The world is edgy right now. Our collective anxiety levels are measured to be at their highest level of all time. We are longingly missing civil dialogue and thoughtful conversations. If I had to wish for one thing right now it would be for truth and accountability. In public and private spheres, we would make great advancements if we embraced these two fundamental values, and I encourage you to represent them yourself in your own actions to make the world a better place.
Now you possibly are asking how does that philosophical opening tie to your finances? It does because I am holding myself to that high standard of truth and accountability and will address a terribly important subject: Capitalism. This letter will address whether capitalism is a good system or a bad system, particularly as contrasted with socialism and other systems. Given that all your investments are based on capitalism, you have a very vested interest in knowing.
Setting the Stage – U.S. Views On Capitalism
Before we start, please know that it would take ten to twenty well-written books to adequately cover this topic. We don’t have that time. Still, let me set the stage by stating that just over half the adult population of the United States views capitalism better than socialism [i](57%) …and that proportion has declined 12% in the last 3 years. Possibly more concerning yet is that young people (under 30 years old) have a greater belief that socialism is a better system than capitalism (44% versus 40%[ii]).
Given the massive importance of the topic (I’d say a nearly existential importance), we would be wise to have some open dialogue on the matter, or we will tear ourselves apart. I’d suggest one of the reasons for the current high level of national angst is we have failed to adequately do so.
Defining Capitalism, Socialism, and Communism
As a matter of definition, there are fundamentally three types of economic systems; capitalism, socialism and communism. The difference between them is fundamentally on who owns and directs production and distribution of goods and services.
Investopedia summarizes it this way:
“Capitalism is an economic system in which private individuals or businesses own capital goods. At the same time, business owners (capitalists) employ workers (labor) who only receive wages; labor does not own the means of production but only uses them on behalf of the owners of capital.” …. Whereas… “In a socialist economy, the state owns and manages the vital means of production.”
Which Economic System is Best?
The debates and underlying motivations for one system or the other have been occurring for millennia, literally starting with Aristotle when he was discussing virtue and happiness (yes, “you could look it up,” as they say). Rather than emotional rhetoric, and having read them, I think writers on both sides of the equation were earnestly seeking to do what they thought was best for the long-term interest of mankind and the systems they lived in. Both sides accuse the other as either being naïve at best, and evil at worse.
Nonetheless, as much as possible, I want you to be informed and objective and appreciate that there are positives and negatives on both ends of the equation…which is what makes it messy.
Shortcomings of Capitalism
Let’s just use a current event to explore some strikingly bad elements of capitalism: the recent banking crisis with Silicon Valley Bank, Signature Bank and First Republic Bank, all privately-owned entities where the Federal Reserve had to step in (“moral hazard”??).
Just look at the headlines of some articles:
- “Silicon Valley Execs Sold $84 MM In Stock Over The Past Two Years, Stoking Outrage At Insider Trading” (Robert Frank, CNBC, March 14, 2023)
- “Signature Bank CEO Joe DePaolo Compensation In 2022 – $8,663,736” (Simply Wallstreet.com, March 25, 2023)
- “First Republic Bank Founder Earned A Big Payday – As Did His Relatives” (being paid $17.8 MM for compensation in 2021 and paying his brother-in-law $2.3 MM for portfolio and risk management work, per Andrew Ackerman et all, Wall Street Journal, Saturday / Sunday edition, March 25 -26, 2023)
Beyond the above, we don’t need Karl Marx or Thomas Piketty pointing out the problems (“Das Kapital,” “Communist Manifesto,” and “Capital In The 21st Century,” respectively), because we can easily name other shortcomings of capitalism:
- Monopoly power
- Negative externalities (i.e. pollution)
- Wealth inequity
- Crony capitalism
- Etc., etc.
These shortcomings absolutely exist… or can exist… and that’s the problem with capitalism.
The Problems with Socialism
But, there are also deep inherent problems with socialism. The above-mentioned shortcomings occur because we are human, and human beings have weaknesses, in the case of capitalism principally the presence of greed. However, in socialist societies we again encounter a natural human weakness, and it is lack of incentive. If your hard work results in the same benefit as your less hardworking colleague… you rationally make the decision quit working as hard. In economic terms, this later behavior is referred to as the “free rider effect,” and it is crippling for societies.
But, and therein is the essential rub; we are human and we need to create economic systems for imperfect human beings. It is instructive that there is a man-on-the-street joke in Cuba where the average employee of the State says: “We pretend to work, and they pretend to pay us.”
What About Communism?
To finish the trifecta, communism (per se) isn’t really practiced anywhere in the world. China professes to be communist, but it is a strong capitalist-communist society (TikTok anyone?). Communism would ideally mean common ownership and each household producing and consuming according to their needs. There is no sovereign entity in the world with a working communist system because the State (central government) always steps in to take ownership, and that ownership commonly leads to corruption because someone is always seeking to gain an edge.
Why Capitalism is a Better System, Even with its Flaws
You should know that capitalism is a relatively new system of 200-300 years, having grown out of feudalism and mercantilism of the middle-ages, so it’s an improvement from the “old” but still greatly flawed. So why do I, a kid who grew up poor in rural Minnesota farming community, and later made a prayerful decision to run the Community Food Bank of Southern Arizona, think that in spite of the unconscionable warts of capitalism — that it is a better system?
Because… if we truly loved our fellow man, we would have to recognize these powerfully positive and impactful realities over the past 200 years when capitalism became the dominant world economic system:
- In 1820, fully 94% of the world population was living in extreme poverty. By 2015, only 9.6% was in extreme poverty.[iii] The poverty number dropped further to 8.4% in 2019.[iv]
- Life expectancy in 1900 was 31 years of age. As of 2020, it has moved up double that lifespan to 71.[v]
- In a great irony, during the lifetime of Karl Marx, who was living in England doing his writing, the average Englishman was 3-times richer when he died than when he was born (1818-1883).
- Instructively, for this rural Minnesota kid, the United States Department of Agriculture had 85,000 employees in 1935 when there were 6.8 million farms in the United States. Today we have 2.0 million farms, a decline of 71%… but as of 2023 we have 105,000 Dept. of Agriculture employees, an increase of 20%. Market discipline would literally force the USDA into bankruptcy… but there simply is no market discipline on government entities.
- Helpful to any analysis, we have the historical observation of no world economy based upon socialism doing well. The socialist systems are certainly different for Cuba, North Korea, Russia, and Venezuela, but the data would not support them as doing as well comparatively. People periodically offer up Nordic countries as “socialist,” but having worked there I can inform you that they are undoubtedly capitalist societies with a strong safety net for a homogeneous society. Sweden actually tried to offer more “pure” socialist-type benefits in the 1970’s, but as growth slowed and inflation increased they found they had to cease those programs.
- Finally, taxation is needed in the United States of America to support crucial human support systems and the country’s protection. As a populace, we can and often do debate the level of taxes needed, but we cannot debate the reality that you need to create wealth in order to tax it. Capitalism seems to be the best mechanism of wealth creation. The USA didn’t exist as a country until 1776 and is now the world’s largest economy at $25 trillion (30% larger than the runner up, China)[vi]. It is also the largest contributor of foreign aid of any country, at $12 billion per annum (300% more than the nearest runner up, Germany)[vii].
Studying Capitalism
Capitalism has been studied for 200 years and some of the great economists and writers on it are David Ricardo (“comparative advantage”), Joseph Schumpeter (“creative destruction”), and Frederick Hayek (“free markets”). These writings are not simply powerful observations but embrace mankind’s intrinsic motivations.
Notwithstanding the above facts, let me point out another fact that not many people are aware: though Adam Smith (“invisible hand”) is often quoted as one of the great “proponents” of capitalism in his book An Inquiry Into The Nature and Causes Of The Wealth Of Nations (1776) – that was not his first book. Adam Smith was a philosopher, not an economist, and 20-years earlier he wrote a thoughtful book called “The Theory Of Moral Sentiments” (1759). In it, he argues that man seeks to do things in his self-interest by seeking a harmony of mind with others. THIS is the invisible hand that should guide us, and we should not be too enamored with systems, but instead naturally pursue sympathy and empathy with others. Capitalism simply provided a mechanism for that unhindered freedom of movement. I think we would be wise to keep that original balance in mind.
The Darwinian movement describes the survival of the fittest of species. Capitalism is simply Darwinism in an economic environment. In fact, failure in business, taking owners down and eliminating all their wealth, must be a logical probability or have set the stage wrong. A famous quote attributed to economist Allan Metzler says it best: “Capitalism without failure is like religion without sin. It doesn’t work.” In a cold reality of a consumer economy as is the United States, the consumer of goods mandates that capitalism must pay heed to those essential characteristics of truth and accountability because you won’t buy again if your first experience is poor. That freedom is alive and well and must never change.
The Bottom Line
But… a full laissez faire market environment is not acceptable because “absolute power will corrupt absolutely” (historian Lord Acton) and thus government has a critical role to ensure rules are set and enforced. The above recounted history and empirical results would tell me capitalism works but has limits. If you could substitute the word democracy for it, I would paraphrase Winston Churchill who insightfully once said that: “Democracy is the worst form of government – except for all the others that have been tried.”
It remains my deep and distinct honor to serve you well.
Patrick Zumbusch
Founder and CEO
[i] “Modest Declines in Positive Views of ‘Socialism’ and ‘Capitalism’ in U.S.” (Pew Research Center, September 19, 2022)
[ii] -ditto-
[iii] “Anyone Who Doesn’t Know These Facts About Capitalism Should Learn Them” (Rainer Zitelmann, Forbes, July 27, 2020)
[iv] 2019 Poverty Number (World Bank.org)
[v] “Anyone Who Doesn’t Know These Facts About Capitalism Should Learn Them” (Rainer Zitelmann, Forbes, July 27, 2020)
[vi] “Top Heavy: Countries by Share of the Global Economy” (Avery Koop, Visual Capitalist, December 29, 2022)
[vii] “Largest donors of humanitarian aid worldwide in 2022 (in million U.S. dollars), by country” (Statista.com, March 29, 2023)
