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Saturday, January 28, 2012

Musings about capitalism - free markets


Many Americans (and others) are staunch advocates of free market capitalism without really understanding its economic dynamics. Free market capitalism has at least three dimensions important for ethics: free markets, government regulation, and including the cost of capital as a cost of production. This post explores free markets; the next two posts will explore government regulation and the cost of capital. A fourth post will then examine free market capitalism from the perspective of Christian ethics. For the sake of brevity, these posts use capitalism and free market capitalism interchangeably.

In my conversations with people on capitalism, current economic problems, and the Occupy Wall Street movement, I find that few people have a substantive knowledge of economics. Preparing these posts has caused me to pull together material that I last presented in a formal way when I taught a college economics course thirty years ago.

The material may seem unusual fodder for a blog premised on the idea that people do not live by bread alone and that emphasizes finding the path to the abundant life. How a person uses her/his money and financial assets best reveals her/his values. Money also makes economic exchanges much easier than bartering and provides a helpful standard of measure for costs and benefits. I feel fortunate to have a degree in business, a degree in economics, and to have taught both subjects in addition to my education and experience as priest, theologian, and ethicist.

I hope that you will find the first three posts lay a helpful and important foundation for the fourth post. One significant advantage of a blog is the opportunity to present in a more organized, extended fashion ideas that do not lend themselves to casual conversation. As always, comments and questions are welcome.

A few preliminary definitions are essentials. In a free market, multiple suppliers compete to sell to multiple buyers. None of the buyers or sellers controls the market. Information about prices and products is readily available to all. Barriers to entry (the cost of setting up a factory, e.g.) are sufficiently low that new sellers can enter the market in response to increased demand.

A market that does not satisfy all of those parameters has limited competition. With limited competition, either buyers or sellers exercise some degree of market control, creating market inefficiencies and ineffective allocation of capital and labor. For example, John D. Rockefeller’s attempt to monopolize oil production through Standard Oil in the late nineteenth century enabled his firms to earn outsize profits. This took money from consumers, who no longer had those funds to invest or to spend on other goods and services. Shareholders (owners) of Standard Oil and some of Rockefeller’s employees benefitted from the monopoly. Everybody else lost.

Pure free market capitalism, in many respects, is analogous to the survival of the fittest in nature, i.e., the fittest firms survive by earning the largest profits and no rules or authorities exist to protect the vulnerable or weak from a firm’s predatory behavior.

Mitt Romney called his work at Bain Capital creative destruction. Bain bought firms, shook up the newly purchased firms to make them more profitable, and then sold the restructured/more competitive firms to new owners. Many people lost their jobs as Bain made operations leaner and more focused on profitable lines of business (actual numbers are not available). The leaner, more profitable firms sometimes then expanded, creating new jobs.

Staples (the office supply company) is Bain’s highest profile example of this. With an influx of capital and management expertise, Staples went from being a small start-up to the major player in the office supply business. In the course of that rapid growth, numerous local independent office supply businesses went out of business, unable to compete with Stapes in terms of variety, price, and service. The fittest survived, generating large profits for owners and many new jobs at considerable cost to the hundreds of its former competitors who no longer exist.

Wal-Mart, the world’s largest business, has similarly affected the businesses that sixty years ago lined the main streets of most U.S. small towns and cities. People shop at Wal-Mart because they save money by doing so. Otherwise, Wal-Mart would not have become the retail juggernaut that it is, i.e., the fittest survived.

Fewer than 10% of American farms have sales over $250,000 but those large farms account for 85% of all farm production. Of the approximately 2.2 million U.S. farms, only 80,000 have 2000 or more acres; those 80,000 farms harvest 40% of the cropland. (2007 U.S. Government census data) Corporate farms are replacing family farms because they can produce more food at a lower cost, i.e., the survival of the fittest.

Competition is not the only force that drives market changes. Some change occurs because of technological advances, fluctuating consumer preferences, and demographic shifts. Firms that catered to consumers in much of the U.S. Midwest now struggle to survive or have gone out of business as people have depopulated a large swath of the Great Plains. Men (except the clergy, who now includes women) no longer wear celluloid collars on shirts. In my life, I have experienced a transition from slide rule to calculator, to mainframe computer, to PC, to handheld PDA. All of these changes have led to creative destruction, i.e., the bankruptcy of firms that failed to adapt and the success of other in the right place, with the right product, and the right technology.

The next post will discuss the role of government in regulating free markets, the third post will consider the cost of capital, and the final post will present a Christian ethical perspective on free market capitalism.

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