In theory capitalism works, in theory

Echoing a famous line, Homer Simpson once remarked that “in theory, communism works. In theory.”

I think the recent financial crisis we are all experiencing is the perfect example of how it is not just communism that fails to account for the desirous, sometimes greedy and underhanded, nature of mankind. Pure capitalism is just as much the theory communism is.

Unchecked, competition can easily degrade into consumer hurting monopolies (think early 20th century American steel barons and modern Russia), exploitation of labor (such as the slavery of early Greece and colonialism of the British empire), lack of product safety (like recent scares over Chinese products with hazardous chemicals), and the cronyism that has recently allowed so many corporations (Enron being the most egregious) and mortgage lenders (Fannie May, Freddie Mack and perhaps every financial lender) who convince the market they are doing well, when in fact disaster is obviously on the way.

As an undergraduate student studying economics, I was once involved in a discussion with other students about how wonderful capitalism is because, we argued, it requires no machinery to work. Leaving people alone to pursue their own desires will naturally create capitalism, and thus wonderful efficiency. If only the government would get out of the way, efficiency will arrive. This is the same argument that many politicians, such as Ron Paul, and most right-wing commentators, like most of Fox news, have put forward.

After years of graduate research into the market system, I now realize how wrong this view really is. Beyond issues of collective action problems, capitalism, to actually work, requires a lot of the society it operates in.

Even at its simplest, capitalism needs some kind of social regulatory system, normally run through a government, to provide organization, determine rules, and ensure the existence of a social system that encourages competition. Far from needing no machinery to run efficiently, capitalism needs a huge system to ensure that people uphold their promises, that people do not cheat each other, that confidence in the system does not erode, that collusion does not derail competition.

The recent financial issues also suggest that capitalism, to avoid (or just mitigate) the large ups and downs inherent in the system, also needs to make sure people that don't know what they are doing (i.e. homeowners that agreed to sub-prime mortgages, as well as the idiots that came up with sub-prime mortgages in the first place) aren't allowed to engage in overly risky behavior.

Of course, for those that doubt me, here's a fun fact: no nation, throughout all of time, has ever actually practiced pure capitalism. Some nations have gotten close, such as the Greek city states 2500 years ago and traders in Florence, Italy in the 1500s. But these nations all relied heavily on a slave system to create the real wealth.