Capitalism and Natural Liberty
Capitalism or "natural liberty" of economics is based on voluntary transactions among parties freely coming together instead of being dictated by third parties.
August 24, 2023
Capitalism is an Economic System, Not an Ideology
Economist Thomas Sowell observed that unlike socialism, communism, and other -isms, capitalism is not an ideology but an economic system. Individuals who participate in free market transactions do not necessarily share wider philosophical, ideological, or metaphysical beliefs. In contrast, socialism, communism, fascism, and other -isms consist of sweeping societal systems that go far beyond economic processes and are predicated upon axiomatic assertions.
Nomenclature and Terminology
Sowell objected to the term capitalism, noting that this was a name given to the system by its enemies and does not accurately capture its essence. The system described is that of free markets first clearly articulated by eighteenth-century British economist Adam Smith. In The Wealth of Nations, Smith referred to free markets as “an obvious system of natural liberty.”
In Knowledge and Decisions, Dr. Sowell wrote that other names associated with economic systems, such as “profit-making,” often do not accurately describe what actually happens. Many free-market businesses have losses as well as profits, and many go out of business because of the lack of profits.
Sowell refers to proprietors and owners of free-market businesses as residual claimants who are entitled to the remaining business revenues after all expenses, including employee wages, production costs, all other overhead and corporate taxes are paid.
This amount may be positive, negative, or neutral. Data from the U.S. Bureau of Labor Statistics have shown that nearly half of US businesses fail within five years and 65% fail within 10 years. Only a quarter of new businesses are still operating after 15 years. Even well-known mega corporations have years with multi-million dollar losses. It has often been noted that a few of those who criticize free markets, including politicians, intellectuals, and teachers, have any experience running a business.
Business proprietors take considerable risks, which Sowell notes are often deemphasized if considered at all in intellectual discourse, for uncertain rewards. Sowell further cited research that the “profits” made by many proprietors of small businesses are essentially wages that are often not greater, and sometimes less, than the wages they could obtain by working for another employer and that many accept lower wages than they could obtain elsewhere as a tradeoff for greater independence.
Free Markets and Freedom
The defining feature of free market or “capitalist” systems, as noted by Economists Milton Friedman and Thomas Sowell, is voluntary transactions by free parties under mutually agreed conditions.
This contrasts with socialist, communist, and other systems in which the transactions and their terms are dictated by third parties. Regarding these non-free systems, Dr. Sowell wrote:
“To say, as John Dewey did, that there must be ‘social control of economic forces’ sounds good in a vague sort of way, until that is translated into specifics as the holders of political power forbidding voluntary transactions among the citizenry.” [Sowell, Intellectuals and Society]
“Collective decision-making by third parties allows those third parties to superimpose their preferences on others at no cost to themselves, and to become the arbiters of other people’s economic fate without accountability for the consequences.” [Sowell, Thomas. Intellectuals and Society (pp. 89-90). Basic Books. Kindle Edition.]
Economic freedom is a basic human right that is a necessary but not sufficient condition for broader political freedoms. Milton Friedman wrote:
“The kind of economic organization that provides economic freedom directly, namely, organization of economic activities through a largely free market and private enterprise, in short through competitive capitalism, is also a necessary though not a sufficient condition for political freedom. The central reason why this is true is because such a form of economic organization separates economic power from political power and in this way enables one to be an offset to the other. Historical evidence speaks with a single voice on the relation between political and economic freedom. I cannot think of a single example at any time or any place where there was a large measure of political freedom without there also being something comparable to a private enterprise market form of economic organization for the bulk of economic activity.
“History suggests only that economic freedom is a necessary condition for political freedom. Clearly it is not a sufficient condition…So it is possible to have economic arrangements that are fundamentally capitalist and yet political arrangements that are not free.
“Yet, even in those cases, the citizenry had a good deal more freedom than citizens of a modern totalitarian state like Russia or Nazi Germany in which economic totalitarianism is combined with political totalitarianism. Even in Russia under the Czars it was possible for some citizens under some circumstances to change their jobs without getting permission from political authority because the existence of private property and of capitalism provided some kind of offset to the centralized power of the state.”
Attacks on free markets range from Soviet-era propaganda conflating free markets and Western democracies with “fascism” to similar claims by modern activists claiming free markets to be part of “systemic oppression,” while representing socialism and communism as promoting egalitarianism, whereas abundant evidence points to the opposite. Often, those militating against free markets have been special interests demanding personal economic benefits at the expense of others.
Nobel Laureate Milton Friedman observed that “underlying most arguments against the free market is a lack of belief in freedom itself” [MIlton Friedman, Capitalism and Freedom, p. 15]. Dr. Sowell observed that attacks on capitalism typically reflect the critic’s desire to control economic decisions, whether himself or through a preferred third party, instead of permitting others to transact voluntarily. Yet this relationship is often obscured by misleading language. He wrote:
“A recent angry e-mail from a reader said that certain issues should not be determined by ‘the dictates of the market.’ With a mere turn of a phrase, he had turned reality upside down. Decisions by people free to make their mutual accommodations with other free people were called ‘dictates’ while having third parties tell all of them what they could and couldn't do was not.” [Sowell, Thomas. The Thomas Sowell Reader. Basic Books, 2011].
The Production of Wealth
Dr. Sowell has noted in multiple works that free markets incentivize the production of wealth, whereas redistribution schemes start “in the middle of the story” as if wealth already existed and that their advocates have shown “no interest” in how wealth is actually created. He and other economists have long observed that redistribution schemes shrink total societal wealth available by disincentivizing from production both those from whom wealth is taken and those to whom it is transferred.
Scarcity and Unmet Needs
In Knowledge and Decisions, Dr. Sowell observed that scarcity is the universal human reality, writing: “The economic predicament is quite simple: there just is not enough to go around.” He continued:
“Some social commentators point to the existence of ‘unmet needs’ in society as evidence of the failure of an economic system, but in fact, economic systems are essentially systems of rationing,any successfully functioning economic system would have unmet needs everywhere.”
Sowell noted that every economic system must deal with scarcity, whereas the biblical garden of Eden and philosophical utopias are not economic systems. State control of markets, he wrote, introduces major inefficiencies, directing resources to designated areas while worsening scarcity in other areas. Such systems ultimately decrease the total resources available to a society.
Unmet needs are found in every society. In free market systems, individual is free to express his preferences and values through the market. Non-free systems take away individual market power and place it in the hands of designated decision-makers with far less knowledge than the aggregate public.
Negative Externalities and Cost-Shifting
One common myth about free markets is that they allow some to engage in unrestrained exploitation. An example would be factories that engage in pollution, earning a profit while degrading the environment and imposing health risks on others.
Economists have noted that these and other circumstances do not represent bona fide free market transactions because they impose costs on third parties. The recommendation noted by various economists is the creation of additional markets for carbon emissions and other pollutants to ensure that parties are paying the full cost of their conduct, that other parties are fairly reimbursed for detriment or loss to them, and that such costs are incorporated into decision-making. More detailed discussion is beyond the scope of this brief summary but are found in the works of Thomas Sowell and other leading economists.
Critics have often charged that capitalism is “inequitable” and harmful to laborers whereas moral virtues and “equity” are imputed to socialism and communism. This is an inversion of reality in both theory and practice. Adam Smith observed that the economic system of free markets or “natural liberty” does not favor the landowners, factory owners, or workers, but all of society. In contrast, communism, socialism, and fascisms explicitly favor certain groups while exploiting others. The actual practice of communism and socialism has repeatedly demonstrated the concentration of wealth and power in the hands of a ruling ideological elite.
Motives and Moral Qualities
Critics of free markets have attempted to imbue them with moral qualities, asserting that capitalism is based on “greed” whereas socialism and communism are based upon virtuous motives. In the lecture “Is Capitalism Humane?,” Nobel Laureate Milton Friedman stated:
“In all systems, whether you call them socialism, capitalism, or anything else, people act from self-interest. The citizens of Russia act from self-interest the same way as the citizens of the United States do. The difference between the two countries is in what determines self-interest. The man in the United States who is serving as a foreman in a factory--his self-interest leads him to worry about not getting fired. The man in Russia who is acting as foreman in a factory--his self-interest leads him to worry about not being fired at. Both are pursuing their own self-interest but the sanctions, what makes it in their self-interest, is different in the one case than in the other. But self-interest should not be interpreted as narrow selfishness.” [Friedman, Milton. Is Capitalism Humane? Lecture given at Cornell University, 1978. https://www.youtube.com/watch?v=ORQtnQRqOKc]
Milton Friedman explained that the capitalist system is conducive to respect for others’’ human dignity, rights, and values, whereas socialism is innately coercive:
“If you look you will find that freedom has prevailed where you have had capitalism and that simultaneously so has the well-being and the prosperity of the ordinary man. There has been more social justice and less inequality. Now the question is that you have to ask, and you have to ask the proponents of these two systems, has socialism failed because its good qualities were perverted by evil men who got in charge--was it simply because Stalin took over from Lenin that communism went the way it did? Has capitalism succeeded despite the immoral values that pervade it? I think the answer to both questions is in the negative. The results have arisen because each system has been true to its own values--or rather a system does not have values, I don't mean that--has been true to the values it encourages, supports, and develops in the people who live under that system.
“What we are concerned with in discussing moral values here are those that have to do with the relations between people. It is important to distinguish between two sets of moral considerations: the morality that is relevant to each of us in our private life, how we each conduct ourselves, behave; and then what is relevant to systems of government and organization, to the relations between people. In judging relations between people, I do not believe that the fundamental value is to do good to others whether they want you to or not. The fundamental value is not to do good to others as you see their good. It is not to force them to do good. As I see it, the fundamental value in relations among people is to respect the dignity and the individuality of fellowmen, to treat your fellowman not as an object to be manipulated for your purpose but to treat him as a person with his own values and his own rights, a person to be persuaded not coerced, not forced, not bulldozed, not brainwashed. That seems to me to be a fundamental value in social relations.” [Friedman, Milton. Is Capitalism Humane? Lecture given at Cornell University, 1978. https://www.youtube.com/watch?v=ORQtnQRqOKc]
Dr. Sowell wrote:
“Nothing better illustrates the difference between a volitional explanation of economic activity and a systemic explanation than the use of ‘greed’ as an explanation of high incomes. Greed may well explain an individual’s desire for more money, but income is determined by what other people pay, whether those other people are employers or consumers. Except for criminals, most people in a market economy receive income as a result of voluntary transactions. How much income someone receives voluntarily depends on other people’s willingness to part with their money in exchange for what the recipient offers, whether that is labor, a commodity or a service.” [Sowell, Thomas. Intellectuals and Society (pp. 89-90). Basic Books. Kindle Edition.]
History abundantly documents that rather than being more humane, communism and socialism have led to abundant atrocities. Nor, as Friedman states, is the self-interest which is acknowledged in capitalism nothing more than narrow selfishness. The difference is in the incentives – both positive and negative – and constraints in the various systems which influence decision-making and its outcomes.