This essay continues the discussion on Keynesian economics. It also offers a rebuttal to Mr. Baidoo’s misguided notions about Keynesian economics. Read on:
Title: “Government is Good: Capitalism Requires Government”
Author: Dr. Douglas Amy
Source: A web project of Douglas J. Amy, Professor of Politics at Mount Holyoke College
Capitalism Requires Government
"Americans need to realize that our economy has thrived not in spite of government, but in many ways because of government."
Without a whole host of government rules, capitalism could not exist. Even regulations and social programs help sustain a market economy by fixing many of its serious social and economic problems.
One of the most common and misleading economic myths in the United States is the idea that the free market is “natural” – that it exists in some natural world, separate from government. In this view, government rules and regulations only “interfere” with the natural beneficial workings of the market. Even the term “free market” implies that it can exist free from government and that it prospers best when government leaves it alone. Nothing could be further from the truth. In reality, a market economy does not exist separate from government – it is very much a product of government rules and regulations. The dirty little secret of our “free” market system is that it would simply not exist as we know it without the presence of an active government that creates and maintains the rules and conditions that allow it to operate efficiently.
GOVERNMENT RULES MAKE MARKETS AND CAPITALISM POSSIBLE
Markets, like governments, are very much social constructs. The market is a set of behaviors that is structured by rules, and many of the most important rules have been developed and enforced by government. Without these rules, our prized free-market economy would be a stunted and feeble version of what we see today. To see how this is the case, lets looks at these essential “rules” – the vast infrastructure of laws and policies that make a modern capitalist economy possible.
• LIMITED LIABILITY LAWS. Capitalism requires capital – lots of it. But without limited liability laws, investors are unlikely to risk investing their money in businesses. In the 19th century, before the passing of laws that limited the liability of investors, anyone who put money into a business that then went under could be held liable for the debts of the company. They could have their personal assets seized and could be financially ruined. Needless to say, this discouraged investment. Without limited liability laws, the economy would not have access to the capital it needs to grow and prosper.1
• PROPERTY RIGHTS. Without the right to own property and dispose of it as you wish, capitalism as we know it could not exist. These legal rights are created and protected by the government. Moreover, in the U.S., the federal courts have extended to corporations the same property rights given to citizens. Corporate property rights – one of the main legal instruments that insulate business from government power – can be created and maintained only by government.
• LAW AND ORDER. A market system cannot work well without a functioning criminal justice system. Otherwise, organized crime would easily take over large sectors of the business community. Extortion, bribery, kidnapping, and murder would become the reigning corporate model. Without the rule of law, our economy would resemble the “mafia capitalism” that Russia has suffered from in its transition to capitalism.
• BANKRUPTCY PROTECTION. Business is inherently risky and one of the largest risks is business failure, particularly during recessions and depressions. In the 19th century, before the creation of bankruptcy laws, business failures would usually saddle entrepreneurs with large and ongoing debts, making it impossible for them to make a fresh start and often putting them in debtors’ prison. Investors and creditors also often failed to get any of the money due to them. Bankruptcy laws protected otherwise healthy businesses that were temporarily short of funds. And these laws allowed entrepreneurs to be eventually freed from crushing debts. Along with limited liability, bankruptcy rules formed a crucial financial safety net for entrepreneurs. It is important to note, however, that bankruptcy laws were passed not simply out of concern or sympathy for failed entrepreneurs, but also as a way to lessen economic risk and therefore encourage more investment and economic growth.2
• A STABLE MONEY SUPPLY. Without reliable money, markets would be based primarily on barter and thus be extremely limited. In the U.S., before the Civil War, almost all paper money was issued by private banks – not the government. This was an unreliable and incredibly chaotic system. Sometimes merchants would not even accept certain currencies. It also meant there was no real control over the money supply – which has a crucial impact on inflation and economic growth. Widespread commerce and a stable economy both require a stable and dependable money system – one in which consumers and merchants have faith. This can only be provided and maintained by the federal government.
• PATENTS AND COPYRIGHTS. Large portions of our economy would grind to a halt if the government did not grant patents and copyrights. Without this massive intervention into the free market, the drug, music, publishing, and software industries could not exist. Bill Gates likes to think of himself as a self-made man, but he would not be one of the richest men in the world if the government did not make it illegal for anyone but Microsoft to copy and sell Windows.
• BANK REGULATION AND INSURANCE. As we have seen recently, a capitalist economy depends heavily on stable banks to finance growing businesses. But banks are inherently vulnerable to “runs” – where worried depositors all seek to take out their money at the same time. Banks cannot survive runs because they have loaned out most of the money deposited with them and therefore cannot pay it out to a large number of depositors at once. Before the passage of banking regulations and federal deposit insurance, banks regularly had runs and failed. The main reason that we had no disastrous runs on banks (and money market funds) during the financial panic of 2008 was that government was there to guarantee those deposits.
• CORPORATE CHARTERS. Capitalism today is corporate capitalism. But the corporation itself is a creation of government. Corporations can come into being only through charters: the legal instruments by which state governments allow businesses to incorporate. These charters and state business laws define what a corporation is, how it is organized, how it is governed, how long it may exist, who has a say in decision making, the rights of stockholders, the extent of its liability, and so on. Most states also retain the right to revoke the charters of corporations that break the law or harm the public interest, though this power is seldom used these days.
• COMMERCIAL TRANSACTION LAWS. Businesses could not operate effectively without laws governing commercial transactions. Few would risk doing business on a wide scale unless there was some way of making and enforcing contracts. Who would sell goods if they couldn’t be sure they would be paid, and who would buy goods if they couldn’t be sure they would receive them? The Uniform Commercial Code is a set of legal rules that determines, among other things, what a valid contract is, how contracts can be enforced, and various remedies for fraud, default, etc. It is over 800 pages long and covers every aspect of commerce in great detail, including laws governing the sales of goods, payment methods, receipts, warrantees, titles, shipping of goods, storage of goods, how sales are financed, and the leasing of goods. It is the legal infrastructure that allows business to be conducted smoothly and reliably.
• INTERNATIONAL TRADE LAW. Global capitalism would be impossible without trade. Governments create the legal frameworks – the treaties and international trade laws – that facilitate and make this trade possible. “Free trade” is a misnomer because it implies that it is international trade that exists free of any political framework. But this is hardly the case. The North American Free Trade Agreement, for instance, takes up two volumes and is over 900 pages long – covering such things as tariffs, customs, dumping, corporate and investor rights, intellectual property rights, financial services, government procurement, and dispute resolution procedures. It also establishes a secretariat, a commission, dispute panels, scientific review boards, eight industrial sector committees, and six working groups to oversee implementation of this agreement. It turns out that free trade requires a great deal of regulation.
• ENFORCEMENT OF LAWS. All of these rules and laws that facilitate business and markets have to be enforced, otherwise they are worthless. Just as international trade treaties require elaborate enforcement mechanisms, so do all our national laws that facilitate the business process. And this is no small effort. We and our governments spend billions of dollars every year to provide police to protect private property, courts to interpret and enforce contracts, and agencies to protect patents, oversee banks, and act as watch dogs in the stock and bond markets. It is revealing that most civil suits are not brought by individuals harassing corporations – as conservatives would have it – but by businesses suing other business. The courts are indispensable for resolving business disputes and thus ensuring the smooth operation of the economic system.
To see how just how essential these government contributions are to the workings of a free market system, you merely have to imagine what it would be like if these measures didn’t exist. Or if we didn’t enforce these laws. Imagine that investors were liable for all debts of a company, that there were no patents, copyrights, or property rights, that contracts couldn’t be enforced legally, that there was no official and stable money supply, and so on. In such a world, markets would be very limited, and economic growth severely stunted. It would hardly resemble the economic world we now live in.
Conservatives would like us to think that there can be a strict boundary between public and private in modern economies. But this is impossible. As the points above make clear, markets and capitalism are quasi-public entities – made possible by a myriad of government rules and laws that establish many of their basic inner workings. We may think of the “private market” as existing separately from the public sphere, but it does not.
FOOTBALL AND CAPITALISM: THE RULES MAKE THE GAME
Consider this analogy: free-market capitalism is constituted by government laws in the same way that sports are constituted by their rules. When we watch football, for instance, we usually see it as a freewheeling game with exciting runs and daring passes. But in reality, football is a highly circumscribed and regulated activity. It is only made possible by a large numbers of rules and regulations that cover everything ranging from the size of the field and the ball, to the number of downs, how scoring occurs, how tackling and blocking must take place, what constitutes a legal play, and so on. And without referees to interpret and enforce these rules, football as we know it would descend into chaos. The defining nature of these rules is shown by the fact that there are different kinds of football, depending on the rules. In Canada, for instance, the field is much larger, teams have one more player, and there are only three downs. In Arena League football, the clock rarely stops, the fields and goal posts are much smaller, and substitutions are very limited. The rules make the game.
Just as rules can create different kinds of football, government laws can create different kinds of capitalism and market relations. This clearly shows how market economies are actually political constructions – with their basic institutional arrangements being developed and managed by government rules. In some European countries, for instance, the government has not granted to firms the broad property rights that corporations have in the United States. This means, among other things, that large businesses are not free to simply move facilities from one region of the country to another. Because these relocations can dramatically alter the economic fortunes of entire communities, businesses must apply to the government for permission to move. In addition, in many other Western countries, government laws give much more power to unions in their relationships with businesses – thus altering the basic nature of the labor market. In some places, for instance, unions are actually mandated by law.
These kinds of market relations are no more or less “natural” than those we have in the United States. There is no one natural form of market relations – just as there is no one “natural” form of football. This is simply an illusion that business interests and conservatives like to foster. Capitalism itself can take on different forms depending on the government rules that form it.
THE FANTASY OF OUR LAISSEZ-FAIRE HISTORY
There is nothing new in the way that government aids business and a market economy. Conservatives would have us believe that our nation began and prospered under a laissez-faire arrangement, until the twentieth century and the advent of the New Deal and big government as we know it. But in fact, there has never been a complete wall between the public and private sectors. Government has always been involved in the economy. Active government support for business and the encouragement of economic growth can be traced back to the very beginnings of our Republic. Consider, for example, section eight in our Constitution – the one that describes the powers given to the newly created Congress. What is striking about most of the powers listed in this section is how mundane they seem. Here are the first eight of those powers:
Clause 1: The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;
Clause 2: To borrow Money on the credit of the United States;
Clause 3: To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;
Clause 4: To establish a uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;
Clause 5: To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
Clause 6: To provide for the Punishment of counterfeiting the Securities and current Coin of the United States;
Clause 7: To establish Post Offices and post Roads;
Clause 8: To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;
What is remarkable about most of these topics is that they have little to do with promoting freedom, justice, equality, or the other lofty political values for which the American Revolution was fought. What they are promoting is economic prosperity. This was the first attempt to create a legal and policy infrastructure that would promote and encourage business growth– establishing protective patents, providing a stable money supply, preventing counterfeiting, creating uniform duties on goods, establishing uniform bankruptcy rules, regulating foreign trade, and so on. Even the creation of post roads was not simply for the mail – these roads were the main avenues of commercial transportation in the states. Later, in clause ten, the Constitution also forbids states from imposing duties on goods from other states and prevents them from impeding the enforcement of states across state lines – all absolutely necessary if businesses are to grow into nationwide enterprises.
So as far back as the 18th century, American government has been working hand in glove with business interests to promote economic growth. In the 19th century, this government effort to aid the economy intensified and took on new forms. As seen earlier, numerous laws were passed on the federal and state level to protect investors and entrepreneurs from excessive risk and to give an artificial boost to economic growth. In addition, the key infrastructure development of that century–and one that fueled rapid economic development in the entire country – was the railroads. These were extremely risky ventures that had to be heavily subsidized by state and federal governments through loans, credits, and land grants.
Government also greatly strengthened and increased farm production through its establishment of agricultural colleges and agricultural extensions services. Further, research and development in public universities and land grant colleges were largely responsible for giving U.S. industries technological leads in areas such as metallurgy, and mechanical, electrical, and chemical engineering during the latter 19th century.3 Extensive and ongoing government tariffs also continued to protect and promote many vital domestic businesses throughout that whole period.
So the conservative idea that until recently we had a laissez-faire economy that prospered without any help from government is really a myth. Robert Kuttner, one of our most insightful commentators on the relationship between government and business makes this point very strongly. Looking at this long tradition of government aid for business in this country, he concludes that it “gives lie to the idea that the United States has historically been a laissez-faire nation.
Despite the constitutional restraints on state power and the generally libertarian national creed, government action for economic and industrial development is deeply ingrained in our heritage.”4
GOVERNMENT AND DEIFICATION OF THE MARKET
Up until this point, I have been talking about how government policies and programs actually help businesses and stimulate economic growth. These have clearly positive effects on business, and even most conservatives would not deny the beneficial economic results of the government enforcing contracts, keeping the money supply stable, limiting liability of corporations, and so on. But the fact is that modern democratic governments also do a lot of things that are not necessarily good for particular businesses – at least in the short run. And these are what really bother anti-government conservatives – things like environmental and workplace regulations that add to the cost of doing business, taxes that lower the profitability of corporations, and social programs that insulate people from the discipline of the labor market. There is no getting around that fact that some governmental actions do indeed reduce profits for some businesses.
For free-market, anti-government conservatives, most of this damaging government interference in the economy is simply unnecessary. In their view, if we simply leave the market alone, it can be trusted to produce virtually all of what we need for the good life in America. This unbridled enthusiasm about the wondrous abilities of markets is expressed well in a variation of the old light bulb joke:
Q: “How many conservatives does it take to screw in a light bulb?”
A: “None. If the government would just leave it alone, it would screw itself in.”
A silly joke – but it does capture well the sense of delusional optimism that many conservatives have about markets. The market is seen as a marvelous self-regulating mechanism that if left unfettered will provide all our basic needs – and a great many luxuries as well. This view rests in large part, as mentioned earlier, on the notion that markets are “natural” and can achieve a kind of perfection that manmade, artificial government cannot. It assumes that market-based decision-making will always produce the public interest – and that attempts by government to regulate markets only distort them and cause problems. As Rep. Dick Armey liked to quip: “The market is rational and the government is dumb." 5
In many ways, then, the conservative movement’s demonizing of government is merely the flip side of its deifying the market. And the term “deifying,” with all its religious connotations, may not be that far off. After all, it was Rep. Armey who suggested that our inspiration to participate in the market may come from above. “We have all been called to Freedom by God,” he said. “I think the free market arose from the calling.”6 Of course, most anti-government conservatives would not take it so far as to claim some kind of divine endorsement of the market; but many do adhere to a kind of “market fundamentalism.” This fundamentalism consists of an unquestioning faith that unrestricted markets are the best way to organize human activity and that they can largely do no wrong. We all need only follow our own selfish economic interests, and the “invisible hand” of the market will inevitably weave this all together to produce the public interest.
Moreover, free market mechanisms, if allowed to, would eventually solve virtually every pressing problem we have, including spiraling health costs, poor quality education, environmental pollution, unsafe products, retirement insecurity, and so on. So if we simply place our faith in laissez-faire capitalism, then we will all reap the rewards.
We shall return with Douglas Amy’s second take on government and market mechanism (with his references)…
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