How Capitalism Will Save Us (71 page)

The rule of law
. A vibrant economy requires that terms of commercial contracts are respected and enforced, and that everyone, including politicians and government bureaucrats, abide by them. When rights are violated, people and businesses have recourse in a fair and judicious court of law. The rule of law should guarantee that officials cannot act arbitrarily, as Argentina’s government did when it recently seized the private pensions of citizens in the country’s national
equivalent of a 401(k). Arbitrary, capricious government is a major reason that Argentina has a lagging, perennially troubled economy, and why it is no longer one of the richest nations in the world, as it was one hundred years ago.

The United States, in contrast, has long been a magnet for foreign investment because its legal system assured a relatively safe haven for investors. Government could not suddenly seize your property or nationalize your business.

Respect for property rights
. Property rights are a critical part of the rule of law. If you own a business, an object, a piece of land, or a house or building, you should not have to fear that an envious or angry government might one day seize it arbitrarily. If a society does not have strong property rights, risk taking will decline. Entrepreneurs would be forced to protect their property by buying influence with the political powers that be, wasting time and resources that would otherwise be devoted to growth-producing enterprises.

Property rights help create prosperity because they allow people to use what they own as collateral. Land and buildings become not just utilitarian items but also sources of capital.

Early on, the United States developed a strong property-rights system, and we take its protections for granted. But property rights as we know them still do not exist in many countries, and not just communist countries like Cuba or North Korea. Until recently, for instance, Egypt had at least eight different property systems. No surprise that countries with Western-style property rights enjoy a far higher standard of living than those that don’t. Studies by the World Bank and others have shown that weak property rights hamper economic development.

Several years ago, noted economist Hernando de Soto calculated that four billion people around the world owned real estate worth $9 trillion. But because of weak property-rights systems, this real estate was, as de Soto put it, “dead capital.”
⁴⁸
Imagine how much of the world’s poverty would be reduced if people were able to fully mobilize these trillions of dollars of assets.

China and other growth-oriented developing countries are starting to wake up to this.

Despite the widely acknowledged importance of property rights to a healthy economy, governments and politicians routinely find excuses for violating them—including in our own country. The U.S. Supreme Court in 2005 flouted the Constitution with its widely criticized decision in the case of
Kelo v. the City of New London, Connecticut
, which sanctioned the misuse of eminent domain law. Eminent domain has traditionally allowed government to forcibly buy property from owners for public purposes—such as a needed highway. But the court decision allowed the continuation of today’s abuse of the law, whereby local politicians exercise eminent domain to condemn people’s property to aid politically connected private developers.

Stable money
. A strong and stable currency was why the United States did better after achieving independence than the nations of Latin America after they broke away from Spain and Portugal. For reasons we have explained earlier in this chapter, sound money is the bedrock of a prosperous economy.

A progrowth tax system
. We have seen that taxes are a price and a burden. Low tax rates on income, profits, and capital gains foster more risk taking and higher growth, bringing about a richer economy with a higher standard of living—and with higher government revenues.

Ease of starting a business
. We take this for granted in the United States. Starting a legal business here is fairly easy to do. That, of course, doesn’t guarantee success, but there are virtually no obstacles to hanging out one’s shingle. But in numerous countries, the process is time-consuming and expensive, involving multiple licenses, procedures, and government agencies.

Each year the World Bank puts out a survey called “Doing Business.” It examines 181 economies around the world. One of the key factors it looks at is how difficult or easy it is to launch a legal commercial enterprise. It’s no surprise that developed countries usually have the most streamlined procedures and underdeveloped ones the most onerous.

Several years ago, the new prime minister of Bulgaria was shocked to discover that an entrepreneur in his own country had to get seventeen legal permissions to start a business. One of his goals became making new-business formation easier through “one-stop shopping”
for the necessary permits. Thanks to his reforms, Bulgaria simplified the process of starting a business, which helped to enlarge its formal economy.

Few barriers to doing business
. Politicians may peddle protectionist tariffs, quotas, or “safety” regulations as “helping the economy.” But as we’ve noted, they’re more often acts of political favoritism, rewarding one or another special interest. They raise the cost of economic activity and allow less of it to take place. Japan was notorious for decades for barring imports of beef from the United States, ostensibly on the grounds of safety, when everyone knew it was for political purposes.

Barriers also exist within domestic economies. As we saw in
chapter 5
, the United States is hardly a paragon of virtue when it comes to states’ abusing licensing procedures to protect politically connected incumbent businesses.

     
REAL WORLD LESSON
     

The best economic stimulus is creating an environment that allows companies and people to mobilize the vast resources and ingenuity of a free market
.

T
he introduction to this book quoted observers who declared American capitalism, as we know it, a thing of the past. Others insist that the prosperity and growth of the last three decades is over. Americans will have to get used to a changed way of living—a “new normal.” Economist and
Forbes
columnist David Malpass has his own word for this economic environment—“dismal.” The new normal, he says, means,

This dreary scenario seems well on its way to becoming reality. In 2009, joblessness has already reached unexpected levels, and there are genuine concerns as to how quickly it will come down in a recovery. Still more disturbing: the United States is expected to take an eye-opening drop in the next Heritage Foundation-Wall
Street Journal
Index of Economic Freedom. Heritage Foundation president Ed Feulner has said that he wouldn’t be surprised if the U.S. was no longer in its traditional place among the top ten most economically free nations.

Is this government-dominated “new normal”—or what it truly is, socialism—really our future? Given American history, this is an astonishing question. Right up until 1929, the federal government was a small
part of the economy. Even though we had, by far, the largest, most developed economy in the world, the United States had the smallest government of any developed country. Spending then was equal to 3 percent of GDP.

Uncle Sam’s power over the economy expanded substantially during the Civil War and World War I. But in each case, the government’s role receded once it was no longer needed, upon cessation of these conflicts.

For instance, the income tax enacted during the Civil War was eventually repealed. During World War I, the size and power of government again expanded—though to a far greater extent. The top income-tax rate grew from 7 percent to 77 percent. To mobilize for that war, Washington nationalized the railroads and the telephone companies and came to exercise enormous powers over whole swaths of the American economy. But again, the federal government’s powers withered when the conflict ended. The top income tax rate was slashed to 25 percent. The national debt was reduced by one-third.

Everything changed with the Great Depression. We’ve discussed how this historic downturn was produced by catastrophic government errors. Then, as now, the impulse among policy makers was “never to let a good crisis go to waste.” And so government’s powers grew mightily. Through massive public-works spending, the launch of Social Security, and welfare programs, along with a blizzard of regulations, Uncle Sam extended an unprecedented reach into the workings of the economy.

We made the point earlier in this book that a growing number of experts, such as economist Amity Shlaes, now believe most of these programs prolonged the Great Depression. Indeed, several years before that historic slump, America had experienced another depression, from 1920 to 1921. Government’s response was minimal. What happened? The economy snapped back as major income-tax cuts were enacted. The great boom of the 1920s was under way.

So why was 1929 different? One major factor was the election of Herbert Hoover as president. Unlike his predecessor, Calvin Coolidge, and in opposition to America’s long-standing political tradition, Hoover was an activist, in the mold of the Progressive school, whose standard-bearer was Teddy Roosevelt. A believer in interventionist government, Hoover didn’t understand capital formation. As president, he pushed for high tariffs on agricultural products to help American farmers. The reaction of Congress was: Why stop at farmers? Why not help everyone else?
Why not help industry? The resulting Smoot-Hawley Tariff devastated global trade and the flow of money around the world. When the market crashed, ushering in the Depression, Hoover’s reaction was only to intervene further.

Like so much government intervention, this well-meaning activism produced Real World consequences that were the opposite of what was intended. Hoover made CEOs of the nation’s largest companies pledge to avoid layoffs and wage cuts, a promise they kept for a year and a half. But with sales plummeting, companies somehow had to cut costs. So they ramped up pressure on their own vendors to slash their prices. The result: severe layoffs at those supplier companies. Unemployment still zoomed. Hoover’s other mistakes, particularly his horrific tax increases, proceeded to shatter the economy. Amity Shlaes explains in her book
The Forgotten Man
that all of this only deepened the Depression.

Hoover’s successor, Franklin Roosevelt, was also of the Progressive school. People he brought with him to his administration had been intoxicated by powers Washington exercised in World War I. They reasoned that if government could mobilize the nation to win the war, why couldn’t it direct the economy to beat the Depression?

And so government involvement in the economy deepened. Roosevelt enacted extensive controls on how businesses could carry out their activities. They served to abort the recovery that was under way in mid-1933. By 1939, the New Deal was becoming a spent political force.

The American tradition of smaller government slowly began to reassert itself. Roosevelt Democrats were dealt a severe setback in the 1938 congressional elections. The rest of their party refused to go along with Roosevelt’s tax increases and actually scaled them back a bit. This trend would have continued had it not been for World War II and the obvious need for unprecedented government powers.

But after the war, government began to contract. Spending was slashed. Labor laws were reformed to curb the power of unions. Taxes were cut slightly despite Truman’s veto. No new social programs were established. Many feared that, without major government spending, the nation would slip back into a depression. Instead the economy blossomed.

Then came the Cold War. The game changed completely.

Events such as the Korean War and the Soviet blockade of Berlin fostered a growing conviction that America needed to take an active role in
the world. We had to build our military to levels never before seen in peacetime. The federal government launched unprecedented social and economic initiatives. An interstate highway program that was the biggest public works project in history, federal aid to education (we needed more scientists and engineers), and the space program were all justified on the basis of “national security.”

In 1960, John F. Kennedy spoke of the need to “get America moving again” to help combat the alleged slump in America’s overseas prestige. One of the justifications for Kennedy’s major progrowth tax cuts in the early 1960s was to show the world that America’s economy was more dynamic than the Soviet Union’s.

Both Democrats and Republicans supported a size and scope of government that were inconceivable before World War II. Not having learned the lessons of the thirties, policy makers had the hubris to believe that if we could put a man on the moon, we could solve all sorts of social and economic problems. Countless amounts of money were devoted to innumerable programs to fight a “war” on poverty. Instead they led to a proliferation of social ills, including welfare dependency, teenage pregnancies, and substance abuse.

But why didn’t government recede after the fall of the Berlin Wall and the end of the Cold War? Actually, it did, but only to a degree. Military spending was scaled back. Even today, defense spending as a proportion of the economy still doesn’t match the Reagan era of the mid-eighties. But the idea that government could guide the economy and provide an endless array of services for people became a given in American politics.

Today, two crises—the War on Terror and the “Great Recession”—are once again causing government to expand. Is socialism inevitable? No. You can have prosperity and entrepreneurship and sound safety nets without massive government domination. That doesn’t mean eliminating government services that people have come to see as fixtures. It means structuring them so they are economically sustainable. The strength and prosperity of this nation were built on a free-market economy and a thriving private sector. Social Security, Medicare, and Medicaid, as we have discussed, can be reformed so that people have more control over their benefits and that funding these programs does not become an impossible tax burden.

Only by encouraging private enterprise will we be able to return to the
growth we’ve seen in the past thirty years. But we can achieve this only if policy makers and the public have a greater appreciation of how the economy works in the Real World and the importance of economic freedom. We’ve summed up key principles below.

1
Free markets are best at serving the needs and wants of people
. Adam Smith explained in his classic work
The Wealth of Nations
that transactions in a free market are about achieving the greatest possible mutual benefit. Because no one is forced to enter into a free-market transaction, it can take place only if both sides benefit. This is the opposite of “exploitation.”

2
Self-interest—not “greed”—compels people in free markets to meet the needs and wants of others
. There are greedy and unethical people in all societies. But greed, which means taking too much of something that you do not rightfully deserve, does not drive transactions in a free market. It undermines them. The bank robber’s coercive demand, “your money or your life,” is the exact opposite of a free-market transaction: there is no mutual benefit, and it deprives the other person of free choice.

3
Only a dynamic, entrepreneurial private sector is capable of producing the growth and prosperity that we take for granted in a free society. Government command-and-control economies simply can’t do it
. The deprivation of state-controlled economies—in nations from North Korea and Venezuela to the old Soviet Union—attests to the inability of state-run command-and-control economies to provide for the needs of their citizens. Bureaucrats and central planners cannot anticipate the vast and complex array of consumer desires we take for granted in a modern society—from cell phones to social-networking Web sites. With its focus on maintaining order and pleasing political interests, government bureaucracies are simply not capable of the risk taking and trial-and-error experimentation that produce growth-generating innovations. But in the open markets of democratic capitalism, if people have a need, entrepreneurs will fill it—if they’re allowed to.