Tag: profit maximization

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/

America First

What does America First really mean and how can we best achieve it? It should mean pursuing a foreign policy—our relations with other countries—that best serves our national interest. That requires that our relations with other countries maximize our security and our ability to profitably trade with them including traveling and vacationing in them. In short, our own interest is best served by having friendly relations with our neighbors. It serves our interest for others to trust us and to interact with us on the bases of known and shared rules. Tourism in the US is one of our best exports both in terms of revenue and its contribution to mutual understanding. Sadly, these goals have been seriously damaged over this year leaving us less safe and poorer than we could have been.

I am reminded of the debate over whether companies should strive to maximize profits (shareholder value). As John Mackey, a co-founder of Whole Food, has insightfully argued, a firm’s profits are maximized (assuming the government is not protecting its monopoly) when its workers, neighborhood, and customers are treated well and kept happy with the most efficient cost possible of supplying whatever the firm supplies. We might call this the right way to serve Shareholders First. Supporting this or that charity or cause should be left to the individual shareholders, who are likely to choose to give to different causes.

Labor Unions

To maximize a company’s market value, it must maximize its expected profits over time (its current market price reflects the discounted present value of expected future profits). To do so it must offer products or services that the public wants at prices they are prepared to pay that exceed the cost of supplying them. These products must be produced with the quality desired and as cheaply as possible. But that requires hiring workers of appropriate skills and providing them with appropriate tools (investments in equipment and other inputs) while paying them no more than is required to attract and retain them. “Appropriate” in these contexts means cost effective (best output at lowest cost).

Unions can help a firm’s management find, train, keep and manage the most appropriate workers. The general work environment is part of what attracts workers in addition to wages and related benefits. The optimal mix of the “right” capital and the “right” labor to produce market demanded products, produces the biggest pie to split between labor and shareholders (i.e., maximizes profits). So, both labor and owners share an interest in getting it right (maximizing). When unions deal with management in this positive sum, win-win frame of mind both they and shareholders benefit. But unions that see the process as zero sum and simply seek to maximize their share of the pie, reduce the size of the pie (loss-loss). American unions too often fall into this trap.

My personal experiences with American unions have not been good. I will share the experiences of my parents and myself that have influenced my views.

During the summers of my undergraduate studies at the U of California at Berkeley, I worked in the oil fields of Kern County for Shell Oil. Children of Shell employees like my dad were given preference for such jobs (typical profit maximizing behavior). A typical summer day in Kern County was dry, with temperatures ranging from 105 degrees to an occasional 112. This was more comfortable than a typical humid day of 95 degrees here in the Washington DC area. The first summer I worked in the fields north of Bakersfield, and the second summer at the ten-section refinery fields where my dad had worked in the refinery west of Bakersfield.

The full-time Shell employees I worked with, along with two other summer hires, were all pleasant and talked about their families and such things during our lunches together in the “doghouse,” as they called it. I had no idea whether they were union members or not. Digging up leaky pipes as a roustabout in such heat was a challenge.

My second year I was promoted to working on a well pulling rig. The traditional rocker-arm wells that you have surely seen in pictures are fairly shallow and push the oil up a pipe as the rocker moves up and down. The pump is attached to the bottom of this pipe and opens to let the oil in, and then closes as it pushes it up the pipe with each rock. We pulled the pipes, with their pump on the bottom end, out of existing wells for repair.

Every now and then the pump at the bottom failed to open to allow the oil to flow out as our rig pulled it up. Those were called wet wells as rather than draining out, the oil spouted out the top and rained down on the rig platform. The first time I encountered a wet well, the guys recommended that I put on a wet suit to keep the oil off me. As I recall it was 110 degrees that day and I turned down the wetsuit. However, as I become covered in oil my sweat stopped evaporating and I almost passed out. I had to sit out the rest of the day in great embarrassment.

My third summer I was paired with the full-time employee in the supply yard behind Shell’s Kern County headquarters that provided all the parts needed out in the fields. We rode around in a forklift to load needed supplies onto trucks that delivered them to the fields. My “partner” was a union member, All he could talk about was how Shell was exploiting us. I hated it and hated him and his antagonistic rather than cooperative attitude. This added to my dislike of American unions.

Many years earlier when Shell workers went on strike, my dad had to strike as well, as he had to belong to the union to work in the refinery. After a month or two, when it was clear that the strike was about to end, several union guys came to our house and threatened my pregnant mother (with my seven-year younger brother), that it would be unhealthy for her if my dad went back to work already.

Many years later, when my mother had become an elementary school teacher, she disliked the teacher’s union as having little real interest in the kids, but spent their time protecting the jobs of mediocre teachers.

It seems to me that unions are helpful or detrimental (good or bad) depending on whether they see their negotiations with their companies in positive sum or zero-sum terms. Mandatory union membership is more likely to result in the latter, detrimental relationship.