The two main economic theories that have been guiding most world economies for the past 150 years or so are capitalism and socialism. In a socialist society the government owns the means of production and decides what goods and services will be offered and how much will be charged. The Soviet Union and China were the leading socialist economies in the 20th century.
In a capitalist society, private individuals own the means of production and make the investment decisions. Each individual seeks to maximize their own wealth, but the market determines success and failure. If demand exceeds supply, prices go up and more producers enter the market, increasing supply and limiting price increases. If supply exceeds demand, prices drop and producers pull back. Inevitably some go bankrupt. The United States, Germany and Japan are the largest capitalist economies.
Capitalism is called “laissez faire” economics (roughly, “let them do what they want.”). Adam Smith is considered to be the father of this theory. He felt that if everyone pursued their own self-interest, the economy, as if guided by an “invisible hand” would produce the greatest good for the greatest number of people.
The drawbacks of socialism are many, which were demonstrated clearly when most of Germany became capitalist and rich after WWII while part of it installed Soviet style socialism. West Germany harnessed market forces and prospered, while East Germany used a Soviet style command economy and floundered. Both China and Russia have changed their systems to make them more like capitalism.
But capitalism also has its drawbacks. The primary one is that we humans really can’t stand the vicious ups and downs required by the marketplace to balance supply and demand.
Going to school on cranberries
The cranberry market is small as markets go. Total annual sales are roughly $1.5 billion. But if we look at it carefully, we can see a clear demonstration of the boom and bust problem of laissez faire economics.
The market was fairly stable in the 80s, with a price per barrel well above the $35 per barrel it costs to produce them. Then, in the 90s, partly because cranberries were labelled as healthy, demand went up, and so did the price, peaking at roughly $66 a barrel in 1996.
Cranberry Price Per Barrel (100 pounds)
Annual US average
In response to the increase in demand and price, investors came into the market. In Wisconsin, where half of all US cranberries are produced. Acreage planted jumped from 13,000 to 18,000. Canada and Maine also added significant acreage. (Massachusetts produces about 30% of the cranberry crop but does not have cheap agricultural land to spare.)
As any follower of Adam Smith would have forecast, when the new crops came into the market, the price started dropping. Then the price plummeted, bottoming out in 1999 at $17.20 a barrel, about half what it costs to produce. As one pundit said,
“In agriculture, short-term profits have a way of blinding players to the long game. When crop prices rise, farmers expand production, creating surpluses that push prices back down again.”
Cranberry growers went from fat city to serious losses. Laissez faire economics says that this is the proper solution to the problem of oversupply. The weakest producers are supposed to be forced out of the market, reducing supply. But the producers don’t want to leave the market. They’ve invested time, money and sweat into their business. They are depending on it to support them in old age. And what else could they do?
Their position is understandable. I can’t imagine watching the price I got for my product or service dropping so precipitously. So the growers, who tend to be quite vocal about smaller government, respond aggressively.
Producers often turn to the government to help them act like socialists to try to control supply by fiat. The cranberry farmers hired a lobbyist and got the government to give them dispensation from anti-trust laws; so they could form a group and issue a “market order” to limit the number of barrels each grower could sell into the market.
Then they implored the federal government to buy cranberries, which it does, adding them to its school lunch program. They also generated new products (can you say “Craisins”?) to stimulate demand.
All this worked. Craisin sales were especially robust. Craisin developer, Ocean Spray, turned 250 million pounds of Craisins into $400 million in cash by 2008. The price peaked at $70 that year. Fat City was back again. But not for long.
Years of overproduction had created a surplus in cranberry concentrate, so Ocean Spray started auctioning it off, quickly driving the price from $53 a gallon down to $33 a gallon.
By 2016 the price of a barrel of cranberries dropped to $18 a barrel. The second major swing from profit to loss since the turn of the new century! Once again growers turned to the government. Massachusetts governor Charlie Baker formed a cranberry task force and Senator John Kerry worked to change labeling requirements.
Many agricultural products are now tightly regulated and often subsidized by the government in order to protect them from this boom and bust cycle. The most complicated and convoluted is probably dairy. We’ve supported the family farm too well. We still produce too much milk.
But agriculture is not alone. Almost every market is subject to the boom and bust cycle in one form or another. Manufacturing is probably the most visible.
Before electricity became common, water wheels powered most manufacturing plants, and New England with its many rivers and dependable rainfall, had an ample supply of running water to move the wheels. It became a manufacturing center. Textiles and shoes were maybe the biggest items. But many other products were made here and in upstate NY.
Once electricity became ubiquitous, labor costs became the deciding factor and over a period of a century or so, manufacturing moved south and west — and then abroad.
Now we are on the precipice of a major bust cycle.
At the end of WWII Americans started having babies with a vengeance. And we got the baby boomers.
The number of people born between 1946 and 1964 was unprecedented. They put tremendous demands on the education system, for one, and it expanded to meet them. Then the demand peaked. (The last baby boomer was born in 1964.)
It fell precipitously for a while, until the baby boomers’ kids came along and filled our schools once again.
Now those kids are finishing school, and demand for college slots is diminishing. Several small New England colleges have closed their doors as they can no longer fill their slots. Cities that built new schools to accommodate the rising number of students are now closing them and turning some of those buildings into elderly housing for aging baby boomers.
Single-family housing is probably next to feel the decline. As the Wall Street Journal reported in November 2019:
“The U.S. is at the beginning of a tidal wave of homes hitting the market on the scale of the housing bubble in the mid-2000s. This time it won’t be driven by overbuilding, easy credit or irrational exuberance, but by an inevitable fact of life: the passing of the baby boomer generation.
“One in eight owner-occupied homes in the U.S., or roughly nine million residences, are set to hit the market from 2017 through 2027 as the baby boomers start to die in larger numbers, according to an analysis by … Zillow. That is up from roughly 7 million homes in the prior decade.
“By 2037, one quarter of the U.S. for-sale housing stock, or roughly 21 million homes will be vacated by seniors. That is more than twice the number of new properties built during a 10-year period that spanned the last housing bubble.“Most of these homes will be concentrated in traditional retirement communities in Arizona and Florida, according to Zillow, or parts of the Rust Belt that have been losing population for decades.
”The government plays a big role in helping us buy homes with mortgage insurance, flood insurance, and down payments as low as 3%. Will we now try to rescue the seniors who have to reduce price to find a buyer for their highly appreciated residences?
Adam Smith would not approve.
I think we need to be realistic. Human nature makes fully free markets unacceptable. We have to find the best way we can to let the market dictate supply and demand as much as we can without forcing people to file bankruptcy every time there’s a downturn.
So capitalism turns to various socialist government actions to ameliorate or eliminate the boom and bust cycles and socialism often uses the market to regulate production. In truth all economies are mixed.