Nit Piketty (18) Flaw in Capitalism

Piketty thinks that he has found a flaw in capitalism: the fact that the return on capital is greater than the growth rate of the economy. He attributes the increasing inequality to a flaw in capitalism. The key is r>g. He writes,

The overall conclusion of this study is that a market economy based on private property, if left to itself contains... powerful forces of divergence, which are potentially threatening to democratic societies and to the values of social justice on which they are based.

The principal destabilising force has to do with the fact that the private rate of return on capital, r, can be significantly higher for long periods of time than the rate of growth of income and output, g.

The inequality r>g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental local contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labour. Once constituted, capital reproduces itself faster than output increases. The past devours the future.

The consequences for the long-term dynamics of the wealth distribution are potentially terrifying, especially when one adds that the return on capital varies directly with the size of the initial stake and that the divergence in the wealth distribution is occurring on a global scale.

r>g is not a flaw of capitalism. It reflects the nature of the world. Capital makes people more productive. This makes everyone better offer off, including labour.

Therefore increasing the capital income ratio is good. The question is who benefits. It seems reasonable that those who do the saving should benefit most. They should benefit more than those who did not save.

Piketty grudgingly seems to accept this reality, but then moves quickly on to attacking inheritances.

Capitalism without Guilt

I recently listened to a podcast of a talk called Capitalism without Guilt given by Yaron Brook at the London School of Economics. I was interested, because I did not expect the Director of the Ayn Rand Institute to be speaking at the LSE. He said that the fundamental objection to capitalism is not economic, but moral.

People operate in the market to make money. Some will have a passion for what they do, but their basic drive is to make their own life better. The businessperson’s motivation is not the “common good” or “social utility”, but to make their lives better. The market is a place where people meet to fulfil their self-interest. Buyers and sellers both want to make their lives better.

We are taught that to be good or virtuous is to be selfless and to sacrifice to others. We were taught to think of others first and yourself last. According to philosophers, morality is about being selfless and caring for others. The more you sacrifice, the more noble you are. The more you give the better you are. According to most moral teaching self-interest is wrong. People honour philanthropy and community service, but denigrate business, profit seeking and entrepreneurship.

We tend to assume that all businessmen are evil. We feel safe because an elevator has been checked by a bureaucrat. We sleep at night because Ben Bernanke is in charge of a monetary system.

We have a morality that is inconsistent with capitalism. Very few people live a selfless life. They pursue self-interest. When you live one life, but believe you should be living another, you get guilt. Guilt is a powerful emotion. It is an amazing mechanism for controlling people. It is why rich people cote for increases in taxes. They need to redress their guilt, because they have this unrealistic morality.

We will continue to move away from capitalism, as long as our current morality is maintained. Brook does not agree with it. We need a new morality with the objective of making a human life as good as possible. Goodness lies in the pursuing self-interest. Ayn Rand said that the number one value is self-interest.

Capitalism is a moral system, because it allows each one of us to pursue our self-interest. This is good. Brook says that we need to reject to morality of living for others, and live instead for our own flourishing. I disagree, but his talk got me thinking. Capitalism has lifted economic well being in an amazing way, but capitalistic economic theory requires people to pursue their self-interest. Yet this does not fit well with Christian morality.

This is a conundrum that has puzzled me for a while. I found the answer in another book that I am reading. I will post on it in the next few days.

John Kay on Capitalism

John Kay made these comments in a talk at the LSE.

The word capitalism is a misleading term that encourages many misapprehensions. One is that economic power rests with the owners of capital. There was a time when this was true, eg Arkwights Mill existed, and this gave Arkwright real power. However, this is no longer applies. In the modern world, economic power rests with financiers, and people like Jamie Dimon, Ben Bernanke and Steve Jobs. Their power comes from their position in the hierarchy, as it always has, in the church, the courts, and other power structures. Their economic power does not come from the ownership of capital. They derive capital from the power they exercise. They do not gain power and influence for their capital. They gain capital from their place in the authority hierarchy.

Ownership of the means of production does not mean anything anymore. The term ownership is unhelpful. No one owns Apple or JP Morgan in the usual sense of the word. The Apple store in Regent Street is 75% owned by the Queen and 25% by a Norwegian sovereign wealth fund.

Share ownership does not mean anything either. There are four aspects of ownership of shares.

1. Decisions to buy or sell shares.
2. Decisions about how voting rights should be exercised
3. The name on the share register
4. The economic interest

All four roles can be exercised by different entities, and they usually are in the UK. Discussion about ownership of shares obscures our understanding of modern business.

Security markets are thought of as a market for buying and selling capital. This is no longer the case. Modern businesses are able to fund their expansion from the surpluses generated by their activities. (Small and medium business do not have access to capital markets). Modern business is less capital intensive, so successful businesses become capital generative earlier in their life. Capital markets are not a means of getting capital into a business, but a way of getting money out. Most activity is financial engineering and not capital raising.

Muller on Capitalism (8)

I have quoted extensively from Jerry Z Muller, because he raises some important issues for those who care about the future of society.

An advanced capitalist economy does indeed require an extensive financial sector. But whatever the benefits and continued social value, the financialisation of society nevertheless had some unfortunate consequences, both in increasing inequality by raising the top of the economic ladder ( thanks to the extraordinary rewards financial mangers receive) and increasing insecurity among those lower down ( thanks to the intense focus on short-term economic performance to the exclusion of other concerns).

Capitalism today continues to produce remarkable benefits and continually greater opportunities for self-cultivation and personal development. Now as ever, however, those upsides are coming with downsides, particularly increasing inequality and insecurity. Marx and Engels accurately noted, what distinguishes capitalism from other social and economic systems is its “constant revolutionising of production, uninterrupted disturbance of all social conditions and everlasting uncertainty and agitation.”

Now as then, the question at hand is just how to maintain the temporal blessing of capitalism while devising preventative and correctives for the evils that are their eternal concomitant.

This last para is really important. The benefits of capitalism are amazing, but the downsides cannot be ignored. All the secular and socialist solutions to this problem have failed. Christianity offers a solution that will work, but unfortunately it has not really be tired. Unrighteous wealth should be given away and righteous wealth should be shared. See Jesus on Money and Secular Capitalism. Christians should be comfortable with insecurity, if they understand God's plans for the future.

Muller Capitalism (7)

Jerry Z Muller suggests that education is not the solution to equality.

In today’s globalised, financialised, post-industrial environment, human capital is more important than ever in determining life chances. This makes families more important, too, because as each generation of social sciences researchers discovers anew (and much to their chagrin), the resources transmitted by the family tend to be highly determinative of success in school, and in the work place.

As the political scientist Edward Banfield noted a generation ago in The Unheavenly City Revisited, “All education favours the middle and upper-classes child, because to be middle- or upper-class is to have qualities that make one particular educable.” Improvements in the quality of schools may improve overall education outcomes, but they tend to increase, rather than diminish, the gap in achievement between children from families with different levels of human capital.

The unrecognised and unleashed power of Christian discipleship is that it can created the middle class attitudes necessary to build human capital.

Muller Capitalism (6)

Jerry Z Muller discuses the impact of capitalism on the roles of men and women.

One crucial impact of the rise of the postindustrial economy has been on the status and roles of men and women. Men’s relative advantage in the preindustrial and industrial economies rested in large part on their greater physical strength—something now ever less in demand. Women, in contrast, whether by biological disposition or socialisation, have had a relative advantage in human skills and emotional intelligence, which have now become increasingly more important in an economy more orientated to human services than to the production of material objects. The proportion of the economy in which women could participate has expanded and their labour has become more valuable—meaning that time spent at home now comes at the expense of lucrative possibilities in the paid work force.

The redeployment of female labour from the household has been made possible in part by the existence of new commodities that cut down on necessary household labour time (such as washing machines, dryers, dishwashers, water heaters, vacuum cleaners, microwave ovens). The greater time devoted to market activity, in turn, has given rise to new demand for household-orientated consumer goods that require less labour (such as packaged and prepared food) and the expansion of restaurant and fast-food eating. And it has led to the commodification of care, as the young , the elderly and the infirm are increasing looked after not by relatives but by paid minders.

As the economy has passed from an industrial economy to a postindustrial service and information economy, women have joined men in attaining recognition through paid work, and the industrious couple today is more likely to be made of peers, with more equal levels of education and comparable elves of economic achievement—a process termed “assertive mating”.

Given the family’s role as an incubator of human capital, such trends have had important spillover effects in inequality.

A family with two professional parents has a huge advantage over a family with one or two unskilled parents.

Muller Capitalism (5)

Jerry Z Muller writes about the growth of service industries and decline of manufacturing. Globilisation has reinforced the trends.

In 1973, the sociologist Daniel Bell noted that in the advanced capitalist world, knowledge, science and technology were driving a transformation to what he termed “post-industrial society’. Just as manufacturing had previously displaced agriculture as the major source of employment, he argued, so the service sector was now displacing manufacturing.

In a post-industrial, knowledge-based economy, the production of manufactured goods depended more on technological inputs than on the skills of the workers who actually built and assembled the products. That meant a relative decline in the need for and economic value of skilled and semi-skilled factory workers—just as there had previously been a decline in the need for and value of agriculture labourers. In such and economy, the skills in demand included scientific and technical knowledge and the ability to work with information. The revolution in information technology that has swept through the economy in recent decades meanwhile has only exacerbated these trends....

Globalisation has not caused this pattern of increasingly unequal returns to human capital but reinforced it. As the manufactured goods and routine services are outsourced, the wages of the relatively unskilled and uneducated in advanced capitalist societies decline further, unless these people are somehow able to find remunerative employment in the untradeable sector.

Muller Capitalism (4)

Jerry Z Muller explains the tension between dynamism and security that is produced by capitalism.

For most of history, the prime source of human insecurity was nature. In such societies, as Marx noted, the economy system was orientated toward stability-and stagnancy. Capitalist societies, by contrast, have been oriented towards innovation and dynamism, to the creation of new knowledge, new products, and new modes of productions and distribution. All of this has shifted the locus of insecurity from nature to the economy.

Hegel observed in the 1820s that for men in a commercial society based on the breadwinner-homemaker model, one’s sense of self-worth and recognition by others was tied to have a job. This posed a problem, because in a dynamic capitalist market, unemployment was a disctint possibility. The division of labour created by the market meant that many workers had skills that were highly specialised and suited for only a narrow range of jobs.

The market created shifting wants, and increased demand for new products meant decreased demand for older one. Men who lives had been devoted to their role in the production of the old products were left without a job and without the training that would allow them to find new work. And the mechanisation of production also led to a loss of jobs. From its very beginning, in other words, the creativity and innovation of industrial capitalism were shadowed by insecurity for members of the work force.....

The dynamism and insecurity created by nineteenth-century capitalism led to the creation of new institutions for the reduction of insecurity, including the limited liability corporation, to reduce investor risks; labour unions to further protect worker interests; and mutual aid societies to provide loans and burial security.

Muller Capitalism (3)

Jerry Z Miller explains that unequal abilities become more significant as barriers to opportunity are removed.

If capitalism has opened up ever more opportunities for the development of human potential, however, not everyone has been able to take full advantage of those opportunities or progress far once they have done so. Form or informal barriers to equality of opportunity, for example, have historically blocked various sectors of the population―such as women, minorities and the poor—from benefitting fully from all capitalism offers. But over time, in the advanced capitalist world, those barriers have gradually been lowered or removed, so that now opportunity is more equally available than ever before.

The inequality that exists today, therefore, derives less from the unequal availability of opportunity than it does from the unequal ability to exploit opportunity. And that unequal ability, in turn stems from difference in the inherent human potential that individuals begin with and in the ways that families and communities enable and encourage that human potential to flourish.

The role of the family is shaping individuals ability and inclination to make use of the means of cultivation that capitalism offers is hard to overstate. The household is not only a site of consumption and of biological reproduction. It is also the main setting in which children are socialised, civilised and educated, in which habits are developed that influence their subsequent fates as people and as market actors. To use the language of contemporary economics, the family is the workshop in which human capital is produced.

Muller Capitalism (2)

Muller says that a serious consequence of the dynamism of capitalism is increased insecurity.

Capitalism’s intrinsic dynamism, however, produces insecurity along with benefits, and so its advance has always met resistance. Much of the political and institutional history of capitalist societies, in fact, has been the record of attempts to erase or cushion that insecurity.

The right has largely ignored the problem, while the left has sought to eliminate it through government action, regardless of the cost. Neither approach is viable in the long run. Contemporary capitalist polities need to accept that inequality and insecurity will continue to be the inevitable result of market operations and find ways to shield citizens from their consequences- while somehow still preserving the dynamism that produces capitalism’s vast economic and cultural benefits in the first place.

Capitalism is a system of economic and social relations marked by private property, the exchange of goods and services by free individuals, and the use of market mechanisms to control the production and distribution of those goods and services….

Throughout history, most households had consumed most of the things that they produced and produced most of what they consumed. Only at this point did a majority of the population in some countries begin to buy most of the things they consumed and do so with the proceeds gained from selling most of what they produced.

The growth of market-orientated households and what came to be called “commercial society” had profound implications for practically every aspect of human activity. Prior to capitalism, life was governed by tradition institutions that subordinated the choices and destinies of individuals to various communal, political and religious structures. These institutions kept change to a minimum, blocking people from making much progress, but also protecting them from many of life’s vicissitudes. The advent of capitalism gave individuals more control over and responsibility for their own lives than ever before- which proved both liberating and terrifying, alowing for both progress and regression.

Muller Capitalism (1)

Jerry Z Muller has published an important article called Capitalism and Equality: What the Right and Left get Wrong in Foreign Affairs (March/April 2013). Jerry Z. Muller is currently a Professor of History at the Catholic University of America. His message parallels that of Guy Standing, but whereas Standing leans towards socialism, Muller is a conservative. He is the editor of a book called Conservatism.

Muller is concerned about the link between capitalism and equality, and is worried that conservatives just ignore the problem.

Inequality is indeed increasing almost everywhere in the postindustrial capitalist world. But despite what many on the left think, this is not the result of politics, nor is politics likely to reverse it, for the problem is more deeply rooted and intractable than generally recognized. Inequality is an inevitable product of capitalist activity, and expanding equality of opportunity only increases it -- because some individuals and communities are simply better able than others to exploit the opportunities for development and advancement that capitalism affords.

Despite what many on the right think, however, this is a problem for everybody, not just those who are doing poorly or those who are ideologically committed to egalitarianism -- because if left unaddressed, rising inequality and economic insecurity can erode social order and generate a populist backlash against the capitalist system at large.

Capitalism

The word capitalism has become unusable. When most people hear the word capitalism, they think of the current system of collusion between business and government, collusion between business and the military and a financial system that privatises profits and socialises losses. The technically correct name for the current system is mercantilism or fascism, but those words have long been forgotten. Most people now use the word capitalism to describe this kind of system. So when Christians try to defend capitalism, people read them as defending the current system, so they lose credibility. Putting the words pure, or biblical, ore free-market on the front does not help, because the meaning of the word capitalism has gone beyond the point of no return.

The economic concept of capital is important. The development and production of capital equipment increased human productivity and allowed us to escape from subsistence living. So the way that capital is created and who should own it and how owners should be rewarded for it are really important questions. However, those issues just get lost in any debate about the morality of capitalism.

So I prefer not to use the word capitalism. When describing the a biblical approach to economic development, I try to be more precise about what the bible teaches. I try to explain clearly how an economic system that is consistent with the scriptures would function. This system (a dangerous word too) would be very different from what we have now and it cannot be encapsulated in any –ism, including capitalism and socialism.

Capitalism and Big Business

Capitalism does not create big business. The State created big business. Large corporations are the result of limited liability laws and other laws that protect big business. Banks that are too big to fail are the result financial regulation.

The American system is not capitalism. It is a system of collusion between political power, business power and military power. (The technical name for this system is fascism, but most Americans are not ready to accept that yet.) This collusion between politicians, big business and the military system has produced the problems that America is now facing. Further regulation will not resolve these problems, but will give more protection to business, which will eventually leader to a new crisis.

Capitalism needs very few laws to function effectively: a law against theft; a law providing for contracts to be enforced; and not much more.

The Death of Capitalism?

Michael Miller of the Acton Institute ends his article with these words.

Socialist economies, cartels, oligarchies, and union-controlled industries where the price mechanism cannot function produce stagnation and create incentives for corruption. It is a false hope to believe that regulation will make everything right. This is a utopian dream that ignores human failing and is the same promise that has been peddled by the socialists.

It is likewise delusional to believe that markets alone are enough. Markets require more than just efficiency; they require virtue. Our Founders taught us that without virtue political liberty could not long be sustained. The same holds true for economic liberty. And yet without economic liberty there can be no political liberty. Like liberty, the market must be moral, or it cannot exist at all.

The entire article is worth a read.