The Biggest Misconceptions About Capitalism
America isn’t one…
Most people will tell you that America is the biggest and best example of what a free market economy can achieve in the world. This couldn’t be further from the truth. America has one of the most highly regulated and taxed economies in the world. Making it far from what a free market economy would provide.
Free Markets requires the separation between economy and state. The state shouldn’t interfere with business and transactions of private citizens and entities. Government involvement usually leads to inherent biases and a decrease of competition. Subsidies and tax breaks help bigger companies achieve monopolies while the small business struggles to compete. This is not capitalism, and not what Thomas Jefferson would have wanted:
“A wise and frugal government… shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned. This is the sum of good government.”
Money earned through the work of the individual should be money earned for that individual. This is definitely not the case in America, where the government gets an absurd 3.5 trillion dollars from taxes. Government might be the worst run business however, somehow having billions of dollars added to the debt each year, even with such massive earnings each year.
Government spending accounts for 41% of the national GDP. This massive purge of wealth prevents individuals and businesses from innovating and creating better products and services for the consumer. Lobbyists from corporations usually favor high regulation, because they tend to hurt the small business from competing. Monopolies would not last long without government protection, because of the amount of pressure coming from up and coming businesses around the world.
The Great Recession
Another major misconception about capitalism is that it was the work of the market that caused the financial crisis. Rather, it was the awful monetary policy from the Federal Reserve that caused the financial crisis. Let me explain:
Alan Greenspan, who was the head of the Federal Reserve from 1987 to 2006, was one of the main culprits of it. His time as chair during the early to mid 2000s contributed to the housing bubble because of how he dealt with interest rates. In 2001, the interest rates were about 6%. Greenspan cut that down to 1% in 2004.
An important rule in economics is that lower prices equal higher demand. And higher prices reduce demand. This applies to interest rates as well. The cutting of the interest rates by the federal reserve led to excessive risk taking by homeowners who would buy homes to sell them at a higher price. The low interest rates did create a housing boom from 2003 to 2005. Home Builders were finding it hard to keep up with the demand of housing up until 2005.
The rapid creation of new homes lead to supply outpacing the demand of purchasing homes as an investment. When the supply of a product or service is more than the demand, prices drop. Homeowners who bought homes as a form of investment could not sell their house for a higher price than when they bought it.
To add onto this, the Federal Reserve started to increase interest rates in 2005. Homeowners, who could not sell their houses at a profit, also could not afford the high interest rates on their mortgages. This is how the financial crisis was caused.
Another important factor of the Financial crisis are the borrowers and the lenders before the crisis. In finance, prime mortgages are loans to people who have a good credit history, usually above 620. Subprime mortgages are loans that are lent to people with poor credit history, which is usually below 620. The US Government in the 90s created policies to boost homeownership for low-income people, whose scores were usually lower than 620. To do this, Freddie Mac and Fannie Mae were required to have at least 1/3 of their mortgage purchases be subprime mortgages. This incentivized further risky lending behavior.
That led to the number of subprime mortgages started increasing rapidly from 2001 onwards. By 2008, there were 27 million subprime mortgage loans. 19 million of those loans were insured by the government or a government agency. The increased interest rates and the massive amount of subprime loans resulted in many foreclosures and the Great Recession.
The Financial Crisis was not the result of unregulated Capitalism, but rather the result of years of government intervention and mismanagement of markets that incentivized higher artificial demand and risky loans.
Government Bailouts
A major misconception of Capitalism is that the government is needed to provide help in the form of cash to businesses in times of economic uncertainty. This is actually counterproductive and does not benefit society for the long run.
Businesses fail, and they fail at high rates. 70% of small businesses fail within 10 years of its inception. Why is that? It is because businesses do not get enough money from consumers. What is important about consumers is that they only purchase what they want or need. What consumers want is what businesses focus on, whether it's the higher quality of the product or the lower price of one. Businesses fail when they fail to meet one of these two criteria.
This means that the businesses that do not fail are meeting one of those important rules. Bailing these businesses out with taxpayer money can be counter productive. They encourage bad leadership and lack of innovation. Yes jobs will be kept, but society as a whole would benefit less. Those resources, such as taxpayer money, could be used in more effective ways that people need.
Government has had a long history of inefficiently allocating scarce resources. For example, in the USSR it took 1,000 kilowatts of electricity to produce 1 ton of copper, while it took 300 kilowatts in West Germany. The problem with letting the government allocate resources is that they do not know the demand a product needs. In a free market system, companies decide what they produce based on the profit they are making from it. Products that create losses are produced less, and those resources such as money, goes into producing more of the product that creates profits.
This can be applied to bailouts as well. Money is a scarce resource. Having too much in circulation will cause inflation. This is why the government does not print infinite money. Bailouts, using taxpayers money, keep failing companies afloat at a time when those resources can be used elsewhere. Those failing companies spend money on payroll when the jobs and money can be used in sectors of the economy where demand is high.
Bailing out companies also fuels mismanagement. Companies like Boeing that in recent years have been borrowing and using their money to buy back stock instead of investing in their own company has recently been bailed out by the US Government. The bailout will only encourage more of this mismanagement and in a few years they will come back asking for another bailout. Letting companies fail will allow for better management to step in and fix the company.
Capitalism has been misrepresented in recent years due to stagnating wages in America. But all economic problems in America can be traced back to awful fiscal and monetary policy by the government.
Thank you for reading.
