The Utilitarian Argument of Capitalism

The use of government intervention is a widely disputed phenomenon. Government intervention in an otherwise free market refers to a somewhat mixed economy. In this economy, government intervention takes place even though the majority of the market is capitalist. This paper aims to explore the utilitarian argument of capitalism and discuss whether government intervention in an otherwise free market leads to inefficiencies on utilitarian grounds.

Capitalism refers to a profit or market system (Shaw, 2008; Gray, 2011). In this system, economic activity is private and operates with the goal of making a profit (Shaw, 2008). According to Shaw (2008), this activity includes all businesses, production, distribution, banking and manufacturing, to name but a few. The government only takes responsibility for national expenses such as health care and education and does not enforce any quotas on private business production levels (Shaw, 2008). This means that in a purely capitalist system, there is no government intervention and a free market exists. Bassiry and Jones (1993) describe this as a “market based, customer-driven economy” (p. 622).

Capitalism has many key features of which four are most important. These include companies, profit motives, competition and private property (Shaw, 2008). In a capitalist system, companies can exist and act as separate legal entities (Gray, 2011; Shaw, 2008). Being a legal entity means that the company has legal rights and obligations and may be tried in a court of law (Shaw, 2008). The employees, shareholders and stakeholders of a particular company are viewed as being separate from the company even though they may work within the company or have a say in how it is run. The second feature of a capitalist system is that a company’s main motive is to make as much money as possible and thereby maximize its profit (Shaw, 2008). Gray (2011) states that the capitalist system assumes that profit is a result of productivity. This in turn means that having a profit motive encourages workers and employees to be more productive. Competition, the third feature, can be seen as a regulator in the capitalist system; a company who sells poor quality products at exorbitant prices will not receive as much business as a company who sells high quality products at lower costs (Shaw, 2008). The company who has poor products and high prices will therefore be forced to better their products and lower their prices in order to achieve their goal of profit maximisation. The fourth key feature is private property. A capitalist system requires that the tangible and intangible means of production, distribution, capital and economic activity are privately owned (Shaw, 2008). Any profits arising from these means will be that of the owners.

Adam Smith, when discussing the political economy of trade, noticed that when individuals were faced with unfamiliar business partners and foreign legal systems, they would prefer to invest in domestic rather than foreign trade (Wight, 2006). Consequently, their home country would gain in investment, which would increase employment and production, amongst other things. This phenomenon led to the “invisible hand” argument: when people pursue their own interests, they will ultimately, without aiming to do so, create the greatest utility for the greatest number of people (Shaw, 2008). This concept of the “invisible hand” can be used as a proxy for the utilitarian argument of capitalism. Smith (1776) (as cited in Shaw, 2008) illustrates this concept by stating that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest” (p. 130).

According to Shaw (2008), the free and unrestrained market that exists under capitalism is more efficient and productive than any other system. This may be because in a free and unrestrained market an individual has the freedom to pursue his interests without any government restriction. One may then argue that government intervention may move some people away from the realisation of their own self-interest. Through this reasoning, it can be said that government policies and regulations would not necessarily lead to the greatest amount of efficiency.

Smith (1776) (as cited in Shaw, 2008) suggests that the removal of government policies and regulations on various resources such as raw materials, markets and labour would lead to the greatest amount of efficiency in a system. Shaw (2008) reasons that if consumers were freely allowed to choose what they bought and suppliers were freely allowed to choose what they sold and how they produced it, there would be no need for government intervention. The law of supply and demand would regulate the market and it would reach equilibrium. The law of supply and demand proposes that in the same way competition keeps an individual from becoming “a ruthless profiteer” (p. 131), it would be in an individual’s best interest to sell an adequate amount of goods at fair prices (Shaw, 2008).

Since China opened up its socialist economy to free market activities in 1978, it has experienced large benefits in many aspects (Pressly, 2011). Expansion in the Chinese economy has led to decreased poverty, increased stability and a better standard of life (Pressly, 2011). From 1978 to 2011, China’s Gross Domestic Profit has increased from $216 billion dollars to $5.8 trillion dollars, the share of world economy has increased from 1.8% to 9.5% and the annual per income capita has increased from $266 to $4300 (Pressly, 2011). This example proves that free market activities can in many ways create a greater good for a greater number of people.

The utilitarian argument that Adam Smith puts forward assumes that people are self-interested, rational beings who are fully aware of the diverse range, price structure, quality and differences and similarities of the products available in the market (Shaw, 2008). In reality, large companies use tactics to manipulate the consumer and thereby reach their profit objectives (Shaw, 2008). Therefore, even with aid, it would be difficult for a consumer to make the rational, self-interested choices that Adam Smith assumes we as consumers are able to make.

Capitalism requires perfect competition. For this to occur, all individuals within the system must take market prices as parameters that they cannot control or change (Tobin, 1991). This, however, is not the case in today’s market. Tobin (1991) suggests that market prices are not “impersonal data” (p. 7) but the result of decisions and negotiations between companies and individuals. Depending on the amount of power a company has, they could control their prices on their own or collude with other firms to set prices at profit maximising levels. This means that many companies practice predatory pricing and create monopolies and oligopolies (Winfield, 2011). The lowest possible economic cost to society is therefore not being obtained, which in turn means that the system is not socially efficient and does not create the greatest good for the greatest number of people (Winfield, 2011).

John Keynes challenged Adam Smith by opposing the idea that the law of supply and demand regulates the market (Tobin, 1991). As mentioned previously, Shaw (2008) reasons that if consumers were freely allowed to choose what they bought, and suppliers were freely allowed to choose what they sold and how they produced it, there would be no need for government intervention. Keynes, however, realised that demand determines the amount a business supplies, as a business will only produce what it expects others will buy (Investopedia, 2011). Keynes suggests that government intervention through fiscal and monetary policy should be used to control demand, which would enable full employment and levels of supply to be determined (Investopedia, 2011).

The utilitarian view of capitalism requires information symmetry. Information asymmetry occurs when the producer has more superior knowledge of the product than the consumer does (Investopedia, 2011). This problem is illustrated in George Akerlof’s “Market for Lemons”; sellers of poor quality goods and services have incentive to market their products as though they are of higher quality and better standard to maximise their profit objectives (Investopedia, 2011). This does not lead to price equilibrium. Instead, the distrust in the system may result in a no-trade equilibrium, which can lead to entire market failures. This is known as adverse selection (Investopedia, 2011). Moral hazards are also caused by information asymmetry as people are more likely to take risks (Winfield, 2011). When individuals are exposed to poor quality goods, possible market failures, distrust and moral hazards, the greatest amount of good for the greatest number of people is not created.

Government intervention can be used to control externalities. Externalities are costs or benefits borne by someone other than the producer or consumer (Winfield, 2011). External costs such as carbon dioxide emissions, pollution, psychological effects and harmful medical effects do not create the greatest good for the greatest number of people. Firms may not consider these social costs and supply too many products. This does not result in equal supply and demand (Winfield, 2011).

One of the major criticisms of capitalism is the blatant economic inequality that exists in many capitalist societies (Shaw, 2008). Individuals in these societies are not born with equal opportunities and the utilitarian argument for capitalism is challenged on this basis. Some proponents of capitalism have claimed that government intervention is the cause of inequality, but Shaw (2008) contends that these arguments have been disproved by both history and economic theory. To avoid the poverty and inequality that capitalism creates, it has been suggested that some form of government intervention should be used. Critics however argue that because of the capitalist economic and political frameworks this would probably not be possible (Shaw, 2008). Another viewpoint is that inequality can be outweighed if living standards are increasing due to a capitalist system (Shaw, 2008). This is a subjective viewpoint which is both difficult to measure and more favoured by people who are advantaged and happy with their current economic situation (Shaw, 2008).

Recent events have illustrated that the global financial crisis may have been caused by the move away from Keynesian economics in 1979 to a free operation of the market (Kumo, 2009). This meant that government intervention was kept minimal during this time. In an attempt to rescue economies and prevent complete market failure, governments have resorted to large fiscal stimulus plans. Kumo (2009) states that governments, such the United States of America, have had fiscal stimuli as large as $878 billion in an attempt to rescue the economy. This example illustrates that government intervention may be needed to create efficiency in an economy.

As discussed throughout this paper, the utilitarian argument for capitalism states that the greatest good for the greatest number of people will be achieved through the concept of an “invisible hand” leading the market to social efficiency and equilibrium. A free market does not rely on government intervention; rather it accepts that a capitalist system operates with a profit-motive under perfect competition and information symmetry, to mention but a few. This paper argued that a capitalist system operating under these assumptions will not lead to the greatest good of the greatest number of people as government intervention is needed to regulate these assumptions. Government regulation of an otherwise free economy will prevent (to certain extents) imperfect competition, information asymmetry, disequilibrium in the law of supply and demand, externalities and inequality. Thus a somewhat mixed economy, where government intervention is used to regulate the inefficiencies in a capitalist market, would be ideal.

Bibliography
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Bassiry, G. R. & Jones, M. (1993). Adam Smith and the Ethics of Contemporary Capitalism. Journal of Business Ethics, 12(8), 621-627.

Gray, J. (2011). Considerations For & Against Capitalism. Retrieved from http://ethicalrealism.wordpress.com/2011/05/01/considerations-for-against- capitalism/

Wight, J. B. (2006). The treatment of Smith’s invisible hand. The Journal of Economic Education, 1 – 29.

Pressly, D. (2011, May 26). Socialist government ‘is China’s key to development’. Business Report.

Tobin, J. (1991). The invisible hand in modern macroeconomics. Connecticut: Yale University.

Winfield, J. (2011). Week 2: Ethics of capitalism. [PowerPoint slides]. Retrieved from www.vula.uct.ac.za

Investopedia (2011). Retrieved from http://www.investopedia.com/
Kumo, W. (2009). The global economic crisis and the resurgence of Keynesian Economics. Retrieved from http://www.politicalarticles.net/blog/2009/03/01/the-global- economic-crisis-and-the-resurgence-of-keynesian-economics/