Tuesday, December 12, 2006

Classical Tenets of Capitalism

I have compiled a list of seven classical tenets of capitalism, to be used for later reference. The ideas and terms stated below are to be understood as the classical tenets, i.e., the tenets of Adam Smith and David Ricardo. Some would consider John Stuart Mill classical. But Mill came later and even though he still accepted the basic tenets, I wouldn't consider Mill classical.

1) Private Property

Most legal systems distinguish between different types (immovable property, estate in land, real estate, real property) of property, especially between land and all other forms of property. They also often distinguish between tangible and intangible property as well.

In common law, property is divided into:

  1. real property - (immovable property) interests in land and improvements thereto
  2. personal property - interests in anything other than real property

Personal property in turn is divided into tangible property (such as cars, clothing, animals) and intangible or abstract property (e.g. financial instruments such as stocks and bonds, etc.), which includes intellectual property (patents, copyrights, trademarks).

The two major justifications of original property, or homesteading, are effort and scarcity. John Locke emphasized effort, "mixing your labor" with an object, or clearing and cultivating virgin land. Benjamin Tucker preferred to look at the telos of property. He asked "What is the purpose of property?" His answer: to solve the scarcity problem. Only when items are relatively scarce with respect to people's desires do they become property.

2) Self Interest

There are many types of "egoism". Psychological egoism says that individuals are motivated by self-interest. Ethical egoism says individuals ought to do what is in their self-interest. And rational egoism says that it is rational to act in one's self-interest. Adam Smith, writing the Wealth of Nations, espoused a psychological egoism. But he argued further that this was a good thing, because:

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

~WON ch.2

The concept of the "invisible hand" is nearly always generalized beyond Smith's original discussion of domestic versus foreign trade. Smith himself participated in this generalization, as is already evident in his allusion to "many other cases", quoted above. And the invisible hand is a natural inclination, not yet a social mechanism as it will be after Leon Walras and Vilfredo Pareto.

3) Competition.

Seen as the most important pillar of capitalism by many people in that it may stimulate innovation, encourage efficiency, or drive down prices, competition is touted as the foundation upon which capitalism is erected. According to micro-economic theory, no system of resource allocation is more efficient than pure competition. Competition, according to the theory, causes commercial firms to develop new products, services, and technologies. This gives consumers larger selection and better products. The greater selection typically causes lower prices for the products compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly).

4) Market-based.

How are goods and services going to be allocated? A market-based economy is one where the price of each item or service is arranged by the agreement between sellers and buyers; the opposite is a command economy, where supply and price are set by committee or a body. However, while a purely free market necessitates that government does not dictate prices, it also requires the traders themselves do not coerce or defraud each other, and that all trades are morally voluntary.

The ideal of a free market is voluntary exchange. If an exchange takes place under coercion or fraud, then that exchange is not considered a free exchange.

5) Economic Freedom

Economic freedom is different from market freedom. The tenet of economic freedom applies to individual economic agents, and is more like a "Free to Choose" principle, which is in essence what capitalist economics is all about. Some have even called 'economics' the study of choice, because what decisions entities make are important to economists. Modern economics studies Rational choice theory which assumes human behavior is guided by instrumental reason. Accordingly, individuals always choose what they believe to be the best means to achieve their given ends.

In Adam Smith's day, however, this had a much more basic notion. The idea was that economic agents were free to choose where to put their investments, what to consume, and what to do. This free exchange and free choice principle allows the capitalist economy to allocate resources as the consumer chooses.

6) Consumer Sovereignty

Those with money and other assets are able to use their purchasing power to tell producers of goods and services what to produce (and how much). Customers do not necessarily have to buy and, if dissatisfied, can take their business elsewhere, while the profit-seeking sellers find that they can make the greatest profit by trying to provide the best possible products for the price (or the lowest possible price for a given product). In the language of cliché, "he who pays the piper calls the tune."

To most neoclassicals, consumer sovereignty is an ideal rather than a reality because of the existence -- or even the ubiquity -- of market failure. Some economists of the Chicago School and the Austrian school see consumer sovereignty as a reality in a free market economy without interference from government or other non-market institutions, or anti-market institutions such as monopolies or cartels. That is, alleged market failures are seen as being a result of non-market forces. However, it has also been argued (e.g., by Goutam U. Jois) that even a "pure" market system violates the consumer sovereignty norm.

Does the doctrine of consumer sovereignty imply that the consumers of labor (the employers) are the sovereigns over the time supplied by workers? The neoclassical school, would argue no since workers can choose which employer to work for (as long as the employer will have them).

Since the demand for labor is a 'derived demand' what workers produce and how they do it is a direct result of the demand for products, and thus they are sovereigns, albeit at secondhand. Conversely, the Marxian school argues that the concentration of purchasing power in the hands of a small minority (the capitalist) means that the bourgeoisie is the sovereign in both product and labor markets. This is reinforced by the normal existence of the "reserve army of labor" which restricts workers' ability to choose between jobs.

7) Laissez Faire

short for "laissez faire, laissez aller, laissez passer," meaning "let do, let go, let pass." From the French diction first used by the eighteenth century Physiocrats as an injunction against government interference with trade, it became used as a synonym for strict free market economics during the early and mid-19th century.

The laissez-faire school of economic thought holds a pure or economically liberal market view: that the free market is best left to its own devices, and that it will dispense with inefficiencies in a more deliberate and quick manner than any legislating body could. The basic idea is that less government interference in private economic decisions such as pricing, production, consumption, and distribution of goods and services makes for a better (more efficient) economy.

As said before, Adam Smith in Wealth of Nations argued that the invisible hand of the market would guide people to act in the public interest by following their own self-interest, since the only way to make money would be through voluntary exchange, and thus the only way to get the people's money was to give the people what they want. Smith said you do not get what you need by appealing to the "love" of the butcher, the farmer or the baker. Instead you appeal to their "self interest", and pay them to exchange their products for yours.

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