This is the promised follow-up to the earlier article Hidden Truths About Modern Capitalism, based on Cambridge economist Ha-Joon Chang’s easy-read book 23 Things They Don’t Tell You About Capitalism.
To refresh your memory, these two hidden truths, or “things,” were explained previously:
Thing 1: There is no such thing as a free market. The truth is, so-called free markets, the foundation of Freidman economics, simply do not and cannot exist in the real world. They are a fantasy, and pretending you can create such markets by formal de-regulation only screws it up for everybody.
Thing 5: Assume the worst about people and you get the worst.The truth is, no society, much less any economic activity, can survive and work efficiently if everyone really operates on the rational basis of grabbing their own short-term personal profit by any means possible, because the system would completely collapse under the weight of cheating, catching cheaters, and punishing them. No trust, no market.
Chang describes 21 other fallacies embedded in the modern theory of free market capitalism. He deconstructs each with devastating accuracy while still making it quite evident that he is not against capitalism as such, only against the peculiar way market capitalism—- or at least its current theory and practice—– has manifested itself today. Indeed, free market capitalism is not the only way to organize capitalistic enterprise, although its adherents (corporate CEO’s, Wall Street financiers, and their Republican sycophants) would like to convince you that it is. They demonize anyone who says otherwise, primarily because, the way they work it, most of capitalism’s many benefits accrue to them, and they want to keep it that way, syphoning the wealth of society out of our pockets into theirs.
While each of Chang’s “things” are insightful, and can arm you with powerful arguments against the depredations of ardent free marketeers, some of his “things ” go straight to the heart of basic free market’s false premises, and a progressive can find them very soul satisfying. Here are some more examples.
Thing 7: Free-market policies rarely make poor countries rich. What they tell you: After World War II newly independent countries tried to develop via state intervention, including socialism, with anemic results at best, or, more likely, disaster and stagnation; their economies did not turn around until each country adopted free-market policies (usually under guidance/coercion from the World Bank and IMF).
What they don’t tell you: In fact, “the performance of developing countries in the period of state-led development was superior to what they achieved during the subsequent period of market-oriented reform.” Examples: in the 1960’s and ’70’s, Latin America grew at 3.1% in per capita terms, while in the period 1980-1990, the time of “market-reform,” it grew one-third as much, or only about 1.1%; Sub-Sahara Africa, unfairly considered by free marketeers to be “destined for underdevelopment” (see Thing 11) grew at 1.6% in the ’60’s-’70’s, but only 0.2% once the free marketeers took over. Not only do free-trade, free-market policies rarely work in real life, the rich, developed countries show historical hypocrisy when they impose those policies on the poor, undeveloped nations of the world while falsely claiming they themselves achieved their present state of wealth thanks to free-trade and free-market attitudes. In reality, “virtually all of today’s rich countries used protectionism and subsidies to promote their infant industries,” including the United States. Alexander Hamilton, our first Secretary of the Treasury, used protectionism to nurture our young industries, and also insisted on government investment in infrastructure like canals, a national banking system, and government bonds (i.e., federal debt)—- a full-blown plan of what we would call state intervention. Even Andrew Jackson, “protector of the ‘common man,’ and fiscal conservative,” who paid off all federal debts, was “notoriously anti-foreign” when it came to foreign ownership of American business, including specifically banks.
The free marketeer argument that America, because of her exceptional circumstances, would have grown in spite of protectionism is false, because many other rich countries succeeded with similar protectionist policies while not having similar exceptional circumstances, countries like Korea, Switzerland, Finland, Germany, even Great Britain, which successfully invented the industrial revolution in the late 1700’s, thanks to protectionism and state intervention. Great Britain only adopted free trade in the 1860’s, after it had firmly established its industrial dominance, as did the United States from the 1980’s on. Then, of course, there is China, with its rapid growth under state capitalism; it is neither a free trade nor a really free market country. “Free-trade, free-market policies are policies that have rarely, if ever, worked.” So much for NAFTA.
Thing 16: We are not smart enough to leave things to the market. What they tell you: “We should leave markets alone, because, essentially, market participants know what they are doing… they are rational,” and, since no government can know their circumstances as well as they do, government interference or regulation is bound to produce inferior results.
What they don’t tell you: People really do not necessarily know what they are doing because the world is too complex and too full of uncertainty. Remember Alan Greenspan, former Chairman of the Federal Reserve Board, who finally admitted it was a “mistake to presume that the self-interest of… banks is such that they were best capable of protecting shareholders and equity…”, and also the Nobel laureates Robert Merton and Myron Scholes with the hedge fund Long-Term Capital Management. Their model for determining the asset pricing of derivatives greatly contributed to LTCM’s bankruptcy in 2000, and they each then went on to similarly bankrupt two other hedge funds. In other words, even professional, full time economists do not know what they are doing. Not only that, even decisions which may seem completely rational for a particular individual or company can lead to a collective irrational outcome—- that is, to market failure, as it did in 2008. “The problem is that we are not even rational to begin with,” so why do we depend on a free market theory which assumes that we are?
In other fields we deal with this complexity and uncertainty by what Herbert Simon called “bounded reality.” He meant that we limit the complexity of problems by restricting our freedom of choice. We already do that in our personal lives by creating daily routines so as to keep from constantly making decisions over and over. What this means when it comes to dealing with the repeating and ever-more-serious financial crises and market failures of free markets is government regulation, especially of financial instruments and the financial market (but also new drugs or other products, the environment, pollution, and so on). It is not necessary that the government “know better” than market participants (although sometimes it does, see Thing 12), because it is by regulation that we can limit the complexity of the activity, and that enables the regulated to make better decisions—- it creates “bounded reality.” I say, we have rules for every game human beings play, why not for the financial game?
Thing 22: Financial markets need to become less, not more, efficient. What they tell you: “The rapid development of the financial markets has enabled us to allocate and reallocate resources swiftly.” Our efficient financial markets are the key to our nation’s prosperity, so it ill behooves us to meddle with them just because of the recent “once-in-a-century financial crisis that no one could have predicted.”
What they don’t tell you: Actually, financial markets nowadays are too efficient. The plethora of clever new financial instruments may have made it very easy for the financial sector to generate huge profits for itself while allocating capital ever more rapidly around the world, but it has also made the overall economy, including the financial system, more unstable. Financial capital is impatient and demands quick, short-term gains, unlike the patient capital used in long-term development of real assets in the so-called “real economy.” Finance turned out to be so profitable that even manufacturing companies morphed into financial companies, so that 45 percent of GE’s profit came from GE Capital in 2003, 80 percent of GM’s profits were from GMAC in 2004, and Ford made all its profits from Ford Finance 2001-2003. The companies made more money by shuffling financial paper than by making automobiles, a fact which to my mind helps, along with globalization and outsourcing, to explain the hollowing out of American manufacturing (keeping in mind the free marketeers’ emphasis on quarterly profits).
The ratio of financial assets to national GDP in the United States, which was 400-500 percent 1950-1970 shot up following the 1980’s deregulation spree to over 900 percent after 2000. This indicated that more and more financial claims, in the form of those new financial instruments, or derivatives, like mortgage-backed securities, were being created for each underlying real asset or economic activity. These collateralized debt obligations, or CDOs were used to create derivatives of derivatives, or CDOs-squared, then CDOs-cubed, then credit default swaps supposed to protect you from default on the CDOs… and so on, a dizzying tower of cards all based on the same underlying real asset. No one could price these squares and cube accurately. I would also point out that computer programs traded (and are still trading) the derivatives back and forth in nano-seconds for short-term gains, far beyond the capacity of any ordinary human investor to compete or control. All this creates economic instability in the short-term; in the longer run it cuts down on the investment of long-term patient capital in real factories and assets, and depresses productivity growth. I believe this helps in part to explain our slow recovery, and why banks are not lending the trillion dollars they have in their vaults: they’re playing with the money in the finance casino. We can, therefore, expect more market failures and more economic pain because nothing really has changed.
Here’s the complete list of Mr. Chang;s Things:
1- There is no such thing as a free market
2- Companies should not be run in the interest of their owners
3- Most people in rich countries are paid more than they should be
4- The washing machine has changed the world more than the internet has
5- Assume the worst about people and you get the worst
6- Greater madcroeconomic stability has not made the world economy more stable
7- Free-market policies rarely make poor countries rich
8- Capital has a nationality
9- We do not live in a post-industrial age
10- The US does bnot have the highest standard of living
11- Africa is nbot destined for underdevelopment
12- Governments can pick winners
13- Making rich people richer doesn’t make the rest of us richer
14- US managers are over-priced
15- People in poor countries are more entrepreneurial than people in rich countries
16= We are not smart enough to leave things to the market
17- More education in itself is not going to make a country richer
18- What is good for General Motors is not necessarily good for the United States
19- Despite the fall of communism, we are still living in planned economies
20- Equality of opportunity may not be fair
21- Big government makes people more open to change
22- Financial markets need to become less, not more, efficient
23- Good economic policy does not require good economists
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