Tag: Economics

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.

Econ 101: Government Budgets

Newspapers are full of articles about the deaths or other losses that will result from proposed budget cuts. Today’s Washington Post, for example, headlined a story on USAID cuts “USAID cuts may cause 14 million more deaths in next five years, study says”  “Washington post /2025/07/01/”

If the government’s spending on X is reduced (aside from any improvement in efficiency) the benefits of that spending will be lost. But our resources are limited. If we spend more on X we have less to spend on Y.  So when we lament the losses from reduced spending on X we should take account of the gain from the increased spending on other things.

To put a bit of flesh on this issue, consider the following: “The administration has cut more than a hundred contracts and grants from the President’s Emergency Plan for AIDS Relief, the HIV and AIDS program credited with saving millions of lives in poor countries. President Donald Trump has shut down the agency that signed off on most PEPFAR spending and fired other staffers who supported it.”  “Rubio-pepfar-aids”

Evaluating whether this cut is “good or bad” is not easy because determining the likely alternative use of the money saved is not easy. If we stick to a fixed government budget total, the alternative use by the government of the money saved might save even more lives (or maybe not). But the saving could also be given to tax payers whose use of that money would reflect their own personal needs and priorities.  

The process used by Elon Musk’s DOGE to arrive at the spending and/or personnel cuts they proposed was not transparent thus is largely unknown to us. But I have serious doubts that it was appropriate. Semafor offers the following advice:

“A lot of US government work is highly inefficient, says the science reformer Stuart Buck. Federally funded scientists say they spend 44% of their research time on bureaucracy, federal procurement is “broken” and often results in the government buying products that don’t work, and “the Paperwork Reduction Act paradoxically results in endless paperwork.” “Many such cases,” says Buck. “We should have an official effort to address these issues… We could even call it a ‘Department of Government Efficiency.’” As you might be aware, there is one: It is “widely viewed as a failure,” but the basic idea is sound. How could we make it good?

“The first step, says Buck, would be taking a long time to deeply understand how each government agency works, so you don’t mistake routine human error or some statistical artifact for fraud. Second, it should focus on high-value reforms, like outdated data systems or software. Third, it should learn from previous attempts to cut red tape — because there have been many, not all of which worked. And importantly, a good DOGE would not mistake things we don’t use for “waste” — like an insurance policy, we hope pandemic preparedness infrastructure and fire departments are never used, but they’re in place in case we need them. The real-world DOGE is a failure, says Buck, because it ignored all of these strictures.”  “Semafor.com/newsletter/06/30/2025/”

I think some, if not many, government programs or activities should be reformed or eliminated. But those the public really want must be paid for by the public paying additional taxes or lending to the government (buying US bonds). U.S. debt is dangerously high (123% of US GDP) and continuing to grow.  So to the extend spending is not reduced, taxes should be raised.