I’ve determined it is the objectively correct definition of “capitalism.”

In this essay, I will convey Munger’s definition of capitalism and defend its superiority.

The stadial theory has three nested stages:

1. Voluntary Exchange

2. Markets

3. Capitalism

Voluntary Exchange

Every society engages in some form of trading goods and services. Adam Smith described as a part of human nature “the propensity to truck, barter, and exchange one thing for another.” The positive-sum exchange of labor and property leads to consumer and producer surplus, i.e., gains from trade. Munger, building on Smith, emphasizes the significance of “propriety” and “justice” being developed in a culture to facilitate “long-term reciprocal relation[s].” One could describe this as building up a baseline of enlightened self-interest and reciprocal altruism to facilitate commerce.

Munger describes Smith’s theory of justice as:

Justice is abstaining from what is another’s. And it has three parts: person, property, and promise. I become committed to not taking someone else’s stuff; I become committed to not interfering with another person’s life; and I become committed to carrying out my promises for their own sake. And, the impartial spectator approves of this.

Bluntly, you can’t have effective commerce without property rights, voluntary participation, and basic moral standards grounded in self-interest. These foundational mechanisms and principles then require certain institutions to scale and become markets. Munger channels Douglass North to define markets as a “set of institutions for reducing the transactions cost1 of impersonal exchange.”

Markets

Scale requires facilitating impersonal exchange and one-off transactions, which includes a general sense of trust and commitment to the version of justice described above. Institutions needed for markets include the formal, consistent rule of law to protect property rights and enforce contracts. Another is money (and sound monetary policy) to facilitate easy exchanges with basically anyone for basically anything. The capability to issue debt allows intertemporal exchange at a basic level. Greater scale enables greater productivity gains from the division of labor, specialization, and comparative advantage. Market prices are signals, wrapped in an incentive — they dynamically convey information and motivation at scale to consumers and producers to drive the efficient allocation of resources via decentralized coordination and thereby spur production for supply to meet demand.

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Capitalism

Liquid magic

Building on the scale, norms, and institutions developed in the prior stages, Munger describes the final stage: “Capitalism is a set of specialized market institutions that allow time travel.” In a word, liquidity. Similar to how markets facilitated impersonal voluntary exchange at scale and debt enabled it over time, the existence of liquidity in large capital markets allows moving value to fixed, physical assets, over time and space. Intertemporal investments are incentivized for borrowers and lenders, with an evaluation of risk and reward for both parties. It robustly solves at scale the chicken-and-egg problem of how to get development going from ~nothing.

Shares of profits

Another critical institution is being able to “sell shares in the profits that don’t yet actually exist.” Beyond the ancient utility of debt, what capitalism “requires is a set of financial markets that allow thick trading where [when] you get prices, you are pricing the future value of a corporation that doesn’t exist.” Liquidity, the corporation, and the stock market unlock massive growth potential via dynamism. Together, these allow entrepreneurs and investors to experiment with answers to the question: What would consumers buy if we could make it for them? You can just try things, under capitalism. Sensible risk-taking is incentivized.

This is a major leap because, while having debt repaid can create profits for both lender and borrower, it has less potential benefit and more downsides. There is far more upside potential for an investor in owning shares of an eventually successful corporation. Plus far less of a burden and risk on a fledgling enterprise to sell shares rather than to take on debt. Business loans need to be repaid as a business grows, whereas growth in equity value is not restrained by having to settle debts and take on new loans. A capitalist system will therefore drastically outgrow a (purely) debt-financed system, because more efficient allocation of risk and reward is possible for innovators and entrepreneurs.

In a sentence

This is why we have nice things

Number go up

We got the Great Enrichment because the development of liberalism and capitalism combined with technological innovation to drive prosperity at scale. Note that Adam Smith was writing in the late 18th century, just as the Industrial Revolution was taking off and the United States was being founded. It’s hard to imagine anyone more correct in their grand theory predicting the future than he was in The Wealth of Nations. Economic growth is the single best variable one can aim at.2

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Why economies fail

Understanding what brings about capitalism makes clear what prevents economic flourishing. Munger emphasizes, in accordance with Gall’s Law, that you can’t have the complexity and benefits of capitalism without the foundation of voluntary exchange and markets: “It’s hard to become a capitalist country because you have to have a set of institutions. Well, you need a different history. Basically. Doug North was right. For most countries, you would need a different history.” If you don’t have the basic norms of voluntary exchange, you are going to get extractive institutions.

An efficient, productive economy is grown, not designed. To succeed, it requires both cultural norms and formal legalistic standards, from the level of the individual to all of society. A society without a strong baseline of trust and property rights as civil rights has such high transaction costs that commerce cannot function efficiently and growth is inhibited: “Capitalism can’t be grafted on to a society that doesn’t have these attitudes and institutions already.”

There is only ethical consumption under capitalism

This conception of capitalism highlights what the typical critic refuses to understand. Capitalism requires and incentivizes ethical behavior; that Adam Smith was as much a moral philosopher as he was an economist is not coincidental. Empirically, we know the abundance generated from pro-social, positive-sum, enlightened self-interest does far more to help the unfortunate at scale through reducing scarcity than mere charity or coerced redistribution ever have. Capitalism takes flawed, overly self-interested human beings and rewards them for delivering goods and services others want. Cooperation is just as important as competition, and they are frequently two sides of the same coin — every transaction is necessarily cooperative and a competition for the best available deal.

Critics of capitalism want to emphasize greed, private ownership, inequality, and exploitation — so rarely acknowledging that no economic system eliminates all human problems, that scarcity is the state of nature, and that commerce and wealth are not zero-sum. In this reality-free view, prices are simply a dictated number that can be altered at whim with no repercussions. Incentives need not be assessed. Subsidies help when supply is held constant. No billionaire is valid. Government is by default good and corporations are inhuman(e). Deregulation is inherently bad. Utopia is one revolution away. They can compare their imagined utopia against the best available reality and their imagination wins every time.

You too can join the capitalist revolution

A related point, which could have saved humanity a great deal of suffering were it sufficiently understood, is the fact that under capitalism employees can be paid partly in stock. It aligns incentives because it provides upside with the success of the company. Additionally, anyone can choose to invest in publicly traded companies. Thus, everyone can be owners3 of the means of production.

Immaterial considerations

Roberts points out at the end that material prosperity does not guarantee meaning or emotional or spiritual well-being. Smith wrote that we want to be “loved and lovely.” Munger agrees. Money is great, but “we can’t substitute commerce for society.” Similarly, liberalism has its origins in allowing competing religions4 to peacefully coexist, but may not itself suffice as a belief structure for any individual’s life satisfaction. These limitations are features, not bugs. No one idea or tool can solve all that is the human condition.

As a lad, I was raised in the tradition of Reagan Conservatism and then converted in my teens to what we could call “Obama Neoliberalism” (i.e., the Center Left, Left Neoliberalism). Those were the glory days of Jon Stewart and Stephen Colbert. Life was simpler then, when reality had a well-known liberal bias. I would argue that it has and does, if one uses the original and proper definition of “liberal.”

As time went on, I became more and more aware of the inaccuracies and blind spots of the progressive canon, and the economic failures of policies favored by the American and global Progressive Left.3 These failures, I learned, were predicted by Classical Liberalism, public choice theory, and James Q. Wilson4. You may or may not find my personal shift to Classical Liberalism persuasive; the facts should still move you toward the neoliberal margin.5

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An underlying belief I possess that led me to consider things the way I have is this: If we truly care about material progress and improving the lot of the disadvantaged—ostensibly the moral driving force of the Left—we should therefore rigorously care about achieving improvements with effective policy and efficient use of finite government resources. The Effective Altruism6 movement takes this approach—recognizing concepts like opportunity costs, diminishing returns,7 and impact levels—to charitable giving on a global level. It would be nice if there were, I don’t know, call it “Effective Progressivism,”8 to check on policy effects and ROI. They could do a lot better if they cared about results.9

As you read the following points, observe if you have the instinctual response to avoid debating them on the merits and shift to a reaction like “everyone already knows this”10 or “that doesn’t mean deregulation will make things better”11 or “what we need is better policy.”12 Or, “actually Social Security is neoliberal enough we just need more funding.” In other words, mind the gap between your factual and opinionated entitlements.

Entitled Facts

The Global War on Poverty

Common measures of poverty in the U.S. do not factor in all taxes and transfers. The very treatments implemented to address the issue. We already “won” the “war on poverty” in absolute terms to reduce suffering—as measured by consumption. The same stunt is often done for inequality. If you don’t move the goalposts and count existing policy interventions, we’re already largely post-scarcity and highly egalitarian—to the extent the U.S. is more progressive and redistributive than any European country by certain measures. Which is probably why poverty became positively correlated with obesity about the same time that bottom line in the chart dropped below 5% in the 1990s. Self-sufficiency, on the other hand…

This great news extends to most of the world. At this point, suffering from scarcity is almost always the result of entrenched political/societal dysfunction or conflict, not lack of charity or redistribution. This is plainly from the growth in global GDP as a result of market economics13 and technological progress, not redistribution.14 Progressives tend to be strongly nationalistic in their redistribution aims and views on trade, and often desire to impose higher regulatory and moral standards for developing countries, which are not yet affordable, thereby supporting policies that hurt the global poor. Sweatshops and child labor are a necessary evil good, actually.

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The Price is High

The incredibly high and rising costs of key parts of the U.S. economy—most notably housing and medicine—largely result from government policy restricting supply while subsidizing demand. Not greed. Not monopoly. Not natural limitations.15 “Cost-disease socialism” is what’s bankrupting us. Perversely, the high prices are frequently blamed on market failures, instead of obviously flawed policy strangulating supply and preventing markets from working. We could have more doctors16 and houses and clean energy if we chose to.

Helping the Advantaged

Instead of the welfare state being aimed at alleviating suffering of the disadvantaged, it turns out that it actually is more aimed at the part of society that is, on average, the wealthiest—the elderly. We’ve managed to rig our redistribution net to take away from the young and productive and give more to the old and wealthy. (It’s probably mere coincidence that the elderly are also the most consistent voting bloc, right?)17 Social Security is for all practical purposes a poorly designed Ponzi scheme18 and Medicare costs are ballooning, as the demographic transition makes all this much worse. Deficits are a tax on the future; too bad unborn generations have such low voter turnout.19

“You didn’t [cause] that”

The common narrative is that things got better for workers in the 20th Century because of unions and activists advocating for government policies to improve things. But it’s actually a tale of economic growth allowing us to make our working lives better so that we could afford trade-off costs.

Similarly, the 40-hour work week and end of common child labor are overwhelmingly a story of increased economic productivity and changing workforce needs, not activist achievement via policy.

In other words, economic feasibility had to be achieved to consider such things at all; formalizing the changes in law is a lagging indicator after it was economically feasible.

The Bad Deal

The New Deal actually managed to significantly prolong the Great Depression via price controls on goods and wages and other harebrained interventions.

China Shocks, Rusty Belts

The stagnation and decline of the Rust Belt is often attributed to the rise of China, globalism, and free trade. However, the main drivers of the decades-long decline were automation and secular trends in job sector shifts, plus union power20 hurting competitiveness. In contrast, the Sun Belt has done well, and even the areas ostensibly hit by the China shock have all had wage growth since 2001.

Eutopian Europe

“Why can’t we be more like Europe?” They have such nice healthcare and trains21 compared to us, after all. A couple of decades ago, that progressive battle cry sounded at least nice in theory. Now though, we can see the lines diverge.

Much of Western Europe is poor and stagnant, and with no air conditioning.22 The famed British NHS is in crisis, as is Britain’s labor force participation, while its “triple lock” pension grows toward infinity during a struggling economy. And poor Germany.

Progressives Against Progress

Perhaps the most powerful indictment of progressivism is looking at the track record of places where progressives have had a monopoly on political power for decades—Blue states and cities. There’s a strong spirit of Blue-tape and degrowth in states like Massachusetts. Blue cities are often terribly managed.

Comparing similarly sized Blue New York and Red Florida is illustrative:

They have comparable populations — New York with about 20 million people, Florida with 23 million. But New York state’s budget is more than double that of Florida ($239 billion vs. roughly $116 billion). New York City, which is a little more than three times the size of Miami-Dade County, has a budget of more than $100 billion, which is nearly 10 times that of Miami-Dade. New York City’s spending grew from 2012 to 2019 by 40 percent, four times the rate of inflation. Does any New Yorker feel that they got 40 percent better services during that time?

What do New Yorkers get for these vast sums, generated by the highest tax rates in the country? (If you are well off in New York City, you pay nearly as much in income taxes as in London, Paris or Berlin — without free higher education or health care.) New York’s poverty rate is higher than Florida’s. New York has a slightly lower rate of homeownership and a much higher rate of homelessness. Despite spending more than twice as much on education per student, New York has educational outcomes — graduation rates, eighth-grade test scores — that are roughly the same as Florida’s.

To summarize, most commonly identified market failures are really policy failures. Economic growth via competitive markets and technological progress is what typically gives us nice things in the war on scarcity, not policy interventions and activism. The efforts of activists, well-intended or not, frequently hurt the productivity improvements we need to improve material well-being at scale, especially in the long run. Usually, critics compare real, imperfect markets to unrealistically effective potential government interventions, which turn out to be worse when actually implemented.

I recommend a strong dose of Classical Liberalism before we drive (further) off a fiscal cliff.

After all that, I should say there has in recent years been a “supply-side” and “abundance” and fiscal responsibility focus from some left-leaning thought leaders such as Matt Yglesias, Noah Smith, and Ezra Klein, and groups like the Center for New Liberalism and the YIMBYs. They do not, in my eyes, take things far enough. But better late than never and I wish them all the luck in the world at shifting the American Left back to an economically informed Third Way that cares about growth and prosperity.