What is the relationship of capitalism and democracy in the United States and how has that relationship changed with shifting societal conditions? What must government do in a capitalistic economy? What should it do? What must it not do? These are perennial questions that must be answered anew by each generation of citizens. The answers are rooted in the nation's history, evolve as events unfold, depend on one's values, and change with our understanding of capitalism, particularly what it does well and not so well.
The term capitalism has several definitions that emphasize different aspects or characteristics. The definition given in Merriam-Webster's Collegiate Dictionary will serve: “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” ( 11th ed., 2004, 183 ). Importantly, this definition points to capitalism as a relative system: mostly private ownership and decisions, along with competitive markets that are principally, but not exclusively, the means to determine who gets how much of what. Thus, a nation might become less capitalistic over time, perhaps by increasing the sphere of economic activity controlled by the government.
Early in the life of the United States, both capitalism and a more modern version of democracy were in their infancy. Although at the time of the drafting of the Constitution the term capitalism had not yet been invented, Adam Smith ( 1793–1720 ) had described and advocated many of its key elements in his Wealth of Nations, first published in 1776. Perhaps the most renowned of his insights was that self-interested behavior in the marketplace acts like an “invisible hand,” guiding people to produce what is of the greatest value to society. Moreover, Smith referred to his economy as “the system of natural liberty” (Bk. 4, ch. 9). This comported well with other ideas that were developing during the Age of Enlightenment ( roughly 1650–1800 ), including John Locke's ( 1632–1704 ) famous right to “life, liberty, and estate” ( 1690, ch. 7, sec. 87 ).
The ideas of these and other Enlightenment philosophers supported a vision of an economy and government that together maximize the liberty of the citizens. Nobel laureate Milton Friedman ( 1912–2006 ) summarized it this way: “On the one hand, freedom in economic arrangements is itself a component of freedom broadly understood, so economic freedom is an end in itself. In the second place, economic freedom is also an indispensable means toward the achievement of political freedom” ( 1982, 8 ).
The economic freedom inherent within capitalism is an important aspect of a person's liberty. One can work at what one chooses, use one's resources as one chooses, or buy what one chooses, all free from coercion by the government. That also means, significantly, the right to refuse. For example, government cannot tell someone where to live or at what job to work. People living in a society where they do not have the right to such choices would hardly be thought of as free. Such freedom was largely absent during the feudalism era, where most people were serfs bound to work on the land owned by the nobility. In modern times under extreme authoritarianism—for instance, in the Democratic People's Republic of Korea (North Korea)—the government controls even such basic circumstances as a person's occupation and where one is allowed to live.
Moreover, economic freedom is a bulwark of political freedom because of its role in power dispersion. The Framers of the Constitution viewed government as a real threat to liberty, even when it was acting in accordance with the wishes of the majority. So a familiar aspect of the design of the American government is to disperse power, principally through three branches of government, legislative bicameralism, federalism, and state sovereignty. Similarly, power is dispersed through private ownership of enterprises. As John Stuart Mill ( 1806–1873 ) wrote in On Liberty ( 1859 ), if the government controlled all of the “roads, the railways, the banks, the insurance offices, the great joint-stock companies, the universities, and the public charities,” and all of their employees “were appointed and paid by the government, and looked to the government for every rise in life; not all the freedom of the press and popular constitution of the legislature would make this or any other country free otherwise than in name” ( ch. 5, 198–99 ).
One government function fundamental to capitalism is the establishment of the legal and social framework under which goods and services can be produced and distributed according to the decisions made by individuals in markets. Thus Congress was given the power to establish and enforce property rights, particularly in Article I of the US Constitution, Sections 8 (copyrights) and 10 (contracts). The Framers were mindful of the arguments of Smith (among others) for more expansive trade and of the problems created by restrictions adopted among the states during the Confederation period. So the Constitution gave Congress several powers and established certain limits that, taken together, expanded both internal and external trade. Among Congress's enumerated powers (Art. I, Sec. 8) were the authority “To regulate Commerce with foreign nations, and among the several states, and with the Indian Tribes,” and “To coin Money, regulate the Value thereof, and of foreign Coin.” Article I, Sections 9 and 10, essentially established a free-trade zone within the United States by preventing the states from taxing exports and imports from other states while making the Unites States a single entity for foreign trade.
As Smith suggested, a system of competitive markets shines in using the self-interested behavior of producers to make what consumers are willing and able to buy. This is the basic notion of economic efficiency, an enormously valuable concept. People in a society will have a higher standard of living if resources are not wasted by inefficient methods of production or by the production of things people value less than alternatives. Markets, however, must be competitive to create efficient outcomes. For example, in a market with a single firm— that is, a monopoly—the seller will limit the amount produced to establish a price that maximizes profit. The result is that production is less than consumers want, and the monopolist is not forced by competition to produce in the least costly way or to establish a competitive price.
Attempting to remedy inadequate competition has been one of the significant economic roles of the US government from the outset. For example, the Framers explicitly omitted giving Congress the jurisdiction to form companies under government charter, something that created monopolies under royal authority in colonial times ( Calabresi and Price 2012 ). President Andrew Jackson ( 1829–1837 ) opposed the Bank of United States because he saw it as a government-sponsored monopoly. In the late 1900s, important industries became less and less competitive—railroads, steel, and oil are familiar examples—and the government responded with the Sherman Act ( 1890 ), the Clayton Antitrust Act ( 1914 ), and the Federal Trade Commission (FTC) Act ( 1914 ). Federal action to promote competition has continued into the twenty-first century with such cases as United States v. Microsoft Corporation, 253 F.3d 34 ( 2001 ), and the lawsuit and subsequent settlement of the merger of American Airlines with US Airways ( 2013 ).
Capitalism excels in producing what consumers want at the lowest possible prices. Moreover, the economy grows and generates prosperity due to innovation and investment that increase productivity, and with it, the overall standard of living. Over time, the American government has adopted a much more active role in trying to maintain both economic growth and economic stability.
In all societies throughout history, living standards for the average person were frozen at the subsistence level until about three hundred years ago. In fact, the entire notion of an economy that presents the opportunity for higher living standards for most people is very recent in human history ( Lucas 2004 ). In the United States, per capita gross domestic product (GDP), measured in 2009 dollars, was just $1,107 in 1790. By 2012, it was $49,226 ( MeasuringWorth.com ). This path of growth, however, has not been smooth. The national experience with periods of recession and excessive inflation, sometimes called the business cycle, showed that such periods are an inherent deficiency of capitalism, and both have become something the government has made increasing efforts to remedy.
A recession is “a significant decline in economic activity spread across the economy, lasting more than a few months” (NBER). Recessions create suffering, especially for those who lose their jobs, businesses, and homes. The worst of these in US history was the Great Depression which began in August 1929 and reached its nadir in March 1933. During the Great Depression, unemployment peaked at nearly 25 percent of the labor force, compared to 10 percent in the recession of 2007 to 2009, the worst since World War II. There have been thirty-three recessionary periods in the United States from1854 through 2009, some as short as six months, and others as long as sixty-five months ( 1873–1879 ) (NBER).
Inflation is “a general increase in the overall price level of the goods and services in the economy” (Board of Governors of the Federal Reserve System). While there are winners and losers during periods of inflation, the losses during unanticipated and rapid inflation vastly outweigh the gains. Workers' wages may not rise as fast as prices. Businesses, whose prices might be locked by contracts, could be squeezed by rising costs for their supplies. Resources are squandered as both consumers and producers waste time and effort in attempting to adjust to inflation. Inflation can be caused when the supply of money in an economy rises too rapidly. Moreover, some recessions in the United States have been associated with decreases in the supply of money. This occurred during the panic of 1907, when the economy shrank by about 10 percent. It ultimately led to the creation of the Federal Reserve System (the Fed) by Congress in 1913.
The very mechanisms by which capitalism generates growth and efficiency create economic insecurity for some people, even beyond the disruptions of the business cycle. For example, small businesses (with fewer than five hundred employees) account for half of the private-sector employment in the United States, but half of those businesses fail within five years ( SBA 2012 ). As part of this dynamic economic churning, 3 to 4 percent of employees, approximately 4.5 million people, typically lose or leave their jobs voluntarily each month (BLS). Others are sick or disabled or lack the skills to find jobs. Peter Edelman ( 2012 ) reported that about 15 percent of the American population was classified as poor, some forty-six million people, including millions of children.
As the society grew wealthier and as societal values changed, some citizens called for a more active government role in providing security from the vagaries of the market system and in reducing poverty across the country. The election of Franklin Roosevelt ( 1882–1945 ) in 1932, with the nation mired in the Great Depression, was a major milestone in this effort. Both the federal and state governments responded with aid programs, such as unemployment compensation for those who became involuntarily unemployed. Subsequent federal, state, and local measures include the Supplemental Nutrition Assistance Program (SNAP, formerly called the Food Stamp Program); the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC); and the Social Security and Disability Insurance Trust Fund. Other attempts to provide security through greater access to healthcare include Medicare, Medicaid, and health insurance obtained through the 2010 Affordable Care Act.
The expanded economic role for government was manifest in other ways. The government switched to support for the unionization of labor and protection of collective bargaining from a history of opposition that was often based on the argument that collective labor action was anticompetitive. Public revulsion over workplace conditions eventually led to laws intended to ensure worker safety and to remove children from the industrial labor force. Minimum wages for some workers were first established during the Franklin Roosevelt administration, and later were raised and extended to include more of the labor force. Many states and some localities have adopted their own minimum wage laws.
Another reason for government's activist economic role is founded on the perceived need for government to take affirmative action to enable people to be free. Steven Miller, Phillip VanFossen, and Aleks Kvasov ( 2006 ) have noted that in this view one does not simply have “negative” rights—for example, the right not to have government interfere with one's religious practices—but “positive” rights as well, including, for example, the right to a quality education, a job that pays a living wage, and healthcare. In the sense of being able to have choices or greater potential to pursue one's interests, a person who does not have these rights is not really free, or at least not as free as one who does. This is certainly an expanded vision of freedom compared to that of the Framers, and it is much more recent. Many of these economic rights are listed in Article 25 of the United Nations Universal Declaration of Human Rights, adopted in 1948.
The role of government in the United States has increased enormously since 1787. Federal spending has grown from about 2 percent of GDP in 1790 to 21 percent in 2012, and about 38 percent if state and local governments are included ( MeasuringWorth.com ). Some of this expansion is the unavoidable result of a changed country in a vastly different world. The military and foreign policy costs associated with global responsibilities are examples.
But this expansion has also resulted from society learning what capitalism does not do well, so government must try. Controlling pollution is an example. Smoothing out the business cycle is another. The very success of capitalism has permitted the nation to address concerns that simply were intractable earlier. In 1800, economic insecurity and poverty were simply facts of life. Today, the effort to ameliorate these problems is substantial, if not completely successful. Entitlement programs, such as Medicare, are the most familiar examples of this. Entitlement programs establish by law specified benefits for individuals who meet certain requirements. In addition, the Framers' view of the limited role of government in protecting freedom has been joined by a competing ideal of government as enabling freedom.
One of the most significant challenges to the expanded role of government comes from scholars who, while acknowledging that there are things capitalism does not do well, argue that there are also things democratic governments do not do well. For example, the branch of economics known as public choice applies the tools of economics to the public sphere. Research in this field raises questions about the incentives motivating elected officials and bureaucrats. One conclusion is that sometimes an imperfect market result might be better than the government cure.
SEE ALSO Constitutionalism ; Democracy ; Entrepreneurship and Innovation ; Federal Reserve ; Fiscal and Monetary Policy ; Free-Market Economics, Theory of ; Freedom of Contract ; Governance ; Limited Government ; Regulation ; Rights, Negative ; Rights, Positive ; Smith, Adam .
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Steven L. Miller
College of Education and Human Ecology
Ohio State University