American Capitalism at Sunset

Our elected representatives keep throwing monkey wrenches into America's engine of prosperity. An eminent economist proposes a radical fix.

Economists, ever since their dismal science was born, have shown a penchant for debating the fate of capitalism. In 1981, Nobel Prize winner George Stigler entered the fray with an essay called "American Capitalism at High Noon." In addition to his prodigious talents as an economist, Stigler displays a refreshing droll humor that is uncommon in our science, and in this essay he is at his wittiest.

Nevertheless, I would dissent from Stigler: I would replace high noon with sunset as the more appropriate metaphor for describing the current state of American capitalism. While impartial observers might disagree about exactly when "high noon" came to pass, it seems clear that only a most desperate barrister would attempt on a contingency-fee basis to convince a judge or jury that the sun shines on capitalism most directly in the 1980s.

It should be noted that Stigler's assessment is not grounded in any measure of the condition of capitalism as such. It is an inference drawn from the proposition that business leaders are a self-interested, intelligent, politically powerful lot who would not condone regulation that did serious violence to their welfare. Given the political potency of the business community, he argues, we must conclude that what is, is what they prefer; ergo, capitalism is at high noon.

As he puts it, "The larger part of the regulations to which businessmen are subjected must be of their own contriving and acceptance. It is they who persuaded the federal and state governments to initiate the controls over financial institutions, transportation systems, communication systems, extractive industries, and so on."

And a bit later in his essay, Stigler observes, "The American business community includes vast numbers of people of high ability, with many more on the horizon because professors in leading business schools are now teaching an elite class of recent college graduates. The American business community has ample financial resources even in these days of onerous taxation. What the American business community lacks is the will to eliminate most business regulations.…I hope that you will…consider whether our ocean of regulations could possibly have been achieved under high capitalism except by the consent of the capitalists. American business likes what it is getting."

As a testimonial to the health of American capitalism, this thesis leaves me puzzled. For one thing, there is no good reason that the health of capitalism should be identified with the success of businessmen in tapping the political process. The ICC—contrived and controlled by railroad tycoons—may very well have benefitted the tycoons themselves and some of their friends. But it is a big step from there to the inference that the welfare of businessmen generally, much less the health of capitalism, was thereby improved. Indeed, there are many (myself among them) who would argue precisely the opposite, that what is good for the New York Central (or railroads in general) need not be good for capitalism.

Moreover, it is worth emphasizing in this context that the political clout of individual producer subgroups, such as the railroads, tells us nothing about the political potency or will of the business community when it comes to eliciting truly pro-capitalism legislation—that is, legislation that fosters markets and economic freedom generally rather than simply transfers wealth.

A second closely related problem I have with Stigler's thesis is the identification of the health of capitalism with regulation. Surely the health of capitalism also depends on the extent to which production is carried on in private, as distinct from government, enterprises.

Indeed, socialization and taxation are examples of a large class of government policies not generally included under the rubric of regulation, but which cannot be ignored in any realistic assessment of the health of capitalism. Two other examples are worth noting: the creation of communal property (the most extreme version of which is the current wilderness-area lunacy), and the care and feeding of labor organizations.

When it comes to evidence for his assessment of the state of American capitalism, Stigler is, with one exception, largely silent. In that exception he addresses only regulation narrowly defined, and he confines his comments to a rejection of one common measure of the level of regulation. "One can count up regulatory statutes," he admits, "but a statute and its regulations are hardly a measure of effective regulations."

It is true that the number of linear feet of law-library shelf space devoted to regulatory statutes, the number of pages in the Federal Register annually, the number of regulatory agencies and their employees, aggregate expenditures by regulatory agencies, and the like are not by themselves evidence of effective regulations. However, only someone who held unshakeable beliefs against the existence of regulatory growth would refuse to revise his views after he was told that all of these measures were growing at an increasing rate.

In fact, such measures are not the only evidence—and not even the most compelling evidence—for assessing the state of capitalism. A more reliable measure of capitalism's role in society is the fraction of output attributable to capitalist organizations, or its complement, the fraction of output accounted for by government expenditures. By that measure, the descent of capitalism from its zenith began long ago almost everywhere in the Western world.

Other indicators that lead to the same conclusion are the fraction of wealth owned by governments, and the extent to which private industry is being nationalized. Expropriation of the world's oil resources and massive nationalizations of industry are examples. In the United States in recent years, the prime example is land. And if we take into consideration the Soviet bloc, China, and similar polities, we would certainly want to revise our impression of what nightfall is like and our estimate of how large a fraction of the planet is in darkness.

It might be argued that the fraction of GNP accounted for by government is surely not a satisfactory measure of the health of capitalism. That is true, just as temperature alone is not a satisfactory measure of the state of the human body. There is no single satisfactory measure of the health of capitalism. Any defensible diagnosis will be a blend of measures.

Economic growth rates, for example, also reveal something about the patient's condition. If we ask what has been happening to the more important growth rates, however, the news is not encouraging. The growth of productivity and disposable income in the United States, for example, have been substantially below historical norms for a decade or more, and that pattern predominates throughout most of the Western world.

The most telling evidence against Stigler's assessment, however, is the performance of stock markets, because this tells us how capitalists have fared over the last two decades. The magnitude of the calamity that has taken place in equity markets since the mid-1960s is one of the best kept economic secrets of all time. The real (after-inflation) value of the Dow Jones stocks fell by 62 percent over the 18-year period from December 1964 to the end of 1982. The real rate of return on all common stocks on the NYSE in the 40-year period from 1926 to 1965 was about 8.6 percent per year. If stocks included in the Dow Jones Index had risen in price in the 1965–1982 period to provide that same 8.6 percent inflation-adjusted rate of return, the index would have had to be about 5,600 on January 1, 1983, instead of 1,047 as it actually was.

Incidentally, these results are not very sensitive to the choice of time-period nor to the selection of stocks included in the sample, so long as randomness and sample size meet statistical standards. The market was not particularly high on December 31, 1964, nor particularly low on December 31, 1981. Moreover, there were no catastrophes, wars, or other cataclysms to account for such a dismal performance. Nor is the experience of the stock market in the United States a special case. Equities have performed badly in most of the Western world over this same period.

When the dismal performance of shares is considered along with burgeoning government expenditures, deceleration of economic growth, creeping socialization of private industry, the communalization of land and other natural resources, and the general proliferation of restrictions on freedom of exchange and freedom of contract—and when we recognize the extent to which these phenomena pervade the world—it is hard to understand how anyone can seriously argue that capitalism is at high noon.

Stigler is interested in where American capitalism currently stands, of course, not for its own sake but for the implications his assessment has for the future of American capitalism. As he puts it, "The fundamental question, remains, Where is the American economy headed?" His answer is characteristically direct: "There is no sound evidence that high noon is rapidly passing for semiprivate enterprise."

Thus Stigler concludes not only that American capitalism is flourishing, but that we can expect it to continue to bloom generously into the foreseeable future. If we place any confidence in the stability of trends, however, the measures of the health of capitalism discussed above offer no support for such a rosy forecast. Quite the contrary.

The growth of government and the concomitant decline in the importance of markets has been going on for many years. While the rate of growth of government ownership and regulation fluctuates through time, the outcome is never in doubt.

A realistic appraisal of current domestic trends, coupled with the overwhelming historical and present dominance of authoritarian governments around the world, suggests that the long-run equilibrium level of government is much more like what exists in the USSR, China, Yugoslavia, etc., than it is like what we have even now in the United States. Freedom on the scale we have experienced it here appears to be a disequilibrium phenomenon, and the erosion of freedom that is gradually undermining capitalism reflects the drift towards long-run equilibrium. In the end, political democracy—which, incidentally, is not the same as freedom—is also likely to be a casualty of the process.

I do not enjoy delivering this doleful message. While the practice of chopping off the heads of messengers bearing bad news has been abandoned, experience has taught me that society has not yet moved to the other extreme: it does not receive such messengers with open arms, either. At best, they are likely to be dismissed as prophets of gloom and doom—as some of those prognosticators who have suddenly made the momentous discovery that scarcity exists, and then stir up crises ad nausea with dire perspectives on various resource-utilization issues such as energy, food, land, air, and water.

Despite my concerns about the fate of the messenger, I am delivering the message because I believe it is the most important social problem of our day; in a real sense, it is the only game in town. Nothing is more important to human welfare than what happens to capitalism, and not simply because of the material benefits which capitalism bestows. What is at stake are institutions we value much more dearly, namely, human freedom and political democracy.

Before we can hope to arrest the decline of capitalism, we have to understand why the decline is taking place. The explanation lies in the realm of political science. Capitalism is being eroded by government, which in the Western world means political democracy. Understanding what is happening in the Western world means devising a theory of democratic political processes which explains why we get the kind of government we get.

Those of us fortunate enough to have been born in the United States have learned from earliest childhood to revere political democracy. The emotion inspired by the story of our founding is enough to induce most of us to place great value on democracy as a social institution. The preeminence of the United States, until very recently, in permitting economic progress for its inhabitants gave us little reason to question either the viability or the efficacy of our political institutions.

But the truth is that most of us have been lulled into a totally uncritical attitude about our form of political democracy. One evidence of this is the corruption of the term democracy by some of its ostensible advocates who use it as a label for whatever cause they happen to be promoting. In the extreme, this has included labeling the most undemocratic governments one can imagine as "democratic republics." Such advocates realize that if they simply append the word democratic to their favorite crusade, many people will, like Pavlov's dog, react favorably.

Let's look closely at one aspect of democracy—legislatures, and particularly Congress. I would suggest that the representative nature of legislative bodies is one major source of the growth of government and the concomitant decline in capitalism.

The distinguishing feature of government, be it democratic or authoritarian, is the power to decide what the law is. The power to make laws is nothing more than the power to decide the purposes for which the police powers will be exercised. Governments provide a variety of services—defense, highways, education, etc. It is not the production of such services, however, that distinguishes government from other organizations. The one function which is uniquely reserved to government is lawmaking.

Statutes are enacted by duly elected legislative assemblies ranging from Congress to town councils; common law evolves out of judicial processes; administrative law is laid down by regulatory commissions and various executive offices. Our focus is on the first of these, statutory law and the legislative assemblies which create that law.

Once any organization is assigned the right to determine for whom the police powers will be available, the door is opened to supplicants who want to have those powers used on their behalf. Whenever anyone, or any group such as a legislature, is granted the right to make law, the potential for selling the use of the police powers is an automatic consequence. Even if the lawmakers were somehow forbidden to invoke the police powers on their own behalf, they would naturally be inundated by offers from others eager to have the police powers invoked on their behalf.

The right to direct the use of police powers—the right to make laws—is an extremely valuable chattel. That fact was not lost on the architects of political democracy in the United States. They displayed remarkable ingenuity in devising a governmental structure calculated to prevent the development of a market in which those who had legislative power could sell the use of the police powers to interested parties.

For example, the Founding Fathers created a bicameral legislature so that statutes had to be approved by two assemblies, and the path to approval was further impeded by having the two assemblies selected by different constituencies.

They lodged legislative veto power in the executive. They fostered interstate competition by limiting the role of the federal government and assigning residual powers to the states.

And they created a constitutional government. Explicit limits on legislatures and the executive were codified in a written document, and a Supreme Court was established to ensure adherence to its provisions.

What is most distressing about the performance of our democracy is the ultimate failure of this sophisticated system. Any realistic appraisal of what legislators spend their time doing today can arrive at only one conclusion. Legislatures—Congress is the prime example—are not engaged in the enactment of statutes for the general welfare, that is, which foster an increase in the size of the economic pie. Instead, the predominant focus of their activities is on exercising the police powers to take from some groups and bestow goodies on other groups, generally reducing the size of the pie in the process.

The propensity for governments to move in this direction was recognized early on by Thomas Jefferson, who wrote in a letter to Edward Carrington: "The natural progress of things is for liberty to yield and government to gain ground.…One of the most profound preferences in human nature is for satisfying one's needs and desires with the least possible exertion; for appropriating wealth produced by the labor of others, rather than producing it by one's own labor.…

"The stronger and more centralized the government,…the weaker the producer, the less consideration need be given him and the more might be taken away from him."

As prescient as Jefferson and his colleagues were, it's unlikely they could have predicted that Congress would eventually carve out for itself the role of a "super-court." But it has. It now functions like a civil court; it dispenses "justice," but it does so without any of the discipline imposed on the judiciary. It is not constrained in its decisions by any commitment to precedent; nor is its purview restricted by procedural canons limiting the rights of parties to bring actions before it. Meanwhile, its verdicts transcend all other law, including the Constitution itself.

The accumulation of power in Congress has not been limited to the legislative domain. Since World War II Congress has systematically and dramatically arrogated to itself an extensive array of executive and administrative powers as well, mostly at the expense of the executive. Nowhere is congressional power more obvious than in the budget process. By slicing larger and larger budgets more and more thinly, Congress controls the activities of executive departments and independent agencies down to minute details.

The power that Congress now has to require that the President spend money that it appropriates is a prime example of congressional imperialism. Congress has used the Vietnam War to adorn itself with new authority in the foreign policy and defense arenas. The President of the United States may be the commander-in-chief of the armed services, but he would be hard pressed to commit US armed forces on any but the most modest scale without the blessings of Congress.

Congress has learned to flex its legislative muscles, especially its budget authority, to control directly actions by the executive departments and independent agencies, such as the Federal Communications Commission. And "control" in this context means not only influencing policy, but getting favors done for individual constituents.

It is only a modest exaggeration today to say that Congress is the government. That is why the congressional staff now numbers in the thousands.

How has all this come to pass? How has Congress managed not only to expropriate the emperor's robes, but also to expand enormously the wardrobe? The answer, I believe, lies in the representative nature of lawmaking. Our representatives are simply capitalizing on the opportunity they have to market the use of the police powers.

Of course, it is illegal for them to peddle those powers for cash to be deposited in their private bank accounts. Not very surprisingly, this legal constraint often alters the form that exchanges take but does not eliminate them. Obliquely selling the use of the police powers in exchange for campaign support, for example, is standard practice.

The market for use of the police powers has grown continuously since the days of the Continental Congress, partly because of spectacular reductions in two classes of associated costs. One of these is the cost of enforcing laws. The decline in enforcement costs means that congressmen can now offer a more valuable product for sale.

When we were a nation of small farms, shops, and stores, big government was simply impractical. Law enforcement costs were so large that extensive taxation, regulation, etc., were not feasible.

Imagine trying to impose an income tax at current rates on a dispersed rural population, where each household was virtually a self-contained integrated production/consumption unit which kept no written records, and the chief means of transportation was the horse. Or, imagine under the same conditions just trying to disseminate—much less enforce—the regulations which now appear annually in the Federal Register.

The evolution of large organizations that paid employees and suppliers by check or cash and kept detailed accounting records; the development of telecommunications, of rail, motor vehicle, and air transportation systems, and more recently of computers and copiers, have all made it much easier for Big Brother to watch over us—that is, they have radically reduced the cost of enforcing laws.

Far more important than this reduction in enforcement costs, however, is the reduction that has taken place in the costs of marketing the police powers. One hundred years ago it was not possible for a congressman to communicate regularly with any significant fraction of his constituency, much less other constituencies. Newspapers, which were the nearest thing to mass media, were more like suburban weeklies than the metropolitan dailies we now know. It was not easy to get timely news out of Washington.

By contrast, the Washington scene now appears as a serialized soap opera entertaining millions of viewers at 6:00 P.M. every evening. An entire channel on cable television is devoted to congressional hearings and floor actions. Congress has built a television studio for its members, allegedly so they can report back to their constituents.

Improvements in telecommunications and transportation, in new printing technology and the growing concentration of the newspaper industry—all have made it much less costly for congressmen to communicate with all the folks back home. The revolution in mass media that has taken place, particularly since the advent of the radio in the 1920s, has converted Congress into an association of hucksters who employ a simple marketing strategy. First, they interpret the current state of affairs for their clientele. The interpretation always points to the existence of evil or of imminent disaster or both. In any case, congressional action is required. A prescription is offered which will remedy the problem. All of the prescriptions tend to have one thing in common. The role of government, and Congress particularly, is expanded. In their marketing endeavors, congressmen are given support and comfort by the journalism community. The latter has long understood that evil and disaster attract viewers and sell newspapers.

Both Congress and the media in presenting their stories exploit "the rationality of ignorance" on the part of the public. Like an electronic computer, the human mind has limited storage and processing capability. Moreover, the average citizen realizes that he is virtually powerless to do anything substantially to affect public policy. So if he is rational, he will resist devoting his limited storage and processing capability to learning about such issues. It pays the average citizen to be politically ignorant.

Thus, by systematically employing this marketing strategy and obviating citizen dissent, Congress has essentially taken over the federal government. And it has been assisted in this endeavor by the congruence of its interests and those of the press.

This brings us to the bottom line. The opportunity to sell the use of the police powers is a problem inherent in the structure of our political democracy. How could it be remedied? Not by electing the right people. If there is any lesson to be learned from the dismal performance of our government since the 1980 elections, it is certainly that.

My first preference for repairing this structural defect is to get rid of representatives in the legislative process by abolishing Congress and the state legislatures.

This is an option most people would dismiss as too radical. I know. I responded the same way 30 years ago the first time I heard an eminent British jurist propose it.

But I ask you to think about the possibility seriously before you reject it. There is no reason why all statutes, including budgets, couldn't be submitted to a popular vote; that is, to a referendum.

My second choice would be something along the lines of the Swiss political system, where any law passed by the federal parliament can be brought to a referendum if a modest number of citizens so petition. Moreover, the right to tax in Switzerland is limited to the cantons.

I believe the prosperity of the Swiss is in no small measure due to these advantages they have in the structure of their democracy. They are worth emulation.

William Meckling is dean emeritus of the Graduate School of Management, and James E. Gleason Distinguished Research Scholar in Management and Government Policy, at the University of Rochester. This article is adapted from a speech delivered in March 1983 at the University of Idaho.