Reframing Capitalism

5 minute read.

I was raised by back-to-the-land hippies, so I grew up with a pretty negative view of capitalism, but also with no clear idea of what the word meant. My parents were distrusting of rich people; a bias I still carry with me even as I'm becoming one. They considered debt to be evil; they never even had a mortgage, having bought five acres in the 1970s for $10,000 which they borrowed from my five-year-old brother's inheritance. They paid him back, though I have no idea if interest was involved. So anathema was debt that I honestly believed I couldn't go to college without a free-ride, since they had no money to send me. I managed to get enough scholarships from writing a dizzying array of application essays, but upon arrival I realized my stress was probably misplaced given everyone else had taken out student loans. 

One of my closet friends in college had the opposite upbringing, where his family not only discussed investment at the dinner table, but played Monopoly with complex derivatives and futures contracts. During the great recession my group of friends was lucky enough to still have jobs and he told us there was no better time to start investing than when the market is historically down. He became our mentor as we began using the stock market. I quickly learned that I was no better than a dart board at picking stocks and that my stress was much lower with index funds. But at this time I also became interested in economics and everything that was being done to try and fix the crisis. 

I eventually realized a fundamental misconception I had about capitalism: that it was an engineered economic system like communism, to which it is so often contrasted. In fact, capitalism is fundamentally the lack of a system; it is what naturally forms when a society has a concept of private ownership and enough laws to keep people from stealing from each other. It has existed as long as people have traded and bartered with each other. And it has been railed against almost as long: look no further than the fact that Christians for many centuries and Muslims largely still forbid usury, the charging of interest on loans. That's a pretty early and fundamental innovation of capitalism and these bans helped create a lot of antisemitism, since Jews were the only group left in the western world who could reasonably make loans to the rest of society. It's a pretty raw deal to be hated for profiting from providing a service that is in so much demand. 

Even the feudal world was capitalist, just with the wealth tremendously concentrated among the nobility. The big discovery that led to our modern understanding of capitalism is that the economy is not a zero sum game. Before Adam Smith and classical economics, the prevailing wisdom especially among the ruling classes was that wealth was a function of resources and since natural resources are finite, you could only increase your wealth by taking someone else's. This was the basis of so many wars. The discovery was that in fact natural resources are only a small fraction of the wealth of a nation; most wealth is created through work and trade. This is critically important because there is effectively no limit to the amount of work that can be done, and therefore the amount of wealth that can be created. In another words, the economy is not a zero sum game: you can become more wealthy by doing more work, for instance by using a machine that helps you make more than you could by hand, and all without taking wealth from anyone else. I cannot stress enough how important this discovery is. Most of our leaders have finally learned that they can increase their wealth faster by cooperating on trade than they can by waging wars. Of course there is currently one glaring exception, and it is a somewhat feudal government whose economy is dominated by resource extraction. 

Okay, so if capitalism is ancient, has helped create enormous wealth, and has even reduced war, why does it get such a bad rap with so many people like my parents? I would posit that inequality is the root of the problem. There are many theories on why inequality tends to increase over time, though no clear consensus. However, it has been shown pretty clearly that inequality has rarely ever decreased except through catastrophe: war, revolution, plague. There's much talk these days of inequality in America, but what's unusual historically is not today's inequality, but the amazingly low inequality in the decades following the largest war in history. Many economists have said don't worry about inequality; a rising tide raises all ships. You should be happy your wealth has increased, regardless of whether someone else's has increased more. But this is not how people think; we compare ourselves to each other, so we feel poorer when we feel left behind, even if we are somewhat better off than before. In this light it is clear that steadily rising inequality is unsustainable and will inevitably lead to revolution as it has so many times in the past, unless some other catastrophe arrives first. 

I would argue that inequality has another side effect that is perhaps of more concern to economists. I believe that as inequality increases, so too does the difficulty of climbing the socioeconomic ladder. Social mobility has been a hallmark of America from the beginning and I think is responsible for a large part of our prosperity. A meritocracy expects the highly capable to rise to positions of power regardless of their background, but this can be hindered by gaps in education and even culture that grow between the rich and poor when they are sufficiently separated. The result is underutilized talent, which means less innovation and slower economic growth. 

Karl Marx also identified this trend of rising inequality, but his prescription was so extreme that the medicine was worse than the disease. It's hard to believe that communism vs capitalism was once a lively debate, since now basically every communist state has miserably failed, generally with much unnecessary suffering and death. Though China continues to call itself communist, and does retain the authoritarianism, it looks less and less communist every day. Communism had several major flaws: authoritarianism and corruption made people distrust the system, economic central planning turned out to be a very hard problem, and removing inequality also removed the incentive to work. That last point I find especially interesting, because it implies there is a sweet spot for inequality: too much and people get angry and inefficient; too little and people don't work. 

What to do to improve the system I'll leave to another post, or probably several, but what I want to leave you with today is how I've learned to frame capitalism. It's easy to hate the rich, to assume they've risen by somehow stealing from you, but the reality is the money they have you freely gave to them in exchange for something valuable they created for you. They are rich, not entirely, but largely because they are good at playing the game of capitalism. Don't hate the player, hate the game; or better yet, help change the rules to make it work better. But also remember that it's not all bad: everything you have, from your house to your car to your phone to the music you listen to and the movies you watch, it's all better than it's ever been (mostly) and it was all created by capitalism.