An overview of finance theory under capitalism

The remarkable rise of financial markets in the first quarter of the XX century was followed by an increased interest in finance. Initially the emphasis was in security analysis, but since the 1950s its focus shifted towards portfolio theory, markets and new financial instruments such as derivatives.

Before the XX century, finance theory was mostly a branch of mathematics (actuarial calculus) dealing with the pricing of risk in fixed income securities (debt) based on the probabilities given by mortality and bankruptcy tables. Given the stable nature of such tables finance was not seen as ideological or having anything to do with the fundamental principles of capitalism.

However, following the rising issue of variable income securities (equity) by joint stock companies, finance theory become progressively the realm of accountants and lawyers dealing with the valuation of stocks on the basis of the calculation of future profits and the rights of each class of shares issued. These concerns were already at the core of the principles of capitalism (property rights and free markets), but remained largely non-ideological because of the nature of such valuations based on common sense forecasting of business profits and the growing prohibition of share manipulation. Such valuations were generally accepted as relevant to value firms.

Yet, this benign acceptance of security valuations came to an end following the 1929 stock market bubble and crash. During that period valuations were so much at odds with the corporate fundamentals that financial analysts had to look elsewhere for explanations.

The first attempt appeared in 1934 with the publication by Graham and Dodd of Security Analysis, a book that has gone through two major revisions but it is still seen today as the bible of financial analysis. The book covered many of the pitfalls of traditional financial analysis but did not cut with the tradition.

However, security analysts were not the only trying to find explanations for extreme volatility in market prices. Accountants responded by increasingly recording non-cash transactions in an attempt to find explanations and macro economists began explaining why arbitrage was not reducing such large departures from price equilibrium.

For this, both professions had to come up with new theories (not new facts) to explain past and current valuations. These theories had to draw on assumptions (subject to ideological bias) and could not be tested in a laboratorial sense.

These rival theories searched for supporters while special interest groups searched for theories that served their interest. Consequently, finance theory ceased to be a reasonably neutral instrumental tool to become a battle field of ideologies with an impact on the interpretation of the principles of capitalism, especially on the role of private property and the profit motive.

This process was fostered in the 1950s by the sudden interest in finance by macroeconomists with a tradition of competing schools of thought and doctrines.

Curiously, accordingly to Miller (1988), the Modigliani-Miller interest on the cost of capital had been awakened by listening to a paper presented by Durand (1952), the last preeminent scholar in the old finance tradition. Modigliani and Miller (1958) developed a general equilibrium model for a closed economy aimed at explaining the “determinants of aggregate economic investment”. By consolidating the accounts of the business and household services into a single balance sheet debt and securities no longer appear, thus proving the proof of their first proposition about the irrelevance of the capital structure.

This proposition had already been proved in finance theory by Durand (1952) for security valuations based on operating income rather than net income, which he did not consider a best approach to capitalization. He suggested that the businessmen’s interests were better served by the maximization of the present value of their investments rather than their profits, because the first took into account their time preference. Moreover, the cost of issuing debt or equity would have to consider the effects of increased leverage or equity dilution on investment value to assess the rate of return required on the investment to preserve shareholder’s value. That way, this required rate of return could be interpreted as an opportunity cost of capital.

Durand’s conclusion was that: “Given a method of security appraisal, the costs of raising capital can be both defined and measured. At the same time I have tried to show that there is at present no generally accepted system of appraisal; hence there can be no generally accepted system of measuring costs”.

In particular, Durand claimed that none of the two methods widely used in analyst’s valuations – capitalized net income or capitalized net operating income – was adequate or correct, when strictly interpreted. Not surprisingly, he was the first (Durand, 1958) to refute the Modigliani-Miller proposition on the grounds that it may apply to certain partnerships but not to corporations, since it neglected a fundamental principle of capitalism – limited liability. Later, Durand (1989) extended his critic to the static nature of a theory based on constant growth rates, by showing that “growth, when resulting from a premium rate of return in an imperfect market, will manifest itself in a premium stock price”.

Nevertheless, Miller and Modigliani (1961) extended their approach to the case of dividends to prove their second proposition about the irrelevance of dividends for firm valuation. Both propositions relied on pure capital markets and the possibility of creating so-called homemade leverage and dividends to create conditions for arbitrage between debt and equity that made structure irrelevant for valuation. These papers were necessarily controversial and triggered an unprecedented interest of macroeconomists in finance which extended also to econometricians and finance professionals.

This would create an new age in finance theory in academia. Given the rather complex and theoretical nature of the Modigliani-Miller approaches, it is still unclear why this happened so suddenly. Especially, since the greatest innovation with a practical use – Harry Markowitz (1952) paper on portfolio optimization - had remained forgotten for almost a decade.

It is nevertheless plausible to assume that the interest of company managers in encouraging a theory that would free them to use whatever capital structure they liked and to decide on how and when to return funds to the shareholders did not remain unnoticed. Likewise the replacement of profit by firm value maximization fade away the monitoring of their performance while justifying their growing compensation in terms of stock options .

In this new era of so-called modern finance, or new finance if we add behavioral finance, theory and practice became increasingly divorced. Contrary to tradition, practitioners began using complex academic theories to impress their marketing targets the same way salesman use super models to sell cars.

Thus modern finance theory became the realm of economists and econometricians, hiding their primeval ideological bias under a heavy use of complex modelling and econometrics.

Curiously, modern finance theory had begun in the right foot with Durand’s (1952) paper on the “Costs of Debt and Equity Funds for Business”, which questioned a proclaimed shortage of equity capital as the reason for the increased retention of earnings and borrowing.

Unfortunately, Modigliani and Miller (1958) reversed Durand’s conclusion and used the cost of capital concept to develop their model on the irrelevance of the capital structure on a firm’s value and the neutrality of dividend policy, by recurring to devices such as shareholder’s leverage and homemade dividends.

Despite the protests of Durand (1959), the Modigliani-Miller theory became fashionable among academics and was seized by managers to reclaim their long held desire to treat indifferently debt holders and stockholders. This fostered the idea (and reality) that managers select shareholders not the other way around, in order to maximize the owners value but that of an enlarged constituency ranging from employees to suppliers.

Combined with accommodating fiscal policies this “new ideology” justified an enormous rise in institutional investment and consequent facilitation of the rise of managerial capitalism. This fueled a number of potentially nefarious policies and political collusions. I address below some of these ranging from the abuse of the weighted average cost of capital to the attempts for (re-)privatization of money.

In conclusion, finance theory may not have had an impact as large as that of technology, but it was still significant. Its role has been mainly accommodating in explaining the trend for financialization and managerial capitalism. On the contrary, it has been lacking on exposing the excesses of financial deepening in finance-led capitalism. Since this is not always benign, one would expect more from financial theorists.

Asymmetries in access to leverage

There is a justified apprehension that in credit-based economies, of the type associated with capitalism, the excessive reliance of credit on collateralization perpetuates an unfair advantage for those endowed with more capital. The popular sentiment that money-attracts-money and misery-attracts-misery. However, the rise of capital markets and the spreading of banking philosophies based on the ongoing concern principles, means that market capitalism dilutes such concerns about the misallocation of savings.

Before addressing the potential misallocation of leverage under financial capitalism, let me make a qualification about the differences between savings and investment and credit and borrowing. The two concepts are often confused because ex-post, in an accounting sense, their value is identical and also because in a popular sense saving is seen as a form of abstinence. Likewise, lending is popularly identified with renting an existing asset, e.g. a lawnmower or cash.

To be more exact we should define investment as the carrying of any asset (whether the butter in the fridge or the computer in the office) from one accounting period (whatever period unit one uses, year, month, etc.) into the next period, either because it cannot be entirely used up within a single period or for precautionary or speculative reasons.

Under this definition one would consider consumption as the use of a portion of newly produced or existing assets during the current accounting period. Thus, as Keynes put it, “when investment changes, income must necessarily change in just that degree which is necessary to make the change in saving equal to the change in investment” . Hence, savings and investment are jointly determined by the propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest.

Therefore, one needs a theory of how financial leverage influences these determinants. In the absence of such theory, one can nevertheless intuition (see Mendes 2000) that the rise of finance capitalism has two offsetting effects on investment – contractionary and expansionary – whose net effect has to be ascertained under specific circumstances.

In particular, large scale investments need to be collateralized through a mix of financial assets and guarantees involving a complex engineering between banks and governments. This necessarily degenerates into collusion between these two sectors which occasionally may crowd-out the funding of enterprise in favor of speculation and government spending. In this sense it is a threat to market capitalism.

However, some speculative occurrences in financial assets have as an underlying a non-financial asset like real estate or similar which causes a misallocation of resources into non-financial assets (e.g. the sub-prime real estate bubble and crash in US). On other occasions it is not clear if the speculative frenzy began with non-financial assets and after transmitted to the financial sector or vice versa. However, such cycles are neither the result nor a threat to capitalism.

In conclusion, finance capitalism may cause some misallocation of resources and favor the leveraging of some sectors (e.g. managerial capitalism) but it is not a fatal threat to market capitalism.

HFT, overtrading and casino capitalism

The extraordinary rise in financialization is the result of a growing economy and new trading and communication technologies. These reduced transaction costs putting speculation at the reach of a growing number of people, for increasingly short-lived and minuscule price discrepancies.

This can be illustrated by a permanent level of overtrading and the rising role of speculation in a casino-fashion, which may be exacerbated by the recent development of high frequency trading (HFT) at speeds only accessible to computers.

HFT refers to algorithmic trading which, according to some estimates, accounts for about 70% of all equity trading in the US stock exchanges. HFT has always existed whenever volatility and sentiment led investors to change quickly their positions. However, in the past the frequency of trading was limited by slow message networks and human communications (despite the development of gestural messages among traders).

With the development of electronic communications and trading platforms, human traders progressively reduced the time to move in and out of positions to a fraction of a second.

However, with the emergence of high speed computing and sophisticated decision and order transmission algorithms, now human traders can be replaced by computer traders which are not subject to such limits. Indeed, by connecting directly their computers to the exchange trading platform, some claim to be able to move in and out of a position in micro-seconds (one millionth of a second ) capturing a fraction of a cent in each trade and still make a profit.

For the time being the investment strategies more likely to be adopted by fast trading robots are front running and pump and dump (both illegal) as well as market making, ticker trading and various types of arbitrage. However, it is foreseeable that it will extend to all types of investment strategy.

The progressive substitution of human trading by robotic trading will certainly transform the equity market into a dual market of the kind already observed in currency markets, where the share of transactions for commercial (tourism, exports and imports) or investment motives (savings and portfolio allocation) becomes very small when compared to that of professional speculators. This evolution raises two types of concerns – excessive overtrading and casino-like price formation.

One must note that overtrading it is usually defined in two ways. In a business context the term is used to describe companies that are doing more business that their working capital can sustain. In the context of markets the term is usually used to describe the brokers practices to influence their customers to engage in excessive buying and selling. I will retain here a broader definition based on financial cycles due to rising volatility and increased speculation.

The drivers of financial cycles would not be fundamentally different from those driving business cycles if it was not for the fact that trading in financial assets seems to go on rising unabated despite recurrent crisis and significant consolidation. For instance, the recent substitution of 18 currencies by the Euro did not result in any reduction in forex trading, quite the opposite. Between 1998 and 2013, the daily average volume of trading rose from US$1.5 trillion to US$5.3 trillion, an amount equivalent to 17.5 times the value of the daily production in the world.

This is only possible because the market is dominated by a dozen of large banks (or market makers) engaged in what one may consider a never ending zero-sum game through which they can only grow by taking ever larger bets against each other. The continuity of this game has an obvious benefit by creating a huge liquidity pool, so that those trading for commercial or investment reasons no longer are limited by the size of the market.

However, this benefit may have serious costs in terms of new operational risks and loss of the information provided by prices. Operational risks occur in the form of flash crashes of the kind occurred in New York on May 6, 2010 and in Singapore on April 23, 2013. Nevertheless, despite the individual havoc that these may cause, they may be considered as “teething problems” which will be minimized to avoid its frequent recurrence and the contamination of the real sector of the economy.

On the contrary, the transformation of markets into casino-like gambling has two enduring risks – boosting financial crisis and diluting the importance of markets for the efficient allocation of resources.

In itself, HFT has not been at the origin of financial crisis, and it is still too early to know if it plays any role in their amplitude.

Since price signaling is a key foundation of market capitalism, there has been a heatedly debate on whether speculation improves markets. In theory, its stabilizing role seems to win the argument, at least in currency markets. In these markets the fundamentals still play a role in the long term, because in currency markets some players (central banks) are legally entitled to collude to manipulate the markets into stabilization. However, in equity markets only trading halting rules perform such function because there is no entity with a stabilizing role.

So, whenever the level of overtrading in equity markets reaches currency proportions we do not know if monetary authorities are able or willing to step in to stabilize equity markets in a similar way. What we know from the latest bubbles is that central bankers alerts about “irrational exuberance” may be ignored for several years. For instance, during the internet bubble of the 1990s it took four years from 1996 to 2000 before the bubble burst by itself.

Overall, neither HFT nor overtrading risks represent a global catastrophic threat to capitalism similar to that of a nuclear arms race or experiments with high-energy super colliders.

Nevertheless, we need to know more about their distortionary impact on price formation and the allocation of leverage to competing projects. Otherwise, to put it in Keynes words (1936): “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done”.

Globalization and winner-takes-all

The globalization of markets and capitalism has increased the opportunities for businesses with a winner-takes-all model. Such business are characterized by high cost of entry once a dominant player has acquired the bulk of the market. Their rise is explained by the benefits of one-stop-shop found in many services.

For instance, in social media users value the opportunity of having all their friends in the same platform (e.g. Facebook). Typically the providers of such services compete by offering a loss-making free service until they manage to establish a quasi-monopoly. Once they have achieved that, they can monetize their dominant position through advertising or by other means. This is not a natural monopoly nor is it protected by any entry barriers other than capital resources.

This strategy is only possible because of the existence of venture capital funding willing to bet on the various contenders for the market, but once one has been established as dominant it is no longer profitable to try to dislodge him.

Similar cases occur when, due to locational or brand recognition advantages, some businesses rely on the captivity of the final consumer to transfer to their suppliers any demand adjustment costs. These situations occur in industries as disparate as publishing and groceries. For instance, during economic crisis supermarket chains force their suppliers to cut prices or offer discounts to sustain consumer demand.

A somewhat similar situation, but less stringent, occurs in the so-called 20/80 sectors where 20% of the producers have 80% of the market and vice versa. Here, removing the entrenched incumbents is difficult because the market may overvalue them and the entry costs are too high. It usually takes a long period and some new technology to achieve that.

These conditions are more common in global businesses ranging from soft drinks to computers. For instance, Microsoft dominance of operating systems was only challenged by the arrival of the smartphones and tablets.

With the globalization of capitalism these conditions become more common but once the globalization process has been completed their number will subside.

Therefore, overall, globalization and winner-takes-all business models are not lethal capitalism and must be seen simply as a temporary nuisance to market capitalism.

Control theory and minority shareholders

Shareholder dispersion raises two related issues – the possible emergence of a control premium and how to protect minority shareholders from collusion between managers and controlling shareholders.

The growing size of firms requires an ever growing dispersion of shareholders and it becomes impossible or risky for a single investor to control 50% +1 of the votes. For instance, in 2015, the largest strategic shareholder (Mitchell’s Michael Kent) in the smallest cap constituent of the S&P 100 index - Devon Energy Corp – owned only 5.07% of the company, less than the 5.46% owned by The Vanguard Group which caters for retail investors. Moreover, the top 10 investors owned jointly less than 32%, while overseas investors from 30 different countries owned 28%.

So, since individual shareholders or groups of controlling shareholders often own less than 50% of the votes, it is normal that such control might be challenged by other investors, thus creating a market for company control. Of course, this requires the existence of an advantage in controlling a company sufficiently large to justify a so-called control premium.

Why should there be any advantage in being part of the control group if trading on insider information is forbidden and management has to treat all shareholders fairly? Finance literature usually explains such interest in terms of governance to discipline the incumbent management more efficiently than through internal control systems.

The assumption underlying such reasoning is that the influence it gives to controlling shareholders in terms of nominating and compensating managers following policies aligned to their interest is offset by a strong discipline preventing managers and controlling shareholders from engaging in tunneling and abuse of non-controlling shareholders.

Yet, even in large markets, like the USA where it is possible to have a lively takeover market, most of the takeover deals are driven by short term financial profits secured through buyout and arbitrage strategies, often at odds with the interest of long term investors. Moreover, even where the judiciary can be relied upon to prevent corporate raiders from expropriating the target’s resources there are still circumstances when some categories of investors can collude with management.

Elsewhere, Mendes (2011), I examined why trade investors may collude with managers to vote for star-like compensation, lowering the return to other investors which lack any self-interest market mechanism to prevent such predatory behavior. In the case of trade investors the materiality and scope for collusion depends on the possibilities to switch suppliers, their relative size and the greed of management. So, the question now is to discuss if it is possible to correct such inefficiency through regulation.

The simplest way to regulate is to impose limits on the ownership of major suppliers, to limit their rights or a combination of both. The first could be easily defined but it can be easily evaded. In particular, for suppliers of financial services, such limits could be easily circumvented by investing indirectly through investment funds managed by them.

Limiting the voting rights of trade investors who are major suppliers is probably a better solution. It does not disrupt arms-length trading relations and it is easily enforced. The only debatable issues would be about the classification of trade investor and the voting restrictions. Beyond the traditional restrictions on voting in related-party transactions, restrictions should cover voting for the election of management and their remuneration, but they could extend to voting in the governance and auditing committees.

Nevertheless, regulation always has its own costs, which cannot be disregarded lightly. In particular, discouraging trade investors may have its costs in terms of business intelligence and synergies.

Still, overall, I believe that easing takeover regulations and limiting the voting rights of trade investors are market perfecting policies, contributing to true market capitalism and the protection of minority shareholders.

Wealth accumulation and the profit motive

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.

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.

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.

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.

As próximas eleições e o dilema de escolher o mal menor

Nas atuais eleições muito Portugueses enfrentam o dilema de ter de escolher o menor dos males. Muitos eleitores desejam punir a atual coligação mas temem que alternativa socialista seja ainda pior. O dilema foi apresentado de forma brilhante neste artigo (http://observador.pt/opiniao/que-desconto-me-fazem-por-este-governo/ ) da Maria João Marques, que o resolveu afirmando que pessoalmente não iria votar na coligação mas apelando a que outros o fizessem. Será esta a melhor solução?

A resposta a esta questão depende da perceção que temos sobre a importância do nosso voto.

Se acreditarmos que o nosso voto poderá ser decisivo então temos que optar pelo mal menor, e a Maria João devia votar na coligação.

Se, como as sondagens sugerem, nem a coligação nem o partido socialista estão perto da maioria absoluta então já temos maior liberdade de voto, mas a nossa decisão deve ser influenciada pelo tipo de governo que poderá sair destas eleições.

Se for um governo minoritário liderado por quem tiver mais votos, então a decisão da Maria João devia depender de quão próximo estão os dois rivais. Isto é, se as sondagens apontarem para um empate devia votar na coligação, caso contrário, terá a liberdade de optar por um voto de protesto.

Se, a alternativa for um governo de coligação, então terá de avaliar se a melhor solução para as próximas eleições, que se seguirão a um governo com vida provavelmente curta, é ter o seu mal menor a liderar a coligação ou não. Se a sua avaliação for sim, então devia votar na coligação. Se for não, terá liberdade para fazer um voto de protesto.

Vejamos agora quais são as suas opções para um voto de protesto, agrupando-as em dois grupos – protesto por omissão ou votação em partidos “alternativos”.

O voto de protesto por omissão tem três opções: abstenção, voto nulo ou em branco. Infelizmente, o nosso sistema eleitoral não permite a representação dos votos nulos com cadeiras vazias no parlamento, e, alguns eleitores temem que a sua mesa de voto possa transformar o seu voto nulo em válido. Por outro lado a abstenção pode confundir-se com o desinteresse e não com um voto de protesto. Finalmente, num país com muitos idosos e analfabetos, o voto nulo tem a desvantagem de poder confundir-se com os erros genuínos desses eleitores. Tudo pesado, talvez o voto nulo ainda seja a sua melhor opção se não tiver partidos alternativos a quem possa dar o seu voto.

A votação em partidos alternativos deve distinguir entre partidos com possibilidade de terem representação parlamentar ou não.

Infelizmente, em relação ao primeiro grupo, entre nós a escolha não é muita pois apenas temos dois partidos de extrema-esquerda (PCP e BE), o que no caso da Maria João invalida esta opção.

Quanto aos partidos de protesto a sua maioria também é de extrema-esquerda ou extrema-direita com as quais a Maria João não se identificará. Os restantes, ou são partidos pessoalizados em torno de demagogos com objetivos pouco claros (e.g. PDR ou JPP) ou são partidos de grupos de interesses específicos nem sempre transparentes (e.g. MPT, PURP ou PAN). Se a Maria João simpatizar com algum desses movimentos (o que não me parece), a sua opção será votar no mais simpático.

Em conclusão, em situações em que temos de escolher um mal menor cada eleitor deve fazer a sua avaliação das múltiplas alternativas que tem (aqui ilustradas com o exemplo da Maria João). Já fiz a minha própria avaliação seguindo este método. Resta-me desejar que o método também possa ser útil a outros eleitores.

Capitalism without democracy?

Is capitalism indifferent to the form of government? Not in its pure form of market capitalism.

Just like competition and free markets are indispensable for economic success, democracy and freedom are essential for a good system of government and the rule of law. For this reason, capitalism and democracy are often said to go hand in hand.

Yet, there are some on the right and left who still believe the opposite. Some take such view on the basis of a mistaken interpretation of democracy and capitalism, while others simply dislike the outcomes of both systems.

Democracy is “Government of the people, by the people, for the people”. This form of government is achieved through majority rule by people's representatives, subject to the constitutional separation of powers and the rights of the minorities, who are elected periodically on the basis of one person one vote.

The alternatives to democracy can be gathered into two groups – totalitarian and authoritarian. Totalitarian regimes are typically governed by a despot or a small group of leaders, invoking an ideology or religion as the general basis for all aspects of life, where any form of opposition is brutally repressed. Authoritarian regimes are a softer version with less dogmatism in terms of ideology or creed, and granting some level of economic and religious freedom as long as their personal enrichment and hold on power is not challenged.

Former examples of totalitarian regimes include Nazi Germany and Stalin’s USSR, while living examples can be found now in countries like North Korea and Saudi Arabia. Today, the classification as totalitarian or authoritarian in countries like Iran, Russia or China is controversial.

For instance, the classification within a given category is not indifferent to the regime evolution, and in this sense one may say that China is moving towards an authoritarian regime while Russia is moving towards a totalitarian system, although, objectively, now there is still more freedom in Russia than in China. Likewise, the distinction between democratic and authoritarian regimes is also controversial in countries like Singapore.

In fact, nowadays, authoritarian and totalitarian regimes do not follow an open anti-capitalist ideology and may even portray as strong capitalist supporters, as long as their rule is not challenged.

The two standard yardsticks to judge the evolution of a political regime are the direct state involvement in the economy and the exercise of civic freedoms under the rule of law. These do not necessarily preclude regimes with strong leaders or with one-party long-term dominance.

However, these inevitably end up creating a self-perpetuating elite that will oppose any competition. To overcome such danger the pursuit of liberalism constitutes an important antidote to preserve both capitalism and democracy.

Indeed representative democracy and capitalism share similar problems in terms of governance. As sometimes I remind my students, there is a remarkable similitude between shareholders and electors. For instance, elections are the equivalent of the shareholders annual meeting, asset managers are similar to political parties, the board of directors resembles the parliament, and the executive officers the government while the senior managers are like the top civil servants.

Therefore, they share similar challenges. For instance, in terms of representation, the need to avoid a divorce between the electors and the elected is analogous to the separation between shareholders and management. Likewise, the rise of self-perpetuating insider elites in political parties is similar to that found in the selection of company board members.

Not surprisingly, the false alternatives to representative democracy, namely direct and “guided” democracy, have an equivalent in the attempts to extend voting rights to non-shareholders and on collusion to adopt rules restricting voting rights.

In conclusion, capitalism and democracy are two distinct but mutually-reinforcing systems. When in pursuit of their true form – market capitalism and representative democracy – they are inseparable. Temporary moves away from any one of them is only possible for short periods or under perverse forms of capitalism.

Russian fears after 20 years

Since the fall of communism, Russia has become again a case study on the loss of freedom in non-capitalist systems, this time the result of a system of oligarchic state capitalism developed in the country.

I am not an expert on Russia, a country I visited only twice and briefly. I visited Moscow in 1991 and S. Petersburg in 2013. The last time, during the visit to the over-crowded Hermitage Museum I seated for a while wondering what had struck me more and it was not the museum.

Mostly, I wondered why after more than 20 years this beautiful imperial city still looked dilapidated and decrepit, and people in the streets and tourist shops still looked fearful, nationalistic and resentful of westerns. It also struck me how limited was the offer of products beyond the babushkas, amber and other semi-precious stones and communist memorabilia.

Having lived my youth under Salazar’s authoritarian regime, a model admired by President Putin, I can understand the Russians’ fear, longing and delusions about past imperial might and equality in poverty. It also lets me sense the body language of those living in fear of the authorities or in servility before those in authority to whom they owe their business.

For instance, a souvenir shop I visited still exhibited a wall plaque stating that it had been opened by special permission of a minister. I also had lunch in a restaurant housed in a former Czar palace and headquarters of the Soviet Trade Unions. It housed many other “companies” which did not have any identification and nobody knew what they did or who owned the place. The meal itself was not much different from what one gets in a workers canteen and the service was very poor. However it have the “luxury” of classical live music played by a young violinist. The whole setting was quite surreal.

Only a lack of truly free enterprise can explain the absence of progress in Russia. In fact, the Russian economy continues totally dependent on the exports of arms and energy, with the later accounting for almost 70% of its exports and, together with other commodities, account for about 50% of the Federal Government tax revenue. Overall, Russian exports are less than 15% of the Euro-Area exports.

Searching for explanations for Russia’s poor performance, Chrystia Freeland’s Plutocrats (2013) compares the rent-seeking strategies of the Russian oligarchs with that of the Chinese Communist Party bosses and concluded that “China’s market reforms have been slower and its avenues for rent-seeking have been more varied and more opaque than a quick privatization drive led from the top”. In my view, this does not explain much about the disparate performances of Russia and China.

The key difference resides in the openness and participation of the two countries in international trade. While China began by creating special free trade regions for foreign investors and sought an early entry into the WTO organization, Russia only fulfilled the WTO membership requirements in 2012.

Equally important was the contempt for small business inherited from the communist regime which, coupled with a lack of property protection, rampant corruption and business fear, discouraged free enterprise and entrepreneurship.

The Russian experience confirms the importance of freedom for capitalism and economic development. Otherwise the incumbents fear the loss of power and people the loss of security and sooner or later turn to authoritarian nationalism invoking the risk of social unrest or imaginary external threats.

These fears can only be overcome through genuine democracy and a move towards market capitalism, by opening up to foreign competition and achieving significant progress in complying with the six principles of market capitalism.

Capitalism and individual freedom rights

Regardless of whether we think about individual liberty as the absence of obstacles, barriers or constraints (negative liberty) or we consider collective liberty as the possibility to take control of one’s life and fundamental purposes (positive liberty), there is no doubt that freedom must be defined in relation to the availability of options. However, since options may be incompatible one must frequently balance them. For instance, we have a tradeoff between privacy and safety or between individual and collective wage negotiations.

Equally, when analyzing the relationship between capitalism and freedom, one needs to consider the freedoms essential for capitalism as well as the way it contributes to the many freedoms. Indeed, capitalism is an economic system that requires two fundamental freedoms – private property and freedom of exchange – and these two types of freedom enhance further other forms of freedom, namely the freedom of association required by joint ownership and free consumer choice and the freedom of information necessary for free trading.

Overall, by promoting individual wealth, capitalism contributes to the creation of more options and individual choice thus overcoming one of the major obstacles to liberty. But, through its principles, it also promotes many other fundamental freedoms not directly related to material goods.

For instance, freedom of thought, belief, opinion and expression is promoted by the capitalist’s drive to advertise its products and services. This commercial interest can only be achieved with freedom to choose the channels to reach clients and a free media.

Freedom to contract and exchange is indispensable for competitive markets and it can only be achieved by freedom of movement, absence of coercion and access to information. Freedom of information, like the freedom of expression is crucial for commercial as well investment decisions. Since asymmetric information is a major source of market inefficiency, capitalism thrives better under free markets.

Likewise, free peaceful assembly is a requirement of capitalism so that employers, employees and consumers can discuss their relative interests both in private and in public places, such as conferences, fairs and exhibitions. This freedom extends also to the right to establish unions and peaceful union picketing to persuade other parties to a wage bargaining.

Freedom of association is crucial under capitalism not only for representation purposes, but also to pool private property into forms of joint ownership, namely joint stock companies. Moreover, by separating personal from corporate responsibility through limited liability, capitalism manages a substantial reduction in risk which is essential to foster entrepreneurship.

Most importantly, capitalism generally promotes peace because all forms of social unrest and war destroy assets, production and profits. The profit motive requires all the above mentioned liberties and, not surprisingly, all totalitarian regimes (whether pro or anti-capitalism) are usually searching for new excuses and ways to control capitalism.

To resist such attacks on freedom, it is important to understand when the fundamental freedoms that capitalism requires and promotes can be subject to some restrictions. For instance, freedom of expression does not mean that corporations are free to lie and manipulate consumers and investors. Likewise, freedom of assembly does not mean that such assemblies may be used to collude on illegal and anti-competition practices. Just like the right of association does not mean that it can be used to establish cartels or the right to information allows them to procure insider information from privileged parties.

The definition of such limits on business freedom is usually controversial and difficult to delimit. In particular, there is a widespread tendency to consider that the role of the state is to protect individual freedom against business practices. This is erroneous, because the state and capitalism should not be adversaries but allies in the promotion of freedom. To avoid this dangerous error it is important that regulators understand the differences between market capitalism and other “distorted” versions of capitalism because only the first guarantees the pursuit of liberty.

To conclude, we should not assume that people are either extremely naïve or evil. All restrictions to freedom must be carefully assessed and, if needed, the error should be on the side of liberty.

The free movement of goods, capital and labour

Capitalism confirmed and extended the benefits from free movement of goods and services, capital and labor. Initially mostly at the national level, but progressively also at the international level.

Throughout the middle ages internal trade was not only risky due to the shortage of transport infrastructure and lack of protection against robbers, but also because of the many tolls required to enter cities, navigate the rivers, use bridges or the right of way over the nobles land. For instance, in 1250 there was 12 tolling stations on the Rhine river between Mainz and Cologne, which are only 170 km apart.

By then slavery had been generally replaced by serfdom. But, about half of the population still continued tied to the lord’s land through bondage and had to provide a certain number of labor services. Serfs were forbidden to live outside the seigniorial territory, had to pay fines to marry serfs of another lord and were subject to a number of fees.

Craftsman and artists enjoyed more freedom but were progressively organized in Guilds which restricted severely their training, trade and mobility. So, the concept of free labor mobility was basically unknown.

Likewise, there was very little capital mobility because the sale of land (the main asset at the time) was severely restricted through seigniorial and inheritance laws. Financial investments were equally very limited and lending was typically provided only to royalty by Jewish merchant- bankers. So, apart from travel and trade-related payments, the transfer of financial capital was too little and mostly to pay for ransoms and tributes.

However, the advent of the commercial revolution in the XIII century and the Renaissance changed dramatically the situation in Europe. By the late XVII century international banking and trade had achieved a significant development in Northern Italy, London and Amsterdam. Yet, its driving forces were still the spices and other exotic merchandise made available through the Spanish and Portuguese sea voyages, which were necessarily limited.

It was up to capitalism, with its focus on manufacturing, to change dramatically the growth of international trade through the export of manufactured goods to the colonies and the import of the raw materials used to produce them. This process contributed to the rise of London as a major international clearing and financial center, where it became possible to borrow and invest internationally.

In turn, the financing of major railways and other ventures in the Colonies in North and South America required massive labor migration.

Of course major human migration had been around since the early days of the homo sapiens. He moved out of Africa some 80 millennia ago, and spread across Eurasia 40 millennia ago. Migration to the Americas took place about 20 to 15 millennia ago and, about one millennium ago, all the Pacific Islands were colonized. Later, significant population movements included the Neolithic revolution and the Indo-European expansion.

Throughout history, most major migrations were caused by the collapse of empires, slavery or religious persecution. For instance, it is estimated that before 1830 2.75 million Europeans left to settle overseas, mostly convicted and fugitives from religious persecution.

The difference under capitalism was that migration accelerated not only substantially, but its motivation also became essentially economic. For instance, between 1835 and 1935, the number of European emigrants rose to 75 million who left voluntarily to America and other continents in search of a better life. With a bit of exaggeration, one may say that with capitalism the labor market transformed from a local market into a global market.

Nevertheless, the dismantling of the barriers preventing the free movement of goods, capital and labor was a slow process. Governments had become addicted to customs tariffs as a source of revenue, wanted to force national savers to lend their money only to them or did not wish to extend their social services to immigrants.

In general, capitalists have a duplicitous approach to the freedom of movement. They support free trade as long as it opens up new markets for their products and supplies, but are against when it means direct competition with their products. Likewise, they welcome financing from foreign investors but do not appreciate it when national banks lend to foreign companies. Similarly, they welcome foreign workers as a way of keeping wages lower but do not like it when foreign companies poach their own employees.

Ultimately, the question remains one of knowing whether restrictions to the free movement should be acceptable as temporary or permanent to avoid major disruptions in the three markets. History has shown that the abolition of barriers has been faster in relation to goods and services, somewhat rapid in relation to long term capital but very slow in relation to labor movement.

In general, and especially in large countries, capitalism can live with movement restrictions, as long as they are not excessive. However, to reach its full potential restrictions must be progressively abolished. Indeed, as our analysis of business cycles has shown, programs of accelerated liberalization usually have been associated with an acceleration of economic growth.

To conclude, capitalism not only accelerates the freedom of movement but it is equally needed to keep the momentum for international free movement of goods, capital and labor.

Political contributions and democracy

Representative democracy has become a very expensive activity. For instance, in 2008 the USA presidential candidates raised more than $1.8 billion in campaign funds, an 80% increase in relation to the 2004 campaign . The Democratic presidential nominee alone, Barack Obama, raised a total of $745.7 million in private funds for his election campaign.

It was the first time in the history of presidential public financing that a major party nominee declined to accept public funds for the general election. Is this a good or bad development and what it says about market capitalism?

The controversy between public and private financing has a long history, especially in what regards the special advantage that private financing may give to incumbents and special interest groups (e.g. trade unions and business associations) over the election process .

In abstract, the freedom of association principle should go with the principle of free financing. However, since public office gives those elected an ample scope for decisions that favor private interests, such power has a monetary value that may supersede the public service motivation. Therefore, the rule of free financing cannot be easily upheld under representative systems.

For this reason, under systems of state capitalism, capping campaign spending and restricting its financing to public funds may prove a better solution to secure a level playing field in democracy.

However, in countries close to market capitalism, why shouldn’t the candidates be able to tender some of their policies to special interest groups? For instance, party A could tender the easing of regulations in the financial sector, more private outsourcing of public services, more arms spending, etc. against political campaign contributions.

There is one fundamental reason why that cannot be made. It would be impossible to create a competitive market for political funding because of the asymmetric nature of the benefits received by the special interest groups and the public in general. Imagine for instance that one thousand banks can earn each 100 million dollars from deregulation while 200 million voters can save one thousand dollars from tighter deposit protection. That is, banks could earn up to 100 billion while depositors could save up to twice that amount. However, this difference may not be enough for voters to outbid the banks because their gain is only a potential saving while that of the bankers is a certain gain.

So, it is unquestionable that market capitalism requires the regulation of political contributions. And, in fact, all democratic countries regulate them, namely by limiting contributions by foreigners, by contractors of public services, trade associations, unions, regulated corporations, etc. These are usually complemented by rules on public disclosure.

Nevertheless, these limits and rules are easily evaded through soft dollars and by setting up special vehicles to make contributions (e.g. foundations, think tanks, etc.) or through the media and other unrelated intermediaries.

So, a level playing field in political campaigning must be promoted more vigorously, namely by capping the size of donations to small amounts, limiting the amount of advertising, etc. However, such limitations must be based in the principles of constitutional liberalism. Otherwise, the strong positive synergies that exist between market capitalism, constitutional liberalism and representative democracy are lost.

The rise of finance and capitalism

Fostered by a growing incorporation into joint stock companies, the progressive adoption of limited liability, the development of capital markets and the use of fiat money, credit rose to become one of the main drivers of economic growth under capitalism.

Yet, from the beginning, this growth in credit and banking raised many concerns, because it would subordinate the production to money making, giving a special advantage to those with access to money and increasing the scope for speculation at the expense of entrepreneurship.

Before addressing these concerns, I shall give first an overview of today’s relative importance of financial and non-financial assets in global wealth.

According to estimates given in Wolf (2010), four economies (USA, Euro-Zone, UK and Japan) held 80% of the $140 trillion in world wealth held in financial assets in 2005. This amounted to 316 percent of world output, up from just 109 percent in 1980.

The breakdown of the global stock of financial assets was: equities ($44 trillion), private debt ($35), public debt ($23) and bank deposits ($38). A substantial share of these assets are held by households and nonprofit organizations.

For instance, in the USA they had 73.5% of all private sector financial assets, mostly in deposits ($6.1 trillion), debt securities ($3.1) and equity ($14.6 trillion in total, mostly directly $5.7 and indirectly through pension funds $4.9). If to this huge sum we add financial derivatives then the ratio between financial and tangible assets (mostly real estate) easily reaches more than 3 to 1.

Such a large degree of financialization, puts financiers at par with other leading groups associated with system change, like the merchants during the commercial revolution and industrialists in the industrial revolution.

So, many see this development as a symptom of financial capitalism rents dominating the economic motives and feeding a time-bomb of debt and speculation which will end in disaster. Before discussing its consequences one needs to assess first its true dimension.

In this regards, the obvious question, is: why do we need so many financial assets when they are often defined just as a pro rata share on a claim? If such claims were only on property titles on existing non-financial assets the ratio would be simply 1:1. However, claims may be also on future assets (financial or non-financial) and their income as well as on contracts (bets) on future events. This distinction is important because while the first is still linked to expectations about future economic growth contracts are mostly related to expectations about expectations and so can easily turn into a form of gambling.

Although speculation has a positive role in providing liquidity and risk sharing, when it goes beyond the needs of markets for goods and services one cannot distinguish between speculators and gamblers in a casino.

But, the fact that some investments are similar to casino games does not mean that financial assets do not have an utility per se. Financial assets are important for the safekeeping and accounting of non-financial assets, to facilitate the transfer, holding and hoarding of such assets (across space, through time and between asset holders) and for risk-sharing and part-ownership. This said, they may also have utility for entertainment, like a roulette in a casino.

However, since most financial assets are not collateralized by non-financial assets this turns them into promises, with a small cost of production, an easiness of transferability and volatile prices. Therefore, there are reasonable concerns that their growth may be subject to wide fluctuations and a cause of periodic crises. Such crises may arise in banking, in currency markets or in securities markets. Sometimes, these crises may even occur simultaneously, spread globally and may lead or lag the business cycle.

Some people are also critical of the growing collusion between financial and political elites. This is nothing new. Already during the emergence of banking in the XV century the bankers played a leading role in the financing of permanently indebted kingdoms. Even in periods of expansion, kings like D. Manuel in Portugal, Henry the VIII in England or Charles V the Holy Roman Emperor were permanently indebted to finance their wars and growing royal courts.

Such loans were frequently interest free and obtained against business concessions for tax farming and other monopolies. Default on such loans was frequent, but their impact in the economy was mitigated by the smaller size of governments and the fact that bankers mostly used their own capital. Then, like now, the obvious solution was to diversify by lending to other merchants and non-sovereign borrowers. Given the growing size of government and managerial capitalism now diversification can only be achieved by strengthening the market capitalism sector.

Another concern is whether the current system creates major global imbalances which favor some countries or are a threat to global stability. Indeed, in the past 25 years there was a major shift in the flows of international capital which now go from emerging and less developed economies to a handful of developed countries, whereas in the past they moved in the opposite direction. The table below shows the recent trend among four of the six major countries ( the other two are China and Saudi Arabia), which account for about 80% of global saving and borrowing.


The table shows that as a percentage of domestic GDP the current imbalances are around 3%, a value that can be sustained over a long period of time. However, it also shows that the UK and USA have had persistently negative savings which were largely financed by Germany and Japan (plus China and Saudi Arabia).

Moreover, it also shows that, with the exception of the USA, non-financial firms have become net savers which is a worrisome signal in terms of finding profitable investment opportunities domestically or reluctance to return capital to shareholders.

So why is investment being directed mainly to the UK and USA? This is a very complex issue. On one hand these two countries benefit from having the most sophisticated capital markets and from being perceived as the most politically stable countries. On the other hand the lack of investment by domestic firms suggests that they may be lagging in technological development and compromise their future competitiveness.

A negative view on this rising role of finance has traditionally been expressed through the so-called immorality of making money out of money, the waste of human talent and resources in non-productive activities (a claim also made in the feudal system against priests and soldiers) and the creation of firms that are too big to fail. This has led some to question the role of the firm, suggesting that instead of value creation to shareholders they should instead aim at maximizing customer satisfaction. For instance, Peter Drucker (1973) claimed that the “only valid purpose of a firm is to create a customer”.

As explained before, these claims are erroneous because the profit motive is one of the fundamental requirements for competition and customer satisfaction.

Indeed, the rise of finance is the inevitable consequence of economic growth and widespread private and institutional capital accumulation. It is therefore a positive feature of capitalism, despite the fact that from time to time some financial markets may get carried away causing some volatility in employment and economic activity.

Innovation, intellectual property and capitalism

Economic history shows a remarkable similarity between economic and technological long term cycles. By looking at a timeline of inventions one can easily detect many points of contact. Indeed, given the two-way causality between technical progress and economic growth it is inevitable that most of the controversies are about the direction in the virtuous circle between science and economic growth. At a microeconomic level, microeconomic textbooks usually explain how innovation benefits both trading parties.

However, the role of capitalism is not just to ease the sharing of the benefits from technical progress. A further advantage, and possibly more important, is the stimulation of innovation. In fact, it is no coincidence that capitalism and technical advancement go hand-in-hand driven by two of the basic principles of capitalism.

First, the pursuit of profit maximization is a major driver of innovation. For instance, all the fantastic new drugs that pharmaceutical companies produce every year are not the result of their concern for the patients but of their lush for profits. Moreover, if they lag in innovation, their competitors will take over their market share. Thus, the profit motive plays simultaneously the role of carrot and stick in the motivation of innovation.

Second, the protection of intellectual property for only a limited period of time provides innovators with enough protection to recover their investment in research, while preventing the undue state protection for incumbent producers. Obviously, the duration of such protection is subject to discussion and in the end its desirable extension is as much a result of political discussion as of empirical analysis.

While the role of profit maximization is often accepted, the legitimacy of intellectual property is at the origin of much heated debate, namely on whether it represents the granting of a temporary monopoly or the protection of a property right.

Many of the issues may be gauged by considering the following question raised by Paul H. Rubin and Tilman Klumpp (2011): “On the one hand, ideas, novels, or musical compositions are products of the mind, and if a man owns his mind as much he owns his body then it seems that, indeed, he would acquire property over what he conceives in his mind. On the other hand, ideas are vague and often conceived in similar form by many people. Since two persons cannot, independently of each other, have ownership over the same good, how can property be acquired over an idea that one conceives the day after it was conceived by somebody else?”.

Thus, the products of the mind are not easily treated within the traditional marginalist cost-benefit analysis. Moreover, the debate between supporters and opponents of intellectual property is often, but not always, aligned politically.

Take for instance the following libertarian views.

Among anarcho-capitalists we have some arguing for infinite copyright terms similar to those applying to non-intellectual property while others oppose them on the grounds that they divert resources from fundamental to patented research.

While amongst left-wing libertarians some oppose intellectual property because it represents an infringement of freedom of speech and the press.

In turn, some conservative libertarians advocate that a distinction should be made on the basis of who supported the costs of R&D and on the purpose of the invention. For example, Deepak Lal (2006) argues against granting copyrights to fundamental research on the grounds that it is mostly done at public financed institutions while supporting them in the case of pharmaceutical companies developing new drugs but not in the music industry selling a new song.

However, others agree with patent and copyright laws but oppose laws protecting trademarks or anti-counterfeiting laws.

Finally, others champion against patents and copyrights on moral grounds, namely arguing that is immoral to refuse to give new medicines for people in need.

The moral dilemma is especially difficult when dealing with life threatening diseases, as illustrated recently during the 2004-2005 Ebola epidemic or with the new Sovaldi drug for Hepatitis C.

The latter, involved a dispute over the price charged by Gilead, the company selling this drug capable of curing this previously incurable disease (priced at US$ 84,000 an amount not covered under most insurance schemes). The company argued that the price was needed to obtain a “fair profit” in the investment of $US 11 billion she had made to acquire the small company that had developed the drug.

This example illustrates another complexity with the regulation of intellectual property – the transferability of copyrights and patents.

Another problem is the enforceability of intellectual property rights on a global scale since some countries do not recognize or enforce such rights. This has led the USA and the European Union to negotiate bilateral agreements (the so-called TRIPS) to secure the protection of patents and trademarks, but these have been perceived as promoting protectionism rather than free trade.

Overall, if one accepts copyrights, patents and other forms of intellectual property protection as a necessary evil in the form of a temporary monopoly the shorter it will be the better. Because, being a form of censorship, it precludes the greater good that comes from sharing each other’s ideas and discoveries.

Moreover, the Internet has created a new tool to achieve the ancient dream of compiling all human knowledge and culture and to store it for free use by present and future generations. The benefits of this universal access to knowledge may outweigh those of granting temporary protection to intellectual property.

However, this requires a difficult judgement whose answer depends on whether free access would erase the profit motive and the rate of capital accumulation. So far, the so-called creative industries have continued to develop through a mix of conventional secrecy, intellectual property protection and new business finance models based on the winner takes all dream and crowd-funding. Whether these new business models will be more capitalist-friendly or not is still too early to know.

Capitalism and international free trade

Free trade is a foundation of capitalism not only at the national level but also at the international level. However, while locally it is easy to understand why free competition protects the capitalist system from capitalists who acquired a dominant position, when dealing with foreigners nationalist sentiments often win. For instance, it is common to find many arguments in favor of domestic producers using the infant industry argument, the notion of national champions or even a mercantilist ideology.

Yet, it is at the international level that societies may achieve better levels of specialization based on relative comparative advantage. This can be confirmed by looking at the link between exports and economic growth in the follow up to major reductions in international trade barriers.

The reduction of tariffs and non-tariff barriers started in 1947 with the signing in Geneva of the General Agreement on Trade and Tariffs (GATT). It continued through subsequent rounds of negotiations and played an important role in the extraordinary growth of international trade. For instance, between 1948-1968 the total volume of merchandise exports from non-communist countries grew 290 percent. Moreover, it outpaced the growth of world output. For example, from 1953 to 1963, trade in manufactured products increased by 83 percent, while manufacturing output rose by only 54 percent.

International trade liberalization was certainly a major driver of economic growth during the so-called Golden Age (1950-1973). Yet, although there are two virtuous circles associated with export-led growth (Marques-Mendes, 1988), one should not confuse the rising share of international trade in GDP as the direct cause of economic growth, because a faster rise in trade is not always associated with accelerating economic growth.

This can be easily confirmed by looking at two countries with high degrees of openness but significant differences in growth performance. For instance, Singapore and Hong Kong, classified ex aequo by ICC as the two most open economies in the world, were reported by the World Bank to have grown between 1966-2013, at market prices and 2005 $US, at an average annual rate of 7.8% and 5.8%, respectively. Meanwhile, during the same period their exports as a percentage of GDP rose 67 and 154 percentage points to reach 191% and 230%, respectively. That is, Hong Kong’s GDP grew less than Singapore’s despite a much faster growth in exports.

Likewise, the next two most open economies, Luxembourg and Belgium, grew in the same period at 3.7% and 2.5%, respectively, but their exports as a percentage of GDP grew 124 and 39 percentage points to reach 203% and 83%, respectively. Overall, in terms of economic growth over the past 47 year period Singapore outperformed Hong Kong by 162% and Luxembourg outpaced Belgium by 75%.

There are many factors explaining such disparate performances, including geography and sector specialization (both Singapore and Luxembourg are regional low tax financial centers) as well as demand factors (see Marques Mendes, 2011 and 2014, on why not all exports are the same), but the type of capitalism pursued is also a driving factor.

To understand the relation between exports and GDP it is useful to breakdown the latter in relation to the three identities used in GDP estimation – expenditure, income and production. For instance, the condition required for exports to exceed GDP under the expenditure approach is that the foreign trade balance (in ratio form) exceeds the ratio between domestic absorption (consumption and investment) and imports. This is more easily achieved in smaller countries and/or in countries where exports have a larger import content.

Likewise, using the income identity, we can see that the excess of exports over GDP requires that exports exceed wages by a factor equal to the wages/profits ratio. Thus, assuming a normal capital share of 40%, exports must exceed wages by 66% which is more easily achieved in low wage countries.

Finally, taking a production approach and splitting it into tradable and non-tradable we need exports to exceed non-tradable by a factor bigger than the tradable/non-tradable ratio. Since many non-tradable are produced in the non-capitalist sectors, it is easier for countries with a smaller state sector to achieve a high export/GDP ratio.

To understand the great advantage of capitalism in terms of capital accumulation and the deepening of the division of labor, one must bear in mind that the later can be achieved through rotation or specialization. These two distinct ways have substantial differences in terms of productivity impact as can be illustrated through a domestic example.

For example, my wife is much better than me at both cooking and doing the dishes, but her greatest advantage is in cooking. So, following the rule of relative comparative advantage she does the cooking and I do the dishes and we both gain by spending less time in the kitchen and having better meals. However, we could share the chores of preparing meals by alternating so that one day I would prepare dinner and she would do it the following day. This seems a more egalitarian division of labor but it would be much less efficient. For one, half of the week we would eat lousy food because it was me cooking. But I would also spend more time in the kitchen.

Obviously, capitalism relies on the division of labor through specialization and has a much greater scope in pursuing it through joint ownership, which facilitates accumulation and the unbundling of the production process.

Nevertheless, imagine that a washing machine is invented that reduced by 2/3 the time and skills needed to do the washing. Who would benefit? We could benefit both by, for example, me using half of the time saved to set the table a task previously done by my wife. But, what if I were a selfish person and insisted in doing only the dishes in exchange for the meal. Now my wife would have to consider to either forego the benefit of technical progress or to divorce me and find a more obliging husband.

Fortunately, in non-domestic activities we would not have such a dilemma because there would be many other suppliers competing to do the washing and those doing the cooking could play them to share on the gains from technical progress. That is why capitalist principles are better suited for non-family activities because one can contract and re-contract frequently.

So, to understand which are the most important drivers for international specialization and trade, one must examine the role played by each foundation of capitalism.

Starting with private property it is evident that the more this is protected the greater will be the level of private investment which accounts for the largest relative share of tradable goods and services. The profit motive is needed to increase the return on capital in a context of high wages. Free markets are indispensable to have a country specialization driven by dynamic comparative advantages needed to foster the benefits of export growth. Meanwhile, joint ownership and limited liability are needed to foster risk sharing and mitigation in international business. Yet, to prevent that these advantages are seized by protectionist interest groups, it is indispensable that the rule of law prevails.

The fundamental principle of the rule of law is that all be treated equal, regardless of sector of nationality. For instance, preference for national suppliers, price controls and distortionary taxes or subsidies are all in flagrant violation of the fair treatment principle required for a level playing field whether at the national or international level.

Cycles and fads in economic growth

The history of business cycles in capitalist economies shows many leading drivers depending on the duration and amplitude used. These range from those based on inventory theories (3-5 years), on fixed-investment (7-11 years), on infrastructure (15-25) or on technology (45-60 years). These cycles interact with credit and financial market cycles. They are often associated with specific events or policies. And, ever since Keynes, a discussion continues among economists and policy makers on whether cycles can be managed through monetary and fiscal policy.

Not surprisingly, the ascending sides of such cycles are often qualified as economic miracles or simply as fads if they take place in just a few regions or sectors. Likewise, one should note that fluctuations in economic activity (a better name than cycles, if one disagrees about their regularity) are not specific to capitalism. Indeed, we may find them in other economic systems, where often they are the result of natural or man-made disasters. For instance, droughts in Africa or Mao’s famine in China. And, it is important to remind, in long term stagnating economies business fluctuations are not always noticeable.

However, the notion that cycles of excess supply or shortages were inherent to capitalism, as claimed by Karl Marx, is not proved at the macroeconomic level. They happen at the level of individual businesses or industries who fail to react on time to the law of diminishing returns, but they rarely occur simultaneously to cause a macroeconomic cycle.

Others invoke temporary spurs in economic activity to support the idea that more centralized (often undemocratic) systems of state capitalism are more successful than a system of market capitalism. In fact, although such systems may have an initial advantage in terms of rapid capital accumulation this quickly transforms into a drag due to the rise of rent-seeking and the loss of competitiveness.

These fads (or economic miracles) are present in the history of almost any country (e.g. in Italy from 1963-74), but will subside whenever they fail to create enduring conditions such as – a high level of education, good governance, business culture and business elites supporting the six principles of market capitalism.

Business elites and culture are ephemeral whenever policies are dependent on a good ruler and not on a wise system, or when they rely excessively on foreigners or a few tycoons that sooner or later will be gone.

Leaders are important to mobilize people and resources, but if they stretch too much their power of persuasion soon their followers will be called down to earth by the correcting forces of the market. And the earlier these are allowed to work the smaller will be the cost of adjustment. This is a key reason why market capitalism is superior to managerial or state-controlled forms of capitalism.

Unfortunately, politicians on the left and the right often use such short-lived episodes to justify and perpetuate their anti-capitalist ideology.

It is therefore, crucial to assess all episodes of a sudden economic success in relation to their sustainability and reliance on an enduring system or a fad and passing leadership.

Subsistence economies and self-sufficiency

Many of the protectionist arguments against capitalism rely on the idea of self-sufficiency and independence as a safeguard for unforeseen events. This idea wrongly stems from confusing prudence with self-sufficiency and risk mitigation with protectionism.

It is normal that after being fustigated by so many natural and human-made calamities people seek safety in self-reliance. In the absence of markets for risk protection, subsistence economies may be seen as providing such safety. Yet, such safety is achieved at an enormous cost in terms of living standards.

I shall illustrate this through the personal experience of my ancestors. Before the 1930s, most of my ancestors lived for centuries in a remote village by cultivating small plots of land. They consumed almost all they produced except for the occasional goat that they would sell to buy clothing. If the wolves decimated part of the herd or the weather ruined the harvest they would have a rough year surviving on potatoes and without replacing their rags.

It was a tough life but they were self-sufficient and independent without a need to rely on others. The same happened with the other villagers, with the exception of the only specialized inhabitant (a carpenter) who had to walk to the neighboring villages to offer his services.

My family fortune changed only when, at the age of fifteen, my father and a friend migrated to Lisbon. He survived doing multiple jobs and later returned home to work in a textile mill in a neighboring village, where he also found jobs for his sister and two of his bothers. As a result I and my five sisters had the opportunity to study and to escape the self-sufficiency trap.

The problem with small self-sufficient communities is not that they do not know about division of labor. Indeed, for those with a romanticized view of such communities, my village had a well-developed communal way of herding, a communal bakery and a kind of labor exchange.

However, isolation and small scale prevented them from participating in trade with outsiders and achieve the necessary scale and specialization needed for capital accumulation.

However, the subsequent construction of roads and communication services did break isolation but it did not stop the village decline, why?

Because the lack of transport infrastructures is not the only obstacle to the development of remote areas. Unless they are a tourist hive or their inhabitants are writers or similar professionals able to work from home for a greater market, they will not be able to combine the profit motive with the joint ownership and limited liability needed to undertake risky ventures which are indispensable for the success of capitalism.

So for many millions trapped in small communities, like my ancestors were, the simplest way out is migration.

Yet, there are many still arguing for self-sufficiency or independence in large communities. They typically invoke the lack of scale and the need to safeguard the supply of goods and services considered essential, with an elastic definition that ranges from food, social services, environment and energy. Such calls for self-sufficiency contradict Ricardo’s law on comparative advantage, probably the only consensual law in economics formulated in 1817.

And, this law is not being ignored in non-capitalist societies alone, but also in Western countries at the core of capitalism. For instance, until recently the USA had a law banning the export of crude introduced in 1975 as a retaliation against the Arab oil embargo of 1973. Yet the ban was never lifted due to opposition from oil refineries and environmental groups. Only now, after a sharp increase in oil supply brought about by the new fracking technology and geopolitical considerations, did the refiners opposition eased and there is some hope for lifting the ban.

Obviously, whether to export crude or refined products should be a business decision not a political one. However, once a country tolerates special interest groups based on protectionism it becomes almost impossible to eradicate them. Thus the importance of free trade to control rent-seeking behaviour that undermines capitalism.

Production, income and welfare under capitalism

When we take a detached long term look at human history, it is impossible not to be impressed by the global economic growth experienced since the rise of capitalism in the early XIX century. This was achieved despite two destructive world wars and the subjugation of half of the world population under communism throughout most of the 20th century.

In his history of economic growth Angus Maddison (2005) shows that: “Over the past millennium, world population rose 23-fold, per capita income 14-fold, and GDP more than 300-fold. This contrasts sharply with the preceding millennium, when world population grew by only a sixth, with no advance in per-capita income”.

Yet, during the first eight centuries of the last millennium economic growth barely matched population growth, while life expectancy only rose from 24 to 36 years. However, from 1820 onwards, per-capita income rose twenty-four times as fast as in 1000–1820, population grew six times as fast and life expectancy increased to seventy-nine years in the West and sixty-four in the rest of the world.

Nevertheless, this was not an even process and it is interesting to recall the various phases identified by Maddison as:
1. The “golden age,” 1950–73, when world per capita income grew nearly 3 percent a year, by far the best performance.
2. Our age, from 1973 onwards (henceforth characterized as the neo-liberal order), is the second best.
3. The old “liberal order” (1870–1913) was third best, only marginally slower in terms of per capita income growth.
4. In 1913–50, growth was well below potential because of two world wars and the intervening collapse of world trade, capital markets, and migration.
5. The slowest growth was registered in the initial phase of capitalist development (1820–70), when significant growth momentum was largely confined to European countries, Western offshoots, and Latin America.

This historically unprecedented growth, the result of a combination of science and capitalism, was more pronounced in the West during the post-world war II period. However, since the collapse of communism we have more examples to show the power of capitalism as a production machine. In particular, when we compare the recent experiences of China, Russia and India, we note that Russia and India are lagging significantly largely because they have been more reluctant to endorse capitalism.

Nevertheless, the fact that large populations still live in poverty raises the question of whether they have been left behind by capitalism. This is not a failure of capitalism. On the contrary, it was often the result of misguided pursuits of alternative systems and the slow take-off under capitalism. Indeed, given the recent moves in Africa towards capitalism, one expects that this continent will progressively begin to recover and will accelerate its growth in the next decades.

Likewise, for those who expected the liberation of half the humankind from communism and the recent surge in technological developments to automatically create another era of unprecedented growth, the early history of capitalism from 1820 to 1870 is an important reminder that take-off is usually a slow process.

The transition to capitalism from subsistence, feudal or communist economic systems faces many resistances and the economic cycles of capitalism may slow down such transition. Both need to be assessed separately, as well as the risks of political turmoil. Otherwise, we risk letting such setbacks obscure the remarkable efficiency of capitalism to eradicate poverty and promote economic growth.

O ranking de Portugal na Europa: PIB ou PNB?

O Finantial Times de hoje
(http://blogs.ft.com/ftdata/2015/05/13/ireland-is-the-wealthiest-economy-in-europe-or-not/?ftcamp=published_links%2Frss%2Fhome_europe%2Ffeed%2F%2Fproduct )
traz um artigo interessante sobre a discrepância das duas medidas de riqueza na Irlanda, onde essa diferença já atinge quase 20% e tem vindo a aumentar enquanto nos restantes países oscila menos de 5%.

As razões para essa discrepância são bem conhecidas e refletem o peso do investimento estrangeiro e o nível da carga fiscal no país. Quanto mais elevado for o primeiro e mais baixo for o segundo maior será o nível de lucros reportados no país de acolhimento e, consequentemente, maior será a discrepância entre PIB (Produto Interno Bruto) e PNB (Produto Nacional Bruto).

É interessante notar que entre os países do Euro, excluindo o Luxemburgo, a Irlanda aparece em primeiro lugar no ranking do PIB per capita, enquanto Portugal aparece em antepenúltimo (15º lugar). Já no ranking baseado no PNB per capita, a Irlanda cai para o sexto lugar (com um valor próximo da média) enquanto Portugal sobe para 12º lugar (com um valor cerca de metade da média).

Qual será a forma mais rápida de Portugal imitar a Irlanda – atrair mais investimento estrangeiro, baixar a tributação ou ambas? Não parece difícil de perceber que reduzir a tributação dos lucros para portugueses e estrangeiros é pré-requisito e a melhor de conseguir ambas.

A nation of shopkeepers?

A reasonable concern about an economic system like capitalism that relies on a large number of (small) enterprises, is that it might degenerate into a society of small-minded people. To paraphrase the disdainful reference of Napoleon and French aristocracy to British merchants – the risk of becoming a nation of shopkeepers.

It is a fact that most of the infrastructure and cultural heritage of humankind was not decided on economic grounds, whether we think about the Pyramids or Mona Lisa. Indeed, some of the major feats of humanity require a level of capital accumulation that is not accessible to individual capitalists and have therefore been often promoted by political or military rulers and religious leaders regardless of any economic calculation.

In fact, Adam Smith had already tackled this question in relation to the British Empire, when he said that: “To found a great empire for the sole purpose of raising up a people of customers, may at first sight, appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation whose government is influenced by shopkeepers.”

Indeed, it is possible that during their short existence, capitalists have already procured more palaces and works of art than the nobility that preceded them. To some they may seem less refined or nouveau rich but, given the nobility’s preference for horses and jewelry, capitalists certainly pushed the human heritage well beyond past forms of wealth accumulation.

The question of whether capitalism promotes conspicuous consumption at the expense of the poor and the arts is not specific to capitalism. Conspicuous consumption is a characteristic of all wealthy classes and new riches, whether obtained through inheritance, lottery or business.

On this matter, one relevant issue is to decide whether corporations should be patrons of the arts and similar aggrandizement or philanthropic endeavors, or if such role and its consequences should be left exclusively to their shareholders.

This decision is often influenced by the tax system which may favor one of the options. Likewise, supporters of managerial capitalism may advocate that company directors are more profligate with donations to the higher arts than individual shareholders would be.

Nevertheless, it is questionable whether governments and directors should impose their own preferences on shareholders. Indeed the shareholders tastes may be very diversified.

For instance, small shareholders are more likely to sponsor local sport teams and artists while the wealthy and corporate directors will sponsor national events and the higher arts. Likewise, the wealthy may be more conspicuous or social minded. For example, Bill Gates has chosen to spend his fortune to fight diseases while one of his co-founders of Microsoft has chosen to spend his money on a super-yacht. These are personal choices and have nothing to do with capitalism.

The role of capitalism is to produce wealth, and the more it produces, the greater the wealth at the disposal of governments, capitalists and foundations to procure the items that will constitute the heritage of future generations.

In this regard, a system of dispersed small enterprises typical of market capitalism is the most efficient to create wealth. So, after all, we may paraphrase Adam Smith and conclude that “a higher aim may be altogether unfit for a nation of small businesses; but extremely fit for a nation whose government is influenced by small business.”