Chapter 5 – Supervised Capitalism
All those evils which the self-styled ‘progressives’ interpret as evidence of the failure of capitalism are the outcome of their allegedly beneficial interference with the market.
-- Ludwig von Mises 1 Government is a bureaucracy. Bureaucratic management is management that is bound to comply with detailed rules and regulations fixed by the authority of a higher-ranking body or leader. It is assigned a budget within which it must work. The need to limit the discretion of subordinates is present in every bureaucratic organization, and government workers are constrained by their assigned regulations put in place by higher-ranking bureaucrats.
Workers must comply with those guidelines without individual innovation or judgment. There is no incentive for improvement.
By contrast, there is little need to limit the discretion of subordinates of business or profit management by regulations other than the imperative underlying all business activities, which is to make their operations profitable. Because the goal of business is to earn a profit, this can be ascertained by accounting methods not only for the whole business concern but also for any of its parts.
In public administration there is no connection between revenue and expenditure. This does not mean that a successful handling of public affairs has no value. It just means that bureaucratic management has no cash value on the market; accounting methods cannot measure its value.
Ludwig von Mises2, the great Austrian economist, wrote of bureaucracy, “It is neither good nor bad. It is the way government administration operates.” He explained that “what many people nowadays consider an evil is not bureaucracy as such, but expansion of the sphere in which bureaucratic management is applied.” (Italics mine) Von Mises observed further, “This expansion is the unavoidable consequence of the inherent trend of present-day economic and social policies toward the substitution of government control for private initiative.” He also stated, “This expansion is the unavoidable consequence of the progressive restriction of the individual citizen’s freedom.”3 Adam Smith4 wrote, “Every individual in pursuing his or her own good is led, as if by an invisible hand, to achieve the best good for all. Therefore any interference with free competition by government is almost certain to be injurious.” Back in 1776, Smith recognized the negative effect of government interference upon business and the individual.
Central government control is the core of political organization, but it is contrary to free enterprise, and it decreases the incentive to save. This corroborates von Mises’ observation that bureaucratic control is incompatible with free-enterprise management.
Bureaucrats have nothing to do with innovation or development of entrepreneurial creation in business. Gerald Weissman, M.D.5 points out, “A cost-driven government program cannot guarantee innovation.” In personal discussions with acquaintances whom I have believed should have understood the free-enterprise system better, I have heard all too often: “Yes, Capitalism is the best system we have, but, of course, it must be controlled.” Further, they insist that, “it must be supervised because capitalism is dominated by greed.” So, I invariably ask, “Supervised or controlled by whom?"
"By the government, of course,” comes the answer. If free enterprises are bureaucratically supervised, managed, or regulated by governmental agencies, then control of production is being exercised.
And that is a varying dose of coercion and an advance toward the announced goal of Socialism to control the means of production.
Chalk up another one for public schools! When large industrial complexes or any business entities depend on government protection, support, or favoritism then true capitalism is being suppressed. The consequent adverse results are blamed upon Capitalism as “dishonest,"
"greedy,” or “unjust.” Therefore, if they are seen as greedy and uncontrolled, then it seems easy to conclude, “controls are needed.” Nevermind the natural forces of the free market, which actually control the success or failure of any entrepreneurial activity! This is a large part of the very reason for my research and study; namely, to comprehend the correct basis of the system of Capitalism and to define the broad, negative effect of mixing in bureaucratic coercion. Bureaucrats simply do not have a proprietary interest; their excuse for action is to add “needed” control to the system: Do I face a task?
In an earlier chapter, I discussed the gradualism of infiltration of socialistic workings into the democratic governments of both Britain and the United States as promulgated by Sidney Webb and George Bernard Shaw. They believed, and I suspect that many supporters of government intervention still believe, that gradual application of government interference is the best method of achieving full Socialism.
But many interventionists are not full socialists. They hold that the establishment of a mixed economy would “improve” Capitalism by a system of permanent management. They undertake to regulate and restrain free enterprise by government interference with business and by labor unionism. Misunderstanding and miscalculation of true free enterprise are reflected in that erroneous assumption. The tragedy of that idea is that it is so widely accepted.
Whether the perpetrators are succeeding by design or merely by sincere belief in adding intervention does not alter the outcome. Ludwig von Mises6 stated, “All methods of interventionism are doomed to failure.” As far back as 1947, von Mises7 wrote, “Capitalism is the economic system for modern Western civilization.” Yet he said, “The policies of all the Western nations are guided by utterly anticapitalistic ideas.” This amounts to an initiation of a so-called ‘mixed’ economy. Collectivists claim that this partial or supervised capitalistic system should stand midway between Capitalism and Socialism and thus should retain the ‘advantages’ of both. It does not.
It appears that the aim of the gradual infiltration of the US education system and the achievement of transforming the spirit of individualism and Capitalism has made unprecedented headway, judging by the deliberate changes taught in the public schools away from the actual history of the successful system of Capitalism and the understanding of individuality. Who could have predicted that the ‘relativism’ of morals and rewritten history now propagated by ‘liberals’ and their influence in our schools could have such far-reaching and negative effects upon the policymaking of those now in big government or upon the perception of so many citizens?
The ‘necessity’ of government to solve social problems is behind the social changes that were made during the 1960s. This brings up a seemingly peripheral question, “Should Congress have the extended power to force people to do what’s in their own welfare and health interests?” Prof. Walter Williams8 reports that he is afraid that most Americans indeed do believe that government should be able to force people to do what the government directs in their health and welfare interests. However, he eloquently makes the argument that there is absolutely no moral case for government’s taking American’s earnings, through taxes, to care for others for any reason whatsoever. Further he said, “This is a problem for Socialism.” Remember, Socialism is the system of centrally controlling all aspects of citizens’ lives and productivity.
And ruefully, this country is approaching those very ends.
A first-rate example of this government-knows-best mentality for people’s health is the present blatant attempt by some in government to dictate how much and what type of food is best for people to be trim and healthy. They state that too many adults and children are obese, so therefore (with the help of unscrupulous lawyers and judges), fast- food companies, soda manufacturers, candy makers “must be regulated.” Who says that any government agency may tell any American citizen what and how much he or she may ingest? Eating is an individual decision. Still, many in government seem encouraged that they can get away with attacking legitimate fast-food companies following their successful attack on the tobacco and asbestos industries. The tobacco, asbestos, and fast- food companies are all legitimate free-enterprise businesses. They did not and do not force anyone to use their products. Yet the government is free to attack and to coerce people to fit a behavior dictated by its ‘liberal’ interpretations or the portrayals of some vociferous, peripheral interest groups.
A ludicrous lawsuit against Nabisco Company’s Oreo Cookies because they contain the ‘harmful’ trans-fatty acids was correctly thrown out of court in May 2003. But legitimately, one may ask, what of “hot” coffee at McDonalds?
Interventionism and Socialism A comparison of interventionism and Socialism is important at this point. The system of government intervention is the hampered market or just plain interference. Government ‘enterprise’ differs from Socialism by the fact that some of its activity still operates in the market economy. Publicly owned “businesses” must buy raw materials and semi-finished products, so that their purchasing must fit into the mechanism of the market. They strive to avoid losses, but they are still dependent on the law of the market. A good example is the production of work shoes, T-shirts, and cotton- weaving materials in State prisons. Acquisition of the raw materials is still subject to market laws, and the market (not the tax collector) decides those costs. The purchase of governmentmade products is on the market, but purchase of State license plates manufactured in those prisons is compulsory.
When taxes are used to cover losses in government industries, then the consumers are further burdened for the extra cost. In those cases, not only must the consumers pay for products and services produced by the government, they must also pay the added-on losses accrued by that non-entrepreneurial activity. This adversely affects those purchasing the products not the government.
In other words the consumers are paying more than just the market price of those products; they are also paying for the ineptitude of the government managers who essentially do not take the consequences for their losses. The law of the market nonetheless operates in such undertakings.
Entrepreneurs, on the other hand, must take the consequences for their losses; they can even go out of business. The interference by government subverts the operation of the capitalist system of market economy, and it demonstrates the futility of interventionism.
However, it must be emphasized that the failure of political intervention in the market does not demonstrate the necessity of adopting Socialism.
Increasing political interference in the profession of medicine, for instance, is only increasing the cost of the failure of trying by central control to care for everyone’s medical needs. This is, of course, entirely contrary to the stated goal of government managements, which is “to keep healthcare costs from increasing out of control.” 9 But what is the real experience?
I have found no reference that reports any reduction of costs in programs that political managements sponsored, started, or ran by the approaches of federal government (or State governments for that matter). What I logically fear is that the federal government’s enactment of Medicare and Medicaid thirty-eight years ago and its congressional starting and subsidizing the early Health Maintenance Organizations (HMOs), which are failing with serious consequences, will nonetheless give justification to those ‘liberal’ types to push for government to ride in to “solve” the mess by taking over with a form of nationalized (socialized) medicine.
That would be a monumental mistake.
Yet, that is the very idea now proposed by Senator Richard Gephart, an early-announced Democratic candidate for President in the 2004 election campaign. Such an action would compound the present problem to such a degree that even the present inefficient Veterans Administration hospital system would look good.10 Fortunately, the citizens of the State of Oregon overwhelmingly rejected a November 2002 ballot issue to establish the first universal health care program ever put before American voters. Remember also the failed Hillary Clinton proposal for such nationalization of Health Care in 1993. That failure did not dampen Hillary’s intent on further pressing for an acceptance of her “Universal Health Care” program.
The push to try to establish universal health care is only part of the present dilemma for the medical profession. Anne Summers, M.D.,11 recently wrote, “The best and brightest and busiest doctors are being forced out of practice, and out of state.” She pointed out that malpractice insurance rates are staggering in West Virginia, Pennsylvania, and New Jersey, and new doctors refuse to move there. Whereas last year in New Jersey there were 82 neurosurgeons, this year there are only 62, and 25 percent of all obstetricians in the State stopped delivering babies altogether.
Dr. Summers’ solution: “Tell your state legislators to pass tort reform in your own state.” To understand how Socialism can work by masquerading as Capitalism, one can refer to the Nazi Germany compulsory economy (Zwangswirtschaft) during the Hitler regime before and during World War II. It used the words: “private ownership of the means of production," "entrepreneurship,” and “market exchange.” The so-called ‘entrepreneurs’ did the buying and selling, paid the workers, contracted debts and paid interest. However, they were no longer true entrepreneurs, because there was no risk taking or individual decision making. They were even renamed and given the title “works manager” (Betriebsfü hrer). It was the government that told them what and how to produce (and how much), at what prices and from whom to buy, at what wages laborers should work, and to whom and under what terms the ‘capitalists’ should entrust their funds. “Market exchange” was a sham, because the central authority fixed all wages, prices, and interest rates. They were prices, wages, and interest rates in name only. Factually, those free- enterprise terms were just quantitative names in the authoritarian orders that determined each citizen’s income, consumption, and standard of living. This made the citizens nothing but civil servants who had no say in their economy.
With only the outward appearance of Capitalism, that was central control of the means of production; it was Socialism.12 Remember, in a free-market economy, the consumer is the boss by freely deciding what he wants and what he is willing to pay and then buying the product he desires. The entrepreneur-producer is successful by producing the best product at the best price. No political control can replicate that efficiency or individual decision- making. This cannot be emphasized too often.
Another “issue” of today’s Democrats’ recent criticisms is to factor the recent accounting discrepancies of a few very large corporations and their ultimate bankruptcies as somehow being linked to the Republicans and particularly President Bush and Vice- President Dick Cheney.* Actually, the accounting systems that had been developed were in part a response to the complicated and oppressive legal rules and tax laws. Functional outlawing of hostile takeovers through political action and ‘creative’ lawyers has reduced entrepreneurial risk-taking and dynamic management to the point of reducing responsibility to share holders of all too many companies.
Maybe the government’s accounting system should be scrutinized to discover the unaccounted-for billions of dollars “lost” in the Education, the welfare, and the military departments. Doug Bandow13 provided some interesting figures. In Washington D.C. in February 2002, the Office of Management and Budget (OMB) announced that 2002’s deficit would run to $106 billion, but five months later it revised its estimate to $165 billion. Last year, the General Accounting Office (GAO) found $17.3 billion in “unreconciled transactions,” that is, cash had simply disappeared. It is very difficult to generate confidence in such inaccuracy and unaccountability.
Money accumulated but not paid out in dividends is then available to large business managers to acquire other business entities.
This was not always bad. The history of early hostile takeovers shows that most of them were profitable in the sense that they resulted in increased share values for the two companies combined.
Still, boards of directors, executives, unions, and many others in the companies taken over through hostile bids, do not like what happens to them in the aftermath of those takeovers.
They often lose their jobs and prestige. So it is understandable * that they would be among those demanding more regulation from the government. Government usually does respond eagerly to such demands—with more regulation.
Acquisitions and takeovers have been the subject of criticisms of big business recently, with Enron as the first and probably the largest of bankrupt entities that showed “greed,” fraud, and huge payments and stock options given to CEOs just prior to their collapse. Originally, bonus payments and stock options were designed to reward high performance. Yet, in spite of mismanagement, those incentives often were still paid, even though the companies faced bankruptcy, like Enron. Admittedly that was a distortion of the original intent of options, but a closer look shows that government regulations are not as innocuous as once assumed.
Congress passed the Williams Act of 1968 that required the notification of the Securities and Exchange Commission of the intent of hostile takeovers and made it more difficult to carry them out successfully. On top of that, many State regulators have allowed managers of targeted firms to delay or prevent takeovers, and the regulators made the takeovers more difficult in spite of the natural market forces fully capable of handling the transactions without disinterested and politically motivated interference. Several analysts have concluded that the recent rash of corporate scandals can be attributed directly to the State and Federal legislation designed to make natural business acquisitions more difficult.
Government regulation in effect has fostered this so-called ‘greed.’ This discussion of government regulation of hostile takeovers is based on the Op-Ed opinion of Herbert Grubel.14 Herbert Grubel is a professor of economics at Simon Fraser University in Vancouver, BC, Canada, and his above assessment is very instructive.
Such unintended consequences, as just related, sound awfully close to the effects of the government subsidies on steam shipping and railroad development (to follow shortly).
There are two kinds of answers for these alleged “market failures.” One is government regulation, which originates from politicians, government regulators, and from those in academia plus the ‘liberal’ media who are antagonistic to the system of Capitalism.
They insist that government step in and ‘regulate.’ The second is from the group of people that believes that Adam Smith was correct, that, “the invisible hand of competition constrains selfish behavior and channels it into the service of the common good.” (Italics mine) President Bush in mid summer 2002 created the Corporate Fraud Task Force (CFTF) to oversee a comprehensive law enforcement response to the many frauds at major corporations that shook our markets. Deputy Attorney General, Larry D. Thompson,15 is chairman of the CFTF, and he said: The criminal law sets a standard whose transgression is, and ought to be, swift and decisive. Vigorous criminal enforcement aimed at both bad corporate executives and corporations is not only harmonious with, but also mandatory for, the country’s economic vitality. A strong regime of criminal enforcement leaves honest business people free to compete, while preventing a few bad apples from spoiling the barrel.
It is not so widely known that markets actually work to prevent greed in the form of excessive compensation, bonuses, stock options, insider trading, and cheating in accounting. Today, there are numerous financial specialists and competitors in the industry who make a living by watching public corporations and noticing when such practices reduce the value of the offending companies’ shares.
A discussion of examples of the effects of government interference in large business is now timely.
Misinformation and Misunderstanding of Early Large Business In its attempt to support the socialist philosophy by deploring Capitalism, the Left has pointed to the huge corporate monolithic business entities of the mid to late 1800s as examples of the ‘inequities’ and ‘injustices’ of capitalism. Looking only at size, perhaps one might be tempted to wonder about the huge conglom erates, particularly if one heard only the complaining harangues of those wanting to divide, politically control, or willfully dismantle such entities, as do politicians and socialists.
It is true for instance, that large grocery chains did affect small local grocery stores and drive most to non-survival. Yet, they certainly did so principally by reducing prices and offering greater varieties of goods for the consumers.
On closer examination of the huge industrial revolution in the U.S., one finds a very different story of entrepreneurial ingenuity and aptitude, which benefited the whole population. It is history that some business entities were indeed conniving and dishonest, but with closer scrutiny those were usually subsidized by government and inescapably suffered consequences. Recorded history relates too little of those episodes. Cronyism was the problem then, and it is still a problem now. It is the substitute of influence and corruption for innovation and competition. Free markets remain free only if the greatest number of people possible is free to enter and leave them. Still, there are always those who try to erect barriers to competition.
Much has been alleged of the so-called “Robber Barons” of the 1800s. One often hears: “They robbed; they cheated; they exploited Chinese coolies.” In short, “they were all that is wrong with capitalism.” So go some of the worn denunciations.
There is a more accurate history, and interestingly it relates right back to government intervention and the exploitations of it by some unscrupulous but clever businessmen.
The real effects of the government subsidies constitute the accurate story of these alleged ‘Capitalism abuses.’ Historically, the expression robber baron was used to describe a landholder who robbed travelers passing through his lands. It came into usage in the United States during 1870-75, being applied to “a ruthlessly powerful U.S. capitalist or industrialist of the late 19th century considered to have become wealthy by exploiting natural resources, corrupting legislators, or other unethical means.”16 Matthew Josephson17 in 1934 popularized the term “robber-barons” in his writing. When the true story is unfolded, we can recognize that this two-word term, for the most part, has been erroneously employed colloquially.
The importance of studying history is to learn from it. Studying the rise of big business, between 1840 and 1920, is the story of how the United States prospered and became a world power. The story is more than a story of simple growth because there is much written about the negative effects of “big” business. However, growth would probably have occurred more rapidly and been much larger had government subsidies not been granted. Large business in bed with politics is not true Capitalism.
Government Subsidies and Steamships Let us start with the story of the application of the steam engine to boats and shipping. The history of mechanized shipping is fascinating because of the major differences between private enterprise and government-subsidized business entities. In recounting this history, certain definitions bring clarity to the difference between those two approaches to this era of shipping. Several men wanted to capitalize on the early development of steam engines applied to boats. Some wanted to be subsidized by government, but others chose to take risks and apply engine power to boating enterprise by free-market methods.
Burton W. Folsom, Jr., wrote, “Those who tried to succeed in steamboating primarily through federal aid, pools, vote buying, or stock speculation we will classify as “political” entrepreneurs.
Those who tried to succeed in steamboating primarily by creating and marketing a superior product at a low cost* we will classify as “market” entrepreneurs.18 (Italics mine) Folsom’s clarification is a good demonstration of accurate definitions.
Robert Fulton was the first American to build a steamboat, and he operated it on the Hudson River in 1807. He was one of the first political entrepreneurs. The New York legislature gave him * This concept is characteristic of free entrepreneurial activity.
the privilege of carrying all steamboat traffic in New York to extend for thirty years. But in 1817, Thomas Gibbons hired Cornelius Vanderbilt to run steamboats between New York City and Elizabeth, New Jersey for less than the monopoly rates. Gibbons brought suit against the Fulton monopoly, and in 1824 the Supreme Court struck down that monopoly in Gibbons v. Ogden.
Chief Justice John Marshall ruled that only the federal government could regulate interstate commerce. Given the time of the case, it likely helped establish the precedent for federal regulation of interstate commerce.
In the year following the Supreme Court ruling, on the Ohio River alone, steamboat traffic doubled and then quadrupled in the year after that. Vanderbilt utilized more powerful engines and improved boat design and used them efficiently to lower costs and fares. Fulton’s group could not meet the new rates and went bankrupt. Chalk one up for unsubsidized private enterprise.
Vanderbilt bought two boats and challenged the Hudson River Steamboat Association with lower fares. He lowered them to no fare, relying on at least $2.00 food sales per passenger. In exasperation, the H.R.S. Association bought him out.
Technology changed steamboats into steamships in the 1840s.
Samuel Cunard, one of England’s first internationally known political entrepreneurs, in 1838 convinced the English government to give him $275,000 a year to run mail and passenger services twice a month across the Atlantic Ocean.
At the same time, such tactics were being used for federal aid on the US side of the Atlantic. One of the most notable political entrepreneurs was Edward K. Collins who successfully convinced the government to give him $3,000,000 down and $350,000 per year to build five ships and beat the “Cunarders.” Collins did beat the Cunard ships across the ocean, but his costs were high and his economic benefits nonexistent. In fact, in 1852 his yearly expenses doubled, yet he had no incentive to reduce his costs.
In hindsight one can note that mail subsidies actually retarded progress and innovation. In England in the 1840s, several steamship companies experimented with iron hulls and screw propel lers, but Cunard thwarted them whenever he could and continued to use wooden hulls and sidewheelers.
In the U.S., Collins, like Cunard, chose wooden hulls and paddle wheels for his ships. Americans were slower to turn to iron ships because their costs of construction were higher. Is spite of that, some American engineers also had been experimenting with iron hulls and screw propellers in order to handle the bigger engines built after 1840.
In 1855, Vanderbilt decided to challenge Collins by offering to deliver the mail for less than Cunard’s fees and less than half of Collins’ charges. The first round of battle Collins took to Congress.
That body supported Collins because not to back him would mean the government had made a mistake in helping him in the first place. That might call into question all federal aid. Oh?
Vanderbilt’s comment from back then is just as timely today, “Private enterprise may be driven from any of the legitimate channels of commerce by means of bounties.” He added that such aid was “inconsistent with the . . . economy and prudence essential to the successful management of any private enterprise.” 19 By spending $600,000 to build a new steamship with an iron hull using a new and more powerful beam engine to drive the propeller, compared to the traditional side-lever engine that drives the paddle, Vanderbilt introduced a more substantial and reliable ship. He then made up for the subsidies to Collins by taking a large number of lower-fare passengers across the ocean in a shorter time. Still the first year was close economically, but when two of Collins’ poorly-built ships sank, Louisiana Senator Judah P. Benjamin* was disgusted, and several of his fellow Senators agreed that the Collins line had been “most miserably managed.” The government aid was withdrawn, and Collins shortly thereafter went bankrupt.
* Judah P. Benjamin later became the Secretary of War of the Confederate States of America during the Civil War.
When the Civil War began, Vanderbilt donated his iron-hulled 5,000-ton ship to the Union. He offered personally to sink the Confederate Merrimac but did not get the chance.
As an interesting side note, a new unsubsidized William Inman Line in the mid-1850s did to Cunard in England what Vanderbilt was doing to Collins in the United States. Inman had gone to iron hulls and screw propellers. Thus, before the Civil War it was Vanderbilt and Inman who led the US and England in cheap mail and passenger service.
Earlier, once the principle of mail subsidy was established, others argued for taking the mail to other places. Two subsidized lines, the U.S. Mail Steamship Company and the Pacific Mail Steamship Company, in 1849 received $500,000 a year to take mail from the east coast to the west coast by portaging across Panama by rail.
Vanderbilt chose not to challenge the subsidized lines through Panama. Instead, he took a year to deepen the San Juan River in Nicaragua and thus made a canal, creating a course 500 miles shorter than the Panama route. He cut the California fare from $600 charged by the subsidized lines to $150 and carried the mail free.
When a political upheaval in Nicaragua caused the destruction of the Nicaraguan canal, Vanderbilt put his ships back to the Panama route. The two government-subsidized California lines bought him out, paying him 75 percent of their new $900,000 government subsidy for his promise not to run any ships to California.