Why Capitalism Works and Government Control Doesn’t

(Ron Knecht) – Friedrich Hayek, perhaps the most important economist of the 20^th Century, won the 1974 Nobel Economics Prize for explaining why competitive markets (capitalism) serve the public interest well but government control (socialism, central planning and control, collectivism, etc.) doesn’t.

Being Austrian, Hayek wrote in the difficult German language and in academic terms.  So, his original prose is difficult for most people to understand in any language.  In 1945, Reader’s Digest published a 50-page simplified version of Hayek’s magnum opus, The Road to Serfdom, to popularize his analysis.  It can be found online, either as a PDF or for purchase.

My friend Professor Mark Pingle, the outstanding University of Nevada-Reno economist, has summarized the argument in the points below, augmented with my edits.

What is the “Road to Serfdom”?  It’s the belief that economic and social life should be consciously directed by government rather than being determined by free choices of individuals and businesses.  The sum of human experience shows clearly that, even where extensive government intervention leads to equality, it’s equality of poverty and slow economic growth.  Usually, it produces great inequality of wealth and power, plus much poverty and oppression.

First, central planners won’t have enough information or the detailed power they need to accomplish their goals.  Imagine trying to determine prices (exchange rates), production locations, etc. for the millions of goods and services for an economy.

Lacking sufficient knowledge and power, they resort to “ends justifies the means” approaches to justify centralizing economic and social power.  The inability to satisfy people’s diverse wants and needs will lead them to promote a “spirit of the party” that sets limited ranges of what people should want and have.  Also, government provision creates dependence and vitiates initiative.

Finally, the more government plans and controls, the harder it is for people and businesses to plan and operate.

First, when people are free to improve their own lives, they do remarkable things they don’t do when they’re just cogs in a machine taking orders.  Also, free markets allow voluntary cooperation and specialization to be maximized, which facilitates economic growth, aggregate wealth creation, and social happiness and wellbeing.

Another subtle point Hayek observed is that freedom is more consistent with the rule of law, but planning will tend to require arbitrary rule.  See, for example, the increase in presidential orders in recent decades and the displacement of legislation by the mushrooming administrative state.

Mainly by keeping as much property private as possible.  That allows most wants to be satisfied via market exchange among people and businesses.  Note that one of the first attacks against market capitalism by collectivists is an effort to delegitimize and anathematize private property.  They claim collective (public) ownership of property makes it serve everyone.  That’s been proven false by the analysis known as the tragedy of the commons.  It shows that, when nobody owns property, nobody takes enough care of it to get maximum social benefit from it.

So, maintaining and promoting competition in market systems is essential.  This requires limited legislation and market regulation because legislators and regulators are often “captured” by incumbent firms to serve their interests.  (Crony capitalism.)  Thus, promoting competition is the goal of anti-trust law, and maximizing benefit to consumers is its lode star.  However, capture theory explains that firms pervert anti-trust law to serve their interests, not those of consumers.

Hayek also advocates using voluntary associations (for example, insurance companies) to mitigate most economic risks to people and firms.  However, it’s also essential to understand that freedom requires everyone to carry some risks.  A key principle of finance is that when an investment risk is high, expected returns must also be high to attract capital.

Perhaps most important, we must limit the powers and reach of government and keep it as decentralized as possible.  This is a key element of the U.S. Constitution: It intentionally limits government power and divides it among levels and branches that check each other.

Finally, in Hayek’s words: “A policy of freedom for the individual is the only truly progressive policy.”