Is Capitalism Sustainable?

Tyranny is unchecked power, concentrated in a few hands. The only hope for people who live in tyranny is the naïve hope that the tyrant will be wise and benevolent.

In many cases, the form this naïve hope takes is expressed through the institution of elections. But majority rule, or for that matter any voting system, is at best a partial solution. Without constitutional protections for individual rights, elections are simply the “freedom” to choose a tyrant.

Advocates for capitalism claim that — unlike in politics — markets “work” even if people are self-interested, because the dynamics of competition limit bad actions. As economists, we have long accepted this claim. But political events, and my own recently published research, have led me to question whether capitalism is really sustainable.

The Problem of Rent Seeking

Sustainability, according to the U.S. Environmental Protection Agency, is “meeting the needs of the present without compromising the ability of future generations to meet their own needs.” We have always thought of sustainability in terms of the environment, or use of resources, but systems like capitalism face some of the same problems.

The reason that we tolerate, or in some cases celebrate, capitalism is that entrepreneurs find ways to produce new products, new services, or new ways of making things that make consumers better off. Many of us would pay far more than the store price for clean water, wholesome food, cars that run for 200,000 miles, or cell phones that connect us to the entire world. Entrepreneurs think up the new goods or services, and competition drives down the price. The result is that many products not available even to the very wealthy in 1900 are now owned by all but the poorest among us.

The word that capitalism uses to identify the rewards for entrepreneurial creativity is “profit,” or what’s left over after the entrepreneur pays all workers and suppliers who make the product. The only way that there can be profits, under capitalism, is if consumers are willing to pay a lot more for the product than it costs to make. Lots of profits, lots of benefits to consumers, rapid increase in the wealth of the society. Sure, that increase may not be equally shared, but it makes sense that the people who take risks and find the right new way to make consumers better off should win big, right?

Maybe. The problem is that even if you believe that, there is another way to make “profits,” at least in the accounting sense of revenues exceeding costs. Economists call that “rent-seeking,” or the use of favorable government rules and regulations to attract taxpayer-funded subsidies or protection from competition. Those government programs may allow producers to charge higher prices, because competition is kept out by regulation. Or the government may take money from taxpayers and simply give it to companies. Either way, no value is created for consumers. In fact, consumers are likely harmed because they are denied choices and have to pay higher prices.

Markets to Government

There’s nothing illegal about rent-seeking, of course. In fact it’s rational. Imagine that you are a corporate CEO, and you want to do some hiring. You could hire engineers, the kind of folks who make new products or make existing products more cheaply. Or, you could hire lawyers and lobbyists, folks who work with government officials to pass new laws that keep out competition or pay you subsidies.

The problem is that if you want to earn honest profits, you have to sell to consumers, who want quality and low prices. That’s hard, especially for mature products in industries that have been around a while. At some level, even the most independent-minded entrepreneurs realize that it’s easier to sell a sad story to the state than it is to sell real products to consumers. In fact, you can’t blame the corporate leaders who succumb to this temptation: there’s nothing illegal about making government your source of revenue.

But it’s not capitalism, which involves the pursuit of profit through selling willing consumers better and cheaper products. And that’s why we wonder if capitalism is sustainable: we are asking our business leaders to have scruples, to leave money on the table by refusing to participate in cronyism. Remember, the argument for capitalism is based on the claim that even self-interested business leaders will benefit the whole system. But if self-interest leads toward cronyism, there’s a problem.

Of course, we could just move one step up the chain, and hope for “good” political leaders. After all, politicians get to design the system of incentives, and in principle that system could deny opportunities for rent-seeking. But why would a politician want to do that? Forcing businesses to line up to beg for favors is a big help at fundraising time.

The problem, then, is that we are on the “road to cronyism,” and it’s hard to see how we can turn off. I recently wrote about this problem at greater length, with my very smart coauthor Mario Villarreal-Diaz at the University of Texas. Here’s the difficulty, as succinctly as I can manage it: corporate leaders benefit, monetarily and in the short run, from negotiating favorable legislation and protection from politicians.

Even if business leaders behave “irrationally” and leave that money on the table — remember, it’s legal to lobby, even if it’s immoral — it’s still true that politicians benefit from making businesses dependent on taxpayer handouts. Businesses that don’t play along will be singled out for “special” attention, either extra taxes or unwelcome regulation.

Money for the Taking

Worse, if some modern Commodore Vanderbilt tried to refuse subsidies, it’s likely he would be fired and replaced by someone who was less principled and more willing to deliver short-run profits from taking subsidies. Or some outside firm might buy up the stock of the principled company, because the equity would be underpriced compared to its value if managers sought government rents and handouts.

It comes down to this: as a company grows, it has fewer opportunities to make new investments that have high returns. At some point, the last dollar invested in honest profits is going to return less than the first dollar to be spent on cronyism. After that, the firm becomes dependent on the state.

And that’s crony capitalism. Independent capitalism may not be sustainable, in the face of such incentives. Russ Roberts and I recently discussed this, on an episode of EconTalk. We didn’t come up with many good solutions. What do you think?

Related Articles – Capitalism, Free Markets