Monday, 1 December 2014

Communist state capitalism in China

China currently lives under a complex mishmash of the leftovers of communism, state capitalism, crony capitalism and laissez faire in the special economic zones. The communist party remains in power, but has progressively replaced the communist ideology by a mix of nationalism and mercantilism.

This new model has been very successful in terms of economic growth and attraction of foreign direct investment. Due to its huge population (1/4 of all humanity), China is now seen as a kind of manufacturing factory for the world.

Under Deng Xiaoping, China introduced in 1979 a policy to modernize their state owned companies by granting them more decision making power and the possibility of retaining a share of the profits. Along with this, marginal players operating outside the boundary of socialism were tolerated as long as they did not threaten the state sector or challenge the Party’s political power. The later spur a movement of entrepreneurial activity through private farming, township and village enterprises, private business in cities, and Special Economic Zones.

Three years after the Tiananmen Square Massacre the Communist Party officially endorsed the “socialist market economy” in 1992. This was followed from 1992 to 1994 by a second round of reforms aimed at creating a true internal market within China by abolishing or reducing the many trade and tax barriers at provincial borders and through the privatization of some state enterprises.

Two other important milestones were the membership of the World Trade Organization in 2001 and the constitutional amendment of 2004 recognizing the protection of private property.

The most radical departure from communism was the 1980 establishment of Special Economic Zones in Zhuhai, Xiamen, Shenzhen, and Shantou opened to foreign investment to experiment with the market economy, import advanced technology and managerial know-how, and sell goods to the global markets without undermining socialism in the rest of the country.

These were later extended to other regions and transformed China from a backward rural economy into the largest offshore processing center of the world. These areas attracted 70% of all foreign investment and contributed to over 70% of its exports. Foreign direct investment (FDI), including from Chinese living abroad, became the driver of an unprecedented export-led boom.
Source: UNCTAD World Investment Report 2014

There are two remarkable features in the evolution of FDI in China. Its ten-fold increase during the 1990-1994 second round of reforms that followed Tiananmen and the fact that since 2005 China also became a major source of FDI. Most of the Chinese outward investment went to Hong Kong and offshore centers but the Chinese have also invested significantly in Australia, South Africa and other African countries rich in natural resources.

These flows are an unquestionable testimony and consequence of the success of China’s mercantilist dualist economy – a state owned economy supported by the largest offshore territory in the world. Indeed, in 2006 its foreign currency reserves, already the world's biggest, topped $1 trillion. They are also the best proof of the power of capitalism as an economic system, even in its distorted version of state capitalism.

The question is to know whether it can survive in its current form and how it may evolve. Judging from previous experiences it is unlikely that the current model will last more than 30-40 years.

For instance, despite the initial economic role of the Chinese military complex and a rising nationalism one hopes that it will not derive into a Nazi/Japanese-like military adventure that would kill its early success and endanger world peace.

Similarly, any drive to obstruct the growth of joint stock companies while transforming the still large and inefficient state enterprises into some form of Tito’s Yugoslav model of self-managed enterprises is equally doomed to fail.

An evolution towards a Scandinavian model of state capitalism would be equally short-lived and does not seem feasible given the cultural differences between the Nordics and the Chinese. Likewise with a move towards a Mediterranean corporatist form.

The Chinese state capitalism is already showing signs of fatigue. As usual, these are more visible in disastrous investments abroad and in a fragile banking system. The latter is a time-bomb in waiting. Some, like C. E. Walter and J.T.H. Fraser (2009), alerted to how the banks are risking the retirement of an ageing population of more than 300 million people. The “heroic savings capacity of the Chinese people” are being used to finance loss making state companies as well as property bubbles and gigantic “Pharaonic” infrastructure investments.

Despite these worrisome signs, the Chinese people have embraced a commitment to education and learning from the Western countries experience without parallel in history. For instance, in the academic year 2010-2011 there were about 340 thousand students studying abroad, most of them financed by their own families. Indeed, in the USA and the UK there are now Universities that survive on Chinese students. These students are very competitive and will foster a new rise in entrepreneurship and modernization as long as their drive to succeed is not diverted towards nationalistic adventures.

Indeed, contrary to what some claim, I do not believe that the peaceful transition from communist state capitalism towards a democratic market capitalism needs a new “third way”. I totally disagree with the Nobel Laureate Ronald Coase predicament that: “Capitalism will be much more robust if it’s not a monopoly of the West, but flourishes in societies with different cultures, religions, histories, and political systems.”

It is not possible to achieve true market capitalism within a communist political system. However, the two transition processes can reinforce each other rather than deter one another.

By correcting the many deficiencies in the Chinese pillars of capitalism, from relying less in joint ventures and better protecting private property to the abolishment of internal restrictions to labor mobility and the opening up of its domestic financial market to achieve international capital mobility on both current and capital transactions, China would ease its political transition towards representative democracy and constitutional liberalism. For instance, a strong adherence to a system of limited liability will enforce credit prudence in the banking sector and might avoid the foreseeable problems with old age pensions.

In conclusion, China is at a crossroad. If she wants to preserve its recent economic success and avoid descending into other forms of state capitalism or to become a crony capitalist system of the Russian type it must fully embrace market capitalism. The more it does so the greater the chances of also managing a peaceful political transition.

Tuesday, 25 November 2014

We’re all capitalists now

The six pillars of capitalism – private property, profit motive, free markets, rule of law, joint ownership and limited liability – allowed this economic system to be the most productive as well as the most equalitarian system ever tried by humanity. Nevertheless, this result was neither procured nor foreseeable from the outset.

For example, one of the widest off the mark forecasts in history was Marx’s prediction that under capitalism the greater part of the middle-class would constantly sink into the proletariat leaving the population divided into a small bourgeoisie and a large proletariat. Indeed, exactly the opposite has happened. Although the wealthiest one percent has increased its share of total income the number of proletarians (those without any assets other than their labor) dwindled to a small number. So, instead of all becoming proletarians now we are all capitalists.

The explanation for Marx’s failure resides in his erroneous theory of wages and employment and from unforeseen developments in terms of labor organization (unionization), welfare state and compulsory savings through retirement, unemployment and health insurance.

Furthermore, apart from the number of capitalists in society, there were other developments that also changed the perception and the role of capitalists.

In fact, under capitalism the social structure no longer is based on breeding but on work and merit. Social mobility is now achieved mostly through education while the social standing of business people as well as that of wealthy and poor capitalists is now at par with the traditional higher classes of nobility and clergy.

Popular capitalism, a term used to describe the rise in shareholding by individual investors, may occasionally hit the headlines but it should not be confused with the process through which people are now simultaneously workers and capitalists. Whether people choose to own shares in a company directly or indirectly through institutional investors depends simply on their perception about which is the best way to manage their capital.

The role of the capitalists investing in equity has also changed in the sense that most of them do not participate in the life of the company into which they invested or simply monitor its development. Indeed, some do not even want to know much about the company where they invested except its price so that they do not become sentimentally attached to the stock.

Nevertheless, although day trading based in technical analysis is a popular approach among some investors, the majority of investors still follow an investment approach based on event or portfolio investing which require a good knowledge about the company. Thus the signs they transmit through their buy and sell orders cannot be ignored by company managers, even when they are not part of the small group of investors that have or might exercise the control of the company.

So, although trading plays an increasing role in today’s capitalism, we cannot identify the kids gesticulating in a modern trading room with a Rothschild standing at the door of the London Exchange in the XIX century. Mostly because they are just agents, while Rothschild was simultaneously agent and principal. So, traders cannot be used to symbolize modern capitalism. Nor should the wealthy be confused with capitalists whenever they invest only in government debt.

As I said elsewhere, 100% leveraged companies cannot exist in the capitalist sector. In this sector, shareholders are indispensable to preserve the profit motive and profit maximization indispensable to a capitalist system. So, although consumers are the main beneficiaries of capitalism with an unequivocal interest in free markets (another pillar of capitalism) they cannot play the role of capitalists and force managers to pursue profit maximization because they would have an interest in securing lower prices at the expense of profits.

Then, since most people are simultaneously consumers, workers and capitalists, how can they achieve at the same time lower prices, higher wages and more profits? This is a false conundrum easily solved in a capitalist system through competition and profit maximization. To pursue profit maximization firms have to optimize their labor/capital mix while investing more in physical and human capital to increase productivity and wages. Through free and competitive markets corporations are at the same time forced to take good care of their customers and try to offer the best service at a lowest price.

In conclusion, as more people becomes capitalist they improve their wealth and income, and, most importantly, they play a role in keeping the system alive and efficient.

In general, most of us, including those with more than a million invested in securities, cannot live on capital earnings alone. Therefore we do not recognize ourselves in the old stereotype of an idle capitalist with a top hat living on investment income and spending only a few hours a month monitoring or trading his securities. But, generally, now we are all capitalists (whether directly or indirectly) despite not fitting into a stereotype. This is clearly an important civilizational advancement of capitalism.

Wednesday, 19 November 2014

Os libertários e os Vistos Gold: Uma nota adicional

Na controvérsia sobre o caso dos Vistos Gold, alguns libertários tentaram separar, e bem, a política de Vistos Gold da sua implementação por parte de funcionários eventualmente corruptos. Porém, alguns foram longe de mais ao defender a política de vistos com o argumento que o dinheiro é todo igual, quer seja obtido através das exportações para a China ou da venda de imobiliário em Portugal aos Chineses.

Já explicámos num outro post porque é que este argumento é falacioso quando estamos perante externalidades significativas. Porém, no caso dos vistos a falácia é ainda maior. De facto, não existe nenhum problema se um país decidir tributar os estrangeiros que o visitam. E, na verdade, quase todos o fazem usando expedientes vários desde o pagamento de selo nas autoestradas da Suíça até à exigência de comprar um visto de entrada para turismo nas fronteiras dos Países Bálticos e muitos outros países. Mais ainda, se esses "impostos" resultarem de um tratamento de reciprocidade ou não forem claramente discriminatórios então serão aceitáveis mesmo numa perspetiva libertária que defende a livre circulação de pessoas, bens e capitais.

Porém, a atual política de Vistos Gold, é totalmente contrária aos princípios liberais por três razões fundamentais:

1) Os Vistos Gold são mais valiosos do que um visto normal, não porque permitem a entrada no espaço de Schengen, mas porque garantem benefícios adicionais em termos de direitos de residência, investimento e tratamento fiscal que não são nem transparentes nem acessíveis a todos. Pelo contrário, parecem concebidos para atrair fundos de origem duvidosa ou para facilitar a evasão fiscal. Ora, não se percebe que Portugal continue a perseguir fiscalmente os seus cidadãos que investem no estrangeiro e ao mesmo tempo queira transformar-se num paraíso para branqueamento de capitais numa clara violação dos princípios de um estado de direito;

2) A “venda” dos vistos não é feita para benefício do erário público mas apenas para benefício de interesses particulares específicos. Se o estado concedesse os vistos a quem investisse em divida pública ainda se compreenderia pois não teriam externalidades negativas nos outros setores da sociedade e beneficiava a todos. Porém, como a sua utilização interessa apenas aos vendedores de imobiliário, os restantes sectores de atividade e os contribuintes ficam com a fatura dos custos de vizinhança indesejável, da má reputação nacional e dos encargos policiais e judiciais. A julgar pelos casos que já surgiram, parece que a hipotética receita adicional de 80 milhões de Euros de IMI não vai sequer ser suficiente para cobrir os últimos;

3) Finalmente, e mais importante sob o ponto de vista liberal, os Vistos Dourados violam claramente os princípios básicos das regras de concorrência internacional. Por exemplo, porquê conceder vistos a quem comprar casas e não a quem comprar sapatos ou recapitalizar empresas? É sabido que os chamados acordos de investimento geralmente distorcem o investimento internacional e por isso organizações como a OCDE têm pugnado pela sua regulamentação e Portugal só ganharia com isso.

Em conclusão, num mundo libertário não havia pura e simplesmente necessidade de vistos. Porém, no mundo atual onde muitos violam as regras de concorrência, a existência de vistos Gold só pode ser justificada em termos de reciprocidade e se comprovadamente os seus benefícios coletivos excederem os respetivos custos. Nunca em nome dos princípios liberais.

Monday, 17 November 2014

The origins of capitalism

The origins of capitalism go as far back as the XI century when Pope Gregory VII dictated the Dictatus Papae letters asserting that the deposal of an emperor was under the sole power of the pope and excommunicated Henry IV to reinforce the power of the Church. Unintentionally, he created the church-state with most of the legal and administrative institutions necessary for the subsequent commercial revolution. However, capitalism only overtook the feudal system in the early XIX century.

During this long period of eight centuries the following events represent important milestones: the Champagne fairs in France (XII-XIII centuries), the banking and Italian Renaissance (XV century), the Portuguese and Spanish discoveries connecting Europe with the rest of the world (XIV-XVI centuries), the establishment of chartered companies and stock exchanges (1555,1652), the rise of mercantilism (XVI-XVII centuries), the scientific, transport and industrial revolutions (XVI-XVII centuries), the enlightenment (XVIII), the publication of Adam Smith’s Wealth of Nations (1776) and the emergence of joint stock companies (XVIII century).

The creation of a commercial economy at the beginning of the XIII century, initially in the eastern Mediterranean, but quickly extended to the Italian city-states and the rest of Europe brought not only new products (spices, etc.) but new developments in business practices. For instance, the Champagne annual fairs revived the international trade between France and Italy and led to the development of merchant law (Lex mercatoria) and the creation of an international payment system based on bills of exchange.

The development of a new class of rich merchants and bankers in Northern Italy enabled the development of the double-entry accounting system and new banking techniques. This new class was essential for the development of the new trade made possible by the Portuguese and Spanish maritime voyages of discovery and the cultural renaissance in Italy.

Foremost in the development of capitalism was the expansion of credit. This was permitted by the progressive abandonment of the usury laws initiated with the English law of 1550. At the same time, another important progress in terms of company law was the establishment of Charted companies that latter led to the joint stock company.

Mercantilism, as an economic theory, is the opposite of market capitalism. It advocates the role of the state to protect infant industries and domestic markets while trying to control the main trading routes to secure a balance of payments surplus. Nevertheless, paradoxically, by promoting a new form of imperialism based more on trade supremacy than on pure conquest, it was initially a major driver of the international trade that preceded the industrial revolution. But, its nationalistic and protectionist policies led inevitably to wars and inefficiencies that could only be solved by the rise of free trade and the progressive abandonment of mercantilism. However, today, in countries like China and other transition economies, mercantilism is still evident in their new type of state capitalism.

The birth of the so-called scientific revolution can be said to have started with the publication in 1543 of Nicolaus Copernicus's De revolutionibus orbium coelestium or with Newton's 1687 Principia. The subsequent debate on rationalism and empiricism revived the interest in science and the progressive development of experimental research that led to the subsequent revolutions in transportation and manufacturing.

First, long-distance transportation of coal and other heavy materials between the mining regions and the cities became possible due to the canal mania in England between 1790 and 1810, which was driven by financial speculation. This was continued by a new railway mania that followed the design by George Stephenson of first steam locomotive in 1814. Meanwhile, based on Watt’s 1794 improved steam engine, steam-powered beam engines stimulated the construction of more sophisticated power looms and increased the scale of production in textile mills in the early years of the so-called first industrial revolution.

On a doctrinal level, the enlightenment philosophers promoted the idea that God expressed his purpose through the laws of nature so that the legitimacy of the ruler’s power was no longer granted by God but by the enlightened elected men. And, most importantly, replaced the heaven paradise by the pursuit of prosperity on earth.

Among them, Adam Smith’s 1776 Wealth of Nations refuted mercantilism and advocated free trade as the basis of classical economic theory.

Finally, the English Joint stock companies act of 1844 and the Limited liability act of 1855 completed the institutional requirements needed to consolidate capitalism as the dominant economic system.

By then the six basic pillars of capitalism – private property, the profit motive, free markets, the rule of law, joint stock companies and limited liability – had been largely adopted in Western countries and capitalism began its process of globalization.

Monday, 10 November 2014

Sim, “Podemos”, mas não queremos!

O reaparecimento na Europa de partidos que contestam a partidocracia existente em muitos países pode ser um fenómeno passageiro e positivo mas também pode transformar-se num perigo para a paz e democracia. O ressurgimento de movimentos ou partidos alternativos acontece tanto à esquerda como à direita. Na direita os casos mais significativos são o IUKP, Partido para a Independência do Reino Unido, a Frente Nacional na França e o Partido Anti Euro na Alemanha. À esquerda os partidos mais significativos são a Coligação de Esquerda Radical na Grécia (SYRIZA) e o partido Podemos em Espanha.

O aparecimento de partidos anti sistema criados em torno de questões específicas (regionais, imigração, ambiente, agricultura, reformados, utopias, etc.) ou de celebridades mediáticas (por exemplo Marinho Pinto em Portugal) são comuns e de curta duração acabando por desaparecer ou ficar reduzidos a um pequeno número de parlamentares. O seu aparecimento é positivo pois trás uma lufada de ar fresco e humor à vida parlamentar sem por em causa a estabilidade política.

Porém, os partidos acima citados beneficiaram da insatisfação nacional (anti Euro no Reino Unido e Alemanha, imigração em França, austeridade na Grécia e independentismo na Espanha) para atingirem um nível eleitoral que pode por em causa a própria democracia e a União Europeia. Um tal descalabro poderá ser facilitado por circunstâncias internacionais, como o neocomunismo de Putin na Rússia, o fundamentalismo islâmico e o antissemitismo no Médio Oriente ou por motivos nacionais como a desagregação do estado-nação na Espanha.

O caso Espanhol é porventura o mais dramático, pois o partido Podemos surgiu há menos de um ano e já supera os dois principais partidos nas intenções de voto dos eleitores Espanhóis. Como explicar esta erupção do partido Podemos? Na verdade, este partido não trás nada de novo. Em termos ideológicos limita-se a repetir uma série de utopias típicas da extrema-esquerda embora reforçadas com toques anarquistas e antipolíticos.

Para percebermos o seu sucesso temos pois de equacionar o conjunto de circunstâncias que o propiciaram. Desde logo, o famoso temperamento e impaciência do povo Espanhol que o levam a alternar entre extremos como por exemplo o anarquismo e o fascismo no século passado. Depois o sentido de insegurança provocado pelas autonomias, pelo desemprego elevado e até pelos problemas na família real.

Estas particularidades foram habilmente exploradas por um jovem carismático e celebridade televisiva (Pablo Iglésias) e encontraram uma grande recetividade nos intelectuais insatisfeitos com a democracia representativa e entre os jovens naturalmente sequiosos de utopias.

Ambos os motivos de insatisfação são razoáveis, mas as alternativas propostas seriam bem piores. Por exemplo, na era das redes sociais a apropriação da democracia representativa por oligarquias partidárias que apenas se servem a si próprias torna-se mais visível e é natural que os eleitores se deixem seduzir por ideias antigas, mas perigosas, como a democracia participativa ou a democracia popular. No entanto, a história está repleta de experiências dessas que acabaram invariavelmente em ditaduras. Por isso, é importante explicar aos mais jovens o que deve ser a democracia representativa, quais as suas limitações e como podemos aperfeiçoá-la.

A procura de utopias é, felizmente, uma das virtudes da adolescência e da juventude. Aos adultos cabe moderá-la o quanto baste. Quando ensinamos a uma criança que não pode comer todos os chocolates que lhe apetece, temos três métodos: deixá-la aprender à sua própria custa (i.e. comer até ir parar ao hospital com diarreia), proibir os chocolates e castigar severamente a desobediência ou deixá-los comer apenas com moderação e explicar-lhes porquê. Para os adultos, o deixar fazer ou o reprimir são sempre as soluções mais fáceis, mas, infelizmente, as menos eficazes e as mais perigosas, sobretudo quando os riscos são irreversíveis.

Por exemplo, nos anos sessenta, nós contestámos o materialismo dos nossos pais e pretendíamos criar um mundo baseado no amor livre, musica, drogas e vida comunitária. A vida ensinou-nos naturalmente que o “amor e uma cabana” é uma utopia que dura menos do que uma paixão de verão e acabámos por nos integrar na democracia representativa sem fazer a revolução que idealizávamos. Mas conseguimos algo - uma sociedade mais livre de preconceitos sociais e preocupações materiais. No entanto, tal como a obesidade ou as borbulhas causadas pelo chocolate, também o nosso idealismo deixou marcas duradouras na geração seguinte em termos de desagregação familiar e alienação.

Pelo contrário, a geração atual é materialista nos seus desejos (sejam eles roupas de marca, viagens, etc.) mas é idealista ao pensar que o consumismo é um direito que deve ser assegurado pelo estado ou pelos pais. Se, como nós, vier a aprender por experiência própria que tal só se conquista com trabalho será a evolução natural das coisas. Porém, se tal como no passado, a sua ânsia for explorada por demagogos com fins revolucionários, acabará por cair num dos conhecidos abismos anticapitalistas - sejam eles do tipo comunista ou fascista.

É neste sentido que os Espanhóis correm perigo com o partido “Podemos”. Quais são os objetivos deste partido:

1) Assembleias de cidadãos, i.e. democracia popular - todos sabemos como essas experiências acabaram em ditadura na Rússia, Coreia, Espanha ou Cuba;
2) Recuperar a economia, quem não quer? A questão está em como: através do mercado ou, como eles deixam antever, através da coletivização cujos resultados são sobejamente conhecidos;
3) Conquistar a liberdade, de quem? Já vivemos numa sociedade livre;
4) Conquistar a igualdade, de quê? género, direitos, deveres, rendimento ou riqueza? Todos sabemos como acabaram as Revoluções Francesa e Russa;
5) Recuperar a fraternidade, como? Quando o partido defende mais promiscuidade e menos família e cerca de metade da população já depende do estado social;
6) Conquistar a soberania, a que nível? Local, regional, nacional, continental ou global. Para quê? Para acabar com a União Europeia, que tanto custou a criar, e voltar aos nacionalismos que tantas guerras fomentaram na Europa;
7) Recuperar a terra, para quem? Parece que desconhecem o desastre da reforma agrária no Alentejo ou a experiência de Mao que matou milhões de Chineses à fome.

Em conclusão, a juventude deve olhar para este programa e dizer:

Sim, podemos! Mas não queremos!
Não queremos voltar a ser escravizados!
Não queremos destruir a União Europeia!
Não queremos demagogias!

Tuesday, 4 November 2014

About limited liability and capitalism

Limited liability can be broadly defined as the legal protection that limits the maximum amount a shareholder or company participating in a business can lose or be charged in case there are claims against the company or its bankruptcy. Liabilities may be personal or corporate and can result from damages caused to third parties or from debts.

The liabilities that need to be limited in a capitalist system are those of firms in relation to their creditors. This type of protection may vary depending on the nature of the legal form used by the company. For instance, a limited partner can only lose his/her investment, but a general partner may be responsible for all the debts of the partnership. Or, parties to a contract may limit the amount each might owe the other, but cannot contract away the rights of a third party to make a claim.

Why is limited liability so important under capitalism? Because it allows the combination of the entrepreneurship indispensable under a capitalist system with the prudence necessary to protect the savings of investors and the development of joint private ownership. Moreover, it facilitates smoother and faster bankruptcies. So, why it took so long to be legally accepted?

The concept of limited liability can be traced back to the Romans, but it was rarely used. In the beginning there were many who considered the idea of limited liability a bad idea, because it was traditionally seen as a sign of weakness and lack of commitment among the part owners.

So, the first modern limited liability law was only enacted by the state of New York in 1811. In England, under the Joint Stock Companies Act of 1844 investors still carried unlimited liability but it was later abolished by the Limited Liability Act of 1855. Nevertheless, the extension of limited liability protection to partnerships only took place in the 1990s. Today, in the rest of the world, there are still many countries where the concept is either ignored or misunderstood.

Within the common law legal systems there were also some who did not oppose limited liability per se but condemned the fact that such privilege was granted by the government. For them, if limited liability was really needed a market for credit insurance and guarantees should be left to develop instead of a legal protection. Such markets did in fact developed but mostly only for international issues and trade where enforcing collections would be more difficult.

Indeed, under the principle of the freedom of contract the parties should be able to choose whether to ask for personal guarantees or to buy protection against the risk of default rather than be forced by law to accept limited liability. However, this would undermine the objective of fostering prudent entrepreneurship and the pooling of capital through joint stock companies which are fundamental under capitalism. This rationale applies only to joint responsibility under the various forms of incorporation, but not necessarily to personal or professional liabilities.

Professionals like lawyers, doctors, accountants and others are prevented by law and ethics from limiting their liability. The argument is that the accreditation of such professionals is not enough to assess the liability risk of their acts and therefore they must be personally responsible for their decisions so that they always make the decisions carefully. In such cases they may opt instead for buying an insurance policy.

Unfortunately, in some countries the definition of professional liability has been abused to make the protection afforded to firms by limited liability void. For instance, Portugal, in a clear violation of the principles of the rule of law, has introduced legislation allowing the tax authorities to seize the personal assets of corporate directors to offset unpaid corporate taxes.

Limited liability provides a strong discipline for both creditors and debtors. Since credits are secured only by the limited assets of the company, lenders must be more scrupulous when assessing the creditworthiness of the borrowers. In turn, this greater scrutiny forces borrowers to be more careful in the assessment and selection of investment projects. The reverse side of this process is that by not relying on personal collateral the volume of debt financing is lower which in turn may limit investment and capital accumulation. Moreover, as long as lenders rely on the future rather than the past value of collateral, the amount of leverage used may be counter-cyclical as they facilitate lending when prices are high and restrict it when they are low.

Yet, overall, these offsetting effects are not enough to reverse the tremendous rise in the role of equity and credit necessary to finance the level of sustainable capital accumulation experienced under capitalism with a rise in small and big firms alike. For instance, between 1860 and 1914, the share of British government bonds of the total market capitalisation of securities in London declined from 50 to 5%, thanks mainly to the rise of equities

Although active markets for risk sharing through derivatives and guarantees have been a positive development in modern capitalism they cannot be a substitute for the limited liability protection. Likewise, the bankers’ desire to protect secured lending by asking for additional personal guarantees should be resisted not only by borrowers but also by regulators to keep the benefits of limited liability.

In conclusion, while liability insurance markets can ease the risk of unlimited liability, the financing of private enterprise and the rise of shareholding ownership is not possible without limited liability. Therefore, limited liability constitutes the sixth pillar of capitalism. And, not surprisingly, some have argued that its unnamed inventor should rank as high as the other inventors credited with the industrial revolution.

Friday, 24 October 2014

Reflexões sobre o falhanço do capitalismo de gestão no BCP e PT

As duas principais experiências de capitalismo de gestão em Portugal (BCP e PT) falharam apesar do seu sucesso inicial. Uma empresa considera-se integrada no sector de capitalismo de gestão quando a respetiva direção exerce o controlo efetivo da empresa apoiada apenas num grupo minoritário de acionistas. Tal é possível através de uma dispersão excessiva do capital e de modelos de governo societário propiciadores desse controlo.

Antes da sua queda, o BCP e a PT tinham mais de 175 e 80 mil acionistas, respetivamente, mas os maiores investidores (Teixeira Duarte e BES) detinham menos de 10% do respetivo capital.

Embora as duas empresas operem em setores regulados, tiveram origens e destinos distintos. O BCP foi criado de raiz pelo seu fundador e gestor enquanto a PT resultou da privatização de um monopólio estatal no setor das telecomunicações.

Ambas as empresas tinham uma liderança forte e muito personalizada (Jardim Gonçalves e Zeinal Bava, respetivamente) que acabou destituída por razões diferentes.

No BCP por um problema de sucessão. Jardim Gonçalves fez-se substituir por um acólito que se rebelou contra o seu protetor originando uma guerra de acionistas. Esse desentendimento permitiu que outros acionistas em conluio com os governantes da altura tomassem o controlo do banco.

No caso da PT por um problema de ambição. Zeinal Bava, com o apoio do BES e dos mesmos governantes lançou-se num projeto de fusão com a OI. Porém, os seus parceiros Brasileiros, alguns dos quais financiaram a aquisição da sua participação na OI com dinheiro da PT, aproveitaram o descalabro do Grupo Espirito Santo que trouxe a nu o “tunneling” que esse grupo fizera na PT para tomar o controlo da empresa resultante da fusão. Isto é, o caçador acabou caçado.

As mudanças de gestão e rearranjos nos grupos acionistas que controlam as empresas no setor de capitalismo de gestão são comuns e não são necessariamente más para as empresas e para os pequenos acionistas quando existe um verdadeiro mercado para o controlo das empresas cotadas.

Porém, à parte as histórias mais ou menos rocambolescas da intriga e guerras palacianas inerentes a esses “golpes de estado” que fazem a delícia dos jornais, tais golpes também são frequentemente acompanhados de perdas significativas para as empresas e para os investidores menos atentos.

Foi precisamente isso que aconteceu no BCP e PT. No primeiro caso as perdas dos acionistas de longa data foram superiores a 80% e no segundo caso os investidores perderam mais de 50%.

Importa pois interrogarmo-nos sobre se estas duas histórias são únicas ou inevitáveis num país como Portugal. Numa primeira análise podíamos ser tentados a culpabilizar apenas os intervenientes e os políticos que se imiscuíram na vida dessas empresas.

Porém, o problema é mais fundamental. Num país de capitalismo de estado como o nosso a intromissão política é inevitável e a existência de um mercado livre para o controlo das empresas é impossível O primeiro problema ainda pode ser atenuado se tivermos políticos responsáveis e menos intervencionistas mas o segundo não tem solução.

Em conclusão, para além destes episódios, interessa é debater se a falência das experiencias de capitalismo de gestão em Portugal não nos devia levar a questionar a continuidade do capitalismo de estado. Infelizmente, a maioria dos comentadores pensa que a solução está em reforçar ainda mais o capitalismo de estado através de “golden shares” e outras medidas semelhantes.

Wednesday, 22 October 2014

Capitalism and joint ownership

One of the fundamental freedoms under capitalism is the freedom of association to form business organizations. Joint private ownership is different from joint public ownership in the sense that the first is voluntary and the second is compulsory. Various types of organizations have been developed throughout history, ranging from the Assyrian partnership, the Roman societates and the medieval guilds to the compagnia e banchi of the Italian renaissance. However, the modern from of incorporation as a joint stock company, that we identify with capitalism, had its origins in the XVI century with the creation of the so-called charter companies.

Chartered companies were established by private promoters that were granted some concession or monopoly by the state. For example, in London the Muscovy Company was first established in 1555 with a monopoly over the trade of goods to Russia. Indeed, since the first boom in the establishment of joint stock companies around 1719 more than 140 years passed before this form of company settled with the new British Company Law of 1862, which introduced the main features of a modern joint stock company.

This is an organization engaged in business, recognized as a distinct legal entity from its members, with certain rights and responsibilities and acting as a mechanism to share risks and rewards. Most importantly, it replaced the personal liability of its shareholders by various forms of limited liability which would allow a larger number of shareholders to be organized and therefore able to undertake much bigger projects.

The law permitted companies to be established indefinitely (without any time limit) and not, as before, only for a limited number of years. So, big corporations could now be established by private investors under the new form of a Joint Stock Company.

This facilitated the public offering and negotiability of ordinary shares, essential for pooling funds and sharing the risk and rewards of investment. The issue of tradable shares had existed ever since the early Roman times when the Societates issued their shares or particulae. Even the chartered companies, such as the East India Company, were established by pooling together the capital of about 250 merchants. Yet, as they were typically placed among a limited group of people, mostly family or business acquaintances, they were not widely held by the public and were not actively traded in the early years of the Stock Exchange.

This was due to the basic distrust of issuers about disclosing their profits and sharing them with unknown people and risking the loss of control of the business to other people. Investors were also suspicious about any hidden reasons as to why a business owner should want to share their business. This was stimulated further by the recent memory of the occasional speculative bubble and other flotation scams such as the infamous South Sea and Mississippi companies in 1719-1720.

Only after the first slave-trade mania between 1827 and 1836 were shares widely held and tradable in the Stock Exchange. Still, most of these shares were preference shares, a class of shares that dominated the issue of equity instruments until the early years of the 20th Century. Preference shares were clearly preferred by company managers as a way of keeping control of their companies.

The process to recognize by statute the existence of incorporated companies was also a long journey. Initially incorporation was seen as a very cumbersome process, which was only worthwhile if it involved the granting of some Government monopoly, as was the case with most chartered companies. For most businessmen the partnership form had the major advantage of avoiding interference of the state. Also, public opinion associated incorporation with promotions of speculative companies such as the South Sea and the Mississippi Companies.

Similarly, the process of raising capital by instalments also gave rise to scams and many investors were easy prey for unscrupulous issuers. The most common scam was to make big issues requiring little paid-in capital to attract less sophisticated investors and then run away with their money.

For many of the same reasons, the separation of ownership and control was also a long process. The overriding idea or obstacle was summarized in Carnagie’s motto that “what is anybody’s business is nobody’s business” and it is much more so when there is a large dispersion of institutional ownership.

Not surprisingly, the separation of ownership and control only reached a significant level between 1900 and 1920, with a clear separation of responsibilities into three distinct levels: the company, the shareholders and its directors. To these, one should now add a new layer made up of professional fund managers. This was partly due to the rise of investment trusts, holding companies and the result of better accounting (despite the standards of modern accounting having been developed only from the 1940s onwards).

The separation between shareholders and the company was instrumental to reach the widespread use of equity and the impressive growth in share dealing. Other factors highlighted in modern theories of the firm such as reduced transaction costs and information technology also played an important part. But, bearing in mind that the growth of big firms also implies the growth in non-market transactions, one must question if its trade destruction effects are smaller than the trade creation effects resulting from more investment and more activities being carried out by profit-driven organizations.

Marxists and other anti-capitalist thinkers in the late 19th century pointed out that capitalism had a self-destroying mechanism, since the untamed rise of big firms would cause so much trade destruction that competitive markets would account only for a residual share of total transactions, unless the growth and size of such firms was capped. This led to the introduction of antitrust laws in most countries, inspired in the US Sherman Antitrust Act of 1890. These laws were aimed at curbing anti-competive practices by prohibiting cartels, dumping and other collusion practices as well as laws to regulate corporate consolidations ending up in the creation of monopolies or oligopolies that would limit competition.

As usual, left and right wing interventionists (e.g. socialists and corporatists) wanted as much regulation as possible while right and left wing laissez-faire supporters (e.g. classical liberals and anarchists) wanted no regulation at all. So, the role of antitrust laws has been permanently questioned and changed. Yet, after more than a century we still do not have enough empirical evidence to define a "good degree of regulation". Nevertheless, a middle-of-the-road solution is to have tough anti-competition laws and flexible anti-concentration regulations.

In relation to the various forms of joint private property one needs to remember that many of the alternatives to joint stock companies like partnerships, mutuals, friendly societies, credit unions and so on, although still in operation, have been increasingly opting for corporate structures, in particular in the mortgage-banking sector.

Finally, it must be noted that joint private ownership could not develop without limited liability. Indeed, the size of large business operations needed a large number of shareholders which could be reached only if the partnership was not entirely dependent on the life of its main owner-shareholder or heirs and if the transfer of shares was possible. Moreover, this liberated the poor from their dependency on the state to invest their meagre savings. And, as a consequence, most large firms today are owned by institutional investors whose end-owners may be big or small investors. For instance, pension funds in the OECD countries accounted in 20111 for about 10% of the US$D 32 trillion invested by institutional investors in listed equities.

In conclusion, joint private ownership is an essential right under capitalism since it is one of the main drivers of its success as a wealth production machine. Nevertheless, it must be exercised mostly through regulated corporations financed by small and big capitalists alike so that capital accumulation can benefit from the pooling of resources without unnecessary damage to competitive markets.

Wednesday, 15 October 2014

Capitalism and the rule of law

The rule of law is said to exist where all people and institutions (including law makers) are subject to and accountable to law that is fairly applied and enforced. That is, individuals, organizations and governments shall submit to, obey and be regulated by law, and not by arbitrary action of the authorities. Capitalism requires a substantive definition of the rule of law and the following institutions are needed: private property rights, the law of contract, an independent judiciary, and a constitution.

The rule of law concept was already known in some ancient and medieval societies, and it was well expressed in Cicero’s dictum that “we are all servants of the laws in order that we may be free”. Yet, only the capitalist economic system depends on a substantive rule of law to ensure that all trading parts have freedom of entry into a level playing market where contracts freely agreed between the parts can be enforced.

The importance of contract enforcement is easy to understand by imagining that someone at an auction had bided successfully for an item but before collecting it met somebody offering him an identical article for a lower price and decided to default on the previously agreed offer. Or, inversely, the seller asked for more money because meanwhile had found a buyer willing to pay more. So, whenever negotiation and settlement do not occur simultaneously, the parts have to rely on the law to enforce their agreement.

Obviously, legal enforcement presupposes freedom of contract and the existence of due process. For instance, if after a proper due process a legitimate Court had determined that the bidder in the example above was forced to raise his hand then it should declare the contract to purchase as null.

The freedom of contract is essential in a market economy regardless of the legal system prevailing in a specific jurisdiction – whether based on common or civil law. Although a civil law jurisdiction of the type prevailing in Continental Europe places more restrictions on the contractual terms that may be agreed between the parts to an exchange it does not follow that a common law legal system is indispensable for capitalism. Likewise in relation to the principles of classical liberalism. Although these have their own merits they are not essential features of capitalism.

However, the rule of law is critical to ensure a level playing field where arbitrary power is banned and the equality of all before the law is guaranteed. Thus excessive regulation or discrimination are not compatible with capitalism. For instance, compulsory purchases, price controls and distortionary taxes or subsidies are all in flagrant violation of the fair treatment principle required under the rule of law. Nevertheless, in some circumstances, described next, it might be difficult to distinguish between fair and unfair treatment.

Take for instance the payment of wages. Under a freedom of contract rule firms should be free to negotiate wages in cash, kind or a mix of both. But if a department store were to pay his employees partly in food and clothing it would be preventing their freedom to buy the quantities they wanted wherever they liked. Even if the firm were to use the payment in kind to increase the workers compensation (rather than reduce it as is sometimes the case) it would still be an unfair exchange as long as workers had no option to be paid in a universal medium of exchange (money).

Often, governments engage in policies of rationing, price controls or subsidization that distort the prices even in markets that are typically competitive. For example, the price of bread, coffee, low skilled labor, medications, etc. may be controlled and yet in such markets there are thousands of buyers and sellers. The alleged reason is the protection of the poor and weak. Although these may be legitimate social objectives such protection should be given directly to those in need without affecting the functioning of free markets.

There are however special circumstances, activities and places where exemptions can be acceptable within a capitalistic system based on the rule of law. For example, during wars or other calamities that disrupt supplies it may be necessary to introduce temporarily rationing or administrative prices.

Note that such restrictions are different from price controls and similar policies applied regularly to state and regulated monopolies because the purpose of such policies is to prevent abuses of position by those granted such monopolies.

Similarly, there are cases where it is fair for sellers to discriminate among customers, as in the sale of alcohol to youngsters or to inebriated adults, but it would illegitimate to restrict access to a bar or restaurant on the basis of race or religion.

It is also important to note that although governments are entitled to special powers under the principles of the rule of law they should not be entitled to special privileges. Consider for example the collection of payments refused or disputed by debtors. While private citizens can only seize the debtor’s assets following a due process and ruling by a judge, some tax authorities (e.g. in Portugal) exercise the right to offset or dispose of the tax payers property without any due process through the judicial process.

To guarantee the rule of law essential for a capitalist systems it is also necessary the existence of an independent judiciary and a constitutional bill of rights that protect the smallest economic agent (the individual) from arbitrary actions of democratic and dictatorial rulers alike.

Again, the purpose of a constitution is to define the citizens’ rights and to limit the power of government to coerce and encroach upon individual rights, property and freedom; regardless of whether they are based on the philosophy that one is free to do whatever is not explicitly forbidden or it is only allowed what is explicitly permitted, notwithstanding the obvious advantages of the first philosophy.

In conclusion, societies that do not adhere to the fundamental principles of the rule of law cannot guarantee the basis for fair competition and usually end up with perverted forms of capitalism.

Monday, 13 October 2014

Free Markets and Competition

Generally speaking, a free market is a contestable market with free entry. That is, a market where buyers and sellers are free to agree their exchanges without any undue interference on demand and supply.

To understand the importance of free entry let us imagine a remote small island community with a single store. Its population is not enough to sustain two stores and as expected the existing store is a natural monopoly. If one of the inhabitants decides to challenge the incumbent monopolist and opens a new store both will run their stores at a loss until one of them eventually is ruined and gives up.

While the two stores remain competing the islanders benefit from greater supply at a lower price, but once the monopoly is re-established they face reduced supply and higher prices so that the surviving store can recover the losses incurred while competing with the other store. Meanwhile, during the competitive period the two store owners engaged in both fair and unfair tactics to gain or keep market share through better customer service, credit terms, product quality, etc. Some of these sales tactics are considered beneficial while others disrupt the traditional rules of civility and trust in the community. Therefore, the islanders’ ruler received many requests to stop them or to let them fight to the end. Which are his options?

He can uphold the laisser-faire principle of no interference to ensure an absolute right to free entry. Alternatively, he may introduce a licensing system to grant the monopoly on a temporary or permanent basis. Both options could be improved to retain the benefits of competition and minimize its costs. For instance, he could ban unfair sales tactics or he could auction periodically the store license. These two options should be carefully assessed to determine which would be the most efficient in a Pareto sense. That is, which would allow competition to generate greater benefits.

This example is not a simple curiosity in remote societies. Indeed, we find many similar situations in developed countries. For instance, licensing is very common in public transport, pharmacies, funerary services, roads and other infrastructures, healthcare, telecommunications, etc. And, such licensing while often done under the guise of consumer protection is in fact used to regulate or limit competition.

In fact, free markets are only a foundation of capitalism as long as they contribute to enhance fair competition, that is to create competitive markets where prices are established in accordance with supply and demand.

The simplest form of a competitive market is a market without entry barriers and where there are many suppliers and buyers so that all parties are price-takers. But, this is not always required. For instance, Stanley Jevons (1871) one of the founders of the marginal utility theory of value, considered that a market could be made of only two counterparties.

Although one may idealize market structures that create a system of perfect competition, capitalism does not need such a stringent form of competition. Some imperfections or regulations are tolerable or even desirable to achieve what Churchill (1909) called the need for competition upward but not downward (e.g. competition that could drive labor into slavery or tax rates to zero).

Such departures from an idealized world of perfect competition may be more or less extensive depending on the nature of the market, e.g. largest in labor markets than in capital or in goods and services markets. Even among the latest one must distinguish between markets with prohibitive carrying costs (e.g. fish markets) and speculative markets where carrying costs are negligible. The second factor to bear in mind is whether the so-called market failures and divergences between private and social optimization are significant and susceptible of correction without secondary damages.

In modern capitalism the most relevant issue is whether monopolistic and oligopolistic markets still can be considered competitive. For instance, does the fact that the Coca-cola and Pepsico share of the soft drinks market has risen from about 50% in the 1960s to the current level of around 70% means that such market is no longer considered as competitive? Of course not, because there is no entry barriers in such market and in fact there are many small producers competing with these two giant firms. However, if their dominance had been achieved or preserved through licensing or any other form of government favoritism then we should not consider such market as competitive.

Currently, there is a market – the market for corporate control - whose freedom is essential to preserve because of the growing separation between ownership and control. In most big firms the degree of capital dispersion is sufficiently large to facilitate collusion between managers and a small group of shareholders who introduce many obstacles (e.g. poison pills) to prevent others from challenging their power within the firm and to seclude them from hostile takeovers. Moreover, invoking the risk of short-termism and the speculative nature of such markets these groups of insiders often succeed in persuading politicians to enact legislation to obstruct the development of markets for corporate control which are indispensable to protect minority shareholders.

In general, the risk of collusion between sellers is the same whether the oligopolies exist in regulated or non-regulated industries. As Adam Smith reminded us long ago “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices”. It also common to find businessmen who were enthusiastic free-market supports when they were challenging the incumbents but transform overnight into the most determined protectionists once they join the incumbents.

In fact, this is the reason why capitalists are not always among the main supporters of capitalism and free markets. Only consumers remain always beneficiaries with the greatest interest in free markets. This is the reason why some argue that, if it was not for Marx, capitalism would be better named as consumerism.

However, consumers are frequently too numerous to organize conspiracies or to simply oppose those of the sellers. That is the reason why, in the end, the existence of free competitive markets depends on the rule of law and governments prohibiting or limiting non-competitive practices.

Wednesday, 8 October 2014

The Profit Motive and Capitalism

The pursuit of self-interest is the second pillar of capitalism and it is expressed by the profits attained. Without profits companies would not know whether an item or service is worth producing and could not measure their success. As remarked by Adam Smith (1776), “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”.

Profits, or net income available to common shareholders to use the accountant’s terminology, are the difference between revenues and expenditures. The outlays include the compensation to suppliers, the taxes paid to governments and interest charged by creditors. This residual amount belongs to shareholders and may be distributed as dividends or kept in the firm as retained earnings.

Contrary to what some finance theories imply, profits may not be considered as a cost to be minimized but rather as a gain to be maximized. Yet, many still see profits as immoral or as something to be curbed rather than maximized because they encourage selfishness and greed.

The immorality of profits is preached by Marxists and some religious leaders. The later invoke arguments similar to those used in the Middle Ages to condemn charging interest on loans. The first appeal to Marx’s mistaken labor theory of value postulating that all goods, considered economically, are only the product of labor and cost nothing except labor. Both doctrines have been refuted by theory and history.

Nonetheless, the need for profit maximizing capitalists or firms is repeatedly debated and needs to be clarified. The debate involves three main topics – whether humans are really optimizers or satisfiers, if it is indispensable for optimal competitive markets and the likelihood of degenerating into a socially unacceptable concentration of wealth.

In relation to the first, recent research on human behavior shows that humans are often driven by motives that cannot be considered as self-interest. However, the proponents of self-interest maximization claim that such deviations are minor and that maximization is still a good proxy for human behavior. The risk of wealth concentration is real, but it is naturally bounded through diseconomies of scale and may be socially constrained through inheritance and income taxes. So, we focus on its indispensability for an optimal allocation of resources through competitive markets.

The idea that the profit motive is dispensable or at least is not foremost in modern capitalism stems from the widespread view that in a world where ownership is very removed from control companies have many stakeholders and that shareholders are merely one of them.

However, in competitive markets, the interests of other stakeholders are better served by shareholders pursuing profit maximization motives. One does not need to endorse Ayn Rand’s (1964) reclassification of selfishness and greed as virtues rather than evils. We can rely on Aristotle’s concept of mean or on Keynes (1936) statement that “it is better that a man should tyrannize over his bank balance than over his fellow-citizens” in the pursuit of his money-making passion subject to rules and limitations aimed at creating a levelled playing field.

Indeed, the profit motive is indispensable in both competitive and oligopolistic markets but the prevalence of one type of market over the other is not indifferent.

Let us illustrate first why the shareholders profit motive is indispensable, despite the current trend in finance theory to focus on firm value rather than shareholder value. Under such theory the manager’s role is to maximize the present value of future cash-flows discounted by the weighted average cost of capital. Assuming the possibility of risk-free arbitrage between debt and stock securities issued by a company or that stocks always sell at book value then the structure of capital would be irrelevant to determine the value of a firm. Thus the managers objective should be the maximization of operating profits (EBIT) rather than the shareholders profit (net income). Moreover, managers could ignore the owners’ desired debt/equity ratio because they can achieve whatever level they wished by leveraging their equity portfolio.

However profit maximization cannot be pursued regardless of who has claims on operating profits, that is, debt holders, tax authorities, shareholders and managers (retained earnings). In what concerns debt holders and taxation the company has a duty to minimize their share by procuring the cheapest source of financing and reducing its tax bill. Retained earnings could be a maximization objective. However, if we accept the proposition that the capital structure does not affect the value of the firm, then even managers trying to maximize the size of their company should be indifferent about whether its growth was financed with internal or external funding and may not feel compelled to maximize retained earnings. Therefore, only shareholders have a genuine and unequivocal interest in profit maximization, regardless of the degree of separation between ownership and control.

That is, shareholders are indispensable for profit maximization irrespective of whether they prefer capital gains or distributions (dividends and stock repurchases).

This is an important conclusion because, theoretically, a corporation could be established by any of the so-called stakeholders - employees, managers, clients, governments, creditors, entrepreneurs and shareholders – interested only in maximizing their own return (e.g. salaries or executive compensation) and minimizing that of the other stakeholders. Even if we consider the so-called serial entrepreneurs, who are successful at finding and developing new business opportunities and are driven more by the entrepreneurship thrill than capital gains or control, they still need the profit motive of passive shareholders to compel management to pursue profit maximization and secure the success of their ventures.

Finally, let us discuss if the profit motive is efficient and indispensable in all human activities and organizations, and in particular for big businesses operating in oligopolistic markets. In the case of public goods and services it is normal that the objective is not the maximization of the financial return for those who provided the funding (taxpayers), but rather the minimization of the cost for the consumers of such services. Likewise, in the case of philanthropic and other non-profit organizations, the objective is not to maximize the donors satisfaction but to maximize the beneficiaries benefit. Although in these organizations we may find many instances where the interests of the ultimate beneficiaries have been hijacked by the interests of the insiders (e.g. politicians, directors, officers or employees) they still cannot be driven by the profit motive.

Fortunately, most human needs are better fulfilled by for-profit organizations. Yet, except under special circumstances, the pursuit of profit maximization does not guarantees Pareto efficiency in the case of markets dominated by oligopolistic firms capable of securing monopolistic rents. So, while profit maximization is an essential foundation of capitalism it needs to be complemented by competitive markets.

In a world where most people is to a greater or lesser extent a passive capitalist increasingly removed from the control of his investments and there is a growing oligopolization in many industries we need to understand how capitalism depends on the preservation of free and competitive markets.

Wednesday, 24 September 2014

Capitalism and Private Property

The acceptance and protection of private property is fundamental for capitalism. By private property we mean not only the individual or joint ownership of produced and natural assets but also the respective property rights in relation to its use and disposal.

The distinction between property rights and property ownership as well as its use for personal or commercial purposes is essential to discuss any acceptable limitations to such rights.

Obviously, personal private property is indispensable even in the most utopian of the communal organizations. For instance, in a hippie commune one could share the food in the fridge but not the toothbrush, and sooner or later, if someone likes only a specific kind of yogurt, he or she would like to be sure that such brand would be left untouched for his private use. However, when discussing capitalism we are not talking about such minutiae in relation to personal objects but rather on what Marxists call productive capital or means of productions.

The means of production may be divided in at least four categories: 1) land and other natural resources, 2) materials, tools and equipment, 3) labor, and 4) know how. Likewise the various forms of ownership must be split into individual, joint, and communal (state) or international. The first two types we call private and the rest we call collective property.

All types of property and ownership coexist in every economic system, but the various economic systems differ on the relative importance and role taken by private property. For instance, in primitive hunting and gathering societies land was the main mean of production and was mostly used for pastures and game and owned collectively. Other natural means of production inseparable from land like water, wind, minerals, air waves or landscape were not perceived as scarce and valuable. Likewise, intellectual property was not important then.

So, collective ownership of natural resources was as important in primitive societies as intellectual property is in modern capitalism. Yet, any limits on the property rights of specific types of property are critical not because of the nature of such property but because of their impact in the of accumulation capital and its efficient use. In this regard joint ownership as opposed to collective ownership became an important lever for competition and capital accumulation despite the obvious drawbacks introduced by large corporations.

Since the late XIX century, a rise in the size of corporations and its share of total assets were inevitably associated with the prevalence of joint-ownership over individual or family ownership. Yet, joint-ownership through joint stock companies and similar organizations does not invalidates the need for private ownership. If anything, increases its scope by facilitating capital accumulation through diversification and risk mitigation. But, it introduces a new reality – the separation of ownership and control and the associated problematic of the relationship between principals and theirs agents.

This separation, inevitably questioned the old stereotype of the capitalist as embodying simultaneously the financier, the entrepreneur and the manager. And, in the early XX century, some economists began replacing the traditional view of capitalism by a system of managerial capitalism. In their classic “The Modern Corporation and Private Property” Berle and Means (1932) described this process and its consequences in terms of corporate law and governance. They claimed that the owners no longer were served by a profit seeking controlling group. The realization that many industries had become oligopolistic and big businesses were run by a new class of professional managers rather than shareholders led some to question whether we still needed capitalists, private property and competitive markets.

For instance, Keynes (1936) in his “General Theory”, although refuting a system of State Socialism, conceived that to achieve an optimum rate of investment “a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment”. Likewise Schumpeter’s (1942) theory on the demise of capitalism claimed that the success of capitalism would lead to a form of corporatism and a fostering of values hostile to capitalism, especially among intellectuals, that would replace entrepreneurship with “laborism”.

Since then the separation between ownership and control has deepened by the rise of another layer of intermediaries between the ultimate owners and their investments. That is, capitalists progressively lost control not only over how to run their assets but also over the allocation of capital, and are now often reduced to choosing professional fund managers.

Still, regardless of how removed ownership is from control, the preservation of this last domain of private property power and rights is indispensable to preserve the profit motive and the role of markets in a capitalist economic system. Otherwise, wealth owners would lose the freedom to dispose of their property, including the right to bequest it as they like, and lose any incentive to venture and to accumulate the capital indispensable for economic growth.

The fact that nowadays most people own a substantial share of their wealth through pension funds owned or regulated by governments and that prudence recommends that they should not be able to withdraw their funds as they please does not invalidates the previous assertion. That is, private property continues to be an essential foundation of capitalism.

Wednesday, 10 September 2014

The economics of disintegration and why the Scottish should vote no

The world and Scotland fear what may happen if next week the Scottish people votes for Independence. Economic theory has a solid knowledge about economic integration and there are a few empirical studies measuring its costs and benefits (including my own here). Independence is the reversal of integration, so we may apply most of the theory to disintegration.

Apart from the immediate impact caused by changing existing relations and institutions, which may be enormous if independence is not a peaceful process, the long term advantages of separation must be proved in terms on how it will impact on the four basic freedoms – free movement of labour, capital, goods and services. To these one may add the pros and cons of financial transfers through a centralized budget and the use of a common currency.

Let me speculate on each one of them. For this I shall assume, optimistically, that the process will be peaceful and Scotland will remain in the European Union, which itself will not disintegrate if the independence movement extends to countries like Spain, Belgium, etc.

In terms of labour market Scotland is now fully integrated with the UK and workers move freely between Scotland and the rest of the UK. So nothing can be won by independence, but losses are foreseeable in terms of job opportunities.

Likewise, in relation to the free movement of goods and services, as long as Scotland remains within the EU, these will remain relatively free. Again, nothing can be gained through separation but the risk of non-tariff barriers will rise.

When it comes to the free movement of capital the answer is not straightforward, because it depends on what the separatists would decide in terms of their future currency. They promise to retain the British Pound but this may prove untenable. Using a foreign currency only works until the rulers of that currency (in this case the Bank of England) pursue a monetary policy that is good for the local economy, but this is uncertain. What is sure is that there will be a significant change in Scotland’s current account because of the North Sea revenues.

Indeed, the case for independence rests on little else than retaining such revenues in Scotland. However, there is no certainty on how long those reserves will last. And, more importantly, they would only reduce the current government deficit from 14 to 8%, or probably much less if one accounts for loss of revenue in the financial sector and increased sovereignty costs, let alone the local politicians’ eagerness for more spending.

This bet on becoming an oil-producing country is a very dangerous mirage. Not only because of the likely effects of the so-called “Dutch disease”, but also due to the rise of populism and anarchy in the fight for such revenues (Venezuela comes to mind when one thinks about it).

Traditionally, the Scottish are viewed as tight-fisted and prudent people. Let’s trust that these characteristics will lead them to prefer the certain to the uncertain and to avoid embarking on an independence adventure with so many risks for them and the rest of Europe.

Wednesday, 3 September 2014

A brief history of Economic Systems

Economic systems are characterized by a set of rules defining the relationship between interacting economic agents. The organization of economic activities is not separate from the political and social institutions adopted by the groups carrying out such activities. Thus, we may categorize many economic systems across the globe and throughout human history.

However, if we consider only broad differentiating factors, we may resume our history to five main economic systems – the gathering and hunting economy, the predatory and slave economy, the medieval serfdom system, centrally planned economies and capitalism or free market system.

With the exception of the centrally planned systems (fascism, national socialism and communism) who were driven by a precedent ideology, all the other systems evolved more or less spontaneously after long periods of gestation. In this brief history of these five major economic systems we highlight their main distinguished features in terms of division of labor, property rights, income distribution and capital accumulation.

Our oldest ancestors (the homo sapiens) appeared as a distinct species some 200-500 thousand years ago organized in small groups, mostly made up of family members. They were basically roving hunters and only settled down and began farming around 10-50 thousand years ago. At this stage their level of organization was much more developed and included a clear division of labor between male (hunter) and female (farmer), a division of property rights between common and family property and an acceleration of capital accumulation on durable goods like lodging and hunting/domestic tools, but also on non-essentials such as jewelry and other cultural and religious artifacts.

As hunters they undertook also predatory activities as a short cut to get what they needed, either by stealing from other tribes or by killing similar species (like the Neanderthals) who competed with them for the same territory and preys. As an alternative to predation, primitive forms of barter trade also appeared, but they were not the primary form of wealth exchange, which continued to be mostly done on a kinship basis. Another important development in terms of farming was the domestication of animals as pets and cattle.

All these developments led to a rapid increase in predatory activities which required larger societies (tribes), a further division of labor, beyond gender and age, between warriors/ hunters, shepherds/ farmers, slaves and clergy, as well as a political power structure beyond the traditional family/tribal hierarchy.

So, in the ancient civilizations of Mesopotamia, Egypt and India that appeared between the 3rd and 4th millennium BC, economic activity was mostly based on predation (conquest) and slavery and the military warriors naturally became the most powerful group within those societies. War permitted not only to obtain slaves to perform domestic, agricultural and construction activities but also to achieve a fast accumulation of durable goods. The organization skills required to command large armies and numerous slaves were essential to increase further the level of specialization in the division of labor needed to construct large durable infrastructures like irrigation, bridges, fortresses or temples.

Although most of these activities were under a centralized command, the development of trade and its tools was also inevitable and facilitated by the development of money exchanges that progressively replaced the traditional barter trade. In particular, the development of pictographic writing by the Sumerians, during the Uruk period at about 3400 BC, was essential to keep trading records and turn Uruk into the most urbanized city in the world and a major trade center in Mesopotamia with more than 50,000 inhabitants.

Ancient civilizations progressively turned into agriculture based societies and big estates, producing wine and oil (the most important commodities for commerce), replaced the small self-sufficient wheat-producing farms. Thus, private ownership of land became one of the crucial factors in the social stratification of those societies. For instance, in ancient Athens and Rome the population was divided into slaves, freedmen, free men, foreigners and women and only some of these groups were considered citizens.

Slaves did most of the work in agriculture, mining and manufacturing. The rulers, whether theocratic, oligarchic or democratic, continued engaged in military campaigns, initially mostly to plunder and destroy the property of the vanquished. However, they soon realized that slaughtering and enslaving their enemies was not always the most profitable course of action. So, they began to demand as an alternative the payment of ransoms and tributes (through various types of taxation) from independent producers and traders. This allowed a much faster accumulation of capital in palaces and jewelry as well as a rise in population.

In Europe and the Mediterranean these civilizations were later vanquished by hordes of barbarians who destroyed most of the cities and centralized forms of government, thus splitting the continent into countless kingdoms. This had two important consequences, the rise of monotheist religions (first Christianity and later Islam) who became a unifying force in those societies and an inward return to the big estates as the base of society. These were invariably involved in frequent wars and alliances that led to the development of a vassalage system - the feudal system.

The driving force of the feudal system was still predation but now the territorial range was much smaller (with a few exceptions like the Charlemagne Empire) and reliance on slaves was slowly replaced by a system of serfdom.

In contrast to what happened with the ancient slaves, the serfs’ master did not have the power of life and death. The serf (whether bound to the soil or to the lord) was considered a living creature with soul and the master had to allow him to attend church and could not force him to work on holy days or to commit immoral acts. The serf usually had a separate hut with an attached plot of land and lived with his family.

Production was often organized in a manor system, where the land was split in three parts, one directly controlled by the lord for his own benefit, another used by the serfs in exchange for labor services and a share of their produce and a third considered free land leased against a money rent. Under this system there was very little incentive to produce surplus for trading, and the lords often reserved a large part of their domain for hunting.

Not surprisingly throughout the middle ages the division of labor, the level of trade and capital accumulation were significantly reduced when compared to the ancient civilizations. This system lasted for a long period, appropriately named the “dark ages”, which only began to change slowly with the fragmentation of the feuds and the resumption of the so-called trade revolution in the XII century and the rediscovery of the ancient civilizations during the Italian Renaissance in the XV century. These developments allowed the rise of a new class of rich traders and bankers who questioned an otherwise rigid class pyramid made up of the Pope, King, Nobles, Knights / Vassals, Freemen, Yeomen, Servants, and Peasants / Serfs / Villeins.

The transition from feudalism to capitalism was also a long process that was only completed in Europe by the end of the XVIII century. One may even say that it began as early as the Crusades in 1096 and was only completed by the British Limited Liability Act of 1855.

The key changes that combined to drive the process were the XIII century trade revolution, the Italian renaissance in the XV century, the Portuguese and Spanish voyages of discovery in the XV-XVI and the scientific, illuminist and industrial/transport revolutions from the XV to the XVII century.

At the institutional level the key marks were the progressive repeal/ ignorance of the usury laws that hampered the use of credit and banking, the creation of joint stock companies who enabled capital accumulation and risk sharing, the development of securities markets and the introduction of limited liability laws that facilitated entrepreneurship.

The end result of this process was that the specialization and division of labor deepened to unprecedented levels, free labor progressively replaced slavery and serfdom and the accumulation of financial and non-financial assets accelerated leading to the fastest ever growth in productivity and trade experienced by humankind. Thus old agrarian societies were replaced by commercial and industrial societies and the traditional rigid social hierarchy was challenged by the new money earned on such activities.

In the Wealth of Nations (1776), Adam Smith refuted Physiocratism and Mercantilism and demonstrated the clear advantages of free labor and free markets, which are the essence of capitalism. The word capitalism itself only made its first written appearance in Thackeray’s novel “The Newcomes” (1855) to refer to those whose capital was not the result of land ownership. The term was also used by Karl Marx in Das Kapital (1867) to denigrate the new economic system by claiming that “social wealth becomes to an ever-increasing degree the property of those who are in a position to appropriate continually and ever afresh the unpaid labour of others”.

The nobility and clergy did not accept easily the loss of power and status brought about by capitalism. Indeed, Marx was not the only one to fight the ideal of “the invisible hand” and decentralization subjacent to capitalism. Among both revolutionaries and reactionaries there were two opposite criticisms of a capitalistic decentralized system. Some proposed a return to a system of small communities (e.g. the model villages of Utopian Socialists or the Anarchist and Hamish communes) while the others proposed a centralized system relying more on economic planning than competition (e.g. communism, national socialism and corporatism).

The experiences with decentralized non-capitalist systems were localized and have been subsiding progressively without a major impact on humankind.

On the contrary, the experiences with central planning had a dramatic impact in our world since they were tried in the first three quarters of the XX century in many developed and less developed countries. The three types of experiments relied on dictatorships to control the economy and the labor market, in accordance with their different ideologies.

Following the Marxist-Leninist doctrine, communists established a so-called proletariat dictatorships, initially run by the oligarchy of the only legal party, which invariably transformed into a single god-like dictator (e. g. Stalin in Russia, Mao in China or Fidel Castro in Cuba). Communists abolished private property and reintroduced forced labor, namely slavery in the Russian Gulags, serfdom in Chinese rural areas and modern forms of slavery in Cuba. They also replaced the markets by some form of central planning.

Forced labor, private property confiscation and central planning proved disastrous, causing the worst man-made famines known to humankind, when 6-8 million people died during the 1932-1933 Soviet famine and 15-40 million starved to death during the 1958-1961 Chinese famine. Capital accumulation and productivity growth lagged so much under this system that in the 1980s communism collapsed by itself in the Soviet Union and the Chinese Communist Party replaced communism by a form of state capitalism.

National-socialism was introduced in the 1930s by the Nazi Party in Germany. It was based on an ideology of racial supremacy, proclaiming that the Aryans were a superior race and the other races should be either destroyed (e.g. the Jews and Gypsies) or become servants of the Germans (e.g. the Eastern and Southern Europeans).

The Nazis did not abolish private property and markets for the Germans, but firms had to work under the direction of the party by contracting to receive forced labor and to supply the government. The Nazis reintroduced the most brutal form of slavery by forcing war prisoners and Jews to work until they died of exhaustion. The party also had a god-like leader - Hitler - who repeated the old forms of predatory economics through outright confiscation of the Jews and the Central Banks of the countries occupied and the introduction of ransoms, forced labor, punitive taxes and the coercive supply of his armies.

The German (and Japanese) imperialist wars to conquer new territories originated the Second World War, the most deadly conflict ever lived by mankind, which claimed the lives of more than 60 million people.

Corporatism, was a milder form of centralized economic system introduced in Italy, Portugal, Greece and Spain during the 1920s and 1930s. Its ideological origin goes back to the Rerum Novarum papal encyclical on the social question issued by Leo XIII in 1891. The basic idea was that labor and capital should cooperate under the guidance of government.

Private property and markets were accepted, but labor relations were regulated by agreement between unions and employers under the supervision of the state. Other markets were also regulated through price controls and licensing.

At the political level, the dictatorships adopted more or less extreme forms of fascism depending on the moderation and warmongering of their leaders, with Salazar in Portugal being the only one who was not involved in war.

The economic consequences of corporatism and the lack of market competition was the impoverishment of Southern Europe relative to the rest of Europe.

Without exception, all attempts to create an economic system by design based on anti-capitalist ideologies only brought oppression, misery and war and have been progressively abandoned in favor of various versions of capitalism.

Despite having so few supporters and so many opponents capitalism vanquished by itself and is now the dominant economic system. So, one is left wondering what is the beauty of capitalism and how long it will last. But, first we needed to understand how mankind got here.

Friday, 22 August 2014

Portugal e a escravatura dos médicos Cubanos

Em declarações recentes o Bastonário da Ordem dos Médicos insurgiu-se contra o pagamento que estava a ser feito aos médicos cubanos contratados por Portugal, reclamando o mesmo pagamento para os Portugueses.

Chocou-me que o Bastonário não tenha referido que o pagamento não é feito aos médicos mas sim ao governo Cubano que por sua vez apenas paga uma pequena fração aos médicos (no caso do Brasil menos de 10%) e retém como reféns a família dos mesmos. Isto é, não acusou o governo Português de estar a ser cúmplice numa forma de escravatura moderna praticada pela ditadura comunista de Cuba.

Para obter divisas o regime comunista Cubano decidiu recorrer ao tráfico de pessoas, na sua maioria médicos. Note-se que não se trata de uma exportação de serviços médicos ou de facilitar ou promover a emigração desses trabalhadores para outros países, o que seria perfeitamente legítimo. Nem sequer, de uma prática de angariação de mão-de-obra barata por agências pouco escrupulosas. Pois, em tais casos, os trabalhadores continuariam livres para rescindir o seu contrato e voltar ou não ao seu país de origem.

Neste caso, embora os médicos cubanos sejam livres de aceitar ou não a emigração, se o fizerem o governo retém como reféns os seus familiares, pode confiscar-lhes os passaportes e nalguns países (como a Venezuela) chega mesmo a mantê-los prisioneiros em regime de trabalhos forçados. Mais detalhes sobre estas práticas Cubanas podem ser lidos neste sítio.

O mais perturbante é que tais práticas subsistem há muitos anos, perante a complacência da OIT e dos sindicatos e a conivência dos partidos, dos governos e meios de comunicação social de esquerda. Para cúmulo da hipocrisia, os Cubanos ainda proclamam que tais práticas são uma forma de solidariedade internacional no seu apoio aos países menos desenvolvidos.

Pelo contrário, o verdadeiro liberalismo defende a livre circulação internacional de mão-de-obra mas só aceita como legítimos os contratos celebrados de livre vontade entre partes livres, i. e. com garantia dos seus direitos fundamentais individuais. Os estados não são donos dos seus cidadãos!

Wednesday, 16 July 2014

Professor Jacinto Nunes – uma lição do mestre sobre supervisão bancária

Esta semana faleceu o Professor Jacinto Nunes. A sua família, o país, e todos os que tivemos o privilégio de o conhecer ficaram mais pobres. A última vez que o cumprimentei foi na receção que se seguiu à última tomada de posse do Presidente da Republica. Fiquei com a impressão de que já não me reconheceu, talvez devido ao congestionamento de pessoas na sala, mas não deixou de me transmitir a sua habitual simpatia. É normal que depois de tantos anos os mestres confundam os seus alunos, mas para os alunos há mestres que marcam para o resto da vida. Foi o que aconteceu comigo em relação ao Professor Jacinto Nunes.

Jacinto Nunes foi meu professor em 1974 ou 1975, creio que na disciplina de Política Monetária, pois já não me lembro bem do ano nem do nome da disciplina. No entanto houve uma lição dele de que nunca me esqueci – sobre a eficácia da supervisão bancária, tema que nos últimos tempos se revelou muito importante em Portugal.

Recordo-me como ele nos explicou porque é que supervisores pouco preparados e mal pagos não podiam fazer bem o seu trabalho. Contou-nos que no passado os supervisores do Banco de Portugal eram tão mal pagos relativamente aos restantes bancários que quando chegavam a um banco ficavam logo intimidados com o edifício e com os caixas do banco. E, quando eram conduzidos ao andar da Administração, já mal conseguiam falar e muito menos questionar perante a altivez dos respetivos administradores e secretariado.

Anos mais tarde, quando trabalhei na banca de investimento, tive ocasião de presenciar situações semelhantes às descritas pelo Professor e outras de sentido exatamente oposto. Isto é, casos onde os supervisores eram tão bem pagos que fechavam os olhos a tudo o que pudesse por em perigo o seu estatuto remuneratório ou futuras oportunidades como administradores não executivos das entidades supervisionadas.

A solução para o problema de como remunerar pessoas com funções fiscalizadoras é antiga e universal. Por um lado, têm de ser bem remuneradas para que possam ter a independência necessária à sua função, mas por outro não podem ser demasiado remuneradas para que não fiquem prisioneiras do seu estatuto.

A grande dificuldade está em encontrar o meio-termo adequado. Na banca hoje é cada vez mais difícil de definir esse nível porque o leque remuneratório aumentou do tradicional 20/1 para 150/1. Nestas circunstâncias não há fórmulas mágicas que nos ajudem. Teremos de recorrer a pessoas sábias com a modéstia e o bom senso do Professor Jacinto Nunes, tão bem expressas no seu livro de “Memórias Soltas”, que vivamente recomendo.

Friday, 30 May 2014

Piketty, the 0.1% debate and the backdoor return of class warfare

Recently economists got very excited by a book on wealth inequality (Piketty, 2014), which reminded me of how economics is still mostly an ideological debate and how far it is from being the queen of social sciences.

We see again the old left wing anti-capitalism rhetoric and its denial by the traditional adulation of the rich by the usual ass-kissing right wing. Economics can claim to be the science of many things, but apparently it is unable to be a science of common sense.

If economists relied more on common sense, they would immediately realize that the rise in inequality is hardly news. There has been plenty of studies showing that. Meanwhile, the focus on the share of the top 0.1%, apart from creating an “identifiable” common enemy, tried to create a stereotype equivalent to the XIX century top hat capitalist depicted by Marxists.

Remember that the later began by focusing on the 1%, but probably this group was too large to provide the necessary stereotype. Note also that the debate relies largely on the Gini coefficient and ignored the different weightings that society may put on inter-group income transfers using the metric suggested long ago by Atkinson.

Yet the greatest failure is on understanding why inequality is rising, and the reason may be quite plainly related to the failure to correct a well-known feature of capitalism.

Capitalism is the most efficient economic system ever devised by humankind that replaced a largely hereditary class system (nobility, clergy and serfs) based on predatory (conquest) economics by a system mostly based on social mobility through free enterprise and trade.

Yet, its central feature, the free accumulation of private property has two limitations. On one hand some ventures require large amounts of capital which are beyond individual means and require institutions (such as governments and institutional investors), and on the other hand the law of compound interest would allow such long-living institutions to ultimately own the entire capital stock and self-destroy capitalism itself. As we have shown in this post, the solution to this feature is easily achievable through reasonable levels of progressive taxes and the taxation of inheritances.

We add here that the survival of capitalism should not rely on artificially curbing the return on capital (Piketty’s r/g) or opportunistically expropriate the rich from time to time as some on the left advocate. There may be some reasonable curbing of executive compensation in listed companies where shareholders are basically powerless, but that is a different governance matter.

Let us exemplify with one of the richest man in the world. Would it make sense to have limited Warren Buffett’s wealth? If we had done so, he would not have created so many jobs and profits through his smart investments and society would be poorer without his $300 billion company. However, he is a very wise man and has decided on his wisdom to donate most of his fortune to charity.

Some will dispute whether that is the best use of his wealth. Some would prefer that he had given his money for research, environment, sports, culture or whatever, while others may say that the government should decide, not him.

How the inheritance money should be spent is an interesting question to debate but not relevant to decide whether to like or dislike capitalism or to bring back through the backdoor a destructive class warfare as advocated by Marx.

In conclusion, common sense suggests that governments should exercise moderation on taxing inheritances and give the taxpayers enough say on where governments will spend their wealth. We do not need to go back to the old divide.