The basic tenet of laissez-faire capitalism is that government intervention in the economy should be directed to two related purposes. First, to ensure that in competitive markets the legislature and courts enforce voluntary contracts between competent parties in accordance with their terms. Second, to ensure that the state powers of taxation and regulation are used to fund and supply those goods that competitive markets cannot provide: defense, courts, public infrastructure and control against fraud and monopoly abuses.
Unfortunately, many critics of the market economy from both the left and the right want government to do more in the name of the greater social good. In a recent essay, for example, Republican Sen. Marco Rubio invokes no less than the authority of late-19th-century Pope Leo XIII to support the view that to “make men better” it is necessary for the state to go further by supporting “dignified work, strong families and strong communities” as the key to civic and economic well-being.
At one level, everyone on all sides of the political spectrum should champion this idea. But the means that Sen. Rubio puts forward to achieve that goal will upset the operation of competitive markets while, paradoxically, simultaneously putting greater strains on social institutions.
His first mistake comes from his proposition that “businesses have a right to make a profit, but they also have an obligation to reinvest those profits productively for the benefit of the workers and the greater society.” Both halves of this statement are wrong.
No business has “the right to a profit” if that proposition means the firm should be socially insulated from bankruptcy if it produces goods and services that consumers and other purchasers do not value. Any covert or explicit system of public subsidies will encourage entrepreneurs to launch dubious ventures and seek by political intrigue to gain tax subsidies that will soak up resources better used elsewhere. What a sound society should do is allow individuals and firms, unfettered by senseless regulation, to maximize profits by satisfying the demands of their customers. The state should neither guarantee any firm a profit nor limit the amount of profit it may make.
Next, it is wrong for Sen. Rubio to insist that businesses have some social duty to reinvest their profits in their workers and communities. In a market system, firms have strong incentives to hire workers needed to produce the best goods and services at the lowest price. That task cannot be accomplished by offering workers trivial wages and horrific working conditions. The good firms necessarily offer good wages and benefits, along with a suitable set of working conditions that help recruit and keep top talent, who are always free to abandon ship for a better offer. There is no need for some extrinsic government standard of dignity that no one can make operational across the full range of firms. And there is no need to make firms support their communities other than through tax payments and community ventures that improve their own goodwill.
Historically, the greatest advances in human progress took place during the laissez-faire period between 1870 and 1940, when technological progress improved the lot of businesses and workers alike, with no targeted assistance from government. These gains were obviously not confined to the top 1 percent of the population, given the simple but powerful fact that, in the period between 1850 to 1940, life expectancy at birth increased from about 38.3 years to about 62.8 years. The changes were driven not by moral suasion but by advances in public health, medicine and worker and public safety.
Nor is Sen. Rubio correct to demand that firms reinvest capital in their own businesses. Obviously, reinvestment makes sense if the firm can put its capital to better use than its shareholders. So startups are often desperate to raise additional rounds of capital to expand their businesses. But large firms often find growth opportunities hard to come by, so they sensibly buy-back outstanding shares or declare dividends to their shareholders.The money that leaves the corporate treasury will not sit idly in shareholder hands. Some fraction of it will be consumed, but much of it will be invested in new small and nimble businesses capable of making dramatic innovations that larger firms cannot match. Just recall that the new American behemoths of Amazon, Apple, Facebook and Google all began as startups. Their success allows them to hire more workers, to engage more suppliers and to service more customers who can then make more efficient use of their own capital and labor.
Finally, Sen. Rubio is wrong to lament that much of modern growth has been directed to “largely speculative financial flows, detached from real production.” No one should lament the decline of dangerous and deadly manufacturing jobs, when today those same tasks can be discharged safely and remotely by a few workers controlling robots and other equipment. Freed workers can move to other safer and remunerative sectors such as health care and other personal services.
Nor is it correct to treat financial flows as if they are somehow separate from production. In fact, the opposite is true: Modern payment systems, for example, allow businesses to better manage cash flows to improve credit allocation in both product and consumer markets. Financial derivatives and other instruments allow global firms to insulate their balance sheets from sharp currency fluctuations. Firms and individuals pay top dollar for these financial services because they improve their own businesses and lives.
Indeed, in the past decade or so, the worst setbacks in financial markets have all stemmed from misguided government regulation of interchange fees on debit cards and from the government seizure of Fannie Mae and Freddie Mac that bankrupted the tens of thousands of shareholders who thought they made safe investments in government-backed securities
Sen. Rubio is wrong to condemn markets for failing to serve human needs. And he is blind to the massive social dislocations that come from unwise government intervention in labor and financial markets.
— Richard A. Epstein is a professor at the New York University School of Law, a senior fellow at the Hoover Institution and a distinguished service professor of law emeritus and senior lecturer at the University of Chicago. His Review-Journal column appears monthly.