Socialist Approach vs Free Market Approach

By Robert M. Liu


The prices of electric power and gasoline in California are high. California consumers are complaining. Who should bear the blame? California governor Gray Davis points his accusing finger at Texas-based oil companies and electric power companies because they, according to the governor, have overcharged California consumers. The governor calls for energy price controls as well as a rebate from the power companies to California consumers. Not a bad move from a political standpoint, since California consumers will have to decide whether they should vote for him in the next gubernatorial election.

While energy price controls could provide short-term relief and might even benefit Gray Davis' political career, which probably hinges on how the crisis will be resolved, I have my misgivings about the long-term effects of price controls, which I tend to see as a socialist approach to deal with economic issues.

During my long years in Shanghai under China's socialist system (I left Shanghai in early 1986), I saw countless price controls: rice price controls; pork price controls; chicken and duck price controls; egg price controls; fish price controls; cooking oil price controls; sugar price controls; housing cost controls; transportation service price controls; electric power price controls; gasoline price controls; medical cost controls; pharmaceutical price controls; cotton cloth price controls. In short, all product prices were artificially fixed, resulting in severe shortages that left the government with no choice but to ration food (such as rice, cooking oil, sugar, pork, eggs, fish) and other necessities (such as cotton cloth and soap) to Shanghai residents. Whenever I ate at a restaurant I had to pay not only cash but also rice coupons.

It is worth mentioning that during the days of "socialist planned economy", the prices of labor (i.e. wages) in China were also controlled by regulation because labor is also a commodity. After all, the term "socialist planned economy" refers to the socialist principle that government (the institution that regulates society) should "plan" (read control) the economy through regulations, price controls and even government ownership. But it transpired that "socialist planned economy" with its numerous price controls didn't work. So, in the late 1970s, China's late paramount leader Deng Xiaoping launched his market-oriented economic reforms, eliminating a large number of price controls.

At first, Chinese consumers complained like mad about rising prices, but since he didn't have to worry about how to win votes from the electorate like Governor Gray Davis has to, Mr. Deng continued to push his market-oriented economic reforms without apologizing for the much higher prices Chinese consumers had to pay for goods and services. As price controls were lifted, wages began to rise as well. In the meantime, for the first time since the founding of Communist China, workers were allowed to switch to better-paying jobs.

In the mid-1980s when I was working for a Shanghai-based financial journal called The World Economic Herald, I witnessed with my own eyes an apparent phenomenon: along with the elimination of price controls, came a certain degree of freedom for the Chinese people. While I'm not say that one-party dictatorship is better than democracy, I do believe Mr. Deng did the right thing in eliminating price controls despite Chinese consumers' complaints.

My point is: you can't have the cake and eat it, that is, you can't have a free society with a free-market economy and yet still want to artificially fix (i.e. control) prices and wages. During the Mao era in China, as price controls kept the prices of goods and services artificially low, wages were also kept artificially low, not to mention the fact that there were draconian measures to control every aspect of people's lives under Mao. The fact is that things are better in China today with less price controls than before when Mao's numerous "socialist price controls" kept all goods and services artificially cheap and affordable, because for those seemingly cheap goods and services, the Chinese people actually paid a very high price in the form of their total loss of freedom.

That's why Governor Gray Davis' call for price controls makes me feel uneasy. In a free society, prices are (and should be) determined by supply and demand, that is, by the forces of the free market. If the price of a commodity is high, it is because demand exceeds supply. On the other hand, if supply exceeds demand, overcharging is out of the question. For instance, no computer shop owner can overcharge his customers for personal computers, because PC supply exceeds demand in the current economic downturn, whether he wants to or not..

Over time, high prices will encourage consumers to conserve and businesses to increase supply, eliminating the imbalances in the economy, whereas price controls tend to encourage consumption (not conservation) and are likely to discourage businesses from increasing supply, thereby perpetuating economic imbalances. In other words, price controls will exacerbate the problem for the long term. That's the difference between what I'd call the socialist approach and the free market approach. From a long-term perspective, the free market approach is more helpful to the economy, because it follows the rules of human behavior, the rules of nature, not wishful thinking.

Why are there energy shortages and blackouts in California? To answer the question, I would like to refer to some of the comments Canadian Prime Minister Jean Chretien made during his recent visit to Beijing. He told reporters that China needs to make its laws more friendly to overseas investors. Otherwise, they won't come — it's as simple as that, he said. He sounded like a pragmatic conservative but was certainly giving China the right kind of advice, which in my opinion can also be used by California. Governor Davis needs to ask himself if California's laws and regulations are friendly enough to encourage oil companies and electric power companies to increase supply. It is amusing to watch the governor point his accusing finger here and there with a straight face on TV, as if to say smart as he is, he has had no schooling whatsoever in economic basics such as the effect of supply and demand.

Still, the question of whether socialism works remains. I would say: Yes, it does — to a certain degree, beyond which, however, it is likely to become counter-productive. Let me give an example to illustrate my argument:

For a full decade, Canada's west-coast province, British Columbia (B.C.), was under the control of the New Democratic Party (the NDP) which calls itself Canada's socialist party and asks working-class families to vote for it since it has a large base among union members. Apparently, it is a left-wing political organization which, in some respects, reminds me of the Democratic Party in the United States. The NDP is for good welfare benefits for the poor and high taxes for the rich — the highest tax rate in British Columbia is 52% according to one web page.

In the beginning, anti-business "class-warfare" socialism did work for the NDP since it helped the party win votes from the poor, allowing it to stay in power. In the meantime, as the province's generous welfare system attracted people in need of welfare benefits from other provinces, its high tax rates scared off businesses and other investors. Some companies moved out of British Columbia and registered themselves in neighboring Alberta, a province under the control of the pro-business Canadian Alliance which offers much lower tax rates to companies. Thanks to the NDP's socialist policies, British Columbia now has the highest unemployment rate in Canada.

Public transportation services in B.C. are run by the government. Ticket prices are kept artificially low, so consumers have no complaints about the costs, but wait... First, these services never make any money. In fact, they are on the life-support machine — taxpayers' money. Then, as if that wasn't bad enough, public transit drivers (i.e. bus drivers) in the Greater Vancouver Area went on strike earlier this year, demanding more benefits. As of this moment, they are still on strike. Consequently, residents in the Greater Vancouver Area have been without public transit service for more than 80 days. Socialist-style government ownership which eliminates private- sector competition has its downside.

In May 2001, the NDP was defeated in a provincial election after ten years in office. The pro-business B. C. Liberals won 77 of the 79 seats in the provincial parliament. The NDP now has only two seats — not enough to be recognized as an official opposition party in the province. I would presume that even working-class people have voted for the Liberals. Perhaps, the harsh economic reality in B.C. after 10 years of NDP rule has awakened ordinary people to the basics of economics, one of which is that while anti-business "class-warfare" socialism helps left-wing politicians to stay in power, it doesn't work for the economy in the long run and so is likely to hurt the interests of working-class families, rather than help them.

British Columbia's new premier Gordon Campbell says he will cut taxes drastically to help the economy. Either because B.C. voters are better educated on economics now than before or because the B.C. Liberals have an absolute majority in the provincial parliament, thereby wielding a strong mandate from the provincial electorate, few in British Columbia would accuse Premier Campbell of being "extremely right-wing", unlike the situation in the United States where President George W. Bush is occasionally accused of being "a right-wing extremist" because of his tax cut plan, regardless of the fact that the U.S. economy is teetering on the edge of a full- blown recession, regardless of many economists' belief that lower tax rates will help the economy.

Congresswoman Sheila Jackson Lee (D-Texas) says the result of a recent opinion survey conducted by New York Times shows most Americans are saying: we don't need tax cuts; we want the budget surplus invested in our future, i.e. social security, health care, education. Based on my observation of human nature, I'd rather guess some people may like tax cuts for themselves but no tax cuts for other people, especially rich people, so that other people's tax dollars can be "invested in our future". The statement "we don't need tax cuts" sounds disingenuous to me.

However, it is my belief that low-income people should pay very little or no tax at all while high-income people should pay higher taxes, so that society can provide a necessary cushion for those in need of government assistance. The question is: how high is high enough? There is a limit beyond which high taxation could hurt the economy as it becomes a disincentive to those capable of creating large amounts of wealth and large numbers of jobs for society.

Excessively high taxation tends to turn government into a "legalized robber" who comes knocking at your door whenever you make good money for your retirement. In such a situation, a high-income person may be forced to decide on one of the following four options: (1) Be a good citizen and grudgingly pay high taxes to the IRS; (2) Try to evade tax at the risk of being caught; (3) Stop creating more wealth through his innovativeness and creativeness; and (4) Leave for a place where tax rates are lower. Option 4 may cause irreparable damage to the economy, because if an innovative, high-income person (for example, a smart entrepreneur) leaves a city for good, it means that city loses a man capable of creating wealth and jobs for the economy. Can any city afford to lose a man like Bill Gates of Microsoft?

At the end of the day, taxes are a cost to the economy and the consumer, because they are part of the costs of doing business which companies inevitably want to pass on to the consumer. If corporate taxes are excessively high, companies will find it difficult to make a profit and the consumer may find product prices unreasonably high because corporate tax costs are passed on to him. If unable to pass on high tax costs to the consumer, companies have to lay off workers in order to make ends meet. That certainly won't help the economy and the working class.

Another example: In America, quite a few companies' chief executive officers (CEO's) earn ridiculously high salaries, and one may think that's "unfair". But if the government imposes a 50% tax on their high salaries to "correct the unfairness", the consumer is likely to bear the extra tax costs. That is because the high salary of a CEO is probably determined by the forces of the marketplace. If a company pays US$1 million per year to hire a man as CEO, it is not because the company wants to, but because the company has to. The man is worth one million dollars net per year — period. If Company A doesn't want to pay $1 million to hire him, Company B will. Since the company and its stock won't be able to perform well without him in the CEO chair, it must hire him. If the government imposes a 50% tax to "correct the unfairness" of the free market, the CEO will have a net income of only $500,000 per year, forcing the company to pay more to ensure that the CEO has a net income of $1 million per year. The extra tax costs have to be passed on to somebody. Who could that somebody be?

While in office, former president Bill Clinton determinedly vetoed Congressional tax cut bills. At the time, the U.S. economy appeared strong. But weakness in demand in the telecom- tech sector reared its ugly head in spring of 2000, triggering a near-recession toward the end of the year where corporate earnings visibility disappeared, necessitating large-scale lay-offs. Still, Congresswoman Sheila Jackson Lee (D-Texas) thinks "we don't need tax cuts" because tax cuts "only benefit the rich", because "we want the surplus invested in our future". The problem is: the future of the private sector (i.e. corporate America) also needs to be invested in. If the private sector is not nurtured with lower taxes, the economy won't be able to grow as vigorously as it should to create more wealth and more jobs, expanding the tax revenue base for the government. Corporate America's history shows that the private sector knows how to use investment dollars more efficiently than the public sector.

True, tax cuts make the rich richer, but that is exactly how tax cuts will work to enhance consumer confidence and business confidence as well as capital formation in the private sector, which in turn stimulates business investment and job creation, allowing wealth to trickle down effectively from the rich to the poor. I understand such a supply-side "trickle-down" process of wealth creation and distribution may appear unfair in the eyes of many people. But unless one believes Adam Smith to be wrong and Karl Marx right, one may have no choice but to put wealth creation before wealth distribution.

Anyway, no matter how rich a man may be, he came from ashes and will have to go back to ashes, leaving whatever wealth he may have created behind for society. So, why worry about his getting richer? If he spends his money, it will help the consumer market. If he invests his money, it will create jobs. Wherever his money flows, it will help the economy. If one thinks this "trickle-down-type" free-market approach is "too capitalistic" to serve the needs of society, then the only alternative to it would be the socialist approach which calls for high taxation, anti- business regulation, plus artificial price fixation. But as the people of British Columbia, Canada, learned the hard way, anti-business "class-warfare" socialism could become a lethal weapon which purports to help the poor and the working class but instead kills the goose that lays golden eggs.

The End

(June 26th, 2001)