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17 October 2020

Capitalism in Crisis

Tag(s): Foreign Affairs, Politics & Economics, Languages & Culture, Business
This is my 500th blog. I started writing these in 2009 when my idea was to draw traffic to my new personal website in order to sell my services as a non-executive director, adviser or consultant. I have now retired from paid work other than my writing and no longer seek that traffic for that purpose. But the blogs have taken on a life of their own and I continue to write them for pleasure and I hope for the interest of my readers. I get positive feedback from some of them; indeed I think it has helped me maintain long-term friendships by having such dialogue. As regular readers will know I have covered many different subjects. Cumulatively the blogs represent over 740,000 words, the equivalent perhaps of six books.

On this occasion I want to write on what I think is one of the most serious issues facing the world. And no, I don’t mean the pandemic, serious though that clearly is. I think there is a bigger danger that could have a longer lasting impact on all our lives if it is not met and that is the crisis that the capitalist system now finds itself in. I find it quite extraordinary that after the numerous failures of socialism/communism without a single success, there are still people who advocate this horribly flawed way of life but I do not doubt that capitalism is not without its flaws and needs constant revision and reform.

There are many ways in which capitalism can and should be reformed and its institutions revised. But there has been considerable human progress over the last 200 years by gradually developing the regulation of private enterprise and the provision of social welfare.

It is the endeavours to replace a capitalist economy completely that have without exception ended in unmitigated catastrophe. In his book Socialism: The Failed Idea That Never Dies Kristian Niemetz absolutely nails the excuse that socialism hasn’t really been tried. Of course it has.

According to Niemetz  “Over the past 100 years there have been more than two dozen attempts to build a socialist society. It has been tried in the Soviet Union, Yugoslavia, Albania, Poland, Vietnam, Bulgaria, Romania, Czechoslovakia, North Korea, Hungary, China, East Germany, Cuba, Chile, Tanzania, Benin, Laos, Algeria, South Yemen, Somalia, the Congo, Ethiopia, Cambodia, Mozambique, Angola, Nicaragua and Venezuela.

Each of these failed experiments has gone through three stages. Initially there is a period in which the latest socialist model is proclaimed to avoid the problems that killed off its predecessors. So it seems that Venezuela, for example, did not follow the path of Stalin. No, what happened there has been even worse.

Then there is the excuses stage when obvious catastrophe is blamed by its apologists on so-called Western imperialism, intrigue or sanctions. Then in the end when the whole authoritarian, poverty creating mess can no longer be denied nor the blame averted, the model and its leaders are disavowed and we are told that it wasn’t real socialism after all.

What makes this even more clear is that in the 20th century we had two perfect laboratory experiments to demonstrate the contrast between capitalism and communism, one in Germany now relatively happily resolved and the other still continuing in Korea.

Germany was divided at the end of the Second World War with the West being occupied by the Western allies USA and the United Kingdom and the East being occupied by the Soviet Union. In the West the allies took great trouble to help the Germans rebuild their country and their economy with democratic leadership and with strong financial support in the form of the Marshall Plan. There was also soft support in other ways, for example the British advised the Germans on what kind of trade unions they should have which meant that industrial relations in West Germany were particularly good. In the East the Soviet Union imposed their communist system, determined who would lead the country and enforced this through their control of the Warsaw Pact.

In order to maintain control of the country the East German government had one of the largest secret services of any country on earth called the Stasi. Neighbours spied on neighbours and children even grassed on their parents. They had to build a wall to stop people in Berlin, which was also divided East and West, from escaping to the West. Before the wall was built 3.5 million had circumvented rules to flee to the West many by crossing Berlin. There was no single example from 1961 when this wall was built to 1989 when it was dismantled of anyone attempting to cross the wall from the West to the East. Over 5,000 people escaped from the East to the West and it is estimated that 239 were killed in the attempt.

When the Soviet Union split apart under similar forces from within, it lost its ability to police and control what was happening throughout the Warsaw Pact countries. Many rebellions took place everywhere with governments falling. The Berlin Wall was dismantled. In 1991 the governments of West and East Germany agreed to merge and reunite the country as a single nation state. At that time the value of the Deutschmark, the currency of West Germany was eight times as high as the value of the Ostmark, the currency of East Germany but the visionary Chancellor of the day generously agreed to equalise into the unified Deutschmark. Even to this day there are still differences in economic performance between East and West, in employment levels and indeed in status but the reunification has been universally peaceful.

Korea was also divided with a war stimulated by the Chinese and with the United States and other Western alliance countries like the United Kingdom and Australia supporting the South. That war has never technically finished. What is the result?  After nearly 70 years of capitalism South Korea is one of the most prosperous and successful economies in the whole of Asia, probably second only to Japan. Some of its companies like Samsung and LG are giants on the world stage. When I visited South Korea on business years ago the people with whom I had negotiations were some of the most aggressive and competitive people I have ever come across. North Korea by contrast is one of the biggest basket cases in the world. Its people live largely on starvation diets under the most extreme oppression and like other such stupid countries what money it has it invests in trying to develop nuclear weapons.

One of the constants of socialist/communist countries is that because socialism is so contrary to normal human nature it has to be enforced by dictatorship, by brutal police methods, by secret police and by strictly controlling its borders. When my wife and I went on holiday to Cuba a few years ago we got on very well with our very friendly guides with whom we went on tours around the country but we were shocked to learn that even though they were travel guides they themselves had never been allowed to leave the country. Only people in a limited number of professions have the opportunity to visit other countries. They are politicians and diplomats of course, and doctors, sportsmen and ballet dancers. Everyone else must stay in Cuba. It is simply because the authorities know that if they allowed people to travel the majority would never return.

But there is much that is unhealthy about capitalism today and unless some serious issues are addressed it will again come under pressure from those who wish not just to reform it but to abolish it and then take us back to the dark ages all over the world. Let's start with the banks.

The current economic crisis in the face of the pandemic and government’s reaction to it cannot be blamed on an economic system because it is affecting every country in the world. Indeed those countries that have authoritarian governments may be able to deal with it more effectively than those that prefer to live in liberty. However, the banking crisis in 2008-10 was directly caused by the banks. For years they had systematically bet on packaging poorly performing loans, particularly mortgages as financial instruments. Once these inevitably collapsed it affected most economies very negatively and put them into recession. Governments then bailed out these banks with public i.e. taxpayers’ money so that the banks could continue as a fundamental part of the economy. In the short-term these actions were undoubtedly correct but they should have been conducted with a series of rules being put in place to ensure that such problems did not recur. If you analyse banks over a long period of time you can see that they are not particularly profitable because on a quite frequent basis they fail and have to be bailed out. During the good years their managers pay themselves colossal salaries and bonuses. In the bad years they continue to pay themselves colossal salaries. They may forego the bonus but they should really pay back all the bonuses they had paid themselves in the previous 10 years. These bonuses should only be calculated on a long-term basis and should be linked to shareholder value. They should not be linked to short-term gains. This is one of the things that is fundamentally wrong with banking and indeed other parts of the capitalism system.

The capitalist system is often described as a free market system. This is not the case. The only free markets are the illegal ones in the sense that they are not regulated. When the Americans unwisely prohibited the sale of alcohol the business of alcohol simply went underground and became a new revenue stream for the mob. It also meant that anybody could produce alcohol and no one knew to what standard it was being produced. In a regulated market alcohol is regulated very highly. Its standards are maintained at national and international levels and its product is a good one.  I don’t mean that in the sense they are liked but in the sense that the product is produced to high standards that are regulated. That is not a free market. Banking is also regulated but to a very poor level. We have seen very few people pay the price for the banking failures of 10 years ago and I think it is inevitable that such failures will be repeated in the not too distant future.

An important part of capitalism is competition. Just as an important part of Communism and one of the reasons it fails is the lack of competition because the state controls the means of production. Therefore you get a lack of innovation, of productivity and of quality. In a competitive market where you have to win the right to have a customer through good service and/or good product it is also important that no one company becomes dominant. The authorities have been foolish to allow companies like Amazon, Google, Facebook and Apple to achieve such dominant positions. The United States Congress has just received a very considerable report to this effect but these companies are now so huge and so rich that it will take many years and many legal fights in order to break them up and moderate their behaviour.

The capitalist model is variable and there is a lot of evidence that different models deliver different results. On the whole family-controlled businesses outperform publicly quoted ones for the reason that family businesses tend to take a longer term view whereas publicly quoted companies are concerned about announcing the next quarterly results and of course the shareholders are checking in and out of the shares like people checking in and out of hotels. Although I myself have invested successfully in a couple of private equity backed companies and was on the board of one, the private equity model is often abused. Too often the private equity investors load the company up with debt, extract the maximum value and hope they can sell it on by perhaps restoring it to the public markets which usually results in the destruction of value.

But the biggest problem lies in the reward structure. Over decades now the average wages in real terms of ordinary employees of American public companies has not increased while the rewards that the top executives pay themselves have increased many times. According to a 2018 report from the Economic Policy Institute the average CEO is paid 271 times the nearly $58,000 annual average pay of the typical American worker. That compares to 1978 when CEO earnings were roughly 30 times the typical worker’s salary so over the course of 40 years the differential, already high back then, is nearly 10 times as high.

Since 1978, and adjusted for inflation, American workers have seen an 11.2% increase in compensation. During that same period, CEOs have seen a 937% increase in earnings. That salary growth is 70% faster than the rise in the stock market.
CEOs defend this extravagant level of pay by saying that it is based on experience and what their role entails but this study found that is actually not the case. “CEOs are getting more because of their power to set pay, not because they are more productive or have special talent or will have more education,” says the report. “Exorbitant CEO pay means the fruits of economic growth are not going to ordinary workers, since the higher CEO pay does not reflect correspondingly higher output.”

The US tops the table for pay differential but we in the UK should not be complacent because the UK is third on the list on 201, behind India on 229. Then come South Africa 180, Netherlands 171, Switzerland 152, Canada 149, Spain 143, Germany 136, and supposedly Communist China 127.

This has to change.

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