Capitalism Versus Free Markets.
Capitalism Versus Free Markets.
The current economic model of the United States is characterized by a few elements. First off, it is rightly considered a capitalist model, meaning that there is an emphasis on who controls the capital, or means of production in the economy, and by extension, the people who control these seek to gain more capital. In the narrow old sense, this would mean things like buildings and machines. There is a newer sense of capital, though, which would include things like intellectual capital, copyrights perhaps, or a particularly gifted employee, and there is monetary capital, the funding which drives all operations. The second element which would define our current economic model is a preference for free markets, sectors of the economy in which goods, services, labor, and capital are allowed to be freely transferred between partners in an exchange. The third element that plays a large role in our economic model is an activist government which regulates the economy and serves to create additional economic activity. These three factors are the primary forces that influence the current economy of the U.S. They have evolved according to the needs of the capitalist end of the economy. The economy of the United States has always functioned to make money, to increase capital, and the other two factors have developed to serve that end. It is believed that in such a system waste will be kept to a minimum and resource use will be maximized. Unfortunately this view doesn’t take into account that any system based on a desire to make money will largely tend to ignore aspects of human life and its interaction with the planet which do not offer the chance to make money. This is also true of investments which don’t make money at a rate which match the alternatives. There is always competition within the capitalist system for whatever capital exists, differing business ideas, equities versus stocks versus derivatives, etc. In this race for the attention of capital expenditures like infrastructure investment, or bank savings, can lag behind, simply because they don’t offer the same rate of return as other investments do. This model can chug along quite well as long as growth remains robust, but when growth starts to dwindle, profit margins become squeezed, and competition, which is harmful for the goals of capitalism, starts to cannibalize the system. And let’s face it: while capitalism helped provide the fuel for industrialization, does anyone expect it to help with our most pressing problems today? Is capitalism going to save us from global warming? Is it going to provide us with a better health care system? Is it going to improve education? Is it going to make the world safer? Is it going to promote sustainable agriculture? No it isn’t going to do any of these, which means we need to shift our focus from a system which is great for laying a base for production and look to one that can help us with these problems.
Competition may be good for free markets but it isn’t good for capitalism. In free markets it reduces waste by making sure that businesses operate as efficiently as possible, and that the companies which offer the best remuneration attract the top talent. But for capitalism competition means undue costs that eat into profitability. This is a distinction that is often missed by free market advocates: that stresses exist between the philosophies of capitalism and free markets, and when these stresses exist free markets will be the loser. As an example anyone who has managed their own investments, especially equities quickly comes to realize how few good companies there are which dominate certain sectors of the economy. There are exceptions to the rule: for instance there are probably more good car companies than we really need, but by and large the global economy is dominated by very few large companies. We can also see this stress played out in the theater which is the relationship between business and the government. There are always stories about companies which labor under excessive government regulation, but the story that is often missed is that large multi-national corporations do not suffer from these pressures nearly to the degree that smaller businesses do. In fact, it could be argued that large multi-nationals are happy with the lid that government keeps on smaller firms because it keeps them from threatening their market pre-eminence.
So if you want to consider how suited our system is toward capitalism remember that the way it developed was with an eye toward helping capitalism. Government intervention is another case in point. The government and large multi-national corporations are not at odds, they work in tandem. There are rare instances when this does not occur, such as in the weak reform of the financial markets that occurred after the financial collapse, but these are isolated incidents, by and large if the government of the United States is doing something it is doing so with the blessing of large corporations. Our system of taxation, of subsidies, of labor policy, etc., is all constructed with an eye toward helping capitalists. But make no mistake, this doesn’t mean that what it does is good for free markets, because large multi-national corporations really aren’t interested in having free markets.
Regularly The Heritage Foundation, (a conservative think tank), issues a report on economic freedom. This report ranks 184 countries on economic freedom, this ranking is based on business freedom, trade freedom, fiscal freedom, government spending, monetary spending, investment freedom, financial freedom, property freedom, freedom from corruption, and labor freedom, (tellingly labor freedom was a late addition to their report coming ten years after they started the report in 1995). I was curious as to what sort of argument was used to back up the argument favoring economic freedom. From the Executive Highlights of their 2012 report comes this quote,
“Rapid expansion of government, more than any market factor, appears to be responsible for flagging economic dynamism. Government spending has not only failed to arrest the economic crisis, but also—in many countries—seems to be prolonging it. The big-government approach has led to bloated public debt, turning an economic slowdown into a fiscal crisis with economic stagnation fueling long-term unemployment.”
O.k. well lets be clear that the cost of public debt incurred due to the crisis isn’t really hitting yet, you had the boost of spending without the cost of additional taxation, so really there was an economic gain without an economic cost. When they talk about a fiscal crisis they are talking about something which has yet to come to pass, so while that is a looming issue you can’t really blame the employment situation or economic stagnation on it. And if we look at global economic performance the U.S., (which has been relatively focused on stimulus), would be in much better shape if it weren’t for the angst over Europe, (which has been focused on austerity).
But their rankings provide some data of some interest, a couple things I noticed. Brazil, (ranked 99th), China (138), and India (123), are listed in the mostly unfree category. These countries are ranked below Rwanda, Albania, and the KyrgyzRepublic. Clearly economic freedom hasn’t got much to do with economic performance.
If we are talking about economic performance the top five on the list include both Hong Kong and Singapore, which is sort of like putting NYC or Tianjin on the list by themselves. It also includes Australia which is heavily dependent on raw material exports. Meanwhile the United States ranks 10th, (four places below Canada), Taiwan ranks 18th, Germany ranks 26th, and South Korea ranks 31st. South Korea is ranked well below Estonia and Lithuania.
So my take on this is that it isn’t so much about how much better off the economies of the countries are that have these “economic freedoms”, it is that the authors of this stuff would rather live in a culture that promotes such freedoms. So the whole presentation is skewed, this isn’t about economics at all, it is about culture. Unfortunately a cultural choice is simply a matter of personal preference, and I guess that isn’t good enough for the people who put this together, they want to quantify the reason a cultural choice is better. If that is what their goal is they should probably concentrate more on quality of life issues versus economics.
One thing that our current system depends heavily on is consumerism, this is, of course, self evident. And since growth is required, increased consumerism is also required. The line people are fed is that this will provide ever increasing jobs, and so ever increasing buying power, and so ever increasing standards of living. The proliferation of stuff to buy and services to use in recent history, from microwaves to lawn care services, has provided opportunity to a lot of people, but it has also degraded standards of living in aggregate.
When people consider how since the 1960s our culture has evolved to require two person incomes in households they generally point to how wages have not kept pace with expenses. This is certainly true of things like health care or tuition for higher education, but a bigger culprit is undoubtedly the explosion of stuff. Since 1970 personal expenditures for durable goods in real terms has risen an average of 7% per year, expenditures on services has risen an average of 4% per year. Those are amazing numbers, and they are due to new avenues for spending, not to increased spending on the same things. In fact real prices for durable goods hasn’t experienced much inflation at all due to productivity increases and the exploitation of lower manufacturing costs in developing countries.
Now this is fine in that it give jobs to people. Quite obviously none of this would have worked if for every new worker entering the economy we had to add equal amounts of people producing the same things, or else everyone would just be making automobiles or baking bread and there wouldn’t be anyone available to make cell phones. So opportunity has permitted these people to find employment, but their doing so, and creating new things to spend money on doesn’t mean that existing workers in old industries are making any more money, they are just being provided with more things to spend money on. So this helps to account for both the increase in consumer debt, and the increased profits of big corporations. The reason that corporate profits are tied to this is that a single corporation may make many things. The rise of globalization has also kept a lid on wages, and required the use of debt to purchase all these new things.
It might be possible to say that what these new businesses are doing is simply offering people what they want, but that is a simplistic view which ignores how driven we are by basic needs, how hard wired we are by evolution to get certain things, how satisfied we are in a primal way by certain behaviors. Markets feed into a lot of things that we never make conscious decisions about, and not all of them are good.
Part of this may also explain why happiness indexes show us to be no more satisfied with life than we were in 1950. We have entered upon a consumer treadmill that takes us nowhere, simply has us working harder and harder to amass more stuff. And in doing so we are working very hard to create opportunity for each other.
A critic of what I am saying would probably first be lead to say, ‘well what is the alternative’, or, ‘do you not want people to have jobs? Do you not want them to have garage door openers or garbage disposals?’ Well I would say that this path is unsustainable, so it doesn’t really matter, it isn’t a matter of choice so much as realizing that this path isn’t getting us anywhere. Ultimately people can only consume so much, they can only be awake so many hours in the day and consume so much during that time, so this path of creating opportunity for others in this way is a dead end. Also we have already seen how we have become dependent upon employment through bubbles to create enough jobs to make the basic economy work. Imagine what the last 25 years would have been like without all those IT jobs and housing jobs, all those jobs in financial services. Its not that if the economy had been structured differently those people would have found more enduring work, it is that the economy doesn’t need all those people for more enduring work and so they are available to help make any sort of enterprise function.
Not only is our current system overly fixated on growth but it is also overly fixated on profits. When the use of IRAs and 401ks exploded labor was essentially made to buy into the performance of the investment end of the economy. This has continued to the point that many people would rather see the value of their portfolios rise than see the unemployment rate drop. This preoccupation with profits is ultimately harmful to the economy. One could say that profits are needed for investment and R&D, and that profitability equals jobs. This is a bit of a skewed way at looking at things. First off investment and R&D aren’t included in profits, they are considered a business expenses, so when we talk about profits we talk about the money left over after these things have been paid for. Secondly investment in new jobs doesn’t occur in response to having a high profit margin they occur in response to expectations of increased demand, and increased demand happens when profits are shared with labor, not hoarded to increase share price. In fact if you have a competitive environment, (and as mentioned earlier the degree we actually do have that needs to be doubted), and companies are profitable without expectations of increased demand they are more likely use their investment dollars not to increase output but to increase profitability by increasing productivity through automation or streamlining operations, investment which actually destroys jobs. So while a business should have profits to soften the impact of business cycles, profits as an end in itself to drive share price is absurd. It creates a goal which actually hurts the economy by draining wages. If you are set on keeping the “equities as investments for all” system then the equities should be valued on the basis on the dividends they are able to pay, not on the profits they are able to retain. Another problem with this pooling of profits is that money is never left laying around, it is always put to work, a chief concern of every CFO is making sure that every dollar one has access to is in some way making money. This mean that profits wind up chasing bizarre means of making a little investment income. Why was there such an explosion of mortgage based securities prior to the financial collapse? Because there was huge demand for such investments. Money needed to find a way to make money, and as this situation progresses it becomes more and more compounded.
This explosion of investment capital creates a harmful imbalance in our economy. An economy should function as a self fulfilling loop. The money in the economy should be sufficient to circulate freely between all the costs required for businesses and labor, and the resulting wages which must be paid to supply the labor to cover those costs, or needs of people. In our system this loop is broken because money is pooling in the investment sector of the economy without getting circulated through the rest. It is also being misdirected into avenues where it doesn’t return. The pooling occurs when people invest in things that don’t immediately cause the funds to circulate. for instance in the traditional banking model when people put money into savings in a bank the bank turns around and loans out a portion of that money, allowing it to re-circulate. In the current model people invest their money into funds, or equities, or treasuries, but the money tends to stay in the investment community, on the books of the funds, it may circulate, but it circulates amongst the funds, buying other assets, very little of it gets put back into the functioning economy. This pooling in turn supports the prices of the assets being purchased. As more money pools it requires more assets, and so different forms of paper assets are created to offer more investment options. While all this happens the government starves for revenue and labor starves for wages and the functioning of the loop which is the economy is broken, debt is used to replace the actual circulation of funds, and ultimately economic activity is strangled.
Not only does this strangle economic activity but it presents a very basic problem for the economy in that the amount of actual currency is far short of the value of paper investments. These paper investments may be the value of the shares people own, or obligations to pay people for “insurance” or the bets they have made on events which may or may not occur. These obligations typically operate on a system of balances. For instance if someone buys a hedge against the price of wheat falling, what amounts to crop insurance, then if that has to be paid out it does so out of money made from people who bet the price of wheat would go up. This is a very simplified way of looking at, but it is the basic idea of how these things work and how the firms which engage in this sort of thing stay in business. The problem is that in total these commitments far outweigh the ability of anyone to actually pay, the money supply simply isn’t large enough. This is normally isn’t a problem, but it can become one as it did during the financial crisis with AIG, then the government must step in and cover this shortfall, perhaps in exchange for equity in the firm which cannot meet it’s commitments, but bailing out is indeed required. Now this begs the question, if there isn’t sufficient currency to cover these commitments then how much are they really worth? It would seem that they are only worth the governments willingness or ability to back them up in the event of a “run” on the system. Given public sentiment against bailouts now, and given the problems with the fiscal position of the government, the actual value of these assets, should be considered to be a small percentage of what they are. It is essentially a game of poker, where the last one holding ones cards is the loser, or better yet, given the amount of cash assets against the amount of claims, the last 80% of people holding their cards lose everything.
So when capitalism evolved it did a good job of creating the environment that allowed the industrial revolution to explode. Capital ready to be put toward aggressively exploiting the economic circumstances of the day. It’s not as if the industrial revolution wouldn’t have occurred without capitalists. It also allowed development of many new means of waging war, and governments are always interested in that, so it would have occurred no matter what. But capitalists pushed it further than any government would have. They did this using free markets to advantage, but only so far as they didn’t threaten their market dominance. But these opportunities were exhausted, and now capitalism chases round and round looking for places to explode its investments, only the capital has grown while the opportunities have shrunk, leaving us with a system which has become toxic. It is time to abandon capitalism, but not free markets.