In Caritas in Veritate, Pope Benedict XVI notes that, “Charity is at the heart of the Church’s social doctrine.” (Paragraph 2) In the same encyclical, he goes on to say that, “Charity goes beyond justice … but it never lacks justice. … Not only is justice not extraneous to charity, not only is it not an alternative or parallel path to charity: justice is inseparable from charity, and intrinsic to it. Justice is the primary way of charity, or, in Paul VI’s words, ‘the minimum measure’ of it, an integral part of the love ‘in deed and in truth’ … to which Saint John exhorts us.” (this is at Paragraph 6, citations omitted)
John Paul II, for example, in Centesimus Annus (1991), noted that, “It is a strict duty of justice and truth not to allow fundamental human needs to remain unsatisfied, and not to allow those burdened by such needs to perish.” (Paragraph 34) Those who are concerned about the potential adverse effects of competitive free market capitalism may ask how charity enters into the question.
The focus of this paper is to demonstrate how free market capitalism, to the extent it is competitive, implements the principles presented in the social encyclicals of the Catholic Church more so than any other economic system. The principles considered are Subsidiarity, Solidarity, and Justice in its various aspects: commutative, distributive, and social. This presentation focuses on the microeconomic and macroeconomic aspects of the economy and how competitive free market capitalism is the most successful economic system in bringing about conformity to Catholic Social Teachings.
For the sake of clarity, I offer a few definitions…
EFFICIENCY means that the per capita standard of living is at a maximum given the stock of resources, technology, etc. The consumer is able to purchase the greatest quantity of goods and services at the lowest possible price, thus maximizing the real purchasing power of their income. This can be viewed as the consumer’s income having the most ‘bang’ for the buck.
EQUITY means that the consumer surplus is at a maximum subject to the constraint that all productive resources are receiving a reward or income just equal to their opportunity cost, no more and no less. There is no producer surplus (economic rent). This is what keeps you working at your current job. You are compensated just enough to keep you from leaving for greener pastures.
CONSUMER SURPLUS is an estimate of how much more consumers would be willing to pay for the market quantity purchased if they had to, but do not have to if only one price is charged to all buyers. While a laptop computer might be worth several thousand dollars to a potential buyer, competitive forces have pushed the prices down to less than a thousand; thus, moving toward maximizing the consumer surplus.
OPPORTUNITY COST is the compensation that a productive resource such as labor, could earn in its next best COMPETITIVE alternative employment. Remember that the productive resources include not only labor, but debt and equity capital, entrepreneurship and land (which encompasses natural resources). Included in opportunity cost is what is referred to as ‘normal’ profits. Using labor as an example, if you are receiving less than your opportunity cost from your employer, in a competitive environment, you would simply find another job that covers your opportunity cost. Conversely, if you are receiving in excess of your opportunity cost as an employee, this violates the principle of equity and, if left unchanged in competitive product markets, will eventually have ramifications in terms of long-term viability for the firm, e.g., General Motors and Chrysler.
PRODUCER SURPLUS/ECONOMIC RENT Normal profits or opportunity cost level profits are a cost in economics just as is the cost of labor compensation. Equity capitalists are self-employed. Technically and simply, the firm they own employs them. The self-employed include stockholders. Income or compensation to productive resources in excess of this opportunity cost level is called a producer surplus (economic rent is the more traditional term), and is above what is needed to bring and keep the resource in the firm’s employment.
CONNECTION BETWEEN CONSUMER AND PRODUCER SURPLUS Any producer surplus flowing to the productive resources such as labor or the owners (equity capitalists) came at the cost of a reduced consumer surplus and some degree of deadweight loss. This causes the consumer/buyer to pay more than they might otherwise have to pay in a more competitive environment. As competition increases, downward pressure of product prices will eventually reduce the producer surplus and increase the consumer surplus along with a restoration of the deadweight loss to the consumer surplus.
JUSTICE is the perpetual and constant will to render to each one his right. (Summa Theologica, II-II, q. 58)
COMMUTATIVE JUSTICE regulates exchanges between persons and between institutions in accordance with a strict respect for their rights. (Catechism of the Catholic Church, 2d Ed., 2411)
DISTRIBUTIVE JUSTICE regulates what the community owes its citizens in proportion to their contributions and needs.(Ibid.)
LEGAL JUSTICE concerns what the citizen owes in fairness to the community. (Ibid.)
SOCIAL JUSTICE is ensured when society provides the conditions that allow associations or individuals to obtain what is their due, according to their nature and their vocation. (CCC, 1928)
SUBSIDIARITY Just as it is gravely wrong to take from individuals what they can accomplish by their own initiative and industry and give it to the community, so also it is an injustice and at the same time a grave evil and disturbance of right order to assign to a greater and higher association what lesser and subordinate organizations can do. For every social activity ought of its very nature to furnish help to the members of the body social, and never destroy and absorb them. (Quadragesimo Anno, 79)
SOLIDARITY is a firm and persevering determination to commit oneself to the common good; that is to say to the good of all and of each individual, because we are all really responsible for all. (Sollicitudo Rei Socialis, 28)
A MICROECONOMIC PERSPECTIVE
As economic markets become increasingly competitive, they approach what are called the microeconomic welfare conditions of equity and efficiency. Equity, which is significantly different than equality, is achieved when the consumers pay the lowest price possible, subject to the condition that all productive resources, labor, debt and equity capital, entrepreneurship, and land receive their opportunity cost, no more and no less. When the consumers pay the lowest price possible, economists say that the consumer surplus is maximized. An equitable income distribution is consistent with commutative justice and brings about a sense of fairness that promotes and reinforces solidarity.
An example of increasing competition is the entry of additional firms into a market, such as the U.S. automotive market in the 1950s. About ninety percent of that market was shared by three American auto firms. Initially the only competition was from imported vehicles that held around ten percent of the market. Within a few years, foreign automotive firms began to transplant their operations into the U.S., primarily in low labor cost areas. They were typically more highly automated and used a lean management style that resulted in a relatively low cost structure. Initially competing at the low end of the market, the transplants began to dominate it. Later they also began to compete seriously in the pricier end of the market.
The transplants gradually increased their market share using primarily domestic U.S. productive resources, until they currently have nearly seventy percent of the market, most of which is from U.S. based operations and some imports into the U.S. Initially the quality of the foreign imports and transplant produced vehicles was suspect and reduced the substitutability of those vehicles for those produced by the Big Three American firms. This quality problem was gradually addressed and overcome, thus making the transplant vehicles increasingly good substitutes for the Big Three produced vehicles that were also increasingly using less costly and higher quality foreign made components in their own vehicles.
An understanding of the economic analysis of this example of increased competition is critical in seeing the link between competitive free market capitalism to the degree of conformity of the economic system to the principles of Catholic Social Teaching.
Technically the increase in competition increases the supply of the product in the market, in this case motor vehicles, thus exerting downward pressure on the market price. There may also be a positive quality effect on the goods and services produced. At the level of the firm, as competition increases, the price elasticity of demand facing the firm increases. Technically, the firm’s demand curve rotates toward the horizontal. This causes individual firm’s price increases to be less revenue enhancing. Economists would say that the more substitutes and the greater their substitutability for existing products, the greater the substitution effect when prices are changed. If competition increases significantly enough, price increases by individual firms may actually decrease total revenues from sales of their product. Economists would call this the price elastic range of the firm’s demand curve.
Individual firms lose their market power to control the price as competition increases. They become more price takers and less price makers, as the expression goes. This in turn decreases the rewards to the productive resources that produce the goods and services in the transformation process of production. As competition increases, the surplus rewards to the productive resources in excess of their opportunity costs decrease.
The effects of this increase in competition bring the income distribution closer to the theoretical economic welfare condition of equity — consumers pay the lowest price possible that pays productive resources their opportunity cost– and thus to conformity with commutative justice. It simultaneously causes the market price to approach the theoretical economic welfare condition of efficiency. The inability to exploit consumers and the resulting rise in the per capita standard of living of the population also bring the economy into closer conformity with solidarity. As the distribution of income is more closely based on opportunity costs of the productive resources such as labor and capital, the closer is the economic system to conformity with distributive justice. This in turn reduces the need for government to reallocate income, thus promoting subsidiarity.
Since everyone is a consumer while only some are productive resources and those productive resources have differing opportunity costs, maximization of the consumer surplus while rewarding productive resources with their opportunity costs, reduces the more severe inequalities stemming from the exploitive use of market power, a byproduct of the lack of competition. This promotes social justice and enables the policies to promote social justice to focus upon other basic causes of social injustice such as illegitimate types of discrimination.
A MACROECONOMIC PERSPECTIVE
As competition increases, the economy moves toward the widely desired goals of high employment and a reasonable degree of price level stability. As these goals are approached, the need for government intervention through monetary and fiscal policies is reduced significantly. This increases an economy’s conformity to subsidiarity and solidarity as well as promoting distributive and social justice.
When markets lack significant competition, prices tend to be rigid downward. In pursuit of profit maximization, when demand weakens, firms tend to reduce output in order to eliminate surpluses and rising inventories, and only when necessary do they reduce the price. Pursuant to profit maximization, there is usually little reluctance to raise price when demand increases causing a shortage at the prevailing price. This lack of competition introduces a downward rigidity in pricing giving rise to twin biases toward recession and inflation.
As markets become increasingly competitive the downward price rigidity weakens as firms lose market power and control over price. Competitive pressures force the price downward and as a result, the economy more closely approaches the macroeconomic goals of high employment and a reasonable degree of price level stability. The fall in the price reduces the decrease in quantity supplied needed to restore equilibrium in the market. This reduces the need for government intervention to achieve the widely accepted goals of high employment and a reasonable degree of price level stability and hence promotes the principle of subsidiarity.
As pointed out previously, when equity is more close to being achieved, it reduces the degree of government intervention to reallocate income to lessen the degree of inequality in the income distribution. As the income distribution conforms more fully to the welfare conditions of equity as well as efficiency, it promotes the principle of solidarity. As equity is more closely approached, the economy moves closely to the achievement of commutative justice.
What drives the economy toward these microeconomic and macroeconomic conditions is what Adam Smith referred to as the Invisible Hand of competition. A more technical version of the Invisible Hand refers to the degree to which the power to manipulate supply or demand is possessed by participants on either side of the market. As competition increases, the market power to influence price of individual firms and productive resources decreases.
The time constraints on this presentation necessitate analysis of only the supply side and how increasing competition works to eliminate market manipulation which in turn bring the economy closer to the economic welfare conditions of equity and efficiency in the micro aspect of the economy and high employment and a reasonable degree of price level stability in the macro aspect of the economy. As these economic conditions are approached through greater competition, the principles of subsidiarity, solidarity, and justice are achieved to a greater degree.
As competition in a market decreases, individual firms such as members of the oil cartel OPEC, or productive resources such as labor, through devices such as unions, have bestowed upon them, a power to control the price by reducing the supply. Unions are labor cartels and while increasing total compensation to workers, they reduce employment and reduce job security in general. OPEC sells less oil but receives more revenue.
The ongoing structural unemployment in the United Auto Worker portion of the auto industry, specifically, the former Big Three, is such an example. Loss of market share to the transplants such as Toyota and Honda and accelerated automation have decimated the ranks of labor in this portion of the U.S. auto industry.
Firms with market power seeking to maximize their profits will reduce supply until the price they charge is that at which their profits are maximized. Technically, this is attained at a production level at which their marginal cost equals their marginal revenue.
Both the economic welfare conditions of equity and efficiency are violated. The higher price enables the productive resources, initially equity capital, to expropriate a portion of the consumer surplus and earn more than the productive resources’ opportunity cost. This is the violation of equity. The use of this market power reduces the consumer surplus and converts it into producer surplus, a more modern tern equivalent to economic rent or reward to a productive resource greater than its opportunity cost. The excessive reward to the productive resource is due to the exercise of market power and not based on service to the consumers.
The resulting price causes a less than optimal level of production, thus violating the welfare condition of efficiency and lowering the per capital standard of living for the population. This lessens the conformity of the economy to the principle of solidarity. It also increases the pressure for increased government intervention to stabilize the economy through monetary and fiscal policies reducing the economy’s conformity to the principle of subsidiarity.
In these less than significantly competitive markets, the producer surplus can flow to other resources such as labor and management as we have seen in the Big Three portion of the automotive market where losses resulted in government bailouts while labor and management continued to receive substantial amounts of producer surplus (economic rent) well in excess of their opportunity costs. This exercise of market power violates commutative justice as well as destabilizing the economy by introducing biases toward macroeconomic instability in the forms of recessions and unacceptably high inflation rates.
Let’s examine in a more specific manner how this damage to society and solidarity occurs. The market power due to a lack of sufficient competition, introduces a degree of downward price rigidity. Twin biases toward recession and inflation result in less than an attainably higher level of employment as well as an inflationary bias and unacceptably high rates of inflation result. This is due to the firm’s willingness to raise prices when shortages develop but results in an increasing unwillingness to lower prices when surpluses develop due to a decrease in the demand confronting the firm. As a result these price changes display an upward or inflationary bias and exacerbate the downward movement of production and the upward movement of unemployment when demand weakens. This downward price rigidity reflecting the market power of firms when significant competition is lacking exacerbates cyclical movements in the economy. It is not due to free market capitalism, but to the lack of competition, Adam Smith’s Invisible Hand is weak or absent.
Government also increases its degree of intervention to reduce the increased inequality in the income distribution resulting from the exercise of market power by the firms and from the rewarding of productive resources in excess of their opportunity costs. Lack of significant competition also reduces the per capita standard of living of the population as efficiency as well as equity is violated.
The post World War II era is cluttered with monetary and fiscal policy interventions that are highly questionable in the results they caused. The tolerance of accelerating inflation in the late 1970s and then the abrupt reversal by the Federal Reserve System, engineering a two and one-half year long recession from early in 1980 to mid 1982 is one such example. The rapid run up of interest rates helping trigger the ongoing economic and financial crisis is another example of the destabilizing intervention by the monetary authority. A third example is the fiscal policy of the last three years in which the Federal budgetary deficit has tripled with few positive results and a growing fear of the inability of the U.S. Government to meet its debt obligations, manifesting sovereign risk for the country.
Cartelistic Free market capitalism, with lack of sufficient competition in many markets, gives rise to the power of firms and productive resources as evidenced by labor unions, and it engenders massive and frequent episodes of government intervention justified by intermittent periods of economic downturns and periods of significant rates of inflation. These frequent and massive bouts of government intervention undermine the achievement of subsidiarity and solidarity and render the attainment of justice more difficult. The need for such intervention can be lessened by implementing policies that promote competition.