The Five Building Blocks of Capitalism (Part One of Saving Capitalism: For the Many, Not the Few)

Capitalism is strange. It’s an economic and political system, yes, but as a concept I believe it’s meaning has become extricated from its original definition. One's stance on capitalism has strangely become a societal indicator for their moral and political standing. I've noticed in left leaning circles it becomes trendy to direct blame towards capitalism for many issues. Desires to reimagine the market economy are absolutely warranted but such ideals are diluted when, today, denouncing capitalism feels more like virtue signaling. While many can agree that capitalism, to some degree, contributes to inequality and ecological destruction, the question of to what extent deserves better focus.

Out of hopes of understanding what capitalism is rather than dismissing it completely, I'm (slowly) reading Robert Reich's Saving Capitalism: For the Many, Not the Few. Within this book he unveils the myth of the "free market" and elucidates who the market is truly designed for. Reich divides this book into three parts. In Part One he shares that markets are determined by 5 core building blocks which are frequently manipulated by those with economic and political power. In Part Two, Reich shows what the current market means for income and wealth distribution in society. Lastly, In Part Three he proposes solutions by changing who the government chooses to benefit.

Saving Capitalism is an enticing read as Reich clearly educates readers about the complexity of capitalism in manageable pieces. I recommend giving it a read if you are interested but I'll warn it can be quite dense at times. In this post I'll discuss Part One: The Free Market and share Reich's proposed "Five Building Blocks of Capitalism" and how it has shaped my understanding of the system.

The Five Building Blocks of Capitalism

In Part One, Reich argues one key point about capitalism; the notion of a "free market" diverts attention from the reality that the market exists and functions because of rules established by the government. Oftentimes, governmental policy discourse spirals into the "free market" vs. activist government debate. Broadly speaking, in the US, the more right an individual leans the less welcoming they are to governmental intervention and regulation, especially in the marketspace. Likewise, political leaning can be tied to if you believe the market is a primarily a source of prosperity or inequality.

Reich is steadfast with the latter and he defends so by describing the 5 Building Blocks of Capitalism: property, monopoly, contract, bankruptcy, and enforcement. Reich aptly explains that "markets depend for their very existence on rules governing property (what can be owned), monopoly (what degrees of market power is permissible), contracts (what can be exchanged and under what terms), bankruptcy (what happens when purchasers can't pay up), and how all of this is enforced. While Reich is adamant with his argument, at no point does he claim to outdo market economies altogether, and hopefully in the subsequent paragraphs I represent and do his stance justice.

What you'll learn from each summary is that the market is a decided system not a natural and mystical force. As we'll see in discussing Property, the decisions that define a market are frequently influenced by those with economic and political power.

Property

Private property is the most basic building block of capitalism. We understand property to be things that we can own. A car, a phone, a house a business. However, not all property is straight forward. How do you draw property lines for amorphous concepts such as intellectual property and the environment? Thus, when determining property, there are rules that define "what can be owned, on what condition, and for how long?"

In the past, slavery was not only common but widely accepted by elites as morally just. Today, since the ratification of the US 13th amendment in 1865, slavery is abolished and owning another individual is (rightfully) unaccepted as private property. Although the example of slavery may be obvious, it is important to note that the rules that govern private property are neither natural nor fixed.

What dictates property becomes muddled when considering non-material property such as information and ideas. Reich uses patents as an example to unveil that the mechanisms that define property are non-trivial. The Patent and Trademark Office grants inventors a temporary monopoly over an idea it is statutory, novel, useful, and nonobvious. If an invention meets these (ambiguous) terms, the inventors have 20-year legal ownership of the idea. In this case, property rules, enforced by the Patent Office, determine what exactly counts as novel and useful, and the length of granted patents (which was extended from fourteen years to twenty years in 1995).

In addition to emphasizing that property is governed by rules, Reich highlights that economic and political power bend these rules to benefit the few. Reich points to tech companies such as Google and Apple for excessively "spending more money on acquiring and litigating over patents than on research and development." In a world where ideas are paramount, it is these billion dollar companies that can afford to deploy armies of patent lawyers to defend patents and sue for patent infringement.

And it doesn't appear that tech companies are stopping anytime soon. As per the figure above which illustrates the number of patents filed by Apple from 1999 to 2019. If you were curious, a whopping 1,996 total patents were granted to Apple in 2020 (not shown). When this is the case, how can the free market truly be free if you have to pay to play simply for waning hopes to be competitive.

Monopoly

Monopoly, the second building block of capitalism, determines the degree to which market power is allowed in a market economy. Reich explains that "businessmen and -women need some degree of market power in order to be induced to take the risk of starting a new business." However, if a business is given too much market power, competition is stifled, and consumer prices increase. To further emphasize this idea, let's revisit patents, which we defined as a temporary monopoly over an invention. Without a patent, a business' product isn't protected by law and any rival could swiftly copy and wipe the business' competitive advantage. But if a patent were to never expire, a business could control an entire industry for eternity given they have enough relevant patents. Thus, rules that govern monopoly and to what degree market power is permissible are essential to the success of a market.

As with property, the rules of monopoly are skewed disproportionately to those with economic (and thus, political) power. Amazon's book selling dominance is one of Reich's many examples in this chapter. Today, Amazon accounts for over half of the US print book market and nearly 80% of the e-book space. In 2014, Amazon exercised this extensive market power by demanding better terms from Hachette (the nation's fourth-largest publisher) by delaying and stopping deliveries of their books. In short, the two giants fought over pricing control over Hachette published e-books. Amazon wished to lower the price of e-books (to promote the kindle e-reader) to which Hachette initially refused. This led to Amazon intentionally preventing consumers from pre-ordering Hachette titles and delaying shipment and reducing discounts of some of the publisher’s titles. They eventually signed a multi-year agreement that ensured Hachette could "set consumer prices of its e-books and will benefit from better terms when it delivers lower prices for readers."

Undoubtedly, Amazon provides consumers with books at lower rates with higher convenience. And one could argue that the Amazon-Hachette dispute was simply "business" and in the end, beneficial to publishers and consumers. But what should not be overlooked is Amazon's willingness to flex it's economic grasp to argue favorable terms. Amazon's revenue would barely be dented without a Hachette partnership yet, the reverse scenario does not apply all thanks to Amazon's dominant market power. And like previously mentioned, with economic power comes political power since the Justice Department failed to act against Amazon's tactics for demanding better terms from publishers. This should be unsurprising as the industry giant has increased it's annual lobbying expenditures from 1.3 million in 2008 to almost 18.7 million in 2020.

Contracts

Contracts, Reich's third building block of capitalism, are agreements between vendors and consumers to do or provide something in exchange for something else. Just as how we discussed property rules determine what can be owned and on what terms, contracts dictate what can be traded and on what terms. Again, the "free market" versus government debate obscures the truth of how these contract rules are established and who they benefit.

In the United States, contract rules prohibit direct transactions involving votes. However, as Reich points out, "anyone even vaguely familiar with how political campaigns are financed might harbor some doubts about the nation's commitment to this principle." From 2000 to 2016, Congress candidate spending was correlated highly with election winners, with over 80% and 70% of the highest spending candidates winning House and Senate elections, respectively. Given that, the extent to which industries and wealthy individuals can steer elections purely through donations cannot be overstated.

Of course, donations and increased election spending do not cause wins, but it is unlikely that they don't impact election results at all. Call it donations or (in)direct vote buying but it is unequivocally the rules of market contracts that make such acts legal. Unfortunately, the benefactors of contract rules are disproportionately those with economic and political clout.

Reich cites the 2014 Level Global Investors hedge fund lawsuit which employed the Securities Exchange Act of 1934 to question whether the fund's $54 million win (made by shorting Dell computer stocks) was based on inside information from a Dell employee. Global Investors' then co-founder Anthony Chiasson claimed he didn't know where the tip came from and doubted the leaker benefitted form the leak, while his lawyer argued that such confidential information is the "coin of the realm in securities markets." After initially convicted, the court of appeals overturned his conviction ruling that Chiasson was too far removed from the leak. Consequently, as Reich writes, the courts made it clear that "it's all about who you know."

Reich makes it apparent that contract rules are established by law despite those same laws being heavily influenced by the wealthy. By now, you probably understand Reich's qualms with capitalism. It's advertised as a force for prosperity rather than a system of inequality. If property, monopoly and contracts have not convinced you of that then maybe summarizing the final two building blocks, bankruptcy and enforcement will.

Bankruptcy

Bankruptcy, the fourth building block of capitalism, describes protocols for when purchasers can't pay. If contracts help define what can be traded and on what terms, bankruptcy is the system that decides what happens when one can no longer trade (or pay). According to Reich, bankruptcy is the system used in most market economies for "finding the balance between allowing debtors to reduce their IOUs to a manageable level while spreading the losses equitably among all creditors." The difficulty in establishing bankruptcy rules is building sufficiently forgiving mechanisms that allow debtors to eventually repay what they owe while not promoting future careless spending. As you may have inferred, these mechanisms are not inevitabilities of a "free market" but established by laws and practices that are too often influenced by powerful interests.

The most notable case of bankruptcy was the 2008 financial crisis. Wall Street's biggest banks gambled billions of dollars' into risky products (subprime mortgages, collateralized debt obligations, and mortgage-backed securities) and found themselves with near worthless IOUs. The Lehman Brothers, the then fourth-largest investment bank in the US, filed for bankruptcy with over $600 billion in liabilities. This catastrophic meltdown was met with Congress authorizing a $700 billion fund to protect other big banks in addition to the Federal Reserve's $83 billion of low-interest loans. As the US sidestepped bankruptcy rules for Wall Street, the financial burden fell on small investors and homeowners who found themselves with higher mortgages than their homes were actually worth.

The rules of bankruptcy benefit the powerful few who are apparently too big to fail. The last year told a similar story with regard to the airline industry. The US government gifted the industry with a $58 billion bailout despite their using nearly all their cashflow on buybacks over the past ten years.

It has taken a global pandemic for the US government to show similar generosity to the rest of us with the release of the COVID stimulus checks. But this may be an aberration since common debtors aren't well protected under the bankruptcy code. For example, the United States’ $1.73 trillion in student loan debt can't be easily forgiven through bankruptcy. Evidence shows that less than half of a percent of student loans successfully file their debts for bankruptcy. If bankruptcy mechanisms are meant to protect debtors, then why are over 120 million households suffering under debt?

Enforcement

The fifth an final building block of capitalism is enforcement, the mechanism in which market rules are imposed and implemented. In contrast to the other four building blocks, enforcement mechanisms are often hidden since decisions on what not to enforce are as important as what is enforced when establishing the rules of the market. Like the other building blocks, what is and (is not) enforced is intentionally decided by the laws and actions of the government. Consequently, these enforcement mechanisms are heavily influenced by actors with deep pockets and political power.

The US government's lack of enforcement is evident in the many trial settlements of major corporations. Settlements happen because the US government would rather avoid long, drawn-out trials, which of course, costs money. While big corporations can pay big for experienced law firms, government agencies on restricted federal budgets struggle to compete with less experienced lawyers and smaller staff. Thus, settlements occur to avoid embarrassment on court and to publicize "punishment". It's seemingly a flawless win-win. But, as Reich explains, doing so undermines the enforcement mechanism.

Reich cites the JPMorgan's $13 billion settlement in 2013 and Cititgroup's $7 billion settlement in 2014, both who were charged for fraudulent sales of troubled mortgages, as examples of failed enforcement mechanisms. Despite the seemingly hefty consequences, both financial institutions escaped with little observable effect on it's stock price. And if you consider JPMorgan's, then at the time, $2.4 trillion in assets (now, $3.7 trillion) and $209 billion in shareholder equity, $13 billion no longer appears significant.

Enforcement mechanisms not only favor entire institutions, they favor wealthy individuals too. As of 2021, JPMorgan Chase has been charged of five felonies under the leadership of Chairman and CEO, Jamie Dimon. Curiously enough, not only has Dimon maintained his position throughout the lawsuits, he remains one of the few banking chief executives to become a billionaire, with an estimated net worth of $2 billion, and continues to cash out on bonuses.

Final Thoughts

Part One of Robert Reich's Saving Capitalism: For the Many, Not the Few provides an excellent briefing of capitalism and it's constituent parts. As I've hopefully summarized clearly, he walks through the five building blocks of capitalism (property, monopoly, contracts, bankruptcy, and enforcement) and argues that the "free market" is not a mysterious force but an actively managed system. Succinctly put, "markets are made by human beings" and as a result, we should realized that they are subjected to (many) flaws that breed inequality. Part of this dilemma stems from the heavy influence of entities with monumental economic and political power. We learned, that whether it is patents, elections or lawsuits, deep pockets provide wealthy corporations and individuals unfair advantages. According to Reich, "economic dominance feeds political power, and political power further enlarges economic dominance."

As for me, like my deep dive into fact checking, I'm learning that it's complicated. Thanks to Reich I now know that economic power can redefine the market asymmetrically. Yet, Part One leaves me wanting to know where capitalism has served us well. Regardless, Reich demystifies capitalism and provides enough evidence to help formulate an informed position on the system. Part One alone is not enough for one to truly understand capitalism, especially given that it primarily focuses on the system's shortcomings. However, I do believe it helps serve as a primer and an awakening to the truth. Now, it's up to us to decide where we take our education from here.

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