order to survive the market maelstrom that punishes high-cost or shoddy producers with bankruptcy and unemployment. In particular, firms have powerful incentives to boost the productivity of all of their inputs in order to reduce production costs, especially labor costs, since these are the bulk of production costs for most enterprises. However, the search for lower-cost methods of production on the supply side of an economy usually leads to the long list of market failures and economic inequality that comprise the Left’s indictment of capitalism, because ruthless competition requires individual firms to do what they must to survive, regardless of the social consequences of their actions. Antipollution rules, worker-safety rules, antidiscrimination rules, payroll taxes, hiring and firing regulations and other restrictions on the managerial prerogatives of firms frequently raise the cost of doing business, and cut into profits by preventing firms from making the least expensive choices. Further, welfare-state benefits boost production costs by increasing wages, thereby giving firms an incentive to reduce their labor inputs by switching to more machine-intensive technologies, or moving to low-wage regions of the global economy. A supply-side economic policy agenda requires Government to promote economic efficiency by weighing the costs of economic policy moves in terms of their effect on productivity or the cost of production, particularly labor costs, against the gains associated with proposed initiatives. Economic policies with deleterious supply-side consequences can partially or completely overwhelm the positive effects of public actions, thereby making it more difficult to improve economic well-being, and frequently leading to undesirable social outcomes as well. Policies that lead to a fall in the supply of labor will certainly put upward pressure on wages and production costs, thereby boosting prices and reducing economic well-being to some extent. However, an overall assessment of the value of a public policy depends on the combined demand and supply effects of public actions, so the merits of public policies can be assessed only after a full accounting of all effects has been undertaken.

Conservative failure and the next capitalism  69 Sensible supply-side policies try to increase the level of worker efficiency in order to reduce costs of production and increase living standards. Workers become more efficient as a result of advances in technology and enhancements in the quality of labor skills, due to improvements in both the quality and quantity of education, including the availability of high-quality schooling across class and color lines. Advances in technology are the result of investments in both basic research and development that improve scientific understanding of the natural and social world, as well as investments in applied research and development aimed at turning general scientific knowledge into commercially viable products. Public policies which boost public- and private-sector investment in basic and applied research, business investment in new plant and equipment, and investment in education— particularly in education aimed at the poor and disadvantaged—boost labor efficiency over the long run. This suggests that public policies which boost the extent of worker protections and therefore the level of wages overall, or that reduce the supply of labor among low-income populations, should be accompanied by other policies that raise labor productivity through education as well as increased investment, thereby creating conditions where the nation can afford to be generous.

Schumpeter’s world We should step back to take a broader view of the contemporary economic situation in order to locate the place of properly understood supply-side economics in policy debates, thereby setting the context to evaluate the economic failures of conservatism. The picture of capitalist development painted in these pages is of a system that expands productivity and a nation’s economic potential through the creation and destruction of occupations, technologies, capital, and ways of life. The great economist Joseph Schumpeter, a conservative contemporary of Keynes and a critical admirer of Marx, coined the term “creative destruction” to capture the organic and brutal character of economic growth under capitalism. Schumpeter’s master works, The Theory of Economic Development (1982) and Business Cycles (2005), portray the growth of income and wealth under capitalism as the outcome of a fight between innovators that bring new ideas, products, and ways of working into being, against incumbents who struggle to survive by either adapting to change, or disappearing from the scene. In Schumpeter’s view, progress and well-being that capitalist economies deliver to the masses through the drive for profit are necessarily connected to unemployment, recession, depression, inequality and social instability. The regular rise and fall of individual and family fortunes in a vigorously competitive society rewarding innovation and adaptability is mirrored by the destruction of jobs and lives by

70  Conservative failure and the next capitalism a process that puts continuous, even escalating pressure on all members of society to prevail in the war for wealth. Persistent poverty and inequality are the inevitable result of an economic process that requires losers as well as winners, just as unemployment and depression are the predictable consequence of an economy where the price mechanism cannot swiftly and painlessly balance aggregate demand and potential output. Setting Keynes’ diagnosis of demand failure in the context of Schumpeter’s long-term vision of creative destruction provides the proper backdrop for assessing the failure of conservative economic policies in the wake of liberalism’s exhaustion. The welfare state’s attempt to simultaneously solve the effective demand problem while promoting equality has simply been overrun by the evolution of capitalism under the pressure of creative destruction. The traditional liberal program is based on premise that Government could force capital to make a better deal with labor over the distribution of economic well-being. Times have changed: workers are no longer able to use national governments as weapons in the war with capital, over the level of wages and their share of the economic pie, because technology and trade make workers in rich countries expendable. The Schumpeterian view of capitalism suggests that there are only two ways for American society to respond to the long-term challenges posed by technological change and international trade in a global economy: innovation or capitulation. Innovation permits the creators of new products or production processes to enjoy the high incomes that flow to successful pioneers that create ideas and technologies that the world values. Highly skilled workers in short supply, like technological pioneers that hold patents on path-breaking innovations, earn high incomes by virtue of the scarcity of their talents. However, the passage of time and the pressure of competition erode the reward from any single innovation, as imitators copy the success of the pioneers and as other societies invest in education. Long-term riches in a Schumpeterian global economy will go to those firms, workers, and nations able to continuously create new ideas, products, and ways of producing that meet the world’s needs. Accordingly, nations that commit themselves to supporting technological change and economic innovation by promoting vigorous competition, along with adequate supplies of highly trained workers, will establish the best conditions for sustained profitability and income growth in the most dynamic sectors of the economy. However, those workers and firms that cannot participate in the innovative sector of the economy must capitulate to the brutal facts of low wages and living standards for citizens without the protection provided by skills or technological prowess. The maintenance of welfare-state benefits for unskilled workers in a Schumpeterian world leads to a growing level of

Conservative failure and the next capitalism  71 low-skill unemployment as firms invest in labor saving technologies or move jobs abroad in order to drive costs down. Over time, the fiscal burden of supporting unskilled populations increases as these workers are slowly pushed to the margins of society, becoming a class of largely unemployable people. The high rates of unemployment and high budget deficits among many European nations over the past three decades are the cost of trying to use the State to protect the living standards of high-cost labor in low-wage sectors of the global economy. The economic emergence of China, India, Brazil, and other formerly poor countries onto the global economic stage will only increase the economic and budget pressure on European welfare states, forcing these societies to make hard choices about the scope of their systems of social protection. Does this mean that tax and transfer liberalism is now a luxury that only the most productive and innovative societies can afford? Is the just society envisioned by the liberal Left, of full employment and redistribution, now the victim of the permanent revolution of creative destruction and globalization that have forever weakened the power of Government to increase the economic well-being of the working majority? No. Although the growing fiscal burden of the old liberal program has made the old form of tax and transfer liberalism untenable, social justice and full employment are attainable in a Schumpeterian global economy if a concern for efficiency is combined with new institutions for distributing the proceeds from economic activity. The old scheme of using the Government to increase labor’s share of the economic pie and to reduce poverty must give way to schemes that simultaneously raise productivity, profits, and worker incomes. The real battle between the Left and Right in the US is over whether and how society can boost efficiency and fairness at the same time.

A street-smart Left To say that the liberal Left must pay attention to the size of the economic pie, as well as to how the pie is divided among the nation’s citizens is not a concession to the Right, but a recognition of economic reality. The redistribution of income and economic opportunity in a technology-driven economy cannot proceed solely by taxing high-income people in order to support the living standards of low-income people, who would be otherwise unable to earn a decent living on their own. The dependency implicit in that sort of arrangement is offensive to the core values of economic independence and individualism that constitute an important part of American civic culture. Yet, the harsh facts of educational and economic inequality mean that children born to poorly educated parents in poor and working-class communities will be unable to enter the competition for high-paying jobs or earn high incomes

72  Conservative failure and the next capitalism without help. The best way for the Left to realize its goals of economic justice is if the Left’s economic program shifts from trying to reduce unequal living standards, by redistributing income from the well-schooled to the badly schooled, to increasing genuine equal educational opportunity for those at the lower end of the income distribution. One of the harsh lessons that the Left has learned at the hands of the Right is that the concern for inequality in consumption—nutrition, housing, health care, and other components of what we usually think of as a person’s standard of living—cannot be divorced from an equal concern with a person’s capacity to earn a living on their own. The evolution of modern capitalism has occurred at the same time that we have learned a great deal about the process of human development, particularly the relative roles of families, schools, and life experiences in the intellectual and academic development of children. A child’s early years, especially the years before he or she enters school, are crucial to the development of cognitive capacities, which set the stage for formal education and skill development that matters for adult earning capacity. There is a great deal of research demonstrating that parental educational attainment, as well as the intellectual and academic culture of the larger community of origin, matter much more than parental income or school spending in the development of children’s cognitive abilities, with the consequence that adult differences in income and economic performance are greatly influenced by events and investments that occurred many years before.8 This means that the difference between good schools and bad schools is as much about whether the schools are able to enhance cognitive capacities of children, as whether they are able to build on capacities that have already developed when children walk through the schoolhouse door. Once the early years have passed, public investments in education rely largely on the prior investments that families and communities have made in their children. The head start that the offspring of the well-educated and well-off have relative to the children of the poor might be offset by extensive investments in the schooling of poor and working-class children, but this requires substantial extra investments in the education of poor kids relative to welloff kids. But the facts of human development mean that we now know that the redistribution of economic opportunity, if it is to succeed in breaking the link between parental and child poverty, must begin when children are developing their cognitive abilities, long before the time that they enter the labor market. Once this “supply-side” view of the role of education and skills is combined with our foregoing review of the difficulties of the traditional welfare state, the economic predicament of modern American capitalism becomes painfully clear. It is no longer enough for the Left to claim that economic

Conservative failure and the next capitalism  73 justice is best served by transferring income from the rich to the poor via redistributive taxation, or by pushing the unemployment rate down as low as it will go by propping up demand. Any Left policy ideas that boost wages at the expense of profits without also finding a way to raise society’s productive capacity is dividing the economic pie in ways that lead to higher costs and slower growth. Yet, liberal-Left policies that would redistribute income from private consumption to investments in people, knowledge, technology, and equipment are supply-side policies that use investment as a device for improving the distribution of economic well-being, by both increasing the size of the economic pie, as well as dividing the pie in a fairer manner. Trouble comes when the level and structure of the social-protection system leads to higher costs and lower levels of economic performance than society can afford, thereby calling for a new mix of demand and supply-side policies that tilt economic activity in the direction of investment instead of consumption. A society that consumes too much—through high trade deficits, high budget deficits in periods of low unemployment (big deficits in depressions are just fine), very low savings rates, high rates of credit card, and personal debt among the buying public, deteriorating public infrastructure, including crumbling roads, bridges, school buildings, leaky sewage systems, and a failing power grid —puts itself in a nasty long-term bind. Indeed, a society that invests too little in people and fairness, like the contemporary United States, cannot afford either social justice or private bounty for the masses, because it will be unable to fulfill its own needs through its own productive efforts, or through trade with others.

Notes 1 Slemrod and Bakija (2008) summarize research on the labor supply responses of married women to changes in tax rates. Most work suggests that the labor supply response of married women to tax cuts is greater than that of men, but not enough to justify the extravagant claims made by supply-side enthusiasts. See Slemrod and Bakija (2008), pp. 105–110. 2 Ibid. 3 Kotlikoff and Burns (2005), p. 115. 4 Economic Report of the President, Statistical Appendix, Table B-19: Federal Receipts and Outlays, by Major Category, and Surplus or Deficit, Fiscal Years 1950–2017. 5 Atkinson and Stiglitz (2015). The economic analysis of corporate taxation discomfits many on the Left with its suggestion that the burden of corporate taxes is inevitably born by others, particularly workers and consumers. Yet, this insight from economic theory is not an argument against the taxation of profit income, but rather an argument against treating profit income as requiring a special tax. Economists regularly make the point that corporate income taxes have powerful effects on the investment, dividend, borrowing, and employment policies of corporations, to the extent that the corporate levies alter the balance of costs

74  Conservative failure and the next capitalism and benefits for routine business decisions. Taxing corporate profits necessarily changes corporate behavior, which in turn affects all workers, buyers, and suppliers who do business with corporations. The Left’s pursuit of economic justice is better served by focusing on progressive income taxation that pays less attention to the source of income and more attention to its level. 6 Op cit., pp. 105–108. 7 Meltzer and Richard (1981) present a mathematical model of the redistribution in a median voter context that explores these points clearly yet rigorously. 8 Bowles and Gintis (2002).

6 Universal capitalism and economic justice

Labor and wealth It is time to move from explaining why the conservative project of restoring unrestrained capitalism has been such a dismal failure, and why the Left cannot rely on welfare capitalism as the antidote to predatory capitalism, to what can be done to make things better. The practical question is: how do we promote equality and social justice in a world where technology, global inequality, and global trade make it ever harder to use old forms of social protection to promote the well-being of workers, particularly poor workers, in rich countries like the United States? A radical suggestion for the Left (and the Right) is that markets and economic justice, properly understood (contra Hayek), are quite compatible. The following pages show that a capitalist road to economic justice is readily available to the Left once we get over our aversion to markets in general, and find a way around the problems with the labor market. This radical suggestion comes with an equally radical solution: reduce workers’ reliance on the labor market by increasing ordinary citizens’ share of profit and interest income. The previous chapters have shown us that the root of the problem with capitalism and the welfare state is that the labor market is a lousy mechanism for distributing economic opportunity and well-being. The problem with the labor market is that its efficiency role in pricing labor is incompatible with its social role of sustaining workers’ real freedom. Some people are locked out of prosperity because they do not possess skills and assets that command a decent return, whereas others can get their needs, wants, and trifling whims met because they own valuable assets that generate substantial returns—property all too frequently inherited rather than earned. The solution to the problems that global capitalism poses to ordinary people is to use Government to turn working people into wealth holders. The Left needs to find a new kind of “tax-and-spend” formula that gives the majority of ordinary working people a way to earn a sizable chunk of

76  Universal capitalism and economic justice the profit income that has hitherto flowed to the small minority that owns most of the capital in this country. The road beyond the welfare state lies in the direction of a new form of capitalism—universal capitalism—which resolves the tension between equity and efficiency by reducing the role of wages in the distribution of income toward labor, in favor of the widespread distribution of profits and interest as an ordinary part of pay. Wages should be allowed to reach their own level—to the extent that this is possible in the face of the flaws in the wage system—so that workers are allocated to their most efficient uses in light of the skill composition of the work force. However, Government should intervene aggressively in the distribution of income, by distributing the proceeds of profit and interest income flowing to a collectively owned national capital endowment, created and sustained by the State on behalf of workers. This collective endowment will distribute capital income on the basis of age, ability, and need, thereby enhancing both equality and efficiency. This endowment—hereafter called the Social Trust Fund—earns interest and dividend income that is then turned over to the fund’s shareholders—the citizenry—who can rightly claim a growing share of capital income by virtue of their rights as owners. These shareholders, like all shareholders, will see their incomes enhanced by the downward pressure that technology, trade, and knowledge puts on wages, thereby converting the victims of economic change into the beneficiaries of the forces that erode their labor earnings and traditional welfare-state protections. Under universal capitalism, the use of public power to promote efficiency and equity will gradually rely less on redistribution through taxation and more on the effective distribution of the benefits of growth in the direction of labor, because workers own a substantial portion of the economy’s capital base.

Universal capitalism versus socialism Some readers might wonder if “universal capitalism” has a strong family resemblance to the “collective ownership of the means of production”— bureaucratic socialism—bringing back a moldy and widely discredited economic scheme through the back door. Universal capitalism is not socialism, either in the sense that Government owns the means of production, or uses its tax and transfer policies to produce or buy a substantial part of the goods and services that workers need. Though some may confuse universal capitalism with socialism, because each idea attempts to redistribute the benefits of growth by changing core ownership relations, these ideas are radically different. The socialist idea, at least in its democratic form as espoused by liberal socialists in North Atlantic countries during the twentieth century, sought

Universal capitalism and economic justice   77 to overcome the conflict between labor and capital over the distribution of income through Government ownership of the means of production. As John Roemer and Nobel laureate Joseph Stiglitz show in their distinct but related analyses of the problems with socialism, Government ownership of the means of production creates a daunting set of incentive problems, impeding economic performance in ways that stymie growth and development, particularly when Government tries to supplant competitive markets.1 The main problem with socialism is that it ignores the direct link of competition, ownership, and efficiency, as well as the link between risk and reward. Societies that drive too big a wedge between effort and reward will ultimately reduce effort and wealth creation, as the rational Right never tires of reminding the world. Yet, contemporary capitalist societies cannot distribute the benefits of economic life widely and fairly, but instead divide the citizenry’s quasi-hereditary classes wherein a highly educated and financially secure elite rules over an economically insecure and poor working majority, thereby undermining the conditions for real freedom and democracy. The goal of universal capitalism is to deliver the benefits of trade and technology to all citizens, not just to the well-born and wealthy. Smart leftists know that the well-being of all citizens is enhanced when we rely on a subtle mix of markets and politics to promote innovation and competition, in ways that enhance health, wealth, and freedom, including environmental and social sustainability. While governments must act wisely yet strongly to offset the damage that market failure does to individual and social wellbeing, the rational Left really has absorbed the important lessons that conservatives have taught the world about government failure and disincentive effects. But the Left is not about to use Government power to tell firms what to produce and for whom to produce it, or to take over the production and distribution of output in the name of fairness or equality, or “the People” (whoever they are). The universal capitalism proposed below uses Government to save for the citizenry in the interest of promoting more equality in the ownership of private assets among the nation’s workers. Government would use a portion of tax revenue collected every year to invest in a variety of mutual funds, managed by wholly private entities for a reasonable profit, and subject to the most stringent regulations to prevent fraud and abuse by fund managers, or by Government itself. The income earned by the mutual funds would be distributed directly to citizens in the form of a regular check—perhaps monthly, quarterly, or twice yearly. Or the interest and dividends on the commonly owned assets could be used to finance important public needs like education, health care, or some other activities, as chosen by the majority of the people or their representatives through the democratic process.

78  Universal capitalism and economic justice

Universal capitalism: Pedigree and history Universal capitalism is an old family of ideas that has haunted laissez-faire capitalism in America, re-emerging in periods of depression and growing inequality only to fall back into the shadows when times improve. Thomas Paine, the great radical among the founders of the (white) American republic, believed that the new democratic society emerging in United States (and that he thought was being born in revolutionary France) should grant ordinary men and women a stake in society, no matter their inherited wealth. For Paine, a revolutionary society committed to freedom had to reduce the drag that inherited wealth and social condition placed on free citizens to participate in society, by promoting equality of opportunity and independent judgment.2 Paine’s idea belongs to that species of universal capitalism that weakens the chains that bind the fortunes of poor children to their parents’ condition. Paine’s words to the French revolution have a distinctly contemporary flavor that recommends them for extended quotation: Already the conviction that government, by representation, is the true system of government is spreading itself fast in the world. The reasonableness of it can be seen by all. The justness of it makes itself felt even by its opposers. But when a system of civilization, growing out of that system of government, shall be so organized, that not a man or woman born in the republic but shall inherit the means of beginning [in] the world, and see before them the certainty of escaping the miseries that under other government accompany old age, the revolution of France will have an advocate and an ally in the heart of all nations.3 The Homestead Act of 1863, which distributed millions of acres of land to ordinary white Americans and European immigrants, as part of the settlement of the interior of the continental US, is a classic example of Government creating an individual stake to support both economic development and social mobility.4 This stakeholder’s form of universal capitalism has re-emerged in recent times in the form of proposals for the Federal Government to provide each young American, upon reaching adulthood, with a significant stake that can be used to finance schooling, buy a home, or start of business. The most comprehensive left-liberal argument for stakeholder capitalism as an alternative to the welfare state has been made by Bruce Ackerman and Ann Alstott of Yale Law School in The Stakeholder Society (Ackerman & Alstott 2008). Ackerman and Alstott begin their argument for a universal stakeholding system with a vigorous attack on both right-libertarian claims about the conflict between freedom and equality, as well as a call to partially replace

Universal capitalism and economic justice   79 the welfare state with a social-endowment system. The authors object to right-libertarians’ studied indifference to real freedom in liberal society, insisting that genuine equal opportunity to live a good life requires that each person have the realistic means to act on their own behalf.5 On the other hand, Ackerman and Alstott also object to the contemporary American welfare state because it values social protection from economic risks more than real equal opportunity and the material prerequisites for real freedom. The authors are very clear about their intentions as Left-liberals: Our primary values are freedom and equal opportunity, not decency and minimum provision. . . . Our first concern is not with safety nets but starting points; not with misfortune but with opportunity; not with welfare, but with economic citizenship.6 Continuing with the theme of the purpose of stakeholding: From this vantage point, it is hardly news that America only promises its children the pursuit of happiness and does not guarantee them success. But it is one thing to make a mess out of your life, and quite another never to have had a fair chance. . . . Each individual citizen has a right to a fair share of the patrimony left by preceding generations. This right should not be contingent on how others use or misuse their stakes. In a free society, it is inevitable that different stakeholders will put their resources to different uses, with different results. Our goal is to transcend the welfare state mentality, which sets conditions on the receipt of “aid.” In a stakeholding society, stakes are a matter of right, not a handout. The diversity of individuals’ life choices (and the predictable failure of some) is no excuse for depriving each American of the wherewithal to attempt to pursue her own happiness.7 Ackerman and Alstott’s stakeholding society is admirable for its simplicity and boldness in pushing a left-libertarian agenda that is a worthy descendant of Paine’s basic idea: give each young person a real chance to achieve, and let them use their stake as they see fit. Some will have good lives, some bad, but all will be responsible for their choices and must live with the consequences. Of course, a stakeholding society must be sure to provide all of its members with a good education so that young people are able to use their stakes with intelligence and wisdom. Real equal opportunity includes rough equality in the ability to make good choices (subject to the natural lottery in raw intelligence and temperament). Further, some basic form of the welfare state will probably be required to make sure that those who squander their stakes, or have an extended run of bad times, are not forced to choose

80  Universal capitalism and economic justice between starvation and crime.8 But Ackerman and Alstott intend to diminish or even replace welfare with opportunity, fully accepting the fact that this sort of change increases equality of opportunity for the young at the cost of greater risk of failure in later life. The stakeholding proposal goes to the heart of a philosophical dilemma that plagues left-liberal approaches to economic policy: how to reconcile the conditions of social protection within each generation with the conditions for equal opportunity across generations. The social-insurance approach discussed in Chapter 5 can, in principle, accomplish both tasks by protecting workers against the economic risks of participating in production, while also protecting the life chances of each new generation by providing genuine equal opportunity of development for all.9 Free public education is, at least theoretically, not only a method for overcoming the well-known market failures associated with private education; most notably, the inability of free markets to allocate educational resources on the basis of talent rather than on the basis of income and wealth. Government-provided schools—i.e. “public schools” in the US; “state schools” in the UK—are also provided on the grounds that genuine equal opportunity requires that each new citizen have access to a good chance to develop their abilities, and to participate in society without regard to their place in the social matrix. This makes public schools a form of social insurance—social-mobility insurance—that weakens the links between poverty and the life chances of those born to deprived circumstances. In this sense, public schooling, in rhetoric if not in fact, acknowledges the material basis for real freedom by investing in the intellectual capacities of children so that they can lead responsible lives as adults. Once each generation matures, the social-insurance system requires each of us to be responsible for the consequences of our choices, while providing protection against those risks that we cannot anticipate or take action to offset. Social protection and equal opportunity, though perfectly compatible as a matter of logic, become incompatible when limited public resources must be deployed against almost inexhaustible forms of social need. The socialinsurance approach is sensible when economic inheritance is limited to the inheritance of property in an industrial economy, not one where knowledge is more important than a willingness to work in cooperation with others. When the primary barriers to economic security are the common risks of recession, inflation, unemployment, on-the-job injuries, old age, bad health, and the like, social insurance can protect everyone who is willing to work, and can contribute to the common insurance pool. Likewise, when the primary barriers to equality are based on racial or gender hierarchies that limit opportunities to acquire knowledge and property in competitive markets, public schooling, as well as antidiscrimination policies, can knock down impediments barring outcasts from achievement.

Universal capitalism and economic justice   81 But redistribution under contemporary conditions faces two meritocracybased barriers: a within-generation barrier as a result of unequal economic risks across the knowledge spectrum; and an intergenerational barrier based on the inheritance of opportunities for knowledge and skills within families and communities. The hard truth of contemporary American economic life is that we no longer have the means or the will to simultaneously protect all workers from the eternal downside risks of life under capitalism, as well as the new immobility risks of life in a knowledge society. Ackerman and Alstott’s proposal for the stakeholder society is a valiant attempt to force the Left to face the fact that intergenerational forms of economic and social inequality are as important threats to both real freedom and economic wellbeing that the welfare state cannot handle. One way to reduce inequality of opportunity across the population is by granting each young person a decent education, as well as a pot of wealth that they can use to acquire the skills and property to compete effectively in the system. The stakeholder solution replaces the dying ethos of worker solidarity of the welfare state with an operational form of the principle of real equal opportunity, particularly the powerful belief that the economic fortunes of poor children should not be tied to the lousy fortunes and bad choices of their parents.

Basic income Left-liberal and socialist readers will rightly grumble that the Ackerman/ Alstott stakeholding proposal does little to mitigate the income risks associated with technology and trade in a modern economy, even if it offers a method of enhancing economic mobility. Is there a way of reducing income risks on a universal basis that nonetheless avoid the traps associated with the traditional welfare state? Phillipe van Parijs has, in a series of articles and in his provocative text, Real Freedom for All: What (If Anything) Can Justify Capitalism? (1995), claimed that the Left can realize its goal of real freedom for all by opting for a guaranteed and sustainable basic income for all citizens as a partial or complete replacement of the welfare state. Van Parijs’ proposal is motivated by two familiar concerns. First, European welfare states, once the envy of so many on the American Left, have lost their allure because of the high tax rates and high rates of chronic unemployment, resulting from the high wages and living standards brought on by extensive job and social protection rules for workers. Second, the popularity of workfare and other means-tested, social-welfare schemes necessarily favors work and some forms of family life over others—particularly, two-parent families over families headed by single people, especially single women—leading to greater levels of Government intrusion into the

82  Universal capitalism and economic justice private choices of citizens that violate the principles of liberal neutrality with regard to individual liberty. A basic income system that pays an unconditional, relatively low but economically sustainable income to each citizen, adjusted for age or number of dependent children, allows everyone to do what they want to do with minimal interference from Government, generating far fewer disincentive effects than contemporary social-protection schemes.10 A basic-income approach is better than means-tested, income-support systems because a person receives the same level of the grant under all circumstances. In a basic-income world a person could choose whether and how much to work, based on the balance between the monetary and personal benefits and costs of work, without having to take account of decisions on their eligibility for the basic-income payment. A basic-income payment might reduce barriers to work by cutting child care and out-ofpocket expenses associated with work. Further, Van Parijs argues that a genuinely free society should not, in principle, favor work over nonwork, by tying survival to an implicit work requirement.11 Some people would certainly choose not to work for wages if they had access to a basic income, though this choice is a very complex matter that goes well beyond the usual prejudices in favor of work. Yet, the level of basic income would have to be sustainable in the strict sense that there would have to be consistent conditions for economic stability, as well as for environmental sanity. A basic-income policy that undermined the economic well-being of future generations by impairing savings and capital accumulation is an unjust policy, in the same way that economic policies encouraging the depletion of nonrenewable natural resources are ethically illegitimate. The purpose of a basic income is to promote equality and social justice in ways that help a market economy maximize sustainable well-being in environmentally sensible ways. The idea of a basic income has been around a long time in American economic and policy debates. Nobel laureate James Tobin proposed a variant of this idea, the so-called “demogrant”; an important part of the economic policy program of Senator George McGovern’s ill-fated 1972 electoral run against Richard Nixon.12 Richard Nixon then proposed a system of family allowances that were essentially basic-income payments to families that the liberal Democrats in Congress defeated for being too stingy.13 Van Parijs’ advocacy of a basic income returns progressive economic thinking to the question of how we might marry capitalism’s robust capacity to create wealth to the need to provide all citizens with a real capacity to act on their own plans, under conditions of equal liberty for all, free from the baleful eye of Government. Van Parijs’ proposal has been subjected to rough treatment by a number of writers who are sympathetic to his project of improving the economic

Universal capitalism and economic justice   83 fortunes of poor and working people by moving beyond the welfare state. Two criticisms are especially relevant. First, an unconditional basic income will allow many workers to quit the labor market altogether, whereas others opt to scale back their working hours in favor of other pursuits. A subsidy to worker leisure, financed by taxing those who choose to continue working, is not likely to be politically popular, to say the least. In addition, many economists worry that a basic-income system will require punishing tax rates if the unconditional payment is to be enough for a single person to meet their most basic needs, thereby recreating significant supply-side disincentives that the rational Right complains about. We will explore the supply-side criticism of the basic-income proposal in more detail below, after considering a specific variant of the proposal that gets around the problem of using taxes to finance the scheme directly. Second, Edmund Phelps of Columbia University has criticized the idea of a basic income by noting that many of the problems of crime and economic isolation among the American “underclass” can be traced directly to the persistent joblessness of low-skilled workers.14 Phelps’ own proposals for improving the plight of low-skilled, low-income workers—a graduated wage subsidy that Government pays employers to hire and retain unskilled labor—is inspired by the observations of Harvard sociologist William Julius Wilson, on the links among chronic joblessness, concentrated poverty, crime and other familiar aspects of life in the most marginal parts of the American system.15 Phelps’ critique begins with the claim that pursuit of wealth under conditions of equal opportunity and open competition is at the core of American notions of social justice.16 This claim echoes that of Judith Shklar in American Citizenship: The Quest for Inclusion (1998), who suggests that American civic culture is built on the fundamental demand that adults earn the right to social respect by being independent actors in work and politics.17 Contemporary workfare systems, for all their flaws, are by these criteria superior to a basic-income scheme precisely by insisting that beneficiaries to income support earn their claim to the social product, instead of living off the labor of others. These critiques of the basic-income approach can be met by turning the basic income into a “participation income” at the cost of creating a new intrusive Government agency to monitor the behavior of citizens.18 The difference between Phelps and Van Parijs comes down to a judgment about the role of work in the life of a community. If work is an essential buffer against antisocial behavior among the badly schooled and unemployable, then it is best to pay firms to hire people even if these workers are unproductive, because this subsidy buys social peace. However, if antisocial behavior is unrelated to work activity, then there is no reason for society to watch over its members, or to force them to work in exchange for

84  Universal capitalism and economic justice a basic income, especially since the point of a liberal society is to promote maximum freedom for all.19

The Social Trust Fund: A variant on the basic income theme One form of this proposal, first explored by Nobel laureate James Meade in Efficiency, Equality and the Ownership of Property (1964), and revisited, as well as extended, in Full Employment Regained? (1995), is so wild, simple, yet totally practical that it is hard to believe a straitlaced economist ever conceived it. Imagine an America where the Federal Government’s budget was usually in surplus—that’s right, a designed surplus wherein tax payments were greater than Government spending. Furthermore, imagine that the Government used these public savings to gradually build up a pool of funds that is placed in a wide range of well-managed mutual funds, with the vast bulk of the dividends and interest earned by these funds going directly to citizens. The Government’s sole claim on fund earnings would be limited to the costs of paying the professionals managing these operations.20 The capital accumulated in this way would be wholly collectively owned but privately managed in the interest of working people. Government would be strictly prohibited from having any role in managing companies, with the penalties for fraud or abuse being so severe as to dissuade hustlers from trying to steal the people’s wealth. Can this sort of program work? Absolutely. In fact, this kind of economic policy so improves the way American capitalism works, and for the benefit of all, especially the poor, that one wonders why the Left has ignored it all these years. The ultimate goal of the Social Trust Fund is to add to the regular earnings of ordinary Americans—especially the poor and working people of this country—by using budget surpluses to boost the pool of national savings. Recall that redistributive taxation is, by its very nature, a device for transferring resources from the well-off to the poorly off in order to correct for the free market’s tendency to lock poor and working people into society’s basement, by denying them access to the keys to survival, mobility, and development: adequate schooling, health care, housing, safety, nutrition and other vital goods and services. The disincentive effects of the welfare state, combined with the fact that some (though by no means all) social protections cut into profitability and growth by boosting wages and reducing the rate of return to capital, have put a brake on the capacity of the Left to use traditional tax and transfer policies to improve the economic wellbeing of the poor and working majority. However, the Social Trust Fund proposal under consideration uses Government’s tax and transfer power to directly create wealth, by increasing the pool of capital available to the

Universal capitalism and economic justice   85 private sector, as well as boosting the capital income of ordinary citizens, thereby combining capital accumulation and progressive redistribution. Over time, as the Social Trust Fund grows and the interest and dividend income earned on this growing pool of collectively owned assets becomes a significant part of the yearly incomes of working people, the old-style social protection programs that the Left has relied on to promote the wellbeing of middle class and poor workers can be phased out. For example, once the Social Trust Fund has become large enough to provide a significant portion of a worker’s income, traditional unemployment benefits can be gradually scaled back, or even eliminated entirely, since workers will have an alternative flow of capital income that provides a cushion against the uncertainties of the job market. A substantial reduction or elimination of payroll taxes to finance unemployment compensation will boost the rate of return to capital as well as the after-tax wages of workers, thereby increasing employment rates by reducing the costs of labor, while simultaneously increasing the net reward for work. A program of this sort deliberately boosts the nation’s savings, thereby increasing the supply of capital to the private sector, while gradually creating a genuine ownership society that pays capital income to ordinary people; something that cannot ever happen under the raw capitalism of the conservatives. Of course, there are many possible problems with this type of program, in part because the scale of Government savings would have a significant effect on the financial system, especially on asset prices and the direction of market activity. Great care and prudence would have to be exercised to avoid major problems in the way that financial markets allocate capital and manage risk, with the consequence that the institutions and agencies managing this social endowment would develop cautiously and operate with extreme care.

Incentives and the trust fund Work The Social Trust Fund overcomes the disincentive problems of the welfare state by turning savings into a device to promote income redistribution in the long term, thereby marrying social justice and economic efficiency. An astute conservative reader might give some credit to our attempt to take incentives seriously by promoting savings, growth, and greater equality of income and capital ownership by channeling a larger portion of the returns to capital to workers. However, this same conservative reader could raise a few important questions about the incentive problems associated with the Social Trust Fund proposal.

86  Universal capitalism and economic justice The first problem is the age-old issue of whether this substitution of capital income for social benefits among workers won’t reduce worker incentives yet again, thereby leading to a fall in the level of labor-force participation and work effort. There is little doubt that a substantial level of income from the Social Trust Fund will lead some workers to reduce their levels of labor-force participation, thereby reducing the supply of labor in some sectors of the economy and putting upward pressure on wages and prices. Yet, there is little reason to think that this sort of behavior is bad for society, once we realize what “taking time off” means in many cases. Some parents of young children will treat their Social Trust Fund payments as a sort of child allowance that allows them to spend more time at home. Other workers may reduce their working hours to go back to school in order to improve their skills, or for the simple joy of learning. Still other workers may choose to work in less lucrative pursuits in the nonprofit sector of the economy, using their Social Trust Fund income to finance their good works on behalf of others, rather than as workers in the for-profit sector. Indeed, a basic-income scheme financed by a social endowment of the type might permit society to get rid of significant amounts of Government employment in favor of a decentralized, initiative-driven system for delivering vital services to client populations that would otherwise have to depend on bureaucratic systems staffed by public-sector workers. This sort of quasi-market-based scheme could, with proper incentive designs and adequate regulations, be a welcome relief from the vast, impersonal governmental machines that turn our relationship to Government into the disagreeable ordeal that it has become. We can be fairly sure that some young people, particularly young men who are badly schooled, or lazy, or mean, may try to get by on their Social Trust Fund incomes, with all of the problems that are associated with a large pool of idle young adults without work, and outside of school or the military. Eligibility for the Social Trust Fund could come with a requirement to steer clear of crime, as well as a work requirement that ties the level of Social Trust Fund payments to a worker’s employment history, with higher payments being earned by those who have longer work records. Indeed, a well-designed Social Trust Fund system might consist of a series of funds that provide payments for different groups of workers who face special circumstances. For example, young workers—whether male or female— who choose to spend time away from work, in order to raise their children or care for an ailing relative, might be paid additional monies out of a supplemental fund for a limited period of time, thereby providing a social subsidy for desirable activities that enhance individual and social welfare. A well-designed system would go to great lengths to avoid discrimination against those who opt out of labor markets for family-related reasons,

Universal capitalism and economic justice   87 while deliberately discriminating against those who would use their capital incomes to finance antisocial behavior. In sum, a proper evaluation of the incentive effects of the Social Trust Fund will weigh all of the positive and negative economic and social effects of regular capital-income payments to workers, rather than simply presuming that any fall in overall work activity in the economy is automatically a bad thing. The details of the Social Trust Fund proposal would have to carefully consider all of the work disincentive effects associated with various levels and types of trust fund payments in order to determine the extent of any tradeoff between the structure of the trust fund system and the level of economic performance. This sort of exercise will require the Left to take complicated, mathematically difficult economic theory and economic policy analysis seriously.21 Savings Our conservative reader might next wonder whether a system of collective wealth will reduce the incentive for individuals to save on their own, thereby partially or completely substituting public-sector saving for private-sector saving, without any net gain in overall saving and capital accumulation. If someone knows that Uncle Sam is using budget surpluses to build up the nation’s pool of capital, and substantial capital income is coming their way, why would anyone go to the trouble and expense of saving? This question is similar to the perennial and important question of whether old-age pension systems discourage private savings by providing public pensions for the elderly. A great deal of ink has been spilled in the debate on this question, with little agreement between those who think that public pensions discourage private savings and those who don’t. Although basic economic theory gives us good reasons to wonder about the effects of public pensions on individuals’ savings behavior, and therefore to worry about the consequences of a social trust fund of the type being proposed, there are so many influences on savings that any overall effect of pensions is likely to be small.22 The consensus among economists who study the question of the effect of public-sector pensions on personal savings in the US is that Social Security does reduce private savings to some degree, though there is very little agreement over how big this negative effect is, or whether it matters much. The dismally low rate of personal savings in this country may be reduced further by a Social Trust Fund scheme, though there is little reason to think that this effect would be very great. One radical variant of the collective endowment approach would completely replace the Social Security system with the Social Trust Fund scheme, thereby ending the special program providing old-age pensions in favor of a unified trust fund system that provides capital income to all workers. One benefit of this move would be to end the generational fight over

88  Universal capitalism and economic justice economic resources entailed by old-age pension schemes that are financed on a payroll tax, on a pay-as-you-go basis, where the Government taxes young workers in order to provide benefits to old workers. The contemporary argument over Social Security, driven by the greater longevity of the American elderly and the resulting fight about whether to boost payroll taxes on the young, cut benefits, increase the retirement age, or all three, suggests that we might want to find better ways to support retired workers in the face of demographic events or policy mistakes that impair the financial health of public retirement schemes. A basic-income scheme financed by a social capital endowment is not, by itself, any kind of cure for the problems faced by public old-age pension systems or old-age medical care. The demographic events that have created our contemporary Social Security, and especially Medicare problems—a Baby Boom followed by a Baby Bust; the substantial rise in the life expectancy of the elderly made possible by modern medicine; and the substantial medical costs associated with the care of a large and ever older geriatric population—would pose a severe challenge to any system, largely because these forces require a society to think carefully about the economic claims of the old, as compared to those of other segments of the population. At bottom, as Nicholas Barr notes in his excellent survey of the challenges faced by modern welfare states, The Welfare State as Piggy Bank: Information, Risk, Uncertainty and the Role of the State (2001), the contemporary problem with public pensions is that the claims of the elderly population, no matter how these are paid for, are in conflict with those of the nonelderly, and especially the young, for a share of the economic pie.23 We have made a series of decisions that, when combined with the bulge in the number of elderly, has granted the old an outsized claim on our economic bounty, putting them into direct conflict with their children and grandchildren. Part of this distributional conflict between the young and old is, as we have seen, due to the fact that payroll taxes are a regressive tax that hits the young harder than the rest of us by boosting labor costs to employers. One way to move beyond these problems with the payroll tax is to build up the Social Trust Fund, so that the elderly have a steady pension financed by capital income instead of by payroll taxes on young workers. This sort of system has the important property that it unites both the young and the old by giving everyone a stake in sustainable economic growth, thereby avoiding intergenerational fighting over the size of pension benefits and the associated level of payroll taxes. Unfortunately, the most important solution to the old-age pension problem—increased levels of labor productivity combined with rational public policies that do not grant the elderly a disproportionate share of our economic resources—depends on factors well beyond the reach of the Social Trust Fund proposal. Yet, even here,

Universal capitalism and economic justice   89 the switch from traditional tax-and-spend policies to a social-endowment scheme can contribute to an egalitarian economic environment by boosting economic efficiency. Of course, the most radical form of the Social Trust Fund proposal—one where payments from the Fund almost completely replace the welfare state, leaving men and women to take their combined capital and labor incomes and buy whatever they need in markets carefully regulated by Government to ensure health, safety, and fairness—will be seen as a threat to those on the Left who still want to use Government to provide things for people. A Social Trust Fund that replaces the large welfare state with the public-sector form of a trust bank for the citizens, combined with a vigorous system to regulate markets—given the ubiquitous problems of market failure and discrimination noted earlier—will seem like a complete surrender to conservatives among those who still distrust the idea that markets can be recruited to the cause of social justice. Part of the problem here is that the Social Trust Fund proposal, particularly in its most radical form, means that Government employment is likely to shrink drastically, thereby reducing the ability of workers to rely on Government jobs as a road to the middle class. Some poor and working-class men and women, and particularly men and women of color as well as white women, will be scared by the prospect that they will have to find work in a world where Government is no longer a prime employer. Black Americans, in particular, have good reason to worry that the decline in Government employment will force them to compete for work in a private-sector job market that is still rife with race discrimination in hiring and promotion patterns, while Government jobs, though in no way perfect or free from the problems of racism, are usually fairer jobs than those in the market sector. Yet, a radical Social Trust Fund system of the sort favored by the author—a middle-aged, black American man with a profound appreciation for the hard facts of racial hatred and abuse that is black life in this country—will in no way lead to the abandonment of civil rights laws, or equal protection regulations, or the capacity of Government to push the private sector to live up to the ideal of equal opportunity. In fact, a Social Trust Fund system that leads to greater economic equality, as well as a fall in the long-term level of taxation, has the side benefit of enabling Government to expand its regulatory activities in matters of equal protection and equal opportunity, if Americans choose to commit the extra resources generated by economic growth to the cause of racial justice.

Getting from here to there How would we get from our current welfare-state arrangements to the economy of the Social Trust Fund? This sort of radical change in public policy

90  Universal capitalism and economic justice would be the subject of a great deal of public debate over a long period of time, with the various sides offering favorable and unfavorable verdicts on the general idea of a collective capital fund, as well as detailed assessments on the merits and problems with different versions of the Social Trust Fund concept. One important roadblock on the path to some type of Social Trust Fund is that the need for governments to run a sustained budget surplus over a number of years would require a significant rise in the level of tax rates, or a cut in other forms of Government spending until the Fund was established, with taxes falling once the Fund was in place and paying out the desired level of benefits, with adequate reserves to handle the various contingencies that it would face. In effect, the Left would ask the American people to trade off a substantial rise in their tax burden or a decline in some services provided by Government in the near and medium term, in exchange for a long-term permanent decline in a wide array of taxes, which would enhance longterm economic growth in ways that we have already considered. In order to minimize the pain associated with the transition to a full trust fund system, the federal budget should be in surplus in an average year, with budget deficits limited to those periods where the nation is in recession or in a time of war. A special system of Social Trust Fund taxes or tax surcharges, high enough to generate a substantial accumulation of funds but low enough to limit any serious disincentive effects associated with these new taxes, could be imposed during economic booms, but suspended during slumps and periods of high unemployment, thereby adding another set of stimulative tax reductions to the nation’s arsenal of antirecession policies. As the trust fund grows, taxes could be gradually reduced to the level necessary to maintain the fund in the face of a growing population, and those minor financial events that require adjustments to the size and structure of the Fund from time to time, in order to maintain its integrity. Very practical questions of dollars and (ethical) sense intrude into this analysis of endowment-based social justice. •• •• •• •• ••

Can the nation afford the Social Trust Fund? What type of economic pressure does the attempt to create a national capital endowment impose on the rest of the economy? Would the attempt to create a Social Trust Fund have undesirable effects on the efficiency, such as it is, of national and global financial markets? What sort of regulatory institutions would have to develop to manage the risks associated with placing large amounts of public monies into assets with variable rates of return? How can these funds be managed, so that workers and their families earn steady returns on portfolios that bear some, and perhaps significant degrees of risk?

Universal capitalism and economic justice   91 ••

What kind of Government policy stances and other guarantees must be offered, in order to assure the public that its commonly held portfolio will be able to withstand the occasional shocks that buffet national and global capital markets—and not be wiped out by the insane gambling that generated the 2007–2009 financial crisis and mini-Depression?

These are all important questions that any specific plan for the Social Trust Fund must address. For now, we will limit our analysis of the practical challenges posed by the Social Trust Fund system to the issue of how the nation can use the federal budget surplus to boost national savings, and thereby create a substantial social endowment. Technically inclined readers are invited to take a look at a full technical analysis of the operation of different social trust fund systems that is developed in an associated website (www.darkeconomist.com). The Social Trust Fund program could be broken up into two distinct phases. In the first phase, the Federal Government would boost national savings by running a budget surplus, placing each year’s excess of tax receipts over expenditures with designated financial managers, who in turn invest these funds into a range of global mutual funds. All earnings on the national endowment would be re-invested in order to generate as high a growth rate as possible, subject to limitations on the acceptable degree of risk. In the second phase, once the national endowment reached a sustainable size, a portion of the endowments earnings would be paid to each adult worker. Government would choose the payout rate which maximized the long-run value of fund earnings, which would usually mean that the optimal level of payments would be a bit less than the level of endowment income. The Social Trust Fund is, first and foremost, an investment system that provides capital to businesses—to small- and medium-sized businesses primarily—in order to put a financial brake on the formation of cartels and monopolies. The Fund would take a very long-term view, investing in businesses that paid stable dividends out of profits that created enduring value for their customers and good jobs for their employees. The Social Trust Fund would be specifically forbidden from engaging in speculation in the prices of assets; the Fund would not gamble with the common property of the citizens, who would be able to depend on a steady flow of capital income generated by well-managed businesses providing goods and services at a competitive price in a safe working environment. The economic crisis of 2007–2009 has demonstrated, beyond any doubt, that casino capitalism is a road to ruin. The new American social contract being proposed would not finance any form gambling, but would instead insist on the effective investment of public savings in the interest of both growth and fairness.

92  Universal capitalism and economic justice This approach to savings, growth, and distribution seeks to gradually limit the role of speculation in the allocation of capital and the structure of economic opportunity in society. Investment and finance rule a capitalist economy, lending the system its dynamism when entrepreneurs and innovators can acquire capital (via stock markets and banks) to finance new ventures that transform visions of new products and ways of producing into the technologies and organization that improve our well-being. But contemporary capitalism is also a predatory system that rewards monopoly and oligarchy, placing the control of society in the hands of an unelected elite that has little to no concern for the havoc brought about when their gambles fail. The Social Trust Fund would seek to gradually squeeze predators out by providing an alternate source of capital that looked to the long future and judged the suitability of investment by its capacity to generate earnings by improving the well-being of consumers and workers. When predation and gambling are separated from the productive life of society, the gaming casino becomes an arena where the idle rich and their trader-enablers can literally exchange gains and losses among themselves—much as a card game redistributes a fixed pot of money between the players. The economic game of creating value by recruiting ambition, talent, and stamina to improve our technologies and serve our needs can and should be divorced from the gambling table, as Keynes noted long ago, when he proposed “socialize investment” in some manner. The Social Trust Fund is a device for socializing savings and putting resources in the hands of producers, whose success or failure would be judged by profit. The citizen/owners of the common fund would have a keen interest in making sure that the firms they financed performed as productive enterprises, while the financial managers charged with supervising the Social Trust Fund competed to earn high incomes and bonuses by prudently choosing winning technologies and enterprises.

International aspects of endowment-based justice The case for the Social Trust Fund as the Left’s next great step on the road to social justice has focused on the need for progressives to move beyond the problems that high rates of tax and extensive social protections pose for employment and equality in the context of a hypercompetitive global economy. We have seen how the switch from the welfare system to a social-endowment scheme could boost growth and equality, by providing workers with a substantial share of profits through increasing national savings, thereby spurring capital accumulation, innovation, and development, while redirecting the flow of capital income down the economic ladder. Yet, we have not said much about how a social trust fund might help ordinary workers in a rich country like the US to improve their economic fortunes,

Universal capitalism and economic justice   93 in a world where profound economic inequality drives the movement of capital and labor around the globe, thereby pitting affluent workers in the rich world against desperately poor people in so many other nations. One consequence of the Social Trust Fund approach is, at least initially, a bit of a paradox. If domestic labor is cheaper, and if higher national savings rates lead to higher levels of labor productivity, as a result of more investment in people and technology, then the switch to a Social Trust Fund can help workers hold their own in the global labor market, thereby protecting their employment prospects and living standards from competition with lowwage workers in other countries. A social-endowment system offers some hope of reducing the pitch of social strife engendered by international labor migration and capital mobility in two distinct ways. First, since payments based on income from the social endowment would be connected directly to capital income, workingclass citizens would see some direct benefits from falling wages tied to immigration, or from the migration of jobs from the US to other nations. Whereas there is little doubt that the only long-term protection for domestic labor from cheaper offshore labor is an increase in the productivity of US workers, the Social Trust Fund means that the losses that working men and women endure under current forms of global capitalism could be reduced to some degree. The closure of the blue-collar road to the middle class by virtue of technological change and globalization need not leave unskilled American labor stranded between a declining job market and its increasingly distant, even hostile, higher-income fellow citizens, if workers can count on capital income as part of their overall pay. Though particular workers in particular places will need effective and aggressive public help to cope with the job losses and adjustment problems that go along with a technologically dynamic global market, a social-endowment scheme would actually allow workers, as a whole, to benefit from the movement of capital and labor across the globe, thereby reducing the downward drag of global competition on their incomes. So a working man or woman in Cleveland or Oakland, who loses a job to someone in Tijuana or Bangkok, will have capital income from the Social Trust Fund to fall back on as they look for work, as well as other forms of social assistance: job retraining or skillenhancement programs financed from other sources. As time passes, when these men and women move to other jobs in other sectors, a portion of their capital incomes would come from profits derived from the very jobs that moved from the US to an offshore site. There is no cheap irony here: the movement of capital and jobs from high-wage to low-wage regions of the world economy can be slowed down by policy, for a time, but would surely happen in any case. A rational, left-leaning public policy regime that seeks to boost the long-term fortunes of the common man or woman

94  Universal capitalism and economic justice must find ways in which workers, as well as consumers, can benefit from the movement of capital and labor. A Social Trust Fund system holds out the hope that American workers can see some tangible economic benefits to their lives from globalization beyond the televisions, automobiles, and computer hardware manufactured abroad.

Notes 1 Roemer (1994) and Stiglitz’s (1996) analysis of the failures of socialism differ in many respects, not least their very different assessments of Hayek’s famous critiques of socialism on incentive and information grounds. Roemer’s suggestion that history has largely borne out Hayek’s claims against socialism is sharply at odds with Stiglitz’s dismissal of Hayek’s analysis as both fundamentally flawed, and as a source of difficulty for Russia and Eastern-European nations making the transition from communism to capitalism. Roemer’s analysis notes that markets and democracy are powerful devices for dealing with three principal agent problems in economics and politics that together are a barrier to the growth of wealth. These three incentive problems—(1) the conflict between workers and managers; (2) the conflict between managers and owners; and (3) the conflict between the State and the citizenry—share the common feature of imperfect information and imperfect monitoring, thereby creating situations that undermine fruitful cooperation. Roemer claims that competitive capitalism aligns the interests of workers and managers, as well as managers and owners, by penalizing inefficiency with unemployment (inefficient workers and managers get fired), whereas competitive party democracy puts pressure on governments to meet the needs of citizens. Stiglitz, on the other hand, claims that although socialism may make matters worse, competitive capitalism cannot overcome these principal agent problems. This difference in perspective leads each writer to offer very different prescriptions to progressives on the proper remedies for the deficiencies of capitalism, in terms of inequality and market failure. See Roemer (1994) and Stiglitz (1996). 2 Jack Fruchtman’s Thomas Paine: Apostle of Freedom (1994) presents a moving portrait of Paine’s ideas on the connections of poverty, inequality, and the fragility of freedom. 3 Fruchtman, pp. 23f. 4 The fact that the Homestead Act was also an instance where ordinary white Americans were endowed with someone else’s land—namely, that of NativeAmerican peoples dispossessed by an expansionist white American settler state—should remind us that American capitalism is based on brutal historic crimes. Better to say that the social and economic mobility for poor whites made possible by the Homestead Act should be both an example of how social endowments can enhance liberty and prosperity, and a warning about how not to build a capitalist society on the basis of genocide. 5 Ackerman and Alstott (2008). 6 Op cit., p. 8. 7 Op cit., p. 9. 8 Op cit., pp. 134–142. 9 See the section entitled “The Problem with ‘Social Justice’” in Chapter 3 (this volume).

Universal capitalism and economic justice   95 10 Chapter 2 of Real Freedom for All (Van Parijs 1995) presents an economic and ethical argument for a sustainable basic income while Chapter 4, particularly pp. 109–124, examines the disincentive effects of contemporary welfare-state policies. Also see Van Parijs, Jacquet and Salinas (2000) for a theoretical comparison of a basic income scheme to the earned income tax credit – the favored income support system in the US. 11 Van Parijs (1995), pp. 136–140. 12 Tobin (1966). 13 Moynihan’s Family Assistance Plan (FAP) was an intriguing attempt to develop a guaranteed income scheme to replace the Aid to Families with Dependent Children (AFDC) and related programs. See Unger (1996) for a brief but complete analysis of the politics of FAP, particularly the opposition of liberal Democrats. 14 Phelps in Van Parijs (2001), pp. 51–59. 15 William Julius Wilson’s The Truly Disadvantaged: The Inner City, the Under­ class and Public Policy (1997) and When Work Disappears: The World of the New Urban Poor (2012) offer analytically and empirically rigorous accounts of the role of economic change, unemployment, concentrated poverty, and economic exclusion in the creation and maintenance of chronic intergenerational poverty that has had a profound influence on social scientists and policy analysts across the political spectrum. While Wilson’s account of the origins of chronic poverty has played a large role in debates about the fate of low-income black populations, his analysis provides the sociological background for Phelp’s critique of Van Parijs’ basic-income proposal. See Wilson (1987) and (1997), and Phelps (2007). 16 Phelps in Van Parijs (2001), pp. 53–55. 17 Shklar (1998). 18 Phelps in Van Parijs (2001), p. 57. In addition, see Phelps (2007), pp. 43–48. 19 For what is it worth, my own experiences in urban America cause me (with reluctance) to support Phelps in this matter, largely because too many city streets in the United States are brutal training grounds in a national warrior culture that rich and middle-class Americans ignore, even as residents of these neglected killing zones try to endure. While I favor a variant of the basic-income idea over Phelps’ wage subsidy for reasons explored later, I also think that it is wise to force young men to do something in exchange for our support. 20 Meade’s Equality, Efficiency and the Ownership of Property explored the inherent difficulty of reconciling the use of free market wages to promote economic efficiency with the obnoxious distributional consequences of unregulated capitalism. Meade’s primary concern, in 1964, was with the effects of continuous labor-saving technical change on the demand for labor, and therefore on the level of real wages. Meade was worried about the prospect that technical change would raise productivity so much that low rates of unemployment could only be maintained through a drastic decline in the level of real wages or, at best, a substantial shift in the distribution of income from labor to capital. In such a scenario, social concern over the worsening distribution of income and economic well-being in a growing economy could lead to many different responses, some of which were more efficient than others. Meade was concerned to show that the usual solutions of his day—trade union activism, tax and transfer policies of the welfare state types, liberal socialism—where Government owned and operated a significant portion of the means of production in the interest of

96  Universal capitalism and economic justice promoting equality, all generated important efficiency problems that counted against their laudable egalitarian aspirations. Meade’s worry about the effect of labor-saving technical change has been replaced by worries about the consequences of globalization and skill-driven technical change, for the economic fortunes of unskilled labor in advanced capitalist societies. However, as the text suggests, Meade’s topsy-turvy scheme for the social ownership of property has a great deal of contemporary appeal. See Meade (1964) in Meade (1993), pp. 60–66, and Meade (1995), pp. 51–62. 21 Anthony Atkinson of the London School of Economics used many of the theoretical and empirical findings of modern public finance to explore a number of aspects of the case for and against the institution of a combined basic-income/ flat-tax regime, as a substitute for contemporary welfare-state arrangements of the social-insurance/graduated income-tax type in Public Economics in Action: The Basic Income/Flat Tax Proposal (1995). Whereas Atkinson’s analysis resists either advocacy for, or criticism of the ideas of a basic income or flat tax, in favor of a positive analysis of the ways that modern public finance can shed light on these proposals, the sophisticated theoretical and methodological approach adopted by Atkinson is an example of the type of rigorous approach that economists of the left should adopt when considering radical departures from the welfare state. 22 Barr (2001) summarizes the state of our knowledge about the connection between public-sector old-age pension schemes and private-sector savings rates, noting that most careful studies find that: (1) there is evidence that public pensions do depress savings, but that (2) the extent of this effect is hard to estimate. Though evidence for the US suggests that the negative effect of private pensions might be greater here than in other advanced capitalist societies, the size of the effect is still subject to a great deal of controversy and, in any case, does not seem large enough to warrant alarm. See Barr (2001), pp. 101–104. 23 Op cit., pp. 89–124.

Conclusion The road to real freedom

The ultimate goal of the schemes I have proposed above, and many other ideas left unstated in the interest of brevity, is to destroy the twin systems of concentrated private power and class privilege in the United States. Liberals have relied on politics, particularly the capture of Federal and State Government power, in order to regulate business and redistribute income and opportunity in the interest of efficiency and fairness. This is a losing strategy because it concedes the need for concentrated power, and proposes that all of our problems are due to that power falling into the wrong hands. The conservative nightmare of the past 30 years, especially when viewed through African-descended eyes, made bluer for all the dark blood shed and dark lives utterly wasted under the aegis of the Right, is a testimony to the fact that power in vicious hands is terrible. But concentrated power is always a threat, particularly to the despised and hated among us, precisely because it is more likely to be seized by the strong to attack the weak. The weak have few resources to capture power, and in the end, must hope that those with power will act ethically and with justice. But the existence of a large powerful State, even one constructed in the interest of social justice, becomes a target of opportunity for the American Right to seize power and pursue its program of abuse of its social enemies. Contrary to the political myths of the Right, the Left’s program worked quite well from the New Deal until the 1980s, when profound changes in the nature of global capitalism, and the use of racial hatred for political gain, stymied further progress along left-liberal lines. The economic crises of the 1970s and 1980s had no tight connection to the weak liberalwelfare capitalism of the Democratic Party, but were instead linked to the fact that the control of the price of oil passed from the consumers’ cartel in the rich world—the US, Europe, and Japan—to the producers’ cartel in the Middle East, which increased the price it charged its customers, like any other collection of self-respecting pirates would. Conservatives seized their opportunity to blame the troubles of that era on the Government’s excessive

98 Conclusion zeal in redistributing income from society’s valiant producers to its indolent and racially inferior moochers—including, of course, lazy union members, who hide behind rules and regulations to lay about. The Right has been singularly successful in crippling the labor movement, as well as the welfare state, exploiting racial anxieties as the historic white republic recedes into the past, while an embryonic and deeply hybrid America is being born. The collapse of the conservative economic and racial project in the aftermath of the recent mini-Depression has not given the Left a second chance to use the old redistributive State because the American oligarchy has purchased politics and blocked the way to reform. As these words are being written, following the presidential election of 2016, Donald Trump, a real-estate mogul and reality-television star turned politician, has ridden the tigers of racial hatred and economic frustration to conquer American politics. He has surrounded himself with white-nationalist advisors in a bid to create a uniquely “American fascism” under the banner of restoring the white working class to glory, by blocking immigration, demonizing Muslims, and returning to the all-too-usual scapegoating of black Americans, even as the taxes for the very rich are set to decline. This turn of events, along with the capture of the Congress by the American oligarchy, promises to undo the tepid reform efforts of the Obama Government, at the same time that the enemies of the New Deal and the incorporation of non-whites under the protections of the Constitution called the “Great Society” are erased with the help of the courts. Any political victories that the white, nationalist Trump regime wins in this way will be worthless to our oligarchs because their program is finished, as the foregoing chapters have shown. But the wounds they are inflicting on the social contract—such as it is now—are grave. As the American people have fallen for the bait of racial blame and now turn on each other out of racial rage, our oligarchs will get to finish the job of extracting more bounty out of the American system, leaving the rest of us with a dying husk of broken infrastructure, incompetent schools, a failing health-care system and a slow-motion, low-intensity civil war. Though we have shown how welfare capitalism has broken down under the dual pressure of economic evolution and conservative assault, a type of political and intellectual paralysis, rooted in an almost pathetic fight between so-called racial groups over crumbs, will bar the way forward until a better road to prosperity through economic solidarity is forged. At its heart, the Social Trust Fund is a direct attack on the oligarchs that seeks to end their reign by breaking their control of the savings and investment process. Banking and other firms of finance will dominate our society and governance so long as concentrated corporate power and concentrated wealth ownership can control the allocation of capital, and therefore purchase politics. The liberals’ reliance on taxation to redistribute income and

Conclusion  99 wealth will invariably fall short, so long as private concentrated power exists. The way to kill oligarchic power is to disempower capital, as well as the State. The right-libertarian daydream of very limited government in an economy dominated by the hyperconcentration of capital, and therefore real power, is a recipe for modern feudalism, wherein the owners of vast fortunes and their employees in the corporate sector, politics, and the media manage public affairs in their own interest, permitting the Little People of the realm all manner of entertainments and, when necessary, inciting little cultural and racial wars in an era of dwindling resources and shrinking opportunities. Of course, our rulers lose power when they lose control of capital, as well as the State. But we must not repeat the mistake of left-liberals, socialists, and social democrats, believing that the collective control of capital through politics will allow the people to control their destiny. We have already seen that the social-democratic project of redistributing well-being via progressive taxation and expenditure policy has definite limits, not the least of these being that the concentration of power in the hands of the State made it easy for a small group of owners to use their wealth to simply purchase politics. The true democratization of capital can only happen when the people own the economy—as small freeholders—and the people earn the bulk of capital income. Using saving to kill oligarchy and rescue democracy is a radical, practical, and efficient form of peaceful revolution that can unite farmers, small business people, office workers, clerics, and teachers, and the hostile members of the racial tribes—stupid though “race” is—into that most glorious collective: a nation of truly free and independent people. Left-libertarians are in complete agreement with their right-libertarian counterparts in seeking a decentralized society where power is so dispersed that no faction—religious, racial, economic, cultural—can grab control of either Government, or business, or culture, to impose an agenda on the rest of us. It is embarrassing that our right-libertarian opposites are naive people, who refuse to understand that the real problem for freedom-loving people is concentrated power in any form—their abject failure to understand just how long we must live with the deadly echoes of the slavery and Jim Crow crimes is proof of their dangerous innocence. Concentrated private power is made possible by the concentration of economic means. The elimination of concentrated private power therefore requires the eventual displacement of the oligarchs by a mechanism that permits the widest possible ownership of capital and distribution of the profits from enterprise. That is the only way for a democracy to survive and grow in a market society as badly fractured by racial hatred as the United States. The most radical but practical step toward real freedom in this country is therefore the reconstruction of the corporation, beginning with the

100 Conclusion destruction of the idea of corporate personhood, and the complete elimination of the corporation from politics. Individuals, rich and poor, of all colors and shades of opinion, can participate in politics as citizens known to each other, with their contributions to the political process as writers and funders known to all. But the corporation has no place in politics; it is just a particular device for raising capital and managing production, where the owners of an enterprise have a limited right to tell their employees what to do. This sort of social tool can never again be allowed to overstep its bounds and become a player in political life, for then the human foundation of democracy, and particularly the mutual vulnerability of citizens in the political process, is replaced by the cudgel of authority connected to the power flowing from concentrated control over the command of economic life. The full exploration of how we can kill off the current form of the corporation is the subject of its own volume, not least because any serious attempt to disestablish the corporate form will be as contentious as, though hopefully not as bloody as, the attempt to establish the rights of working people in this country. For now, I ask readers to think about how the Left can move beyond its capitulation to the Right, by reclaiming markets and competitive capitalism as a first step toward destroying oligarchy and robbing it of its primary weapon: concentrated private capital.

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Index

‘n’ denotes the note on the page provided Ackerman, Bruce, The Stakeholder Society 78–81 Alstott, Anne, The Stakeholder Society 78–81 autonomy 8, 17–18; material conditions for 54 Barr, Nicholas, The Welfare State as Piggy Bank 88, 96n22 basic income 6, 8–9, 81–8, 95n16, 96n21 Becker, Gary 42 capitalism: American 1–2, 27; changes in American 4–5; conservative acknowledgement of suffering under capitalism 40–1; cooperation 5; raw capitalism 27–9; universal capitalism 75–96 Chicago School, defense of capitalism 42–4 Clinton, Hillary 5–6 Clinton, William Jefferson 55 conservatism 1–2, 7, 8, 41n8; failure of modern conservatism 54, 69; social conservatives 45 corporations, end of corporate personhood 100 Dworkin, Ronald 7 economics: analytical economics 10; corporate profits taxation 64; Neoclassical or orthodox economics

6, 10; supply-side economics 4, 62–3; theory 6, 23 efficiency wages 29–31 equality: equal opportunity 8; material conditions for equal liberty 10–11; rational conservatives and equality 50–2; right-libertarians and leftegalitarians 17, 19–20 freedom 7, 8, 10; American freedom 16–21; capacities versus rights 15; competition and freedom 35; conservative failure to preserve freedom 57; equality and freedom 53–4; freedom and prosperity 23; “freedom” of the homeless 15–16; links between private property and freedom 25, 43–4; personal responsibility and 15; prosperity and freedom 44; as purpose of economic life 11, 24–5; real freedom 14–16, 56 Friedman, Lawrence, Crime and Punishment in America 21n5 Friedman, Milton 1, 7, 42 Gray, John, freedom and the purpose of markets 54 Hayek, Friedrich 7; and classical liberalism 43, 47, 50; connection to Rawls’ Theory of Justice 39, 49; Law, Liberty and Legislation: The Mirage of Social Justice 58n6, 58n7; merit

Index  105 and justice 53–4; in support of a basic income 58n7; The Constitution of Liberty 40, 40n3, 41n8, 57n1, 58n10; The Road to Serfdom 13–14; The Use of Knowledge in Society 23–7, 35, 40n4; 94n1 Homestead Act 78 incentives 9, 24–9, 38, 46–50; Social Trust Fund and 85–9 income distribution 2–4, 54, 58n12, 72 inequality: conservatism and 67–8; of consumption 72; education and wage inequality 51, 56, 72; income 2–4, 59; injustice 27; necessity of 14, 69–70; social inequality 54 Keynes, John Maynard: mass unemployment 31–2; Schumpeter and 69–70; socializing investment 92 Kotlikoff, Laurence 63 Kropotkin, Pieter, The Conquest of Bread 16 Laffer, Arthur: failure of the Laffer curve 59–63; Laffer curve 47–9, 61–2; Rawls and Laffer, 49 liberalism: and equality 16–21; classical liberalism 11–13, 43–6 libertarianism: left-libertarians 1, 6–8, 10–11, 15–16; left-libertarianism and stakeholding 79; right-libertarians 8, 10–15, 16–20, 23, 32, 35, 49, 99; versus stakeholding left-liberalism 79 Lucas, Robert 42 McGovern, George, demogrant 82 markets 22–41; adverse selection and moral hazard 33–5; coordination 23–7, 29; difference between markets and capitalism 22; market failure 29–38; monopoly 7, 35–9; principal–agent problem 30 Marx, Karl 26, 69 Meade, James 1, 84 merit 52–6 monopoly, and the Social Trust Fund 91–2 Murray, Charles, Losing Ground 55

Nixon, Richard, basic income 82 Nozick, Robert 11 Obama, Barack: business liberalism 5–6; health insurance 37–8 Paine, Thomas, freedom and citizen’s stake 78 personal responsibility 52 Phelps, Edmund, basic income versus wage subsidy 83 Piketty, Thomas, Capital in the TwentyFirst Century 2 poverty 7, 28 prisons, and inequality 20 public choice 64–6 race: anti-discrimination policies 80; capitalism and racial conflict 50; conservatism and racism 97; government jobs as a safety net against racism 89; stupidity of race 99 rational right: critique of social justice 44–7; defense of capitalism 42–4; disincentive effects of anti-poverty policy 55; importance of incentives 47; necessity of suffering under capitalism 40; policy failure 66–7; problems with basic income 83 Rawls, John: difference principle 49; Hayek and Rawls 49; Theory of Justice 49 Reagan, Ronald 47 real freedom 8; labor markets and 84; public schools and 80; stakeholding and real freedom 79; threatened by inequality 77 redistribution 8; a better Left approach 71–3; conflict between the old and the young 87–9; liberal failure 98–9; meritocracy and redistribution 81; new forms of egalitarian economics 59–60; right-libertarian critique of 12–14; social insurance and 80; via the Social Trust Fund 84, 87; structural inequality and redistribution 54–6 Roemer, John, on socialism 77

106 Index Schumpeter, Joseph 69–71 Sen, Amartya 7; connection between freedom and markets 24–5; “Equality of What?” 21n4; nature of merit 53. Shklar, Judith, American Citizenship 83 Smith, Adam, The Wealth of Nations 23–4 social justice: conservative critique of 44–7; as a form of democratic oppression 45–6 Social Trust Fund: as alterative to tax and transfer liberalism 76; full proposal 84–94; guaranteed dividend income 2; reducing conflict between immigrants and the native born 93; replacing Social Security 87; saving 87–8; transition to 90–4; work 85–7 socialism 9; impossibility of socialism 26; socialism versus universal capitalism 76–8 Stilger, George 42 Stiglitz, Joseph, on socialism 77 supply-side economics: conservative supply-side economics 4, 47; failure of conservative supply side

economics 59–66; leftist supply-side economics 67–9, 71–3 Tobin, James, demogrant 82 Tomasi, John 11 topsy-turvy nationalization 1 Trump, Donald J. 5, 98 unemployment: European welfare states and 81; as a market signal 26, 27, 67; mass unemployment 31–3; minimum wages and 30; Schumpeter and 69–70; transition to Social Trust Fund 90 universal capitalism: history 78–81; and stakeholding 78–80; versus socialism 76–7 Van Parijs, Phillipe 7, 11; Real Freedom for All 81–4 wealth, common ownership under capitalism 6 welfare state 2, 8; Hayek’s critique 41n8, 50; left alternative to welfare state 81–92; as ways to manage risk 9–10, 14, 59–60, 63–7 Wilson, William, Julius, American “underclass” 83