Will Capitalism Be A Victim of Its Own Success?

The economist Joseph Schumpeter describes what he sees as capitalism's Achilles Heel in his book Capitalism, Socialism and Democracy.


[Thanks to cambridgeforecast.files.wordpress.com for the image.]

Writing in a more approachable style, another economist Benjamin A. Rogge gives an overview of Schumpeter's main points in his work Can Capitalism Survive?. (See this excerpt.)

Rogge begins by citing Schumpeter:

"Can capitalism survive? No, I do not think it can. The thesis I shall endeavor to establish is that the actual and prospective performance of the capitalist system is such as to negative the idea of its breaking down under the weight of economic failure, but that its very success undermines the social institutions which protect it, and inevitably creates conditions in which it will not be able to live and which strongly point to socialism as the heir apparent."

Marx said something similar about capitalism, but the difference is that Marx relished the idea, and Schumpeter feared it.

Rogge interprets Schumpeter's theory thus:

"In effect if capitalism is to survive, it must defend itself in the arena of values and emotions—and here its very success as an economic system reduces its chances of victory."

I've been looking for the reasons for capitalism's lack of general defense and appeal, and this sounds like a plausible explanation. We ignore at our own peril the influence of emotion and culture over logic and observation.

Schumpeter demonstrates why most types of individuals do not have the incentive to protect the very system that provides them with their standard of living. Rogge's translations of Schumpeter's ideas are so clear and succinct that I'll paraphrase him.

Who are these individuals who don't know a good thing when they see it?

1. The working people. Why will they not protect capitalism? In Rogge's words, "[b]ecause they do not connect their affluence with the capitalist system, because they are incapable of understanding any economic system as such, because they are more aware of their daily frustrations and insecurities under the system than they are of their long-run gains from the system, and because they are taught by the intellectuals in society to resent the capitalist system and its central figure—the businessman."

2. The businessman. Why will he not protect capitalism? "[E]ven if he were fully aware of the problem and determined to do something about it, the businessman lacks the capacity to capture the imagination of the society." Or as Schumpeter himself says so eloquently, "[t]he stock exchange is a poor substitute for the Holy Grail."

Schumpeter also explains:

"A genius in the business office may be, and often is, utterly unable outside of it to say boo to a goose—both in the drawing room and on the platform. Knowing this he wants to be left alone and to leave politics alone. [...] There is surely no trace of any mystic glamor about him which is what counts in the ruling of men."

A perfect example of this is General Motor Corp Vice Chairman Bob Lutz's recent statement dismissing global warming as "a total crock of s---." Ironically, he is part and parcel of GM's decision to spend millions of marketing dollars proving to the public that the company takes environmental factors seriously.

Schumpeter claims that business faces a second setback. Rogge puts it this way:

"As capitalism matures, the form of the business firm and the role of the businessman change in such ways as to weaken the businessman's will to resist the critics of capitalism. [...] Capitalism creates the organization man—and the organization man is indifferent to the fate of capitalism."

I'd written something similar in a previous post. I said:

"A businessman is a businessman. He is not an idealogue, or even an idealist, except in his more private moments. A businessman enjoys the challenge. He plays by the rules, no matter what they are."

Not an idealist indeed. We have only to observe how the big corporations, including the trade unions, wait until they see who the winner is likely to be before handing out campaign finance money.

3. The intellectuals. Why will the majority of them not protect capitalism?

"The intellectual tends always to be a critic of the system, of the establishment, whether he is in Russia or the U.S. [...] [I]n 1942 Schumpeter accurately foresaw the current surplus of intellectuals, surplus in the sense of there being far more intellectuals than employment opportunities with income and prestige equal to the self-evaluations of such people. For this, said Schumpeter, the intellectuals will hold the capitalist system responsible, which will add fuel to their already burning critical fires. Moreover, the widening gap between their own incomes and those of the businessmen will induce them to find ego-restoring explanations of the businessman's success—luck, exploitation, fraud, monopoly, etc. These rationalizations are described by Schumpeter as 'the autotherapy of the unsuccessful.'"

4. And lastly, the politicians. Why will they not protect capitalism? Because "the governmental bureaucrats, with whom [the intellectuals] share a common educational background [...] will be increasingly involved in administering anticapitalist legislative policies"--presumably by nature and by definition, because not to do so would be professional suicide.

Read the rest of the Rogge piece. It's a great one.

So ultimately, our socioeconomic system is determined by the politicians we elect, and the majority of voters (and therefore most politicians) are anti-capitalist--and this is true whether they be Republican or Democrat.

To make this point clear, I'll refer to the expert on that subject, Virginia Postrel, author of The Future and Its Enemies. In her perspicacious work, she pulverizes the split between left and right, turning the compass around so that it divides "stasists" from "dynamists", i.e. those Republicans and Democrats who prefer the status quo, who believe they can control the uncontrollable, and who fear change, on the one hand; and those who are confident in themselves and in society's capacity to organize itself, and who therefore crave the freedom and uncertainty of evolutionary dynamism, on the other.

Schumpeter and Rogge, you're right. I think the stasists are winning, at least for the short, medium, and shorter long-term. Hopefully, good sense will win in the end, at least in the Darwinian sense.

How to Resist the Temptation to Scapegoat

It's always tempting to scapegoat some player in a game that is not going the way you want it to, even when the problem lies not with the players but with the game itself.

I am having a friendly debate with a very good friend, an economics and law professor, who insists that we need more regulation, that the government hasn't done enough to prevent those evil bankers and brokers from getting rich off the backs of the poor innocents of middle America.

I argue that, although it may be true that some bankers are rotten and regulators have been sleeping at the wheel, this will always be the case under macroeconomic and regulatory conditions such as we have in the US today.

I maintain that the underlying fault lies not with an individual player's greed or incompetence, although this does play a role; it lies rather with the foolish adaptation of bad rules of the game, rules that are based on the fallacious notions that government can manage a macroeconomy and that monopoly-encouraging intrusions by regulators into the banking industry, among others, are helpful.

While perusing today's Wall Street Journal, I received some help for my side from their daily human-interest column about a Venezuelan banker named Victor Vargas.


[Thanks to polobarn.com for the photo.]

If anyone walks and talks like a greedy banker, Vargas is it. This is the kind of fellow my friend loves to hate. Read what Vargas says:

"People write stories about me saying I have a Ferrari, a plane, a yacht. But it's not true. I've got three planes, two yachts, six houses."

Can you imagine Mozilo saying something like this? Vargas is just the kind of man who would get lynched here in the US for saying something like that in times like these.

But several other sentences leapt off the page at me:

"Venezuelan elites have learned to profit amid repeated volatility."

Exactly. People adapt in difficult times.

Some argue that these are the most stable times we have ever lived in. Some believe, as Milton Friedman and I do, that things could be much more stable if government and their appointed economists would get out of the money management business.

The 1970-80s inflationary-stagflationary episode incurred unprecedented capital losses. The extent of the financial market instability of those years has been compared to the Great Depression.

The 1980s and 90s brought us Latin American bank bail-outs, US savings bank failures, and a hedge fund panic. 2000 gave us the Dot.com crash. Today we have the housing bust and the credit crisis, an interrelated double-whammy.

Each time, macroeconomic policy has accommodated us back into the same expansionary credit parameters that brought us all of these episodes in the first place. And today, once again, we're issuing more credit to bail ourselves out of the 2007 housing and market crises--actions that will only serve to create our next bubble, unless the world has finally lost faith in our money managers' capacity to steer the ship.

Just look at the damage to the dollar. According to the AIER, you need $20.78 today to buy one 1913 dollar's worth of goods.

Markets have simply adapted to the fluctuations, and market players have learned to live with the new rules. Volatility has become the norm, in the US as in every country around the world. Look to the most flagrant examples (like Venezuela) to study the underlying phenomenon at work.

More quotes:

" 'Venezuela has developed a special business culture, where the game is played amid high inflation and other distortions,' says Venezuela-born Latin America specialist Gilbert W. Merkx, who directs the Duke University Center for International Studies. 'You can either get very rich or lose a lot of money playing the game, and it always gets more complicated as the distortions get worse.'"

Exactly. People adapt. Just because US inflation is at only 4 percent while Venezuela is at 22, doesn't mean that the players don't adapt, that "a special business culture" doesn't develop. It does.

"Mr. Vargas says his survival strategy is remaining agnostic about politics."

Exactly. Play the field. Don't play politics. Where have we seen that before? How many US companies wait to see which way the political wind is blowing before writing their campaign finance checks?

"In 2002, [Vargas] helped convince other bankers not to join strikes led by businesses that were aimed at ousting Mr. Chavez. As president of the banks' industry association, he helps negotiate banking regulations."

Exactly. Where have we seen that before? How many US banking regulations are put in place through consultation with industry big-wigs? Why fight city hall when you can feather your nest and get so big the government has to bail you out if you bet incorrectly?

" 'A businessman has to deal with his government, no matter how far to the right or left it is,' he says."

Exactly. A businessman is a businessman. He is not an idealogue, or even an idealist, except in his more private moments. A businessman enjoys the challenge. He plays by the rules, no matter what they are. And if the game is rigged, the tough competition will attract some rough characters who don't mind playing by rigged rules because they have a knack for manipulating people and rules to their advantage. At some point the less ferocious will throw down their cards and leave the table, leaving only the hard core participants. "I'm an intuitive guy," says Mr. Vargas.

"Mr. Vargas's high-level government contacts have attracted critics who say he's suddenly become rich as 'Mr. Chavez's banker,'" which he doesn't deny directly, side-stepping the accusation with statements like, "I've been rich all my life!" and that he's only met Chavez twice.

In sum, for the winning players in a rigged game, the motto is "Why beat 'em when you can join 'em, play unfair, and make it really big." That's the strategy that works today, in Venezuela or in the US.

Who is our US Treasury Secretary? Henry Paulson, former CEO of Goldman, Sachs. No personal attacks from me, of course, rather just an observation of the tight relationship between government and big business, even in this "capitalist" country (see links below).

Who is recommending that the Fed go ahead and issue credit galore to save Wall Street, even if it means tanking the dollar--indeed who has rationalized dollar devaluation, through a "non-partisan think-tank," "scientific," "economic" evaluation, into a way to solve our problems? The Peterson Institute, whose chairman is a founding partner in one of the largest hedge funds in the world, Blackstone Group, and who was once a Secretary of Commerce and an Assistant to the President for International Economic Policy. (His partner at Blackstone is a former Yale colleague of George W. Bush. Small world, isn't it.)

Want to influence government policy? Create a think-tank.

What do you say to this, dear Professor?

See this post for the development of my argument that government incapacity to manage the macroeconomy and over-regulation are the causes of our problems. I also describe how this country is a mixed economy, not a purely capitalist one, which may just be affording us not the best of both worlds, but the worst.

Capitalism's Scourge

Reading the Wall Street Journal's lead story today, I can't help but think back and wonder just how this mess could happen in a world that has supposedly "seen the light" about free markets and capitalism since the 1980s.

The article describes the difficulties soon to be revealed by some very large insurance companies, who are required by their contracts to pay up during this financial turmoil but who are unable to come up with the cash as promised. The potential amounts involved are so large as to cause tremors of fear to ripple throughout the stock markets of the world. This is only the latest of many death knolls for the recent booms in our boom/bust/stagflation economy.


[Thanks to news.bbc.co.uk for this picture]

Many people, from wise old economic owls and international financial geniuses, to permabears and silly gadflies like me, saw these events coming. (See this post for links to past warnings from all sectors.) I as a staunch capitalist can't help but ponder, how is it that brilliant corporate minds could allow their companies to get us into this? It's really mind boggling.

My easy answer is twofold (admittedly not scientific).

The Mixed Economy

Surprise, surprise, the US does not have a capitalist economy. Over the last couple of centuries, companies have realized that the best way to survive next to a growing public sector is to work hand in hand with city hall rather than trying to fight it, because of the mutual short-term privileges this affords both parties. You rub my back, I'll rub yours.

The naive believe that large corporations prefer free markets, but this is not always true. Some--and some of the most successful--have found it is much easier to achieve their goal of monetary success (profit is not an improper goal) by using all the tools at their disposal including the politicians, rather than "wasting their time" manifesting on behalf of a political ideal such as a more pure capitalism, especially when that ideal is rejected by a majority of voters.

It's the old "if you can't beat 'em join 'em" syndrome.

Example: In order to stem bank failures experienced during the 1800s, and to give themselves the allure of protectors of the poor, the US state and federal government politicians began toying with the idea of requiring banks to obtain special charters in order to deal in certain transactions. The banks resisted at first, but quickly understood that by acquiescing to this requirement they would be able to limit the playing field around them.

The new requirements would throw rocks and hurdles at the big banks' competitors, thereby obtaining for the larger, more robust survivors special status and monopoly-like privilege with protection from the state. (This is not always the panacea it appears, to wit some of the railroad "robber" barons of a hundred years ago who disappeared just as quickly as they appeared.)

This phenomenon of mutual vice has taken hold over the years behind the public's back and in the name of "public welfare," and today our biggest financial houses have become so intertwined with government, so huge, that they are now what economists refer to as "too big to fail." In other words, any threat to their collective survival means instability for the whole economy, if not even for the entire world.

I continue my conjecture by stating that such power, influence and monetary gain (you've heard about the salaries of the big CEOs, including their bonuses, stock options and severance packages) attract not only very able people, but also a few less than honorable people who don't mind compromising their capitalist ideals, and/or some with limited longer-term foresight who--to give them the benefit of the doubt--have not been excessively thorough in their analysis of the risks they are asking the nation to incur and insure through too-big-too-fail government bail-outs and FDIC and other compensation.

Fiat Money

The second part of my answer deals with the "fiat" (unstandardized) nature of money in today's world economies. See this post and others for an explanation. In sum, the wave of excess credit issued by the central banks of the world caused much mischief in financial markets and is a major factor in our mess.

Both of these elements come from the public's irrational behavior--or let's call it emotional behavior, so as to avoid a t'is-t'aint-style academic economic debate. We approve of capitalism, but we also approve and vote for quick fixes for "me." Does it feel good to have the government act as protective daddy and approve of banks through charters, even if it is counterproductive? Most will answer yes. The counter-productivity doesn't show itself until too late, and in obscure, misleading ways.

Does it feel good to have insurance on our CDs and checking accounts through the (insufficiently funded) government FDIC program? Of course. Do we want to punish the big finance houses even if it means we ourselves might suffer? That would be masochistic.

Walking the straight and narrow is difficult for all parties to the capitalist game, and the result is a mixed economy that causes more trouble than it cures.