I read a fair number of books, magazine articles, news sites, and some blogs. In general, my impression is that a great number of individuals really do not understand what constitutes a free market. Some believe a very simplistic ideal that when the USSR was a going concern the government officials set the official price of all goods and services, while in the “free world” governments did not set official prices. The USSR has been defunct for well over twenty years and the new Russia has embraced a semi free market. Well, that’s just the trouble, isn’t it, you think. Either a market is free or it is controlled by government. Ah, that’s just the rub. Economic textbooks tell us about that mythical free market where supply and demand set prices as goods and services are offered and delivered. But what does that have to do with the price of tea in China? Are there any free markets in the world today, and if not, then why not?
Adam Smith was a very observant professor of Moral Philosophy. His tract on capitalism was written based on first hand observation of individuals and groups as well as his thinking through the interactions individuals make. He never said that free markets existed, h only said that they should and then proceeded to show various groups, from business combines, craft guilds, and government, interdicted that free market with rules, regulations, laws, combines, trusts, and so forth. He was greatly against the British Government, from the Crown down to the city and town, interfering with the markets. Grants of monopoly, patents, and the like greatly impeded the free markets. Now I say markets because there are many markets, as many as there are industries and product sectors. Until mobile cell phones, your telephone service was a physical monopoly. That is, in order to enter the land line phone business one would have had to erect the poles or dig the trenches to place the cables from the central office switching machine and connect them to the house. That is rather wasteful if you have four or five supplies of service since the cost of capital for the construction of duplicate facilities would have driven the price of service very high just to recoup those fixed costs. Thus a monopoly was granted to one service provider whose operations were overseen by a regulatory agency. And rise in prices had to be justified by a rise in costs. And those costs were closely scrutinized for their validity. Now we have a few mobile cell phone service providers who had created a limited free market. I say limited because they are guided by regulatory agencies to some extent. And they must apply for permits to erect new transmission towers, and the like. The physical limitations of radio frequency spectra means that they jointly own a physical monopoly. In order to enter the mobile phone service business one must buy one of the providers.
Now lets us assume for the sake of argument that you are a arts and crafts person. You create some form of art or construct some sort of craft product. Maybe you weave baskets from grasses, straw, and cane. You buy your materials and devote your time to the production of baskets. No regulations, laws, rules, or government interference that impedes your manufacture. Now where to sell these products. Perhaps you can advertise in the local print media or online and thus attract orders for your baskets. Unfortunately you have entered the twilight zone unwittingly. Did you apply for a business license? Are you charging and collecting sales tax? Is your home zoned for any type of business practice? Did you fine your semi annual forms that the local, state, and federal government expect to receive with all the documentation? Have you paid your quarterly estimated income tax to the IRS? What was to have been a free market is suddenly not so free. True, there is no government agency setting your prices or approving of your raw materials or even ensuring you are breaking no labor laws. But now you have discovered hidden costs to your business and that affects your price structure. If you were baking and decorating cakes and pastries you would have even greater interference from the local and state government. Your baking facilities (your kitchen) would be subject to quarterly or even monthly inspections by the health department. You might be required to have licensed training and be required to pay a yearly fee (like a hairdresser or realtor). You may be forbidden to use certain ingredients or sell to certain establishments. The rationale is that this is for the public good. Whether you are selling goods or services or both, the government hand is in your pocket and in your business.
Capitalism is one term that so many individuals confuse with business operations. Simply put, capitalism is when individuals save income and invest those savings in the ownership of a business. If one is an auto mechanic and saves part of his income so that he can buy the tools he needs for his services and rents or buys a suitable building where he can offer his services, then that auto mechanic is a capitalist. He may need to borrow funds or capital to obtain the necessary building and equipment to engage in that business,but he is a capitalist. And if a woman saves a part of her income so that she might buy shares of stock in some corporation, then she is a capitalist. In fact, simply owning any savings is owning capital and being a capitalist. Except for the last few years we have expected a return on our savings, interest paid for lending our money to the bank. The bank lends out our savings to earn an income for its business. And a share of stock is, by the way, a right to participate in the profits of a corporation, if there are any. To participate in the profits is a way of saying the right to receive any distribution of such profits. A corporation, through its board of directors, which are presumably elected by the share holders, may decide to retain all after tax profits for future investment. Retained earnings is one way that a corporation or business raises its own capital. Another is through issuing bonds and debentures. A third is by borrowing against collateral, which may be fixed assets (land and buildings) or accounts receivable (an income stream) or rolling stock (company owned vehicles, aircraft, etc).
But hasn’t capitalism fail this country, indeed, the world? No, that has been a failure of government. As we learned in the discussion on why free markets aren’t really free, we now turn to capitalism and learn how government can destroy it. One way is through the Federal Reserve Bank, the private bank that sets interest rate, bank capital reserves, and other economic interventions. The interest rate that the FED sets is the rate that a bank can borrow capital from the FED, If the rate is very low, as it is today, then the bank does not need to pay a higher interest rate to its savings customers. Capital has a cost and that cost is tied to the acquisition of it. One either saves income for future investment or one borrows capital from a source that has capital to lend. Now I could say money but my point is that capital is an investment while money is consumed by buying goods and services. Most individuals confuse the two. Just as a house is usually an investment because it usually rises in value (unless there is great speculation in buying and selling housing, in which case the value of any particular house is questionable), an automobile, with rare exception, is an expense and not an investment. Its values diminishes over time until it becomes a collectable due to the rarity of the survival of others like itself. And then we have the subject of taxes. Who pays taxes collected from businesses and corporations? Ultimately it is the consumer, although in a slight way the stockholders and business owners may be penalized by receiving less income. No, the consumers pay for taxes of all business by paying a higher price for the goods and services they consume. The ultimate deep pockets are the taxpayers, that collective of the people, not large corporations and governments.
The interference by government (a collective reference) in economic activity is usually meant to guide individual and collective actions of the people whom it governs and the institutions of business. That is why we have fiduciary laws that are suppose to safeguard the funds, monies, stocks, bonds, and other fungible assets of individuals, groups, and businesses. We have environmental protection laws and regulations, we have public safety laws, we have a lot of regulations and agencies that are suppose to oversee such acts. But if these agencies, these laws are gutted, stripped of funding, or revoked so that dislocation of the public trust is achieved, then it is not capitalism that has failed, it is the rule of law and government order. When we allow the system to be gamed we should not be surprised when greed and wrong doing runs rampant. This is often one of the most pressing problems with Democracy. Our country was set up as a Republic, that is, we hold elections so that we can choose individuals to represent our interests in governmental affairs. A straight Democracy means majority rule, pure and simple. A democracy is often likened to a trio in practice. Two wolves and a sheep deciding what to eat for diner. The minority loses. The concept of a democracy is that the individual supposedly knows what is best for himself. In a republic it’s the representative that supposedly knows what is best for the individuals he represents. Both forms of government are open to abuse. One can go back and read Socrates and Plato on the pleasures and dangers of both forms of government. And there has been a very long intellectual history of the discussions of the two.
So what do we know? Free markets are rarely free but encumbered in one way or another and to a depth that society and culture demand. Capitalism makes capitalists out of savers and funds economic activity, but corporate and business governance is always an interactive problem with advantages, disadvantages, and trade-offs. And governments best work when we demand honesty and competence. It sounds easy but the devil is in the details.