How Capitalism Will Save Us (72 page)

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Entrepreneurial innovation is a free society’s foremost “natural resource” and the true driver of a democratic capitalist economy
. This is the Real
World principle that even the “experts” can miss about democratic capitalism: the broadest prosperity is created in nations that give people the greatest latitude to innovate. Entrepreneurial inventiveness and creativity turned Hong Kong, an area with few natural resources, into an economic powerhouse. It is what transformed the mysterious black ooze bubbling up from the earth into the fuel that powers our engines and automobiles. And it is why the United States has consistently outperformed its competitors. Without the freedom to innovate in open markets, society would never have advanced.

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“The rich” make everyone richer
. People become rich by meeting the needs and wants of other people. They build or invest in the innovative, job-creating businesses whose goods and services make life better. The outsized wealth of many rich individuals reflects the risks they take as entrepreneurs or investors. People who start businesses are the
last
ones to benefit from the wealth they create. They reap their profits after paying off their workers, creditors, and investors—and that’s when things are going well. People who buy into capitalism’s bad Rap think rich and poor are fixed groups with opposing interests. But in the Real World, rich people are not only necessary, they’re vital to a healthy economy. Their investment, entrepreneurship, and spending provide opportunities that enable other people to build their own wealth. Throughout history, countries that have scapegoated and destroyed their merchant class—from Uganda to fifteenth-century Spain—have seen their economies collapse or decline.

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Profit is a vital barometer in a democratic capitalist economy and the key source of investment capital
. Profit does more than make some people rich by generating dividends and capital gains. It is the way our economic system mobilizes people to provide for others. Profit is a critical barometer of demand, telling producers where they should invest—or where they should cut back. It keeps supply flowing smoothly. Profit is also a key source of the investment capital that companies use to expand operations, innovate, and create jobs. Contrary to what Marx believed, profit is not just “surplus.” It replaces what has been lost as a result of the economy’s creative destruction. Politicians like to think that punishing profits serves the public interest. But the Real World economic truth is
that it does the opposite. Without the barometer profits provide, you end up with shortages and other distortions. There would be no capital to build the advances of the future. Nations that have banned profit have seen their economies—and societies—decline.

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Government’s role in the economy is not to “do nothing;” it’s to help free markets work
. Government does indeed have a critical role in democratic capitalism. Open markets cannot function successfully where there is no government to protect people’s rights and assure the rule of law. Government’s role in a democratic capitalist economy is to create hospitable conditions that give people the freedom to meet one another’s needs. It should enable them to develop their talents and to innovate, with the least possible interference and protection from harassment. Government must create an environment of certainty and predictability, such as assuring stable money and instituting a progrowth tax system. Government is also needed to respond to challenges created by change. One example: how should the law respond to the copyright issues raised by online distribution of music? Far from doing nothing, government should be essential to creating an environment that allows economic freedom, where people can advance and businesses can be established and thrive.

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The most effective regulation in the Real World establishes the “rules of the road” and does not attempt to micromanage markets
. People who buy into the bad rap on capitalism fail to recognize that, to a great extent, free markets are self-regulating. Regulations may be designed with good intentions. But in the Real World too many rules are a drag on an economy. They stifle innovation, locking in the status quo and favoring established market players. They rarely if ever produce their desired results or deliver on the promise of fairness. Instead they impose artificial constraints on activities that produce marketplace imbalances—economic distortions that end up hurting the very people the rules were supposed to help. The most effective regulations in a free-market economy establish the “rules of the road.” They establish basic guidelines for conduct and are not politically motivated or capricious.

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Government tends to politicize and not solve economic problems
. Innovations and solutions in a free market are developed by entrepreneurial
people and businesses. They succeed or fail based on how well they provide what people want. In contrast, government policies directed at solving market problems, or achieving fairness, are developed by politicians seeking to please political constituencies and remain in power. Rather than fostering open markets with the greatest degree of competition, government, in the name of protecting favored groups, more often imposes rigidities—restricting activity or imposing costs that limit the number of market players. The result is less innovation and growth—and often, market imbalances that hurt people. With government’s political solutions, you often get rationing, shortages, and higher prices for most consumers. Think rent control—where a few people get cheap apartments, with costs shooting through the roof for everyone else—and the wild prices of today’s heavily regulated health-care market.

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The best economic stimulus results when government unleashes the private sector by lowering tax rates and opening up markets. Government efforts to “stimulate” or “fine-tune” the economy—through spending or monetary policy—have never produced sustained long-term growth
. Big government spending failed to lift the United States out of the Great Depression, which lasted more than a decade. And it failed to revive the economy of Japan in the 1990s, despite ten stimulus spending programs. That’s because the taxes and borrowing needed to fund government’s “investment” suck job-creating capital from the economy. Similarly, government attempts to artificially “fine-tune” the economy through increasing the money supply may deliver a short-term boost. But as the financial crisis has demonstrated, it also creates disastrous economic distortions like the housing bubble. The way to lasting economic growth in the Real World is for government to reduce impediments to productive economic activity—cutting taxes and regulations and unleashing the energies of entrepreneurs. When the federal government shrank as a portion of the U.S. economy during the 1980s and ’90s, the economy enjoyed its greatest expansion to date.

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The best way to boost tax collections is to enlarge the tax base through progrowth tax policies—namely, meaningful cuts in tax rates
. Economic growth means that people and businesses earn more. That, in turn, means a larger tax base and higher tax collections. Tax collections
rose, not fell, after the tax cuts of the 1980s. Tax increases may produce an initial spike in revenues, but they ultimately slow growth and shrink an economy. Remember, taxes raise the cost of constructive economic activity. Therefore less of it takes place. The best way to bolster an economy and increase tax collections is through reasonable tax rates that allow for optimum business investment and job creation.