Thursday, December 29, 2011

It looks good on paper...  

The capitalism of Adam Smith gained popularity in part because it was easy to follow, and had the helpful appearance of calm reason. It also described in many ways the actions of people in the real world of his time as free markets were just beginning to become intricate. I have long subscribed to his basic premises, but the advancing complication of our global economy has shown a few serious gaps between theory and reality.

Kenneth Rogoff identifies some of the problems with modern capitalism.
Perhaps the real point is that, in the broad sweep of history, all current forms of capitalism are ultimately transitional. Modern-day capitalism has had an extraordinary run since the start of the Industrial Revolution two centuries ago, lifting billions of ordinary people out of abject poverty.  Marxism and heavy-handed socialism have disastrous records by comparison. But, as industrialization and technological progress spread to Asia (and now to Africa), someday the struggle for subsistence will no longer be a primary imperative, and contemporary capitalism’s numerous flaws may loom larger.
First, even the leading capitalist economies have failed to price public goods such as clean air and water effectively. The failure of efforts to conclude a new global climate-change agreement is symptomatic of the paralysis.
Second, along with great wealth, capitalism has produced extraordinary levels of inequality. The growing gap is partly a simple byproduct of innovation and entrepreneurship. People do not complain about Steve Jobs’s success; his contributions are obvious. But this is not always the case: great wealth enables groups and individuals to buy political power and influence, which in turn helps to generate even more wealth. Only a few countries – Sweden, for example – have been able to curtail this vicious circle without causing growth to collapse.
A third problem is the provision and distribution of medical care, a market that fails to satisfy several of the basic requirements necessary for the price mechanism to produce economic efficiency, beginning with the difficulty that consumers have in assessing the quality of their treatment.
The problem will only get worse: health-care costs as a proportion of income are sure to rise as societies get richer and older, possibly exceeding 30% of GDP within a few decades. In health care, perhaps more than in any other market, many countries are struggling with the moral dilemma of how to maintain incentives to produce and consume efficiently without producing unacceptably large disparities in access to care.
It is ironic that modern capitalist societies engage in public campaigns to urge individuals to be more attentive to their health, while fostering an economic ecosystem that seduces many consumers into an extremely unhealthy diet. According to the United States Centers for Disease Control, 34% of Americans are obese. Clearly, conventionally measured economic growth – which implies higher consumption – cannot be an end in itself.
Fourth, today’s capitalist systems vastly undervalue the welfare of unborn generations. For most of the era since the Industrial Revolution, this has not mattered, as the continuing boon of technological advance has trumped short-sighted policies. By and large, each generation has found itself significantly better off than the last. But, with the world’s population surging above seven billion, and harbingers of resource constraints becoming ever more apparent, there is no guarantee that this trajectory can be maintained.
Financial crises are of course a fifth problem, perhaps the one that has provoked the most soul-searching of late. In the world of finance, continual technological innovation has not conspicuously reduced risks, and might well have magnified them. [More worth reading]
Of all the issues he lists and others that I wonder about, I think at the top is the current "capitalist" obsession with budget deficits. This anxiety is rooted in several mistaken ideas.

One is the interpretation of financial propriety, wherein borrowing is linked to a lower moral status. I have argued before that borrowers and lenders are engaging in a peer-to-peer transaction, but until (and I think we are there for the most part) lenders have no one to pay them to use their money this mistaken moral judgement will continue to mislead public policy.

Deficits on a personal or national level are a bad idea when things are going well. During the early part of this century we could have continued our deficit reduction, but chose to cut taxes unnecessarily and splurge on Medicare D, not to mention devise obscure instruments to fund wagering in housing. The anger many now feel at those actions is triggering a response they should have advocated THEN, not during a steep recession.

Our mistaken blind belief in simplified capitalism is now leading into even deeper financial difficulty, as economic growth is the only proven answer to address our spluttering economies. It also diverts us from other important issues that impair our economy.
It is also leading to austerity – taxes are increasing and government spending is falling at the local and state level around the country. A difficult fiscal conversation still lies ahead at the federal level, but cuts and contractions of various types seem likely.
Some people argue that Americans need to tighten their belts. That’s an interesting discussion, particularly at a time with unemployment is still above 8% (with recent declines largely the result of many jobless workers’ decision to stop looking and drop out of the labor force altogether). Precipitate austerity is hardly likely to help the economy find its way back to higher employment levels.
But what about government support for the big banks? Is this contracting in the light of our current fiscal pressures? Unfortunately, it is not; much government support remains, implicitly through allowing banks to be “too big to fail,” and explicitly through various kinds of backing provided by the Federal Reserve.
The rationale – or perhaps we should call it ideology – behind supporting big banks is that they are needed for the economy to recover. But this position looks increasingly doubtful when the banks are sitting on piles of cash while creditworthy consumers and businesses are reluctant to borrow. [More]
Right now the US costs for public borrowing is negative across the yield curve. It costs us not to borrow. Wasteful government spending is of course inefficient, but even deficit-abhorring farmers are asking for better bridges, locks, and other infrastructure. With the massive construction sector still in the doldrums, investment in infrastructure, energy, and education will generate returns that at least will be positive.

Recognizing the difference between our global economy and that of Adam Smith would be a good first step in tackling our problems. Capitalism is not a stand-alone invention, but a system shaped by an increasing number of minds as more people around the world are able to make economic decisions. Our public (government) decisions should likewise borrow from a more current and applicable set of alternatives. Just because Smith's system was easier to understand does not make it accurate or right.

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