Is capitalism obsolete?

We now live in an economy which is very different from that in which capitalism, in its modern form, emerged and it is doubtful how relevant efficiency in production is the the key sectors of the knowledge economy.
Older forms of the ownership of the means of production do exist, alongside this: farms owned by farmers, dental practices owned by partnerships, cooperatives, consultants etc. These are all forms of production where the full sophistication of modern capitalism (form example access to capital markets) is not worth the costs it imposes, so they ancient forms of ownership suffice.
It is even possible to prove, with mathematical rigour, that given perfect competition and certain other conditions, this is a perfectly efficient system.

Capitalism excels in allocating scarce resources resources to where they are most economically productive. Consumer demand drives the allocation scarce supplies. This demand then feeds up a chain, as suppliers buy from their suppliers. Competition provides the incentive for efficiency.

Of course there are problems with this wonderfully efficient system. The distribution of wealth is one, externalities (such as environmental damage) are another. Despite this no other system that has been tried as managed the same sheer efficiency in creating wealth.

The economic arguments for believing that capitalism is efficient rests on the assumption that each unit of a product made uses more of whatever resources are used to produce it. The more of a product is made the more resources need to the allocated to its production. The problem is that an increasing proportion of the cost of many products and services is not related to how much is supplied. This is true of many major industries:

  • Software: There is no marginal cost of production apart from a negligible distribution cost. There is no capital cost for manufacturing facilities (except as a component of the cost of distribution). The only cost is the development of the product.
  • Entertainment, music and publishing: in recorded forms, once a recording is made the cost of producing more is negligible. As with software copies can be made cheaply.
  • Pharmaceuticals: For many drugs, once they are developed, the actual cost of production is comparatively small. The marginal cost of production is a trivial part of the cost.

Other industries, such such as electronics, computer hardware and other (especially high technology) manufacturing also spend heavily on research and development (R & D) and this is reflected in the prices they charge. This cost is again not related to the volume produced. Almost others have some element of similar costs in their prices -for example the cost of designing a car.

Without scarcity the case for capitalism breaks down. There is no clear cut case of believing that R & D and production of creative material is best carried out by profit making firms.

It is possible to link these activities to future profits through the use of patents and copyrights, but these are very crude links imposed by governments rather than an efficient market mechanism. They limit distribution (which directly reduces the gains to society, and and therefore economic efficiency) and the amount of the incentive depends as much on government fiat imposing the terms of the incentives, as on market forces.

These mechanisms boost firms profits by creating monopolies but at the same time are ineffective at funding R & D that governments subsidise research both directly and indirectly through grants, tax concessions, and the selective granting of government contracts.

In addition great deal of research is carried out by non-profit organisations (such as universities and medical charities). For example, the internet was developed by academic and military researchers and much of the software that makes it useful was developed either by academics or by others with non-commercial motives.

If we were to remove R & D from the commercial sector (I do not say private sector because of the important role of private non-profit organisations and individuals) we would do this by abolishing patents, tax breaks and other incentives they receive for carrying out R & D.

The immediate winner, if we did this, would be the consumer, particularly the poor (such as those who currently lack access to patented medicines). Without the monopolies they gain from patents (and copyrights for software) firms would operate in a more competitive market, making them much less profitable, and more, at the same time, more efficient.

This would be a major change rather than tinkering, it would mean that one of the most important economic activities was carried out wholly outside capitalism. These are not just a large part of the economy, these are the activities that drive the future development of the economy.

We do not even know if R & D would slow without patents and copyright – free software provides compelling evidence that the sharing of information and the freedom to tinker with others’ inventions would speed up development. Books and music existed long before copyright and art will go on. What we do know is that corporate profits would shrink and prices would fall drastically.