I have always been excited by the creative possibilities of feedback loops.
Feedback loops in the sensorimotor system are how it is possible for us to learn to balance, walk, and run; to reach, grab, throw, and catch; to understand and speak language; and many other aspects of life. Feedback loops in our worldwide ecological systems help new species evolve and find ecological niches to live in, often alongside older species but sometimes displacing them. Feedback loops are also central to Adam Smith’s original vision for a self-improving economic ecology of buyers and sellers.
My enthusiasm for the role of feedback in the economy convinced me that I should consider myself a supporter of capitalism. Even with all of its evident defects in the modern world, isn’t it worth supporting this vision of feedback-driven improvement? In a recent conversation, a friend opened my eyes to an important distinction.
The Free Market is where the positive feedback effects of competition take place. Buyers search the marketplace for the best combination of high-enough quality and low-enough price. They “vote” with their purchases for the Sellers that best meet their needs. Sellers search for sweet spots in the trade-off between quality and price that gathers them enough “votes”, that is, sales. Sellers who can’t find a good enough sweet spot change their approach or go out of business. Creative innovations shift the sweet spots toward higher quality and/or lower prices. Sellers scramble to find the new sweet spots, and Buyers find that their options keep improving.
What’s not to like? This was Adam Smith’s vision back in 1776, and it has been a compelling driver for economic growth ever since. I still think it’s a wonderful thing.
Isn’t the Free Market the same as Capitalism? I certainly thought so. But my friend showed me that it is not.
Capital is the money that must be invested to become a Seller. To manufacture widgets to sell, you need to make the widgets, which requires supplies, machinery, workers, and a factory. You need money to spend on advertising, warehousing, delivery, accounting, and many other things, before you can begin to bring in money from sales to Buyers. In an ideal world, Adam Smith’s vision of the free market dovetails with George Bailey’s building and loan company in the 1946 film “It’s a Wonderful Life!” Money saved by individuals is pooled and loaned as capital to aspiring Sellers, who (on average) pay it back later with interest. In this idealized picture, money to be used as capital is yet another product with Buyers and Sellers in a free market.
But is this how we see Capitalism working out in practice in our economy?
As the World Wide Web grew enormously, a need became clear for users to find the information they wanted. To meet that need, we saw (among others) Gopher, then Alta Vista, then Yahoo, then Google. However, Google has remained dominant over the past quarter-century, partly through technical innovation, but partly through protecting themselves against competition within the Free Market. Similar stories are true of all of the major technology companies: Amazon, Apple, Facebook (now Meta), Google, Microsoft, Nvidia, and others.
The critical management skills for running these dominant companies are no longer for cultivating technical innovation. They are for erecting barriers to entry for potential competitors. In the high-tech entrepreneurial space, the goal of the founders is typically not to compete with leading companies, but to be acquired by them, allowing the founding entrepreneurs to cash out and become wealthy venture capitalists themselves.
The goal of the Free Market is to maximize the success of both Buyers and Sellers. A successful Free Market requires regulation, to prevent exploitation of either Buyers or Sellers by a small number of dominant agents of either type. Free markets are positive-sum games, in which Buyers, Sellers, and the society as a whole come out ahead.
The goal of Capitalism is to maximize return on investment. Many of the regulations necessary to protect the free market constrain their ability to maximize return. So, capitalists often end up acting in ways that are hostile to those regulations and destructive to the Free Market.
To gain the benefits of Adam Smith’s vision, we need a Free Market, including a free market for capital to invest in new enterprises. But free markets need regulations, to protect against exploitation. In particular, capitalism is necessary, but must be kept on a short leash.
PS. For a related argument, please see:
Benjamin Kuipers. 2012.
An existing, ecologically-successful genus of
collectively intelligent artificial creatures.
Collective Intelligence (CI-2012).