Capitalism, Socialism, Communism: formulating the problem

Introduction: I consider the main existing economic systems with the goal to reformulate the centuries-old economic debate as something like a problem in many-body physics (admittedly, very vaguely stated.)

Laissez-faire capitalism, or what is often called “wild capitalism”, is the most liberal, (i.e., free), economic system imaginable, whose description dates back to the works of Adam Smith. It is comprised of many small private units, firms and households, which try to maximize their profit or minimize their expenses. These units exchange goods, (i.e. interact), in a market in such a way that the whole system eventually achieves equilibrium, where the supply of goods from the firms equilibrates the demand for these goods by the households. The role of government is reduced to providing the medium for transactions (i.e., a market and the money) and ensuring that they are done in an honest way.

For someone, familiar with the basics of statistical physics and strongly correlated systems, the existence of such equilibrium in a many-body system does not seem impossible. Adam Smith, living in 18^th century, was in a less fortunate situation. He had to introduce the concept of “the invisible hand” which has incurred much ridicule. “Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.” - John Maynard Keynes.

Though hypothetically such an equilibrium state is possible, it still remains to be determined under which conditions it exists, whether it is achieved on realistic time-scales, and whether its parameters are always consistent with the demands of the general welfare as whether salaries in the labor market are sufficient to provide livelihood.

Laissez-faire capitalism is known to work in many situations but has also run into spectacular failures, most notably the Great Depression. It now exists only in developing capitalist countries (for example, in Russia), but still has many supporters, such as the Libertarian movement in the United States, represented by Ron Paul.

Communism is the total opposite of Capitalism. A communist government controls all production (i.e. the “firms”) and distributes goods to households. Ideally, even money is not needed under such a system.

In theory a centralized system is capable of producing and distributing required goods more efficiently than the many uncoordinated actors of laissez-faire capitalism. However, in practice it is known to be very slow in adjusting to the demands of households due to the length of the command chain (i.e., government bureaucracy), and its participants’ lack of personal interest in higher efficiency. It is also highly prone to abuse due to the excessive concentration of power in the hands of a small group of people, which tend to abuse this power either through deliberate evil doing or due to simple incompetence. The existing communist countries are examples of such abuses.

Communism also showed itself badly during the Great Depression: a famine in large and normally agriculturally profitable areas of Southern Russia and Ukraine took millions of lives in early 1930’s and even resulted in widespread cannibalism. It remains an open question whether “Holodomor” was the result of a deliberate genocidal policy by Stalin (as the Ukrainian government insists) or simply of his and his advisers’ economic incompetence. In either case it was exacerbated by the high centralization of power.

Regulated Capitalism is an attempt to salvage individual freedom, inherent in the Capitalist system, while limiting the possibility for its failure. It is achieved by establishing “fair rules of the game”: such as anti-monopoly laws when a greater number of competing firms are desirable and regulating natural monopolies where competition is unwelcome (e.g. water and electric supplies and public transportation are often cheaper and more efficient when provided on large scale).

Government may also play a greater role in carrying such functions as building public roads, enforcing law and order, and protecting the environment. While these functions are funded via taxation, it can be argued that taxpayers get fair value in exchange for what they pay. A firm that makes greater use of public roads than a private individual could pay proportionally more in taxes. A similar argument can be extended to funding the police and legal systems since businesses are more dependent on their protection than individuals.

Socialism attempts to improve general welfare by forcing the redistribution of wealth and by more heavily regulating business. I focus below on the economic shortcomings of socialism, but it is necessary to note that the main opposition to redistributionist policies is ideological. Although redistribution is often justified on the grounds of fairness, (i.e., general welfare) it is ultimately unfair from the point of view of individual rights, encoded in the laws of all the developed Western societies. Indeed, this redistribution is in fact a forceful confiscation of legally obtained private property. 

From the point of view of welfare, the main drawback of the socialist system is that the attempts to correct market outcomes often result in negative side effects. For example, rent control laws often give advantage to long-term tenants over those who are looking to move in: the latter are forced to pay a higher price for the same kind of property than the former. Similarly, labor unions drive higher benefits and salaries of employed workers (the price of labor) resulting in lower demand in the labor market, and therefore in higher unemployment than would exist in free market conditions.

While all the developed modern economies are to some extent socialist, their current state suggests that the socialist system is unstable. This is mainly due to the lack of a balancing mechanism that would restrict the growth of welfare benefits, which the majority inevitably awards to itself via the democratic process. This growth is usually funded via borrowing or increasing taxes, which are the same via the Ricardian equivalence, practices that cannot continue indefinitely. Eventually socialism either evolves into its logical extreme of Communism, the Marxist view, or faces the threat of economic instability and relapses back into a state with less welfare distribution, which what seems to be currently happening in Southern Europe and Ireland. In Israel such a turn took place as the result of hyperinflation in the 1980’s under the government of Shamir and Peres.

Formulating the problem

We thus face the problem of designing a social system which would be stable and generate satisfactory outcomes in terms of general welfare. This should include:

1. Formalizing the elementary units and the interactions in a laissez-faire capitalism system and finding under which conditions the system self-organizes and when, or whether, it can be stable.

2. Elucidating the basic mechanisms of instability in Socialist and Communist systems.

3. Determining the proper mixture of free competition, enforcing “fair rules of the game”, and wealth redistribution which would be stable, while providing a sufficient level of general welfare.