The Concept of Capitalism
Bruce R. Scott
FUTURECASTS online magazine
Vol. 11, No. 11, 11/1/09
Describing the elephant:
So, what is
"capitalism," anyway? For two centuries, whole library shelves
have been filled with efforts to answer that question. However, there is little
confidence in the answers. There is always evidently so much left unexplained.
Theorists resemble at best the blind men describing the elephant by the part
they find themselves examining.
The focus is too narrow that inevitably leaves out much of the rest of the elephant.
Economic analysts must step back and open their eyes to view substantially more of the elephant.
Both political and economic systems must be robust enough to function with imperfect men and women achieving imperfect results at all levels. There are strong natural incentives that create constant threats to the proper functioning of both spheres and require constant effort at containment. At any moment, they must be a part of any valid economic analysis.
In "The Concept of Capitalism," Bruce R.
Scott of the Harvard Business School demonstrates conclusively one major
shortcoming of most efforts. The focus is too narrow. It inevitably leaves
out much of the rest of the elephant. This short - 75 page - monograph is the
author's summary of a much larger work, "Capitalism, Its Origins and
Evolution as a System of Governance," that will be published shortly.
Scott asserts convincingly that economic analysts must
step back and open their eyes to view substantially more of the elephant.
Government and private institutions and political policy
facilitate market mechanisms and do much that is absolutely essential. While the
author discusses the economic institutions and political spheres separately for
analytical purposes, the monograph right from the beginning emphasizes the deep relationships.
Indirect governance through regulated competition:
capitalist system is characterized by "indirect governance through
regulated competition" both in economic and political markets.
It is an economically, politically and legally empowered civil society working through the political markets and the courts that maintain limits on political excess.
"Only a political authority can correct these market frameworks, and this in itself should warn us that externalities will never be eliminated. Thus a market economy should be presumed to contain distortions that range from small to large, and even 'extra-large.'"
The political and economic systems are interdependent,
with each influencing the other. Competitive economic markets provide economic
discipline and accountability through the trading process, and competitive political markets provide
political discipline and accountability through the election process.
Thus, the maintenance of competitive capitalist markets
that meet the broad economic needs of the people and the nation depends on the
political markets functioning properly to assure that both political and
economic markets work for the
people instead of just for the politically influential and economically
Capitalism is as much a political phenomenon as an economic one. It involves - and requires - not just Smith's "invisible hand" in economic markets, but the "visible hands" of political actors in political markets.
Capitalism must be viewed as part of a system
where economic markets are embedded in institutions designed and governed by
political authority. Capitalism is as much a political phenomenon as an
economic one. It involves - and requires - not just Smith's
"invisible hand" in economic markets, but the "visible
hands" of political actors in political markets. In
democracies, political markets include elections, legislatures, and the
activities of civil society and economic interests. "Visible hand"
impacts of human agency also flow from government and private institutions that
have economic authority.
The huge concentrations of industrial power were ironically used by socialists and communists as a reason for establishing "a centrally planned, coercive state that would monopolize power even more" than either feudalism or the 19th century industrial giants.
"Smith's conception of atomistic capitalism, where
firms had little or no economic power," was already an inadequate framework for
analyzing capitalist systems as they had developed by the last part of the 19th
century. By that time, capitalist markets were dominated by vast industrial giants.
Democracies were few in number at that time and governments had not launched any
efforts to "embed markets in regulatory frameworks" to protect labor
or other interests.
The narrow scope of modern economics:
Capitalism was actually viewed in a broader context
at that time. The field was called "political economy" and it recognized the
role of politics in economic markets. Since then, theoretical and analytical
economists have persistently narrowed their focus first to just economic
relationships and then "to economic relationships that can be
mathematically modeled, as though economics were a science devoted to the
discovery and exposition of a system of natural laws."
The massive role of government in facilitating and governing markets has been obvious throughout the two century history of capitalism.
Today, microeconomics and the prevailing conception of
capitalism focuses predominantly on largely self regulating markets assisted by
such basic government services as property rights and rule of law and security
for persons and property. (Smith specifically recognized defense, rule of law and
infrastructure as important government roles.) This may have been adequate in
Smith's time, Scott points out, but is certainly inadequate today.
Merrill's view is also hopelessly simplistic. The massive
role of government in facilitating and governing markets has been obvious
throughout the two century history of capitalism. Human agents from the
political sphere, Scott points out, must play substantial roles "if the
market frameworks are to reflect public interest through proper recognition of
true social costs and benefits."
Competition cannot be the only regulatory agency.
Other critics, most prominently Milton Friedman, have also provided alternatives to the narrow focus of the mathematical economists, but their focus, too, has been too narrow. Scott criticizes Friedman for concentrating on the abuse of political power and ignoring the potential for abuse of economic power. (See, three articles beginning with Friedman & Schwartz, "A Monetary History of the U.S.(1867-1960)," Part I, "Greenbacks and Gold (1867-1921)") Competition may be a powerful disciplinary force in the economic markets, but its impact on market participants may vary greatly with size, geographical position, economic status and other factors. The interests of those with "meager resources, little education or human capital, and/or no financial capital with which to take advantage of market opportunities," will not be adequately protected by unfettered markets. Competition cannot be the only regulatory agency.
The need for a broader focus than mathematical
economists can provide is obvious. Economic influence can undermine political functions
just as political influence can undermine economic functions, Scott points out.
"Economic power can be a force for the subversion of equality among
persons, and thus a force for the subversion of freedom and democracy."
Neo-classical theory has proven inadequate as a basis for development policy. "It is concerned with the operation of markets, not with how the markets develop."
The five decades of failure of development economics
since WW-II has been the subject of economic historian Douglas North. Scott
supports his view that neo-classical theory has proven inadequate as a basis for
development policy. "It is concerned with the operation of markets, not
with how the markets develop," Scott points out.
Human agency -
human political choices - play a major role in the development of the pertinent
institutions, Scott emphasizes. The focus on the "trading paradigm" misses the aspect of
capitalism which bears most directly on the "productive paradigm"
involving the marshalling of resources for profitable development.
Capitalism is certainly more than a system for trading. It is the production paradigm that "is most susceptible to gross abuses of power," and is most subject to the influence of human agency within the capitalist system. If political actors do not develop and maintain property rights, contract rights, rule of law systems and the whole panoply of supporting and regulatory institutions, modern capitalism cannot exist.
The importance of institutional framework becomes clearly evident from a summary of the corporate production paradigm.
As focus on the production paradigm demonstrates, capitalism is certainly more than a system for trading. It is the production paradigm that "is most susceptible to gross abuses of power," and is most subject to the influence of human agency within the capitalist system. If political actors do not develop and maintain property rights, contract rights, rule of law systems and the whole panoply of supporting and regulatory institutions, modern capitalism cannot exist.
The essential elements of the capitalist economy thus include not just the product markets but also the factor markets and the supporting institutions and the political activities that develop and govern them. Politics includes political and societal institutions that are generally studied in the field of political science and remain outside the purview of economists. However, the contests for political influence have a direct impact on economic developments, and economic influence directly influences political developments.
The role of the "visible hand:"
Scott views capitalism as a particular system of
governance. Since it is more than just markets, it must be analyzed as part of
the broader field of political economy. It must include the political authority
that governs how institutions, incentives and constraints are designed and
shaped through political processes and the courts as well as how they are administered.
The modern field of economics in general and mathematical economics in particular are currently focused narrowly just on market transactions. Without the broader scope of political economy, economic policy will continue to fail at development economics, and the field of modern economics will continue to fail to provide an understanding of the business cycle.
political sphere, human agency "determines the rights,
responsibilities, and resulting powers of individuals and institutions within
the economic system over time." This is the broad province of "political
economy." The modern field of economics in general and mathematical
economics in particular are currently focused narrowly just on market
transactions. Without the broader scope of political economy, economic policy
will continue to fail at development economics, and the field of modern
economics will continue to fail to provide an
understanding of prosperity or decline in developed nations. Major causes
involved in the swings of the business cycle will remain beyond the
understanding of modern economists.
Market participants act in the relatively free economic markets within the bounds of laws and rules that establish acceptable behavior.
Scott explains capitalism as a three level system
of economic markets, private and public institutions, and political authority
accountable to political markets. It is an indirect system of governance, since
market participants act in the relatively free economic markets within the
bounds of laws and rules that establish acceptable behavior. Informal
customs among market participants are of course also very important.
Friedman's view, the author points out, is that most market
constraints should be by the customs developed over time by market participants.
Markets should be impersonal, apolitical, and unbiased, and government should
play as minimal a role as possible. However, even Friedman accepts that
government's role has to include doing what "the market cannot do for
itself, namely to determine, arbitrate and enforce the rules of the game." But
Scott asserts that the market system described by Friedman actually describes informal gray or black
market trade or the roadside fruit stand, not capitalism. It would be neither as
efficient nor transparent as appropriately governed capitalist markets.
The assertion that market capitalism "separates
economic activities from political views" is a practical impossibility,
the author points out in a further criticism of Milton Friedman. Political biases are
inherent realities in these as in all political actions. The laws "are
always created by political actors and therefore, to some extent, always contain
a political agenda or tilt within them." Economic analysis must be broad
enough to encompass this political fact of life.
Laws and regulations designed to facilitate markets
contrast with those designed to burden markets or constrain them in favor of the
politically influential. As an example of a rule that facilitates a market,
Scott refers to the credit card law requirement that issuers assume
responsibility for most charges on lost or stolen cards. The issuers
can spread these costs widely and most effectively act to minimize them. This
increases cardholder confidence in the use of the cards.
Democratic governments thus have an unavoidable responsibility to protect the citizenry from the abuse of economic power. They must also provide a wide range of "public goods." The study of economics and the analysis of economic markets thus must include both the political and economic spheres and all their interactions.
As in professional sports, the institutional context shapes
but does not control competitive behavior. In the formative years, the rules of
a sport draw upon "custom,
consensus and un-coerced conformity," evolving over time. However, modern professional games are governed by formal rule-making
bodies. Modern capitalist markets are governed according to sometimes narrow
majorities in legislatures and courts.
The vast growth of power and political as well as economic influence
of the 19th century industrial giants provides prominent examples of how
unfettered market participants can destroy freedom in political as well as
economic markets. Economic power can be, and has been, abused just like
political power. Markets can be shaped to work for the few rather than for the
many. This has in fact been common in oligopolistic nations from Russia and
Central Asia to Latin America.
The power relationships in capitalist systems are
emphasized by Scott. He focuses on the scope and interplay of the linkages
between economic and political power.
Capitalism cannot be understood without the political inputs of "human agency." There is and always has been a "visible hand" involved in shaping free market capitalism through political processes.
Capitalist free markets are embedded in institutions of public administration and government.
It is the state that grants the power to enter, compete and exit from markets, and restrains participants from abuse of such power. Market participants are compelled to follow the rules.
Numerous alphabet soup institutions play governing and
administrative roles in the U.S. Economic analysis must cover "the basic institutional
foundations, including physical and social infrastructure as well as the
individuals and organizations operating them." The author mentions
transportation and communications infrastructure as well as educational, public
health and legal systems. These institutions define acceptable market behavior.
They are agents of the state. (They also include the private agencies that have
public responsibilities, like securities and commodities exchanges and regional
Indeed, various forms of economic, administrative and political
coercion are pervasive in free market capitalism. Coercion is employed "to
create the freedoms of a capitalist system." It is the rule of law that
creates and enforces contract rights. Thus, capitalist free markets are embedded
in institutions of public administration and government.
The state, in turn, has a powerful interest in the efficient
functioning of its markets. Aside from nations suffering from the oil or other
natural resources curse, it is from a prosperous market economy that governments
draw their revenues and derive their power - political, economic, diplomatic and military.
Historically, during times of military threat, free market nations like Great
Britain and the Netherlands actively mobilized their economic resources for use
in their conflicts. Even mercantilist policies could be justified as a means of
mobilizing economic power for state purposes.
However, equilibrium alone is not enough. Equilibrium may be at a very low point due to distortions or inefficiencies affecting the market. Scott mentions the Great Depression and also the Credit Crunch with the prior expansion of the housing and mortgage debt bubbles. During the Credit Crunch, the markets struggled to maintain and regain equilibrium in supply and demand against major distorting influences. (See, "Moral Hazard and Conflicts of Interest in the Credit Crunch.")
Capitalism thus must be analyzed as a mix of sociology,
administration, politics, economics and law.
"The essential institutions of capitalism cannot develop along with the needs of society absent the informed and capable input of human agents, such as those empowered through a government."
Capitalism must be viewed as including the "political level" where human agency impacts markets.
The political role may appear static in the short run. As the system
operates according to its existing rules and regulations, government is involved only in an
administrative capacity. However, government is not just a "given"
factor. As time passes, changing conditions in the
markets and changing societal objectives require adjustments to the laws and
regulations that only political authority can provide. Thus, political markets
are just as dynamic and vital as economic markets in understanding capitalism.
Scott is not naïve about the capabilities of the political decision
making process. He recognizes that government policies can undermine the
markets, and frequently have. Loose credit and low interest rate policies played
a significant role in the housing and mortgage bubbles of the Credit Crunch, and
it was an obvious political mistake to leave it to the markets to deal with
the results. Economic analysts thus have no choice but to cover the mix of
political influences when analyzing market conditions. Political authorities
must be held accountable for policies that adversely impact the markets.
Abuse of the commons:
Mitigating "the tragedy of the
commons" is a vital political and institutional role emphasized by the
He uses the term "commons" broadly to encompass not just tangible assets but intangible assets as well, like defense, law, and the institutions of capitalism and democracy themselves. Prevention of the degradation of such assets can only be done through government.
Currently, the degradation of fisheries provides a classic example of the tragedy of the commons in a still largely informal economic market of the type Friedman described. Atmospheric pollution provides another example.
Market frameworks themselves are an intangible "common" that can be - and have been - and even today are being - subject to abuse. The framework for goods and services markets grew naturally from common practices and the laws, infrastructure and physical security that facilitate the markets. However, factor markets, involving land, labor, technologies and capital, required far more political and institutional input. Serfs and slaves had to be freed from feudal obligations, corporate entities had to be accorded legal status. These developments occurred much earlier in some nations than in others, and sometimes required violent change. In some states, even today, these changes remain partial at best.
Government ownership of economic entities
creates conflicts of interest that as a practical matter become irresistible.
(This applies to government sponsored enterprises, too.)
The regulatory and tax framework will always be biased in favor of the government entities.
Scott thus advises caution in establishing government economic entities or in government takeover of private entities. Exceptions for public utilities and during periods of national emergency are recognized.
Competition in the political market:
Government actions inevitably
"tilt" the markets towards politically influential groups. The
tilt may be explicit and/or implicit. Indeed, there will always be a combination
of impacts, and they will not always be consistent.
Among the broad categories of people vying for political favor are
capital and labor, investors and creditors, producers and consumers. Promotion
of growth and development may vie with protection of the status quo. Different
levels of risk may be accepted or rejected. Responsibilities are allocated.
Government decisions inevitably favor certain interests over others.
The market for land is a primary example. This market is shaped by zoning
laws and laws governing property rights. Both zoning laws and property rights
can be changed by pertinent officials as societal priorities change.
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Copyright © 2009 Dan Blatt