Monday, March 09, 2009

capitalism 101

A thumbnail sketch of my understanding of the capitalist system.

Capitalism is a dynamic system, a profit driven system, a wealthy system and a flexible system

Up to a point. But beyond that point all of those attributes turn into their opposites. It becomes a moribund system where profits fail, wealth disappears and flexibility becomes pointless. My guess is that the current Keynesian measures (stimulus packages) to solve the current crisis will not work.

Capitalism is a dynamic system

It continually creates new types of jobs and destroys old types of jobs. The productive forces are continually developed.

Barry Jones wrote Sleepers, Wake! in 1982, tracking the massive changes in employment from agriculture to industry to Services to Post service (Education / Leisure) from 1780 to 1980

More recently, Clayton Christensen has written and spoken about disruptive technologies such as computer startups that sometimes begin in garages and then become highly successful: Apple, Microsoft, Google are well known examples.

These changes push the workforce in the general direction of more skills and more education, as mind numbing, labour intensive work is augmented by technology which becomes increasingly smart.

Capitalism is a profit driven system

If a commodity can’t be sold at a profit in the market place then eventually it won’t be made.

New technology, (which can be expensive), is introduced by capitalists into workplaces to increase productivity. This new technology creates new jobs and destroys old jobs but in growth conditions can lead to an overall increase in employment.

New technology can lead to increased output and, with economies of scale, cheaper products. The cost of plant (fixed costs or one off costs of tooling up) has gone up but production costs per unit have gone down (technology enhanced productivity). With sufficient volume of sales this can and has created cheaper products. However, only big capitalists (monopolies) can maintain this brutal regime. Due to competition between capitalists the overall tendency is for the rate of profit to fall. Hence the smaller under capitalized companies tend to fail and be eaten up by monopolies, who have larger reserves of capital.

When capitalism is going well then increased productivity leads to cheaper goods which leads to more demand which leads to more employment. If this is happening in a whole country then GNP or GDP per worker increases and standard of living goes up.

This has been the general trend in the long boom since the end of WW2, although it has been interspersed with downturns or recessions (1973-4 oil cartel, 1981-2 (contractionary monetary policy to control inflation), 1992 and 2000-02 tech bubble)

Capitalism is a wealthy system

Due to the rapid development of the means of production over the past centuries capitalism can sustain a high standard of living for nearly all members of industrialised society. Even people on welfare can have swimming pools (plastic), foxtel for entertainment, recreational drugs and the like. There is a more or less endless range of distractions which induce many people to not pay detailed attention to political and economic developments.

Capitalism is a flexible system

For most of the time (recessions excluded) capitalism is flexible enough to make adjustments (without excessive government regulation) to keep most people satisfied and to keep unemployment within "acceptable" limits for most of the time. Since the overall trend for 60 years has been growth and recessions have been of relatively short durations (1-2 years) in most industrialized countries (exception: Japan) then the overall impression is gained that capitalism works or at least works better than socialism (the main historical alternative), which is regarded as discredited.

These flexible adjustment mechanisms at the level of the workplace include natural attrition (not replacing workers who leave), part time / full time work choices, retraining, overtime, casual employment and flexible timing in the introduction of new technologies.

At the government level they include migration policy, school leaving age policy, retirement age policy (elaborate Superannuation schemes; at what age are people eligible for the pension), fiscal policy and monetary policy ...

For most of the time capitalism seems to work. Many economists speak highly of the ability of the market to automatically regulate the complexities of this dynamic system. Recessions are inconvenient but perhaps worth tolerating, in the absence of anything demonstrated to be superior, if the overall trend is growth. It's remarkable that some people have lived their whole lives (eg. since 1945) in the belief that our system is economically stable (within acceptable limits) only to discover now that perhaps it is not. It may take a while before that belief evaporates. My evaluation is that our current rulers don't have a clue.

Now we have a major downturn and there is no end in sight. Growth has slowed dramatically in most countries and now unemployment is beginning to soar. The reassurances from those who brought us to this point, that it will all be over in a year or so sound hollow. We need to look deeper at the causes of the current crisis.

(based on Unemployment and Revolution, Part 2)


Anonymous said...

First, you mention there is a recession like it is an economic truth, a consequence of growth, and it is not.

The main reason why the economy is not growing and there is a lot of unemployment is because banks created this scheme of variable rate, in which buyers could buy houses they could not buy with a fixed APR.

The scheme is that consumers would behave like a pyramid. A fonzi scheme. It worked.

Eventually though, the economic layers realize they can sell a house in the US and buy a mansion in other parts of the world. They sell. Then ones who didn't sell now have trouble paying their variable rate mortgages.

The banks' shareholders lost their money because the houses no longer have their value. Citibank is now worth pennies. Borrowers lost their homes. But this is a zero sum game, who won?

Some people made a lot of money and they are not mentioned in the news.

If the financial system now won't give you loan money, why does the federeal reserve give them money? What's the point? They are broke anyway, because remember that banks are owned by a lot of shareholders who know lost all their savings.

Banks should be granted money by the Federal Reserve only if they loan the money at reasonable fixed APR. It may sound unrealistic, but think about it:

1. Borrowers will know for sure how much money they owe. Taking a variable APR is a bad idea.
2. This will set minimum prices for real state. Now we don't know what their real prices are.
3. Houses are used as collateral (warranty) by the bank, therefore the bank has a lot of houses worth zero. If we can set the right price, banks will have cash.
4. Stop creating structured debt. That's non sense. If you can't know for sure how bad a collateral is, the whole package is worth zero.

Bill Kerr said...

hi anonymous,

Thanks for the comment

If this crisis is basically financial in nature then your analysis and solution might work or be part of a more comprehensive solution

From my reading the financial crisis masks an underlying and more fundamental crisis of overproduction which goes back to at least the early 1970s. Money flowed from the manufacturing sector to the financial sector because of the falling rate of profit in manufacturing. This delayed the current crisis but helped to make it more serious when it finally broke.

This is part of an analysis put forward in these articles:

Robert P. Brenner, Jeong Seong-jin, “Overproduction not Financial Collapse is the Heart of the Crisis: the US, East Asia, and the World” The Asia-Pacific Journal, Vol. 6-1-09, February 7, 2009.

The Global Collapse: a on-orthodox View by Walden Bello

I'm not saying that these articles have it right in all aspects but that they do present a broader perspective that is closer to the truth than your exclusively financial analysis

John Dougan said...

I wouldn't call it overproduction so much as bad investment. And that is almost certainly caused by the various central banks printing more money. Monetary inflation counterfeits the signs of a boom and that causes investors, manufacturers, etc. to build excess capacity or other malinvestments. Eventually, this gets noticed and the bad investments have to be liquidated so the money can be recovered to some extent and put into productive investments.

Business people can compensate for monetary expansion in their planning to some extent, but it is very hard to tell just how much of the signs are actual increased demand and how much is inflation.

Of course the solution, not printing money willy-nilly, isn't very attractive to governments and the banks (and others) that feed off the government tit. Since they have first use of the new fiat money, they get the most value from it (as it hasn't yet been devalued by the inflation it's existence will cause) and it's more subtle and less likely to be noticed than raising taxes.

Bill Kerr said...

hi john,

I'm still getting up to speed on these complex questions (political economy). I'm getting to the point where I think I can frame some of the important questions to ask (some progress but a long way to go). Thinking aloud my question is:

How could we tell if it's primarily a financial crisis (as you say) or whether it's mainly an overproduction crisis (starting in the 1970s) which has been masked for many years by manipulation of finance? (as Brenner says )

These issues are difficult (for me at least) but need to be delved into deeply in these times IMO

John Dougan said...

It's both. Overproduction in a given sector of an actual free market (which we don't have) isn't usually a long term problem as it will drive down prices and make that sector less profitable resulting in investors putting their money somewhere else.

The big problem is when the signs of overproduction are masked by government monetary policy. Continual monetary expansion devalues the currency and causes prices to rise. Rising prices are also exactly what you see in the case of increased demand. Investors see this and invest in increased productive capacity. And since this is happening by currency manipulation, it occurs across the entire economy so when the eventual bust finally arrives everybody is affected. There is some theoretical and historical indication that in the case where booms and busts occur without the aid of monetary policy (due to investor optimism or an information deficit) they tend to be confined to more narrow industry sectors and tend to have faster recovery times.

If you consider that much of the problem was generated by printing fiat money you will see why some of us belive that the "stimulus" is nothing of the sort. That is what got us into this hardly seems likely to get us out. What they are trying to do is restart the inflationary spiral and that probably won't work. The only real solution is to let the market clear out the excess investments so the resources can be put into things we actually value.

One place I recommend you look for your explorations into political economy is Economics in One Lesson by Henry Hazlitt. It was written to specifically clear out some of the more pernicious economic fallacies and to help one think like a descriptive economist.