Many people deplore the fact that the top 20 percent of U.S. households account for 55 percent of the nation’s after-tax income, and the top one percent own nearly 40 percent of the country’s wealth. Such inequality seems to offend some sense of justice and fairness and this prompts policies to tax the rich and redistribute income to people on the bottom. The very nature of the U.S. progressive income tax is intended to tax the rich at increasingly higher rates to achieve a more “equitable” distribution of income.

In discussions on equality, we often do not define our terms well. Most of us would agree that equality of opportunity is desirable. But, equality of opportunity in no way guarantees that outcomes will be equal. In fact, inequality of outcomes is the natural and expected result of any fair, competitive process, whether the competition is for Olympic medals, Nobel Prizes, grades, or dollars.

For example, in the 1992 summer Olympic games, almost 100 countries competed in over 230 individual and team events in 26 different sports. In all, 815 gold, silver, and bronze medals were awarded. The countries that received the most medals represented only ten percent of the total number of countries that competed. Yet that top ten percent won more than 65 percent of the total medals awarded. The top 20 percent of the countries won more than 85 percent of the total medals awarded.

An analysis of Nobel Prizes awarded in the four science categories—physics, chemistry, medicine, and economic science—also shows a dramatic inequality of outcome. Since 1901 there have been 447 Nobel Prizes awarded to individuals from over 30 countries. Three countries (United States, Great Britain, and Germany) earned almost 300 Nobel awards. In other words, the top 10 percent of the countries receiving awards got 67 percent of the total Nobel Prizes. The top 20 percent (United States, England, Germany, France, Sweden, and Switzerland) earned over 80 percent of the total prizes granted.

As long as everyone is free to compete in a fair contest with well-defined rules, no one is offended by the inequality of outcomes at the Olympics or in Nobel Prize competition. No one ever seriously suggests that Olympic medals or Nobel Prizes (with the possible exception of the prize for literature and peace) be redistributed to achieve “equality of outcome.”

Why then do people object to an unequal distribution of income or wealth? The results of income distribution conform very closely to the inequalities outlined above in the Olympics and for Nobel Prizes. An unequal distribution of income is a natural and expected outcome—just like the unequal distribution of Olympic medals or Nobel Prizes. The economy is a competitive marketplace and there will always be people who excel in business, science, or the arts. Through some combination of skill, perseverance, hard work, and luck, successful people like Bill Gates, Oprah Winfrey, and Michael Jordan make more in a year than most of us make in a lifetime. But then the United States usually wins more Nobel Prizes in a year than Japan has won all century.

Taxing the most successful people in our society and redistributing income to the most unproductive members of society is not a solution to the so-called evils of income inequality. Redistribution through a punitive, progressive tax system harms everyone—it makes the richest, most successful people less productive and the least productive people even less productive. In the same way that redistributing Olympic medals would weaken and undermine athletic competition, income redistribution weakens our economic system.

In the same way that a Ponzi scheme or chain letter initially succeeds but eventually collapses, socialism may show early signs of success. But any accomplishments quickly fade as the fundamental deficiencies of central planning emerge. It is the initial illusion of success that gives government intervention its pernicious, seductive appeal. In the long run, socialism has always proven to be a formula for tyranny and misery.

A pyramid scheme is ultimately unsustainable because it is based on faulty principles. Likewise, collectivism is unsustainable in the long run because it is a flawed theory. Socialism does not work because it is not consistent with fundamental principles of human behavior. The failure of socialism in countries around the world can be traced to one critical defect: it is a system that ignores incentives.

In a capitalist economy, incentives are of the utmost importance. Market prices, the profit-and-loss system of accounting, and private property rights provide an efficient, interrelated system of incentives to guide and direct economic behavior. Capitalism is based on the theory that incentives matter!

Under socialism, incentives either play a minimal role or are ignored totally. A centrally planned economy without market prices or profits, where property is owned by the state, is a system without an effective incentive mechanism to direct economic activity. By failing to emphasize incentives, socialism is a theory inconsistent with human nature and is therefore doomed to fail. Socialism is based on the theory that incentives don’t matter!

In a radio debate several months ago with a Marxist professor from the University of Minnesota, I pointed out the obvious failures of socialism around the world in Cuba, Eastern Europe, and China. At the time of our debate, Haitian refugees were risking their lives trying to get to Florida in homemade boats. Why was it, I asked him, that people were fleeing Haiti and traveling almost 500 miles by ocean to get to the "evil capitalist empire" when they were only 50 miles from the "workers’ paradise" of Cuba?

The Marxist admitted that many "socialist" countries around the world were failing. However, according to him, the reason for failure is not that socialism is deficient, but that the socialist economies are not practicing "pure" socialism. The perfect version of socialism would work; it is just the imperfect socialism that doesn’t work. Marxists like to compare a theoretically perfect version of socialism with practical, imperfect capitalism which allows them to claim that socialism is superior to capitalism.

If perfection really were an available option, the choice of economic and political systems would be irrelevant. In a world with perfect beings and infinite abundance, any economic or political system–socialism, capitalism, fascism, or communism–would work perfectly.

However, the choice of economic and political institutions is crucial in an imperfect universe with imperfect beings and limited resources. In a world of scarcity it is essential for an economic system to be based on a clear incentive structure to promote economic efficiency. The real choice we face is between imperfect capitalism and imperfect socialism. Given that choice, the evidence of history overwhelmingly favors capitalism as the greatest wealth-producing economic system available.

The strength of capitalism can be attributed to an incentive structure based upon the three Ps: (1) prices determined by market forces, (2) a profit-and-loss system of accounting and (3) private property rights. The failure of socialism can be traced to its neglect of these three incentive-enhancing components.

Prices

The price system in a market economy guides economic activity so flawlessly that most people don’t appreciate its importance. Market prices transmit information about relative scarcity and then efficiently coordinate economic activity. The economic content of prices provides incentives that promote economic efficiency.

For example, when the OPEC cartel restricted the supply of oil in the 1970s, oil prices rose dramatically. The higher prices for oil and gasoline transmitted valuable information to both buyers and sellers. Consumers received a strong, clear message about the scarcity of oil by the higher prices at the pump and were forced to change their behavior dramatically. People reacted to the scarcity by driving less, carpooling more, taking public transportation, and buying smaller cars. Producers reacted to the higher price by increasing their efforts at exploration for more oil. In addition, higher oil prices gave producers an incentive to explore and develop alternative fuel and energy sources.

The information transmitted by higher oil prices provided the appropriate incentive structure to both buyers and sellers. Buyers increased their effort to conserve a now more precious resource and sellers increased their effort to find more of this now scarcer resource.

The only alternative to a market price is a controlled or fixed price which always transmits misleading information about relative scarcity. Inappropriate behavior results from a controlled price because false information has been transmitted by an artificial, non-market price.

Look at what happened during the 1970s when U.S. gas prices were controlled. Long lines developed at service stations all over the country because the price for gasoline was kept artificially low by government fiat. The full impact of scarcity was not accurately conveyed. As Milton Friedman pointed out at the time, we could have eliminated the lines at the pump in one day by allowing the price to rise to clear the market.

From our experience with price controls on gasoline and the long lines at the pump and general inconvenience, we get an insight into what happens under socialism where every price in the economy is controlled. The collapse of socialism is due in part to the chaos and inefficiency that result from artificial prices. The information content of a controlled price is always distorted. This in turn distorts the incentives mechanism of prices under socialism. Administered prices are always either too high or too low, which then creates constant shortages and surpluses. Market prices are the only way to transmit information that will create the incentives to ensure economic efficiency.

Profits and Losses

Socialism also collapsed because of its failure to operate under a competitive, profit-and-loss system of accounting. A profit system is an effective monitoring mechanism which continually evaluates the economic performance of every business enterprise. The firms that are the most efficient and most successful at serving the public interest are rewarded with profits. Firms that operate inefficiently and fail to serve the public interest are penalized with losses.

By rewarding success and penalizing failure, the profit system provides a strong disciplinary mechanism which continually redirects resources away from weak, failing, and inefficient firms toward those firms which are the most efficient and successful at serving the public. A competitive profit system ensures a constant reoptimization of resources and moves the economy toward greater levels of efficiency. Unsuccessful firms cannot escape the strong discipline of the marketplace under a profit/loss system. Competition forces companies to serve the public interest or suffer the consequences.

Under central planning, there is no profit-and-loss system of accounting to accurately measure the success or failure of various programs. Without profits, there is no way to discipline firms that fail to serve the public interest and no way to reward firms that do. There is no efficient way to determine which programs should be expanded and which ones should be contracted or terminated.

Without competition, centrally planned economies do not have an effective incentive structure to coordinate economic activity. Without incentives the results are a spiraling cycle of poverty and misery. Instead of continually reallocating resources towards greater efficiency, socialism falls into a vortex of inefficiency and failure.

Private Property Rights

A third fatal defect of socialism is its blatant disregard for the role of private property rights in creating incentives that foster economic growth and development. The failure of socialism around the world is a "tragedy of commons" on a global scale.

The "tragedy of the commons" refers to the British experience of the sixteenth century when certain grazing lands were communally owned by villages and were made available for public use. The land was quickly overgrazed and eventually became worthless as villagers exploited the communally owned resource.

When assets are publicly owned, there are no incentives in place to encourage wise stewardship. While private property creates incentives for conservation and the responsible use of property, public property encourages irresponsibility and waste. If everyone owns an asset, people act as if no one owns it. And when no one owns it, no one really takes care of it. Public ownership encourages neglect and mismanagement.

Since socialism, by definition, is a system marked by the "common ownership of the means of production," the failure of socialism is a "tragedy of the commons" on a national scale. Much of the economic stagnation of socialism can be traced to the failure to establish and promote private property rights.

As Peruvian economist Hernando de Soto remarked, you can travel in rural communities around the world and you will hear dogs barking, because even dogs understand property rights. It is only statist governments that have failed to understand property rights. Socialist countries are just now starting to recognize the importance of private property as they privatize assets and property in Eastern Europe.

Incentives Matter

Without the incentives of market prices, profit-and-loss accounting, and well-defined property rights, socialist economies stagnate and wither. The economic atrophy that occurs under socialism is a direct consequence of its neglect of economic incentives.

No bounty of natural resources can ever compensate a country for its lack of an efficient system of incentives. Russia, for example, is one of the world’s wealthiest countries in terms of natural resources; it has some of the world’s largest reserves of oil, natural gas, diamonds, and gold. Its valuable farm land, lakes, rivers, and streams stretch across a land area that encompasses 11 time zones. Yet Russia remains poor. Natural resources are helpful, but the ultimate resources of any country are the unlimited resources of its people–human resources.

By their failure to foster, promote, and nurture the potential of their people through incentive-enhancing institutions, centrally planned economies deprive the human spirit of full development. Socialism fails because it kills and destroys the human spirit–just ask the people leaving Cuba in homemade rafts and boats.

As the former centrally planned economies move toward free markets, capitalism, and democracy, they look to the United States for guidance and support during the transition. With an unparalleled 250-year tradition of open markets and limited government, the United States is uniquely qualified to be the guiding light in the worldwide transition to freedom and liberty.

We have an obligation to continue to provide a framework of free markets and democracy for the global transition to freedom. Our responsibility to the rest of the world is to continue to fight the seductiveness of statism around the world and here at home. The seductive nature of statism continues to tempt and lure us into the Barmecidal illusion that the government can create wealth.

The temptress of socialism is constantly luring us with the offer: "give up a little of your freedom and I will give you a little more security." As the experience of this century has demonstrated, the bargain is tempting but never pays off. We end up losing both our freedom and our security.

Programs like socialized medicine, welfare, social security, and minimum wage laws will continue to entice us because on the surface they appear to be expedient and beneficial. Those programs, like all socialist programs, will fail in the long run regardless of initial appearances. These programs are part of the Big Lie of socialism because they ignore the important role of incentives.

Socialism will remain a constant temptation. We must be vigilant in our fight against socialism not only around the globe but also here in the United States.

The failure of socialism inspired a worldwide renaissance of freedom and liberty. For the first time in the history of the world, the day is coming very soon when a majority of the people in the world will live in free societies or societies rapidly moving towards freedom.

Capitalism will play a major role in the global revival of liberty and prosperity because it nurtures the human spirit, inspires human creativity, and promotes the spirit of enterprise. By providing a powerful system of incentives that promote thrift, hard work, and efficiency, capitalism creates wealth.

What would you conclude about the quality of product or service X under the following circumstances?

1. The employees of Airline X and their families are offered free airline tickets as an employee benefit. The employees refuse to travel with their families on Airline X and instead pay full fare on Airline Y when flying.

2. The employees of Automaker X are offered a company car at a substantial discount and they instead buy a car at full price from Automaker Y.

3. Employees at Health Clinic X and their families are offered medical care at no additional cost as a benefit and yet most employees of Clinic X pay out-of-pocket for medical services at Clinic Y.

In each case, the employees’ willingness to pay full price for a competitor’s product or service and forgo their employer’s product or service at a reduced price (or no cost) makes a strong statement about the low quality of X. What makes the inferior quality of X even more obvious is that the employees at Firm X, since they work in the industry, would have better informationabout product (service) X and product (service) Y than the average person.

What then should we conclude about the quality of public education in the United States given the following facts? Public school teachers send their own children to private schools at a rate more than twice the national average–22 percent of public educators’ children are in private schools compared to the national average of 10 percent.

In large cities across the United States, more that a quarter of public school teachers’ children are attending private schools–50 percent in Milwaukee, 46 percent in Chicago, 44 percent in New Orleans, 36 percent in Memphis, and 30 percent in Baltimore and San Francisco.

In New York City, as of 1988, no member of the Board of Education and no citywide elected official had children enrolled in a public school.

Public school teachers are giving public education a failing grade by their disproportionate patronization of private education when it comes to the education of their own children. The sharp decline in SAT scores over the last 30 years confirms that the quality of public education is deteriorating. SAT scores (a measure of the academic ability of high school seniors) were fairly stable between World War II and the early 1960s, averaging about 978. Starting in the early 1960s, SAT scores steadily declined and reached a low of 890 in 1980. Since then, SAT scores have risen slightly to the current average of about 900. Numerous other tests of the education abilities of high school seniors by independent groups (National Assessment of Educational Progress, National Endowment for the Humanities, and the International Association for the Evaluation of Education) have also shown a serious decline in the quality of public education over the last 30 years.

Increased Costs

Accompanying the decline in the quality of public education has been a dramatic increase in the cost of public education. Since World War II, real spending per public school student has increased 40 percent each decade, and has gone from about $1,000 per student in 1945 to over $5,000 per student in 1990 measured in constant dollars.

Rising teacher salaries have contributed to the increased cost of education, rising from $12,000 to $35,000 in real dollars between 1945 and 1990, about twice the growth rate of average national incomes. And public school teachers’ benefits have increased even faster than their salaries. From 1975 to 1985, teacher salaries rose by 10 percent in real terms, but real fringe benefits doubled. Benefits now contribute an additional 25 percent to teachers’ average after-tax income. The increases in teachers’ salaries and fringe benefits have largely coincided with the increased unionization of teachers, 90 percent of whom are now in teacher unions.

Teachers’ salaries are not the real problem, though. The largest contribution to the increased costs of public education has come from the growth in the administrative sector of public schools. Administrative employment has grown far faster than instructional employment and has significantly increased educational expenditures to finance an expanding administrative bureaucracy. For example, between 1960 and 1984, the number of nonclassroom personnel grew almost 600 percent, nearly ten times the growth rate of classroom teachers. The number of nonteaching, administrative employees (46 percent of total) is now almost equal to the number of classroom teachers (54 percent of total) and continues to grow.

Consider the following cases of bloated public school administration. The Chicago Board of Education, which has 3,300 employees, is larger than the entire Japanese Ministry of Education. The New York City public schools system has 250 timesas many administrators as the New York Catholic school system (6,000 administrators in public school system versus 24 in Catholic school system), even though New York public schools have only four times as many students as the Catholic schools.

Administrative costs have exploded since World War II as the number of school districts has declined, from over 100,000 districts in 1945 to fewer than 16,000 in 1980. As school districts have consolidated and grown in size, they have become increasingly bloated–more top-heavy, more bureaucratic, more centralized, less efficient–and more costly to administer.

Doomed to Failure

American public schools are failing miserably. They suffer from the same underlying structural flaws that make all socialist programs eventually fail–protection from competition and insulation from failure. Socialism is a defective theory, and any system based on socialist principles will fail, whether it is an entire economy or a single program. Socialism failed in East Germany and the Soviet Union and it is failing in the American public education.

Since public schools have (1) an effective monopoly on education and (2) the government as their source of funding, public education is insulated from competitive market forces. Undisciplined by profit and loss accounting, public schools have no incentive either to operate efficiently or to cater to their customers. In contrast to private firms which are forced to serve the needs of their customers or go out of business, public schools can ignore their customers because they are protected from failing by the deep pockets of the American taxpayers.

In fact, operating efficiently and cutting costs undermine and sabotage the agenda of the entrenched public education bureaucracy, because operating efficiently will lead to a reduced budget. Perverse incentives are in place to guarantee failure–the worse public education is, the more money and resources will be budgeted to try to solve the education "problem." Given the political framework, it makes sense for the educational establishment to deliver an inferior educational product as a way to attract increasingly larger budgets. In contrast to the private sector where resources are constantly being directed towards the most efficient and profitable enterprises, the public sector diverts resources towards the least effective, most inefficient programs.

In regard to public education, we have seen collectivism in action–a failing, inefficient bureaucracy getting more and more resources–more money, higher salaries, more benefits, more employment. And as public schools become increasingly bureaucratic and politically oriented, they become more and more responsive to the political process and engage in rent-seeking activities to protect their monopoly status. Because the main sources of educational funding are state and federal governments, political constituencies–politicians, teachers’ unions, political parties, and lobbyists–become more important to educators than parents and students. The attention and focus of education is directed away from local concerns towards the political process at the state and federal level.

In addition to the monetary expense of public education, we need also to account for the role that public education has played in the costly erosion of our personal freedom and the costly expansion of Big Government during this century. In the same way that political disincentives discourage educational efficiency, public school educators also have strong disincentives to teach students to think clearly, logically, and independently about economic and political issues. Clear economic thinking and an appreciation of private enterprise would be counterproductive to an agenda of increased funding of public education. If students and parents developed clear, independent thinking as part of public education, they would become increasingly intolerant of inefficient state-run bureaucracies like public schools. They might even demand an end to the public education monopoly.

The diversion of public funds toward an expanding public sector is made much easier if students are subtly influenced from an early age to be tolerant of government solutions and programs. Government schools therefore have flourished and expanded, along with a general expansion of government at all levels, largely because public schools have failed to educate students on the proper role of limited government as set forth in the U.S. Constitution. Since the early part of this century, the size of the federal government has gradually increased, and is now at a historically unprecedented level. From the birth of the nation in 1776 until the early 1930s, government spending at the federal level never exceeded 3 percent of national income except during periods of war. Since the 1930s, spending by the federal government has steadily increased and has now reached 30 percent of national income. State and local government spending has also increased, from 7 percent of national income in 1930 to 12 percent in the 1990s. When we take into account the further burden of complying with government regulations and time spent filing tax forms (5.4 billion man hours), the total cost of government to society is more than 50 percent of national income. The average American now works from January 1 until July 10 every year to pay for the total cost of government.

The failure of public schools to educate students effectively has contributed to the increasing role of government over the last 60 years. The expansion of the public sector and the "stranglehold of the political power over the life of the citizen" has largely coincided with the increased bureaucratization, politicization, and unionization of public education. It may have been impossible for government to expand so rapidly over the last 60 years without a public education system to subtly desensitize students to the growth of the state and the erosion of personal freedom.

As Leonard Read of The Foundation for Economic Education pointed out years ago, people will never give up their freedoms all at once. However, they will be rather indifferent about losing their freedom gradually over time, as we have seen happen in this century. To explain this phenomenon, Read used the analogy of boiling a frog in a kettle of water. If you boil the water first and try to throw the frog in the kettle, it will immediately jump out as soon as it lands on the water. However, if you put the frog in a kettle of cold water and heat the water up slowly, the frog will slowly cook to death before it realizes what is happening.

Likewise, the growth of the welfare state and the erosion of freedom have happened so gradually over the last 60 years that most people have not even realized that it has happened. As a society, we would never have allowed federal government spending to expand from 3 percent to 30 percent of national income in one year, but we have tolerated that expansion of government over a 60-year period. Part of the reason we allowed this to happen is that we became immune in public schools to the gradual loss of freedom and accompanying growth in the government. The doctrine of state supremacy is subtly woven into the inculcation of students by statist, unionized, civil servant teachers who have incentives to perpetuate and expand the role of the state and public education.

We need to break the "stranglehold of political power" over our educational system by introducing parental choice, competition, and market solutions in education. Contrary to public opinion, education was largely supplied by the private sector from the 1700s until the first few decades of the 1900s. Schools were small, local, and private, and were forced by competition to be responsive to students and parents.

The private sector would deliver world-class, first-rate, superior education in America once the stranglehold of the "educational octopus" is broken. Innovation and experimentation in education would be encouraged in a competitive educational marketplace. Parents would have the same diverse choice in the educational marketplace that they now have when arranging for music lessons, karate instruction, or swimming lessons. In a competitive educational environment, private schools and public schools would be forced to serve the public interest or they would go out of business. Consumer sovereignty would reign once again in the educational marketplace. Costs would decline and quality would improve.

Through education and training we develop skills and abilities to improve our human capital, which is our investment in the future. The productive capacity and standard of living of a country depends on the quality of human capital available. Therefore, there is no more important responsibility than the education of our children since this is our investment in the most important resource of all–human capital.

There is no surer way to guarantee that our children continue to receive an inferior education than to continue educating 90 percent of our children in the public school system. Education is far too important a responsibility to leave in the hands of a government bureaucracy whose monopoly status allows it to be insensitive and unaccountable to parents and students.