From economic shutdowns to trillions of dollars in new government spending, the 2020 COVID-19 pandemic led to a dramatic increase in government action. While much of the increase was temporary, there is now a growing desire to further expand government. We see calls for single-payer health care systems, expanded child-care subsidies, and trillions of dollars in federal infrastructure investments.

Arguments about what government should and should not do are not new. We regularly see them in the debates over the merits of socialism versus free market capitalism. While these debates are often in the abstract, over the last century countries have experimented with variations on both economic systems. The Hoover Institution’s Human Prosperity Project critically examined many of these experiments to see which economic system is best for human flourishing. 

Part 2: How do socialism and capitalism affect income and opportunities?

Delivering broad-based prosperity should be the primary goal of all economic systems, but not all systems deliver the same results. Supporters of capitalism argue that free markets give people—entrepreneurs, investors, and workers—the right incentives to create goods and services that people value. The result is higher standards of living. Those sympathetic to socialism, however, respond that capitalism may produce wealth for some, but without government involvement in the economy many are left behind.

In his Human Prosperity Project essay Socialism, Capitalism, and Income economist Edward Lazear analyzed decades of income trends across 162 countries. He studied how incomes for low and high earners changed as countries shifted from government-controlled economies to more market-oriented economies.

Lazear points to several specific examples. First, China: in the 1980s, the Chinese Communist government began to adopt market-based reforms. Lazear finds that the market reforms, as skeptics of capitalism would predict, did increase income inequality. But, more importantly, the market reforms lifted millions of people out of poverty.

Part 3: What about mixed economies?

Of course, most modern-day critics of capitalism are not advocating for complete government control over the economy. They don’t want the economic policies of the Soviet Union or early Communist China; instead, they point to nations with mixed economies to emulate, such as those featuring social democracy. So how do these policies affect incomes and opportunities?

Economist Lee Ohanian compares the labor market policies of Europe and the United States in his essay The Effect of Economic Freedom on Labor Market Efficiency and Performance. Compared to the United States, European nations have higher minimum wages, stricter rules that prevent the firing of workers, and high rates of unionization. These rules are intended to protect workers, but Ohanian finds that they discourage employment and result in lower compensation rates.

What about the effects of income redistribution and the taxes that pay for it? Supporters argue that these programs keep people out of poverty. Critics, however, argue that financing these systems comes with high costs both to taxpayers and to recipients.

In their essay Taxation, Individual Actions, and Economic Prosperity: A Review, Joshua Rauh and Gregory Kearney consider the effects of raising tax rates on high-income Americans to finance new government spending. They examine the effects of income and wealth taxes in Europe. They find that wealth taxes and high income tax rates discourage high-income filers from investing in a country, which ultimately reduces economic growth. Thus, calls in the United States to increase income and wealth taxes “come despite a body of evidence showing that the country is already one of the more progressive tax regimes in the world, that wealth confiscation results in worse outcomes for the broader economy.”

The long-term consequences of redistribution don’t fall just on taxpayers. Such transfer systems also create incentives for individuals to leave or stay out of the work force. In their contribution to the Human Prosperity Project, economist John Cogan and Daniel Heil consider the effects of Universal Basic Income (UBI) programs, which would provide a “no-strings-attached” cash benefit to families. They find that modern UBI proposals in the United States would either prove costly—requiring tax rates that would reduce incentives to work and invest—or would require steep phase-out provisions that punish recipients who try to re-enter the workforce. In either case, the result is that UBI programs are likely to reduce employment rates, ultimately depriving recipients of long-term economic opportunities.

Part 4: What about other aspects of human flourishing?

Human flourishing is more than material prosperity. For example, it requires a clean environment and access to good health care.

It might seem that socialist economies—where government controls the means of production—would have better environmental track records. Yet the evidence suggests the opposite. In his essay Environmental Markets vs. Environmental Socialism: Capturing Prosperity and Environmental Quality Economist, Terry Anderson summarizes the literature on economic systems’ effects on the environment.