Capitalism 101
The capitalist system of economic organization works by mass producing consumer goods cheaply. The key argument here, in overly simplified terms, is that capitalism creates increasing amounts of value for the same or lowered prices. Think about how many hours you would need to work to purchase a car in the 1940’s vs how many hours you would need to work to purchase a car now. Your average car in 2020 with all of its fancy features costs orders of magnitude less than the janky moving metal slabs of the 1940’s.
The true output of capitalism is increasing the dignity, the pleasantness, and the intensity of human life…Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.
Joseph Schumpeter
The moral argument for capitalism is that it is the only system that has proven to consistently increase the quality of life and the standards of living of the poor [1]. From my experience, folks that have lived in the developed western world their entire life do not fully appreciate the efficacy of the capitalist system at decreasing poverty.
Does it work?
How do we know that capitalism works as described above? We cannot know for sure but we do have a handy approximation in the Consumer Price Index (CPI) by the US Bureau of Labor Statistics.
Here is a graph of one from 1998 – 2018.
The bottom part of the graph shows that the capitalist system works splendidly. TV’s, cars, clothing etc are cheaper than they have ever been in history. Not just cheaper but also of better quality. Adjusting for quality, the lines of the bottom half of the graph should be even lower. The top part of the graph makes for a sobering read. The costs of education, healthcare, childcare, and housing have all ballooned out of proportion and it is debatable that quality has increased in tandem.
In fact, I think building is how we reboot the American dream. The things we build in huge quantities, like computers and TVs, drop rapidly in price. The things we don’t, like housing, schools, and hospitals, skyrocket in price. What’s the American dream? The opportunity to have a home of your own, and a family you can provide for. We need to break the rapidly escalating price curves for housing, education, and healthcare, to make sure that every American can realize the dream…
Marc Andresseen
The bottom part of this chart highlights the strengths of the system while the bottom part exposes some of its weaknesses.
Capitalism and Technology
The great growling engine of change – technology.
Alvin Toffler
To really understand how the capitalist engine works, we have to understand the business of technology and innovations. Imagine you’re in a far away time in history when music records did not exist. You are a local singer in your town and you do two performances every weekday and four on the weekends. You are the star of your town and you get well compensated for your musical talent. In fact, you have a monopoly on the singing and performance business in your town and the town folk accept the exorbitant prices that you charge them for concert tickets. Life is going swimmingly until someone invents a way to store media on a tape/disk. Some of your concerts are recorded once and duplicated on millions of disks. People no longer feel comfortable paying your concert prices as they can just listen to recordings. You no longer have a monopoly on the singing business as the music recordings from singers from other towns and other parts of the world, perhaps even more talented than you are, are imported into your local town. The net effect this new technology is a drastic price reduction for the average consumer of music and a corresponding increase in their standard of living. The average town folk can now buy more music consumption for the same or lower amounts of money.
Still on the thread of music let’s explore a more relatable example. Imagine you are in the 90’s and are a heavy music consumer. Whenever one of your favorite artists releases a new album you shell out $12-$20 to buy their CD. This is $12-$20 is non-recoverable money. So if the album turned out to be trash or your neighbor stole the record or your dog ate it, you do not get that money back. Fast forward twenty years and some people have invented smartphones and the technology to stream music over an internet connection. You now have a Spotify plan of $9.99/month that lets you listen to an almost infinite amount of music every month without the overhead of a physical record and If the album is a flop, you just find a new one to play. Again, smartphone technology + streaming technology = orders of magnitude reduction in price for the average music consumer. The broke college student can now buy more music consumption for the same or lower amounts of money.
Why is technology one of the main driving forces of capitalism [2]? Because it reduces the cost of production of a good or a service by several orders of magnitude. A few extreme examples to illustrate this point. First example, let’s imagine that I have a fleet of immortal geese that lay golden eggs for me to sell every morning, I effectively have a zero cost of production so I can afford to price my gold at a lower price than the folks(my competitors) that dig it out of the earth. My ridiculously low cost of gold production means that I can also supply much more gold than they can which will ultimately benefit the consumers of gold. Second example, If I have a car factory that is run 24/7 by self repairing robots that also produce all their raw materials, I have a zero cost of production so I can afford to sell my cars at a lower price than Ford, Toyota etc. which will ultimately benefit the consumer. The robots and the geese in the aforementioned examples are effectively “technology” and they highlight its importance in fueling the capitalist engine.
In summary, capitalism is beneficial to the average consumer to the extent to which it can drive down production costs and corresponding prices without adversely affecting supply.
Using this framework, we can begin to make sense of our Consumer Price Index graph above. The bottom half are goods and services that capitalism has used technology to drive their production costs down to almost zero. With a conveyor belt factory, it does not cost much to mass produce cars, tv’s, clothes, and phones [3]. The top part tells a different story. So far, capitalism has not been successful at reducing the production costs of healthcare, childcare, and education. This makes intuitive sense. The services of healthcare, childcare, and education have such an enormous amount of variation that it is hard to think of how technology can “mass produce” and scale these services. The percentage of variation from one iPhone XS to the next is negligible and probably not even perceptible by the average eye. However, the percentage of variation from one 70 year old with diabetes to another 70 year old with diabetes or from one high schooler to another is enormous. Effectively, technological mass production, conveyor belt style or software style, is a powerful variance reduction and price reduction technique.
However, we should not attempt to take this argument farther than common sense will allow. The reader will notice that these sectors – healthcare, childcare, and education- are some of the most heavily politicized and bureaucratized sectors of the economy. Conditions that make it hard for technological innovation to flourish. The reader will also notice that housing was not mentioned in the variance reduction argument. I don’t believe rising housing costs is a flaw of the capitalist system. We already know how to scale the production of cheap houses. Partisan political games, overly restrictive environmental laws, complex tax codes, NIMBY’ism and a downward trend in interest rates provide better explanations for the rising costs of housing in America.
Solutions?
Are there solutions to the soaring prices of healthcare, education, housing etc.? Below I outline some possibilities.
Innovation
Although fairly ambitious, this is my most preferred solution. We are already seeing some of it in the educational technology space as the ongoing pandemic has forced many learning institutions to take online learning more seriously. Well curated learning materials in video format, high speed internet connection, and user friendly software to host learning on are all levers that will no doubt scale the supply of education and reduce prices. In the medical space, telemedicine is also gaining some ground and becoming more widely adopted. I am not quite bullish on this front though. We will need more fundamental and more revolutionary technology than the internet/video technology to radically reduce prices and increase the supply to match the demand of these services.
Decreasing Demand
The previous solution focused on increasing supply (and decreasing prices) via technology to match demand. This argues for the reverse. It is a somewhat pessimistic argument but by no means is it irrational. In fact, it is already being effected, consciously or unconsciously, in the modern society. A few illustrative examples follow.
Millenials are increasingly staying with their parents, living with roommates and delaying marriage to manage the rising costs of housing. More people are picking up active hobbies and going to great lengths to get and stay fit perhaps as a response to the rising costs of healthcare. Modern couples are more likely to have one or no children perhaps as a response to the increasing costs of childcare. Trade schools, coding bootcamps, and online certifications are becoming increasingly more popular as they provide cheaper alternatives to the ridiculously expensive college system. All of the aforementioned examples collectively decrease demand or at least channel demand to alternatives in order to cope with the rising costs of goods and services.
New Policies
This is also a very ambitious solution. Policy reform needs the agreement of parties, often with diametrically opposed interests; a feat that is nearly impossible to achieve in the current political environment. Let’s zoom into medical care to buttress this point.
The Balance Budget Act of 1997 effectively reduced the number of medical residency spots available by putting a cap on the amount of a residents salary that can be reimbursed by Medicare. The American Medical Association(AMA) has aggressively lobbied against cheap retail health clinics and is very much in favor of limiting the scope of other well qualified medical professionals like Nurse Practitioners. Overly restrictive immigration policies like the J1 visa, limit the amount of foreign medical professionals allowed to practice in the United States.
All of the aforementioned policies act collectively to decrease the supply of doctors in the system and thus increase healthcare costs. This is even more severe with increased demand for healthcare services by the aging boomer demographic. I don’t have the time to collect detailed facts on housing policies and education policies but I am willing to bet a lot that they are not much different from the medical case.
Socialism and its variants
This is my least preferred solution but it is probably the most plausible long term solution amongst the others.
My biggest argument against Socialism is that the government and the political establishment cannot attract the quality of minds necessary to even give socialism a fighting chance. A very long time ago, the government, politics, and the military were the most attractive destinations for highly talented, ambitious people with lots of energy. See the founding fathers for individual examples. Wall Street soon became that place and not very long ago the preferred talent destination shifted to Silicon Valley. No offense to government officials and politicians but the average government official is a bureaucrat that’s better at playing political games than at doing productive work. Exactly the kind of person that you do not want in charge of the healthcare, education or housing of an entire country. See the government’s handling of the current pandemic, the pitiful unemployment filing infrastructure in most states, and your average experience at the DMV/Secretary of State or even better, healthcare.gov, for examples of this argument in action.
But my petty arguments do not matter in the grand scheme of things. It is becoming increasingly evident that socialism will have a place in America’s long term future. Just ask the Millenial and Gen Z demographics. Sanders might not have won the democratic nomination for this year but there are many more like him to come.
Footnotes
[1] Capitalism also massively benefits the rich and creates a lot of wealth inequality. The range of inequality depends on the measuring device. Measured in “money” terms, of course, capitalism accrues orders of magnitude more benefit to the rich than the poor. But measured in “quality of life” terms, the inequality gap is not as wide. The lower middle class man with his internet connection, motor vehicle, air conditioner, cheap entertainment has a better quality of life, in consumption terms, that some old Persian king from 1000 years ago. I will stop here as the topic of inequality deserves a separate post.
[2] To be clear, this should not be misconstrued as “technology produces Capitalism”. In fact, it is probably the reverse. Technology is just one of the main tools for rapidly decreasing the cost of production of a good or service by orders of magnitude.
[3] One could make the argument that the almost zero cost of production of these goods can be explained by globalization and outsourcing production to developing countries and China. This argument does not tell the full story. Globalization and production outsourcing will be impossible without the underlying technologies of the modern supply chain, air travel, water travel, and the internet. Technology is at the bedrock of globalization.