Recently, there has been a heated debate about whether capitalism or some form of socialist reform is best suited to fighting climate change, with ideas ranging from carbon taxes and subsidies to ending capitalism as we know it.
However, as one of my economics professors recently pointed out to me, capitalism versus socialism may be the wrong debate entirely. Instead, we should be talking about free markets versus government regulation.
This may sound like the same debate, but it isn’t. The main distinguisher between socialism and capitalism is ownership of the factors of production (inputs). Under capitalism, inputs are privately owned while socialism calls for public ownership of inputs.
A free market is characterized by little to no government regulation (taxes, quotas, subsidies, etc.) on economic exchange, allowing for uninhibited competition that can encompass any voluntary economic activity. By this definition, both capitalist systems and socialist systems usually have some level of market activity.
While relatively free markets are a characteristic of capitalism, the two are not synonymous. No capitalist country has a completely free market system, and countries that consider themselves socialist generally have some elements of a free market (see this index of economic freedom for details).
In a free market, the lack of restrictions gives entrepreneurs the freedom to find innovative solutions to problems. Without a significant amount of luck, government-mandated solutions are unlikely to be better than the innovations of the market; they cannot foresee and quickly adjust to day-to-day changes, nor are they capable of gaining and using all of the knowledge of individuals.
Combating climate change is important, and entrepreneurship is one of our most powerful weapons in this fight—making innovation a key reason why we should not immediately dismiss free market solutions in favor of government regulation. If entrepreneurs are unable to take the risks necessary for innovation, we may be depriving ourselves of technologies that could help us fight climate change in ways we cannot yet imagine.
The American market for energy effectively illustrates this concept because energy has a history of benefitting from subsidies. Subsidies are payments from the government to producers that artificially lower the costs of production, allowing the producer to sell at a lower price in the market. These subsidies often gain support as a way to allow new technologies, approaches, or providers to enter the market and become competitive more quickly.
This strategy seems like a great way to encourage clean energy. By artificially making clean energy cost less, consumers would substitute away from fossil fuels and toward clean energy.
However, subsidies reduce the drive to innovate. If the producer is already the least costly in its market, why bother developing a more efficient process? And on the flip side, if one industry is heavily subsidized, why bother trying to compete?
Government-subsidized solar and wind energy have become an increasingly popular consumer choice. However, much like those received by their fossil fuel competitors, these subsidies reduce solar and wind producers’ incentives to research new methods or make substantial changes because the subsidy already keeps them competitive in the market.
What may be even more concerning are the barriers to entry subsidies could create for other environmentally-friendly solutions. Entrepreneurs who believe it is possible to re-purpose the harmful emissions of fossil fuels may have difficulty getting started if they have no hope of competing with subsidized wind and solar.
The competitive environment of an open market provides not only the cheapest cost but also the most innovative solutions; it allows consumers to reveal preferences with their pocketbooks. As producers compete to provide a product consumers prefer, innovation naturally follows.
Meet the Author
Kate Best is an intern with the NDSU Center for the Study of Public Choice and Private Enterprise. She is studying economics and mathematics at NDSU. The views expressed in this article belong to the author.