On the Future of Capitalism: The Wisdom of Markets?

This dictionary rendering by Merriam Webster serves as a useful definition of what people understand by the term capitalism.
"An economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market"

The historical reality is that this description is an idealization. Over time it has been necessary to impose constraints on "pure" capitalism in order it ensure that basic social needs are not compromised. Most would agree that some degree of regulation of action within a capitalist system is appropriate to inhibit egregious abuses of the social contract. The national and state governments participate in this of regulation. In effect, government and private industry are partners in capitalism.

Capitalism and its interactions with its national and world environment is the study that encumbers economists. These economists like to think of themselves as scientists whose efforts allow them to draw conclusions. These conclusions then become the basis for theories. Unfortunately, these theories are not provable, but nevertheless, economists become attached to them and confer on them the status of economic "law."

Capitalism exists within a constantly changing social and political structure, a constantly changing world economic environment, a constantly changing world physical environment, and within a rapidly evolving technology environment. If everything in the world is in flux, it seems reasonable to suspect that the economic system we think of as capitalism must change also.

Given the recent financial debacle, the ongoing debt debacle, the shifting of global economic and political power, and the threat of major environmental changes, it seems an appropriate time to stop and ponder what all this might mean for how government and private enterprise might propagate their partnership into an uncertain future. A number of articles have appeared addressing this issue. Not surprisingly, opinions are highly colored by political beliefs and faith in the continuity assumed in embracing a few economic "laws." The plan is to discuss at least three of these articles in the near future, but first we start with a brief diversion.

It is clear that the most divergence of opinion resides in the role assigned the government in the future. One of the most tightly held beliefs of economic conservatives is that it is always best to allow the "wisdom of the market" to take precedence over the government in making decisions.

This is such an article of faith for some that almost no one stops to ask if markets are actually "wise." The notion assumes that a large number of rational, self-interested participants will make better economic decisions than a few governmental technocrats. There is even a concept known as the "wisdom of crowds," which seems to assume the larger the number of ignorant people you have guessing the answer to a particular question, the more likely they are to arrive at the correct response—on average. Those who tend toward cynicism will see similarities between the wisdom of the markets and the wisdom of crowds.

Leonard Mladinow has written a book titled The Drunkard’s Walk: How Randomness Rules Our Lives. As the title suggests, Mladinow spends a good deal of the book exposing what appear to be the result of "expert" decisions, but are really better explained by random factors. Consider one experiment performed to assess the degree to which the intrinsic qualities of a product might determine its success in the marketplace. The topic chosen was music.

"For their study they recruited 14,341 participants who were asked to listen to, rate, and if they desired, download 48 songs by bands they had not heard of. Some of the participants were allowed to view data on the popularity of each song—that is on how many participants had downloaded it. These participants were divided into eight separate "worlds" and could only see the data on downloads of people in their own world...each world evolved independently."

If these eight marketplaces where performing efficiently, then one could expect similar rankings in choosing the best music.

"But the researchers found exactly the opposite: the popularity of individual songs varied widely among the different worlds....In this experiment, as one song or another by chance got an early edge in downloads, its seeming popularity influenced future shoppers."

So as—randomly—one piece or another went a few clicks ahead, others began to favor that music and jump on board. So much for the wisdom of the market. Perhaps that is why corporations abhor free markets—they cannot tolerate random results. The market has to be controlled so that the desired purchases are made. One still learns about music by listening to the radio—and who determines what is played on the radio? The producers of the product do not follow the market, the market follows the producers.

To follow up on our government versus corporation theme, the government could have assembled a group of music experts (DJs?) who would be asked to assemble the best music and ensure that it was played on the radio so that the music would be heard. Would this be creating a marketplace that provided better service to both the listeners and the performers?

There is a role for government in the economy and there are areas where the government plays no useful role. Now if only we could decide where to draw that line.