Better Fetters

There is a long history of decrying “unfettered capitalism” to justify the imposition of added fetters of various sorts on our freedom to choose how and with whom to productively associate. For instance, Jonah Goldberg noted late last year how it had been utilized by people ranging from Economics Nobel Prize winner Joseph Stiglitz to “No bull” prize loser Bernie Sanders. Its common usage is also attested to by the over 800,000 hits the Google search I just did turned up, almost all claiming the need for more and “new and improved” fetters on capitalism. 

Goldberg’s focus was on the fact that America has, in fact, fettered the hell out of capitalism. He offers a long list of such fetters, from the early 20^th century through the New Deal and the Great Society to our current alphabet soup of regulatory agencies. Beyond the burdens of regulation, he also names progressive income taxes, which when the multiple taxation of certain streams of earnings (e.g., corporate earnings that must bear the joint burdens of property taxes, corporate profit taxes—often at state as well as the federal level–and dividend and/or capital gains taxation, before they reach the ultimate owners) is taken into account, can make us only minority owners of our own productive efforts.

The importance of Goldberg’s identification of massive current fetters on capitalism is that if you have an argument whose major premise—problem X is caused by “unfettered capitalism”–is false, the conclusion that we need more fetters does not logically follow. Our perceived problems may well be the result of the fetters that have already been imposed. After all, we don’t credit parasites on sharks for their speed in the water and conclude that more parasites would make them faster. 

However, in part due to space limitations, Goldberg’s list of fetters is incomplete. Think of how poor a job the government often does at defining and enforcing the property rights that are the foundation of all voluntary arrangements, tasks which are presumed to be effectively done under capitalism. Think of all the ways government restrictions raise the cost of defending those rights and preventing abuses through the legal system. Think of the ways in which government raises the transaction costs of voluntary arrangements. Think of every price ceiling and price floor, which wipe out mutually beneficial trades in the same way that taxation and burdensome regulations do, and every government barrier to entry and competition in markets (e.g., the need for certificates of convenience or necessity to build a hospital and state and local government licensing requirements). As illogical as he reveals scapegoating “unfettered capitalism” to be, it is worse.

There are two additional issues which go beyond Goldberg’s article that I wish to particularly emphasize. The first is to highlight the “thinking at the margin” that is an essential part of applying economic principles. Proposed new fetters are almost always treated as minor, implying small adverse effects. But even small additional fetters can have large adverse effects.

Consider an analogy to taxation. If we were starting from zero taxes, the imposition of a small (say, 5%) tax on an item would eliminate those trades that would have generated between just more than zero in net gains to the parties to just under 5%. There would be a burden on society, which economists call the welfare cost or excess burden—the costs imposed on society over and above the revenue raised—but it could be relatively small.

However, what if this market was already highly fettered by multiple other taxes, regulatory burdens, etc.? Say there was already an effective marginal tax rate of 35% in that market. Adding a new 5% tax would raise the tax rate from 35 to 40%. And that would eliminate those trades that would have generated between just more than 35% in net gains to the parties to just under 40%. If the reduction in trades for the tax increase from zero to 5% was the same as that for the increase from 35 to 40%, the harm from the latter would be far greater. 

In fact, there is a widely known result in public finance that for straight line supply and demand curves (in which each equal increase in effective tax rates would reduce trades by the same amount), the welfare cost or excess burden is proportional to the square of the marginal tax rate. Doubling the marginal tax rate quadruples the welfare cost. So if a 5% tax rate has a welfare cost of $W, what would the welfare cost of a 40% tax be? Well, doubling 5% gets you to 10%, doubling again gets you to 20% and doubling yet again gets you to 40%. That is, 40% is eight times 5% so the welfare cost would be eight squared, or 64, times $W. In other words, when we are already heavily fettered, as now, further increases are far more damaging to those of us who make up society than almost anyone recognizes.

The second area I would like to extend Goldberg’s argument is to emphasize more heavily that capitalism is inherently fettered. His title emphasizes that “Opponents of ‘Unfettered Capitalism’ Are Fighting a Phantom,” because of the many existing government fetters. But virtually unnoticed in the public discussion is that capitalism is inherently fettered. And that leads to the question of which fetters—those of markets or those of government when it overrides markets—are most productive or least harmful. 

Most importantly, free market arrangements are fettered by the fact that no one’s property rights can be invaded. The consent of all those others whose rights are involved is required. This means that stealing is not allowed under capitalism. That is a critical fetter ignored in virtually all the horror stories of what unfettered capitalism does, which rely on the asserted overriding of people’s rights. In other words, those stories are about crony (violation of) capitalism, which is not capitalism.

In contrast, that fetter that does not apply to government policies, which can be, and routinely are, used to violate existing property rights. The fact that government theft is common and, in fact, the main ingredient in new government fetters, but market theft is disallowed by capitalism, is a phenomenally important difference. 

Further, where property rights are poorly defended from others’ invasions by government (as with very costly legal mechanisms for enforcement, or inappropriate definitions of property rights), the problem is government failure to defend the basis of capitalism—clear, enforced property rights—rather than a failure of a system of voluntary arrangements that can be built when those rights are effectively defended.

Another major fetter capitalism’s critics ignore in their rhetorical rush to imply that “big business” can do whatever it wants is that imposed by repeat business and reputation. Mistreated customers will search for better alternatives, cutting into future profits, and do so more successfully, the fewer the fetters on alternatives. Reputation effects produce similar incentives for other customers, who also wish to avoid ill-treatment. And technology has hugely improved such mechanisms. Further, other capitalization mechanisms are everywhere in free markets. For instance, say you are currently particularly dependent on a trading partner. Your partner could take advantage of you. But if that would lead to the future foregone profits from you and others exceeding the value of added current profits, your trading partner would not want to take advantage of you even though he or she could. 

In sum, “unfettered capitalism,” one of the favorite piñatas of those who would substitute their judgements for what people would decide for themselves, were their choices not overridden, is a highly misleading oxymoron. We are heavily fettered by public policies, making it hard to logically blame what does not exist for current problems. The burdens borne because of those fetters are also far higher than almost anyone recognizes, because of a failure to think at the margin. And unlike the fetters that are imposed on us by government, those inherent in the voluntary arrangements of capitalism are bulwarks against the aggression of others, whose primary practitioner is government. In other words, effectively defined and enforced property rights create a capitalism that is more effectively fettered and far more productive for all of us than government-imposed fetters that restrict and violate them.

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