Capitalism: Money, Morals and Markets
By John Plender
Capitalism, by which I mean a market-based system where private ownership of industry and commerce is supported by property rights, has lifted millions out of poverty. Since the start of the industrial revolution in the eighteenth century, living standards in the West have been transformed.
And since the mid-twentieth century, the process of industrialisation and urbanisation that holds the key to raising rates of economic growth has spread to the developing world.
According to the World Bank, the number of people living at or below $1.25 a day, after adjusting for the purchasing power of the dollar in different countries, has fallen from 52 per cent in 1981 to 21 per cent in 2010 – a transformation in living standards without precedent in human history. *
As Karl Marx rightly perceived, industrial capitalism has always been inherently unstable, which is the first and most palpable defect of the system.
The environmental cost of bringing emerging market countries up to the per capita income levels of the advanced countries is rising all the time.
The rising living standards for which capitalism deserves credit are accompanied by a high degree of insecurity – an insecurity that is exacerbated at the time of writing by tight fiscal policies in the US and Europe.
The other key discontent about capitalism concerns its ethical basis.
The centrality of the money motive in driving the market economy has long been a worry for many. In the aftermath of the financial crisis, that concern has been heightened by extreme levels of inequality within both developed and developing countries.
There is also a clear sense of unease in the English-speaking world at the increasing financialisation not only of the economy, but of everything from public services to the arts.
Sadly, there is every likelihood that we will experience a further and more damaging crisis in due course.
The centrality of the money motive means that many of the winners in the system are often profoundly flawed or unattractive people. The successful capitalist is not always a great advertisement for capitalism, which is not helpful in convincing people of the merits of the system.
Karl Marx and Friedrich Engels, were pleased at the removal of feudal restraints on enterprise, but railed at the glorification of self-interest and what they saw as the morally scandalous foundations of capitalism. For them, the conflict of interest between rich bourgeois capitalists and poor exploited workers was irreconcilable. Others, following Rousseau, worried that the individualistic nature of a capitalist society was destroying a shared sense of community.
Perhaps the more legitimate heirs of the tradition of Goldsmith and Ruskin are today’s anti-globalisation and environmental activists who fear that a by-product of the capitalist pursuit of profit in a global free market will be ecological catastrophe.
The ultimate watershed on business’s long march from pariah status towards semi-respectability came when the Chinese leader Deng Xiaoping declared, after starting to open up China’s economy in 1978, that ‘to get rich is glorious’.
It in no coincidene that Ding’s conversion broadly coincided with the ascendancy of the Chicago school of economics and the presidency of Ronald Reagan, who oversaw the conclusion of the Cold War.
Other intellectual champions of this ethos included Ayn Rand, mentor of the subsequent chairman of the Federal Reserve Alan Greenspan.
The Japanese version of capitalism is uniquely egalitarian, with companies shareholders. In effect, Japan has tried to solve the ethical dilemma at the core of capitalism by turning capitalism into corporate communism.
Thrift and self-restraint disappeared from the very heart of the Anglo-American capitalist edifice, the financial system, in the first decade of the new millennium.
Money and business have suffered a major setback on the path towards respectability as a result of the great financial crisis that struck in 2008.
Voltaire, the great all-purpose Enlightenment intellectual, is said to have remarked that if you see a banker jump out of the window, jump after him – there is sure to be a profit in it. That neatly encapsulates the deep-seated popular conviction that bankers are among capitalism’s most self-seeking, devious and unfathomable creatures. It is a view that has been greatly reinforced by the recent financial crisis.
Indeed, a central lesson of the financial crisis and the Great Recession is that the world economy and the capitalist system are now hostage to oversized, over-complex and unmanageable financial behemoths. Banking thus remains profoundly problematic.
There is a more fundamental reason, albeit not well understood, why bankers will always incur ill will – namely that their business model is a confidence trick.
Hence the quip generally attributed to Henry Ford: ‘It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before morning.’
Why, you might ask, does society tolerate what amounts to a fraud against depositors and a powerful force for economic instability?
A rigid firewall was erected between commercial and investment banking by the Glass–Steagall Act of 1933. The legislation that imposed the division was repealed in 1999, when the world’s biggest banks were enthusiastically expanding while taking on more risk.
At the Bank of England, Mervyn (now Lord) King was notoriously uninterested in financial stability issues before the crisis.
The biggest banks in the US and Europe appear to have suffered an extraordinary collapse of ethical standards in the light not only of widespread mis-selling but of the numerous criminal charges brought against them for rigging the interbank lending rates used in global financial markets such as the London Interbank Offered Rate; rigging the foreign exchange market; criminal violations of the US sanctions regime against Iran; criminal drug money laundering; and facilitating tax evasion.
In the cumbersome bureaucracies of the international banking world it is unbelievably difficult to change a culture that has become so heavily infected by greed. It is probably impossible to change it when the incentive structures that govern executives’ behaviour are completely at odds with the demands of an ethical approach to doing business.
Tempting though it is to put bankers in the stocks, allocating blame is a less important priority than re-designing the system to prevent a further crisis. And the problem now is that despite its appalling cost in taxpayer bailouts and lost output, the crisis has not – incredibly – delivered a big enough shock to bring about a better, simpler and more fool-proof regulatory system, any more than it has succeeded in restoring the stock of moral capital.
A further snag in safety proofing the system is that the politicians, especially in the US, are beholden to Wall Street and the banking lobbyists because they are dependent on them for campaign finance. So attempts, misconceived or otherwise, to impose structural solutions such as the Volcker rule are being unpicked thanks to the efforts of the banks’ lobbyists.
When banks were smaller, the acute flaw in their business model – the confidence trick – was something that society could tolerate thanks to the ability of governments and central banks to stabilise the system. Today, it is quite another matter.
To put it crudely, capitalism has been hijacked by the banks. That is not how it is meant to work. The only question is how long it will take before the system blows up again.
The reality is that wealth in a modern capitalist economy comes from producing whatever it is that people want to consume. So if they want to consume more and more services, the service sector inevitably becomes a greater source of wealth than manufacturing.
Some economic historians argue that an oversize financial sector is an indication of national decline.
Indeed, as countries grow richer, people spend more on labour-intensive services like health care, leisure and education. *
More fundamentally, the decline in the manufacturing industry’s share of employment and output reflects economic progress in the shape of rapid productivity growth – an increase in the output generated by each individual worker. This is important for reasons outlined by the economist Paul Krugman: ‘Productivity isn't everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.’
Some economic historians argue that an oversize financial sector is an indication of national decline.
And where a country plays host to banks that are disproportionately large in relation to gross domestic product, such activity can wreck the economy, as Iceland, Ireland and Cyprus know to their cost.
It remains remarkable that the two great periods of financial dominance in the past 100 years seemed to breed huge inequalities of income and wealth, huge mountains of debt and great social tension, as well as precipitating crises that unleashed the Great Depression and the Great Recession.
When finance becomes increasingly remote from servicing industry and commerce, it is time to watch out. And when it becomes disproportionately large in relation to the economy, it needs to be cut down to size.
A striking feature of the Anglo-American approach to capitalism in the two and a half decades before the great financial crisis was a belief in what Ronald Reagan called ‘the magic of the marketplace’- underpinned by the best efforts of economists at the University of Chicago.
Implicit in the theory is the notion that capital markets are self-correcting.
Much of the instability that currently afflicts the world economy is a direct reflection of an aberrant turn in the direction taken by academic economics over the past sixty years.
Consider, first, the huge influence that the efficient markets hypothesis has had over the thinking of central bankers.
Missing from the work of efficient market theorists are the insights of behavioural finance, which brings the disciplines of psychology and sociology to the analysis of behaviour in financial markets.
Today, markets are dominated by professional fund managers. How can we explain the continuing existence of bubbles when professionals rather than inexpert individual savers drive the level of the market?
These fund managers, the agents, may have a very different agenda to that of savers and trustees, the principals.
Queen Elizabeth II famously asked at the London School of Economics why no one had predicted the crisis. But many had - and made fortunes out of it.
The reason so many people did predict these bubbles was that, on most conventional measures of market valuation observed over decades, the markets were hopelessly overvalued.
The trouble is that they are more readily identified by people who have worked in markets over decades than by academics, or by central bankers who are hostage to Chicago-induced myopia.
Going back over a much longer period, economics has incorporated an extraordinarily crude conception of human nature, with its belief in a perfectly rational, utility-maximising, autonomous individual.
The result, as the widely respected British economist John Kay has observed, is that their models resemble the completely artificial worlds found in computer games. *
The economists’ quest for the status of physical science for their discipline has also encouraged them to seek to drain their academic discipline of moral content.
A much better rationale for the crisis is to be found in the work of the economist Hyman Minsky.
In short, this economist, sadly unfashionable in the first decade of the new millennium, provided a remarkably accurate route map to the credit bubble and subsequent crisis.
The usefulness of modern economists is thus seriously in question. It is hard to disagree with John Kay’s assertion that they fail to engage with the issues that confront real businesses and households. Their forecasting abilities are not a great advertisement for the economics profession. And their modelling activity is rooted in a form of deductive reasoning reminiscent of the medieval schoolmen.
The belief in trade as a benign influence on relations between states is a fine example of the kind of thinking eschewed by modern economists, since it is unsupported by any economic model and is rooted in analysis of human motivation.
For his part, Adam Smith in The Wealth of Nations argued that consumption was socially benign and that the market economy was the best means for achieving what he called ‘universal opulence’.
Yet Smith went further than this. As well as suggesting that a commercial society was conducive to greater individual liberty, he thought that trade contributed to more peaceful relations among nations.
The notion that economic interdependence is conducive to peace has proved remarkably resilient.
For its part, the US has to fear that there might be circumstances in which China would be prepared to incur large economic costs in pursuit of broader strategic ambitions.
In practice, the striking thing about the relationship is how many unintended consequences have resulted from these two countries pursuing economic policies that are driven primarily by their own domestic concerns.
In extreme circumstances, it is possible that, as before the First World War, nationalism will trump economic interest.
There may nonetheless be room for a less strong version of the liberal internationalist thesis.
It certainly now seems inconceivable that a German army will ever again sweep into the Netherlands, Belgium or France. Nor does the US seem remotely likely to use force against another developed country.
Even so, it is not unthinkable that democratic, advanced countries will engage in future wars of plunder.
Speculation is as divisive a subject as money itself. It also has a special place, as we shall see, in the nagging debate on the moral character of capitalism.
Discussing the rights and wrongs of speculation calls for the making of important and often difficult distinctions.
From an economic perspective, then, there is good speculation and bad speculation. The good sort, based on sharp analysis of economic fundamentals, makes markets work more efficiently. The bad sort results from a bandwagon effect where speculators simply follow a trend.
‘Speculation is only a word covering the making of money out of the manipulation of prices, instead of supplying goods and services’.
Yet perhaps the real problem with speculation, as with so much in the workings of capitalism, is the in-built tendency towards excess.
It is, in the end, a question of balance. If speculation becomes excessive, the economic costs, as we learned in 2007–09, can be horrendous. We will be living with a hugely increased debt burden as a result, as will our children.
Somehow, saving seems more virtuous than debt-financed spending.
John Maynard Keynes referred to relations between debtors and creditors as the ultimate foundation of the capitalist system. And the ambivalence about debt has been reinforced throughout the ages by a heavy legal and cultural bias in favour of creditors against debtors.
The perennial revolutionary programme of antiquity was a call to cancel debts and redistribute land.
One can see all of economic history through this prism – a battle between those who lend money and those who borrow it.
Excessive debt, like fragile banking, can pose a serious threat to the workings of capitalism.
Conventional ideas of honesty require that debts be repaid in full. The imperative of economic growth, which we rely on to raise living standards, may mean that it is sensible to relieve the debtor of the full obligation. The question is how to strike a balance between these two positions.
Where private individuals are concerned, the historic trend has been for intolerance towards defaulting debtors to wane over time, as modern bankruptcy laws attest.
In 2012, the world’s pre-eminent currency, the dollar, could buy the equivalent of about 4 per cent of what it bought in 1913 when President Woodrow Wilson signed the Federal Reserve Act, the legislation that gave birth to the American central bank. Over the same period, the record of other central banks as guardians of the currency has been as bad or worse.
One of history’s lessons, then, is that freedom turns artists into entrepreneurs.
Andy Warhol, famously said that ‘finally one lady friend of mine asked me the right question: “Well, what do you love most?” That’s how I started painting money.’
The art critic Harold Rosenberg neatly characterised the radical nature of Warhol’s view of the artist as the producer of just another commodity:
It is very striking that over the past three decades, when art prices have achieved particularly dizzy levels, the rich in Britain and America have collected most of the gains in income growth while ordinary people’s incomes have stagnated.
Robert Hughes may have been exaggerating when he said that the art world was ‘the biggest unregulated market outside illicit drugs’, he was certainly onto something.
Taxation goes to the heart of the compact between the individual and the state in the system of democratic capitalism, involving a tension between people who feel they have a right to keep what they earn and those who argue that a just society requires the better-off to provide a safety net to the less well-off through the tax and benefit system. This boils down to the question of how to distribute the spoils of capitalism. *
It is much easier to raise tax to enhance the capacity of the state if people feel they can trust their fellow taxpayers and the government to fulfil their obligations. The only alternative, if trust is lacking, is tough or even savage enforcement.
The ability to extract money from the taxpayer is fundamental to the capacity of the state.
And it is striking in the history of capitalism that democratisation and liberty have expanded with the growth of the number of income and property taxpayers. In effect, taxpayers swap a share of their income for participation in the political process.
The post-war social contract brought about a growing willingness on the part of the electorate to accept the case for individual financial sacrifice for collective goals.
The collision of an inevitably imperfect tax system with the growth of public spending became acute as economic growth slowed down in the 1970s. At the same time, politicians acquired the habit of tinkering with the fiscal plumbing by offering tax reliefs to interest groups who might help put them in power.
Paradoxically, we now have more taxation without representation on a voluntary basis, because declining turnouts in elections in the US and Europe mean that a growing proportion of the electorate pays taxes but does not vote.
In contrast with the feudal period, when economic fluctuations were driven chiefly by the forces of nature, war or plague, capitalism introduced regular boom-and-bust cycles. The system is inherently unstable and has become more so as a result of the deregulation of finance since the 1960s. The economist Hyman Minsky provided the best explanation of the dynamics of this instability.
For modern politicians, the rate of increase in gross domestic product remains overwhelmingly important, imposing a yardstick that many feel reduces economic endeavour to banal materialism and to the commodification of human society.
The precise shape of a future crisis is always hard to predict, but against this background it seems likely to be very messy. What is clear is that any future crisis will be even bigger than the last one because banks are more concentrated as a result of mergers and acquisitions prompted by the 2007–09 debacle.
The position today is the same only more so. It is as if an innate feature of the roller-coaster capitalist system is that it constantly finds both old and new ways of making people uncomfortable.
The world economy thus remains hostage to the big banks and it does not require genius to see that another global financial crisis will strike in due course, even if marked progress has been made in reducing global poverty, the system has not shaped the political economy of a just society. *
The idea that speculation, debt and greed can be socially useful remains troubling for many. Moreover, the constant tendency to excess in the workings of the capitalist system, not least in the form of extreme inequality of income and wealth, erodes its legitimacy.
When disadvantaged people with low incomes observe that the political agenda has been corralled by the higher-income elite, they conclude that there is little point engaging with the game of politics and feel that taxes are an unfair imposition.
Attempts over centuries to legitimise capitalism, to make it respectable and to wish away the contradictions inherent in its ethical underpinnings, have nonetheless failed.
The arguments of today’s pro-market ideologues have been severely tarnished as a result of the recent credit bubble and the subsequent financial crisis.
The bankers have hijacked capitalism by exploiting the corporate governance vacuum, buying up the politicians wholesale through campaign finance and intensive lobbying.
The extraordinary scale on which big banks have been rigging interest rates and foreign exchange markets and ripping off their customers is almost beyond comprehension, as is the paltry nature of the penalties incurred by individual bankers.
In the end, it is the efforts of business people working within a market system that have lifted millions from poverty all across the world over the past two and a half centuries. It would take far worse than anything capitalism has inflicted on the world so far to
outweigh that enormous benefit on any true set of scales.
It is, in its way, a call for us all to grow up and seek to remedy the injustices of the capitalist system while acknowledging its merits.
Yet sadly, with politicians in thrall to the business and banking lobbies, the representatives of the people are not only unlikely to turn the money motive to best use; they are most unlikely to curb the excesses of an inherently unstable system through more stringent and coherent regulation.