Capitalism vs. Socialism
From economic shutdowns to trillions of dollars in new government spending, the 2020 COVID-19 pandemic led to a dramatic increase in government action. While much of the increase was temporary, there is now a growing desire to further expand government. We see calls for single-payer health care systems, expanded child-care subsidies, and trillions of dollars in federal infrastructure investments.
Arguments about what government should and should not do are not new. We regularly see them in the debates over the merits of socialism versus free market capitalism. While these debates are often in the abstract, over the last century countries have experimented with variations on both economic systems. The Hoover Institution’s Human Prosperity Project critically examined many of these experiments to see which economic system is best for human flourishing. The video below describes the project’s objectives:
So how do socialism, capitalism, and their many variants compare?
What do these economic systems look like?
In heated policy debates and on social media, we often hear policies described as socialist or capitalist. Sometimes it seems the terms are used as pejoratives rather than as honest descriptions. So what do these terms actually mean?
Capitalism refers to an economic system where economic decisions—such as what to make and how much to charge for it—are made by private actors. There are robust protections for property rights, which give people more reason to invest in businesses and invent new products. By contrast, in socialism economic decisions are largely made by the government. Policy makers decide what gets made and determine prices and wages.
Now, of course, even in capitalist economies governments still play an economic role. Likewise, private individuals still make some decisions in socialist economies. It gets even more complicated: some economies have social democracy, where governments leave most economic decisions in the hands of individuals but take an active role in redistributing income and regulating labor markets and industries.
You can find a helpful glossary of related terms here.
How do socialism and capitalism affect income and opportunities?
Delivering broad-based prosperity should be the primary goal of all economic systems, but not all systems deliver the same results. Supporters of capitalism argue that free markets give people—entrepreneurs, investors, and workers—the right incentives to create goods and services that people value. The result is higher standards of living. Those sympathetic to socialism, however, respond that capitalism may produce wealth for some, but without government involvement in the economy many are left behind.
In his Human Prosperity Project essay Socialism, Capitalism, and Income economist Edward Lazear analyzed decades of income trends across 162 countries. He studied how incomes for low and high earners changed as countries shifted from government-controlled economies to more market-oriented economies. His conclusion?
The historical record provides evidence on how countries have fared under the two extreme systems as well as under intermediate cases, where countries adopt primarily private ownership and economic freedom but couple that with a large government sector and transfers. The general evidence suggests that both across countries and over time within a country, providing more economic freedom improves the incomes of all groups, including the lowest group.
Lazear points to several specific examples. First, China: in the 1980s, the Chinese Communist government began to adopt market-based reforms. Lazear finds that the market reforms, as skeptics of capitalism would predict, did increase income inequality. But, more importantly, the market reforms lifted millions of people out of poverty. Lazear notes:
Today, the poorest Chinese earn five times as much as they did just two decades earlier. Throughout the 1980s and before, a large fraction of the Chinese population lived in abject poverty. Today’s poor in China remain poor by developed-country standards, but there is no denying that they are far better off than they were even two decades ago. Indeed, the rapid lifting of so many out of the worst state of poverty is likely the greatest change in human welfare in world history.
As the video below highlights, market reforms led to similar economic miracles in India, Chile, and South Korea:
What about mixed economies?
Of course, most modern-day critics of capitalism are not advocating for complete government control over the economy. They don’t want the economic policies of the Soviet Union or early Communist China; instead, they point to nations with mixed economies to emulate, such as those featuring social democracy. So how do these policies affect incomes and opportunities?
Economist Lee Ohanian compares the labor market policies of Europe and the United States in his essay The Effect of Economic Freedom on Labor Market Efficiency and Performance. Compared to the United States, European nations have higher minimum wages, stricter rules that prevent the firing of workers, and high rates of unionization. These rules are intended to protect workers, but Ohanian finds that they discourage employment and result in lower compensation rates. His analysis indicates:
These findings have important implications for economic policy making. They indicate that policies that enhance the free and efficient operation of the labor market significantly expand opportunities and increase prosperity. Moreover, they suggest that economic policy reforms can substantially improve economic performance in countries with heavily regulated labor markets and high tax rates.
The video below highlights some of Ohanian’s key findings:
What about the effects of income redistribution and the taxes that pay for it? Supporters argue that these programs keep people out of poverty. Critics, however, argue that financing these systems comes with high costs both to taxpayers and to recipients.
In their essay Taxation, Individual Actions, and Economic Prosperity: A Review Joshua Rauh and Gregory Kearney consider the effects of raising tax rates on high-income Americans to finance new government spending. They examine the effects of income and wealth taxes in Europe. They find that wealth taxes and high income tax rates discourage high-income filers from investing in a country, which ultimately reduces economic growth. Thus, calls in the United States to increase income and wealth taxes “come despite a body of evidence showing that the country is already one of the more progressive tax regimes in the world, that wealth confiscation results in worse outcomes for the broader economy.”
The long-term consequences of redistribution don’t fall just on taxpayers. Such transfer systems also create incentives for individuals to leave or stay out of the work force. In their contribution to the Human Prosperity Project, economist John Cogan and Daniel Heil consider the effects of Universal Basic Income (UBI) programs, which would provide a “no-strings-attached” cash benefit to families. They find that modern UBI proposals in the United States would either prove costly—requiring tax rates that would reduce incentives to work and invest—or would require steep phase-out provisions that punish recipients who try to re-enter the workforce. In either case, the result is that UBI programs are likely to reduce employment rates, ultimately depriving recipients of long-term economic opportunities.
What about other aspects of human flourishing?
Human flourishing is more than material prosperity. For example, it requires a clean environment and access to good health care.
It might seem that socialist economies—where government controls the means of production—would have better environmental track records. Yet the evidence suggests the opposite. In his essay Environmental Markets vs. Environmental Socialism: Capturing Prosperity and Environmental Quality Economist Terry Anderson summarizes the literature on economic systems’ effects on the environment. He points to research showing that countries with more economic freedom tend to have better environmental outcomes:
Seth Norton calculated the statistical relationship between various freedom indexes and environmental improvements. His results show that institutions—especially property rights and the rule of law—are key to human well-being and environmental quality. Dividing a sample of countries into groups with low, medium, and high economic freedom and similar categories for the rule of law, Norton showed that in all cases except water pollution, countries with low economic freedom are worse off than those in countries with moderate economic freedom, while in all cases those in countries with high economic freedom are better off than those in countries with medium economic freedom. A similar pattern is evident for the rule-of-law measures.
Anderson explains this surprising result with the adage that “no one washes a rental car.” In free-market societies, property rights give individuals incentive to protect and preserve the resources they own. In countries without these property rights provisions, no one has the right incentives, much like no one has the incentive to wash a rental car (except the rental car companies). The video below further explains why free markets and cleaner environments go hand and hand.
What about health care? Many developed nations that have generally free economies have still opted for government-run health care. The programs vary by country. Even in the United States, the government plays a large role in health care. Large government programs such as Medicare and Medicaid provide health care to low-income families, the disabled, and seniors. Nevertheless, relative to most developed nations, the United States relies far more heavily on the private sector and markets.
In his essay The Costs of Regulation and Centralization in Health Care Dr. Scott Atlas compares health care in the United States with that in other developed nations. The United States consistently ranks high across a variety of quality metrics. The system offers shorter wait times and faster access to life-saving drugs and medical equipment. The result is that the US system tends to deliver better medical outcomes than other developed nations. Watch this video to learn more:
We’ve seen that whether we look at income statistics or environmental outcomes, economies with freer markets tend to have better outcomes. Nevertheless, there still may be unseen dimensions of economic systems that these statistics don’t address. Is there another way to determine which system is best for human flourishing?
Perhaps the best method is to observe where people choose to live when offered the choice. In his essay Leaving Socialism Behind: A Lesson from German History, Russell Berman catalogues widespread immigration from East Germany to West Germany during the Cold War. Watch this video to learn its causes:
Citations and Additional Reading
- Why did liberal democracies succeed while communist nations failed in the twentieth century? Hoover Institution senior fellow Peter Berkowitz provides an answer in his essay Capitalism, Socialism, and Freedom.
- In his essay Socialism vs. The American Constitutional Structure: The Advantages of Decentralization and Federalism, John Yoo highlights the constitutional provisions that would make it difficult for the United States to adopt widescale socialist policies.
- Explore the other Human Prosperity Project essays here.