Comparing Free Enterprise and Socialism

Report Economic and Property Rights

Comparing Free Enterprise and Socialism

April 30, 2019 Over an hour read Download Report
David R. Burton
Senior Fellow in Economic Policy
David Burton focuses on tax matters, securities law, entrepreneurship, financial privacy and regulatory and administrative law issues.

Summary

What is being offered by contemporary socialists are fairy tales, and we should not mistake them for the truth. These portrayals of socialism and their caricature of capitalism are inaccurate, vacuous, and utopian. Socialism takes from those who work, take risks, innovate, educate themselves, or save and gives to those who do not—or to those who have political power. A century ago, at the advent of the Russian Revolution, one could be a socialist and hope in good faith that socialism could achieve, or at least advance, its utopian aspirations. Now, socialism has a long record of dismal failure. In fact, it has been tried many dozens of times and failed each time.

Key Takeaways

The U.S. economic system today is a hybrid of free enterprise and socialism with a strong element of crony capitalism.

Socialism has a long record of failure and has been tried many dozens of times. It is arithmetically impossible to pay for the progressive agenda by taxing the rich.

In addition to being ethically superior to socialism, free enterprise has a record of increasing incomes and reducing poverty.

The U.S. economic system today is neither free enterprise nor socialism. It is a hybrid of the two with a strong element of crony capitalism. Many American politicians are now overtly calling for socialist or highly progressive policies, usually in the name of economic equality.

This Special Report compares free enterprise to socialism and briefly addresses a series of foundational issues regarding competing economic systems. Topics addressed include socialism, free enterprise, crony capitalism, how socialism is marketed, economic or distributive justice, poverty, the morality of socialism and free enterprise, the economic record of socialism and free enterprise, the efficacy of markets, the Nordic countries’ experience, innovation and entrepreneurship, equality, social cooperation, private property and individual liberty, socialism and the middle class, and the U.S. economy today. Readers who wish to read further on a particular topic will find additional relevant materials in the endnotes.

What Is Socialism?

State ownership of the means of production is the central tenet of traditional socialist or communist thought.REF Traditional socialist and communist economic policies involve state-owned enterprises and a high degree of state control over all aspects of economic life.REF

Over time, politicians came to understand that they did not need to have legal ownership of, or legal title to, businesses or other property in order to control them by regulation, administrative actions, or taxation.REF Furthermore, not having legal title meant that they could disclaim responsibility when government control did not work out well. Thus, the meaning of the term “socialist” evolved considerably during the last half of the 20th century to mean a strong state role in the economy, the pursuit of aggressive redistributionist policies, high levels of taxation and regulation, and a large welfare state—but not necessarily government ownership of the means of production.REF

In this sense, many 21st-century proponents of “socialism” promote policies designed to promote greater economic equality and to protect workers that are often indistinguishable from those of modern progressives, social democrats, or labor parties.REF In contemporary Europe, however, calls for state ownership of enterprises, especially banks, transportation companies, and utilities are now once again on the rise.REF Thus, the traditional socialist understanding appears to be regaining some ground. Both forms of socialism are collectivist ideologies that seek to radically reduce individual economic freedom in favor of political control over economic life.REF

What Is Free Enterprise?

Free enterprise or a free-marketREF system is an economic system based on voluntary exchangeREF in which entrepreneurs and businesses compete by offering goods and services to other businesses or consumers.REF Firms successfully compete by offering better and less expensive products or by offering innovative new products. Firms that make poor investments or fail to innovate by improving products or reducing prices typically become unprofitable and ultimately fail. They are allowed to do so.

Workers and employers reach mutually agreeable terms of employment and are typically free to end the employer–employee relationship when they want to do so.REF Markets and, critically, the price mechanismREF are allowed to operate with little government interference. A free-enterprise system: (1) provides robust private property rights;REF (2) enforces contracts;REF (3) provides rules against fraud; (4) maintains rules against imposing substantial negative externalities (pollution, for example);REF and (5) entails government provision of true public goods.REF Free enterprise is sometimes called capitalism,REF although free enterprise is about much more than the accumulation or use of capital.

Who Should Control the Economy: Politicians or the People?

The central economic question facing any society is the degree to which economic life should be organized or controlled by the state or based on a spontaneous order arising from the voluntary actions of individuals and civil society.REF Should economic cooperation be voluntary, as it is in free markets, or based on government coercion, as it is with socialism? In other words, who should control the economy—politicians (democratically elected or otherwise) and bureaucrats or the people?

Communists, socialists, social democrats, and progressives support an economy largely planned and controlled by government. Conservatives, classical liberals, and libertarians support an economy governed by the rule of law where people interact and cooperate largely free of government interference.

Crony Capitalism, Special Privileges, Rent Seeking, Industrial Policy, and Mercantilism

There are many names for businesses seeking to use the power of government to obtain competitive advantage or special privileges. Writing in the 18th century, Adam Smith called it the “mercantile system”REF (others later referred to it as mercantilism). During the 19th century, it was often called “special privileges.”REF Economists often call it “rent seeking.”REF More recently, it has been called corporate welfare,REF crony capitalism,REF industrial policy,REF state capitalism,REF venture socialism,REF political capitalism,REF or political entrepreneurship.REF By whatever name we call it, when government and businesses collude to distort the marketplace and to restrain competition and entrepreneurship, it reduces social welfare and harms consumers, economic growth, job creation, and overall incomes.REF It allocates income and wealth based on political power and favoritism.

Government should not be about exploiting the power of government for the benefit of special interests, whether those interests are business interests, labor union interests, or other interests. Policymakers have an obligation neither to distort the marketplace to favor the politically connected nor to not create artificial barriers to competition. To do otherwise is not only economically counterproductiveREF but endangers the public trust in government when discharging its appropriate functions.REF

The level of crony capitalist interventions by government in the marketplace today is staggering. The federal government alone provides over $100 billion in direct corporate welfare payments to businesses.REF The government massively interferes in credit markets by making loans and loan guarantees to favored business.REF It insures risks with exposure of trillions of dollars.REF It bails out failed businesses.REF It operates or sponsors large business.REF State and local governments, in particular, actively create cartels and impose unneeded occupational licensing regimes.REF Government interferes in international trade, protecting some industries at the expense of others.REF It regulates to the advantage of politically connected businesses.

This crony capitalist economy is one of the reasons that $2.6 billion is spent lobbying the federal government each year and billions more are spent trying to influence legislative and regulatory outcomes in more subtle ways.REF In many cases, it is more cost-effective to lobby government to achieve competitive advantage than to invest in productivity-enhancing equipment or research and development to bring better or less expensive products or services to market.

Marketing Socialism

Senator Bernie Sanders (D–VT) says that “Democratic socialism means that we must create an economy that works for all, not just the very wealthy.”REF Socialist popularizer Danny Katz writes, “Socialism is a society whose top priority is meeting all of its people’s needs—ranging from food, shelter, and health care to art, culture, and companionship.”REF Teen Vogue opines “Capitalism takes the position that ‘greed is good,’” while “anti-capitalists view capitalism as an inhuman, anti-democratic, unsustainable, deeply exploitative system that must be dismantled.” Teen Vogue continues, “In a capitalist country, the focus is on profits over anything else; in a socialist country, the public is seen to be more important, and social welfare is a major priority.”REF During the last election campaign, democratic socialist Alexandria Ocasio-Cortez (D–NY) said, “In the wealthiest nation in the world, working families shouldn’t have to struggle. This movement for Congress is about education and healthcare; it’s about housing, jobs, justice, and civil rights. It’s about preparing for the future of our environment, energy, and infrastructure. It’s about championing the dignity of our neighbors. And it’s about getting money out of politics.”REF

A central tenet of good marketing is to frame the presentation so that the seller is offering what the potential buyer already wants to buy. That is much easier than convincing the buyer that he needs the product. Socialist marketing, in this sense, is quite astute. Given the marketing campaign conducted on its behalf, it is little wonder so many have heeded the siren call of socialism. Who, after all, is opposed to “an economy that works for all” or “meets all of its people’s needs”? Everyone wants education, health care, housing, jobs, justice, companionship, and the like for themselves, their family, and their neighbors. The problem with these marketing riffs in support of socialism is that socialism will thwart rather than further these objectives.

What is being offered by contemporary socialists is a fairy tale.REF Although we may appreciate the literary qualities in a good yarn, we should not mistake them for the truth. These portrayals of socialism and their caricature of capitalism are inaccurate, vacuous, and utopian.REF Socialism takes from those who work, take risks, innovate, educate themselves, or save and gives to those who do not—or to those who have political power. Socialists love to compare an idealized Socialist utopia to real-world “capitalism” and act as if socialism has never been tried.REF A century ago, at the advent of the Russian Revolution, one could be a socialist and hope in good faith that it could achieve, or at least advance, its utopian aspirations. Now, socialism has a long record of dismal failure. In fact, it has been tried many dozens of times and failed each time. As discussed below, to the extent that socialism is seriously tried, it ensures mass poverty. But even socialism-lite reduces the material well-being of average people.REF Moreover, socialism is profoundly unjust.

Economic Justice, Distributive Justice, and Social Justice

A society’s understanding of economic justice—often called distributive justice by philosophers—is of central importance to how the society is organized, whether it is prosperous and whether its members can flourish.

Conservatives,REF classical liberals,REF and libertariansREF celebrate the fact that people have unequal (or diverse) talents, propensities to work, preferences, risk averseness, attachments, and cultures because these are central to the rich tapestry of an enlightened, humane, and prosperous society. These differences will inevitably lead to economic differences. This unplanned spontaneous orderREF and unequal distribution of material goods is just if the distribution is the result of individuals acting freely in accordance with just rules.REF The core of the conservative, classical liberal, and libertarian view of economic justice is respect for voluntary exchange and private property.REF

Any political system that mandated economic equality would be unjust. This becomes intuitively obvious to most if a few common situations are considered. Is it fair, equitable, or just that someone who works 80 hours per week should be paid the same as someone who works 40 hours per week or the same as someone who can work but chooses not to work at all? Should someone who has a dangerous or unpleasant job be paid the same as someone who has a safe, pleasant job? Should someone who works hard and does what his or her employer needs to be done be paid the same as someone who shirks responsibility and does as little work as possible? Should someone who is experienced, knowledgeable, and competent be paid the same as someone who is not? Should someone who prepared for a profession, paying tens of thousands of dollars of tuition and studying for years without compensation, be paid the same as someone who has not? Should someone who risks years of effort, for little or no compensation, to launch a business that brings a beneficial new idea, good, or service to the marketplace be compensated the same as someone who bears little risk? Should a person who defers consumption by saving and investing for the future have the same income as someone who never saves? Should all students’ grades be the same? Should admission to better universities be determined by lottery rather than academic merit?REF Most would answer no.

The intuitive sense of distributive justice raised by these questions is that it is unjust to treat unequal situations equally. It is a sense that justice requires goods, both material and intangible, to be distributed on the basis of merit, contribution, what is deserved, or “just desserts,” however defined, and that justice involves individual actions rather than a given distributional pattern to be determined in advance and enforced by the state.REF In other words, how or why someone’s wealth or income was obtained matters morally.

Most modern liberals, progressives, or socialists largely reject this view.REF To them, income or wealth inequality is morally problematic no matter the reason for the inequality because our natural endowments, inclinations, character, family, and social background are undeserved. If an individual works hard or is smart in school, employment, or enterprise and is therefore better compensated than others, progressives regard that as unfair because, they argue, the intelligence and work ethic involved came largely from genetic, family, or social factors.REF This view entails rejecting either the reality of, or the importance of, our freedom, our individuality, and many of the most important aspects of our humanity since, they believe, our character and our dispositions to work, to think, or even to loveREF are not chosen by us but determined by factors other than our choices. Using various principles, guideposts, or definitions, usually involving one of many competing conceptions of “equality,” “fairness,” or “social justice,”REF they seek to have government enforce a predetermined distribution of economic goods. Individual effort and merit are largely irrelevant to their conception of economic justice.

Most conservatives, classical liberals, and libertarians do not find it to be of particular moral concern that a middle-income person has a lower income or less wealth than an affluent professional or that a millionaire has a lower income or less wealth than a billionaire. Relative wealth or income ratios do not cause them anxiety. They are not ideologically committed to some pre-determined, government-enforced distributional outcome.REF They reject the view that wealth or income is like manna from heaven to be distributed by the state.REF They prefer unequal prosperity to equal stagnation and poverty. They support fairness, not equality of outcomes, and do not regard an equality of outcomes as fair or just.REF Instead, they seek equal protection of the law or equal justice under law. Their sense of economic justice is largely predicated on supporting voluntary exchange, choice, economic freedom, and private property.REF

Poverty

What conservatives, classical liberals and many libertarians find to be of moral concern is not income or wealth inequality per se but poverty,REF because poverty hinders the ability of the poor to flourish and to lead a fulfilling life.REF Public policies, private charity, education, and other initiatives to address poverty and create opportunity are warranted but the pursuit of economic equality is not. The objective of these efforts to alleviate poverty should be to create self-sufficiency rather than dependency so that people may thrive. Existing programs fail to meet those objectives.REF Poverty in this objective sense means inadequate economic means to flourish or to live a good and decent life. It does not mean “relative poverty” or “inequality” because poverty in this relative sense cannot ever, even in principle, be abolished since some will always have less than others.

After millennia where the mass of humanity lived in grinding poverty and even the affluent lived lives that would be considered hard today, free enterprise lead to the Great Enrichment, a 30-fold improvement in the material well-being of humanity that has lifted many billions of people out of poverty and allowed for longer, more fulfilling lives.REF In contrast, there is no more reliable means of driving a large proportion of a country’s population into poverty than to seriously implement a socialist agenda.REF

Poverty is not a function of economic inequality. “Economic policy,” narrowly construed, can have a substantial impact on opportunity and the incomes of the broader public but typically is not the cause of long-term poverty. Sometimes people are poor because of chronic mental or physical conditions or infirmities that make work difficult or impossible. Other poverty is driven by counterproductive behavior that causes people not to thrive, including substance abuse, failing to graduate from high school, having children before marriage, or failure to seek work.REF

Furthermore, existing government policies are ineffective or cause, rather than alleviate, poverty.REF Government policies cause poverty by: (1) creating a poverty trap so that working makes little or no economic sense for low-income persons;REF (2) making it illegal for less-skilled workers to work;REF (3) creating barriers to employment;REF (4) raising costs and prices;REF (5) slowing economic growth;REF and (6) impeding opportunity generally.REF Although work is both economically, socially, and psychologically uplifting,REF government policies systematically discourage work.REF Labor force participation rates, particularly for men, have declined precipitously.REF

Is Socialism Ethical?

Socialism is unethical for at least nine main reasons.

  1. In seeking to achieve equality of outcomes by some measure or some other government-dictated allocation of income or wealth, it seeks to treat unequal circumstances equally.REF Those who work, study, take risks, defer consumption, or undertake unpleasant tasks would be provided equal incomes to those who do not.
  2. Socialism systematically tramples on our liberty and involves the systematic application of coercion.REF Politicians and bureaucrats—not people themselves—would make many of the most important decisions in our lives and severely restrict our choices.
  3. Socialism necessarily involves denigrating our humanity, dignity, and ability to flourish. It would radically curtail the ability to choose one’s calling, to chart our own course in life, to excel, to be creative or innovative, to dissent, and to raise our families as we decide to be best.REF
  4. Mild socialism harms the public’s standard of living. To the extent that socialism is seriously implemented, it demonstrably leads to mass poverty and deprivation. There are no counterexamples. Knowingly adopting a set of policies that will lead to mass deprivation or even a markedly lower standard is unethical.REF
  5. Socialism is a poor steward of scarce resources. It encourages overuse and over-consumption of underpriced resourcesREF and makes achieving any particular economic end more costly in terms of resources used. Moreover, it typically increases externalities, such as pollution, imposed on society.REF
  6. Taking another’s money for yourself or to give to someone else—whether using government as an intermediary or not—is not morally praiseworthy. Having George “rob Peter to pay Paul” or allowing Paul to take from Peter does not rise to the level of virtue or have moral merit. Voluntarily using your own time and money to help another is a different matter. Beneficence, charity, and compassion are virtues.REF But charitable acts involve voluntarily giving of yourself to another—not compliance with state coercion.
  7. By placing most power in society in the state and removing power and resources from the private sector, socialism harms voluntary associations, civil society, and the communities and the web of relationships that they constitute. Socialism impedes and often seeks to suppress relationships fostered by non-governmental institutions and centers of power and influence not controlled by the state.REF
  8. Socialism stifles dissent and free speechREF and promotes a deadening, bureaucratic uniformity. Government control or regulation of the media, political speech, and elections is the norm in socialist countries.
  9. Socialism endorses and formalizes counterproductive envy,REF resentment, and hostility toward achievement and accomplishment. It seeks to tear down and diminish those who excel or succeed.REF

Socialism’s moral failures can be summarized as follows:

  • It treats unequal circumstances equally;
  • It systematically empowers politicians, bureaucrats, and the politically powerful at the expense of individual freedom and choice;
  • It denigrates our humanity, dignity, and ability to flourish;
  • It demonstrably reduces a society’s standard of living and dramatically increases poverty;
  • It wastes scarce resources;
  • It makes charity and compassion difficult, increases dependency, and reduces self-sufficiency;
  • It harms voluntary associations, civil society, and the family;
  • It stifles dissent and free speech and promotes a deadening, bureaucratic uniformity; and
  • It endorses and formalizes counterproductive envy and resentment.

Is Free Enterprise Moral?

Free enterprise does not suffer from socialism’s moral failings. The moral advantages of free enterprise can be summarized as follows:

  • It rests on voluntary cooperation among free people whether as workers, managers, investors, or consumers and rejects coercion;
  • It empowers ordinary people rather than politicians, bureaucrats, and the politically well-connected;
  • It allows people to author their own lives, to choose their own calling, to innovate, to create, to be different, and to flourish;
  • It leads to dynamism and an improved standard of living and has lifted more people out of poverty than any other system;
  • It encourages the sound stewardship of scarce resources;
  • It affords the dignity of self-sufficiency rather than offering the corrosive lethargy of dependence;
  • It rewards work, prudence, thrift, diligence, creativity, and innovation;REF
  • It leaves room for, and does not seek to control, voluntary associations, civil society, charity, and family in society; and
  • It leaves room for people to lead different kinds of lives, to be different, to dissent, and to speak freely.

Socialism’s Record

A Washington Post columnist, Elizabeth Bruenig, opines that “it is time to give socialism a try,”REF as if socialism has never been tried. It has been tried many dozens of times. Everywhere it has been seriously tried, it has led to mass poverty and despair. Socialism’s record is unblemished by success. It is an old, tried, failed ideology. To deny this evident historical fact requires a willing blindness or an extraordinary degree of historical ignorance.

The adoption of any set of policies that achieved anything approaching actual economic equality would so alter incentives, destroy productivity, and impede the ability of society to develop the information and dynamism necessary to meet the needs and wants of its people, that general impoverishment is the known result.REF Moreover, it is naïve to believe that people in politics or government are somehow different, special, or better than others. They generally act in their own interest and are no more or less charitable or selfless than those outside government.REF Politics in general should be stripped of its romance.REF Socialism amounts to the politicization of nearly all aspects of our lives. It should be understood for the exercise of bureaucratic and political power on behalf of powerful interests that it is.

Recent examples of socialist failure include Venezuela,REF North Korea,REF Greece,REF Cuba,REF and Brazil.REF Dramatic examples of past socialist failures include the Maoist People’s Republic of China,REF the Union of Soviet Socialist Republics,REF and the other Council for Mutual Economic Assistance (COMECON) countries (including the People’s Republic of Bulgaria, the Republic of Cuba, the Czechoslovak Socialist Republic, the German Democratic Republic (East Germany), the Hungarian People’s Republic, the Mongolian People’s Republic, the Polish People’s Republic, the Socialist Republic of Romania, the Socialist Republic of Vietnam, and the People’s Socialist Republic of Albania),REF Khmer Rouge Cambodia, and several dozen developing countries.REF Socialism has often led to mass murder. Socialist regimes have killed 100 million to 110 million people (not counting national socialist Germany).REF

Where less extreme versions of socialism have been tried, usually in democratic societies, it has led to a pronounced slowdown in growth and usually a decline in the standard of living. Even more moderate steps to reduce economic inequality—such as those associated with modern welfare-state progressivism or mixed economy social democracy—have a significant cost in terms of reduced incomes and social welfare.REF In other words, economic equality would dramatically reduce the size of the economic pie that egalitarians seek to divide equally.REF

American progressives have called for a wealth taxREF and federal income taxes of 70 percent.REF Higher marginal tax rates and a higher user cost of capital reduce the productive capacity of an economy and reduce real wages.REF These losses do not increase linearly but instead increase with the square of the marginal tax rate.REF Where socialism has been reversed or relaxed, living standards quickly improve.REF

A relatively simple way to determine whether ordinary people find socialist countries to be superior or inferior to relatively free countries is to observe relative immigration and emigration. People “vote with their feet.” Socialist countries typically either have significant out-migration or must build walls and use coercion to keep people within the country.REF Relatively free countries have high levels of immigration or have border enforcement designed to keep people out.REF

The Record of Free Enterprise

Free enterprise caused a 30-fold improvement in the well-being of ordinary people over two centuries.REF There is a strong correlation between economic freedom and material well-being.REF Economic growth and living standards improve when societies increase economic freedom. The move toward greater economic freedom has lifted billions of people out of socialist-caused poverty, most notably in China and India.REF In the developing world, free-enterprise policies can lift a country from poverty to a Southern European standard of living over a few decades.REF

Why Markets “Work”

Free markets are much better at providing low-cost, high-quality goods and services that people want than a government-controlled economy. To the extent that government interferes with market processes and substitutes political control for unimpeded markets, economic performance will decline. There are six primary (and interrelated) reasons for the superior efficacy of markets over politics as the regulator of economic life.REF

  • Competition increases choice and promotes efficiency;
  • Markets provide better incentives;
  • The price mechanism better allocates scarce resources to meet consumer wants than bureaucracy or politics;
  • Markets and private enterprises better develop and use information;
  • Markets and private enterprises provide greater and more rapid innovation and discovery; and
  • Markets employ distributed planning rather than central planning.

Competition. Under free enterprise, firms compete to provide consumers and other firms goods and services. Those that provide better quality or lower prices earn a profit for their owners. Those that do not experience losses and, if they do not adapt, fail.REF This process drives costs down and drives prices toward marginal costs. It rewards innovation, quality, cost control, and understanding consumer wants and needs. Government routinely restricts competition, driving up prices and restricting choice and innovation.REF

Incentives. People respond to incentives. People will work, save, and invest more if there is an incentive to do so.REF People will tend to work for employers or in occupations that pay better. People will tend to invest where returns are expected to be higher. This allocates scarce resources to where they are most in demand. By taxation, tariffs, regulation, and inflation, government routinely reduces the incentive to work, save, and invest—and alters incentives to distort markets and make them less effective.REF

The Price Mechanism. As the price of something goes up, people will supply more of it and demand less of it. This mechanism enables the supply of resources to rapidly move from uses where they are less valued to where they are more highly valued.REF Government policies that interfere with the price mechanism misallocate resources and can create, for example, shortages or overuse of a resource.REF

Information. Perhaps the most under-appreciated function of markets is how they rapidly obtain and convey information to economic actors. The preferences, expectations, and actions of billions of people are reflected in the price of goods and services and in capital markets. It is simply impossible for government to collect and act on this information with anything approaching the speed and effectiveness of markets.REF

Innovation and Discovery. As discussed below in greater detail, innovation and entrepreneurship are critical to improving the lives of ordinary people. But the high levels of risk associated with entrepreneurial ventures will only be undertaken if the potential rewards are high as well. In a free economy, entrepreneurs do not need political or bureaucratic approval or that of a scientific committee. They can risk their own time and money and that of their investors. If they are right about their ideas, we all win. If they are wrong, only they and their investors lose. Political actors investing taxpayer funds—rather than their own—and investing for political rather economic reasons do poorly at emulating entrepreneurship. Moreover, government routinely impedes entrepreneurship.REF

Distributed Planning. Socialist economies are often called planned economies. This is a misnomer. The real question is whether the plans are devised by a central government or whether the planning process is distributed among millions of individuals and business. In a socialist economy, people must conform to the government plan established by political and bureaucratic processes. In a free economy, markets coordinate millions of plans, and those plans are continuously altered based on what happens in markets.REF

The Nordic Countries

The oft-mentioned “socialist success stories”REF in the Nordic countriesREF are nothing of the sort: These countries are not socialist.REF Business taxation is highly competitive. Nordic corporate tax rates are lower than the U.S. tax rate—even after U.S. tax reform.REF Nordic countries do heavily tax individuals, including middle-income individuals.REF Unlike the U.S., they impose an additional value-added tax—a consumption tax—at a rate of 24 percent to 25 percent in addition to income and payroll taxes.REF

As measured by four leading indexes, the Nordic countries are among the most economically free countries in the world. The 2019 Heritage Foundation Index of Economic Freedom, for example, ranks all the Nordic countries as “mostly free.” Out of 180 countries ranked, Iceland has the 11th most economic freedom in the world with Denmark (14th), Sweden (19th), Finland (20th), and Norway (26th) close behind.REF The U.S., in comparison, ranks 12th, up from 18th in 2018.REF As Danish Prime Minister Lars Løkke Rasmussen said in a speech at Harvard University: “I would like to make one thing clear. Denmark is far from a socialist planned economy. Denmark is a market economy.”REF

SR213 Table 1

This was not always the case. From approximately 1970 to the early 1990s, Sweden, for example, had extremely high tax rates, high levels of government spending, high public-sector employment, and a series of policies aggressively intervening in labor and credit markets. Because of poor economic performance, a cross-party consensus reversed or moderated these policies, marginal tax rates declined, particularly for capital income,REF and Sweden’s economy dramatically improved.REF The Nordic countries’ high economic freedom scores reflect these changes.REF

The Nordic economies have not generally performed as well as the U.S. economy. Average wages and output per capita are lower.REF The average wage in the U.S. is 21 percent higher than the average wage in the Nordic countries.REF This is the price they pay for their high taxes.

Why Do Dynamism, Discovery, Innovation, and Entrepreneurship Matter?

Entrepreneurship matters.REF It fosters discovery and innovation.REF Entrepreneurs also engage in the creative destruction of existing technologies, economic institutions, and business production or management techniques by replacing them with new and better ones.REF Entrepreneurs bear a high degree of uncertainty and are the source of much of the dynamism in our economy.REF New start-up businesses account for most of the net job creation in the economy.REF Entrepreneurs innovate, providing consumers with new or better products. They provide other businesses with innovative, lower-cost production methods and are, therefore, one of the key factors in productivity improvement and real-income growth.REF

The vast majority of economic gains from innovation and entrepreneurship accrue to the public at large, rather than entrepreneurs.REF Entrepreneurs are central to the dynamism, creativity, and flexibility that enables market economies to consistently grow, adapt successfully to changing circumstances, and create sustained prosperity.REF High levels of entrepreneurship only occur under free enterprise. Government attempts at emulating private entrepreneurship usually end badly.REF

The Meaning of Equality

The United States Declaration of Independence states that “All men are created equal,” and the 14th Amendment to the Constitution provides that no state shall “deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.” The Founders were clear that equality did not mean economic equality.REF

The principle of equal justice under law has roots in antiquity. The Athenian Pericles, in his famous Funeral Oration,REF put forth a version of it, as did Aristotle in his Ethics.REF It rests on the idea that we are all God’s children, the principle of self-ownership and shared dignity. John Locke argued that “all men by nature are equal” and have equal rights that must be respected, but that they must also respect the equal rights of others.REF Edmund Burke said that “In this partnership [civil society] all men have equal rights; but not to equal things.”REF

Libertarians, classical liberals, and conservatives generally support equal political rights, moral equality, and equality before the law. Most also support equality of opportunity, usually understood as freedom from arbitrary limits on individuals’ ability to pursue lawful aims. Conservatives and classical liberals also typically support publicly funded education to advance equality of opportunity and republican self-government. Conservatives and classical liberals are aware of the importance that strong families, a robust civil society, and sound cultural norms play in fostering opportunities and the character formation necessary for pursuing opportunity. This is why they oppose policies that would weaken the family and civil society and defend a culture that is supportive of traditional, “bourgeois” or middle-class virtues.

Social Cooperation

Progressives often say something like, “Government is simply the name we give to the things we choose to do together.”REF This is untrue. We “do things together” in businesses, civil society (religious congregations, charities, associations, and other nongovernmental organizations), and in families. The question is whether social cooperation will be voluntary or coerced. You can elect whether to cooperate with a business (as an employee, customer, or investor) or a nongovernmental organization. While you cannot choose your family (other than your spouse), the nature of the relationship is entirely voluntary for adults.

The nature of social “co-operation” through government is entirely different. It involves involuntary compliance with politically or bureaucratically determined laws, regulation, and taxes—and the sanctions for non-compliance can be severe.

Private Property and Individual Liberty

Lord Acton famously observed that “Power tends to corrupt and absolute power corrupts absolutely.”REF In a socialist economy, power is centralized in a few powerful political actors. In a free economy, economic power is distributed among hundreds of millions of people, and even billionaires account for only a small portion of a multi-trillion-dollar economy. One can choose not to do business with a private firm. One must simply comply with government mandates. Private enterprise, private property, and private voluntary associations are the foundation of a free society in which individuals are free to author their own lives.

Socialism and the Middle Class

We often hear that progressive promises will be paid for by “taxing the rich.” This is arithmetically impossible. In Table 2 above, data from the Internal Revenue Service Statistics of Income shows that imposing a 100 percent flat tax on those with incomes of $1 million or more would increase federal revenues by about $986 billion.

SR213 Table 2

Thus, this policy would not even eliminate the federal deficit, currently about $1.1 trillion annuallyREF—let alone pay for utopian progressive causes. Nor does it consider the federal payroll taxes or state and local income, property, and sales taxes already paid by this group. And, of course, this would be a one-time revenue increase. Once such confiscatory taxes were imposed, these taxpayers would elect not to work, otherwise earn income, or realize capital gains since they would keep none of it.

Middle- and lower-income taxpayers do not bear a high federal income tax burden. In 2015 (the most recent year for which data is available), the top 10 percent of U.S. taxpayers paid 70.6 percent of income taxes.REF The top quarter paid 86.6 percent of all income taxes.REF Middle-income taxpayers do pay substantial federal payroll taxes, but these taxes fund Social Security and Medicare, both of which are highly progressive once the benefit structure is taken into account.REF Medicare taxes pay only about one-fifth of the cost of providing the program’s benefits for an average worker and three-fifths of the cost for a high-income worker.REF

The new American socialist or progressive agenda would require roughly doubling federal expenditures. The Congressional Budget Office 10-year federal spending baseline projection is $57 trillion ($12.4 trillion or 22 percent of which will be debt-financed).REF Progressive proposals for single-payer health insurance would increase spending by $32 trillion to $33 trillion over 10 years,REF a 58 percent increase in federal spending.REF Free college education,REF the “Green New Deal,”REF jobs guarantees,REF and other proposed programs would cost many trillions more. As the European experience with generous welfare states demonstrates, socialist or highly progressive policies must be funded by imposing very high consumption, payroll, and income taxes on the middle class. Notwithstanding the “tax the rich” rhetoric from progressive politicians, there simply is no alternative to dramatically raising middle-class taxes if the progressive agenda were to be implemented.

The United States Economy Today

Government expenditures amount to 33.6 percent of the gross domestic product (GDP) in the U.S. today.REF That understates government’s burden on the private economy because government itself is included as part of the GDP at cost and because GDP does not account for the depreciation of capital or capital consumption.REF Government regulations control or influence virtually all business decisions.REF Electric, gas, and water utilities, the health care sector, and banking are so heavily regulated that they are not privately controlled enterprises in the conventional sense.

Compliance, legal, and lobbying costs have increased substantially over the past decade. Through government-sponsored enterprises, loan guarantees, insurance, spending, tariffs, licensing, and regulation, governments at the federal, state, and local level routinely favor the politically connected and exercise tremendous control over the economy.REF The U.S. today is a long way from a truly free economy. But politicians and bureaucrats do not control every important aspect of the economy, either. Thus, the U.S. is a long way from being a socialist country. It is a hybrid or mixed economy.

Conclusion

Socialism has a century-long record of failure. It has been tried many dozens of times. Its record is unblemished by success. If seriously implemented, socialism causes mass privation and misery. But even “socialism lite” substantially reduces the standard of living of ordinary people.

Free enterprise has a record as well. It has led to a 30-fold improvement in the standard of living over two centuries. Developing countries that adopt pro-market policies thrive. Socialist countries that reverse their policies and make pro-market reforms see rapid improvement. Markets and the price system are simply better at providing prosperity because of better incentives to work, save, invest, and innovate; superior development and use of information; and improved allocation and use of scarce resources and competition. Free enterprise lifts people out of poverty and provides civil society or government the means to address poverty. Socialism exacerbates and creates poverty.

If implemented, American socialist and progressive policies would dramatically increase taxes on the middle class. It is arithmetically impossible to pay for the progressive agenda by taxing the rich. Middle-class incomes would decline and unemployment would increase. The European experience illustrates this.

Free enterprise is ethically superior to socialism. An economic system based on voluntary exchange and economic liberty that empowers individuals and families is superior to a system that empowers politicians and bureaucrats. Socialism politicizes virtually everything. Socialism treats unequal circumstances equally and results in injustice. Free enterprise provides the dignity of self-sufficiency rather than offering the corrosive lethargy of dependence. Free enterprise allows people to author their own lives, to choose their own calling, to innovate, to create, to be different, and to flourish.

—David R. Burton is Senior Fellow in Economic Policy in the Thomas A. Roe Institute for Economic Policy Studies, of the Institute for Economic Freedom, at The Heritage Foundation.

Authors

David R. Burton
David Burton

Senior Fellow in Economic Policy