In view of the fact that the United States political/economic system has turned into a mostly illiberal and highly regulated democracy, the question “Is capitalism inherently unsustainable?” deserves attention.
Politically, capitalism is a form of social organization based on the recognition of individual rights. Economically, it is a system where owners of capital exercise their property rights to trade with each other voluntarily, thus establishing a free market. The freedom refers to the principle that no individual or group (including the state) may initiate the use of force against anyone else. The implementation of this principle requires a proper social organization – a legal system to resolve disputes and a police force to prevent the initiation of force and implement the decisions of the legal system.
Economically, capitalism (the free market aspect of it) is the only system that has ever worked in practice – economies have resisted collapse to the extent to which elements of free markets were present. This fact is partially recognized today in the sense that a free market is held to be valuable but fragile and in the sense that total state control of the economy has been thoroughly discredited. The success of free markets is not surprising. In a free market, every individual exercises his own judgement and takes responsibility for the consequences. Good judgement necessarily wins in such a system. As the economy grows in size and complexity, better and more specialized judgement is required for success, making it impossible for the state to control the economy effectively. Although it is certainly difficult to predict the results of a particular decision in the higly interdependent and complex economies of today, the complexity is its own defense as long as the market is free. In a complex economy, the effects of a bad decision are larger and more widespread and can be noticed earlier than would be possible in a simple economy. As long as people are free to make their own decisions, they can distance themselves from the bad decisions and minimize their risks. But when the economy is regulated, the effects of decisions are artificially suppressed by penalizing good decisions and rewarding bad ones. This is true irrespective of the kind of regulation imposed. Consider some examples. When the state puts a cap on the price of a particular commodity, thus reducing the profits of the producers, it makes production less attractive for newcomers, raises the barrier to entry, encourages monopolies, keeps supply short and removes the possibility of the price being lowered by competition. When the state bans insider trading or short selling of stocks, it prevents the spread of information that would otherwise happen. When the state lowers interest rates, it reduces the value of good investments and raises the value of bad investments. A regulated economy is more stable in the short run, but the stability is spurious. It is achieved by constantly changing the rules of the game to equalize results. Regulation is like a teacher’s policy of awarding similar grades to students irrespective of their performance, reducing the motivation of the brighter students and instilling a false confidence in the duller ones. The students from such a class fail when they encounter a world outside the teachers influence, the brighter ones because they never learned to work hard, the duller ones because they never learned to work well. When the damage done by regulation goes beyond the ability of the state to control, the results are catastrophic (as we see today). The short-term stability from regulation comes at the price of a certainty of a catastrophic collapse, something that is unlikely (though not impossible) in a free market. It is not free markets but regulation and the mixed economy that is completely unsustainable. Free markets are inherently stable in the long term, simply by virtue of the fact that good ideas work.
Politically, however, capitalism is unstable. The success of capitalism depends on a proper understanding of individual rights – most importantly property rights. This is impossible without a sound philosophical grounding – most importantly ethics – and difficult in any case. When the state enacts laws that violate someones rights, it turns from a protector of men into a looter. Unlike the action of the free market which corrects itself, violation of rights turns a difficult problem – how to objectively define and protect rights – into an impossible one – how to dispose of loot in a just manner. These difficulties exist even when a state recognizes its role as being limited to a protector of individual rights. They are enormously compounded when this recognition is absent. A state that actively oversteps its role is fundamentally corrupt and the corruption inevitably increases. Left to itself, such a state necessarily degenerates into an autocracy, constantly expanding its powers and violating rights, until its economy collapses and the state is forced to change its political principles. But a collapse does not necessarily mean that capitalism will be established (The example of Russia is a case in point). Establishing and even maintaining a system of proper well defined rights requires active, principled and continuous effort. As Thomas Jefferson put it “The price of freedom is eternal vigilance.”
However unstable the political aspect of capitalism may be, it is the only system that is proper to man – the only system that recognizes that man requires freedom to succeed, that the standard of truth is reality and not consensus, that the proper purpose of man’s life is his happiness, that the proper principle for interaction among men is trade, and that the standard for mutually beneficial trade is profit. Just as sustained effort is required to achieve any goal that man may set for himself, sustained effort is required to keep a society capitalist – effort to understand a proper code of ethics, to understand the principle of rights, to apply these principles to concrete situations, to establish and maintain objective laws based on these applications and most importantly to reverse or correct any mistakes that might be made along the way.
This post was written as a response to a comment that capitalism is unsustainable because of an innate desire for security in most men. The claim about the desire for security might well be true. However it is not these men who make the world or set its terms. The world is made by the men of vision who dare to think and plan beyond the short term – by the scientists who spend years on their research, by the businessmen who invest their money without expecting returns for several years, by the activists who can project a better future, and most importantly by the philosophers who devise theories and set the direction of the activities of men. Capitalism has declined not because of a desire for security, but because the principles underlying it have never been fully understood, and consequently the effort to sustain it has either been absent or misguided.