From the early XX century the rise of large corporations and consequent separation between ownership and control has dominated the debate on entrepreneurship and capitalism. The debate naturally turned to whether – business concentration and owner absenteeism – would reduce the role of the market and the profit motive as foundations of capitalism and wealth accumulation.
In itself, wealth accumulation neither goes always pari passu with status and power nor does its regional and occupational origin follows a rigid stratification. Nevertheless, some periods are usually associated with a particular source of wealth or class of individuals.
For instance, at the turn of the XIX century in Britain, London commerce and finance were seen as the origin of the largest fortunes of the epoch. Likewise, at the turn of the XX century in America, the Silicon Valley internet entrepreneurs and the New York hedge fund managers were regarded as those more likely to accumulate great fortunes.
So, both in relation to the sources of wealth and to its distribution, we may identify cycles that are usually due to various causes but never as a direct result of capitalism.
Nevertheless, the path to capital accumulation does affect the efficiency of capitalism since different groups have different propensities to save and pursue different investment strategies. In particular, the rise of institutional investors adds new agency problems in relation to portfolio allocation and a possible dilution of the profit maximization motive caused by the owners absenteeism and a growing rent-seeking monopolization.
Indeed, these agency problems were already felt in the early XX century by authors like Thorsten Veblen (1921) who stated that: “The company … is, therefore, an impersonal incorporation of liabilities to the stockholders, and by employing these liabilities as collateral (formally or informally) it will then procure further capital by an issue of securities (debentures, typically bonds) bearing a stated rate of income and constituting a lien on the assets of the corporation.“
The questioning of the role of the firm culminated in the classical book by Berle and Means (1932) arguing that: “The property owner who invests in a modern corporation so far surrenders his wealth to those in control of the corporation that he has exchanged the position of independent owner for one in which he may become merely recipient of the wages of capital... [Such owners] have surrendered the right that the corporation should be operated in their sole interest...”.
This trend led finance theorists to treat shareholders as if they were debt holders and to a growing influence of managerial capitalism; with firms turning into bureaucratic organizations without the entrepreneurial spirit of the early promoters.
Many large firms frequently collude with governments and become more driven by rent-seeking than value added under competitive conditions. Often they are also managed through planning and search to grow through mergers rather than entrepreneurship. These fears, which were already present before the 1940s, are obviously a threat to capitalism, but they do not mean that modern capitalism is already following the path of Venice which transformed from a thriving trading city in the XV century into today’s museum city.
Accountants’ ever increasing recording of non-cash transactions in financial reporting also eroded the traditional use of profits as the right bottom line metric to measure business performance. As net income becomes less and less meaningful, investors moved up the income statement and use other measures such as operating and gross income. And, as these progressively become subject to creative accounting, they had to turn also to cash flow statements. This proliferation of metrics did not help the profit motive.
Moreover, finance experts progressively substituted profits by shareholder value which blurred further the use of profits. And things are getting worse, since many increasingly replace this concept by the broader one of firm value. Because these metrics are based on specific theories, they are easily abused by managers with self-perpetuating and self-aggrandizement agendas .
To conclude, the rising wealth created by capitalism facilitated the emergence of ever bigger firms, creating a growing divorce between owners and management, fostering the replacement of profit maximization by vague metrics of shareholder and firm value, which, together, compound the erosion of the profit motive as a foundation of capitalism. Fortunately, this is largely confined to the managerial sector of capitalism and, although a serious threat to be fought, the erosion of the profit motive will not be lethal to capitalism.
Monday, 30 November 2015
Friday, 27 November 2015
Human capital and social mobility
In general, capitalism is based on meritocracy. For instance, paternal earnings had the least effect on sons’ earnings in Canada, Norway, Finland, and Denmark, where less than 20 percent of income advantages were passed onto children (Isaacs, 2008). However, there are concerns that this does not apply across the board (e.g. the USA, UK and Italy have low mobility) and that mobility is mostly determined by the parents education.
Yet, there are also concerns that under capitalism markets do not work well for long term human capital investment.
For instance, some professionals see their investment in training destroyed because of supply and demand mismatches. This happens to many graduates who end up in low skill jobs. This mismatch between qualifications and job opportunities may be specific to some markets or may be the result of cyclical trends, but it is not a feature of capitalism.
Markets with a permanent excess supply of labor are usually found in industries with winner-takes-all business models. For instance, in the entertainment industry there are only a limited number of slots for handsomely paid super-stars, which act as a magnet to the many candidates to win the super-star lottery. The consequence is that most of the runners-up end up working in bars or McDonald’s, thus losing the investment they made in art school.
Changes in cyclical trends are also significant and can be illustrated by teachers. The demand for teachers depends on population growth with demographic cycles usually long but, occasionally, suddenly shifted by migratory flows or changes in enrollment policies that cause large mismatches in demand that cannot be corrected quickly.
For instance, the baby boom of the 1950s and the economic growth in the 1960s generated an impressive growth in the population of schooling age and enrollment rates. However, the subsequent decline in fertility rates had the opposite effect. It had a dramatic effect on the employment and earnings of teachers who, starting from a position of high social status, ended up unemployed or in a low-status low-wage sector. That is, their investment with a view to social climbing through education had a negative return.
Although the return on education depends on many factors, including parenting, it is obvious that the laws of supply and demand influence the income and status of the various professions which are subject to rotation in status. This flexibility is required by competitive markets but it affects differently the various professions.
For example, if someone trains to be a sales representative in one industry and that industry shrinks he or she can still move to another industry because his qualifications are not specific to that industry. That is not the case in highly specialized jobs. These have a higher risk of becoming obsolete or requiring extremely high costs of retraining.
However, while free competition may increase the risk of human capital obsolescence it also increases the opportunities for more investment in human capital, and the later exceeds by far the first. Moreover, the impact of free competition on human capital is probably less than that of technology and demography.
In conclusion, capitalism may be disruptive in relation to returns on human capital and social mobility, but it is not a major cause on the inequality of individual returns. On the contrary, it is a driving force in the promotion of equality of opportunities.
Yet, there are also concerns that under capitalism markets do not work well for long term human capital investment.
For instance, some professionals see their investment in training destroyed because of supply and demand mismatches. This happens to many graduates who end up in low skill jobs. This mismatch between qualifications and job opportunities may be specific to some markets or may be the result of cyclical trends, but it is not a feature of capitalism.
Markets with a permanent excess supply of labor are usually found in industries with winner-takes-all business models. For instance, in the entertainment industry there are only a limited number of slots for handsomely paid super-stars, which act as a magnet to the many candidates to win the super-star lottery. The consequence is that most of the runners-up end up working in bars or McDonald’s, thus losing the investment they made in art school.
Changes in cyclical trends are also significant and can be illustrated by teachers. The demand for teachers depends on population growth with demographic cycles usually long but, occasionally, suddenly shifted by migratory flows or changes in enrollment policies that cause large mismatches in demand that cannot be corrected quickly.
For instance, the baby boom of the 1950s and the economic growth in the 1960s generated an impressive growth in the population of schooling age and enrollment rates. However, the subsequent decline in fertility rates had the opposite effect. It had a dramatic effect on the employment and earnings of teachers who, starting from a position of high social status, ended up unemployed or in a low-status low-wage sector. That is, their investment with a view to social climbing through education had a negative return.
Although the return on education depends on many factors, including parenting, it is obvious that the laws of supply and demand influence the income and status of the various professions which are subject to rotation in status. This flexibility is required by competitive markets but it affects differently the various professions.
For example, if someone trains to be a sales representative in one industry and that industry shrinks he or she can still move to another industry because his qualifications are not specific to that industry. That is not the case in highly specialized jobs. These have a higher risk of becoming obsolete or requiring extremely high costs of retraining.
However, while free competition may increase the risk of human capital obsolescence it also increases the opportunities for more investment in human capital, and the later exceeds by far the first. Moreover, the impact of free competition on human capital is probably less than that of technology and demography.
In conclusion, capitalism may be disruptive in relation to returns on human capital and social mobility, but it is not a major cause on the inequality of individual returns. On the contrary, it is a driving force in the promotion of equality of opportunities.
Thursday, 26 November 2015
Capitalism and philanthropy
Although capitalist are frequently depicted as ruthless profit seeking individuals, it is nevertheless true that most philanthropists are businessmen. That is, they may be unforgiven when making money but generous when bequeathing it. How can we explain this apparent paradox? It is a matter of self-interest, the result of guilt, vanity or is it the result of institutional constraints? I shall explore these issues with special reference to the USA where philanthropy is more widespread.
According to the Giving USA Foundation, Americans gave $358.38 billion in 2014, a 7.1% increase from 2013. Of these, corporate giving amounted to $17.77 billion (a 13.7% increase from 2013). The total given was equivalent to 2.1% of gross domestic product in 2014, of which about half goes to religious and educational projects. It largely exceeds the $148.18 billion contributed by the US as international net official development assistance in 2013.
These figures suggest that, when encouraged, the private sector is capable of contributing substantial amounts of money for redistribution on a non-profit basis. Whether, it is also more efficient on its allocation and use than the government it is an open question. Common sense dictates that each sector has its own comparative advantages in relation to specific groups of beneficiaries, and therefore the state and private roles should be complementary rather than competitive.
Another important issue is whether capitalists should be free to bestow their giving to whom they wish. Each individual has its own set of priorities and should be free to select them. Regardless of what each individual thinks, we cannot say that Bill Gates is more philanthropic than Rockefeller was simply because the first gave money to fight malaria in Africa while the second gave a villa in lake Cuomo to be used as a retreat by academics.
Obviously, the state should not follow the wish of individual politicians without bearing in mind the priorities of society as whole expressed by free voting. Moreover, the state priorities should not be imposed on private donors. All that authorities should do is to encourage through co-financing or tax breaks the allocation of private donations to certain objectives.
A more controversial issue is whether the donors generosity should be left to each individual or if a minimum rate should be applied. For instance, if at the time of death they should be subject to an inheritance tax on all wealth not bequeathed to charities. In chapter 13 we explain why inheritance taxes provide a powerful restraint on wealth concentration required to preserve market capitalism. However, this only applies to large fortunes. All the others should be left to be masters of their own generosity.
Indeed, although there are some scrooges among capitalists, it is important to notice that most of them are only greedy when making money and not when giving it away. So, in general, philanthropy not only supports capitalism but it also complements it by supporting those that by misfortune or careless were left out by the wealth produced under capitalism. This said, philanthropy should be an individual decision, not something that should be practiced by corporations, for the reasons I gave in another post.
According to the Giving USA Foundation, Americans gave $358.38 billion in 2014, a 7.1% increase from 2013. Of these, corporate giving amounted to $17.77 billion (a 13.7% increase from 2013). The total given was equivalent to 2.1% of gross domestic product in 2014, of which about half goes to religious and educational projects. It largely exceeds the $148.18 billion contributed by the US as international net official development assistance in 2013.
These figures suggest that, when encouraged, the private sector is capable of contributing substantial amounts of money for redistribution on a non-profit basis. Whether, it is also more efficient on its allocation and use than the government it is an open question. Common sense dictates that each sector has its own comparative advantages in relation to specific groups of beneficiaries, and therefore the state and private roles should be complementary rather than competitive.
Another important issue is whether capitalists should be free to bestow their giving to whom they wish. Each individual has its own set of priorities and should be free to select them. Regardless of what each individual thinks, we cannot say that Bill Gates is more philanthropic than Rockefeller was simply because the first gave money to fight malaria in Africa while the second gave a villa in lake Cuomo to be used as a retreat by academics.
Obviously, the state should not follow the wish of individual politicians without bearing in mind the priorities of society as whole expressed by free voting. Moreover, the state priorities should not be imposed on private donors. All that authorities should do is to encourage through co-financing or tax breaks the allocation of private donations to certain objectives.
A more controversial issue is whether the donors generosity should be left to each individual or if a minimum rate should be applied. For instance, if at the time of death they should be subject to an inheritance tax on all wealth not bequeathed to charities. In chapter 13 we explain why inheritance taxes provide a powerful restraint on wealth concentration required to preserve market capitalism. However, this only applies to large fortunes. All the others should be left to be masters of their own generosity.
Indeed, although there are some scrooges among capitalists, it is important to notice that most of them are only greedy when making money and not when giving it away. So, in general, philanthropy not only supports capitalism but it also complements it by supporting those that by misfortune or careless were left out by the wealth produced under capitalism. This said, philanthropy should be an individual decision, not something that should be practiced by corporations, for the reasons I gave in another post.
Monday, 16 November 2015
Why socialism often ends-up in dictatorship
In contrast to a capitalist system, socialist regimes invariably transform into authoritarian or totalitarian political regimes; regardless of whether they reached power through popular vote or revolution.
That revolution often ends up in non-democratic regimes is an historical fact that can be explained by the revolutionaries desire to cling to power, regardless of whether they are pro or anti-socialists and anti-democracy.
What needs explaining is why socialists who were voted into power and promised to respect democracy also turned into non-democratic regimes. We can find two different routes.
First, when socialism evolves into communism. Then, it necessarily abandons its pro-democracy ideals because communism was based on the concept of a class (proletariat) dictatorship later renamed popular democracy.
Whether socialism will inevitably degenerate into communism was already debated in the XIX century. For instance, in Bastiat’s Law (1850), the author claimed that “men will resort to plunder whenever plunder is easier than work… As soon as the plundered classes gain political power, they establish a system of reprisals against other classes. They do not abolish legal plunder”.
Indeed, one hundred years later, a similar pessimism about human nature was the basis for Schumpeter’s (1942) prediction that capitalism would degenerate into a form of corporatism to be replaced by socialism.
Fortunately, history has shown that socialism does not always evolves into national socialism or communism and sometimes reverses into social-democracy, which accepts both capitalism and democracy. However, as the Scandinavian experience shows, this reversion has to be substantial otherwise the regime will not survive.
There is another possibility for socialism to survive temporarily within a democracy by exploring what we may call Latin-American populism.
The most emblematic example is found in Venezuela, a country with the oldest bipartisan democracy in the region. Former President Hugo Chavez was elected with the support of a largely impoverished population which was “bribed” to re-elect him through state sponsored social programs paid by the middle classes and the un-economic exploitation of the rich natural resources of the country for the benefit of a small group of trusted cronies.
However, this model of socialism is inevitably doomed for two main reasons: 1) the economic inefficiency of the system is so high that even the dilapidation of natural resources is not to enough to hide a generalized economic decline, and 2) the demands of its supporters on the welfare state rises with any new benefit so that public finances soon collapse.
These two factors are abundantly seen in Venezuela, where the socialist rulers, faced with growing opposition, have introduced all sorts of paranoiac prohibitions and persecutions in order to hang on to power, including the prohibition of travelling abroad for media directors and the detention of the opposition leader.
In conclusion, socialism will inevitably send democracy to a kind of limbo, from which it is only possible to exit by reversing its path towards social-democracy or by evolving towards state capitalism or communism and dictatorship.
That revolution often ends up in non-democratic regimes is an historical fact that can be explained by the revolutionaries desire to cling to power, regardless of whether they are pro or anti-socialists and anti-democracy.
What needs explaining is why socialists who were voted into power and promised to respect democracy also turned into non-democratic regimes. We can find two different routes.
First, when socialism evolves into communism. Then, it necessarily abandons its pro-democracy ideals because communism was based on the concept of a class (proletariat) dictatorship later renamed popular democracy.
Whether socialism will inevitably degenerate into communism was already debated in the XIX century. For instance, in Bastiat’s Law (1850), the author claimed that “men will resort to plunder whenever plunder is easier than work… As soon as the plundered classes gain political power, they establish a system of reprisals against other classes. They do not abolish legal plunder”.
Indeed, one hundred years later, a similar pessimism about human nature was the basis for Schumpeter’s (1942) prediction that capitalism would degenerate into a form of corporatism to be replaced by socialism.
Fortunately, history has shown that socialism does not always evolves into national socialism or communism and sometimes reverses into social-democracy, which accepts both capitalism and democracy. However, as the Scandinavian experience shows, this reversion has to be substantial otherwise the regime will not survive.
There is another possibility for socialism to survive temporarily within a democracy by exploring what we may call Latin-American populism.
The most emblematic example is found in Venezuela, a country with the oldest bipartisan democracy in the region. Former President Hugo Chavez was elected with the support of a largely impoverished population which was “bribed” to re-elect him through state sponsored social programs paid by the middle classes and the un-economic exploitation of the rich natural resources of the country for the benefit of a small group of trusted cronies.
However, this model of socialism is inevitably doomed for two main reasons: 1) the economic inefficiency of the system is so high that even the dilapidation of natural resources is not to enough to hide a generalized economic decline, and 2) the demands of its supporters on the welfare state rises with any new benefit so that public finances soon collapse.
These two factors are abundantly seen in Venezuela, where the socialist rulers, faced with growing opposition, have introduced all sorts of paranoiac prohibitions and persecutions in order to hang on to power, including the prohibition of travelling abroad for media directors and the detention of the opposition leader.
In conclusion, socialism will inevitably send democracy to a kind of limbo, from which it is only possible to exit by reversing its path towards social-democracy or by evolving towards state capitalism or communism and dictatorship.
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