CHAPTER 1
Capitalism and the Role of Government
Chapter Goals
This chapter serves as an introduction to the two fundamental questions examined throughout the entire
book: What is the proper role of business, both in America and in the global society? And how much
government regulation is necessary or optimal to achieve that role for business? The students are
doubtlessly familiar with the broad features of the capitalist-collectivist continuum, but experience
suggests that a brief refresher may be helpful. The most fundamental role of this chapter, however, is
simply to clarify for the students the cause and effect relationship between economic philosophy and law.
The law springs from its roots in political economy (among other sources) and, in turn, the law works to
preserve that economic system. Characteristically, students seem not to think of the law as an expression
of fundamental economic and philosophical choices. The relationship between capitalism and the
particular legal system is not clear to most Americans.
Chapter Learning Objectives
After completing this chapter, students will be able to:
1. Describe capitalism and its relationship to individual rights.
2. Compare and contrast capitalism and collectivism.
3. Differentiate between communism and socialism as collectivist philosophies.
4. Evaluate arguments regarding government’s proper role in the global, technology-based economy.
5. Describe the primary characteristics of a “mixed economy.”
6. Analyze the impact of capitalism on equality, fairness, and community in American and global society.
7. Discuss the theory and practice of privatization.
8. Discuss the current state of capitalism in China and Russia.
9. Describe the income and wealth gaps in America.
Chapter Outline
Part One—Introduction
The chapter starts by asking students the following questions—are you a capitalist? If so, what role, if
any, should the law play in your business life? How much government does America need? These
themes, examining the relationship between government and business, are the core of the text. Since the
fall of the Soviet Union and the general decline of communist influence, free market reasoning has
dominated worldwide economic discourse. Indeed, noted theorist Francis Fukuyama argued that
capitalism and Western democracy had so thoroughly proven their worth that the capitalism/collectivism
debate was over. Events, however, have challenged Fukuyama’s bold thesis. The Great Recession,
including the subprime mortgage crisis, the stunning power of the Wall Street banks, and the continuing
turmoil of globalization have raised grave doubts about the economic reliability of capitalism. Likewise,
government’s failure to send corrupt bankers off to jail, rampant greed, and the Occupy Wall Street
movement have magnified longstanding doubts about the morality of capitalism.
I. Capitalism Challenged: Economics
A. The Great Recession
In late 2008, America’s financial markets seemed near collapse. Lending had essentially frozen.
Fearing a Great Depression as occurred in the 1930s, the federal government had, during both the
George W. Bush and Barack Obama administrations, essentially flooded the market with cash, took on
much of the debt held by endangered banks, and, through its Troubled Asset Relief Program (TARP),
bailed out companies that were deemed “too big to fail.” Additional stimulus measures included tax
reductions, bond sales, infrastructure and “green” projects, and enhanced unemployment benefits.
Most of the TARP money has been repaid, but economists differ both on the need for the stimulus
efforts and on their success.
B. Subprime Mortgages
The financial community’s near collapse had been most directly ignited by the subprime mortgage
crisis; a situation in which the nation’s housing bubble burst and millions of Americans were no longer
able to pay their home mortgages. Instead of continuing their sometimes meteoric rise in value, those
homes had plunged in price and much of the total real estate market had essentially imploded. The
resulting mountain of bad debt could not be managed by the American financial institutions that were
holding it; fear paralyzed the lending markets, and the government felt obliged to step in to prevent a
greater financial tragedy.
C. Big Banks
America’s biggest banks, including the five largest—JPMorgan Chase, Bank of America, Citigroup,
Wells Fargo, and Goldman Sachs—were deemed “too big to fail” during the subprime mortgage crisis,
and they remain a grave threat should the economy falter again. The Dodd-Frank Wall Street Reform
and Consumer Protection Act includes provisions designed to reduce the likelihood of big bank
failures, but implementation of the new law has been troubled. Federal regulators in 2013 proposed
requiring the biggest banks to increase their capital on hand substantially to guard against unexpected
losses and reduce the risk to the American economy.
D. Globalization
Globalization represents the international flowering of capitalism; the power of free markets has been
embraced, enthusiastically or reluctantly, almost everywhere on Earth. That power raised new threats,
including the spread of America’s corporate influence and values around the globe. Now, however,
globalization seems to be entering a new phase. In a “hyper-connected,” “flat” world, people are linked
together in an economic and cultural intimacy scarcely imaginable a few decades back, but new
evidence suggests that a period of “de-globalization” may be emerging. International trade and money
flows are slowing or actually declining. Globalization has succeeded in raising wages significantly in
emerging powers such as China and India. As a result, manufacturing jobs are returning to America in
surprising numbers. Of course, globalization is not vanishing, but its economic advantages are shifting
and new nationalistic urges threaten to slow the pace of global linkages.
II. Capitalism Challenged: Morality
Beyond fears about capitalism’s economic performance, particularly its instability and harshness, critics
point to capitalism’s indecencies.
A. Wall Street Abuses
Certainly many Americans are puzzled, if not angered, by the government’s inability to criminally
punish the big banks and bankers who profited so handsomely in the events that led to the nation’s
economic collapse and who, in several cases, had to be bailed out with public money following the
collapse. Those same bankers have not only escaped jail, but they continue to earn stunning sums of
money. Responding, however, to harsh publicity, among other factors, some of the big banks have
either cut or curbed executive pay.
B. Greed
CEO salaries for the top 200 U.S. corporations (not limited to bankers) rose 16 percent in 2012.
Among those top 200 CEOs, the average income was 273 times the income of the average worker—
up from a 20 to 1 ratio in 1965.
Congress showed its concern about CEO pay in a Dodd-Frank provision requiring the Securities and
Exchange Commission to give shareholders a “say on pay” by writing new rules requiring periodic
shareholder voting on executive compensation. At this writing, “say on pay” seems to have
encouraged attention to CEO pay, but a shareholder backlash has not yet materialized.
Anger with corporate greed and perceived abuse of power led to a grassroots global protest
movement labeled Occupy Wall Street. Hundreds of peaceful protesters (mostly young, often
college-educated and jobless) camped in New York’s financial district in late 2011 to “restore
democracy” while denouncing the “greed” and “corruption” of the “upper 1 percent.” The movement
then spread to many other American cities and around the globe. Occupy Wall Street gained
enormous publicity as a leftist assault on corporate America and the wealthy, but the movement
sputtered—perhaps for want of a clear, coherent message.
III. Capitalism Challenged: America in Decline?
The economic and moral challenges to the American capitalist system, the rise of China, and the ongoing
political dysfunction in Washington, DC, have combined to shake people’s faith in America’s future. Some
critics attribute the nation’s problems to fundamental flaws in capitalism and in the American character.
In America’s version of capitalism, as political scientist Benjamin Barber sees it, people find liberty in
commerce. People can buy whatever they want; therefore, they are free. But that undemanding vision of
liberty means they have no sense of obligation for social and political ideals greater than self-satisfaction.
A. Vast Resources
America remains dominant in economic, military, and international affairs, and, as Goldman Sachs
recently told its clients, people should recognize “the key economic institutional, human capital and
geopolitical advantages the U.S. enjoys over other economies.” In particular, Goldman pointed to
America’s attractiveness as a location for investment, the nation’s vast natural resources (especially
arable land, oil, and gas), a workforce that is younger and more energetic than those of its chief rivals,
and its continuing leadership in innovation.
IV. Purpose: What Do We Hope to Accomplish?
Chapter 1 serves as a foundation for the book’s detailed investigation of the following questions:
What is the proper ethical/social role of business in American life?
How much, if any, government regulation of business is necessary to secure that role?
A. Markets and Governments
Most nations are practicing varying combinations of markets and rules that can be labelled as mixed
economies. The pure free market approach assumes that the business system and the society at large
can be operated free of all but foundational legal mechanisms such as contract and criminal law. The
wisdom of the market would “regulate” American life. Most forms of government including regulatory
agencies, consumer protection, environmental rules, and all but the most basic government services
would be eliminated.
Today’s global debate is not so much about capitalism versus communism as about the mixed
economy. Substantially open markets have shown themselves to be the stronger vehicle for
productivity, efficiency, and personal freedom.
B. Law
Once a society settles on some broad political and economic principles, it employs the law as a
primary method of social control. To understand the law, people need to understand its roots in the
economic, political, and social preferences of America and the world.
Part Two—Capitalism: Reduce Government?
Capitalism in America was built on the strong philosophical foundation of personal freedom and private
property rights. Monopolistic abuse followed, however, and government grew to curb the power of big
business. Thus, America’s substantially free market was gradually constrained by government regulation.
The proper balance between open markets and government intervention remains perhaps the central
public policy debate in American life.
The controversial philosopher and novelist Ayn Rand was an uncompromising advocate of free market
principles. She believed the necessary categories of government were only three in number—the police,
the armed services, and the law courts. Rand’s philosophy of Objectivism contends that the practice of
free market principles is necessary for a rational, moral life. Rand’s views and the quality of her writing are
heavily criticized, but she has been cited as a powerful influence by some of America’s leading corporate
and political figures. Her books, including Atlas Shrugged and The Fountainhead, are among the
best-selling novels of all time.
“Man’s Rights,” by Ayn Rand
The following sentences are excerpts from this reading:
If one wishes to advocate a free society—that is, capitalism—one must realize that its
indispensable foundation is the principle of individual rights. If one wishes to uphold individual
rights, one must realize that capitalism is the only system that can uphold and protect them.
Every political system is based on some code of ethics. The dominant ethics of mankind’s history
were variants of the altruist-collectivist doctrine which subordinated the individual to some higher
authority.
Under all such systems, morality was a code applicable to the individual, but not to society. Society
was placed outside the moral law, and the inculcation of self-sacrificial devotion to social duty was
regarded as the main purpose of ethics in man’s earthly existence.
The most profoundly revolutionary achievement of the United States of America was the
subordination of society to moral law.
The United States regarded man as an end in himself, and society as a means to the peaceful,
orderly, voluntary coexistence of individuals. The United States held that man’s life is his by right,
that a right is the property of an individual, that society as such has no rights, and that the only
moral purpose of a government is the protection of individual rights.
America’s inner contradiction was the altruist-collectivist ethics. Altruism is incompatible with
freedom, with capitalism, and with individual rights…
It was the concept of individual rights that had given birth to a free society. It was with the
destruction of individual rights that the destruction of freedom had to begin.
For further information the students could refer to the following websites—http://www.aynrand.org
Free Market Solution to the Baby Shortage?
This section displays an advertisement that appeared in the Stanford Daily (Stanford University) seeking
egg donors. Experts estimate that about 10,000 babies annually are born from “donated” eggs and about
$38 million is spent on those eggs. Fees range from a few thousand dollars to $50,000 or more. The
fertility industry is lightly regulated by the federal Centers for Disease Control and Prevention. A few states
are considering their own rules. Most industrial nations have banned paid “donations.” [Source: Jim
Hopkins, “Egg-Donor Business Booms on Campus,” USA TODAY, March 16, 2006, p. 1A.]
I. Capitalism in Practice—“Privatization” in America and Abroad
Most commonly, privatization follows the following two patterns:
Contracting out where government, in effect, turns over a portion of its duties, such as garbage
collection, to a private firm; and
The sale or lease of public assets, such as an airport, to a private party.
Price-driven, free market solutions range from highly pragmatic cost savings to exotic proposals for
changing long-standing traditions. Greece, currently the most visible privatization example, faces a
collapsing economy and an unemployment rate exceeding 25 percent.
Struggling American governments see privatization as a solution for financial distress. State officials say
the privatization plan will save millions of dollars while improving medical care. Citing free market
efficiency and personal freedom while challenging moral conventions, privatization supporters envision
major changes to daily life. The underlying idea is that the market can make decisions more efficiently and
effectively than government while also maximizing personal freedom.
A. Space Travel
Trying to save money while emerging from the Great Recession, the U.S. government has retired its
shuttle rockets and will encourage the continuing development of private-sector rockets that are
expected to carry on space exploration and travel in cooperation with the government. Presumably,
space will be “commercialized” with companies hauling space travel customers and exploiting vast
mineral resources that may lead to a new “gold rush.” Critics, however, think the private sector is
unlikely to be able to meet the enormous safety and financial hurdles involved in sustained space
travel.
Room for Big Ideas
SpaceX founder Elon Musk (the cocreator of PayPal and the founder of Tesla, the electric car
company) recently said he is working on a vertical liftoff passenger jet as well as a project called a
Hyperloop, a tube that would be capable of moving people from San Francisco to Los Angeles in 30
minutes.
B. Toll Roads, Parking Meters and Congestion Pricing
Private companies are building, maintaining, and operating new toll roads in places such as northern
Virginia and suburban San Diego to the Mexican border. Taking the privatization movement a step
further, state and local governments are selling or leasing existing roads to private companies.
However, critics worry about the effect of declining service, excessive tolls, too much profit for the
investors, pricing poorer drivers out of access to the roads, and trading secure government jobs with
benefits for low-wage private-sector jobs without benefits.
While adding to and upgrading infrastructure through privatization, governments and their agents are
also turning to pricing/market mechanisms to reduce demand for that infrastructure.One expanding
initiative is congestion pricing that involves making a service more expensive at times of peak demand
to curb that demand.
C. Schools
Is capitalism the answer to poor school performance? The idea was unthinkable a few decades ago,
but some increasingly frustrated parents and school boards have adopted a free market “fix.” Schools
are experimenting with market-based approaches such as for-profit web-based classes, open
enrollment (students attend the school of their choice regardless of their place of residence), charter
schools (funded by taxes but freed of much government oversight), and vouchers (students “spend”
their taxpayer-provided dollars on the school of their choice). Experts believe that direct payments
alone do not lift results, but when combined with tutoring and other support tactics, learning may be
strengthened.
Privatize Higher Education?
The Anderson School of Management at the University of California at Los Angeles (UCLA) received
permission in 2013 to substantially privatize its prestigious MBA program. Those opposing Anderson’s
privatization fear that UCLA’s responsibilities for the general welfare may be replaced by the more
self-interested goals of those running the program, its donors, and the business community. Of course,
the long-term interest of the Anderson School is in taking only those steps that strengthen the school’s
performance and reputation in a highly competitive MBA market, and even in its
self-sufficient/privatized mode, the Anderson School continues to be a part of UCLA and the University
of California system.
D. Privatization a Success?
Privatization often brings substantially reduced costs and improved expertise, but sometimes the
transition does not work well. Some privatization efforts, such as Florida’s plan to lease its “Alligator
Alley” toll road, fail because of an absence of private-sector bids. Some projects do not generate the
anticipated savings. Although more than 30 states contract with private prisons, a 2011 study in
Arizona found little or no savings in doing so even though private prisons often “cherry pick” the least
expensive prisoners.
Firefighters Watch a House Burn
Obion County, Tennessee, firefighters drew national attention in 2010 and 2011 when they allowed two
rural family homes to burn to the ground because the families had not paid their $75 annual
subscription fee to the city-operated fire department. Apparently, no one was seriously injured in either
fire. The homeowner in the 2010 blaze, Gene Cranick, said that he offered to pay the fee on the spot,
but the fire department declined and engaged the fire only to the extent necessary to protect the
property of a neighbor who had paid the fee.
[Source: Jason Hibbs, “Firefighters Watch as Home Burns to the Ground,” WPSD Local 6—News,
Sports, Weather—Paducah, KY, September 30, 2010 [http://www.wpsdlocal6.com/; Timothy W. Martin,
“Putting Out Fires for a Fee,” Wall Street Journal, March 12, 2012
http://online.wsj.com/news/articles/SB10001424052970203961204577269591267553530?
mg=reno64-wsj.]