Limits of Capitalism

Capitalism has been so successful that even theoretically communist countries like China have embraced it. But it cannot solve the scarcity of attention without significant changes in regulation, because of three important limitations. First, prices will always be missing for things that we should be paying attention to. Second, capitalism has limited means for dealing with the concentration in wealth and market power arising from digital technologies. Third, capitalism acts to preserve the interests of capital over knowledge. We need to make changes now, precisely because capitalism has been so successful—the problems that are left are the ones it cannot solve.

Missing Prices

Capitalism won’t help us allocate attention because it relies on prices that are determined in markets. Prices are powerful because they efficiently aggregate information about consumer preferences and producer capabilities, but not everything can be priced. And increasingly, the things that cannot be priced are becoming more important than those that can: for example, the benefits of space exploration, the cost of the climate crisis, or an individual’s sense of purpose.

The lack of prices for many things is not just a question of a missing market that can be created through regulation. The first foundational issue is the zero marginal cost of copies and distribution in the digital realm. From a social perspective, we should make all the world’s knowledge, including services such as medical diagnoses, available for free at the margin. But this means that as long as we rely on the price mechanism, we will under-produce digital resources. Just as the Industrial Age has been full of negative externalities such as pollution, resulting in overproduction, the Knowledge Age is full of positive externalities, such as learning, which implies underproduction. If we rely on the market mechanism, we will not pay nearly enough attention to the creation of free educational resources.

The second foundational issue is uncertainty. Because prices aggregate information, they fail when no such information exists. When events are either incredibly rare or have never occurred, we have no information on their frequency or severity, and the price mechanism cannot work when forecast error is infinite. For instance, large asteroid impacts on Earth occur millions of years apart, and as a result no price can help us allocate attention to detecting them and building systems to deflect them. As a result, we pay a trivial amount of attention to such problems relative to the potential damage they would cause.

The third foundational issue is new knowledge. The further removed such knowledge is from creating a product or service that can be sold, the less use the price mechanism is. Consider early aviation pioneers, for example. They pursued flight because they were fascinated by solving a challenge rather than because there was an obvious market for air travel. Or take the early days of quantum computing: actual machines were still decades away, so at that time the price mechanism would not have allocated attention to the discipline. Much of this knowledge therefore needs to be produced by allocating attention through other mechanisms, such as government funded research, academic institutions, and prizes.

The fourth foundational issue is that in order for markets and prices to exist, there have to be multiple buyers (demand) and sellers (supply). There is no demand and supply for you to spend time with your children or to figure out your purpose in life. Capitalism cannot help us allocate attention to anything that is deeply personal.

A way of summarizing all of these examples is to think of the world as divided into an economic sphere (where prices exist) and a non-economic one. Market-based allocation of attention can only succeed in the former and, to the extent that there are insufficient counterweights, will do so at the detriment of attention allocated to the non-economic sphere. This is the high earning parent, who doesn’t spend enough time with their children, or the legions of science PhDs optimizing ad algorithms instead of working on the climate crisis.

Power Laws

When it comes to the distribution of income and wealth, many different outcomes are possible, and what actually happens depends on the underlying production functions. Consider a manual production function that was common before industrialization. If you were a cobbler making shoes by hand, for instance, there was a limit to the number of shoes you could produce.

Then along came industrialization and economies of scale. If you made more cars, say, you could make them more cheaply. That is why, over time, there were relatively few car manufacturers around the world and the owners of the surviving ones had large fortunes. Still, these manufacturing businesses stayed fairly competitive with each other even as they grew large, which limited their market power and thereby the amount of wealth that they generated. Many service businesses have relatively small economies of scale, which has allowed a great many of them to exist, and markets such as nail salons have remained competitive. Finance is one clear exception to this among services. A few large banks, insurance companies and brokerage firms tend to dominate the finance industry, and that has accelerated in recent years, largely because financial services have already been heavily impacted by digital technology.

With digital technology we are seeing a shift to ever-higher market power and wealth concentration. When you plot the outcomes, such as companies by revenue, the resulting curves reveal so-called ‘power laws’: the biggest firm is a lot bigger than the next biggest firm, which in turn is a lot bigger than the third largest, and so on. This pattern is pervasive throughout digital technology and the industries in which it plays a major role. For instance, the most watched video on YouTube has been watched billions of times, while the vast majority of videos have been watched just a few times. In e-commerce, Amazon is an order of magnitude larger than its biggest competitor, and several orders of magnitude larger than most e-commerce companies. The same goes for apps: the leading ones have hundreds of millions of users, but the vast majority have just a few.

Digital technologies are driving these power laws due not only to zero marginal cost, as explained earlier, but also to network effects. Network effects occur where a service gets better for all participants as more people join. For example, as Facebook grew, both new and early users had more people they could connect with. This means that once a company grows to a certain size it becomes harder and harder for new entrants to compete, as their initially smaller networks offer less benefit to participants. In the absence of some kind of regulation, the combination of zero marginal cost with network effects results in extremely lopsided outcomes. So far, we have seen one social network, Facebook, and one search company, Google, dominate all others.

This shift to power laws is driving a huge increase in wealth and income inequality, to levels that are even beyond the previous peak of the early 1900s. Inequality beyond a certain level is socially corrosive, as the wealthy start to live in a world that is disconnected from the problems faced by large parts of the population.

Beyond the social implications of such inequality, the largest digital companies also wield undue political and market power. When Amazon acquired a relatively small online pharmacy, signaling its intent to compete in that market, there was a dramatic drop in the market capitalization of pharmacy chains. Historically, market power produced inefficient allocations due to excessive rents as prices were kept artificially high. In digital markets, in contrast, powerful companies have often pushed prices down or even made things free. While this appears positive at first, the harm to customers comes via reduced innovation, as companies and investors stop trying to bring better alternative products to market (consider, for example, the lack of innovation in Internet search).

Joseph Schumpeter coined the term “creative destruction” to describe the way in which entrepreneurs create new products, technologies, methods, and ultimately economic structures to replace old ones. Indeed, if you look at the dominant companies today, such as Google, Amazon and Facebook, they are all relatively new having displaced in importance those of the Industrial Age. However, such ‘Schumpeterian' innovation will be more difficult going forward, if not downright impossible. During the Industrial Age, machines served a specific purpose, which meant that when a new product or manufacturing technology became available, the installed base of machines became essentially worthless. Today, general-purpose computers can easily implement a new product, add a feature or adopt a new algorithm. Production functions with information as a key input have a property known as ‘supermodularity’: the more information you have, the higher the marginal benefit of additional information [55]. This gives the incumbent companies tremendous sustained power—they gain more marginal value from a new product or service than a new entrant does.

Self-Conservation

Toward the end of the Agrarian Age, when land was scarce, political elites came from the landowning classes, and their influence wasn’t truly diminished until after the Second World War. Now, although we have reached the end of the time of capital scarcity, political elites largely represent the interests of capital holders. In some countries, such as China, senior political leaders and their families own large parts of industry outright. In other countries such as the United States, politicians are heavily influenced by the owners of capital because of the need to raise funds, the impact on policy of lobbyists, “think tanks” and foundations backed by capital, the skewing of public debate through capital-owned media (e.g. FOX), as well as global “regulatory competition” allowing capital owners to play governments off against one another in order to limit wealth redistribution through taxation. Consider just lobbying: over a five-year period, the 200 most politically active companies spent nearly $6 billion to influence policy. A clever study from 2018 [??] showed how this kind of lobbying directly impacts the language of laws subsequently drafted by lawmakers.

The net effect of all of this are policies that are favorable to owners of capital, such as low rates of capital gains tax. Low corporate tax rates, with loopholes that allow corporations to accumulate profits in countries where taxes are low, are also favorable to owners of capital. So in 2020 we have some of the lowest effective tax rates for corporations and wealthy individuals and families in US history (‘effective’ means what is paid after exemptions and other ways of reducing or avoiding tax payments).

In addition to preserving and creating financial benefits for the owners of capital, corporations have also attacked the creation and sharing of knowledge. They have lobbied heavily to lengthen terms of copyright and to strengthen copyright protection. And scientific publishers have made access to knowledge so expensive that libraries and universities struggle to afford the subscriptions [56], [57].

A key limitation of capitalism thus is that without meaningful change, it will keep us trapped in the Industrial Age by keeping governments and the political process focused on capital. As long as that is the case, we will continue to over-allocate attention to work and consumption, and under-allocate it to areas such as the individual need for meaning and the collective need for the growth of knowledge. Parts Four and Five of The World After Capital will examine how we can get out of the Industrial Age, but first we will take a closer look at the power of knowledge and the promise of the digital knowledge loop.