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.

Kay on Free Markets (3) Diffusion of Power

Free markets diffuse economic and political power. John Kay says that a major benefit of free markets is that rent seeking is constrained.

Rent seeking is the process by which the ambitious find it more rewarding to batten on the wealth created by other people than to create it themselves. Rent seeking takes, and has taken, many forms – castles on the Rhine, the Wars of the Roses; ten per cent on arms sales, or seven per cent on new issues: awarding yourself control over former state assets, stealing the revenues from your country’s resources deposits, seeking protection from foreign competition, blocking market access by new entrants; winning sinecures or overpaid positions by ingratiating oneself with public servants or corporate employees. The mechanisms of rent-seeking range from the application of armed force to victory in democratic election; the methods pursued range from lobbying on Capitol Hill and in the restaurants of Brussels, through access to the King or the Chief Executive.

But while rent seeking is ineradicable, we can have more of it, or less. Politics everywhere used to be dominated by rent seeking; factions would battle for control of the state and when they won such control would use it to steal as much as they could get their hands on. In much of the world, it is like that still. ‘It’s Our Turn to Eat’ is the stomach churning title of one fascinating recent book about the corrupt – and moderately – democratic politics of modern Kenya. We have come to recognise the resource curse – wealth from national resources does more harm than good in many countries because of the rent-seeking it attracts – and foreign aid may have some of the same characteristics. But in Western Europe, at least, corrupt politics has ceased to be an avenue for rent-seeking.

The ability of a political/economic system to resist rent seeking depends on the degree of economic decentralisation. If there are concentrations of economic power. Individuals will try to get their hands on the rents concentrations of power attract whether they are found in the public sector, in private businesses, or in groups of private business. The wider the extent of the opportunities this created, the greater the tendency for individuals to gain wealth and influence for themselves by attaching themselves to power rather than exploiting their own individual talents and by developing distinctive capabilities in their own economic activities…

The ability of a market economy to restrict rent-seeking, its capacity to channel the desire for acquisition into channels that create wealth rather than extract it, depends on measures both to prevent the concentration of economic power and to limit the terms of access to such concentration. These are constraints on the economic power of the state: constraint on the concentration of economic power in large businesses: constant vigilance at the boundaries between the state and business: and a mixture of external supervision and internal restraint which prevents individuals who pull levers of economic power from using these levers to direct renting to themselves.

Because the last decades have confused a pro-business stance with a pro-market stance, we have emphasised some of these conditions at the expense of others. Western – and especially Anglo-Saxon societies – have constrained the economic role of the state. These measures have reduced the scope of one focus of rent-seeking, that by organised groups of public employees. A substantial element of such rent-seeking remains in areas that remain inescapably within the public sector. And, despite the furore over MPs’ expenses, we have continued to do well in maintaining the financial, if not necessarily the intellectual, integrity of our politics and politicians. Few people enter British, or west European, politics for the money. If the worst we have is the odd moat-clearing or duck-house, and the occasional sale of a peerage, we are not doing badly: although it is important we should continue to make a fuss about these issues. Corruption is a slippery slope, long and gentle.

There was a recent time, however, when similar restraint applied in large business: when people knew, as people in the UK Treasury do know but people in the Kenyan Treasury do not, that a lot of money may pass through your hands without any of it being yours. The senior managers of large British industrial companies before the 1980s did not pay themselves large salaries because they did not think it appropriate to do so. They would have been insulted by the idea of a bonus or success fee in much the same way as a doctor or teacher would still be insulted by a bonus or a success fee. They saw their jobs as a responsibility rather than a reward. These conventions have gone: and in the United States, the problem of the diversion of a substantial part of the rents earned by large corporations into the hands of senior managers is now a serious issue.

This is, however, a side show. The larger issue is the concentration of power of large business, or groups of large businesses, and the use of the leverage that power gives to strengthen established positions and enhance the economic and political power still further.

The most dangerous form of rent seeking in the modern economy is the collusion between governments and the financial sector.

Kay on Free Markets (2) Process of Discovery

John Kay says there is a good deal more to the power of markets than the price mechanism. Markets are a process of discovery based on freedom to experiment, combined with discipline in which unsuccessful experiments are terminated quickly. A chaotic process of experimentation is the means through which a market economy adapts to change.

The world is uncertain: not just risky, but uncertain, in the sense used by Keynes and Knight. Not only do we not know which future outcomes will happen: we are unable to specify at all fully what these possible outcomes will be. If we could predict or anticipate the invention of the wheel, we would have already invented it. Market economies do not predict the future, they explore it. That is a fundamental – perhaps the fundamental – difference between a planned and a market economy.

Hayek continues to be the most eloquent exposition of the concept of the market as a process of discovery. His argument was a priori , but vindicated by the failures of the eastern bloc in the post-war era. These planned economies failed in the development, not just of consumer products, but of business methods. Their technological development was disappointing in almost all not related to military hardware. Centralised systems experiment too little. They find reasons why new proposals will fail – and mostly they are right in finding reasons why they will fail because most experiments do fail. Market economies thrive on a continued supply of unreasonable optimism. And when, occasionally, the experiments of entrepreneurs succeed, they are quickly imitated. It is a sad fact of the market economy that even for innovations that are commercially successful, few are commercially successful for the innovator.

If market economies are better than planned societies at the origination and diffusion of new ideas, they are also better at disposing of failed ideas. Honest feedback is not welcome in large bureaucracies. In authoritarian regimes, such feedback can be fatal to the person who delivers it. In less draconian contexts, unwanted messages can be fatal to careers. And when I talk about large bureaucracies here, I am talking just as much about large private bureaucracies as large public ones. Disruptive innovations most often come to market through new entrants – from Google, EasyJet, Amazon. Incumbents have good reasons to be suspicious of novelty and protective of their established markets and activities.

The health of the market economy depends, therefore, on constant replenishment of the business sector by new entry. If, as planner or sponsoring department, you had been planning the future of the computer industry in the 1970s, would you have asked Bill Gates and Paul Allen?, If, as planner or sponsoring department, you had been planning the future of aviation in the 1980s, would you have asked Stelios Haji-Ioannou? If, as planner or sponsoring department, you had been planning the future of retailing in the 1990s would you have asked Jeff Bezos? Of course not: whether you were the politburo or permanent secretary you would have asked men in suits like yourself.

Watching the impact of electronics and the internet on children and grandchildren, makers of business and public policy have at least understood these issues. Committees of the middle-aged Twitter about technology like embarrassing adults trying to have fun at the teenagers’ disco. But, like those adults at the party, we are not really serious. Whether planners or governments of a market economy, we see industries through the eyes of established firms in the industry. And in doing so. miss the pluralism that is the market economy’s central dynamic.

Most people who develop a new business to try out a new idea fail. The few that succeed change the economy. This process of discovery is what has made the free market successful.

Kay on Free Markets (1)

The neo-classical economic model claims that free markets lead to an optimal economic situation. The proof of this claim requires so many restrictive assumptions that the proof is not worth much.

In the Future of Markets, John Kay takes a much less perfectionist approach. He suggests three elements to the triumph of the market economy. He says that economists focus too much the first and not enough on the second and third.

1. Efficient resource allocation
2. Markets as process of discovery
3. Diffusion of political and economic power.

Kay says that a defence of the free markets must include all three elements.

There is one central theme that runs through all three strands in the success of the market economy, a theme which I have called disciplined pluralism. When prices act as signals decentralised enterprises and decentralised information are brought together to create a coherent result. Markets as a process of discovery are based on freedom to experiment, combined with discipline: unsuccessful experiment is acknowledged and terminated. Markets as a means of decentralising power are the determinant of the areas where politics and economics meet.

1. Efficient Resource Allocation
The price mechanism is generally a better guide to resource allocation than central planning. John Kay says,

The model of ‘prices as signals’ describes how self-interested agents – individuals or firms – might, through independent decisions, make consistent and efficient choices about how to organise production and distribution and the allocation of capital, labour and other resources. In a loose formulation, this idea has been around since the beginnings of economics. Many people interpret Adam Smith’s famous remark about ‘the invisible hand’, and his observation that it was not the benevolence of the baker, but his self-love, that furnished our table in this way. In an astonishing demonstration of the power of spontaneous order, decentralised markets manage the process of coordinating complex production systems better than centralised direction.