How Capitalism Will Save Us

by Steve Forbes

  At one time, Malanga writes, such organizations were privately funded. They focused on serving the poor and did so without the help of government. All of this changed with the Johnson administration’s War on Poverty:

  The feds allocated billions of dollars to nonprofits through direct grants or via money funneled through state and local government agencies. In the process, the federal government paid nonprofits to do everything from running homeless shelters and rehabilitation programs for drug addicts to opening job training centers and designing and operating preschool programs. In just a few years, the money turned many charities into government contractors, reliant on public funding and serving an agenda set by Washington or local governments. The sudden availability of so much government money also prompted enterprising individuals to get into the public-contracting game and create new nonprofits of their own….

  Today, though the city’s population has increased only slightly since the mid-1970s, social-services jobs number more than 160,000, making them one of the fastest-growing sectors. Indeed, private social services [even before the crash] now rival Wall Street as one of Gotham’s biggest employers; three times as many people work in private social agencies as in publishing. But while these service jobs are counted as part of the private sector, they’re financed almost entirely with government money. The industry continues to rely for its growth on expanding government budgets, fueled by tax collections.

  Once narrowly focused on serving those in need, the social-services sector, Malanga writes, is today a government-supported industry. Inevitably politics enters the picture.

  [M]any nonprofits have become political power bases, replacing the local political clubhouses of the 1960s. Executives and founders of nonprofits have used their agencies as launching pads for political careers, so that today a job in the nonprofit sector is as likely a route to the City Council or the state legislature as being a lawyer and member of a local political machine once was. And channeling money into nonprofit groups is a sure way for a legislator to win friends and influence people.32

  Funded as they often are by pork-barrel spending, organizations have resisted reforms—like being made subject to competitive bidding to win government grants. Some have become enmeshed in scandal, Malanga says: “City Council staffers have created phony nonprofit groups and allocated money to them as a way of parking cash that could be dispensed later.”33

  One wonders if this is the kind of safety net the Founding Fathers or anyone else had in mind.

  Occasionally, it is possible to scale back and reform counterproductive government programs. President Bill Clinton realized the unsustainability of welfare in 1996 when he signed into law the Personal Responsibility and Work Opportunity Reconciliation Act. Welfare rolls dropped by nearly two-thirds. What happened? Sixty percent of the welfare mothers who left the program found employment.

  What about Social Security and Medicare? Government can administer these programs. But they must be overhauled to make them sustainable. Younger people should directly own their Social Security and Medicare accounts. That way, the government won’t be spending—and wasting—other people’s money.

  No one denies the need for safety nets for those who truly can’t help themselves or for those who are victims of natural disasters. They’re part of a humane democratic capitalist society. But they need to be economically sustainable in the Real World.

  REAL WORLD LESSON

  A thriving market economy is the best answer to poverty. Social programs in a democratic capitalist society should not be so costly that they crush the private sector.

  Q IF INNOVATION IS CRITICAL TO ECONOMIC GROWTH, THEN SHOULDN’T GOVERNMENT MONEY BE USED TO FUND IMPORTANT YET UNPROFITABLE ENDEAVORS—SUCH AS BASIC MEDICAL AND SPACE RESEARCH?

  A THERE’S NOTHING WRONG WITH SOME GOVERNMENT FUNDING OF CERTAIN KINDS OF BASIC RESEARCH, AS LONG AS GOVERNMENT DOESN’T CONTROL IT COMPLETELY.

  Government funding of science constitutes a fraction of total spending and is not a burden on the economy. Add up all government research and development from defense to space to health to the sciences and it all wouldn’t come to 5 percent of the budget. What makes up the bulk—40 percent—of domestic nondefense spending is actually entitlements—Social Security, Medicare, and Medicaid.

  It’s all about proportion. Throughout our history, government has financed or engaged in many important endeavors. The Lewis and Clark expedition was initiated by Thomas Jefferson to explore vast new territories the United States had acquired from France in the Louisiana Purchase. In the 1920s, the Department of Commerce helped set standard measurements. Government engages in map making and has helped set uniform time zones.

  The United States has also encouraged ventures such as the building of railroads with land grants. After World War II, Uncle Sam accorded pipeline companies powers of eminent domain so that national gas networks could be built across state lines. Government has also supported basic research in health and medicine that might not have been undertaken by the private sector. Even Adam Smith believed that the government had a duty to maintain

  those public institutions and those public works, which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay the expense to any individual or small number of individuals.34

  The economy and society have benefited from many of these efforts. Without government funding, we would probably never have had the space program. No private company could have developed satellites. The costs were prohibitive. Even today, what company could spend the equivalent of tens of billions of dollars to send a man to the moon when there is no economic return?

  However, this does not mean that the government should run technology or biotech companies or be in the business of dictating the direction of all science and health research via a cabinet-level “Department of Innovation,” as some have recently suggested. Such a bureaucracy in the Real World would inhibit innovation.

  Why? Because while government—most often, the military—can occasionally develop new technologies, innovation is not its core capability. At its heart, government is a bureaucracy. Its business is enforcing rules, managing and preserving what has been already been established. Risk taking, unless specifically sanctioned, is usually avoided. Why do anything that could get you criticized? Better to keep your head down.

  In contrast, innovation is all about risk—experimentation, trial and error. Hayek recognized that open markets are more innovative by their very nature because they encompass a diversity of people and know-how. People in all kinds of unexpected places are developing and testing new ideas. Hayek wrote in The Constitution of Liberty that the disorder and freedom of capitalism are precisely what enables this. You never know where the next big thing will come from. In contrast, “the majority action” usually taken by government focuses on what has been tested and proven.

  We do not know how individuals will use their freedom…. If it were otherwise, the results of freedom could also be achieved by the majority’s deciding what should be done by the individuals. But the majority action is, of necessity, confined to the already tried and ascertained, to issues on which agreement has already been reached in that process of discussion that must be preceded by different experiences and actions on the part of different individuals.35

  Author Sheldon Richman also makes the point that the private sector’s market discipline promotes better decisions about where to focus research efforts and resources. “Entrepreneurs … earn profits only by anticipating what people will find beneficial and be willing to pay for. They must take costs into account and have no taxpayers at their disposal.”36

  Thus, the National Institutes of Health has spent hundreds of billions of dollars on research over the last twenty years, yet it has developed only eighty-four new drugs. Most of the advances that have produced medicines for the broad population have come from pharmaceutical companies. And as we’ve already noted, the milit
ary created the mainframe computer and what became the Internet. But it was the private sector that developed these technologies into the revolutionary innovations they ultimately became.

  NASA did indeed put a man on the moon in the 1960s and shuttles into space. But in recent years it has been criticized for bureaucratic afflictions, including poor cost control, inefficiency, and operational decline. The agency’s research helped give birth to the computer-chip industry in the 1960s. But forty years later, by the early 2000s, the New York Times reported that the agency relied on “outdated computer chips, circuit boards and eight-inch floppy-disk drives” and had to search for replacement parts on eBay.37

  One need look no further than the White House for examples of the backwardness of bureaucracy. The Washington Post reported that when the tech-savvy Obama administration took over its new digs at the White House in 2009, it “ran smack into the constraints of the federal bureaucracy… encountering a jumble of disconnected phone lines, old computer software, and security regulations forbidding outside e-mail accounts.” The paper quoted an Obama spokesman who complained, “It is kind of like going from an Xbox to an Atari.”38

  REAL WORLD LESSON

  The fundamental disorder of free markets makes them more creative and innovative than a government bureaucracy.

  Q ISN’T THE FREEMARKET PRESCRIPTION FOR THE ECONOMY ESSENTIALLY TO “DO NOTHING”?

  A QUITE THE CONTRARY, IT IS TO CREATE THE CONDITIONS THAT ENABLE THE DYNAMIC MARKET TO WORK.

  Shortly after taking office, President Obama responded rapidly to the financial crisis. He unveiled his massive stimulus package, calling on Congress to “act boldly and act now” to pass it immediately.39 Even those who didn’t agree with his breathtaking spending were impressed by his swift response. His decisive performance no doubt helped contribute to his initial high approval ratings.

  When a crisis hits, most people are taught that the correct response is to “do something” to “fix” the problem. That impulse is ingrained in our collective psyche as a “can-do” nation. When something bad happens, we’re supposed to come to the rescue with all the expertise at our disposal, doing what we know how to do best. For politicians, “doing what they do best” means making laws and spending lots of money. Not only politicians but also the public seem to want leaders who will act. So you can’t entirely blame people when they assert that the response to a crisis in the economy is to intervene and “do something” to change the situation. To do otherwise is considered by many to be downright un-American.

  In the 1930s, Friedrich von Hayek was asked what should be done about the Great Depression. Hayek famously said, “Do nothing. The economy will recover on its own.”40 Author and economist Mark Skousen writes that this was not what people wanted to hear. “When the economy didn’t recover for years, Hayek and the Austrians lost the war of ideas to Keynes.”41

  What Hayek probably meant was that government should not impose artificial constraints on the market and instead allow it to work. That doesn’t mean “doing nothing.” Mark Skousen believes that Hayek might have won his debate with Keynes if instead of recommending that we “do nothing,” he’d presented his ideas for what they most likely were: a plan to stimulate the economy by lowering taxes, eliminating draconian regulations, and creating an environment of sufficient certainty that businesses could invest, grow, and recover.

  Hayek’s words may not have been well chosen. But his ideas are constantly borne out in the Real World. Despite the chest beating of freemarket critics over even normal business cycles, most recessions don’t last very long and are self-limiting. Prior to the financial crisis, the average recession lasted an average of eleven months.

  Again, remember the story of the pencil. The market’s “invisible hand” responds spontaneously to meet the needs of people. When there is an imbalance in demand or supply, the market automatically works to restore equilibrium—without any bureaucratic diktat or government stimulus. That includes correcting the conditions that cause a recession. If too many people are out of work, for instance, prices drop. Lower prices and, eventually, pent-up demand spur people to start buying again. Entrepreneurs, including people who may have been laid off in the downturn, take advantage of cheaper prices and available manpower and start new businesses. The economy begins to recover.

  Unfortunately, in the Real World, government efforts to “do something” and “fix” a down economy often end up creating additional imbalances and barriers that inhibit these forces. They make things immediately worse—or set the stage for a future market upheaval. People understood this in the early part of our history. As Robert Higgs, an economist at the Independent Institute, a respected market-based policy think tank, wrote recently,

  the United States managed to navigate the first century and a half of its past—a time of phenomenal growth—without any substantial federal intervention to moderate economic booms and busts. Indeed, when the government did intervene actively, under Herbert Hoover and Franklin D. Roosevelt, the result was the Great Depression.42

  The Smoot-Hawley Tariff was far from the only government move responsible for the Depression. Economist and historian Amity Shlaes compellingly recounts in her landmark book The Forgotten Man: A New History of the Great Depression that a succession of interventions caused and prolonged the historic slump. She recently wrote in Forbes,

  [President Hoover’s] tenure was marked not by laissez faire or respect for private property—indeed, Hoover had labeled property a “fetish” before he became president. The Great Engineer was in fact the Great Intervener, meddling in multiple areas, raising taxes and backing tariffs, to the economy’s detriment. Mistrusting the stock market as unreal, Hoover berated short-sellers and exhorted businesses to keep wages high when they could ill afford it.

  International, monetary and banking factors all played a role in creating the Depression, but the counterproductive Hoover mattered as well. As economist George Selgin has noted, the most absurd of the Hoover increases was a 2% levy on checks, which caused people to further drain money out of their bank accounts so they could pay their bills, untaxed.43

  FDR took office in 1933 in the pit of the Depression. He immediately instituted a bevy of measures intended to boost the economy and create jobs—including public-works programs, wage and price controls, and enormous tax increases. Not only did they drain the economy of capital, they created an uncertain, hostile climate that crippled private-sector businesses and job creation.

  Roosevelt’s National Recovery Administration, created in 1933, pulled wages up when perishing companies could not afford it; come 1935, the Wagner Act gave unions more bargaining power, forcing further wage increases on companies. Roosevelt’s multiple tax increases caused businesses to postpone investment. Especially counterproductive was FDR’s “undistributed profits tax,” which punished firms for being cautious and forced them to disgorge cash at the worst possible moment.

  … Other big players also saw what was going on. Week in, week out, the chief economist of Chase bank, Benjamin Anderson, penned a diary reporting the negative consequences of government regulation, taxation and prosecution. Lammot Dupont summed it up when he wrote, “Uncertainty rules the tax situation, the labor situation, the monetary situation and practically every legal condition under which business must operate.”44

  Shlaes writes that this uncertain climate caused the United States to rebound more slowly than France, Britain, and Canada. When it finally took place, our recovery was less than robust. American unemployment was higher than in those other countries. Before the Depression an American worker earned 30 percent more than his British counterpart. However, by the beginning of World War II, U.S. workers had lost their wage superiority.

  Robert Higgs has noted that the “regime uncertainty” created by policy activism is “what Keynesians usually fail to grasp.”45 Whatever the intentions of such policies, in the Real World, “activism itself works against economic prosperity by creating … a pervasive
uncertainty about the very nature of the impending economic order, especially about how the government will treat private property rights in the future.”46

  Higgs points out that similar economy-inhibiting regime uncertainty is being created today by “the government’s frenetic series of bailouts, capital infusions, emergency loans, takeovers, stimulus packages, and other extraordinary measures crammed into a period of less than a year.”47

  REAL WORLD LESSON

  Attempts by well-meaning politicians to “do something” often exacerbate economic imbalances by creating uncertainty and imposing new, artificial constraints on a market.

  Q WHAT’S THE BEST WAY TO FIX THE ECONOMY?

  A CREATING THE OPTIMUM ENVIRONMENT FOR THE RISK TAKING AND ENTREPRENEURSHIP THAT PRODUCE JOB CREATION.

  For starters, we should avoid repeating the mistakes that got us into this crisis. The Federal Reserve and the U.S. government must have a firm policy, codified into law, that assures a stable dollar. The way to do this is a link to gold. Gold’s effectiveness in creating a healthy economy is borne out by history: George Washington and our first Treasury secretary, Alexander Hamilton, wisely recognized that a monetary policy based on a gold standard constituted the bedrock of a strong economy. Their prescience and insight helped give birth to America’s economic miracle.

  Along with going to a gold standard, we should fully privatize Fannie Mae and Freddie Mac. These monster government affiliates should be broken up into several parts and their ties to government severed. Breaking up Freddie and Fannie into smaller private mortgage entities would eliminate the market distortions created by these two giants; it would open the field to new companies that would not have to fear having to compete against the U.S. government. The smaller entities could perform Fannie and Freddie’s role: raising private capital to buy mortgages from banks and mortgage bankers, then packaging and reselling them to pension funds and other investors. If one of these smaller companies got into trouble, the impact on the market wouldn’t be as great.