Capitalism vs Big Government. “The Good, the Bad and the Ugly”.

I loved those “spaghetti westerns”, staring Clint Eastwood as the good, and Lee van Cleef as the bad, and Eli Wallach as the ugly. When I compare capitalism to big government, depending on the situation, each of these institutions can represent the good, the bad and the ugly. Both have a major role to play in our society, and it is about balance.

President Eisenhower coined the expression “the military and industrial complex”. We need a strong military to protect us, which is good. However, President Eisenhower reminded us about the potential economic power of this constituency, which can be bad if expenditures are not appropriately monitored.

Now, when we talk about the “ugly,” it can also be found in both sectors of the economy. In government, we have to be concerned about corruption and “crony” capitalism, where tax payer dollars go to prop up failed enterprises like Solyndra. In addition, the stimulus bill sent billions to the Energy Department that disbursed loans and grants among green companies. This was to create five million new jobs. Instead, Solyndra went bankrupt, squandering $535 million in loan guarantees. Furthermore, there were other bankruptcies, such as Beacon and Enerl. That was “ugly”.

In addition, to avoid the glare of crony capitalism, the democrats like to talk about one of their perceived successes, the bailout of General Motors and Chrysler. While it looks as though these companies are doing much better, the process to accomplish this restructuring was ugly. Contract law was grossly violated as the unions, which had less ownership of these companies than other creditors like bond holders, were given preferential treatment in the settlement. Moreover, according to Kimberly Strassel of the Wall Street Journal, political sway and not good economics determined what auto dealerships would be kept open.

On the other hand, capitalism can be ugly too. When chief executives and top management of corporations receive compensation that is at historically high multiples of middle management, and is not commensurate with performance, this is reprehensible. Unfortunately, there are too many examples of boards of directors that are not properly executing their roles to oversee management and protect shareholders. Enron, Worldcom, Lehman Bros., Lucent, Eastman Kodak, General Motors are just a few of these examples. Many years ago, executives joined boards as part of their corporate responsibility, and at the same time gain stature and experience in order to improve their resumes. Compensation was modest, and not the primary goal. This has changed dramatically today as boards appear to be corrupted by excessive compensation fostering a “do not rock the boat mentality” that inhibits their role as ombudsman.

Nevertheless, as egregious as the “bad apples” in a capitalistic system can be, big government has the proclivity to be much worse. At least, the private sector has the price mechanism and the profit incentive to regulate costs. Moreover, poorly managed companies will eventually be punished in the marketplace. Whereas the government has no natural disciplines to keep costs under control, and corrupt politicians can remain in office for a long time unless there are term limits. Also, government bureaucracies have of a tendency to be inefficient since reducing budgets and head count diminishes power, control, and generally makes it harder to do more with less. In fact, power, politics, corruption and inefficiency seems to be the order of the day when it comes to big government.

Joseph Schumpeter was a famous Austrian-Hungarian-American economist that popularized the term “creative destruction”. This refers to how the market place works under a capitalistic system where profitable, well-managed companies will survive, and poorly managed companies will eventually be driven out of business. This process can be harsh at times, and have an adverse affect on peoples lives. However, it is a much more efficient way to allocate capital than having big government control the market place. Japan, is a classic example of how the government, not the market place, managed creative destruction. As a result, over the past twenty-plus-years, its economy has stagnated. It would have been much more humane to have the marketplace clean out the excesses more quickly than have the government drag out this process over so many years.

This begs the question of what is the role of government? We need government to protect us not only from external threats but internal as well, provide for infrastructure spending and a safety net for those who are incapable of helping themselves. This represents the “good”. However, there is an economic cost for this protection. If we want clean food, water, and basically a clean environment, we need appropriate government regulations. The trick is to have intelligent, cost-effective regulation that will not strangle economic growth. Therefore, the government should act as referee between the public and private sectors of the economy, not a wedge that inhibits growth.

Unfortunately, the federal government is not acting as a referee today, but has become a dominant force in our economy. Alexis de Tocqueville, the great French political thinker and historian said, “ The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.” Unfortunately, Congress and the Executive branches of government have already figured this out. According to two governmental agencies, the U.S. Bureau of Economic Analysis, and the Office of Budget and Management, more than half of Americans receive transfer payment from the federal government. Transfer payments, i.e. medicare, social security, medicaid, welfare, have grown markedly from $24 billion in current dollars in 1960, about a one-third of total federal government outlays, to $2.2 trillion in 2010, approximately two-thirds of these outlays. That equates to approximately $7,200 to every person in America. The result of this largess is that federal government debt and deficits are at historically high levels versus the GDP, approximately 100% and 8.7%, respectively. The last time we had such high levels was during World War II. Furthermore, federal government spending is projected to increase as far as the eye can see, with no corrective measures in sight.

Unfortunately, we are reaching a major inflection point as the commercial for Fram Oil Filters used to say, “pay me now or pay me later.” However, due to the current weakness in our economy, we are in a precarious position. If we act too precipitously to rein in spending, it could be counter productive by causing a recession. What we need is an orderly, long-term plan to bring our fiscal house in order and create economic growth. Nevertheless, if we wait to deal with this problem, it will become more painful and expensive to resolve. We need not look any further than what is happening today to the PIIGS of the European Union (Portugal, Italy, Ireland, Greece), to know what our future destiny will be - structurally high unemployment with little or no economic growth.