The rise of the bourgeoisie under the capitalist system inexorably meant a change in the existing social hierarchy. Yet, historians are divided on whether the existing ruling classes - aristocracy and the clergy - waned or simply adapted and became part of the business class. Obviously, there are many individual cases to support both theories but, overall, under capitalism the new social hierarchies no longer were based on inbreeding within the same class.
The nobility had already undergone two major transformations when it changed from a warrior class into a courtier elite and when its income became increasingly dependent on financial investments. However its investment in industry and commerce had to wait until the XIX century, when by necessity or interest they began to marry with rich business people and to sell nobility titles to the wealthy.
This mingling with the bourgeoisie was initially resisted and for many years the nobility tried to position itself as arbiter between workers and capitalists or as sponsors of alternative economic systems.
In what concerns the adaptation of the clergy to capitalism, we need to distinguish between Christians and the other religions and, within the first, a fundamental divide between Catholics and Protestants.
For Max Weber and other authors the protestant ethic is often identified with the rise of the spirit of capitalism, by linking moral righteousness with making money. Indeed, the preaching of puritanism was essential to promote the savings necessary for capital accumulation. Concurrently, the proving of one’s faith through worldly activities was crucial to develop the entrepreneurial spirit associated with capitalism.
On the contrary, Catholicism preached resignation, asceticism and monastic contemplation which favoured the preservation of the status quo in the social hierarchy. Rome has traditionally been slow to breakup from existing powers, whether in relation to the acceptance of democracy or the condemnation of Nazism and communism.
Not surprisingly, protestants embraced capitalism while the catholic church, accepted reluctantly the role of markets and advocated a middle-of-the-road alternative based on the corporatist doctrine proposed by Leo XIII in 1891. The failure of this system has not prevented the catholic church from searching for new alternatives, nowadays mostly through a mix of Marxism, Latin American populism and global environmentalism.
Islam, the other big Abrahamic religion, is also generally anti-capitalist despite being founded by a merchant. Curiously, at the time of the so-called commercial revolution Muslim merchants were probably wealthier than their counterparts in northern Italy but they did not evolve towards capitalism. The main reason resides in the sharia law which, despite being favourable to commerce, prohibited joint stock companies, restricts the use of credit, does not accept the rule of law and favours theocratic regimes. Overall, Islamic theologians have been much more slow than the Christians to reinterpret the ancient scriptures to new times.
In India, Hinduism favoured an endogamy caste system which today still continues to be a big obstacle to the development of capitalism because individuals are not free to be professionally or socially mobile.
Buddhism and Shintoism, despite being religions and philosophies who favour meditation over action, did not hamper the development of capitalism in countries like Japan and South Korea, once their feudal systems and the emperor’s divinity were abandoned. Indeed, many entrepreneurs adhere to Buddhism as a relaxation and productivity-enhancing technique. Remarkably, these countries managed to keep their family and cultural traditions while westernizing and embracing capitalism.
In China, despite attempts to abolish religion during Mao’s Communist regime, Confucianism, Buddhism and Taoism remained alive and gained a new momentum since the Chinese Communist Party embraced capitalism. Confucian ethics emphasises the importance of the family but is not formally a religion. Unlike biblical religions, the Confucian system has no point of leverage by means of which disobedience to parents could be justified. In principle, its values are not opposed to capitalist principles but it is too early to know if it will impact on the future of capitalism in China.
In general, the clergy cares more about competition between religions and political power than economic systems. Nevertheless, because capitalism values materialism, democratizes economic power and reducesthe importance of political power, the clergy fears that capitalism will lessen the status of religion. Therefore, their preferred position continues to be one of critical acceptance of capitalism or support for alternative systems.
Overall, both nobility and clergy have now reluctantly accepted capitalism as inevitable, but they are not wholehearted about it. In fact, before taking this position, they often supported some of the various failed attempts to find an alternative to capitalism.
Showing posts with label capitalism. Show all posts
Showing posts with label capitalism. Show all posts
Thursday, 12 February 2015
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.
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, 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.
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, 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.
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.
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.
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.
Wednesday, 8 May 2013
Left and Right today
Now that capitalism is almost the only economic system worldwide (with a few bizarre exceptions in North Korea and Cuba) does it still makes sense to talk about left and right? Can we distinguish the various types of capitalism using the left and right categorization?
If one uses the left and right categorization to depict a spectrum of opinions that we may represent through a statistical distribution then it still makes sense to talk about the left and right tails of such distribution.
However, we should recall that this categorization originated during the French Revolution to designate where the pro-monarchy (right) and anti-monarchy (left) seated in the French National Assembly (parliament). Later this designation was generalized to other divisions over single issues. In particular, it was extended to describe those in favour of the status quo (conservatives) and those in favour of moderate/drastic reforms (progressives/ radicals).
Historically, the most important split in the XIX century was over the emerging economic system of capitalism. Since this new system affected most aspects of society, it no longer represented a single issue divide. It became a split over a portfolio of visions usually designated as ideologies until the collapse of communism in 1989.
Yet, once a portfolio of visions becomes too diversified, it loses its internal coherence and no longer can be represented by a single distribution with a left and right tail. If I pick a number of divisive issues in economics, politics or moral I may end up sometimes on the right and others on the left.
For example, one of the current raging debates in economics is over the question of government economic stimulus. Typically, the supporters of the status quo sit on the right and the interventionists sit on the left. However, the interventionists are also divided into two opposing camps over the use of pro-cyclical (fiscal austerity) and anti-cyclical (fiscal expansion) policies. Can we split these into left and right?
As an economist, I believe that government intervention must be always counter-cyclical, but should be used only to smooth extreme volatilities in the business cycle. So, with unemployment above 15%, when looking at the labour market, I find myself on the left side. But, with interest rates close to zero, when looking at the bond market, I find myself on the right side against further monetary easing. So, should I average these two distributions and become a centrist? Not really, because these two visions are not necessarily incompatible.
Likewise, I am a strong supporter of market capitalism as the main driver of progress. But it does not mean that I do not accept a limited role to other forms of capitalism like managerial capitalism or state capitalism. Can I grade their relative roles in terms of left and right? Clearly not.
In conclusion, in general terms, in the absence of a coherent portfolio of ideologies we no longer should characterize ourselves as leaning towards the left or the right. But, over single issue divisions one should not be afraid to sit on the tail of the distribution. Under this eclectic approach, do we risk becoming a weathercock turning opportunistically with the prevailing wind? Yes, but it is a risk that should be mitigated by a scrupulous respect for our values and it is a risk worth taking to enjoy the greater benefits of freedom and variety.
If one uses the left and right categorization to depict a spectrum of opinions that we may represent through a statistical distribution then it still makes sense to talk about the left and right tails of such distribution.
However, we should recall that this categorization originated during the French Revolution to designate where the pro-monarchy (right) and anti-monarchy (left) seated in the French National Assembly (parliament). Later this designation was generalized to other divisions over single issues. In particular, it was extended to describe those in favour of the status quo (conservatives) and those in favour of moderate/drastic reforms (progressives/ radicals).
Historically, the most important split in the XIX century was over the emerging economic system of capitalism. Since this new system affected most aspects of society, it no longer represented a single issue divide. It became a split over a portfolio of visions usually designated as ideologies until the collapse of communism in 1989.
Yet, once a portfolio of visions becomes too diversified, it loses its internal coherence and no longer can be represented by a single distribution with a left and right tail. If I pick a number of divisive issues in economics, politics or moral I may end up sometimes on the right and others on the left.
For example, one of the current raging debates in economics is over the question of government economic stimulus. Typically, the supporters of the status quo sit on the right and the interventionists sit on the left. However, the interventionists are also divided into two opposing camps over the use of pro-cyclical (fiscal austerity) and anti-cyclical (fiscal expansion) policies. Can we split these into left and right?
As an economist, I believe that government intervention must be always counter-cyclical, but should be used only to smooth extreme volatilities in the business cycle. So, with unemployment above 15%, when looking at the labour market, I find myself on the left side. But, with interest rates close to zero, when looking at the bond market, I find myself on the right side against further monetary easing. So, should I average these two distributions and become a centrist? Not really, because these two visions are not necessarily incompatible.
Likewise, I am a strong supporter of market capitalism as the main driver of progress. But it does not mean that I do not accept a limited role to other forms of capitalism like managerial capitalism or state capitalism. Can I grade their relative roles in terms of left and right? Clearly not.
In conclusion, in general terms, in the absence of a coherent portfolio of ideologies we no longer should characterize ourselves as leaning towards the left or the right. But, over single issue divisions one should not be afraid to sit on the tail of the distribution. Under this eclectic approach, do we risk becoming a weathercock turning opportunistically with the prevailing wind? Yes, but it is a risk that should be mitigated by a scrupulous respect for our values and it is a risk worth taking to enjoy the greater benefits of freedom and variety.
Sunday, 24 July 2011
Marx and Friedman Were Wrong About the Suicidal Nature of Capitalism
The suicidal nature of capitalism has been predicted by several authors, both supporters and enemies of capitalism. By suicidal we mean a process through which capitalism would weave its own destruction.
Among the most influential theories we found Karl Marx’s surplus value theory of capital accumulation, Schumpeter’s claim that the success of capitalism would lead to a form of corporatism fostering values hostile to capitalism, especially among intellectuals, Milton Friedman’s theory on the suicidal nature of capitalists and Solzhenitsyn's attack on the commercialized nature of Western culture. In this post we will examine why Marx’s and Friedman’s predictions are wrong.
Marx’s prediction derives from his theory of capital accumulation presented in Chapter XXV of his book The Capital. In a nutshell Marx breaks down capital into fixed costs (the value of fixed capital) and variable costs (the sum of wages) and assumes that as the accumulation of capital proceeds the ratio between the two would increase resulting in a growing number of unemployed (the so-called industrial army reserve). This system would implode through over-production, over-population and misery.
It is easy to see why his model is wrong. First, not all technical progress is labor saving (on the contrary). Second, his Malthusian assumption of an ever growing population is wrong because fertility rates diminish with increasing incomes. Finally, and most importantly, he failed to see that workers would become capitalist and now hold a large part of a nation’s capital through pension funds and personal holdings. This was his most clamorous failure. Instead of his prediction that we would all become proletarians we all became capitalists. His motto “workers of the world unite” should have been “capitalists of the world unite”.
Friedman’s theory on the doom of capitalism was given in a Lecture at the Cato Institute entitled “The Suicidal Impulse of the Business Community”. His main contention was that when faced with policy issues business people tend to be very short-sighted. This leads them to seek government protection for their own industry, to favor public education which tends to be socialist-oriented, to lobby for the transformation of anti-trust laws into regulatory controls and to give more political contributions to nonprofit left wing organizations (three times more) than to non-profit right wing institutions.
He admits that he has not a good explanation for this suicidal behavior but advances three possible reasons. These include the presumption among business people that everyone is an expert in economics, the Schumpeterian argument that within large organizations people develop essentially bureaucratic-socialist attitudes and that there is a general propensity to look out for government action as an all-purpose cure for every ill. He dismisses the first two and retains the last.
By doing so, Friedman makes four mistakes. First, he ignores that like everybody else, given the chance, business people will be free riders on Government money. Second, payments to left wing organizations are made as insurance or protection against those from where they see more danger. Third, he fails to make a distinction between the different types of capitalism (managerial capitalism, state capitalism and market capitalism). Finally, as Adam Smith noted long ago, capitalists and conservatives are not necessarily the great defenders of capitalism. The true defenders of capitalism are consumers and investors without a controlling stake in their companies.
It is one of the great ironies of history that the capitalistic economic system, the greatest wealth creation machine ever invented, has so many enemies and critics among its beneficiaries (ranging from the church, government, academia to the business community). Yet, the supreme proof of its superiority is the fact that despite so many enemies and without an army of supporters it has nevertheless conquered the world.
Among the most influential theories we found Karl Marx’s surplus value theory of capital accumulation, Schumpeter’s claim that the success of capitalism would lead to a form of corporatism fostering values hostile to capitalism, especially among intellectuals, Milton Friedman’s theory on the suicidal nature of capitalists and Solzhenitsyn's attack on the commercialized nature of Western culture. In this post we will examine why Marx’s and Friedman’s predictions are wrong.
Marx’s prediction derives from his theory of capital accumulation presented in Chapter XXV of his book The Capital. In a nutshell Marx breaks down capital into fixed costs (the value of fixed capital) and variable costs (the sum of wages) and assumes that as the accumulation of capital proceeds the ratio between the two would increase resulting in a growing number of unemployed (the so-called industrial army reserve). This system would implode through over-production, over-population and misery.
It is easy to see why his model is wrong. First, not all technical progress is labor saving (on the contrary). Second, his Malthusian assumption of an ever growing population is wrong because fertility rates diminish with increasing incomes. Finally, and most importantly, he failed to see that workers would become capitalist and now hold a large part of a nation’s capital through pension funds and personal holdings. This was his most clamorous failure. Instead of his prediction that we would all become proletarians we all became capitalists. His motto “workers of the world unite” should have been “capitalists of the world unite”.
Friedman’s theory on the doom of capitalism was given in a Lecture at the Cato Institute entitled “The Suicidal Impulse of the Business Community”. His main contention was that when faced with policy issues business people tend to be very short-sighted. This leads them to seek government protection for their own industry, to favor public education which tends to be socialist-oriented, to lobby for the transformation of anti-trust laws into regulatory controls and to give more political contributions to nonprofit left wing organizations (three times more) than to non-profit right wing institutions.
He admits that he has not a good explanation for this suicidal behavior but advances three possible reasons. These include the presumption among business people that everyone is an expert in economics, the Schumpeterian argument that within large organizations people develop essentially bureaucratic-socialist attitudes and that there is a general propensity to look out for government action as an all-purpose cure for every ill. He dismisses the first two and retains the last.
By doing so, Friedman makes four mistakes. First, he ignores that like everybody else, given the chance, business people will be free riders on Government money. Second, payments to left wing organizations are made as insurance or protection against those from where they see more danger. Third, he fails to make a distinction between the different types of capitalism (managerial capitalism, state capitalism and market capitalism). Finally, as Adam Smith noted long ago, capitalists and conservatives are not necessarily the great defenders of capitalism. The true defenders of capitalism are consumers and investors without a controlling stake in their companies.
It is one of the great ironies of history that the capitalistic economic system, the greatest wealth creation machine ever invented, has so many enemies and critics among its beneficiaries (ranging from the church, government, academia to the business community). Yet, the supreme proof of its superiority is the fact that despite so many enemies and without an army of supporters it has nevertheless conquered the world.
Wednesday, 20 July 2011
Capitalism, What Capitalism?
In most countries wealth is created under various economic systems. An economic system is defined by a set of rules defining the relationship between interacting economic agents. For instance, in a feudal system the relationship between the landlords and their subjects was based on serfdom. Similarly the relation between the state and its citizens is exerted through coercion.
By contrast in voluntary and capitalist sectors the relationships between economic agents are defined freely through contractual arrangements. The first is based on bundling resources, risks and benefits while capitalism is based on unbundling them. In a capitalist system capitalists own the resources and profits but take the risks, while guaranteeing a contractual wage paid to workers. Both systems require the right to private property and its protection but only capitalism requires that most transactions between different agents be carried out through free and competitive markets.
The study of wealth predates the emergence of capitalistic systems but the modern economic science has its foundations in Adam Smith’s book on the Wealth of Nations. His book does not use the words capitalism or capitalist (curiously, the word capitalism had been used since 1633 but it was only popularized in the mid 19th century by the Marxist opponents of capitalism). Instead, the book is centered in showing why competition through competitive markets is the most efficient way of allocating resources and producing wealth. Since the capitalist system is the only system dependent on market competition it follows that, apart from a short experiment with communism, the history of modern economics and capitalism are inextricably intertwined.
Yet, the statisticians who have been developing the system of national accounts since the 1930s have never attempted to report the wealth contributed by each economic system – state, voluntary and capitalist. Instead they give us a breakdown of employment and GDP by sectors of activity and type of organization (e.g. households, government, financial and non-financial firms). Thus, when one wants to measure the contribution of the agents working in the capitalistic sector the task becomes almost impossible.
This is so because the so-called for-profit sector includes many types of capitalism. Moreover, the exchanges between for-profit firms and the other two sectors (state and voluntary) have reached a large volume of transactions which are not always executed on a competitive basis. Often such activities create a sector called grey-capitalism.
The various types of capitalism must be defined on the basis of their reliance on free and competitive markets. The purest form of capitalism is called market capitalism and it includes all self-employed and investor-controlled firms which are basically price-takers trading in free and atomistic markets. Other types of capitalism include the regulated industries, oligopolies, and management-controlled firms that operate under various not-fully-competitive systems, namely: managerial capitalism, crony capitalism, socialist state capitalism, corporatist state capitalism or social market capitalism.
Since economic theory has only proved the supremacy of pure competitive systems, any departures from such systems should be accepted only as a second best option justifiable solely by market failures and externalities. However, in the absence of entirely free markets, competition between the various types of capitalism does not ensure that the winner in terms of market share will be market capitalism. Indeed, quite the opposite may happen.
So, paradoxically, a rising share of market capitalism can only be achieved by regulating the growth of the other not-for-profit and capitalistic sectors. The rationale for such regulation is that the maximum collective welfare can be only achieved by a growing sector of market capitalism. That is, true capitalism ≡ market capitalism!
By contrast in voluntary and capitalist sectors the relationships between economic agents are defined freely through contractual arrangements. The first is based on bundling resources, risks and benefits while capitalism is based on unbundling them. In a capitalist system capitalists own the resources and profits but take the risks, while guaranteeing a contractual wage paid to workers. Both systems require the right to private property and its protection but only capitalism requires that most transactions between different agents be carried out through free and competitive markets.
The study of wealth predates the emergence of capitalistic systems but the modern economic science has its foundations in Adam Smith’s book on the Wealth of Nations. His book does not use the words capitalism or capitalist (curiously, the word capitalism had been used since 1633 but it was only popularized in the mid 19th century by the Marxist opponents of capitalism). Instead, the book is centered in showing why competition through competitive markets is the most efficient way of allocating resources and producing wealth. Since the capitalist system is the only system dependent on market competition it follows that, apart from a short experiment with communism, the history of modern economics and capitalism are inextricably intertwined.
Yet, the statisticians who have been developing the system of national accounts since the 1930s have never attempted to report the wealth contributed by each economic system – state, voluntary and capitalist. Instead they give us a breakdown of employment and GDP by sectors of activity and type of organization (e.g. households, government, financial and non-financial firms). Thus, when one wants to measure the contribution of the agents working in the capitalistic sector the task becomes almost impossible.
This is so because the so-called for-profit sector includes many types of capitalism. Moreover, the exchanges between for-profit firms and the other two sectors (state and voluntary) have reached a large volume of transactions which are not always executed on a competitive basis. Often such activities create a sector called grey-capitalism.
The various types of capitalism must be defined on the basis of their reliance on free and competitive markets. The purest form of capitalism is called market capitalism and it includes all self-employed and investor-controlled firms which are basically price-takers trading in free and atomistic markets. Other types of capitalism include the regulated industries, oligopolies, and management-controlled firms that operate under various not-fully-competitive systems, namely: managerial capitalism, crony capitalism, socialist state capitalism, corporatist state capitalism or social market capitalism.
Since economic theory has only proved the supremacy of pure competitive systems, any departures from such systems should be accepted only as a second best option justifiable solely by market failures and externalities. However, in the absence of entirely free markets, competition between the various types of capitalism does not ensure that the winner in terms of market share will be market capitalism. Indeed, quite the opposite may happen.
So, paradoxically, a rising share of market capitalism can only be achieved by regulating the growth of the other not-for-profit and capitalistic sectors. The rationale for such regulation is that the maximum collective welfare can be only achieved by a growing sector of market capitalism. That is, true capitalism ≡ market capitalism!
Tuesday, 28 September 2010
Hayek vs. Keynes: On individualism and collectivism
With the demise of anarchism in the 1930s and communism in the 1990s, we may say that the boundaries in the political spectrum on the role of the state in capitalism are defined by the extremes of the liberal (socialist in the European sense) and the libertarian movements. Currently, the bibles for both left/right-wing libertarians and liberals are still Hayek’s Road to Serfdom (1944) and Keynes’s General Theory (1936).
The two “prophets” were contemporaries, but Hayek outlived Keynes by almost fifty years. Indeed, as Hayek admitted later on his autobiographical interview, they engaged frequently on controversy but “remained personally on the best of terms, and I [Hayek] had in many respects the greatest admiration and liking for him as a man”. Keynes himself said of The Road to Serfdom: "In my opinion it is a grand book...Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in deeply moved agreement".
However, today’s supporters of Keynesian and Hayekian theories behave as fanatical or newly-converted followers. Often their behavior resembles that of the fanatics in the Abrahamic religions and sects who believe that their particular faith is the only truth and all other believers are infidels and enemies. Both religious and economic followers fail to recognize that their “prophets” followed the same god and ideals (liberalism) and that their differences were mostly about how to achieve them. Keynes and Hayek embraced the same theory of political economy based on market capitalism and economic liberalism.
Both believed that they should be based on nineteenth-century individualism and not in its misleading meaning of selfishness and egoism used today. The advantages of individualism as recognized by Keynes were: 1) the best safeguard of personal liberty; 2) greater efficiency (through decentralization of decisions and the play of self-interest); and 3) best safeguard of the variety of life and peace. Similarly, for Hayek the merit of individualism rests on recognizing the super individual forces which guide the growth of reason. Individualism is thus an attitude of humility before this social process and of tolerance to other opinions.
If they differ only by degree and not on fundamentals, where are then their key differences? The key differences are the result of how they see the trade-cycle and the trade-off between individualism and collectivism. Although both favor individualism over collectivism, Keynes is willing to sacrifice the first to achieve full-employment. Hayek refutes such compromise and doubts that collective (government) action can achieve such objective without running the greater risk of creating a totalitarian society (greater concentration of decision-making power).
So, their “followers” would do better by focusing on the limits of their theories and on studying the circumstances under which they can be applied.
The two “prophets” were contemporaries, but Hayek outlived Keynes by almost fifty years. Indeed, as Hayek admitted later on his autobiographical interview, they engaged frequently on controversy but “remained personally on the best of terms, and I [Hayek] had in many respects the greatest admiration and liking for him as a man”. Keynes himself said of The Road to Serfdom: "In my opinion it is a grand book...Morally and philosophically I find myself in agreement with virtually the whole of it: and not only in agreement with it, but in deeply moved agreement".
However, today’s supporters of Keynesian and Hayekian theories behave as fanatical or newly-converted followers. Often their behavior resembles that of the fanatics in the Abrahamic religions and sects who believe that their particular faith is the only truth and all other believers are infidels and enemies. Both religious and economic followers fail to recognize that their “prophets” followed the same god and ideals (liberalism) and that their differences were mostly about how to achieve them. Keynes and Hayek embraced the same theory of political economy based on market capitalism and economic liberalism.
Both believed that they should be based on nineteenth-century individualism and not in its misleading meaning of selfishness and egoism used today. The advantages of individualism as recognized by Keynes were: 1) the best safeguard of personal liberty; 2) greater efficiency (through decentralization of decisions and the play of self-interest); and 3) best safeguard of the variety of life and peace. Similarly, for Hayek the merit of individualism rests on recognizing the super individual forces which guide the growth of reason. Individualism is thus an attitude of humility before this social process and of tolerance to other opinions.
If they differ only by degree and not on fundamentals, where are then their key differences? The key differences are the result of how they see the trade-cycle and the trade-off between individualism and collectivism. Although both favor individualism over collectivism, Keynes is willing to sacrifice the first to achieve full-employment. Hayek refutes such compromise and doubts that collective (government) action can achieve such objective without running the greater risk of creating a totalitarian society (greater concentration of decision-making power).
So, their “followers” would do better by focusing on the limits of their theories and on studying the circumstances under which they can be applied.
Thursday, 29 April 2010
Should Warren Buffett look for a successor or return the money to his investors?
This weekend takes place the annual Woodstock for Capitalists (officially called the Annual Meeting of Berkshire Hathaway Inc). Warren Buffett expects that attendance will exceed 35,000. What will be in the mind of all these investors? I guess that a popular topic will be: Has Warren chosen a successor?
Finding a successor is normal for most companies when their founder chooses to retire. But, Berkshire is not a normal company. Berkshire is a bit like Cerberus, the three-headed dog of Greek mythology. To simplify we may say that it is one-third insurance group (a typical corporation), one-third private equity firm and one-third investment fund. A typical corporation requires a complex bureaucratic organization which takes many years to assemble and will become self-perpetuating. This is not the case with investment funds.
You may see collective investment vehicles (funds) as a pool of money looking for a manager to invest the funds pooled together by many independent investors. Or the other way around, you may see fund managers as promoters trying to persuade investors to trust them with their pool of money. Whatever way people see collective investment schemes, most investors never see the pooling of money as a perpetual commitment. Indeed, many funds even have a mandatory termination date.
So, should the independent co-owners of a diversified portfolio part their way or try to find another fund manager? Fund managers are a bit like artists, each one with his unique style. In that sense they are irreplaceable. For instance, when Pavarotti died his admirers did not try to find another Pavarotti. They simply turned their loyalty to another artist. He could be an opera singer, a rock star or even a painter.
At 86, Warren Buffett is the unquestionable master of value investing. Should his co-investors be in the look-out for a new master of value investing (which may not turn up for many years) or should they simply search for today’s masters of various other investment styles? Warren has always advocated the need to look for talented and honest people to run his operations, while stressing that he must not delegate risk control.
In the end, will the master investor surprise us on which Cerberus head leads Berkshire?
Finding a successor is normal for most companies when their founder chooses to retire. But, Berkshire is not a normal company. Berkshire is a bit like Cerberus, the three-headed dog of Greek mythology. To simplify we may say that it is one-third insurance group (a typical corporation), one-third private equity firm and one-third investment fund. A typical corporation requires a complex bureaucratic organization which takes many years to assemble and will become self-perpetuating. This is not the case with investment funds.
You may see collective investment vehicles (funds) as a pool of money looking for a manager to invest the funds pooled together by many independent investors. Or the other way around, you may see fund managers as promoters trying to persuade investors to trust them with their pool of money. Whatever way people see collective investment schemes, most investors never see the pooling of money as a perpetual commitment. Indeed, many funds even have a mandatory termination date.
So, should the independent co-owners of a diversified portfolio part their way or try to find another fund manager? Fund managers are a bit like artists, each one with his unique style. In that sense they are irreplaceable. For instance, when Pavarotti died his admirers did not try to find another Pavarotti. They simply turned their loyalty to another artist. He could be an opera singer, a rock star or even a painter.
At 86, Warren Buffett is the unquestionable master of value investing. Should his co-investors be in the look-out for a new master of value investing (which may not turn up for many years) or should they simply search for today’s masters of various other investment styles? Warren has always advocated the need to look for talented and honest people to run his operations, while stressing that he must not delegate risk control.
In the end, will the master investor surprise us on which Cerberus head leads Berkshire?
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