Econ 101: Capitalism and Socialism

The popularity of socialism seems on the rise. Is it justified?

Starting from the top, the difference between capitalism and socialism is who decides how our resources (capital and labor) are allocated. Under capitalism the private owners of a country’s resources decide how to use what they own. They are driven by the desire to maximize profit. Under socialism public owners (government) of our resources decide how to deploy them. They are driven by…. Well let’s see.

Capitalists (company shareholders and the management they employ) seek out the goods and services the public want and the cheapest way to provide them. Entrepreneurs develop new products and services they hope the public will want and will pay for. The government’s role is to protect private property, enforce freely-agreed contracts, provide infrastructure that facilitates trade, and enforce law and order (including defense from potential foreign invaders). Freely negotiated prices reflecting supply and demand provide capitalist with essential information in their search for maximum profits.

While capitalists own the capital they deploy, they must attract and hire the labor who work with it. Consistent with their pursuit of maximum profit they seek the most productive (skillful) workers at the lowest cost (wages). While a worker’s wage is a very important part of their willingness to accept a particular job, every other aspect of the conditions of their employment is important as well. Thus, their employer has a profit incentive to establish with employees the least-costly way of satisfying those demands. These incentives (private ownership and profit maximization) have maximized the incomes of capitalist economies. https://wcoats.blog/2026/08/02/econ-101-profits/

The incomes of the average person hardly changed from poverty levels for thousands of year. But with the advent of capitalism and the industrial revolution average income in the United States over the last 250 years increased 50 to 60 times.

Some capitalists have become very rich. For seventeen years Bill Gates was the richest man in the world. Was that a bad thing–a price we had to pay for the benefits of capitalism? I have always and continue to think that I have benefited from Gates’ Microsoft products (Windows, Word, Excell, PowerPoint to name a few) far more than I have paid for them. But that is the nature of capitalist free market transactions: win-win.

In Socialist economies, the “government” owns much of the economy’s capital (e.g., government grocery stores, or airplane factories), and determines how to allocate much of its resources (what to build and produce—e.g., silicon chip factories). While the government might seek to determine what the public wants, it will also determine what it thinks it should have.

But who is the government and what are the incentives it faces when making its decisions? The government consists of elected politicians (in democracies) with the power to make laws, the public officials they appoint to various agencies to implement them, and the workers those officials employ. The primary incentive for politicians is to get elected and reelected. Presumably that depends on supporting (and actually implementing) the policies most voters in each congressional district want. Voters might support policies they think are in the country’s best interest or in their own personal best interest.

Many of the voters in the state of Washington work for Boeing aircraft and might favor government programs that direct tax money to that company. Boeing has a large complex a few blocks from where I live in Pentagon City Virginia (half a mile from the Pentagon). It builds nothing there but seems to keep its workers busy.

Unlike the profits from sales by private firms to their customers, which result from the voluntary purchases of satisfied customers, the goods and services provided to the public by governments are rarely paid for by the recipient. Nor are their costs paid for by the politicians or officials who provide them. Therefore, the incentives of governments (politicians, officials, employees) are very different than those of private firms.  This is true of any government but the scale of what is directed by socialist governments is significantly greater.

Consider the implications of these incentives for the workers hired by socialist governments. By the way, in 2024, the US federal government employed just over 3.0 million people (excluding 1.3 active-duty military personnel). State and local governments employed an additional 20 million, or a combined 7.1% of the total population.  As government officials are not spending their own money, their incentives for choosing workers can be quite different than are those for private capitalists. Hiring friends and relatives may be more rewarding to public sector bosses than those who are most qualified and hard working.

The incentives for corruption in large governments are significant. Thus, the American constitution provides checks and balances between the congress, executive, and courts. Moreover, congress has established additional oversight of executive branch agencies in an effort to keep them honest. Unfortunately, in January 2025, President Trump abruptly fired at least seventeen presidentially appointed inspectors general from major cabinet departments and federal agencies without providing the 30-day advance notice or substantive rationale required by the Inspector General Act. And by the way, Trump’s net worth and business revenues have surged during his second term, with financial analysts estimating he brought in roughly $2.2 billion to $2.4 billion during his first year back in office alone, pushing his overall net worth to an estimated $6.5 billion. This does not include our tax money he has used to put his name, picture, and gold all over the place. This is a failed businessman who declared bankruptcy six time. Just sayin.  

Even if a Socialist government is led by honest people truly committed to the general public’s interest, they lack the market prices that guide capitalists when deciding what would be “best.” Moreover, they are not likely to offer multiple options when choosing policies to impose on the public. It is unlikely that a socialist government will establish a range of different policies to satisfy different tastes. The top-down decision making of socialist governments is more likely to impose uniform approaches to the provision of goods and services and rules. In capitalist economies we are freer to choose among a wide variety of e.g., stores following different approaches to satisfying their customers.

When choosing capitalist or socialist economies, we want to know which has been more successful in allocating our resources to their most productive and desired uses. Given the differences in the incentives faced by each outlined above, have socialist governments been better at “choosing winners” than capitalists? The answer from the real world is overwhelmingly clear.

Given the different incentives faced by each, it should not be surprising that the economic well-being of capitalist and socialist economies has been dramatically different. The most dramatic comparison of the economies of two otherwise similar countries are the former East and West Germany and North and South Korea. In 1989, the year before East and West German merged into the Federal Republic of Germany, percapita income of West Germany was about double that of East German. The differences are much more dramatic between North and South Korea. In 2024 percapita income in North Korea was only 3.4% of South Korea’s.

Perhaps those promoting socialism do so thinking that it would better service the poor. This has not been true, but it does suggest that capitalist societies need to provide well-considered safety nets for those who stumble. The U.S. does not have a perfect set of safety net policies by any means. I advocate a Universal Basic Income and a government financed by a consumption (rather than income) tax. These maximize the freedom of choice and incentive to work. https://wcoats.blog/2023/01/15/fair-tax-act-of-2023/

Econ 101: Profits

Is it a bad thing for oil company profits to increase when oil prices jump?

A country’s economic wellbeing—its national income and standard of living—is maximized when its economic resources (capital and labor) are allocated to their most profitable uses. When that is the case, no other use of capital and labor can increase the value of total output. This includes goods produced for export in order to pay for goods and services imported.

An economy that has maximized its output in this way (allocated all its resources to their most productive uses), will suffer a drop in income if a tax causes a change in this resource allocation. As an example, consider a tax (called a tariff) on the importation of certain medicines now produced abroad. In fact, President Trump is threatening a 100% tariff on imported generic drugs, with the rate rising to 200% later, if manufacturers do not move production to the U.S. Hopefully it is obvious that if the existing allocation of resources between products and whether they are produced here or there is optimal (maximizing output), then shifting the production of the drugs now produced in India (for example) to the U.S. will result in a fall in our aggregate income. The resources devoted to producing what ever we exported (to pay for our drug imports) would have to be shifted to domestic production of the drugs now imported. We will lose the comparative advantage of the existing allocation. The reallocation will reduce overall output. In short, if the allocation was optimal to begin with, the tariff and reallocation will reduce aggregate income. It is a bad idea.

But what about the jump in oil company profits because of the Iran war induced increase in the price of oil?  When resources are optimally allocated, risk-adjusted profits will be the same everywhere because resources will be moved to where profits are higher (thus lowering them) until they are the same everywhere (risk-adjusted). Oil prices have increased because of the war-related fall in the supply of crude oil. Nothing has changed in the cost of lifting and supplying existing non-war-related supplies of crude. In the real world, of course all kinds of things are changing all the time and it is very desirable for resource allocations to change as well in response. That is precisely what chasing profits does.

The increase in profits from producing the same amount crude in the U.S. from the increase in the world price of oil, creates a profit incentive to allocate more resources to finding and pumping it up. That is very desirable for easing the current supply shortage. An increase in profit is a market incentive to increase the resources devoted to producing something. It would be counterproductive to interfere with that very desirable response.

Foreign Students

The Trump administration finalized a major rule to tighten student visas by ending the “duration of status” policy and imposing a fixed four-year maximum admission cap. https://www.dhs.gov/news/2026/07/16/trump-administration-issues-final-rule-end-foreign-student-visa-abuse   Why? Foreign students benefit the U.S. in a number of ways and we should seek to increase their number.

First: hosting foreign students is an export, it pays foreign money into the U.S. via tuition, room and board and other purchases these students make in the U.S.. The inflow of foreign exchange helps provide us with the means for paying for what we import from abroad. https://wcoats.blog/2025/11/04/trade/

Second: Foreign students gain firsthand experience of life in the U.S., often making lifelong friends. They take this knowledge home improving American relations with other countries. American student benefit from meeting and befriending the foreign students, thus broadening their knowledge of other cultures.

Third: When foreign students decide to remain in the U.S. we benefit from their knowledge and expertise increasing American income and wealth.

According to annual economic impact data calculated by NAFSA: Association of International Educators, foreign students spent and contributed $43.8 billion and supported approximately 378,000 jobs in the U.S. in the 2023–2024 Academic Year. This fell 2% during the next year, which was the first year of the current Trump administration.

We would do much better to deport Stephen Miller.

Sec Hegseth

Several residents in my condo work in the Pentagon or are in the Navy. They have complained to me that Sec Hegseth has fired some of the most outstanding Generals in our military. I asked Walter Slocombe, who was the Undersecretary of Defense for Policy during the Clinton Administration, what he thought about that. Here is his reply.

“Re firings.  The military like other huge complex organizations is shaped by its top leadership and civilian control includes choosing top level promotions.  And it’s legitimate for the Secretary of Defense to pick officers partly on the basis of whether he believes candidate shares his policy views.

“That said it is dangerous to make these choices largely on that factor.  The risk is great of incubating political cliques in the associated with parties or individual politicians.  (I had the impression the Bundeswehr had some of this.)

“Moreover its important the top leadership feel free to be candid with the civilians (while being equally committed to execute decisions once made.)  Hegseth goes way over the line in prioritizing loyalty.

“In addition he apparently believes virtually any woman or minority in a senior job is a “DEI hire.”  That means the senior officers will be even more heavily white than is now the case.  It seems clear that Hegseth systematically rejects recommendation for promotions of non-white males.

“Principles aside going in that direction that ignores the very real facts about the demography of the military–30% of enlisted are Black and 18% are Hispanic.  But only 25% of officers are black or Hispanic.  And only 11% of generals and admirals are minorities or Hispanic.  That disparity inevitably affects perspectives in the force.  It’s not that officers % must exactly match enlisted but that explicit discrimination is very bad for morale.”

Tariffs again

“Mr. Trump said that generic-drug manufacturers must move production to America or their products will face a 100% tariff from August 2028. A 200% levy would follow from August 2029.” 

All economists and hopefully you as well understand that your standard of living (income) is higher (much higher) because you can specialize in what you are best at and trade for the rest (exploiting “comparative advantage”). If you had to be totally self-sufficient you would be dirt poor.

Unfortunately, Stephen Miller and Donald Trump don’t understand this or is it just that Trump gets such a kick out of throwing his weight around that he doesn’t care??

Immigrants

Aside from Native Americans (a story we should study more carefully), virtually all Americans at our founding were immigrants. Throughout our history immigrants have contributed enormously to our economic growth and wealth. Even today the United States is home to over 125 foreign-born billionaires, making up a massive segment of the nation’s top wealth brackets. Most of these leaders are self-made, primarily building their fortunes in the technology, finance, and aerospace sectors.

These immigrants did not become billionaires by taking income from the rest of us. They became billionaires by creating products and services that we benefited from. They became rich by raising our (the common man’s) incomes and standards of living.

Immigrants represent a disproportionately high percentage of business owners relative to their share of the total U.S. population even today. According to data from the U.S. Census Bureau’s Annual Business Survey and economic research groups, there are over 6 million business owners in the United States who were born abroad.

Immigrants also occupy a massive share of top leadership positions. A landmark study by the National Foundation for American Policy found that nearly 80% of America’s privately held, billion-dollar companies (“unicorns”) have either an immigrant founder or an immigrant in a top executive role, such as CEO or Chief Technology Officer (CTO). While not all current CEOs are foreign-born, 46% of Fortune 500 companies were founded by immigrants or the children of immigrants. Over 1 in 5 business owners nationwide is an immigrant, and nearly 4 out of 5 highly valued modern tech companies rely on foreign-born leadership at the executive level.

Why is this important and why should we oppose the Trump administration’s efforts to reduce immigration? Immigrants do not choose to come to America to change it. They come generally to join what it offers, which is personally freedom to work hard and prosper. We must never forget that in free markets, transactions benefit both the seller and the buyer—win-win. Attracting innovating and hardworking people from around the world lifts their incomes but also ours. Why would we want to slow or stop that process?

Foreign students studying in American universities and colleges are a temporary form of immigration (as are agricultural guest workers) from which we benefit in several ways. One benefit is making friends. Foreign students learn first-hand what America is about and take that understanding home with them. They are also an important export (i.e., they earn dollars for the schools that teach them), thus reducing our balance of payments deficit. Surely, we should encourage more students to come, but over the last four academic years the number of Chinese students studying here has fallen every year.

There are other benefits. Immigrants also tend to bring bits of their culture with them. This is most obvious for cuisine, the variety of which is a wonderful contribution to the quality of our lives. Along with hamburgers, hot dogs and T-bone steaks, I have first-rate Chinese, Japanese, Italian, French, Lebanese, Mexican, Peruvian and mixed-cuisine restaurants within walking distance.

We need much more legal immigration (those vetted for the appropriateness of their character and skills) while preventing the illegal type. Those who are afraid of immigrants should move somewhere else themselves in my opinion.

The Rights of Sovereign Countries

The 193 sovereign countries in our world determine when and if people and goods of other countries may cross their borders into their territory. The safety and other standards required for their own products (cars, planes, medicine, breakfast food, etc.) are equally required for those imported. For example, US chicken is banned from EU and UK because of American post-slaughter Pathogen Reduction Treatments (PRTs), specifically the use of chlorine or other antimicrobial chemical washes to kill bacteria like Salmonella and Campylobacter, which are not approved of in these countries.

But the extensive cross-border trade and movement of workers and tourists have so enormously benefited the standard of living of almost every person on the globe that countries have generally cooperated to harmonize these standards. Two hundred years ago almost 80% of the world’s population lived in extreme poverty. That figure fell to almost 60% a hundred years ago and almost 10% today. ” Study finds wealthy nations reap huge benefits from immigration”.

This dramatic increase in wealth has been greatly facilitated by establishing international standards for many of these goods and services for which international standard bodies have been created such as the International Organization for Standardization (ISO), International Telecommunication Union (ITU), World Health Organization (WHO), and the World Trade Organization (WTO). The World Bank (WB) and International Monetary Fund (IMF, for which I worked for 26 years) are among a broader group of international institutions promoting global cooperation.

Obviously, a country cannot allow the airplanes of other countries to enter and fly over or land in its territory without agreed standards for flight path reporting and control tower protocols. But what about satellites? They are part of the amazing story of telephone communications overseen by ITU in Geneva, Switzerland. On my cell phone I can connect to any other telephone in the world and have a conversation. It is unbelievable really.

On my first trip to Kabul in January 2002 we had to step outside to use our iridium satellite phones to connect with IMF headquarters in Washington DC (or anyone else for that matter). Landmines were later discovered in the garden we walked around while talking on our iridium phones.

Satellites can be stationary (i.e. move at the same pace the earth rotates so that it remains above the same territory below), or not and can be in a low or high orbit. Rules govern how a satellite should behave when passing over or near other satellites to prevent interference.

Satellites, unlike airplanes, are governed by a framework of international agreements and treaties, most notably the Outer Space Treaty.  Satellites move freely through orbital paths because a nation’s airspace only extends upwards to a certain (though legally undefined) altitude, while satellites operate in “outer space.” A satellite is governed by the laws and regulations of the specific country that launched or registered it. That launching country is completely responsible for authorizing, continuously supervising, and regulating the satellite’s operations. Nonetheless it is expected to abide by ITU regulations and assignment of the use of radio frequencies. ITU manages satellite frequency rights by acting as a global registry and coordination body to prevent signal interference, rather than by directly issuing operating licenses.

The United States is officially withdrawing from 66 international organizations. This includes 31 United Nations entities (such as the UNFCCC, UN Women, and the UN Population Fund) and 35 non-UN organizations (including the IUCN, the Green Climate Fund, and the World Health Organization). In my view, this dismantling of the global system of cooperation is a serious mistake—damaging both the US and the global system. The US has not, however, withdrawn from the ITU. But will the US play by the rules? The unpredictability of the Trump administration has the world wondering and worrying how far American destruction of the global order will go.