How Capitalism Will Save Us (4 page)

Contrary to what is commonly perceived, the iPod did not magically spring from the mind of Steve Jobs. Like YouTube, CC Patton’s iport, the pencil, and countless other innovations, it emerged from people looking to fill a perceived need. In 2003, journalist Rob Walker noted in the
New York Times Magazine
that the iPod came not from “a specific technological breakthrough” but from the innovations of other companies. Jobs himself acknowledges in the article that he basically brought the pieces together.
¹⁴
That’s typical of the process of creation that takes place in a free market—it’s spontaneous and unpredictable. You’ll never know where it will take place.

The widespread inability to perceive the full picture of free-market wealth and creation has encouraged many of the beliefs that are part of capitalism’s bad rap. For example, it drives opposition to free trade. As we discuss in our chapter on globalization, commentators who bemoan “outsourcing” and “trade deficits” fail to see that trade with other nations also results in billions of dollars coming back to the United States in the form of foreign investment—producing jobs in other sectors of the economy. Our trade with China, for example, is what generates all those dollars that the Chinese plow back into U.S. Treasury bonds—the investment that the Obama administration now seeks to help underwrite its massive spending and keep our government financially afloat.

What capitalism’s critics ignore is the fact that until the current recession, U.S. unemployment in the last three decades had gone down, not up. America’s unemployment rate through most of this decade has been substantially lower than during the years of the 1950s and early
’60s—hovering between 4 and 5 percent. And this is true even though “labor force participation”—the proportion of adults in the workforce—is higher than it was forty years ago.

That’s right, over the past thirty years, despite all the millions of jobs destroyed by the rise and fall of companies and industries in our democratic capitalist economy, over forty million net new jobs have been created. Overall personal incomes have increased from $2 trillion to $12 trillion. The net worth of American households (that is, assets minus liabilities such as home mortgage debt) has increased dramatically, from $7.1 trillion to $51.5 trillion. The economy as a whole has expanded mightily. Our standard of living has soared.

Yet unlike government programs that are launched with press releases and media fanfare, there is usually no “official” announcement of the jobs and standard-of-living improvements produced by capitalism’s invisible hand. No speeches or bill signings in the Oval Office. Most of the time, things simply just happen.

Still, there’s no getting around the fact that business failure, the downside of risk-taking and innovation, is part of the process of wealth creation in dynamic capitalism. No one denies it can be painful. Yet, as we discuss in this book, the consequences of not allowing it—a lower standard of living and even greater joblessness—are far worse.

Some people who have lost jobs in the recession may be feeling hot under the collar about now. However, as we will show repeatedly, the financial crisis and recession was anything but a case of normal freemarket creative destruction. It was exactly the opposite. History’s most devastating economic upheavals have never been caused by the normal cycles of free market; they have been caused by catastrophic distortions that occur when government doesn’t allow markets to work.

In a healthy, open economy, when there is an imbalance—too much or too little of something—the market eventually corrects it. Take cell phones. They were once rare and exceedingly expensive. Now everyone has them. Consumers no longer faint at the sight of their cell-phone
bills. Prices have come way down, and many companies are struggling to make a profit.

Because a market is about serving the needs and wants of others, it will eventually do so—if people are given sufficient economic freedom. However, when government imposes artificial constraints, through regulation or through its own direct participation, it creates an imbalance—a distortion—that market forces aren’t permitted to correct.

The result can be severe dysfunction, as we have with today’s government-dominated health care. Or in the case of the larger economy, it can produce the meltdown we experienced in the past two years.

Distortionary federal policies have played a role in every historic economic disaster. This was the case with the Great Depression, the disastrous consequence of the Smoot-Hawley Tariff. That levy, intended to save American jobs, ignited a trade war between the United States and other nations, killing global employment. And it is the case today, with the subprime-mortgage mess and subsequent financial-sector meltdown. Both began with the massive distortion of the mortgage market engineered by misguided federal policies and the giant government-created mortgage corporations Fannie Mae and Freddie Mac.

These two behemoths were created with the worthy goal of boosting home ownership. Their immense size—larger by far than all private-sector competitors—and their ties to the federal government enabled them to create massive distortions in the mortgage, housing, and financial markets that brought the nation’s financial system to near collapse.

A still bigger role was played by the Federal Reserve System, which lowered interest rates to boost the economy after the dot-com bust of the early 2000s—but ended up keeping them too low for too long. Without this error in monetary policy, the housing bubble never would have reached the catastrophic size that it did.

Rather than free markets betraying Alan Greenspan’s faith, it was the other way around. Greenspan’s low-interest, weak-dollar policies as head of the Federal Reserve Bank undermined free markets. Ayn Rand would not have succumbed to the temptation to believe that a government agency like the Fed could fine-tune the American and global economies. Nor would she have forgotten that a key component of a free market is a strong, stable, and reliable currency.

There’s another misunderstanding that’s common to believers in the Rap. Just as they tend to see free-market destruction and ignore the bigger creation that’s simultaneously taking place, they also tend to see certain government activities as fostering “creation” and prosperity—when in fact they’re doing exactly the opposite by
destroying
wealth and jobs.

Job programs and other government spending may create some employment. But they do so by siphoning off tax dollars from countless individuals and corporations—resources that would have otherwise provided the capital for new job-creating ventures. What happens when there isn’t enough capital? Companies can’t expand—and often can’t stay in business. New ventures remain on the drawing boards. Jobs that would have grown the economy can’t be created—and in many cases are destroyed.

Thus, the massive public-works programs of the 1930s created some temporary employment, but not enough to end the Great Depression, which eventually faded with World War II. Nor did some ten economic stimulus programs, which created infrastructure-building jobs in Japan throughout the 1990s, succeed in pulling the nation out its decade-long economic slump, despite almost quadrupling the national debt.

In 2009, people of all political stripes decried the massive government spending of the Obama administration on the grounds that it would create an enormous debt to be paid for “by the next generations.”

Actually, they’re wrong. Government spending is not some green-eyeshade accounting matter to worry about in the future. It has
immediate
impact in the here and now—by producing increased taxes and borrowings that drain the economy of private-sector capital.

Chapter 3, “Aren’t the Rich Getting Richer at Other People’s Expense?” explores common misconceptions surrounding “the rich” and the role they play in driving a democratic capitalist economy, creating wealth not only for themselves but for everyone else.

What if people like Steve Jobs and Bill Gates—or for that matter, Henry Ford and Thomas Edison—had been prevented from amassing
the capital they needed to expand their businesses or bring their innovations to the world? Millions of jobs and livelihoods never would have come into existence. Throughout history, countries that have punished or banished their commercial class have discovered what happens—the economy stagnates or actually collapses.

Our chapter on taxation, meanwhile, asks the question, aren’t higher taxes the price we pay for a humane society? Of course we need to pay taxes. But contrary to the claims of politicians, they’re not an “investment.” Government initiatives rarely deliver a return like a private-sector investment. Even government bonds that repay investors divert capital that likely would have been better invested in growth-creating businesses.

Taxes make work and other transactions more expensive. Thus, fewer of them take place. As we discuss, the best way to generate tax revenues is through policies that encourage a growing tax base by allowing entrepreneurs and businesses to generate the capital to expand. And the best way to do this is to keep tax rates reasonable—or through a low flat tax.

S
ome may recognize the ideas in this book as free-market economics. We call them Real World Economics because we believe that is a more accurate term. The U.S. economy, after all, is not a totally free market. It is made up of many markets. Some are freer than others. The markets that are freer, that give the greatest latitude to entrepreneurs and innovators, that let buyers and sellers work out price and supply solutions, create more wealth for more individuals than any controlled by government.