The Two Kinds of Capitalism

Original post date: February 12, 2014
Article by: Ben Douglas

The term “capitalism” is often thrown around in American political discourse without a specified or coherent meaning. Frequently in a debate, opposing parties will attack or defend their own perceived ideas of what capitalism is, without realizing that their opponent has in mind a completely different system. In the spirit of clearing up this widespread miscommunication, a clear delineation should be maintained at all times between two competing economic systems, both of which are frequently referred to as “capitalism.” These two systems, I will argue, are different not just in degree, but in kind.

The first type of capitalism is “free-market” or “laissez-faire” capitalism. This is the capitalism of Enlightenment Philosophers Adam Smith and David Hume, economist Ludwig von Mises, and Nobel prize winners Friedrich Hayek and Milton Friedman as well as their many acolytes. Proponents have historically self-identified as liberals (in the classical sense) and supported property rights and small government. Rarely, if ever, do they support monopoly.

Indeed, a vast body of literature in the free-market capitalist tradition is stringently anti-monopoly. An exception is typically made for the provision of law, courts, protection, roads, and some minimalist regulatory institutions, although a number of laissez-faire capitalists have proposed that the market could produce these services better than the state, notably Bruce Benson, David Friedman, and Murray Rothbard.

The second type of capitalism is “crony” capitalism. Florida State University economist Randall G. Holcombe describes it as “an economic system in which the profitability of firms in a market economy is dependent on political connections.” In addition to politicians and businessmen who stand to benefit from crony capitalist policies, proponents include well-intentioned neoconservatives and New Deal or left-liberals, whose support is often inadvertent.

Neither kind of capitalism is intrinsically pro-business. Each proposes a different method of doing business. Under both systems, businesses are profit maximizing. Under free market capitalism, however, profits can only be made by producing goods or services that satisfy the wants of consumers. Under crony capitalism, businesses attempt to have laws passed protecting one’s business from competition and imposing costs on the competition. Tariffs protect domestic manufacturers from foreign competition. Subsidies give their recipients a leg up on the competition. Patents grant their holders flat-out monopolies. Regulations impose costs on doing business, thereby creating barriers to entry. The process by which businesses attempt to be at the receiving end of these privileges is known as rent-seeking.

In a crony-capitalist economy, businessmen cannot simply opt out of rent-seeking. Failure to hire lawyers and lobbyists can be a fatal move— deciding to play nice does not mean the other guy will. The practices of “defensive medicine” and “defensive patent aggregation” are two examples of this. Very successful companies are often the target of antitrust lawsuits brought on at the behest of jealous competitors. The extreme malleability of antitrust law enables any company to be arguably found in violation, if its industry is interpreted narrowly enough

For these reasons, the two kinds of capitalism—free-market and crony capitalism—are different in kind. Under the former, profits are made solely by serving consumer demand. Under the latter, profits can also be made by using the political system to manipulate the market to reward some businesses at the expense of others. This point is further supported by the fact that each system is instituted using entirely opposite means. This will be the subject of my next blog.

About DeVoe Moore Center

The DeVoe L. Moore Center is conducts economic research and policy analysis focused on state and local policy issues and is located in the College of Social Sciences and Public Policy at Florida State University in Tallahassee. As an educational institution the DMC provides professional research experience to undergraduate and master’s students through an extensive program of internships and independent study, preparing them for a future in public policy, economic development, public sector accountability and entrepreneurship.
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