Blaming corporatism for capitalism

Professor Edmund Phelps and I have written an editorial piece with Project Syndicate on corporatism, capitalism and the fatal confusion between the two. I reproduce the whole essay here, courtesy of Project Syndicate

The future of capitalism is again a question. Will it survive the ongoing crisis in its current form? If not, will it transform itself or will government take the lead?

The term “capitalism” used to mean an economic system in which capital was privately owned and traded; owners of capital got to judge how best to use it, and could draw on the foresight and creative ideas of entrepreneurs and innovative thinkers. This system of individual freedom and individual responsibility gave little scope for government to influence economic decision-making: success meant profits; failure meant losses. Corporations could exist only as long as free individuals willingly purchased their goods – and would go out of business quickly otherwise.

Capitalism became a world-beater in the 1800’s, when it developed capabilities for endemic innovation. Societies that adopted the capitalist system gained unrivaled prosperity, enjoyed widespread job satisfaction, obtained productivity growth that was the marvel of the world and ended mass privation.

Now the capitalist system has been corrupted. The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system, however, is not capitalism, but rather an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic, wasteful, unproductive, and well-connected firms at the expense of dynamic newcomers and outsiders, and favors declared goals such as industrialization, economic development, and national greatness over individuals’ economic freedom and responsibility. Today, airlines, auto manufacturers, agricultural companies, media, investment banks, hedge funds, and much more has at some point been deemed too important to weather the free market on its own, receiving a helping hand from government in the name of the “public good.”

The costs of corporatism are visible all around us: dysfunctional corporations that survive despite their gross inability to serve their customers; sclerotic economies with slow output growth, a dearth of engaging work, scant opportunities for young people; governments bankrupted by their efforts to palliate these problems; and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal.

This shift of power from owners and innovators to state officials is the antithesis of capitalism. Yet this system’s apologists and beneficiaries have the temerity to blame all these failures on “reckless capitalism” and “lack of regulation,” which they argue necessitates more oversight and regulation, which in reality means more corporatism and state favoritism.

It seems unlikely that so disastrous a system is sustainable. The corporatist model makes no sense to younger generations who grew up using the Internet, the world’s freest market for goods and ideas. The success and failure of firms on the Internet is the best advertisement for the free market: social networking Web sites, for example, rise and fall almost instantaneously, depending on how well they serve their customers.

Sites such as Friendster and MySpace sought extra profit by compromising the privacy of their users, and were instantly punished as users deserted them to relatively safer competitors like Facebook and Twitter. There was no need for government regulation to bring about this transition; in fact, had modern corporatist states attempted to do so, today they would be propping up MySpace with taxpayer dollars and campaigning on a promise to “reform” its privacy features.

The Internet, as a largely free marketplace for ideas, has not been kind to corporatism. People who grew up with its decentralization and free competition of ideas must find alien the idea of state support for large firms and industries. Many in the traditional media repeat the old line “What’s good for Firm X is good for America,” but it is not likely to be seen trending on Twitter.

The legitimacy of corporatism is eroding along with the fiscal health of governments that have relied on it. If politicians cannot repeal corporatism, it will bury itself in debt and default, and a capitalist system could re-emerge from the discredited corporatist rubble. Then “capitalism” would again carry its true meaning, rather than the one attributed to it by corporatists seeking to hide behind it and socialists wanting to vilify it.

Saifedean Ammous is a professor of economics at the Lebanese American University and Foreign Member of Columbia University’s Center for Capitalism and Society. Edmund Phelps, the 2006 Nobel laureate in economics, is Director of the Center.

Copyright: Project Syndicate, 2012.

The problem of regulation

Economist Hernando De Soto has a good piece in the Financial Times about the Tunisian economy, particularly pertaining to the heartrending story of Mohammad Bouazizi, the fruit-seller who set himself alight after the Tunisian government banned him from selling his fruits and confiscated his fruit cart.

De Soto makes the point that Professor Edmund Phelps and I had made in our FT Op-Ed in January: the fact that the government controlled the fate of normal people like Bouazizi with its restrictive laws and regulations makes it impossible for people to prosper and live in decency. Bouazizi’s was an extreme reaction to this fate, but it should not distract from the fact that millions of people in Tunisia and the rest of the world face the same predicament.

De Soto writes:

Bouazizi flicked his lighter on at 11.30am, one hour after a policewoman, backed by two municipal officers, had expropriated his two crates of pears ($15), a crate of bananas ($9), three crates of apples ($22) and an electronic weight scale ($179, second hand). While a total of $225 might not appear to justify suicide, the fact is that, as a businessman, Bouazizi had been summarily wiped out.

Without those goods, Bouazizi would not be able to feed his family for more than the next month. Since his merchandise had been bought on credit and he couldn’t sell it to pay his creditors back, he was now bankrupt. Because his working tools were confiscated, he had lost his capital. Because the customary arrangement to pay authorities three dinars daily for the property right to park his vendor’s cart on two square yards of public space had been terminated, he lost his informal access to the market. Without property and trade, his reputation as a reliable administrator of goods was now undermined in the only market he knew.

He was not on a salary. He was a budding entrepreneur. According to his mother and his sister, his goal was to accumulate capital to grow his business. But this was impossible as we discovered when we investigated the records and the laws he had to comply with.

To get credit to buy the truck he so needed, he needed to demonstrate he had some kind of legally recognised collateral. The only legal collateral he had access to was the family house in SidiBouzid. However, he had never been able to record a deed in the property registry, an indispensable requirement for using the house as a guarantee. Compliance requires 499 days of red tape at a cost of $2,976.

To create a legal enterprise he would have had to establish a small sole proprietorship. This would require taking 55 administrative steps during 142 days and spending some $3,233 (12 times Bouazizi’s monthly net income, not including maintenance and exit costs). Even if he had found the money and the time to create a sole proprietorship firm the law did not enable him to pool resources by bringing in new partners, limit liability to protect his family’s assets, and eventually, issue shares and stocks to capture new investment.

Today, the majority of people, particularly the highly-educated, still see nothing wrong in principle with this arcane set of restrictions on the freedom of people to trade. Most everyone will agree that this burden is excessive, and that some ‘reform’ is needed to make the process faster, more transparent, or more responsive. The World Bank and IMF have issued countless reports on the importance of public sector reform, good governance and efficient institutional arrangements (or whatever the latest buzzword is). But rarely does anyone question whether such restrictions should exist at all.

There is no reason for any of these rules to exist. There should never be a government authority that decides who can and cannot sell fruit, what fruits they can sell and how they can sell them or for how much. Such an authority could never exercise this power to the benefit of those regulated by it. It can, at best, be a mild waste of time and effort, but it will more likely be an insurmountable burden for millions of Bouazizis whose livelihoods are destroyed because a bureaucrat somewhere believes he knows what’s best for them.

No one, anywhere, should need to apply for a license from anyone to sell fruits. The only person to whom a fruit-seller should be accountable is his customers, who in turn should never have their freedom to buy anything restricted in any way. This is the very simple yet powerful idea of free exchange: Any transaction undertaken freely between two consenting adults must be mutually-beneficial to both of them. Otherwise, they would not have undertaken that transaction. A simple idea, but with powerful implications.

When a fruit-seller has no recourse whatsoever to violence to impose his will on his customers, the only way he can get the customers to buy from him is if he provides them with desirable fruits at a price that suits them. When the customers have no recourse whatsoever to violence to impose their will on the fruit-seller, the only way that they can get him to give them his fruit is by paying him a price he finds suitable. As such, both parties have an interest in meeting each other’s expectations–otherwise the transaction would not happen. This, on its own, is what motivates people to provide for one another peacefully and satisfactorily on a free market.

With the freedom of the customer to chose from different providers, there is no need for any other form or regulation or authority to infringe coercively on the providers. The fruit-seller has no interest in selling bad fruits, as that would displease his customers, who will go somewhere else. He has no interest in cheating his customer as that would make him lose business. This is how a free market functions: you do well by doing good, not necessarily because you want to be good, but because you cannot prosper otherwise.

The imposition of regulation in such transactions is usually done with the best of intentions. High-minded bureaucrats think they are making life better for fruit vendors by ensuring proper licensing is observed and certain standards are adhered to. They aren’t. Consumers get the standards they want from the providers they want simply by voting with their feet: The providers that don’t give people what they want go out of business. Regulation wastes a lot of resources on compliance, and causes all sorts of market failures like price distortions, shortages, and surpluses. Most importantly, it closes the door in front of the likes of Bouazizi from freely providing for willing customers.

To believe that regulation is unnecessary and harmful is not an idealistic and detached view. It flows necessarily from a belief in human equality. If you firmly believe all humans are equal, what is it that allows a third person to infringe with the threat of violence on the right of two people to transact freely with one another? Bouazizi and his customers were both made worse-off by both being denied the right to transact freely by government. There is no reason for these regulations to exist. Bureaucracies that enforce these regulations should not be reformed or streamlined or made more efficient–having more efficient mechanisms of regulation means more efficient mechanisms of repressing people’s freedoms. These agencies should simply be abolished. If they’re not abolished, we should at least hope and pray that they become as incompetent and ineffective as possible.

The Luddites are back

I was disappointed to read today an article by Martin Ford arguing that technological advancement will destroy the jobs of workers, and that as a result the world is headed towards a jobless economy. This is pure nonsense.

Such nonsense isn’t new, of course. Since the beginning of the Industrial Revolution in the late 18th century, many people with a limited understanding of economics have made the same mistake. These Luddites have always fought technological advancement thinking it would destroy jobs and ruin society. The automated loon, they warned, was going to destroy the livelihood of the British textile worker. Mechanized farming was supposedly going to starve farmers. The steam engine was going to make redundant large chunks of the labor force. Indeed, much of Karl Marx’s confused economic theories are based on just this fallacy, positing that as capitalists grow richer, they can afford to replace more workers with machines, leaving behind large numbers of disgruntled proletariat that must then unite and revolt to… I don’t know, go back and work disgusting menial jobs, I guess.

Yet somehow the average Brit today is far better off than they were before those machines came about. British workers earn more, work less and work in much better conditions than two centuries ago. Unemployment in Britain is still very low (in spite of its increase after the recent depression.) Had the Luddites and Marxists been right, one would imagine that two centuries of technological progress would have left absolutely nobody with a job today.

The problem with this Luddite Fallacy is simple: technological advancement increases the productivity of labor and therefore makes labor more valuable. As a result, workers earn more. Technological advancement allows workers to produce more output for every hour they work. A farmer using a tractor can produce several times as much food as a farmer using a donkey. We live in a world of scarcity: we could always use more food, more clothes, more stuff. The only real constraint on our production of stuff is how much labor hours we have to devote to it. The more productive our labor, the more production we have. The more production we have, the more labor earns. Technological advancement does not take away the jobs of workers, it allows workers to do more productive jobs. We will never run out of jobs, because we could always use more humans making more scarce products to meet other humans’ never-ending wants.

To Luddites like Martin Ford, the invention of the wheel would have appeared an unmitigated disaster–just think of all the lost jobs in the carrying-painfully-heavy-stuff industry! But in reality, it was a great boon for humanity, as it freed humans from carrying heavy loads and instead allowed them to focus on more productive things like making food, clothes, houses, and so on.

Therefore, it is no coincidence that humanity’s economic conditions continue to improve with technological advancement. This is not going to change any time soon. The more productive our technology, the better off we are. If humanity were to listen to Luddites like Martin Ford and fight technological advancement, none of us would have any time to do any of the immensely productive things we do in today’s modern society. We would be too busy engaged in very primitive tasks like carrying heavy loads for us to do anything else.

We should not worry too much from people like Mr. Ford. The Luddites of the early 19th century did succeed in destroying many machines and some factories, but these victories against human advance were short-lived. Their movement died and their ideas became the butt of jokes, while technological advancement continued to make life better for everyone. While Luddites like Martin Ford may influence some people with their deceptively appealing ideas, they are utterly powerless to stop the ingenuity of billions of human beings from making life better for all of us. Or so I hope.

Corporatism, Capitalism and the Arab Spring

Corporatism, Capitalism and the Arab Spring is the title of a Working Paper I completed for the Columbia University’s Center for Capitalism and Society. It is freely accessible on the Center’s website. All feedback is appreciated.

This is the abstract of the paper:

This paper examines the economics of the popular revolutions that removed the ruling regimes of Tunisia and Egypt in early 2011, and presents the concept of a corporatist economy as a better framework for understanding the economic systems of these countries. The deposed regimes had instituted a deep corporatist governance system that placed control of most economic activity in the hands of the regime and its closest loyalists. This corporatist system was very beneficial for the regime and its cronies, but was very destructive of economic freedom of the majority of people, leading to economic stagnation, youth alienation and the eventual mass protests that deposed the regimes. Moving forward, what these economies need is not a return to socialism, nor a retrenchment of corporatism, but a move towards dynamic free market capitalist economies that allow individuals the freedom to make their own living and determine their own future.

On Mubarak’s odious debts

On October 6th I had a piece published with Project Syndicate on the debt legacy with which Mubarak has saddled the Egyptian people. I argue that the Egyptian government should announce it is not liable for Mubarak’s foreign debts, and that the person who should be made liable for them is Mubarak himself. The piece is freely accessible on Project Syndicate’s website.

The piece is also available in Arabic, Spanish, Russian, French, German, Italian, Czech, and Mandarin Chinese.

On Aid to Egypt and Tunisia

In June, I wrote an article for the Financial Times on the question of foreign aid and loans to post-revolutionary Tunisia and Egypt. The crux of my argument is that this aid would be a bad idea for three main reasons:

1- foreign aid’s track record is less than stellar, and it is unlikely to spur the economic growth and development its advocates promise. Foreign aid money goes to governments and development agencies which essentially engage in central planning, a discredited idea that has has a woeful track record whenever it has been tried. Prosperity doesn’t come from the planning of the few, but the freedom of the many.

2- Foreign loans will, on top of failing to spur economic growth, turn into a heavy debt burden on the recipient country, leading to increasing debt repayment burden, requiring higher taxes and potential fiscal and monetary crises.

3- The political impact of handing large sums of money to the transitional governments of Egypt and Tunisia will be to give them inordinate power, and make them accountable to their foreign funders, rather than to their people. It is worth remembering, after all, that the deposed regimes of Ben-Ali and Mubarak were themselves the recipients of large amounts of foreign funding, and we all saw how that worked out.

The article is available on the Financial Times’ website (requires free registration). Excerpts:

Perhaps most important, aid has a political impact too. Those calling for new support seem to forget that the deposed regimes already received plenty of international aid finance. Under the aegis of the International Monetary Fund and the World Bank, they presided over elaborate privatisation and reform programmes, which benefited those close to power but did little to help the wider population. In truth the regimes tended to use this support to strengthen their rule, building state security apparatuses and creating kleptocratic governments accountable only to their foreign bankrollers.

Today, with both Tunisia and Egypt led by provisional caretaker governments, the risk is that the power granted by control of this spending will subvert their precarious democratic transitions. Generous aid programmes mean leaders do not need to please their citizens, or gain their trust to secure power; they can instead use donor money to build a security state and buy off their opposition. Without aid, however, governments find it harder to build corrupt client networks, and must instead be responsive to the demands of their people.

A better approach would be for assistance to wait until elections are completed, and elected governments are formed. Even better, donors should be willing to put the question of funding to the public in a referendum, allowing the people to choose whether they really want projects today and then debt tomorrow. Indeed, given the strong relationship between donors and the deposed regimes, it is not impossible to imagine free elections producing new leaderships that reject new funding, aiming instead to reduce or eliminate foreign aid and debt.

Without this, a dysfunctional body politic and a large debt burden may be all that Tunisia and Egypt are left with following the distribution of donors’ money. Yet the people of Tunisia and Egypt rose up against unaccountable dictators aided by just this largesse. Now they deserve the chance to decide for themselves whether they want the same foisted on their ruling classes again.

On Arab Economies

Back in April, I wrote a piece with Project Syndicate on what the economic challenges facing Arab countries in light of the revolutions taking place across the Arab World. The article views two different approaches that economic reforms might take: More government provision of goods and services, or less government supervision of economic activity. I am in favor of the second. The article is freely accessible on Project Syndicate website.

It has also been translated to Arabic, Spanish, Russian, French, Italian, and Mandarin Chinese.