Capitalist myth no.1: Who are the wealth creators?

One of the necessary consequences of governments failing to measure up to the current economic crisis – and as yet there is no evidence whatsoever that they plan to do anything the change or manage the system that put us where we are today – is that the old self-congratulatory myths start to resurface. Perhaps the most important of these myths is the fantasy that it is bankers and investors who are the true wealth creators.

Why does this myth matter? Because it is this myth ensures that the rich are also the powerful, through their unchallenged control the commanding heights of the economy. Because it is the myth that they are doing something unique and almost magical that we must not importune them for taxes or justifications of their prestidigitations, lest these magicians, these golden geese, fly away, casting us into helpless penury. It is also this myth that allows them to carry on without the sort of scrutiny to which every other strategic area of society, such as the social services, manufacturing, the education and health systems, the military and so on, is subject. It is this myth that allowed them to reward themselves with a disproportionate share of society’s wealth. It is even more important than the myth of the market because, above all else, the myth of the wealth creators allows those it mythologises to effectively disempower everyone else.

But in reality is quite preposterous to identify wealth creation with a single sector of society. It is a simple tautology that wealth is created every time anyone takes a resource and turns it into something it solves a human problem (from hunger to vanity), that makes the real world materially more efficient or effective, or otherwise makes the world a better place.

A small part of this wealth is economic. But even if one focuses exclusively on goods and services that can be bought and sold, even there it would be preposterous to claim that wealth is created at the top. Every bolt screwed onto a machine, every machine operated to make a useful product, every product used to perform a valuable service, every service performed – they all add value. Nor is simply a question of the direct production of wealth. Every manager with a discretionary budget has the opportunity to create more wealth or less, depending on how they chose to use it.

One feature of modern economies that especially militates against the idea that wealth is created at the top is the progressive professionalization of roles in the economy. An employee is someone you may to do as you tell them; but a professional is someone you pay to tell you what to do. This is clear enough with doctors, lawyers and so on, but it is equally true of professional staff. And their role in the organisation is specifically to know how to create wealth in their area better than their superiors. So the more the modern economic organisation is staffed by professionals, the less claim those a the top have to be exclusively the wealth creators. On the contrary, they are increasingly only coordinators of those who create the wealth.

Hence the difficulty of maintaining a hierarchical structure in strongly professional organisations – because it is increasingly difficult to maintain the myth that those a the top know best. This leaves senior executives in the contradictory position of wielding the power to hire and fire, to invest and disinvest and generally control the organisation, yet lacking any realistic claim to unique insight, awareness or pre-eminent skill. Rather like the absolute monarchs who created to modern state in the seventeenth and eighteenth centuries, the business hierarchs of modern world have created a massively powerful system – the modern capitalist business – that has less and less time or place for those who were its progenitors.

So what is it that distinguishes the bankers and the financial sector in general? In these terms, not very much. To the extent that they are merely managing budgets, nothing at all. The leverage and reach they exercise may seem vast, but to claim that this means that they create more wealth than others makes no more sense than saying that only the top person in a human pyramid gives it height. It’s rather like a previous era when it was salespeople who were idolised rather than the analysts, the superstar executives, the ‘quants’ and other financial monsters: they too were disproportionately rewarded for selling things other people actually made. Of course, an exceptional individual can make an exceptional difference, but that is true of wealth creation at every level. And it is not as though the evidence actually support the claim that bankers, let alone the financial sector as a whole, actually do create disproportionate wealth.

So what have they been doing for the last couple of decades that explains their fabulous rewards? Haven’t our economies grown exceptionally quickly? Isn’t that to the credit of the financial sector? In the illusory terms of global figures and monetary values, yes to both. But did anyone but themselves enjoy the wealth? No. When in 2008 the banks finally realised how unsure their financial footing was and started to pull the rug from under one another, it turned out that most of the monetary increase in wealth was an illusion. The bubbles had inflated the money but not increased the material wealth society enjoyed. In fact most people are no better off now than before the financial sector was let off the leash. The geese, it turned out, produced eggs of gilded lead, not true gold.

But even that is not the bottom of the barrel. Even if they had been creating exceptional wealth, those at the top of the tree are also the ones who decided on whose behalf wealth is created. This is not after all a completely neutral activity. You can decide how to divide up the surplus. The choice is quite simple: they can allocate the wealth to the shareholders, to the workers, to society (through taxation and true corporate social responsibility) – or to themselves. As ever, those at the top favoured their shareholders. But not as much, it turned out, as they favoured themselves. Despite the longer hours, the heightened insecurity and lower happiness, the average American is no better off than in the 1970s, and much the same is probably true in Britain too. There were no more goods and services, especially not for ordinary people – which is to say, for the vast majority of the real economic wealth creators. So even if they had created great wealth, don’t hold your breath waiting for your share. What you get is a insecurity and relentless pressure.

Finally, the bankers turned out to have produced something that is now busily reducing the total wealth in society. By dislocating the structure of ownership and credit in the economy as a whole, a great deal of its material wealth, its homes and security and comforts, has been debased from wealth to debt, as people of honest working people who thought they had the money to pay for it suddenly don’t. Through no fault of their own, millions are losing their livelihood. Among the very poorest in developing countries, tens of millions have been shoved into absolute poverty. Many will simply die.

But the mythology of wealth creation has already started to revive itself. And why not? For nothing has really changed, except that we now despise the bankers we once admired, and politicians (who have been offered a truly golden opportunity to become popular heroes without a hint of crass populism) are confirming the electorate’s worst suspicions about them.

Quaking in their Gucci boots

... as George Monbiot described the bankers the other day[1], writing about the British government's utterly supine response to the banking crisis and those who caused it. Apparently Brown and Darling have declined to learn the lesson Nassim Nicholas Taleb suggested last April - that 'People who were driving a school bus blindfolded (and crashed it) should never be given a new bus'. In fact it's pretty hard to identify even one of Taleb's 'ten principles for a Black Swan-proof world' [2] that has found its way into public policy.

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail.
2. No socialisation of losses and privatisation of gains.
3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.
5. Counter-balance complexity with simplicity.
6. Do not give children sticks of dynamite, even if they come with a warning.
7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.
8. Do not give an addict more drugs if he has withdrawal pains.
9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.
10. Make an omelette with the broken eggs.

No, as far as I can see it, not one of these lessons has been learned. Well done, chaps. Apparently, say Brown and Darling, it is 'impractical' to change the system so that we can exercise any control over it. Which can only mean that that system is out of control, but we are not worried enough about its unintended effects to do anything about it.

But is Taleb's own prescription enough?

Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

But even if we did all this (personally I love the one about abolishing the Nobel prize for economics), would Capitalism 2.0 really be the answer? We got into the present crisis by allowing capitalism's basic rules - the structures and interests that underpin all forms of capitalism, which Taleb and other critics from within show no inclination to criticise, even in the name of Capitalism 2.0 - to play themselves out with unprecedented freedom. This particular 'black swan' was no improbable mutant but the entirely predictable (and predicted on both right and left) effect of capitalsm's most basic causes, that was only inconceivable to those of the Thatcher/Reagan generation of politicians and the idealists of economic theory for whom, no matter what the question, unbridled capitalism was the right - no, the righteous - answer.

Meanwhile, George Monbiot's own diagnosis - that no one bears more responsibility for the current mess than Gordon Brown and Alan Greenspan - essentially that this was a crisis induced by political irresponsibility and weak regulation - has some merit, but by focusing on the individuals or even on rather secondary functions of the economy rather than the structure of the economy itself - distracts attention from the real problem. The crisis was not created by poor management of our economic system; no, it was created by the very nature of that system.

So what are we looking at here? Both capitalism's intellectual critics and its would-be political masters are unable to see what got us into this, or that there is no version of capitalism that will not, eventually, pull the same trick.

Not that capitalism is an unqualified disaster. Far from it - it is after all only through capitalism that the modern world, with all its fabulous wealth and freedom, took shape at all. But it must be understood that capitalism is rather like adolescence: a huge improvement on its predecessors, but not something to be hung on to for its own sake. There is life after the teens, and there is history after capitalism.

[1] 'The Great Cop-Out,' Monbiot.com, 8 September 2009.
[2] 'Ten principles for a Black Swan-proof world', FT, April 7 2009.

The train now arriving in Fantasy Gulch...

My God, it's only two days since I wondered how long it would be before market enthusiasts started trumpeting how wonderful market economies were after all, and already the Financial Times has responded with one of those I-wouldn't-believe-it-if-I-hadn't-seen-it-with-my-own-eyes pieces they are so very good at.

In today's edition, Philip Stephens has penned a piece entitled 'Crisis? What crisis? The market confounds the left'. Leaving aside the drivel he talks about 'the left' (of which, pace Mr Stephens, the Labour and Democratic parties are decidedly not members), he manages to boast that the return to profitability of various banks proves that liberal market capitalism really is the bee's knees.

Pace the doomsayers who predicted imminent Armageddon, liberal market capitalism has survived: somewhat humbled and, in the case of the financial services
industry under much tighter official supervision, but recognisably much as it was.

Indeed it is - and we will pay for it again, the next time it goes wrong. But the idea that this proves that the system is basically OK? Oh really? And that little detail of the trillion dollars we gave them? The millions of unemplyed? The wrecked businesses? The tens of millions around the world these bankers have thrust into an absolute poverty smug Mr Stephens cannot imagine? I could go on about this at enormous length (again), but if there is one thing that doesn't prove that a system is healthy, it is when it recovers from a completely self-induced disaster by being fixed by someone else.

But what can we expect from a paper that is so utterly incapable of rational thought about market economics?

Booking a trip to Fantasy Gulch

Now that we have bailed them out to the tune of a trillion-odd pounds/euros/dollars, surprise surprise, the banks are returning to profit. Meanwhile, the various government institutions who are supposed to be deciding how to avoid another train wreck are stumbling around trying to grasp what really needs to be done, but are so thoroughly tarred with the same brush as the financial sector that they cannot even conceive of what is required.

And every time governments make a move, another little patronising missive comes from entirely non-credible banking body bemoaning how any new regulation on capitalisation or bonuses will only hamstring the system – as though the last couple of years were not warning enough that what ‘the system’ needs is not just hamstringing but evolution into a completely new kind of animal.

How long can it be before the banks start issuing press releases claiming that the current crisis is just a flash in the pan and that everything is really all right? I give it until the end of June at the latest.

Duck!

My love affair with the Financial Times continues unabated, and this time I find that their scientific reporting is as spot-on as their analysis of business and capitalism. In today’s on-line edition, Clive Cookson’s report on the huge new European telescopes launched yesterday from Guyana (‘Huge telescopes aim to solve mysteries’) tells us that the telescopes ‘will operate in close proximity at a point in space called L2, 1.5km from earth’.

I hope they chose their orbit carefully. 1.5 km means that they will miss Ben Nevis pretty comfortably, but as Everest is rather over 5 times that height, it might be a bit of a white-knuckle ride elsewhere. The authoritative SatNews.com suggests that 1.5 million kilometres may be nearer the mark.

Of course, the FT is not a science paper, but you’d hope journalists and editors could manage to spot such a blindingly wrong number. It also raises the question of whether the current economy downturn is in fact a very reasonable reaction to the FT misreporting economic data by six orders of magnitude?

Markets and the Return of the Economic Zombie!

As someone or other once said, generals always plan to fight the next war with the weapons of the last. Much the same seems to be true of economists. In the light (if that is the word) of the last year or two, the idea that market economics is still a contender for the basic model for the economy is quaint to say the least. Even if you take capitalism for granted (which, for the time being, I think we can), markets and market theory are hardly contenders for tools for managing it. The reason I say this is because a) markets don’t really exist, and b) even if they did, standard market theory is at best half-baked and at worst simply false.

Perhaps I should restate the claim that markets don't exist. Markets don't exist as market economists imagine them. The assumptions market economics is based simply do not apply to current economic conditions, and have not been relevant for at least half a century. Market theory has always assumed a number of things (the various perfections of 'perfect competition'), most of which only really exist in minimal, distorted and illusory forms.

For example, 'perfect information' was always nonsense and we have a whole raft of industries - marketing, advertising and lobbying - on hand to keep things that way. The recent history of financial engineering also demonstrates amply how easy it was for markets to be dominated by mechanism that many players plainly did not understand, so that they had little idea what they were doing from day to day. Even George Soros said he had kept clear of derivatives because he did not understand them. Recent developments such as ‘deep pools’ can only worsen this situation by deliberately concealing market information. There are some areas where markets are still quite real, but I doubt that plumbers and fish markets command much of anyone’s GNP.

As for another key condition for markets to be efficient, ease of entry, this ceased to make any sense when economies reached the scale where only major corporations and governments could summon up enough capital to enter any major industry. Conversely, ease of exit was rendered irrelevant with the arrival of large-scale fixed capital as the sine qua non of most industries. Fixed capital is notoriously difficult to dispose of at a decent price even when it is still usable, and if you are keen to exit a market it is probably because it is shrinking, so you won’t find anyone to buy it.

Likewise for all the other key assumptions of market economics. They make a neat, if narrow, theory, but none of them actually applies under modern economic conditions.

As for the idea that market theory is at best half-baked and at worst simply false, market economics claims that markets will always tend towards equilibrium. This is hardly what history would suggest, and it ignores at least two intrinsic features of market economies.

Firstly, the various kinds of market imperfection I have just mentioned all serve to push markets into disequilibrium, because they create special interests (often very widespread or of involving very large players) who are keen to seek, create and exploit disequilibrium.

Secondly, the real tendency of markets is not towards equilibrium but towards bubbles and monopoly. Bubbles arise when it is not the intrinsic value of goods and services that are being invested in but movements in the market itself (i.e., when, as Keynes put it, the speculative froth on the surface of the stream of solid investments is inverted into a maelstrom of speculation that drowns out real investment). This inversion became inevitable as soon markets become a forum for making money by speculation rather than for allocating scarce resources. When this orgy of money-making has reached the point where market players start to notice just how far this process has diverted the formal ownership of resources from any economically plausible use, collapse ensues as inevitably as the original bubble.

Given how market economists like to define the market as an efficient mechanism for distributing scarce resources, inveterate leftists like me find it grimly ironic to note that it capitalism itself, whose sole rationale is to make money, that ensures that markets lead inevitably to bubbles, the misallocation of resources and collapse.

As Oscar Wilde said, a cynic is a man who knows the price or everything and the value of nothing, so it’s nice to see that even in the impersonal world of the market, the inherent cynicism of market theory gets its comeuppance. Pity about the millions of ordinary people whose lives it destroys.

As for monopolies, as we all know, productivity is generally much improved by economies of scale. That in turn generally demands large-scale investment, typically in machinery and rationalisations that are closed to small players. But this reduces the number of businesses that can afford to operate in this market, or for which the size of the market leaves elbow room. And so the spiral starts and continues until only a handful of players is left. Not technically a monopoly, so there is still some limited competition, but even an oligopoly consists of a small number of players whose interests vis à vis their customer are identical – and identically predatory. And certainly any notion of a free market has long since disappeared.

Another nice irony of market capitalism then: as with bubbles, monopolies show how it is the very workings of historic markets that rendered modern market theory irrelevant. Not in this case because they create bubbles that destroy the value even as they generate lots of money, but because they create an economic universe in which, far from a large number of small players buying and selling, a small number of truly vast players distort the entire economy to suit themselves.

Basically, Adam Smith’s enthusiasm for the market was based on an economy of small players with small, easily liquidated investments in a large market. A nice dream of a cosy middle class world. Market theory persists with this dream. But we don’t live there any more.

Is Asian capitalism different?

What I hope is a last word on derivatives. Apparently in 2000 Gao Xiqing, an adviser to the then Chinese premier, said that:

if you look at every one of these [derivative] products, they make sense. But in aggregate, they are bullshit. They are crap. They serve to cheat people.

[Quoted in an article by Kishore Mahbubani in today's FT.]

On a somewhat wider stage, however, Mahbubani's piece claims - quite rightly for the moment, perhaps - that there are various distinctively Asian versions of capitalism, all of which are a good deal more conservative than the ‘western’ model. For example, Asian societies have much higher levels of savings, since the Asian financial crisis of 1997-98 have restored a degree of government regulation, they have learned to ignore the IMF’s market fantasies, and so on.

Which is very sensible indeed. But how sustainable is it? As Mahbubani notes, the high savings level is the product of centuries of economic and social uncertainty. But the same might be said of westerners, whose personal prudence in these matters was once legendary. Indeed, some economic historians have claimed that our high ‘propensity to save’ was one of the foundation stones for capitalism itself. Likewise for regulation: it is not so very long ago that no one in the West would have dreamed of deregulating our economies to anything like the extent that we have.

But things change. Once consumerism – rapidly emerging in the east as in the west – takes command, the vast marketing machines will make sure that savings are quickly eroded. There will come a time when Asian economists will recommend the deregulation of markets, and there will come a time when Asian governments will be so exposed to global economic pressures that they will be unable to resist. That’s how capitalismworks – not western capitalism or Asian capitalism - just capitalism. After all, what we have in the west is not a specifically western model at all – it is simply capitalism completely let off the leash. When it is let off the leash in Asia too, they can fully expect the same tribulations.

And plainly Asian capitalism can be fooled into playing along with the western model, because for a long while they did. In 1997-8 they learned better – but to what extent did even that happen because there are at least two major global players in Asia – India and China – neither of which has really been absorbed not the global capitalist network at every level of society? They are both heading – indeed, sprinting – that way, so why should we expect them not to succumb to the 'western' model?

There is an answer. It's a combination of peak oil, climate change and the ecological devastation that is already making itself felt all across Asia. But Asian capitalism? No, I doubt very much that that can resist effectively on its own. Why should it? 'Western' capitalism didn't, even though philosophers and historians and politicians and pundits of every stripe claimed the same virtues for the west as Mahbubani does for Asia.