The Paradox of Capitalism and the Paradox of Socialism

Capital, Capital Formation, Capitalism
and Capitalistic Societies

Capital is property that has been acquired and saved rather than being consumed. Seed corn is an example of capital. A farmer is creating capital who keeps some of the seed from a harvest to plant for next year’s harvest.

Capital formation occurs in societies where people generally consume less than they produce, saving the difference for future productive use. Poverty-stricken countries suffer from a lack of capital formation, as in the country of Bangladesh, described below in this chapter.

In the lexicon of Andrew Galambos, “Capitalism is that societal structure whose mechanism is capable of protecting all forms of private property completely.”

Property in Galambos’ lexicon comprises an individual’s life, his or her tangible and financial assets, and finally and most importantly, an individual’s thoughts, ideas, actions, and intellectual property in the case of creative people.

Galambos believed that a socialist like George Bernard Shaw considered his literary works as his personal property—which they were—and that if society so defined and protected intellectual property, it seems likely that Shaw would not have had such a negative view of capitalism.

A capitalist is a person who enables and facilitates production by providing capital for productive use by himself, or others, or both himself and others. An entrepreneur is someone who organizes the factors of production, namely innovation, land, labor, and entrepreneurial activity.

John D. Rockefeller (1839-1937) was a capitalist and entrepreneur whose name has become identified–wrongly–with with nefarious, cut-throat competition designed to bankrupt competitors. [See Chapter 13: Monopolies–Coercive and Non-Coercive regarding Rockefeller and his company’s competitors] By the age of 70, Rockefeller had accumulated wealth amounting to $900 million, the largest inflation-adjusted fortune in history. Yet Rockefeller’s fortune was small in comparison to the value he created for society through his entrepreneurial activities, which include the following: virtually creating the petroleum industry, reducing by 90% the cost of kerosene used in illumination, providing well-paid employment for many thousands of people, unwittingly saving the sperm whale from extinction, and giving away most of his fortune for socially beneficial purposes, such as endowing the University of Chicago.

Being an entrepreneur requires courage and business talent. Even the most severe critics of Rockefeller’s competitive practices praised his entrepreneurial abilities and what they created. Ida Tarbell, author of a highly acclaimed and influential literary indictment of the competitive tactics of Rockefeller’s Standard Oil Company, expressed appreciation and approval of the company’s efficiency and productivity.

Muhammad Yunus: Banker to the Poor

One of the great contemporary benefactors of poor people is Muhammad Yunus (born 1940), a Professor of economics in Bangladesh.

Bangladesh is one of the poorest countries in the world, and one of the hungriest despite its location on the fertile Bengal Delta. Its 150 million people live in an area the size of the American state of Florida (population 19 million).

Professor Yunus was born into a prosperous Muslim family. He earned a PhD degree in economics (1971) from Vanderbilt University in Nashville, Tennessee. From 1969 to 1972 he was a professor of economics at Middle Tennessee State University.

Upon his return to his native country in 1972, Yunus became a university professor of economics. In 1974 Bangladesh suffered a nearly year-long famine in which roughly 1.5 million people died of starvation and disease. Professor Yunus asked himself what good were all his elegant economic theories when people were starving to death in nearby villages. He went into the villages and tried a great number of things to alleviate the poverty and hunger.

Yunus began offering individuals tiny loans for self-employment. Yunus’ first loan was to a group of women who were barely surviving on earnings from making bamboo stools by hand. To get the money to buy bamboo they borrowed from village money lenders. The money lenders took the stools in payment of the loans, allowing the stool makers 10% of the cost of the materials, an equivalent of $US 0.02 (two cents) a day for their work. It took all day to make one stool by hand. The two cents a day of income was barely a subsistence wage.

Yunus saw that the stool makers were condemned to a life of hard work just for subsistence; that most of the benefit of their work was going to the money lenders, who had money, while the stool makers did not.

The Professor decided to try to reverse the cycle of dependency and poverty. He loaned US $27 to a group of forty-two stool makers, about US $0.64 each. It was enough for them to pay off the money lender and keep all the revenue from selling their stools.

From this minuscule transaction grew Grameen Bank (Village Bank), an institution which by 2013 had loaned a cumulative total of $11 billion to 8.5 million borrowers. This so-called “micro-lending” and “micro-finance” has spread to almost every country in the world, including the United States.

It is not religious strife that causes destitution in Bangladesh.  The problem of Bangladesh is lack of economic freedom and opportunity. Bangladesh ranks 132nd out of 177 on the Heritage Foundation’s Economic Freedom Index. There is a direct relation between poverty, lack of freedom, and a high level of extraction of wealth from the people by the state that rules them. This universal phenomenon is documented in the book Why Nations Fail: The Origins of Power, Prosperity, and Poverty (2012) by Daron Acemoglu and James A. Robinson, professors respectively at the Massachusetts Institute of Technology and Harvard University.

The Failure of Foreign Aid

The Bangladesh state has been heavily dependent on foreign aid. From 1977 to 1997 the Bangladesh state waged a war of repression against indigenous non-Bengali tribal people in the southeastern part of the country, an area known as the Chittagong Hills Tract (CHT). The Bangladesh state has moved Bengalis into the CHT en masse over objections of the local tribal peoples. The Bangladesh state persistently violates human rights of the people of the CHT and commits atrocities against them. Yet rich countries continue to send aid to the Bangladesh state.

According to Damon Acemoglu and James Robinson, Professors at MIT and Harvard University respectively, in their book Why Nations Fail (2012), foreign aid from rich to poor countries has been an abysmal failure. They say that “many studies estimate that only about 10 or at most 20 percent of aid ever reaches its target . . . Throughout the last five decades [roughly the 1960s through the 2000s], hundreds of billions of dollars have been paid to governments around the world as ‘development’ aid.  Much of it has been wasted in overhead and corruption . . . Worse, a lot of it went to dictators such as [Joseph] Mobutu,” (1930-1997) (dictator of the Congo, later renamed Zaire) who became fabulously wealthy by misappropriating foreign aid meant to help the people of his country.

Foreign aid consists of payments by a state to another state, and also payments from the aid activities of Non-Governmental Organizations (NGOs).

In comparison, microloans are not gifts to a state. They are loans to individuals who, in the case of Grameen Bank, have a 99% repayment rate. The loans are capital placed in the hands of people who use it wisely, by all accounts from Professor Yunus’ book.

According to one source, foreign aid from rich to poor countries has totaled $3.19 trillion dollars from 1970 to 2010. That is 277x as much as the $11.5 billion in micro-loans made by Muhammad Yunus’ Grameen bank from 1983 to 2013.

If even ten percent of the money squandered on foreign aid by “developed” countries since 1970 had been turned over to Yunus’ Grameen bank and similar organizations to increase their  micro-lending to individuals, far more good would have been done in alleviating global poverty.

Capitalism and the State

Much of the bad reputation of “capitalism” stems from anti-capitalistic activities by business people themselves, often in conjunction with the state.

The agricultural industry is a prime example. Federal farm price supports in the U.S. have been a staple of federal policy since the 1930s. They were adopted ostensibly to protect small family farms, but the overwhelming bulk of the federal spending on farm price supports goes to large-scale farming operations, enriching them at the expense of consumers.

The American “defense” industry is a costly example of companies using the state to obtain business at public expense, although this is not to argue that the United States does not require military procurement from industrial companies for reasons of national security. Defense industry contracts with the state are by and large on a “cost plus” basis, allowing the contractor its costs plus an extra amount for profits. Cost plus contracts provide  a perverse incentive for higher costs, which mean higher profits under the cost plus formula.

Large commercial banks and Wall Street investment banks provide another prominent example of businesses seeking the aid of the federal state, and thereby imposing a large cost on the American public.

According to a knowledgeable analyst of the banking industry, in the financial crisis of 2008, “. . . twelve of the thirteen largest banks would have failed if not for [federal] intervention [i.e., bailouts].” The bailouts were provided under a policy known as “too big to fail” that was not part of the laws of the U.S., but was an implicit policy of the federal state dating back to the mid-1980s. The existence of the “too big to fail” policy seems to have eliminated the fear of failure that otherwise would motivate prudence and caution in banking; that lack of prudence in large banks was undoubtedly an important factor causing the financial crisis of 2008.

The response of Congress to the big bank woes in the financial crisis of 2008 was to enact a new law in 2010 that codified the “too big to fail” rule, making it virtually certain that the federal state would protect big banks from their own errors and mismanagement. Five years after the financial crisis of 2008 several of the largest banks are larger than they were before the crisis.

The general public does not recognize that much of what is considered the evils or faults of capitalism in America is actually the product of collusion between businesses and the state, for example business seeking state protection from competition, seeking subsidies from the state, seeking bailouts when they get into trouble and seeking low interest rates and lax regulation of lending in order to stimulate business during an economic downturn.

It is not capitalism as defined by Andrew Galambos when companies and industries are for free enterprise only insofar as it suits them, but want state aid to help them out or to rescue them from failure. It is no wonder that capitalism has a negative image. Not only is capitalism maligned by critics who favor collectivism, but some supposed capitalists are their own worst enemies due to the consequences of their collusion with the state.

The Paradox of Capitalism

There is a paradox in capitalism. It is beneficial—but much maligned.

The paradox arises because in a capitalistic society there is equality of opportunity but inequality of outcome. Some people become more prosperous than others. Some people are relatively poor while others may appear inordinately rich. Some people are born bright; others dull; some people possess high inborn capabilities while others struggle even to be average in what they do.

This disparity in economic rewards engenders envy and resentment, especially among intellectuals, artists, scientists, educators, and creative people in general. Their unhappiness with contemporary capitalism is not without justification. They see their own contributions to society rewarded less well—and often far less well—than popular entertainers and business people, whose activities they may disdain. In a truly capitalistic society, where property – including intellectual property – is protected, the achievements of scientists, artists, and thinkers would be compensated in proportion to their value. The plight of the innovator under the primitive capitalism so far known to humanity is addressed in the later chapters of this book which focus on rewarding innovation and protecting intellectual property.

In the quest for economic equality, collectivists seek to control human activity in order to redistribute property and wealth by taking from those who have more than average to transfer to those who have less. Political imposition of income redistribution and other collectivist measures quickly lowers the standard of living of most people. But to people who think of themselves as socialists that does not matter. Thus, in the British parliament in 1990, a Labor Member of Parliament voiced a chief socialist criticism of then Prime Minister Margaret Thatcher, leader of the British Conservative Party, that: “. . . over her eleven years [in power since 1979] the gap between the richest 10% and the poorest 10% has widened substantially.” Mrs. Thatcher replied: “All levels of income are better off than they were in 1979. . . You would rather the poor were poorer provided that the rich were less rich. . . You do not create wealth and opportunity in that way.”

Labor Hypothesis of Value as Source
of Hatred of Capitalism

The labor hypothesis of value claims that the value of an item is expressed by the amount of labor required to create that item.

The labor hypothesis of value is belied by everyday experiences in life. Value depends not on the labor cost of production, but rather on the subjective determination of people as expressed by their actions in the market place. A mass-produced pencil selling for less than the cost of an inexpensive piece of candy is worth as much, if not more, than a handmade pencil that required a single individual to labor many hours, if not hundreds of hours, to produce. This example is elaborated in clear and colorful description in the essay entitled I, Pencil (1958) by Leonard E. Read. 

Karl Marx rested much of his communist ideology on the labor hypothesis of value, namely that since labor is the source of all value, capitalists and entrepreneurs provide nothing of value, and whatever they take out of society is “surplus” capital produced by workers but extorted from them through exploitation of the working class.

The labor hypothesis of value idea has generated envy and hatred of entrepreneurs and capitalists. In communist societies that loathing has been evoked as justification for “liquidating” (a euphemism for murdering) the exploitative capitalists and entrepreneurs. In political democracies the labor theory of value has evoked political action to impose heavy taxation on the incomes and estates of capitalists, entrepreneurs, and also anyone else who somehow manages to earn or acquire more than the average of his fellow humans.

The Paradox of Socialism

Socialist ideologue Karl Marx held that there would be an inevitable struggle for power in a capitalistic society, in that the working class would have to get rid of the capitalist ruling class in order to achieve economic equality. The paradox of socialism became evident when socialism in power fostered a relative inequality more pronounced than the inequalities of the past, an inequality that was apparently unexpected by idealistic socialists before they achieved total political control of various nations.

The rise of a privileged class under Russian communism was the theme of the famous novella Animal Farm (1945) by George Orwell (1903-1950), English socialist, novelist and journalist. In Animal Farm, the pigs led a rebellion to run the farmer off the property—in order to end human exploitation of the animals. The pigs then enunciated Seven Principles of “animalism,” to govern the farm and all its animal inhabitants. Over time the pigs became privileged overlords, eliminated the Seven Commandments, and replaced them with a single principle:

“All animals are equal, but some animals are more equal than others.”

In his famous book The Road to Serfdom (1944), Nobel Laureate F.A. Hayek posits that a socialist state will evolve into dictatorship in which a privileged class rules with the help of unscrupulous underlings who enjoy special privileges themselves and positively delight in having authority over others, and using it to enforce rules handed down from above.

Numerous books about the Soviet Union describe the privileges of the political upper crust in the purported “classless society”: special doctors and hospitals for the elite; special stores where they could buy the finest food in a country where food was of meager quality and inadequate quantity for most; relatively high quality housing in a society where housing was notoriously of poor quality and in short supply; and much more. The difference between the lifestyle of the communist party elite as compared to most citizens of the country was of far greater relative magnitude than the lifestyle of the rich in the west in comparison to “ordinary” people in western societies.

In China, beginning in 1976 upon the death of the incredibly brutal and murderous Mao Zedong, the ruling elite turned away from the ideology of communism, while continuing to assert that they were still socialists.

Under Deng Xiaoping (1904-1997), Mao’s successor as paramount leader of the CCP (1978 to 1992), the Party instituted new policies that it called “socialist modernization,” which, however, permitted some economic (but not political) freedom. That process has transformed China from a poor, backward, inward looking country into a society where, with the approval of the Party, it is considered glorious to get rich. Still, there is a ruling elite consisting of an oligarchy comprising several hundred people.

Among this ruling elite of China it is common to become gloriously rich, even super-rich by any international standard. In the Chinese political elite there are more than a few billionaires. They become rich through “guanxi,” a Chinese term that can be described approximately in English as influence, connections and nepotism. In exchange for facilitating business dealings, politicians receive lavish rewards from the proceeds garnered by entrepreneurs of state-protected enterprises.

The accompanying image of the Korean peninsula and northeast China at night illustrates how an entire nation can be impoverished by the consequences of a ruling elite enforcing rigid adherence to socialist ideology. Below the border with South Korea and above the border with China, there is brilliant illumination, while North Korea is kept in the dark at night by the absence of electric lighting except at Pyongyang, its capitol.

It is not only electricity that is scarce in North Korea. So are food and other necessities of life. Due to food shortages and inadequate nutrition, the average 18-year old North Korean male is five inches shorter than the average for 18-year old males in South Korea. Famine in North Korea killed two million of the 20 million inhabitants in the mid-1990s. ¹

According to an article in The New York Times of February 6, 2018, “food in the North is still rationed, with the best goods distributed only to a small group of elites with government connections.” ²

Special privileges for the political elite are not limited to communist countries. America’s political elite enjoy an abundance of special privileges. As of early August 2013, one such perk includes the exemption of Members of Congress and their staffs from the provisions of the Affordable Care Act, also known as ObamaCare. To read more about the special privileges of America’s political elite, continue to the full text of this chapter.

Corruption Under Socialism

There are no capitalists present to corrupt public officials in communist countries. Nevertheless, there is corruption causing suffering and loss of life in the totalitarian regimes of countries where the ruling people operate under the name communist or socialist.

88,000 people died in China in an earthquake on May 12, 2008. Much of the loss of life was due to political corruption. According to World Socialist Website (www.wsws.org), “Four months after the massive earthquake in Sichuan province on May 12, a Chinese government committee finally admitted last month that shoddy workmanship and substandard materials—the result of corrupt collusion between local officials and construction companies—were behind the collapse of 7,000 school classrooms. . .

“Of the 70,000 killed (not including 18,000 still missing and almost certainly dead), a large number—some 10,000—were students who died as school buildings collapsed.

“In many cases, relatively new schools were flattened in a matter of seconds, making it impossible for children to escape. By contrast, the surrounding buildings were often still standing, indicating serious structural problems in school construction.”

In Armenia, in 1988 during the rule of the Soviet Union, an earthquake claimed the lives of 25,000 people. In 1994, sixteen people died in suburban Los Angeles in an earthquake of similar magnitude. A principal cause of the much higher loss of life in the Armenian earthquake was the shoddy Soviet-style construction of the region’s buildings due to faulty design, and substandard construction materials.

How can such things happen under socialism? This is further evidence of the paradox of socialism as discussed in the preceding section. An explanation for the events in Armenia and China is discussed in the full text of this chapter.

Choice and freedom

In capitalism humans have the maximum freedom of choice; their choices are limited only by restrictions inherent in the laws of nature. In socialism human choices are limited by political laws.

An important distinction between capitalism and socialism lies in the treatment of choice. Choosing is an essential characteristic of humans. Being free to choose allows people to express their individuality and humanity. Pure capitalism, as defined by Galambos, allows complete freedom of choice so long as one does not interfere with the freedom and property of others. Pure socialism in operation imposes drastic limits on human choice, and thus on human freedom.

The existence of a person under pure socialism is little better than that of a slave. In fact, humans were virtually slaves on farms in the Soviet Union (1918-1991), communist China until very recently, and in every walk of life in Cuba and North Korea up through this writing (in the year 2013).

In social democratic societies, such as the democracies of Western Europe, even though humans are far freer than under pure socialism, their choices are curtailed. Taxation, for example, moves the choice of how to use one’s earnings and assets from the individual to the state. The state may take over half an individual’s earnings in the welfare states of Europe, and even in America. The more socialistic a country, the less freedom of choice is left for its residents.

The Bright Future of Humanity

Jacob Bronowski (1908-1974), a great scholar, scientist, and teacher, provided an insight about the history of human civilization during the transition from life as hunters and gatherers, always on the move, to settled village life after the development of agriculture. Bronowski’s observation is as relevant to the future of mankind as it is to our past. It is as follows.

For some thousands of years after the first development of agriculture, fierce nomads came out of the desert to rob the village farmer of his surplus harvest, stored against a barren time until the next harvest.  Ultimately, the victory of the warrior-nomads was futile. They, too, eventually had to settle down and become farmers or starve.

It appears that a similar process will occur in the not too distant future of our species.

As human society has developed into the 21^st century, we remain afflicted by a different class of predators: the kleptocratic rulers of the state and their minions. Everywhere, the state rules, controls, and taxes productive people, while producing itself nothing but coercion—and in the extreme, war, slavery, poverty, and misery. The supposed justification of the state is to provide security from domestic crime and foreign aggression. However, judging from the 185 million violent deaths in the 20^th century alone (from war, poverty, famine, terrorism, and corruption) the state’s promise to protect its citizens appears to be empty.

The state everywhere is in process of self-destruction—in the political democracies as much as in the tyrannies by which political people rule others with an iron fist. This self-destructive process of the state may take several generations to complete, but that amount of time is insignificant in the long span of human history. It may occur sooner rather than later because as the debts and unfunded liabilities of the state grow larger than the ability of the people to pay through taxes, politicians react to this problem like the proverbial ostrich with its head in the sand.

Meanwhile, solutions are emerging already to the problem of organizing society without coercion. We make observations about this process in the introductory chapter entitled “Replacements for the Political State.” The prosperity that will come from the withering away of the state and the end of its depredations seems likely to be far greater than any so far enjoyed by humans.

Our species’ knowledge is advancing at an accelerating rate. The biggest danger to human existence is the use of science and technology to build and use weapons of mass destruction. However, our species has among it a few highly capable people who may be able to innovate and create real and reliable defenses against weapons of mass destruction.

Human ingenuity most likely will obviate weapons of mass destruction by developments of a scientific and technological nature. Work and investigation of defense against such weapons is already ongoing in leading countries.

Anyone with imagination and appreciation of the positive achievements of humanity in science and the arts as well as the spontaneous and gradual development of a more progressive social order ought to be optimistic about the long term future. We live already in an era when human ingenuity and creativity from almost every culture on planet earth is spreading around the world.

Biological science has led to enormous advances in medical care, enabling humans to live longer, healthier lives than at any point in history. Information technology has made it possible for individuals to communicate at the speed of light from the farthest corners of the globe. The emancipation of women, long delayed, is spreading across the planet. And many more examples abound.

The catastrophes wrought in the collectivist societies that sprang up in the twentieth century are now part of the accumulated knowledge of human society. Humanity will be better off even if in most countries the only consequence of this knowledge of collectivist catastrophe is repugnance to and rejection of the undemocratic means by which collectivists seized power in Russia, Germany, China, and elsewhere in the twentieth century.