Why socialism won’t work

With increasingly ubiquitous iPhones, internet, central air conditioning, flat-screen TVs, and indoor plumbing, few in the developed world would want to go back to life 100, 30, or even 10 years ago. Indeed, around the world, the last two centuries have brought vast improvements in material living standards; billions of people have been lifted from poverty, and life expectancy across income levels has broadly risen. Most of that progress came from capitalist economies.

Yet those economies are not without their problems. In the United States and the United Kingdom, the gap between the rich and poor has become intolerably large as business owners and highly educated workers in urban areas have become richer while workers' wages in rural areas have stagnated. In most rich countries, more trade has brought a bigger, better variety of goods, but it has also displaced many jobs.

With social instability in the form of mass protests, Brexit, the rise of populism, and deep polarization knocking at the capitalist economies' doors, much of the progress of the last several decades is in peril. For some pundits and policymakers, the solution is clear: socialism, which tends to be cited as a method for addressing everything from inequality and injustice to climate change.

Yet the very ills that socialists identify are best addressed through innovation, productivity gains, and better rationing of risk. And capitalism is still far and away the best, if not only, way to generate those outcomes.

Today's socialism is difficult to define. Traditionally, the term meant total state ownership of capital, as in the Soviet Union, North Korea, or Maoist China. Nowadays, most people don't take such an extreme view. In Europe, social democracy means the nationalization of many industries and very generous welfare states. And today's rising socialists are rebranding the idea to mean an economic system that delivers all the best parts of capitalism (growth and rising living standards) without the bad (inequality, economic cycles).

But no perfect economic system exists; there are always trade-offs—in the most extreme form between total state ownership of capital and unfettered markets without any regulation or welfare state. Today, few would opt for either pole; what modern socialists and capitalists really disagree on is the right level of government intervention.

Modern socialists want more, but not complete, state ownership. They'd like to nationalize certain industries. In the United States, that's health care—a plan supported by Democratic presidential candidates Elizabeth Warren (who does not call herself a socialist) and Bernie Sanders (who wears the label proudly). In the United Kingdom, Labour Party leader Jeremy Corbyn, who was trounced at the polls in mid-December, has set his sights on a longer list of industries, including the water, energy, and internet providers.

Other items on the socialist wish list may include allowing the government to be the primary investor in the economy through massive infrastructure projects that aim to replace fossil fuels with renewables, as Green New Deal socialists have proposed. They've also floated plans that would make the government the employer of a majority of Americans by offering guaranteed well-paid jobs that people can't be fired from. And then there are more limited proposals, including installing more workers on the boards of private companies and instituting national rent controls and high minimum wages.

For their part, modern capitalists want some, but less, state intervention. They are skeptical of nationalization and price controls; they argue that today's economic problems are best addressed by harnessing private enterprise. In the United States, they've argued for more regulation and progressive taxation to help ease inequality, incentives to encourage private firms to use less carbon, and a more robust welfare state through tax credits. Over the past 15 years, meanwhile, capitalist Europeans have instituted reforms to improve labor market flexibility by making it easier to hire and fire people, and there have been attempts to reduce the size of pensions.

No economic system is perfect, and the exact right balance between markets and the state may never be found. But there are good reasons to believe that keeping capital in the hands of the private sector, and empowering its owners to make decisions in the pursuit of profit, is the best we've got.

One reason to trust markets is that they are better at setting prices than people. If you set prices too high, many a socialist government has found, citizens will be needlessly deprived of goods. Set them too low, and there will be excessive demand and ensuing shortages. This is true for all goods, including health care and labor. And there is little reason to believe that the next batch of socialists in Washington or London would be any better at setting prices than their predecessors. In fact, government-run health care systems in Canada and European countries are plagued by long wait times. A 2018 Fraser Institute study cites a median wait time of 19.8 weeks to see a specialist physician in Canada. Socialists may argue that is a small price to pay for universal access, but a market-based approach can deliver both coverage and responsive service. A full government takeover isn't the only option, nor is it the best one.

Beyond that, markets are also good at rationing risk. Fundamentally, socialists would like to reduce risk—protect workers from any personal or economywide shock. That is a noble goal, and some reduction through better functioning safety nets is desirable. But getting rid of all uncertainty—as state ownership of most industries would imply—is a bad idea. Risk is what fuels growth. People who take more chances tend to reap bigger rewards; that's why the top nine names on the Forbes 400 list of the richest Americans are not heirs to family dynasties but are self-made entrepreneurs who took a leap to build new products and created many jobs in the process.

Some leftist economists like Mariana Mazzucato argue that governments might be able to step in and become laboratories for innovation. But that would be a historical anomaly; socialist-leaning governments have typically been less innovative than others. After all, bureaucrats and worker-corporate boards have little incentive to upset the status quo or compete to build a better widget. And even when government programs have spurred innovation—as in the case of the internet—it took the private sector to recognize the value and create a market.

And that brings us to a third reason to believe in markets: productivity. Some economists, such as Robert Gordon, have looked to today's economic problems and suggested that productivity growth—the engine that fueled so much of the progress of the last several decades—is over. In this telling, the resources, products, and systems that underpin the world's economy are all optimized, and little further progress is possible.

But that is hard to square with reality. Innovation helps economies do more with fewer resources—increasingly critical to addressing climate change, for example—which is a form of productivity growth. And likewise, many of the products and technologies people rely on every day did not exist a few years ago. These goods make inaccessible services more available and are changing the nature of work, often for the better. Such gains are made possible by capitalist systems that encourage invention and growing the pie, not by socialist systems that are more concerned with how the existing pie is cut. It is far too soon, in other words, to write off productivity.

Here, it is worth considering the lessons of a previous productivity boom: the Industrial Revolution. As the economist Joel Mokyr has shown, it took new innovations like the steam engine more than 100 years to appear in productivity estimates. The same could be happening today with smartphones and the internet. Meanwhile, even as that upheaval transformed the human experience, creating a more comfortable existence for most everyone, it was also messy and disruptive. The early part of that innovative cycle—like others since—displaced existing workers while the gains flowed to the owners of capital first, causing social instability.

This time around, the effects may end up being less wrenching: The divisions between owners of capital and workers are not as clear as they used to be. More Americans than ever own stock through their workplace retirement accounts. Stock ownership is on the rise in many non-U.S. capitalist economies, too. And several other countries, such as Australia and the United Kingdom, also offer retirement accounts, making their citizens shareholders as well. Unlike 200 years ago, workers' interests are already more aligned with those of management.

Stock ownership in retirement accounts hints at the kinds of market-friendly policies that can share wealth while preserving innovation and risk-taking. In the United States, there is room to make taxes more progressive, especially when it comes to estate taxes, and to close tax loopholes that make it easier for companies to exploit the system. The social safety net could be expanded to include jobs retraining, an enhanced earned income tax credit, and grants to innovate or work remotely in smaller cities or more rural areas. And the health care industry is indeed in need of reform.

More generally, capitalism can be made more inclusive, and government programs can help smooth its rough edges. But none of these changes require governments to take over entire industries. Depending on the market, the reform could be a less intrusive government option, subsidy, or sometimes just better accountability.

Most fundamentally, inequality is tolerable if the poor have a shot at becoming rich, too. That shot has never been so great as the American dream in particular promised, but there is little evidence that economic mobility has actually gotten worse in recent years. Still, to avoid greater instability—and to ensure the greatest possible buy-in for the capitalist system—today's business and political leaders can do more to make sure everyone at least has a chance to roll the dice. Here, education reform and development of rural areas are necessary to close the gap.

And that's not socialism—it's building off capitalism and making better use of today's and tomorrow's workers.

Allison Schrager is an economist, journalist at Quartz, and co-founder of LifeCycle Finance Partners.