Monday, July 6, 2009

Does Capitalism Work?

Here is a map depicting how each states' GDP compares to other countries around the world:

What system can generate such a circumstance? How can comparatively small states like New Jersey can produce more than the geographical area of Russia? Is it merely that New Jersey has more natural resources than all of Russia? Or that the people of New Jersey are smarter than the people of Russia? Or is it related to each states' respective proximity to the natural state of liberty?

From the index of economic and political freedom:
"State involvement in economic activity remains considerable, and institutional constraints on economic freedom are severe. Non-tariff barriers add significantly to the cost of trade. Inflation is high, and prices are heavily controlled and influenced by the government. Virtually all foreign investment faces official and unofficial hurdles, including bureaucratic inconsistency, corruption, and outright restrictions in lucrative sectors like energy. Corruption weakens the rule of law and increases the fragility of property rights and the arbitrariness of law enforcement."

The answer is quite simple - the government acts as an obstacle to natural market activity. Price controls and excessive bureaucracy prevent individuals from disposing of their property how they see fit. A weakened rule of law and barriers to trade stifle risk taking and entrepreneurship. All of these things lower productivity. The truth becomes clear - it does not matter how many natural resources a country has, nor how intelligent the population is. If government will not allow people to trade freely with each other, guarantee the security of property and establish the rule of law, productivity and quality of life will suffer.

Thomas Jefferson, George Washington, and the rest of the founders took a different approach. They recognized both the economic and personal woes that emerge from a bloated State. The United States was founded on the principles of individual liberty and the rule of law, precisely what is lacking in Russia. Capitalism works, and one need to look no further than to compare New Jersey to Russia.

* It should be noted that New Jersey outproduces Russia despite being one of the most heavily taxed and regulated State's in the Union.


  1. Imagine what would happen if we actually let capitilism run free!

    - Gabi

  2. Why do we want to maximize total gdp?

  3. Also, I think the correlation between the average years of schooling a country's adults have and per capita GDP is stronger than the correlation between p.c. GDP and the country's economic freedom index... So then what?

  4. Well I would think we want to maximize production so that people can distance themselves from the natural state of poverty, for one.

    The other point you mention makes sense. As the division of labor increases and becomes more specialized, there will be a need for more specialized training. An economy that is strictly agricultural will need less education than an economy that produces innovative technologies and mechanized production. But we all start from the same point, and what I took from this map was the implication that if other countries' governments stopped interfering in their citizens' affairs then the people would become more educated over time. You can't spend money on education if you're stuck in a state of poverty and the government is holding down free trade, no?

  5. Well, what I meant was as follows: If it is true that education plays a larger role in wealth-creation than economic freedom (given certain minimum requirements) then, if your goal is to maximize wealth, you would be in favor of Congress raising taxes to create a better education system, right?

  6. I'm going to question that premise on conceptual grounds. If you don't have economic freedom then it doesn't matter how educated you are - the layers of bureaucracy and limitations on trade won't let you maximize much, if anything. Education may play a larger role once you have already established a "free trade zone" like the 50 states and then given them some time to start producing. You yourself even said "given certain minimum requirements". So the idea that Congress can somehow diminish economic freedom (raising taxes) to produce wealth through education is silly. The only way the educated could produce is if they possessed economic freedom after they graduated! Or are we now just going to pay for each other to go to school so that we have an alphabet of acronyms after our surnames, because the more acronyms we have the more wealth we will be able to produce?

    Secondly, I love how you are asking very good questions and forcing me to clarify myself, but come on. Congress creating a better education system? Congress? Really? You'll never spend someone else's money as carefully as you'll spend your own, and that applies all the more so to Congress who seeks power, fame and prestige.

  7. Right. So first of all that's one reason why I think blindly maximizing gdp is crazy. If we sat around paying each other to get degrees we could have infinity gdp.

    Also you are right that Congress is filled with people you wouldn't want managing a garage sale.

    But I don't know what you mean by "So the idea that Congress can somehow diminish economic freedom (raising taxes) to produce wealth through education is silly." Imagine a state. Say, New Jersey. Say the NJ legislature raises the state corporate tax from x% to x+3%. So NJ's "Economic Freedom" score drops a point. And, if they waste that money GDP per capita will fall. But let's say they set up a quasi-governmental committee and give them the cash to improve schools, and the QGC succeeds. GDP per capita in NJ now rises above the level it was at before the tax hike. These are *possible* circumstances, right? If I could guarantee that the net effect would be an increase in gdp-p.c., would you be in favor of the tax hike?

  8. Just to add a by-the-way: as far as I understand, most economists would agree that:
    a) such a set of circumstances (and net effects), in certain situations, is possible;
    and b) thus, gov't should sometimes intervene in markets.

    Not that this fact is of supreme importance (and by the way, I wouldn't include Boudreaux in "most economists"), but it's not irrelevant either.

  9. You are right, after I posted my comment I realized that there theoretically could be a scenario where the government spends money in such a way that it actually boosts productivity.

    Nevertheless, I would still not be for a tax hike. Not because of a moral issue, even though there may be one, but simply because of an economic issue. Government is structured in such a way that it is slow to act and does not anticipate market conditions in the future. This is like, by definition how politicians operate. They only see as far as the next election. Their "time preference" is focused on the short term. An entrepreneur is trained to look at the long term, bigger picture. He will make decisions that take into account current market conditions as well as the future, to the best of his ability. Whether or not he makes an accurate forecast is irrelevant. He is free from bureaucracy and is able to make dynamic changes with his money on the fly. This allows him to *adapt* in a much swifter fashion than the heads of a government committee.

    In other words, I wouldn't want the government involved in "making education better" because even if you could prove it to me that in the short term they could actually deliver a profitable service, there is little to no chance the service will stay profitable in the intermediate term, let alone the long term.

    It seems to me to be the same old thing - if the government was as efficient as the marketplace then it wouldn't be government anymore. That's my problem with Obama's "public choice" plan. He says he just wants to offer a competitive plan but anyone with half a brain can see that if it was really competitive it wouldn't need to be government. What would that add?

  10. How about externalities? In some cases there could be benefits that are impossible, or at least too logistically difficult, for a free market to capture.

    In this case, for example, improving an individual's education might benefit the entire community (lower crime, more trade?). However, the school can't convince everyone in the community to shell out for that guys education, because each member of the community would get almost all of the benefits without contributing himself (the "free rider problem").
    Again, I agree that governments make messes of things, but in some cases couldn't gov't inefficiencies outweigh gains from eliminating externalities / free rider problems?

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  12. Where do you draw the line with externalities? That looks like quite a slippery slope, nevermind the fact that governments are inferior to individuals in adjusting to a dynamic marketplace.

    As far as crime goes, you need rule of law and protection of property rights to facilitate trade. Pretty much the main point of this post was actually showing how the weaker those two things get the more impoverished and subject to corruption/crime the people become. Not the other way around.