All human beings love the taste of freedom. While our ‘utility maximizing’ nature is being fiercely debated by economists and sociologists, there is one fact which both economists and sociologists agree upon – humans love making their own choices and taking their own decisions. Capitalism (on paper) has guaranteed all of these individual rights. No other economic system has respected individual liberty and at the same time achieved efficiency. Some might contend that Communism or Collectivist approaches have worked. But in some way, it has ended in the same hegemonic mess that we see in a capitalistic society. Of course, there is no doubt that capitalism has its flaws. That is the reason why I am writing this article and many economists/policymakers are having a heated debate on this topic. In this article, I will attempt to shed some light on the flaws of modern-day capitalism and possible solutions that would make the system more efficient.
Capitalism’s efficiency has always been questioned throughout history. We have the Marxian critique from the 19th Century which states that capitalism is ‘a contradiction-laden system.’ In 1929, many prominent economists questioned it again during the Great Depression years. Fast forward to 2008, we see that again the system is under great scrutiny – we see an economic, financial, social, and political dimension to the critiques. We can observe that these crises disproportionately affect poor people, people of color, and people with vulnerable jobs. Now, one might think how a system with so many flaws is being lauded by a majority of people around the globe. The problem isn’t with the idea of capitalism, but the common interpretation of capitalism is broken. We assume that the players in the market and the economy are from a weird species known as ‘Homo economicus.’ Anyone who has done basic science classes in High School can tell that there are no such species on our planet. Unfortunately (or fortunately) we are ‘Homo sapiens.’ We do not make rational decisions, nor do we work at our maximum level. The ‘rational human beings’ theory sounds good on paper but in reality, we have seen that it seldom works. This assumption has done a lot of damage to capitalism and how we perceive economic systems. Capitalism isn’t alone here – even Socialists and Marxists have made similar assumptions in their theories. As the economist Thomas Sowell jokingly remarked in an interview, “Marxists/Socialists think that human beings are blocks of wood.” If this isn’t a unique problem faced by capitalism, then one might ask why I’m listing it as a flaw specifically by capitalism. That is because that this flaw can be corrected using some behavioral methods (in a capitalist economy). Nudges or positive reinforcements in the form of incentivization have been proved to be effective. The proponents of this theory, Richard Thaler and Cass Sunstein, played an integral role in the Obama administration’s economic policies. The same duo traveled to the other side of the Atlantic to advise Tory Prime Minister, David Cameron. There is enough empirical evidence that people respond to incentives. Incentives can be shoved to our throats by absolute government intervention, as in the case of some socialist/communist states. But that won’t be effective in the long run, as it doesn’t guarantee ‘individual freedom’ or happiness. Some incentives like ‘Nudges’ can be used without coercing the people in concern and at the same time achieve the needed results.
Another issue that is faced by capitalist economies is the issue of rising inequality and low social mobility. While these countries achieve a slightly higher rate of growth, it comes with a terrible side-effect – the malady of poverty and inequality. There’s a disturbing correlation between the rate of growth and inequality. It is an inversely proportional relationship, at least in developed countries. The graph below shows this relationship. It takes the Gini coefficient on the X-Axis and GDP growth-rate on the Y-Axis.
Does this mean that a high GDP growth rate can be achieved by sacrificing equity? The answer is no. While these datapoints expose the flaws of the current state of capitalism, the goal of stable GDP growth (indicating productivity) and low Gini coefficient (indicating lower inequality) is not a pipedream. The solution is at the intersection of economics and sociology. The first way to do it would be to improve ‘Human Capital’ investments. Basic factors like worker productivity, healthcare, and education must be made accessible for most of the population. It is proven that there’s a direct correlation between access to good education, healthcare, and improved social mobility. Economist Raj Chetty’s work on social mobility has proved that this correlation is true theoretically and empirically. In the short run, this might increase government spending and taxes might need to be increased. But this is just a small price to be paid for a better standard of living. Increased Human Capital investment leads to be better productivity. Better productivity improves efficiency and that is the ultimate economic goal. Another probable solution would be to increase Social Capital. It is defined as ‘the network of relationships between people who live and work in a particular society, enabling the society to function effectively.’ This includes better family structures, lesser racial violence, and stable childhoods. In some countries, all of the factors mentioned above are interlinked. For example, upward mobility rates for black men in the U.S are much lower compared to the national average. This is because black men are more likely to be spending their childhood with a single parent. They also face racial discrimination which harms the Social Capital. To create awareness about Social Capital, we need to make sure that education till 12th grade is compulsory for everyone. The government must implement policies that incentivize minority students to study in more competitive schools. The base for this goal is set in elementary schools. So, the focus should be from the primary level.
Modern-day capitalism fails to understand the salience of another basic economic concept – externalities. It can be defined as a cost or benefit that a third party incurs without agreeing to incurring that particular cost or receiving the benefit. Externalities can be both positive and negative. While positive externalities serve as a good incentive to the economy, negative externalities can have deleterious effects on the markets and the economy in general. The best example of a negative externality would be air pollution caused by excessive usage of automobiles and emissions from fossil fuel factories. Air pollution could be viewed as an unfavorable cost to the economy because it is a negative externality that hampers the standard of living. For example, the counties in the ‘Cancer Alley’ of Louisiana are known to be the hotbed of various health issues. This is due to the pollution from the coal powerplants that have polluted the nearby water bodies. The air quality in this part of Louisiana is said to be one of the worst in the whole of the U.S. The businesses which have a profit-maximizing motive haven’t considered the potential harm caused by their production processes. Lack of government intervention coupled with political lobbying and corruption has led to this situation. These businesses contend that their work adds to economic growth and keeps employment stable. While this might be partially true, this ‘pro-growth’ argument is fallacious. Consider an industry that relies on using natural resources and also pollutes the environment. If it pollutes beyond a level, it’s going to increase the unwanted costs in the form of negative externalities. This in turn affects individual worker productivity by affecting Human Capital conditions. When worker productivity decreases, there will be a commensurate decrease in the standard of living. That directly affects long-term economic growth and economic stability. But this is solvable. There is a growing consensus for the implementation of Pigouvian Taxes. This is a tax that’s imposed on economic activities generating negative externalities. Carbon taxes are an example of a Pigouvian tax. The Carbon Tax is a price paid by businesses for increasing the carbon footprint. This would disincentivize businesses to pollute more as it increases the cost of production. While this hasn’t been discussed in a political setting, several theoretical and empirical findings prove that these taxes are effective.
All of these policies require some heavy government intervention and public spending. In today’s heavily polarized political discourse, it has become tough to navigate on certain policy issues – as it has become deeply partisan and less scientific. It is no secret that the Laissez-Faire model of self-correcting individuals is a myth handed down to the West. At the same time, excessive power given to the government and lack of private property can have severe repercussions on the economy and the polity in general. The third way would be to make capitalism more humane. These flaws can be corrected with small policy changes that are based on empirical evidence and facts. That is the beauty of capitalism. So, to combat dogmatism and to embrace pragmatism, we need one tool – Progressive Capitalism.