Saturday, January 19, 2008

Capitalism versus Corporatism (Part 1)

According to Wikipedia,
Capitalism generally refers to an economic and social system in which the means of production are predominantly privately owned and operated, and in which investments, distribution, income, production and pricing of goods and services are determined through the operation of a market economy. It is usually considered to involve the right of individuals and groups of individuals acting as "legal persons" or corporations to trade capital goods, labor, land and money (see finance and credit).
Capitalism is the system that has created the prosperity we've gained in this country over the past several hundred years. In a true free market, a buyer and seller only agree to a transaction if it's to the mutual benefit of both parties. The buyer believes that the item he wants is worth more to him than the money he is willing to exchange for it. The seller believes the money is worth more to him than the item. Both parties agree to make the exchange because they both benefit from it. This free exchange automatically develops in a non-primitive economy. People specialize and they need to exchange the items or services that they are skilled at providing with other items and services they need or want.

In a modern economy, businesses develop that use capital from their investors and the the skills of their workers to create products desired by their customers. In a true free market, multiple businesses compete to provide the same services giving consumers choices. This competition results in low prices and high quality products. If consumers think they can find something cheaper and of higher quality from another company, they will take their business elsewhere. Companies understand this and must compete on cost and quality in order to retain their customers. New businesses will enter the market if they think they can provide something cheaper or of higher quality.

The virtuous cycle is driven by the owners seeking profit. If a business is not satisfying the needs of its customers, it will start to lose money. The owners will start to see their profits fall and their their capital consumed. If they don't correct this either by making the business meet the needs of its customers or by shutting the business down, they will lose all their capital. On the other hand, owners that make profit will need to continue to increase quality, lower costs, and innovate in order to maintain profits. A business may get far ahead of its competition allowing it to make very high profits, but this will attract new entrants into the market. They will see the opportunity to undercut the market leader thus attracting away his customers. This cycle continues on and on. By rewarding those who create the most value and punishing those who do not create value, the free market provides customers with the lowest cost and highest quality products. This feedback system is very important. It only works if you reward success and punish failure.

It's important to differentiate capitalism from corporatism. Corporatism is an economic and political system whereby power rests in the hands of the government and official cartels that are created or licensed by the government. These cartels correspond to various industries. For example, there might be a banking cartel, a military cartel, a healthcare cartel, and a steel cartel. In Corporatism, big government and big business make the decisions. Corporatism is also known as fascism, but that term can confuse people because they often conflate it with Nazism.

Another form of corporatism, or neo-corporatism, is where the government is heavily influenced by various businesses, labor unions, and industry trade groups. This is a softer form of corporatism that has many of the same consequences. I'm not aware of any true systems of corporatism today, but this softer form of corporatism is widespread.

Corporatism does not provide the benefits of Capitalism. In Corporatism, consumers generally do not get the highest quality products at the lowest prices. Cartels are effectively monopolies and they collude to fix prices. Fixing prices above the free market price allows them to make higher profits than they would otherwise make in the competitive market. When prices are fixed, there is less innovation and incentive to reduce costs and increase quality. Since prices are fixed, a company can not charge more for a higher quality product. Since profits are high, there is less incentive to lower costs.

In a cartel, businesses do not face the constant existential threat of a competitor coming in to take away their customers. In fact, with corporatism, companies are protected from failing as the companies that fail have large amounts of influence with the cartel and with the government. The cartel and the government will step in to prevent the failure because they don't want to disturb the system that benefits them. In this way, the system subsidizes failure. A cartel will also seek to retain the status quo and prevent one company from getting ahead of the others. This tends to punish or taking the incentive away from success. In this way, corporatism does not have the creative destruction present in capitalist systems but rather has the exact opposite characteristic of maintaining the status quo.

In corporatism, it's not just the prices of products and services that are fixed. Labor unions may have much influence and try to fix the price of labor. When the price of labor is fixed, there is little incentive for an employee to work harder because there is no way to make more money by doing a better job. Likewise, these systems also generally make it hard to fire an employee so an employee can often get away with the minimum amount of work that's just enough to avoid being fired.

Another thing that can be fixed is the cost of money. A banking cartel can set interest rates. Interest rates are the cost of money. If I borrow money, the interest is the cost to borrow. If I lend money to somebody, the interest is the price I charge. A banking cartel that also has a monopoly to create and destroy money is even more powerful. This debasement, or inflation, results in the loss of value to all existing money. Whoever gets the newly printed money receives an enormous benefit. In corporatism, the beneficiaries of this newly printed money are generally the other cartels and special interests. This is to the harm of the average person who does not get the money first but rather sees his existing money and wages lose value.

So what type of system does the United States have? I will address this in part 2. You can probably guess where I am going...


Vijay said...

Excellent post. Most left-wingers (I hate to misuse the term liberal as an appellation for them) confuse and conflate Corporatism and Capitalism, and use the former to disparage the later.

Understanding the difference is an important step in dispatching the prejudices of the left.

Steve said...

You mention that you can't think of any truly corporatistic modern economies. You may have thought of (and already dismissed) Japan. If you haven't they have an interesting way of doing things...

Jon Perlow said...

That's pretty interesting. Did the government explicitly encourage this model or was this something that developed on its own in the free market? Are the banks in the Keiretsu part of a government banking cartel like the United States Federal Reserve system?

If these corporations had enormous political and social influence, I would then say that it was a true form of corporatism. But it sounds like they are moving away from this model according to the article, but I guess old habits are hard to break.