On The Theory Of Capitalism

A refrain often heard in economic circles is that if everyone would just let capitalist greed-based behavior work “without government interference” everything would turn out just fine.

I sometimes wonder if those same people would also assert that a business model that let the behavior of greed-based sales people work “without management interference” is okay.

Adam Smith’s idea of the “invisible hand” magically balancing economic forces for the good of everyone is, of course, the basis for this line of thought. As is too often a reality, a single term or phrase such as this can be used to misinform, which is unfortunately true in this case. Those who assert the magic of capitalism based on it don’t understand the circumstances under which it was penned.

There are too many details of Smith’s theories and writing to explore here, but it needs to be noted that his 18th century writings were based on economic conditions that were new to the world. The Industrial Revolution was in its infancy, and Smith’s attempts to take the observations of this newborn (along with older economic activity) and develop an accurate, comprehensive and useful economic theory, was doomed to eventually fail. There just wasn’t enough information yet available on which to build a framework to make any concrete assertions. Not only was there not enough information, any that was gathered was likely to contain errors, having had little chance to be confirmed.

Although I cannot claim to have read every scientific theory ever developed, I think it’s safe to argue that any theory first asserted is never accurate in its original incarnation. Theories are constantly being tested and tweaked in order to validate them against the data. As new data is confirmed, theories must be discarded or changed if there is a mismatch that can’t be reconciled through discovery of error, fraud or extension.

To be clear, my use of the term theory is in the scientific sense, being analogous to an explanation, not a hypothesis, as is often taken as the meaning of theory by the general public.

Centuries after Smith’s writings, it is now clear that there is no invisible hand making things right. An unrestricted capitalist economy produces vast rewards for a small minority while producing hardship for the vast majority.

In addition to producing an ideal result, a capitalist economy let loose without controls also causes crashes in both individual sectors of the economy as well as countries as a whole. The recent “dot com” and real estate busts are just two examples of sector collapses, with the Great Depression and the Long Depression being examples of international crashes in the 19th and 18th centuries respectively.

Along with the information we have from nearly continuous events such as these, we are failing to take the new and confirmed information into account to come up with new theories that actually work and make sense when verified against the data.

It reminds me of the pre-Copernicus view of the sky. The “theory” that the earth was the center of the universe was asserted for millennia — even scientifically — with only the odd moment or two when someone suggested otherwise. Those ideas were quickly abandoned for numerous reasons, including the conflict with religious doctrines and more powerful and better known philosophers.

It wasn’t until the 16th century when Nicolaus Copernicus was able to finally challenge the notion that the earth was at the center of things in a way that stuck — eventually. He worked on what was at first a hypothesis, then a real theory, for decades, publishing On the Revolutions of Heavenly Spheresshortly before his death in 1543. He delayed publication for so long because his ideas were so radical that he didn’t want to be subject to the wrath and scorn that he thought was certain to follow. It turned out that he was wrong about the public reaction — at least in the sense of it being immediate. His book garnered little attention until well after his death.

It wasn’t until the early 17th century when Galileo Galilei used the newly invented and workable telescope to confirm with even better data what Copernicus asserted. Most people know the story of Galileo and the wrath he endured from the Catholic church from that point.

The establishment was still going with the earth-centered view, even though it was becoming increasingly tenuous. For a very long time mathematical models had to be periodically tweaked to add new and interconnected moving crystal spheres to the ones thought to control the planets (and stars) in order to make the equations match observations. Eventually, as more detailed observations were continually confirmed, keeping the earth at the center just didn’t make sense. Only a sun-centered system fit the data and to deny the mounting evidence any longer was virtually impossible.

To be clear, the analogies I have used don’t prove anything one way or another when it comes to economic theory; no analogy is a component of the proof of anything — it’s only a tool to help give clarity to a point that may not be readily understood. This comparison, does, however, give a direction and a path that has been repeatedly proven to work. Namely, following the data in a scientific sense to see what theory, if any, fits. If one doesn’t, a new one needs to be developed that does match the data.

It could very well be that a modified form of capitalism is advantageous instead of harmful. But from the results currently available, uncontrolled individual greed doesn’t seem to do the best for the most. In contrast, it seems to produce a whole lot of losers and just a very small number of winners.

But the data needs to be inclusive. It is common for people to put together numbers that only look at one country, such as the U.S. Any information gathered with this restriction is going to be wildly inaccurate because the results and effects of capitalism are international. If someone wanted to look at the U.S., they would have to include the countries that supply products to the U.S. economy, as well as those who get products from the U.S. The notoriously poor living conditions of the countries that support the U.S. can’t be ignored in an Enron-like, off-the-books accounting formula. Adding more crystal spheres is not a valid option.

The cries from critics have been out there from nearly the beginning of capitalism, and, like Copernicus and Galileo, they have been accumulating data that is not going to be possible to ignore forever. Aristarchus of Samos in the 3rd century BC is generally recognized as the first person to put the sun at the middle of things. Let’s hope that it doesn’t take as long as that for us to eventually get the message like it did with the solar system.