Monday, June 4, 2012

Profits, Competition, and Social Welfare

by Gary S. Becker

The Becker-Posner Blog

June 3, 2012

The financial crisis and the resulting recession have led to a strong reaction in many countries against the profit motive and private enterprise. Left of center political parties are gaining office and power in France, Mexico, Greece, and elsewhere with the promise of much greater regulation of banks and other businesses, renationalizing some companies, and constraining profits through higher taxes and other ways.

It is easy to sympathize with the hostility to the many banks that behaved (in retrospect) so foolishly in ways that damaged everyone else as they took on excessive risk in their quests for greater profits. One can understand also the general reaction against capitalism and “market failures” since commercial and investment banks were in the past a leading example of capitalism at work. Yet anyone concerned about the welfare of the poor and middle classes should resist the temptation to attack competitive private enterprise and capitalism- monopoly or crony capitalism should be deplored. This is only partly because “government failure” also contributed in an important way to the financial crisis as regulators did not rein in the asset explosion of banks and households. Indeed, regulators often encouraged lending to lower income families to buy houses with low down payments, large mortgages and ballooning interest payments.

The main reason to be concerned about the attacks on competitive capitalism is that it has delivered during the past 150 years so much to all strata’s of society, including the poor. I will try to demonstrate this not with a general analysis, but with several rather impressive examples.

China in 1980 was among the poorest countries in the world. It had just gone through the Cultural Revolution and the Great Leap Forward that contributed to the deaths of tens of millions of rural and other Chinese. In desperation, a few farsighted Chinese leaders decided to allow private enterprise and capitalism to gain a toehold in its agricultural sector. To the great surprise of many Chinese political leaders, the result was an explosion in farm output, even though farmers had only tiny plots of land to work with. Seeing the success of the liberalization of farm output, China extended the incentive system to industry by encouraging the growth of private enterprises in some sectors. Again, the results far exceeded expectations as these private companies, many owned by Taiwanese and Hong Kong residents, were not only far more efficient than state owned enterprises, but they also became the leaders in the rapid expansion of exports from China to the US and other countries.