A Strong Dose of DiLorenzo

Given what passes for economic understanding today and the disastrous policies we're forced to endure, you might think economic decision-making consisted of a coin toss with a two-headed penny. Every problem is the market's fault and government's responsibility to fix. The root cause is always too much freedom ' the solution, therefore, is to have less of it.

In this picture, government is like a patient dog trainer working with incorrigible canines. It struggles to control the beasts for the good of society, otherwise we'll be devoured by the wolves.

The Real Lincoln [4] author Thomas J. DiLorenzo profoundly rejects this view. In his latest book, How Capitalism Saved America: The Untold History of Our Country, from the Pilgrims to the Present [5], Professor DiLorenzo weaves history and economics into a highly readable and detailed account of how free market capitalism puts food on the table and government takes it away. [1] As the country rose from its wilderness beginnings through freedom and private property, government kept agitating for expansion under duplicitous cover. In case after case, DiLorenzo shows how intervention led to corruption, waste, and often the opposite of its stated purpose. Even worse, intervention failures were either ignored or given as the excuse to intervene again to 'fix' what failed.

In his book, DiLorenzo sometimes points out how a 'strong dose of capitalism' helped a particular economic problem. I contend that a 'strong dose of DiLorenzo' is what we need to set our thinking straight. Since we'll be going beyond the typical review and covering his material in some detail, think of this article as a kind of economics first aid until you get his book.

Capitalism versus Mercantilism

Capitalism, he tells us, is characterized by private property rights, consumer focus, mass production, a reliable system of prices, entrepreneurship, and freedom. If there is one lesson to be taken from his book, I believe, it is this: Economic freedom causes prosperity.

Competition arises naturally in a free economy, but some people turn to government to minimize it. Thus, we have capitalism corrupted, otherwise known as mercantilism, which prevailed in Europe during the 17^th and 18^th centuries. Mercantilism is an arrangement of state-sponsored monopolies and protections from competition. As Adam Smith explained in Wealth of Nations, under mercantilism 'the interest of the consumer is almost constantly sacrificed to that of the producer.'

In spite of Smith's attacks on mercantilism, a strong mercantilist lobby has existed in the U.S. since its inception, beginning with Alexander Hamilton and his supporters pushing for a more aggressive government that would centrally plan the economy for preferred business interests.

Specifically, they advocated:

1. - Tariffs to protect American businesses from foreign competition

2. - Tax-funded subsidies for certain businesses ('corporate welfare')

3. - A central bank to print paper money to pay for these schemes

The special business interests who advocated bringing the corrupt European mercantilist system to America supported the American Whig Party from the 1830s to the 1850s, and then backed the Republican Party. Lincoln's election, among other things, represented the triumph of mercantilism in America. We've been subjected to 'creeping mercantilism ever since,' DiLorenzo says.

Environmentalists versus Conservationists

Today, of course, competition turns cutthroat when it comes to using government as a source of privilege. In particular, DiLorenzo notes how politically active environmentalists exert great influence over the economy. Environmentalists should not be confused with conservationists, who work to improve the environment. Environmentalists, who are usually politicians, journalists, lobbyists, or intellectuals, work to block the production of goods and services.

According to environmentalists, capitalism is responsible for using up the world's finite resources. But they've got it wrong, DiLorenzo says: environmentalists confuse the present supply with all the natural resources in nature. Thus, 'their fundamental premise is in error.'

They overlook the fact that companies have built-in incentives to conserve natural resources. One way to maximize profits is to minimize costs, and one way firms lower costs is to figure out how to use fewer resources in their products.

Private property also provides the right incentives for conservation. In addition to pride of ownership, financial incentives play a role simply because property is worth more when it's taken care of. But instead of fighting for property rights, environmentalists fight for more government ownership of resources. Nor do they push for sound liability laws, which provide businesses incentives to avoid harming the environment.

How Capitalism Saved the Pilgrims

The story of America's first settlers illustrates the power of a work/reward nexus and how private property got our country underway.

In both Jamestown and Plymouth during the early 17^th century, settlers arrived and began the practice of communal ownership of production. In spite of ample game and fertile soil, most of them starved to death within months of their arrival. Everything they produced was to go into a pool to support the colony. As such, there was incentive to free ride ' to shirk, not work.

The situation changed radically after settlers were given private plots of land. The lazy and indolent suddenly became 'very industrious.' Women who had pleaded frailty before now worked long and hard, since they saw it would benefit themselves and their families.

Economic freedom thus allowed the colonists to flourish and to harness their abundant natural resources. Each region specialized according to its resources. By 1775, the economy was at least 10 times larger than it had been in 1690. A per capita income of $60 made colonists among the richest people in the world.

But while the colonies were thriving, the Mother Country was sizing them up.

America's Capitalist Revolt

At the end of the Seven Years War in 1763, Britain had a large war debt and an expensive empire to run, and looked to the American colonies as a source to exploit economically.

DiLorenzo discusses the various tariffs, taxes, and trade regulations England attempted to impose on the colonies as a way of increasing British revenue. Parliament would pass a law, merchant-led colonists would resist, and the British would back off and try again.

Finally, in 1773, the British thought they had devised a mercantilist policy the colonists would accept ' the Tea Act. Though it established a monopoly, the act would allow the colonists to buy England's tea cheaper than smuggled tea, while the British would enjoy an exclusive market on a very popular commodity. Our perceptive forefathers fired back with the Boston Tea Party.

By the time the colonies declared their independence, they were in large part revolting against the king's determination to impose mercantilist policies on them.

In ratifying the Constitution, the states set up a system of reciprocal checks with the central government, reserving ultimate sovereignty to themselves. But some influential men rejected this view, most notably Alexander Hamilton, who admired English mercantilism.

For the first 70 years of the country's existence, politicians fought over the mercantilist issues Hamilton advocated. States rights were regarded as essential to holding mercantilism at bay, since states reserved the right to interpose and nullify any act of government that exceeded its delegated authority.

The fight ended with Lincoln's election. The tariff rate tripled and stayed that high or higher for the rest of the century. The Legal Tender Act of 1862 and the National Currency Acts of 1863 and 1864 established a centralization of power that Hamilton himself could scarcely have made worse. And while pursuing a policy of total war to deny states their right to secession, the government granted vast subsidies to railroad corporations, prompting other industries to agitate for similar handouts in the decades that followed.

The Lincoln Administration thus raised mercantilism's plundering swift sword over the corpse of states rights.

Highways of Capitalism

There are fatal flaws in capitalism, mercantilists believed, one of them being the 'free-rider' problem. No one wants to pay for a road, but everyone wants to use it. Government, the argument goes, needs to subsidize construction of roads, along with canals and railroads, for the good of the country.

But as DiLorenzo explains, the free-rider problem is a myth. Most roads and canals were privately financed in the 19^th Century. And in those cases where government did get involved, it produced a financial debacle.

Individual states funded internal improvements during the early decades of the 19^th Century, and not a single project was completed. They were mired in the usual government problems ' cost overruns, corruption, inefficiency. By 1850, all but two states had amended their constitutions, forbidding taxpayer funding of internal improvements.

The Working Class

Everyone knows capitalism exploits the working class. It's only the facts that speak otherwise.

As capitalism grew in America, workers became progressively more productive as capital investment per worker increased. New, more productive machinery enabled workers to improve productivity immediately. As profits rose, workers became more valuable to their employers and wages went up.

From 1820 to 1860, workers' wages grew at about a 1.6 percent annual rate. The purchasing power of an average worker's paycheck increased between 60 and 90 percent, depending on the region of the country. Between 1860 and 1890, real wages (adjusted for inflation) increased 50 percent. The average workweek was shortened as well, making real earnings closer to 60 percent.

Today, average middle-class families live better than 19^th Century millionaires. Things such as jet travel, air conditioning, heart bypasses, even aspirin were not available to the rich back then. At first, they were a luxury of the wealthy only, but in time became available to almost everyone.

But aren't the rich getting richer and the poor getting poorer?

From 1967 ' 1997, the share of total national income going to the top 20 percent increased from 43.2 percent to 49.4 percent, whereas the share going to the bottom 20 percent fell from 4.4 percent to 3.6 percent. These figures seem to support the popular view of the rich getting richer while the poor lose out.

But DiLorenzo notes several problems with these numbers:

• - They say nothing about the fate of actual individuals

• - They assume there is no opportunity for the 'poor' to advance

A University of Michigan tracking study of specific, individual families from 1975 to 1991 show these results:

• - Only 5 percent of families in the bottom fifth of income distribution in 1975 were still there in 1991.

• - The poorest families made the largest gains. Those who started in the bottom 20 percent in 1975 had an inflation-adjusted gain in family income of $27,745 by 1991. Those in the top 20 percent improved by only $4,354.

The rich are getting richer, but the poor are getting richer much faster.

The Truth About the Robber Barons

The American economy has always had two kinds of entrepreneurs, market entrepreneurs and political entrepreneurs ' or capitalists and neomercantilists. Simply put, we have a mix of 'self-made men and women as well as political connivers and manipulators.'

Capitalists are market entrepreneurs; they sell new, better, or less expensive products on the free market without government subsidies of any kind, direct or indirect.

Neomercantilists are political entrepreneurs; they use government favors or handouts to get ahead financially.

A market entrepreneur makes a better mousetrap and tries to convince people to buy more of his and less of his competitors'. A political entrepreneur lobbies Congress to prohibit the importation of foreign-made mousetraps. Or if his chief competitor is a big domestic firm, he instigates an antitrust investigation.

Some entrepreneurs fit the label 'robber baron' quite well. Leland Stanford, former governor of and U.S. senator from California, used political connections to have the state pass laws prohibiting competition for his Central Pacific railroad. It was a profitable monopoly scheme for Stanford and his business partners.

On the other hand, James J. Hill built a transcontinental railroad, the Great Northern, without any government aid, while opposing government assistance to his competitors. John D. Rockefeller built Standard Oil with his own money and by paying close attention to every detail of his business, always looking for ways to cut costs, improve his output, and expand his line of products. Both Hill and Rockefeller created thousands of new jobs in the process of developing their businesses.

Real robber barons spend their time wining and dining politicians to make sure the favors continue to flow; their patrons in government count more than the businesses they run. Unfortunately, most historians tend to lump market entrepreneurs with their conniving counterparts, calling them all 'robber barons.'

Antitrust Myths

According to myth, capitalism fosters monopolies that restrict production to drive up prices. Therefore, a Republican Congress, acting in the public interest, passed the Sherman Antitrust Law of 1890 to maintain free markets and open competition. A look at history, as DiLorenzo shows, dispels these illusions.

In the late 19^th Century, 'yellow journalists' like Ida Tarbell attacked trusts for:

• - Bribing legislators

• - Enjoying protection by tariffs

• - Driving out competition by lowering prices

• - Victimizing consumers by raising prices

• - Defrauding investors by watering stocks

Responding to these charges,

• - While it's true some businesses bribed legislators, it is not true that trusts invented the practice. (Legislators sometimes threatened firms with harmful regulation for the very purpose of attracting bribes.) If trusts were as powerful as the yellow journalists claimed they were, DiLorenzo points out, the Sherman Act would never have passed.

• - The trusts that benefited from high tariffs have the Republicans to thank for their high tariff policy. But Standard Oil grew not because of protectionism but because they were successful at cutting costs and prices while developing new and better products.

• - Underselling the competition is the essence of competition and is a good thing, i.e., it benefits consumers.

• - From the end of the War Between the States to 1900, the U.S. experienced deflation, a general lowering of the average price level. The trusts' efficiencies and economies of scale enabled them to lower prices. Nor did they practice predatory pricing. As economists have explained, that is a losing policy. No firm has ever achieved monopoly power that way ' or any way, on an unhampered market.

• - Any firm that defrauds investors should be prosecuted under existing law. Using such a charge to break up a trust is groundless.

Support for the Sherman Act came from less competitive firms that wanted to break up their more successful rivals. Cotton farmers, for example, were upset that jute was being used to cover cotton bales instead of cotton, so they petitioned government to restrain jute farmers. Special-interest lobbying of this kind typified the period before Sherman.

The New York Times initially supported the Sherman Act, then turned against it. Four months after Sherman, Congress passed the McKinley Tariff, one of the highest yet. The Times charged the GOP with gross hypocrisy. Sherman was a distraction, it said, a move to put the GOP in a favorable public light. 'Behold! We have attacked the Trusts. The Republican party is [their enemy],' it editorialized on October 1, 1890. Senator John Sherman himself condemned the trusts because they 'subverted the tariff system' with their low prices.

The Times called the McKinley Tariff the 'Campaign Contributors Tariff Bill.' The paper said Sherman's speeches supporting the tariff showed he cared only about providing benefits to the GOP's corporate supporters at the expense of consumers.

Did Capitalism Cause the Great Depression?

According to official legend, capitalism has inherent tendencies to nosedive into a recession or depression, and to 'save' capitalism from itself, government must intervene with enlightened policy initiatives. During the Depression we had:

• - Tax increases

• - Debt

• - Inflation

• - Wage and price supports

• - Huge government spending programs

• - Pervasive regulation of business

Prior to the Great Depression, the worst economic downturn was the depression of 1837. It was short-lived because President Martin Van Buren didn't try to fix it. He kept government out of the way while the market created wealth and jobs.

Part of the myth surrounding the Great Depression is the claim we had too much economic freedom during the 1920s. Historians blame President Hoover for making the depression worse because he did nothing. In truth, Hoover's interventionist policies were the cause of the Great Depression. Roosevelt's continuation of these policies made the Depression longer and more severe.

In retirement, Hoover sounded somewhat laissez-faire, but while in office he was anything but. As Secretary of Commerce, for instance, Hoover increased the department's budget by more than 50 percent and hired more than 3,000 additional government bureaucrats.

Hoover believed prosperity could be brought about and maintained only by artificially propping up labor. He initiated labor legislation during the 1920s to keep wages high, believing such wages could be maintained without causing unemployment, even in the absence of high productivity.

He also believed in the Fed's 'easy credit' policy of inflation, government-supervised competition, and the GOP sacred cow of high protectionist tariffs. As president, he signed the Smoot-Hawley tariff, which sparked a trade war and made the depression much worse.

He also championed public works as a means of stimulating the economy. In 1929, he spent a large chunk of the federal budget on an expanded public works program while pressuring state governments to do the same. Government spending swiped money from the private sector, which depressed private sector spending and made the economy worse.

So What Caused the Bust?

In 1913, the U.S. Government created a cartel called the Federal Reserve System, giving it a monopoly on the issue of bank notes. Its most important function is to inflate the money supply through bank credit expansion. As the money supply increases, prices tend to rise. As a measure of the Fed's effectiveness, the price level in 1789 was about the same as it was in 1913. Since then it has gone up 'by at least a multiple of fifteen,' DiLorenzo notes.

Another effect of bank credit expansion is the boom ' bust cycle, which Austrian economist Ludwig von Mises first explained. Mises was the only economist in the 1920s to predict the Great Depression.

According to the Austrian theory, the money in circulation is either spent on consumption items or saved and invested. The ratio of consumption to savings and investment reflects the degree to which people prefer present to future satisfactions.

When savings are high, people are future-oriented ' they are postponing consumption for a later time. Under such conditions, interest rates are lower, and businesses take that as a signal to invest in capital goods to service future consumer demand.

When interest rates are lowered through credit expansion, however, it sends a misleading signal to businesses. 'Savings have not really increased,' DiLorenzo explains. 'Businesses will eventually find that there is not sufficient consumer demand for the products produced with their additional capital investments.'

The boom phase of the cycle is the period corresponding to business expansion under conditions of artificial credit. The bust comes when businesses realize their mistakes and must liquidate unprofitable investments.

During the period 1921-1929, the money supply increased by $28 billion, or 68 percent, at an average annual rate of 7.7 percent. As DiLorenzo notes, cheap credit does stimulate the economy, 'but in that stimulation are the seeds of recession.'

At the end of 1929, the money supply leveled off and the economy went into recession to correct the mistakes made during the boom. 'The bust was caused by government,' he concludes, 'not capitalism.'

Instead of letting the economy recover, as Van Buren and other political leaders had done, Hoover shifted gears and intervened massively, turning the recession into the Great Depression.

How the New Deal Crippled Capitalism

Newt Gingrich said Roosevelt was 'the greatest figure of the 20^th Century' for getting us out of the Depression. Almost every politician would agree with him. In fact, Roosevelt's economic policies made the Depression worse, while establishing precedents that continue to hurt our freedom and prosperity to this day.

Roosevelt:

1. - Doubled federal spending from 1933 (his first year in office) to 1940

2. - Created dozens of new federal programs

3. - Employed some 10 million Americans in government 'relief' jobs

Yet by 1938, the economy was no better off than it was in 1933.

The average rate of unemployment from 1933 ' 1940 was 17.7 percent. Roosevelt brought unemployment down after that by sending millions of men off to war.

Other measures tell the same story:

• - Per capita GNP did not recover to its 1929 level until 1940: 1929 - $857, 1940 - $916

• - Personal spending: 1929 - $78.9 billion; 1940 - $71.9 billion

• - From 1930 ' 1940, net private investment was minus $3.1 billion, as Americans failed to add to their capital stock

Prosperity wasn't restored until 1947 when wartime economic controls and government spending and employment levels fell drastically. Federal spending declined from $98.4 billion in 1945 to $33 billion by 1948. Keynesians had predicted a two-thirds cut in government spending would be a recipe for another depression. Instead, the private economy quickly recovered.

With government downsized to a significant degree, production increased by almost a third in 1946 alone. Corporate share prices soared. 'It was capitalism that finally ended the Depression,' DiLorenzo writes, 'once some of FDR's massive interventions were scaled back and the federal budget was reduced by about two-thirds.'

Did Capitalism Cause the Energy Crisis?

The oil industry got its start under laissez-faire and transformed the world with hundreds of thousands of jobs, while improving the standard of living for millions and making the machine age possible.

Today, it is heavily regulated, causing high prices, shortages, and other problems. What happened?

In 1917, only six years after breaking up Standard Oil for alleged monopolistic practices, government decided to create an oil cartel, naming Standard's CEO, A. C. Bedford, to run it. The U.S. had recently joined the war overseas and wanted to eliminate 'wasteful competition' by collaborating with industry to set prices.

After the war, government said it needed to maintain the cartel 'in the public interest' to conserve resources. Industry executives were pleased.

The industry also supported high tariffs on imported oil. Consequently, crude oil prices rose from 10 cents a barrel to 85 cents a barrel between August 1931 and June 1932, the outset of the Great Depression. American manufacturers, dependent on oil as an energy source, suffered greatly.

By 1960, government had fully cartelized the oil industry, having imposed import quotas during the preceding decade.

The 'energy crisis' emerged in the 1970s for two reasons: OPEC imposed an embargo ' a sharp reduction in supply ' and a barrage of environmental regulation reduced domestic supply. In addition, Nixon's wage and price controls of 1971 were lifted in 1974 on all products except oil. This stimulated consumption but made it less profitable to increase supply. Price controls created shortages, and long gas lines were the result.

What ended the energy crisis? Price deregulation.

Initiated with Carter and accelerated under Reagan, 'price deregulation created the largest production boom in the history of the American petroleum industry,' DiLorenzo writes.

Because of OPEC's embargo and government's price controls, crude oil prices had risen from $3 per barrel in 1972 to $35 a barrel by 1981. Following deregulation and the spike in oil supply, crude oil dropped to $10 a barrel and lower by 1985.

Energy crises ensued in the natural gas industry and in California's electric power industry in the 1990s, both of which DiLorenzo discusses in detail. But it's the same story ' government regulation created shortages.

The Never-Ending War on Capitalism

Studies of government regulation show that it is either ineffective or makes a problem worse. Yet, for any economic problem, the answer is always more intervention.

Most politicians view businesses as cash cows to be plundered for the benefit of their own political careers. In 1997, Professor Fred S. McChesney discussed this problem at great length in a book, Money for Nothing. 'Because the state can legally take wealth from its citizens,' McChesney said, 'politicians can extort from private parties payments not to expropriate wealth.'

For example, a politician proposes some onerous legislation that would harm individual businesses or entire industries, then sits back and waits to be bribed to withdraw or vote against the anti-business legislation.

Recent court rulings have turned lawyers into multimillionaires. Because of the shift from personal responsibility to after-the-fact litigation, some lawyers spend their lives digging up cases and evidence against corporations because a few people wantonly misused their products.

Overlawyered.com posts examples of the open season on corporations. In one case, lawyers in California mass-mailed letters to small businesses around the state offering not to sue them under the state's 'unfair competition law' if they coughed up $5,000 each. The Wall Street Journal labeled the practice 'the shakedown scandal' in the 'shakedown state.'

Liability lawsuits have imposed a 'tort tax' on the economy, driving up the price and limiting the availability of products and services. They've also stifled innovation, since new products carry more risk than older tried-and-true products.

Anti-capitalism is an ongoing crusade, but the crusaders do not have truth on their side. As a careful examination of this country's history makes clear, capitalism has been America's great blessing. 'The more Americans come to understand the truth about capitalism,' DiLorenzo concludes, 'the more reason they will have to be optimistic for the future of their country.'

Get the full story in his book [5].

References

1. DiLorenzo, Thomas J., How Capitalism Saved America: The Untold History of Our Country, from the Pilgrims to the Present, Crown Forum, New York, 2004.