When Theory Meets Reality

When Theory Meets Reality

Mark Lazar’s December 2021 Newsletter

The theory of Communism may be summed up in one sentence; abolish all private property.
~ Karl Marx

 

Item YTD Change
Dow Jones Ind Avg 11.16%
S&P 500 Index 20.15%
EAFE Foreign Index 3.55%
Emerging Market Index -6.11
Barclays Agg Bond Index 2.44%
2021 GDP Growth Forecast 6.7%
Unemployment Rate 4.6%

*Market index data as of 11/30/2021

 

In 1848 German philosophers Karl Marx and Friedrich Engels published The Communist Manifesto, a short treatise concerning the nature of society and politics. Marx supposed the world was made of up two classes; those who owned businesses, private property, and employed labor—the bourgeoisie. And those who sell their labor for wages—the proletariat. In fairness, 19th century England, where Marx spent most of his adult life, was primarily a two-class system, made up of either landed gentry; wealthy land holders who gained their status through family lineages, or the underclass, consisting of poorly educated, unskilled laborers who were relegated to low-paying, menial jobs, with little opportunity to improve their standard of living. However, the Industrial Revolution led to the rise of a middle class, and produced college-educated professionals like doctors, engineers, lawyers, and other white-collar workers who weren’t yet wealthy, but perceived a distinction between themselves and the lower classes.

While he didn’t introduce the concept of the Labor Theory of Value, Marx had his own version of it, which postulated that all value comes from labor, and that any profit derived from private enterprise must come from the pocket of said labor. But Marx seemed to miss what every first-year economic students knows, which is a functional and efficient economic model requires four factors of production, or ingredients, if you will: land, labor, capital, and entrepreneurship, and each provides value to the consumer.

Think of any successful business and try to imagine it being so without one of these four resources. Which of the four is most important, you might ask? I believe that question would be akin to asking which component is the most important for a car to function: the engine, transmission, battery, or fuel? Obviously, they’re all necessary for a car to be a useful form of transportation.  

Another question you might ask is why then are there nations which seem to have all four factors, such as Venezuela and Argentina, yet their economic status is far below countries such as the U.S., Canada, or Australia? There is one more critical requirement for a nation’s economy to grow and prosper: a government that maintains law and order in addition to protecting property rights. In other words, rule of law. While Marxist theory makes for interesting classroom discourse, its fatal flaw is it simply doesn’t work in the real world. Labor is a necessary input for any functional economy, but is labor more valuable to society than ideas/intellectual capital or entrepreneurial spirit? More valuable than land, or financial capital? And if there wasn’t a profit motive, what would be the incentive for innovators, entrepreneurs and those with capital to take risk on some new business or idea? 

To prevent “evil capitalists” (think Bill Gates, Jeff Bezos, Michael Dell, Steve Jobs, Sam Walton, Elon Musk, and the like) from pilfering the pockets of labor, Marx envisioned a benevolent government seizing the means of production, whence all wealth would then be equally distributed, thus achieving his goal of equity, or equality of outcome. Marx wrongly believed wealth is a zero-sum game. It ain’t. Yes, the aforementioned captains of industry made billions of dollars in profits, but is the country/world worse off because of them or better? How many millions of highly paid employees work for these companies? How many customers freely trade dollars for their products, not because they are forced or coerced to, but because they create value? How many vendors get paid? How capital projects were built because of these companies? How many billions in tax dollars were collected by the government? And how many trillions of dollars of profit have shareholders enjoyed, including private, state, and federal pension plans, 401K plans, and various retirement accounts? In Marx’s utopia, there would be no Amazon, no Apple, no Windows-based computers, and no Starbucks. Instead, Uncle Sam would be running everything, meaning you’d have the same innovation, service, and efficiency you get from the IRS, Social Security Administration, and the DMV.

Unlike a state-run economy, a capitalist or market economy, is based on voluntary exchange; where buyers and sellers come together and exchange money for goods or services, and in doing so both parties increase their respective utility. The beauty of capitalism is that a profit motive serves the public good far more efficiently than any government program. Unlike the private sector, which must create value or perish, government agencies aren’t subject to any such requirements. Darwinian survival of the fittest consequences do not apply to the state, which is why a profit motive is the purest and best motive. The quest for greater riches compels merchants to compete for your dollars through ongoing innovation, improved quality, greater service, and lower prices. The invisible hand serves the common good far more efficiently and effectively than any government agency.

Marx’s command economy makes perfect sense—in theory; let’s have really smart (experts), altruistic people in the capital city figure out everything and, with Solomon-like wisdom, run our country for us. But how would they know what we want, how much to produce, and how much we’re willing to spend? How would they know we wanted a Windows-based computer, an iPhone, a Tesla, Facebook, or Amazon? And how many/much should be supplied, and at what price point? A market system knows the answer to those questions, as it’s both a price mechanism as well as a feedback system

In stark contrast to a neat, orderly, centrally planned economy, a decentralized free market system is messy, confusing, and unpredictable. But one thing is for certain; it’s the only known method for raising society’s standard of living, both for the rich and poor alike, albeit not equally. Whereas other social economic systems simply redistribute existing wealth and, in the process, decrease the incentive for wealth creation (e.g., innovation, entrepreneurship, risk-taking, hard work, sacrifice, etc.), a capitalist system does the very opposite, which might explain why the US, that represents 4.2% of the world’s population, has 41% of the world’s wealth. 

It’s been said that a college professor is one who when observing something working in practice will ask, yes, but does it work in theory?

 

Mark Lazar, MBA
Senior Vice President–Investments
Certified Financial Planner™
pathwaytoprosperity.com