Chapman’s News & Ideas Scott Powell on American Free Enterprise, its Critics and its Sources of Renewal

The following is a transcript of Discovery Sr. Fellow Scott S. Powell’s lecture last week at Florida Atlantic University, Boca Raton.

There have been many civilizations that have come into being over the last 6,000 years—from the ancient Mesopotamians, Egyptians, and Asian civilizations that sprang up around the Euphrates, Tigress, Nile, Indus and Yellow River valleys, to the more recent and advanced Greek and Roman civilizations, which have more directly shaped Western civilization. While each of these civilizations made their own contributions to progress during the times in which they flourished, none of them unleashed the kind of economic development and entrepreneurial productivity witnessed in the first two hundred years of the American civilization.

As a starting point, it is worth considering the basics. The tools brought by the first colonists that arrived in the new world and settled in Jamestown, Virginia in 1607, and then in Plymouth, Massachusetts in 1620, were primitive. They were the same basic rudimentary tools of sustenance—such as shovels, axes, hoes and ploughs—that previous civilizations had also used.

But something happened in America that sped up progress beyond what had ever happened previously in human history. What I would like to do is identify some of the key human characteristics and arrangements that helped the American economy take off and create a revolution of upward mobility and prosperity — one that became a model that has benefited other countries around the world who adopted similar ways. Next, we’ll consider some of the main reasons why and how this extraordinarily beneficial system has come under criticism and why it continues to be on the defensive despite its success. Then, we’ll look briefly at the competing alternative—socialism—with particular attention to understanding whether it is a viable alternative. We will open it up for discussion and perhaps wrap it up by my touching on some of the things that could be done to restore some balance and appreciation of the system and institutions which have provided so much material well-being.

In reflecting on how it all began in America, one can’t help but be struck by the courage of the explorers and earliest settlers who crossed a dangerous ocean from Europe in what were very unseaworthy boats. Within three or four generations of arrival, what stands out is the quality of the character and the depth of the spiritual attitudes and philosophic thinking of the people who were assuming leadership roles, culminating in what we have come to call the Founding Fathers—towering figures like Thomas Jefferson—the primary author of the Declaration of Independence; James Madison—the “father” of the Constitution; George Washington—the hero-general of the War for Independence; John Quincy Adams—the remarkable statesman and ambassador, to name only a few.

What is probably underappreciated about the Founders is that they had no illusions about human nature. The Founders accepted that all humans are flawed, and they believed, therefore, that it was wise to limit power and to structure institutional arrangements so as to check abuse on the one hand and empower people to be free to pursue their dreams on the other. The Founders had no illusion about government—they believed government had a propensity to abuse power and even do more harm than good—so establishing a system of checks and balances and separation of powers was essential. If society was to progress and prosper, they believed it would come from the moral character and initiative of the individual, rather than from government institutions and programs. If you have read The Federalist Papers, you can’t help but recognize that the level of the Founders’ thinking and discourse was considerably more elevated than that of almost any political leaders on the scene today.

It is an interesting fact of history that 1776 was not only the year of the Declaration of Independence, but it was also the year that Adam Smith’s Wealth of Nations was first published. For those of you not too familiar with The Wealth of Nations, it was the first written work that comprehensively explained the essential free market elements and principles, and why they work together for the economic benefit of society.

The most quoted passage from The Wealth of Nations is one in which Smith asserts that there is an invisible hand at work whereby society benefits as a result of individuals pursuing their own self-interest. To quote from Smith’s old English words:

Every individual endeavors to employ his capital so that its produce may be of the greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than he really intends to promote it.

The word “capitalism” itself cannot be found in Smith’s Wealth of Nations. In fact, we could say that “capitalism” is a bit of a misnomer. It is a term of disparagement that was coined by radical socialists—notably Karl Marx—in the nineteenth century. Smith preceded Karl Marx by almost a full century. A better term for our purposes would be to refer to it as a free market system wherein participants engage in production and exchange freely—as individuals, partnerships or companies owned by stockholders—without government involvement.

What was surprisingly missing from Adam Smith and other early economic theorists, such as David Ricardo, was the vital input and creative leadership of the businessman who decided how to invest capital, organize labor, and conduct trade. For Smith, the “invisible hand” was a self-regulating mechanism that automatically brought about equilibrium and a harmony of interests.

Looking objectively at modern free enterprise, we can see that equilibrium and a harmony of interests rarely exists for very long before the disruptive input of an entrepreneur comes along to change the way business is done. And it’s not just new inventions, whether the internal combustion engine, electricity, the airplane or wireless communication; it is also in the way in which labor gets transformed, from the implementation of the assembly line to the internet. This lack of attention to the beneficial role of the entrepreneur was an unfortunate legacy. Marx and Lenin would subsequently accuse the capitalist of being little more than a parasite who exploited labor, capital, and markets, sucking profit from the industrious people of the economy. But I am getting ahead of myself. We will get to the critics of capitalism, but first let’s finish identifying the key elements of a free market system that enables it to provide so much benefit to societies which embrace it.

So as we consider the topic at hand, based on Adam Smith’s three foundational requirements of: 1) Private Property Rights; 2) Rule of Law; and 3) Competitive Market Exchange, we have to add a fourth requirement of Entrepreneurial Leadership in order to identify the essential elements for a free market system to work and provide the framework and incentives for efficiency, reliability, and innovation that are necessary for human progress.

Adam Smith, a native of Scotland, could be thought of as one of the philosophical founding fathers of the British, and especially the American, economic system, for he himself described private enterprise as “the obvious and simple system of natural liberty.” The system that Smith described was in total synch with the founders’ ideas that were expressed in the Declaration and then formalized in the Constitution. And remember—the Constitution was a blueprint for a system of limited government that would not only protect, but also empower a free people.

Beyond Washington and the Founders, Abraham Lincoln—considered one of the greatest presidents in U.S. history—may have opened to the door to federal state power that went beyond the Constitution, but his rhetoric paid tribute to the importance of individual freedom and free markets.

Lincoln believed that the Declaration of Independence contained not just some ideals, but real goals to be actualized by our government. He recognized that while “all men are created equal” and “endowed by their creator with certain unalienable rights,” the government of the United States had not allowed these to be realized. He sought not only an end to slavery, but also to bring about a more level playing field where no group or party had favored or penalty imposed by government.

A few months after his inauguration in 1860, Lincoln described his understanding of the founders’ vision in an address to congress, declaring that “the leading object of government is … to lift artificial weights from all shoulders; to clear the paths of laudable pursuit for all; to afford all an unfettered start and a fair chance in the race of life.” “This,” he said, was “the leading object of the government for whose existence we contend.” In short, Lincoln viewed government’s role on economic matters was to lighten the load and get out of the way rather than impose legislation and regulations that created barriers to business mobility or discouraged individual initiative.

During the last half of the 19th century, the United States was in the throes of the industrial revolution, which was also underway in Europe. But it was the U.S. that was the most important contributor in three key sectors of this revolution: 1) transportation, which was greatly advanced by application of steam engine power; 2) electricity, which revolutionized lighting, communication and the magnetic motor; and 3) industrial processes, which improved quality and productivity and led to the economies of scale of the assembly line and mass production. And, it may be that the assembly line was more instrumental than scientific invention in raising the standard of living and accelerating the creation and distribution of wealth.
The industrialists of the late nineteenth century were aggressive competitors and innovators, who included figures like:
• Cornelius Vanderbilt, who focused on steam transportation and built empires of maritime shipping and then railroads, where his real fortune was made.
• Andrew Carnegie, who was an innovator in the production of steel.
• John D. Rockefeller, who did the same in oil production.
• JP Morgan, who made his mark in banking, but also was a dealmaker responsible for creating the nation’s largest company, U.S. Steel, by merging Andrew Carnegie’s empire with several other steel companies
• And there where many others such as old Gustavo’s Swift, whom you probably never heard of. Swift made his mark by upsetting the existing network of local butchers when he created assembly-line meatpacking and built his own refrigerated railcars to deliver low-price beef to distant markets.

I mention Swift because he actually originated the assembly line that Henry Ford has traditionally been credited with having invented. Ford actually learned about this mode of mass production when he visited Swift’s meatpacking plants, which had implemented an automated moving line for the slaughter and disassembly of cattle some eighteen years before Ford applied the automated line to the manufacture of automobiles.

To some extent opposition to large-scale private enterprise came from small scale producers, who denounced these innovators as “robber barons,” accusing them of monopolistic practices and appealing to government for relief from these new more efficient competitors. The Sherman Act of 1890 was the first major legislation designed to reign in large corporations and protect the less efficient economy of small-scale firms.
By the early 20th Century, the benefits of free enterprise became so widely diffused that things that previously had been considered luxuries for the upper class, such as sewing machines, refrigerators, and automobiles, became affordable to common people of the middle class because of mass production and the innovation of installment financing. And this same pattern has continued again and again with new technologies and new products, from a full range of home appliances, to computers, cell phones, digital cameras, and smartphones, to name but a few. It is private enterprise that has primarily led the way in developing all these products and it is competitive free markets that have driven prices down and made products affordable.

Despite this success of the free market system, which results in constant innovation and improvement at lower prices—fulfilling the promise of what Adam Smith called “universal opulence”—the critics of capitalism are more numerous and influential than ever.

So no that we have covered the good, let’s discuss the bad, and talk about the main sources of this hostility toward capitalism.

As I am sure you know, the most comprehensive critique of capitalism started with Karl Marx, whose works, written in the mid-19th Century, were influential among intellectuals, but whose call to action never really took root among the masses. Marx, Lenin and their Neo-Marxist successors’ attack on capitalism had three or four main points that still linger in much of the public consciousness.
• First, Exploitation: Capitalism was charged with exploiting workers, producing economic inequality and an unfair distribution of wealth and power.
• Second, Alienation: Capitalism was said to alienate the worker from the fruits of his or her labor, causing workers’ lives to become increasingly devoid of meaning.
• Third, Class Struggle: Capitalism was charged, by its very nature, to lead to class struggle between the owners of the means of production (the bourgeoisie), and the workers (the proletariat).

While the economic theories of Marxists have been largely discredited and proven false, their legacy lives on in our culture. Think about it—hardly a day passes without hearing about exploitation of workers, threats to and abuse of the environment, racism and inequality of classes, the need for government to raise minimum wages, and alienation and social injustice of one kind or another. Increasingly, to listen to the media and pop culture, it seems America has become more a nation of victims than a land of opportunity.

The hostility to the free market that came out of Marx and his successors continues to be subliminally at work at in three basic ways.

First, by critiquing early capitalism and championing the exploited underdog, the left captured the moral high ground—a position they have continued to hold for the last 150 years. As a result, business is on the defensive and the target of ever more regulation.

Second, Marx’s analysis concerned itself with classes and had no appreciation for the value and importance of the individual. For Marx, there was no beneficial role of an individual entrepreneur, who has always been a primary source of progress and creativity.

Third, Marx and his successors legitimized the idea of a utopian society and effectively launched a surrogate and secular religion that keeps morphing into ever new iterations—all of which tend to be anti-business—and these continue to have enormous power and appeal to both the idealistic, the alienated, and the disenfranchised.

What is important to understand about these surrogate religions—whether radical environmentalists, animal rights advocates, global warming alarmists, or opponents of genetically modified crops, to name only a few—is that their followers do not require empirical evidence in order to keep the faith. For instance, even though evidence that links carbon emissions to questionable global warming is inconclusive and largely unproven, the animus doesn’t die; it just morphs into what is now called climate change. So the war against fossil fuels continues on, while many of the alternative energies, which remain uneconomic and inviable without government subsidies, get promoted.

The intellectual legacy of Marx cannot be underestimated in terms of affecting the idiom of our language and particularly the consciousness of the so-called “information and knowledge class” who shape the way our society thinks. The knowledge class today consists of the majority who works in the media and produces the news, documentaries, and movies; the educational establishment including university professors, particularly in the humanities and social sciences, lawyers, and professionals in huge and growing non-profit foundations. In general and on balance, the knowledge class generally depicts business and corporations in a negative light. And this doesn’t just come from left-leaning university professors. Can you think of a movie you have seen produced by Hollywood that did not portray businessmen as villains rather than heroes?

This legacy continues to be at work today. Consider the relative silence about the importance of individual responsibility, morality, and character, in contrast to the steady drum beat about the need for new laws and regulations and expanded government action to solve the grievances of some class—with business is being one of the big targets. And because empirical evidence is not important to the secular progressive believer, when the new laws and regulations fail to solve the purported problems or even make things worse, as is often the case, there is a tendency to assume that the program didn’t go far enough or spend enough. So government power keeps growing at the expense of private sector free enterprise.

Hostility toward big business got a huge boost starting with Teddy Roosevelt’s trust busting policies at the turn of the 20th century. The next big thrust against business came with the progressive movement and administrations of Woodrow Wilson and FDR. The expansion of government power has continued through most administrations since FDR, both Republican and Democratic. Growth of state power and restrictions on individual and business freedom have tended to increase and follow in the aftermath of every economic crisis, such as the stock market crash of 1929, the recessions and bear markets of 1973-74 and of 2000-2002, and the 2008 Financial Collapse and the Great Recession that followed and continues into the present.

I know I have given you a lot to think about, but let’s jump ahead and drill down a little on the recent two crises of financial contraction, then turn to talking about the socialist alternative, and open it up for discussion.

First, let’s look at what Washington—the federal government and the Federal Reserve—did to deal with the 2000-2002 stock market crash and the fraudulent accounting practices that brought bankruptcy to several large companies, Enron and WorldCom. Enron’s December 2001 $64 billion bankruptcy—which was the largest in U.S. financial history—was shocking. Seven months later, in July of 2002, WorldCom filed an even larger bankruptcy at some $107 billion. Congress of course, felt it had to do something to prevent the next Enron and WorldCom, and passed the Sarbanes-Oxley Act. And, like so many laws passed hastily in time of crisis, Sarbanes-Oxley was very poorly constructed, amounting to a one-size-fits-all regulatory policy that added $2 million of compliance costs to small public companies and much higher costs to larger companies. The result was a contraction of capital formation and a huge decline in companies growing and going public through IPOs, which meant less job creation in the dynamic entrepreneurial sector of our economy. At the same time, Federal Government and Federal Reserve policies created an unnatural boom in the unproductive assets of residential housing, financed by Wall Street institutions all too willing to pursue and expand new mortgage bond-related business to make up for the decline in their traditional investment banking business. And this set the stage for the next financial collapse of 2008 and what has followed.

In regard to the causes of the 2008 collapse and what followed—what I called The Great Recession—there is plenty of blame to go around relating to the housing and mortgage sectors. But what you won’t hear in the popular media is that the chief cause of bad mortgage underwriting and the misallocation of capital was largely driven by bad government policies. It was government public policy that pushed for expanding and socializing homeownership to the poor through lower mortgage underwriting standards, known as sub-prime. And it was government, specifically the Department of Housing and Urban Development (HUD) that put political pressure on the mortgage giants Fannie Mae and Freddie Mac—the biggest crony institutions of all—to buy an increasing amount of sub-prime mortgages. Once Fannie and Freddie legitimized the subprime mortgage category, Wall Street investment banks opened up the spigots and dove into the same pool—accelerating the mortgage-driven housing boom and bringing on more speculative excess. And of course, we have to acknowledge that Federal Reserve chairman Alan Greenspan, a Republican, poured gas onto the fire by cutting interest rates to 1% and keeping them low for a number of years. The boom ultimately led to the largest economic collapse in U.S history, the aftermath of which we are still dealing with today, nearly six years later.

The response to this last crisis started with the Bush Administration, which bailed out or coerced mergers of failed institutions, with the exception of Lehman brothers, originated and passed the Troubled Asset Relief Program (known as TARP), which effectively forced all the major banks to accept funding from the federal government, whether or not they actually needed assistance. By end of the Bush term, the Federal Reserve had lowered interest rates—as measured by the Federal Funds rate—to zero. Then the new Obama administration passed the $800 billion stimulus with newly created debt, and proceeded to encumber the economy with two massive regulatory bills—the Patient Protection and Affordable Care Act (commonly referred to as Obamacare) and the Dodd-Frank Wall Street Reform and Consumer Protection Act. The result of these two showcase pieces of legislation is, so far, proving to be quite negative to the economy. Small businesses, which are the primary drivers of new employment and job growth, are substituting part-time employees for full-time with a goal of staying below 50 fulltime employees, the threshold at which Obamacare requires providing healthcare coverage to employees. As a result of Dodd-Frank, banks are facing so many new and changing regulations that lending has been made so much more difficult, requiring banks to staff up with lawyers and compliance officers, who add costs and hurts profitability. In short, health care choices are diminishing while costs are rising and bank lending has suffered from more regulatory hurdles, requiring more paperwork than ever.

Meanwhile, interest rates, controlled by the Federal Reserve—which are basically the price of credit—remain at zero percent. One reason that we remain mired in what we call the Great Recession more than six years after the Crash of 2008 is that a zero interest rate policy has unintended consequences—one of which may be that by mispricing credit, it is prolonging the downturn.

Another basic point that eludes many is that with every new law and regulation comes the need for more government workers for inspection and enforcement, who are paid for by higher taxes or more borrowing. And the affected private sector companies then have to pay more attention to compliance than to innovating and pursuing business opportunity. Large companies can generally absorb regulatory costs more easily than small companies, but it often means lawyering up and hiring more auditors, accountants and lobbyists, which divert resources away from the real business purpose. The net result is that today, big business is to a very large extent a system of crony capitalism.

The irony of the modern dilemma is that while free enterprise provided amazing progress and a high standard of living, the people it has benefited have also neglected and jeopardized the future of free enterprise by failing to make a moral defense of the free market and failing to help subsequent generations with gaining a balanced understanding of the dynamics and forces at work, which largely amount to an ever more regulated crony capitalist economy. The net result is that the free market goose which lays the golden eggs is being weakened, and even strangled.

In wrapping up, and as I mentioned, I would like to shift gears for a minute and address several important questions that you have probably thought about regarding the socialist alternative to capitalism, and have some fun in engaging you in discussion.

First, let me ask you if you think there is some true socialist model that could work? Or is the disastrous experience, with food shortages and mass starvation—which resulted when Marx’s full-blown ideology was put into practice in scale, such as in Russia and the Soviet Union, China, and North Korea—the likely outcome?
Then I’d like to ask you the corollary question: Why is it that socialism doesn’t seem to be able to work? Does it have some fundamental flaws that prevent the theory from ever being able to work successfully in practice? What are your thoughts? What do you think?

The essential reasons that socialism cannot work

The essential reasons that socialism cannot work are rooted in understanding both a moral and an economic understanding. I see five key elements that provide clarity about the prospects for socialism in practice. The first three reasons are basically related to moral understanding and the fourth and fifth are related to economic understanding.

As a prelude to the specifics, I would suggest that all the evidence of life from the earliest ages on, strongly indicates that socialist systems are inconsistent with human nature, and so the burden of proof, it would seem, lies with those who advocate it. After all, how can any system work that is constructed in such way that contradicts the nature of the participants and players. But let’s turn to the specifics:

1)The importance of Incentives. Without incentives, parties will not take the moral initiative to improve, undertake developing new products and new and better ways of doing things. If the state does not allow entrepreneurs to benefit from new breakthroughs and better ways of doing things, most individuals will not bother taking those risks.
2) The role and importance of Risk. Risk is essential in the decision-making process and the allocation of capital. When people stop taking risks to undertake new ways and come up with new processes and products, the rate of improvement, change and progress diminishes.
3) The importance of Failure. The ability to fail is absolutely vital in the moral sense of a learning process that leads to improvement, breakthrough, new and better products and ways of doing things. Capitalism is a competitive system that allows for failure, and the reduction of inefficient ways of doing things and the elimination of products and services for which there is declining demand for whatever reason. Would anyone argue that society and resources would have been well-served by keeping the telegraph or buggy whip industries alive or protected?
4) The importance of Competition to mitigate corruption. Because socialist systems lack competition, invariably they result in corruption of the worst kind – wholesale corruption of cronyism. The competitive drive of the free market system allows merit to be identified and raised up and rewarded.
5) The vital importance of the Pricing System. Prices turn out to be “carriers” of information that are absolutely critical to the allocation of resources throughout the economy. Prices cannot be determined by a central authority such as government. Prices are constantly changing and can only be determined by the competitive process of a free market system.

Concluding Comments
Corporations and industries can continue to go the way of cronyism and seek government protection and favor—the new road to serfdom of what I will call “creeping regulatory socialism.” Or we can get more people to choose real reform and renewal. That choice would first and foremost require the need to turn away from the crony behavior of seeking government protection, subsidy, or favor.

And making that choice may no longer be the natural one in a corrupted capitalism system, such as what we have. It is probably necessary to first recognize the need to help private enterprise—individuals and corporations—to understand the benefits of getting free from the mafia-victim-like-mentality of trying to buy protection from government regulation and choose to devote more resources to supporting organizations and cause that uphold the free market system. Corporate largess could and should sponsor and fund chairs and programs in the social sciences and at business schools that teach about the virtue of business, competition, innovation and entrepreneurship. What Professor DE Rosa has done in this course needs to expanded and institutionalized. Every business school should have a course teaching about the importance of defending the free market system against its critics. It would also be beneficial to fund research and investigative reporting government corruption, waste and abuse.

I’d like to conclude by suggesting that while the hour is late in America, and the national debt and regulatory burdens are huge, it is possible to turn things around. If people like you realized that a truly competitive free market system is far more dynamic in driving progress and creating jobs and wealth, and far less costly for tax payers than the deformed system that we have currently, we could begin to see the American enterprise battleship begin to turn.