Related to: Fight zero-sum bias

Disclaimer: (added response to comments by Nic_Smith, SilasBarta and Emile) - The point of this post is not to argue in favor of free markets. The point of this post is to discuss an apparent bias in people's thinking about free markets. Some of my own views about free markets are embedded within the post, but my reason for expressing them is to place my discussion of the bias that I hypothesize in context, not to marginalize the adherents to any political affiliation. When I refer to "capitalism" below, I mean "market systems with a degree of government regulation qualitatively similar to the degree present in the United States, Western Europe and Japan in the past 50 years."

The vast majority of the world's wealth has been produced under capitalism. There's a strong correlation between a country's GDP and its citizens' self reported life satisfaction. Despite the evidence for this claims there are some very smart people who are or have been critics of capitalism. There may be legitimate arguments against capitalism, but all too often, these critics of capitalism selectively focus on the negative effects of capitalism, failing to adequately consider the counterfactual "how would things be under other economic systems?" and apparently oblivious to large scale trends.

There are multiple sources of irrational bias against capitalism. Here I will argue that a major factor is zero-sum bias, or perhaps, as hegemonicon suggests, the "relativity heuristic." Within the post I quote Charles Wheelan's Naked Economics several times. I believe that Wheelan has done a great service to society by writing an accessible book which clears up common misconceptions about economics and hope that it becomes even more widely read than it has been so far. Though I largely agreed with the positions that he advocates before taking up the book, the clarity of his writing and focus on the most essential points of economics helped me sharpen my thinking, and I'm grateful to him for this.

A striking feature of the modern world is economic inequality. According to Forbes Magazine, Amazon founder Jeff Bezos made $7.3 billion in 2009. That's more than the (nominal) 2009 earnings of all of the 10 million residents of Chad combined. Many people find such stark inequality troubling. Since humans exhibit diminishing marginal utility, all else being equal, economic inequality is bad. The system that has given rise to severe economic inequality is capitalism. Does it follow that capitalism is bad? Of course not. It seems very likely that for each positive integer x, the average world citizen at the x^th percentile in wealth today finds life more fulfilling than the average world citizen at the x^th percentile in wealth 50 years ago did. Increased inequality does not reflect decreased average quality of life if the whole pie is getting bigger. And the whole pie has been getting a lot bigger.

While it's conceivable that we could be doing better under socialist governments or communist governments, a large majority of the available evidence points against this idea. Wheelan suggests that

a market economy is to economics what democracy is to government: a decent, if flawed, choice among many bad alternatives.

A compelling argument that it's possible to do better than capitalism (given human nature/limitations as they stands) would at very least have to address the success of capitalism and the relative failure of other forms of government up until now. In light of the historical record, one should read the financial success of somebody like Jeff Bezos as an indication that he's making the world a lot better. Yet many idealistic left wing people have a vague intuition that by making a lot of money, business people are somehow having a negative overall impact on the world.

There are undoubtedly several things going on here, but I'd hypothesize that one is that people have a gut intuition that the wealth of the world is fixed. In a world of fixed wealth like the world that our ancestors experienced, the only way to make things better for the average person is to redistribute wealth. But this is not the world that we live in. On page 115 of Naked Economics, Wheelan attempts to exorcise zero-sum thinking in his readers:

Will the poor always be with us, as Jesus once admonished? Does our free market system make poverty inevitable? Must there be losers if there are huge economic winners? No, no, and no. Economic development is not a zero-sum game; the world does not need poor countries in order to have rich countries, nor must some people be poor in order for others to be rich. Families who live in public housing on the South Side of Chicago are not poor because Bill Gates lives in a big house. They are poor despite the fact that Bill Gates lives in a big house. For a complex array of reasons, America's poor have not shared in the productivity gains spawned by DOS and Windows. Bill Gates did not take their pie away; he did not stand in the way of their success or benefit from their misfortunes. Rather, his vision and talent created an enormous amount of wealth that not everybody got to share. This is a crucial distinction between a world in which Bill Gates gets rich by stealing other people's crops and a world in which he gets rich by growing his own enormous food supply that he shares with some people and not others. The latter is a better representation of how a modern economy works.

It's a great irony that there are people who have rejected high paying jobs on the grounds that they must be hurting someone because the pay is high when they could have helped people more by taking the high paying jobs. To be sure, some people do make their money by taking money away from other people (the case of some of the behavior of the "too big to fail" banks comes to mind), but on average making money seems to be good for society, not bad for society.

The case of trade

Trade and globalization are key features of modern capitalism. These practices have received criticism both from (1) people who are concerned about the well being of foreigners and (2) people who are concerned about the well being of Americans. I'll discuss these two types of criticism in turn.

(1) I remember feeling guilty as an early adolescent about the fact that my shoes and clothes had been made by sweatshop laborers who had been paid very little to make them. When I heard about the 1999 WTO protests as a 14 year old I thought that the protesters were on the right side. It took me a couple of years to dispel the belief that by buying these things I was making things worse for the sweatshop laborers. I implicitly assumed that if they were being paid so little, it must be because somebody was forcing them to do something that they didn't want to do. In doing so, I was anchoring based on my own experience. It didn't initially occur to me that by paying very little for clothes and shoes, I could be making life better for people in poor countries by giving them more opportunities. I eventually realized that if I restricted myself to buying domestic products I would probably make things better for American workers, but that in doing so, I would deny poor foreigners an opportunity.

And it was only much later that I understood that giving a country's citizens' the opportunity to work in sweatshops could ultimately pave the way for the country to develop. It took me many years to internalize the epic quality of economic growth.

Wheelan says

The thrust of the antiglobalization protests has been that world trade is something imposed by rich countries on the developing world. If trade is mostly good for America, then it must be mostly bad for somewhere else. At this point in the book, we should recognize that zero-sum thinking is usually wrong when it comes to economics. So it is in this case.

[...]

Trade paves the way for poor countries to get richer. Export industries often pay higher wages than jobs elsewhere in the economy. But that is only the beginning. New export jobs create more competition for workers, which raises wages everywhere else. Even rural incomes can go up; as workers leave rural areas for better opportunities, there are fewer mouths to be fed from what can be grown on the land they leave behind. Other important things are going on, too. Foreign companies introduce capital, technology, and new skills. Not only does that make export workers more productive; it spills over into other areas of the economy. Workers "learn by doing" and then take their knowledge with them.

and quotes Paul Krugman saying

If you buy a product made in a third-world country, it was produced by workers who are paid incredibly little by Western standards and probably work under awful conditions. Anyone who is not bothered by those facts, at least some of the time, has no heart. But that doesn't mean the demonstrators are right. On the contrary, anyone who thinks that the answer to world poverty is simple outrage against global trade has no head - or chooses not to use it. The anti-globalization movement already has a remarkable track record of hurting the very people and causes it claims to champion.

Why does people's disinclination to use their heads on this point produce such disastrous results? Because (a) the relativity heuristic which hegemonicon mentioned is ill-suited to a world with so much inequality and perhaps because (b) the intuition that the pool of resources that people share is fixed is hardwired into the human brain.

(2) In an interesting article titled Why don't people believe that free trade is good?, economist Hans Melberg cites the following statistics:

89% of economists in the US think trade agreements between the U.S. and other countries is good for the economy, compared to 55% of the general public. Only 3% of economists think trade agreements are bad for the economy, while 28% of the general public think so (p. 111). 68% of the general public think that one reason why the economy is not doing as well as it could, is that "companies are sending jobs overseas". Only 6% of economists agree (p. 114)

_{Source: Blendon, Robert J. et. al., "Bridging the Gap Between the Public's and Economists' View of the Economy", Journal of Economic Perspectives, Summer 1997, vol. 11, no. 3, pp. 108-118.}

My impressions from casual conversations and from the news is that people in the general population have a belief of the type "there's a limited supply of jobs, if jobs are being sent to Southeast Asia then there will be fewer jobs for Americans." Of course there's no intrinsic barrier to people in Southeast Asian and the people in American all having jobs. The idea that the supply of jobs is fixed seems to arise from fallacious zero-sum thinking and Melberg lists zero-sum thinking as one of four factors relevant to why people believe that free trade is bad.

There is a genuine problem for America that arises from allowing free trade, namely the phenomenon of displaced US workers. But aside from being outweighed by the benefits of free trade to America, this phenomenon can and should be considered without the clouding influence of zero-sum thinking.

[1] See a remark by VijayKrishnan mentioning essays by Paul Graham which may overlap somewhat with the content of this post.

07/19/10 @ 1:30 AM CST - Post very slightly edited to accommodate JoshuaZ's suggestion.

07/19/10 @ 9:34 AM CST - Post very slightly edited to accommodate billswift's suggestion.