Wednesday, 05 July 2023 13:59

Capitalism and Democracy

Rate this item
(0 votes)

Capitalism and Democracy

Kenneth G. Elzinga

Kenneth G. Elzinga is the Robert C. Taylor Professor of Economics at the University of Virginia.

The University of Virginia recently received a major gift to establish the Karsh Center — whose stated mission is to “promote understanding and appreciation of the principles and practices necessary for a well-functioning, pluralistic democracy.” Thomas Jefferson, one of the Founding Fathers of the United States, also is the founder of the University of Virginia. One wonders what his reaction would be that his “academical village” would house a Center for the “practices necessary” for democracy.

In this paper I raise the question: what is the connection between Capitalism and Democracy? Are they substitutes? Are they complements? Are they antagonists?

To explore this relationship, it is instructive to consider taxonomy: what is Capitalism? And what is Democracy? After defining terms, I shall describe decision-making under Capitalism versus decision-making in a Democracy. One might construe the connection as the difference between casting votes with dollars versus casting votes with ballots.[1]

So, let us start with taxonomy.

Capitalism is a portmanteau expression that one could spend hours unpacking. Many people, when they unpack the term Capitalism, start with Karl Marx — who is commonly thought to have coined the term. He did not. But because of Marx’s influence, his use of the term has given it enormous traction.

Many people identify Capitalism with the economies of Western Europe and the United States. By that taxonomy, Capitalism means an economic system involving a complex alliance between government and business and coalitions between government and organized labor. That is not how I define the term Capitalism.

In teaching principles of economics over the years to some 50,000 students, on occasion I use the term Capitalism, but I tell my students to think of that term as synonymous with market allocation, free markets, voluntary exchange, or free enterprise. They do not carry as much baggage as the word Capitalism.

Adam Smith recognized that Capitalism, or market allocation, was based on people engaging in what he called “truck, barter, and exchange.” Smith’s expression, “to truck,” leaves students today confused. They think of “truck” as a noun, as in a vehicle. But Smith used the term “truck” as a verb that means to engage in trade. Today, rather than “to truck,” one might say: to buy and sell.

Many scholars in law and political science, along with many others outside the academy, think of Adam Smith as the ambassador of Capitalism. However, in reality, Smith described the cart. The horse that goes before the cart of “truck, barter, and exchange” is John Locke’s description of freedom:

“Freedom means the ‘liberty for every man to . . . dispose, and order as he . . . [likes] his person, actions, possessions, and his whole property . . . and not be subject to the arbitrary Will of another, but freely follow his own.’”[2]

Freedom means individuals have the right to lead their lives as they wish so long as they respect the rights of others. The existence of private property is a predicate to being able to do this. Two individuals, X and Y, cannot “truck, barter, and exchange” unless X knows which assets are his to sell, and Y knows what assets are hers, to ensure that the purchase is value-enhancing for both X and Y.

Democracy is another portmanteau expression one could spend hours unpacking. A short definition is that of citizens being able to select those who will govern them. In polite circles, to be critical of Democracy runs the risk of being cancelled or discredited. How can one be critical of a system where the governance of a nation’s people is through the representatives they elect?

By that definition, how indeed?

But individuals legitimately can restrain their enthusiasm for Democracy when they understand its traditional majoritarian characteristic: when Democracy means the governance of a nation’s people by the will of the majority of its members. When Democracies govern by the will of the majority, that spells trouble for minorities.

One way to understand Democracy in the United States is through Alexis de Tocqueville’s book, Democracy in America. To Tocqueville, Democracy was like a three-legged stool: Representative government, universal suffrage, and majority-based governance.

An admirer of Tocqueville would be sobered by his prediction that Democracy will degenerate into “soft despotism” and the “tyranny of the majority.” Tocqueville feared the that the “never-dying, ever-kindling hatred which sets a Democratic people against the smallest privileges is peculiarly favorable to the gradual concentration of all political rights in the hands of the representative of the state alone.[3]

A highly regarded account of Tocqueville can be found in Olivier Zunz’s The Man Who Understood Democracy: The Life of Alexis de Tocqueville. In an interview about this book, Professor Zunz outlined some features of Tocqueville’s analysis of Democracy. First, Zunz makes clear that Tocqueville agreed with John Locke when he affirmed that “the right to property is the basis for civilized society.”[4] Second, Zunz makes clear how Tocqueville admired and applauded the energy and hard work of the American people. Let me come to a full stop here. We have a French intellectual expressing admiration for Americans! That is worth noting — and would be a rarity today.

In admiring Americans for their energy and hard work, Tocqueville first thought this trait was motivated by the pursuit of financial gain. But he came to realize something different was going on. Tocqueville wrote: In America, “Individuals served the common good by satisfying their personal ambitions.”[5]

Anyone familiar with Adam Smith’s Wealth of Nations will recognize in that observation an uncanny parallel with Smith’s description about allocation by markets: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”[6]

Zunz also describes Tocqueville’s quest to balance equality and liberty — and how Tocqueville hoped to find “an extreme point at which liberty and equality touch and become one.”[7] On this, Tocqueville was disappointed. It was a fool’s errand for Tocqueville to seek a balance between equality and freedom. As Milton Friedman explained:

“A society that puts equality . . . ahead of freedom will end up with neither equality nor freedom. . . a society that puts freedom first will, as a happy byproduct, end up with both greater freedom and greater equality.”[8]

What are some of the differences between how “Capitalism” operates (as a means of allocating resources), and “Democracy” operates (as a means of governance)?[9] Put differently, what is the difference between choices that are made in markets voting with dollars and choices that are made in a democracy voting with ballots?

There are many differences. Some important ones are described below.

When individuals vote with dollars, they do so in accord with their Rational Self-Interest. Rational Self-Interest also is a portmanteau expression that one could spend hours unpacking. Let me offer some observations on the concept of rationality that pertains to Capitalism and Democracy.

The theory and application of the Rational Actor model is not so much a divide as it is a chasm that separates economists from the rest of the academic world. Economists take a lot of flak for their emphasis on Rational Self-Interest.

Critics argue that the Rational Actor model as a theory of human behavior is wrong: people do not behave that way. Or, alternatively, the Rational Actor model is a tautology: people do what they do. Take your pick.

To those trained in economics, Rational Self-Interest is not the only motivator of human conduct, nor is it a tautology. The pursuit of self-interest simply means, to use an example, a consumer buys a blouse only if the expected benefits exceed the cost. To buy a blouse if the opportunity forgone was greater than the expected benefits would be irrational.

If someone is considering robbing a bank, the Rational Actor model will push that decision, as well, through a cost-benefit grid. The prospective bank robber weighs the benefits of the money he expects to misappropriate if successful versus the costs to his life and liberty if caught.

One can examine the Rational Self-Interest principle from a positive perspective and ask, “Do people behave in accord with their self-interest in a predictable fashion? Do people act only when the benefits exceed the Costs? That is a positive question. One might conclude yes, they do; or no, they don’t; or maybe they do sometimes and sometimes they don’t.

One also can look at Rational Self-Interest from a normative perspective and ask, “Should people behave in accord with their self-interest? That is a normative question and an important one as well.

When consumers vote with dollars in the marketplace, economics offers a yardstick to measure expected value and expected cost. Whether the benefit-cost ratio is greater than one or not gives meaning to the rationality of casting dollar votes by both buyers and sellers in a market transaction.

When it comes to Democracy, it is not clear if there is a connection between Rational Self-Interest and voting (whether the election is local, state, or federal). The probability of an individual vote affecting the outcome of an election approaches zero. This makes voting in a democracy irrational or, in everyday language, a waste of time.

Why do people truck, barter, and exchange? Economics is particularly good at explaining this kind of behavior. Under Capitalism, when a consumer votes with dollars, this affects the outcome. But under Democracy, when a citizen votes ballots, the outcome is unaffected. In Democracy, one can claim, “every vote counts.” But in reality, no single vote counts. The fundamental decision-maker in a democracy is the state, not the individual voter.

So why do citizens vote with ballots? The answer is not transparent. Thinking like an economist, three reasons come to mind.

The first is virtue signaling: to vote identifies the voter as a good person who participates in the community. Voting, in other words, runs parallel to why some people attend church, even though they do not believe in God. A second reason to vote is that one is paid to do so. If a political party bribes voters more than the opportunity cost of their time to vote a certain way, voting becomes rational (if not immoral and illegal). A third reason to vote is because it is traditional to do so. If one adopts the familiar framework of dividing economic activity into three bins — that of markets, central planning, and tradition — then voting falls in the last bin.

It has never been a strength of economics to understand tradition-bound economies. Economists often are left like Tevye, the dairyman in the musical “Fiddler on the Roof,” asking, “Why do we do things this way?”

The economist’s principle of Revealed Preference also illustrates a difference between voting with dollars under Capitalism and voting with ballots under Democracy. Voting with dollars usually reveals a consumer’s actual preferences. Voting with ballots does not.

Revealed Preference is what is behind the shortest joke that economists tell among themselves. This is the joke: An economist and a friend are walking down a street and the friend [pointing] says, “I’d like to own a car like that.” The economist replies: “No, you wouldn’t.” That is the whole joke.

Economists find this funny because they understand that if this statement were true, that car is what the friend would be driving. But instead, the friend has chosen another car, perhaps less exotic, less expensive, because, for the friend, that is the choice that makes more sense in terms of costs and benefits.

One can see by this joke the further divide between how economists look at decision-making in markets for goods and services versus decision-making in political markets. Economists pay attention to what people do, not what they say or promise. Economists zero in on actions, not talk. Economists focus on preferences that are revealed.

To be sure, politicians might be evaluated by what they do, but they are always engaged by what they say. Consider the press conference. A company could hold a press conference — some have. A consumer could hold a press conference — that has probably happened. But no one can dispute that a press conference is much more important in the marketplace for politicians than it is in the marketplace for goods and services.[10]

Consider a line in Gerald Manley Hopkins’ poem, “As Kingfishers Catch Fire.” The most famous line in this poem is: “Christ — for Christ plays in ten thousand places.” But for an economist, the most profound line is “Crying What I do is me: for that I came.”

“What I do is me.” That is Revealed Preference in five words.

Now consider one of the most fundamental differences between voting with dollars under Capitalism and voting with ballots under Democracy; the distinction involves Competition. In the U.S., the term Competition — to non-economists — centers on sports: Competition on the field or on the court — among athletes. It is not so with economists.

Economists spend considerable time and energy thinking about Competition, but in a different way than non-economists. Competition is not a source of entertainment or diversion. Competition — and its opposite, Monopoly — are at the heart of microeconomics.

Economists teach about Competition in the first course in microeconomics. They consult in antitrust cases involving issues of Competition. There currently is a debate about how much Competition versus Monopoly exists in the United States economy.

Competition also is at the heart of the distinction between voting with dollars under Capitalism versus voting with ballots under Democracy. Capitalism involves much more Competition than Democracy. Democracy involves much more Monopoly than Capitalism. There are several reasons for this.

First of all, market Competition generally is continuous. Almost every day of the year, Old Navy competes with TJ Maxx for consumer votes. McDonalds competes with Wendy’s, not just once every four years, or once every two years, but day in and day out.

Political Competition, on the other hand, takes place at very discrete intervals: every four years in the case of choosing the president, every two years in the case of choosing Congressional representatives.[11]

Market Competition almost always allows several competitors to operate at the same time. That is, if a majority of fast-food customers prefer McDonalds, that does not mean that Burger King, Five Guys, Wendy’s, and Carl’s must close up shop.

Political Competition generally is an all-or-nothing contest. Whoever gets a majority of the vote for some office gets the entire market. Market Competition, on the other hand, thwarts Tocqueville’s tyranny of the majority. Under Capitalism, a Monopoly of a market — whether it be a market for land, labor, or capital — is rare.

When it comes to Competition, consider the difference in the barriers to entry for a new political party compared to the entry of a new firm. The problems entering a market may seem daunting for new firms. Think of Under Armour, as a new entrant in sports apparel, going up against incumbent firms like Nike and Reebok in the market for athletic attire. But the barriers to entry in the political marketplace border on insurmountable.

In the U.S. economy, the markets for most goods and services are what economists call “Contestable.” Incumbent firms are threatened by new entry, what Joseph Schumpeter called the “gales of creative destruction.”

In the U.S. political system, Republicans and Democrats have a Duopoly on political power. The barrier to entry protecting this Duopoly is like a moat that is both wide and deep, as Green parties and the Libertarian party have experienced. Even in an election when there is great dissatisfaction with the two major political parties, the Libertarian Party and Green Party candidates are given no chance of winning.

Two magazines I read regularly are Hemmings Motor News and The New Yorker. As a consumer, both magazines compete for my dollar votes simultaneously. As a voter, I cannot simultaneously consume a candidate from the Democrat and Republican parties — for the same office. Therein lies another distinction between Capitalism and Democracy.

Another difference between Capitalism and Democracy: compared to the political market, the market for goods and services allows a range of ages to participate. Teenagers in the U.S. have enormous buying power in the market for goods and services. But Democracy generally is restricted to people above 18 years of age.

People with felony convictions have difficulty voting. But convicted felons who have done their time are welcome to vote with their dollars at literally millions of merchants.

If a consumer buys a new automobile and the dealer promises that the car will come with satellite radio, in a market transaction the consumer can bind the dealer to that promise through a contract. Politicians in a Democracy are not held liable for their promises in the same way that private firms in Capitalism are.

George Bush once made a famous campaign promise: “Read my lips, no new taxes.” He spoke these words on August 18, 1988, at the Republican National Convention. Then he became president of the U.S. and taxes were increased. President Obama said that under the Affordable Care Act, you could keep your doctor — that turned out not to be true.

Nobody can sue politicians for breach of contract because voting is not a contract. A commercial transaction can be.[12]

Another difference between market allocation and government allocation is speed. This is an unexplored area of research. Imagine, as a Gedanken experiment, a study was made of major construction projects (Costing $100 million dollars or more). The study would compare those projects funded by the private sector with those funded by the public sector. That is, the study would compare those projects “voted” into existence by the dollars of capitalism with those voted into existence by the ballots of democracy. An example might be a manufacturing facility versus a bridge.

Las Vegas would not give even odds that such a study will find the bridges come in under budget and ahead of time, while the manufacturing facilities come in over budget and late. If one discovered boxes of rifles and ammunition marked for immediate delivery to General George Armstrong Custer at Little Bighorn River, it is more likely the boxes would be in a government warehouse, and not with FedEx or UPS.[13]

How one views the Present versus the Future also reveals a significant difference between voting with dollars under Capitalism versus voting with ballots under Democracy. Casting dollar votes usually involves selecting something tangible in the here and now: a consumer buys a large screen monitor at Best Buy; a sandwich at Chick-fil-A; or fills her car’s gas tank or charges its battery.

Voting with ballots under Democracy often is for something that might take place in the future: A politician offers to “fight for you” — if elected (that’s in the future). Or a politician offers a vision for the future, such as peace in the Middle East, or stopping climate change. The future deliverable usually is difficult to define or measure.

Among all the differences at the taproot as to why voting with dollars under Capitalism differs from voting with ballots under Democracy is the economic principle of Cost. Cost is viewed and tabulated differently in markets for goods and services versus how Cost is viewed and tabulated in the political marketplace. Generally, with some exceptions, Capitalism forces buyers and sellers to consider Costs. Generally, with some exceptions, Democracy does not force voters or politicians to consider Costs.

Economists understand that there are very few activities or endeavors that do not involve Costs — as well as benefits. Here economists differ with non-economists: politicians and ordinary voters — who often focus only on the purported benefits of an endeavor to the exclusion of its Costs.

Economists have a definition of Cost that is unique to their tribe and profound in its concept: The Cost of any activity or endeavor is the highest-valued opportunity forgone. This perspective on Cost is the most valuable tool in the economist’s toolkit.

I tell my students that they understand this profound principle if they can explain why a prominent attorney from Washington, D.C., who has business in Atlanta, cannot afford to take the bus or the train to Atlanta. The bus or the train is too Costly — in terms of opportunities forgone.

I ask them to imagine two doctors who take a morning off work to play golf together: a cardiac surgeon and a pediatrician — and each pay the same greens fees, each loses one Titleist golf ball, each one buys a glass of iced tea afterwards. So, the explicit Cost is identical for both physicians. Economists understand that the Cost of the round of golf — the Economic Cost — probably will be greater for the cardiac surgeon than the pediatrician. An economist would understand why cardiac surgeons do not play as much golf as pediatricians. Golf costs them more.

Tom Sowell once wrote: “The first lesson in economics is Scarcity, there isn’t enough of anything to satisfy all those who want it; the first lesson of politics is to disregard the first lesson of economics”[14] Scarcity means Choices have to be made. A Choice involves a Cost: the highest value forgone. Economists understand Cost. Non-economists often do not.

One can learn this lesson from poetry. Consider Robert Frost’s poem, “The Road Less Traveled”: . . . two roads diverging in a yellow wood, and I, being one traveler, able to take only one. The road not taken is the Cost of the road traveled — it is the alternative opportunity forgone.

Another poetic description of the connection of Cost and Choice is found in a poem by Auden (as one would expect, it is subtler than the Frost poem).

“Clear, unscaleable, ahead

Rise the Mountains of Instead

From whose cold, cascading streams

None may drink except in dreams.”[15]

For Auden, the Choice one makes means the Choice not made can exist only in one’s dreams.

If a politician in the midst of an election campaign promises more roads, or more schools, or more nuclear submarines, or expanded health benefits, it would be a rare occasion if the politician were to explain what will be given up — in terms of goods and services forgone — as a result of the additional roads, schools, nuclear submarines, or health care. An example of this happening in the political marketplace would be the exception that proves the rule.

Under Capitalism, if a firm does not pay attention to Costs, it will have to change its business plan — or go out of business. Under Democracy, there is little prospect that the U.S. Postal Service, the Department of Labor, and even the Department of Commerce will perform in a way that they will cease to exist.

When economists study markets, there is no phenomenon that warrants the label: “kicking the can down the road.” That is not a descriptor of Capitalism; it is a descriptor of Democracy. Congress, as an institution of Democracy, has a track record of abdication. The problem du jour is kicked down the road rather than resolved. It would be idle to contend that business firms can get away with kicking a can down the road, because kicking the can down the road does not work under Capitalism. The discipline of the market will intervene.

If one stacks up how decisions are made in markets versus how decisions are made by government, the market wins — if the goal is consumer welfare.

Instead of expanding this list of differences between Choices that are made in markets voting with dollars and Choices that are made in a Democracy voting with ballots, let me suggest a second Gedanken experiment. Imagine the difference between the greetings you hear upon entering Chick-fil-A and the IRS. Upon entering the former, one is asked: “How can I help you?” Upon entering the latter, one is told: “Take a seat.”

*****

In serious conversations about Free Markets, Adam Smith’s name often surfaces. In serious conversations about Democracy, Tocqueville’s name often surfaces. A scholar not often cited in such discussions is C. S. Lewis. Most people think of Lewis and his writings like The Narnia Tales or his contributions to English literature or Christian apologetics. But Lewis was prescient about Democracy. Here are Lewis’s words on the subject:

“I am a democrat [small “d” democrat] because I believe in the Fall of Man. I think most people are democrats for the opposite reason. A great deal of democratic enthusiasm descends from the ideas of people like Rousseau, who believed in democracy because they thought mankind so wise and good that everyone deserved a share in the government. The danger of defending democracy on those grounds is that they’re not true. . . . I find that they’re not true without looking further than myself. I don’t deserve a share in governing a hen-roost [Americans would say chicken coop], much less a nation. Nor do most people. . . . The real reason for democracy is just the reverse. Mankind is so fallen that no man can be trusted with unchecked power over his fellows. Aristotle said that some people were only fit to be slaves. I do not contradict him. But I reject slavery because I see no men fit to be masters.” (Lewis, 1986, p. 17, Present Concerns).

The philosopher Richard Rorty once wrote, “Take care of freedom and truth will take care of itself.”[16] If Rorty is correct, that if truth is to be pursued, then freedom needs to be nurtured and protected.

If freedom is to be valued, then any thoughtful discussion of how to improve Democracy ought to include the question of how to reduce the size of government — and replace it with market allocation. If one compares decision-making by votes versus decision-making by dollars, one implication to be drawn is that a nation is more likely to have freedom with a minimum of government control and a maximum of what Adam Smith called the “obvious and simple system of natural liberty.” [17]

Books and conferences will continue to be held on the study and promotion of Democracy. No doubt efforts will be made, some sincere, some sinister, to improve the governance of Democracies.

In the end, when all the discussions on Democracy are over and the levers of governance are pushed forward or pulled back, the words of the Irish poet Oliver Goldsmith — penned even before Adam Smith wrote The Wealth of Nations — will continue to ring true:

“How small, of all that human hearts endure,

That part which laws of kings can cause or cure.”[18]     *

 


[1] I entitled this paper Capitalism and Democracy. It could be called: Capitalism versus Democracy. My remarks have a debt to my former colleague, James M. Buchanan. See, in particular, James M. Buchanan, “Individual Choice in Voting and the Market” Journal of Political Economy LXII (1954), 334-43. Reprinted in Fiscal Theory and Political Economy: Selected Essays by James M. Buchanan (1960), chapter IV, pp. 90-104.

[2] John Locke, Second Treatise on Civil Government, chapter II. 1689.

[3] Alexis de Tocqueville, Democracy in America, Chapter III.

[4] Jay Tolson, “Following Alexis de Tocqueville: A Conversation with Historian and Biographer Olivier Zunz.” from The Hedgehog Review, vol. 24, no. 2, Summer 2022, p. 80.

[5] Ibid. p. 86.

[6] Adam Smith, The Wealth of Nations, Book I, Chapter II, p. 25.

[7] Alexis de Tocqueville, Democracy in America. (1840) Vol II, part 2, chapter 1. p. 581. (trans. Arthur Goldhammer, Library of America)

8 From “Created Equal,” an episode of the PBS “Free to Choose” television series (1980, vol. 5 transcript).

 

 

[10] The budget for a corporation on marketing and advertising pales in comparison to what is spent by a political party in an important election.

[11] Many people buy a car only once every four years or so. But there are other people buying cars every week of the year. The market competition between Ford, Toyota, Chevrolet, and Honda is continuous.

[12] Still another difference between market Competition and political Competition is that in market Competition, the consumer generally has more information about what is being purchased than a voter has about a candidate.

[13] I am unable to identify who made this quip. I believe it is George Stigler. In checking with Claire Friedland, George Stigler’s longtime research assistant, she told me she was not sure but that it sounded like something Stigler would say or write.

[14] Thomas Sowell, Is Reality Optional? And Other Essays. Hoover Institution Press: 1993.

[15] W. H. Auden, from Twelve Songs: VI

[16] Richard Rorty, Interviews with Richard Rorty (2005), 58.

[17] Adam Smith, The Wealth of Nations, Book IV, Chapter IX.

[18] Oliver Goldsmith, “The Traveller,” 1764.

Read 1305 times
Login to post comments

Calendar of Events

Annual Dinner 2023
Thu Oct 19, 2023 @ 6:00PM - 08:00PM
Annual Seminar 2023
Thu Oct 19, 2023 @ 2:30PM - 05:00PM
Annual Dinner 2022
Thu Oct 13, 2022 @ 6:00PM - 08:00PM
Annual Seminar 2022
Thu Oct 13, 2022 @ 2:30PM - 05:00PM
Annual Dinner 2021
Thu Oct 14, 2021 @ 6:00PM - 08:00PM
Annual Seminar 2021
Thu Oct 14, 2021 @ 2:30PM - 05:00PM
Annual Dinner 2020
Thu Oct 22, 2020 @ 5:00PM - 08:00PM
St Croix Review Seminar
Thu Oct 22, 2020 @ 2:00PM - 04:30PM

Words of Wisdom