The Current Crisis of Capitalism

The Crisis of Capitalism

The most common critique of capitalism is that while free markets are important, they may not necessarily produce results that are compatible with liberty. This is because capitalism evades the opportunity aspect of freedom that refers to the real opportunities (means) that one has in order to achieve what one has reason to value. Accordingly, Sen objects to libertarianism on the grounds that its ‘consequent-independent’ stance provides too restricted an information base to encompass basic variables that human beings have a reason to value.  Thus, stark poverty and extreme hunger can exist precisely because people have libertarian rights—the negative freedoms—but no right to nourishment which is a pre-condition for appreciating freedom. This means libertarianism is ultimately indifferent to achieving substantive liberty as an end. He raises the question as to why should the status of economic needs, which can be a matter of life and death, be lower than that of personal liberties?

Although the above critique is philosophically potent, the crisis of Capitalism is much deeper than it appears on the surface, and to explore such crisis full fathom, one needs to go back to the roots of capitalism and vet its key tenets one by one. Take, for instance, the apparently neutral objective function of profit maximization for a person, business firm or a financial institution. From both the ethical and economic perspectives, theoreticians and practitioners alike have yet to justify that unequivocal pursuit of profits is good for humanity as a whole.

A top-down consequential appraisal could possibly lead to the conclusion that just three centuries of industrialization with this aim has polluted the planet earth to the extent that probably for the first time in the history of mankind, the human species is at the risk of becoming extinct by the consequences of its own handiworks. The divide between self-interest and social interest has clearly widened at least along the important dimension of environmental protection as companies continue to de-forest and pollute through mining and manufacturing practices incompatible with sustainability. In terms of making any difference to the lives of hundreds of millions of world’s hungry and poor, the most profit maximization can achieve under ideal conditions is Pareto optimality, which is consistent with status quo and inequality. Not surprisingly, wider wealth circulation and poverty alleviation remain distant goals.

As an exclusive mandate for managers of business firms, profit maximization has frequently let down the world financial markets and national economies by introducing systemic shocks inspired at roots by corporate greed unchecked by decades of ‘deregulation’, another important policy tool flowing from the philosophy of ‘laissez faire’. As a result, corporate governance has been in shambles; the state ‘enthusiasm’ for deregulation has been dented worldwide; and Acts like Sarbanese-Oxley in the US, make provisions for having auditors upon external auditors to keep the latter on a straight and narrow path of integrity, while maximizing profits. The trickle down of deregulation and privatization has been in terms of increasing concentration of wealth as well as industry ownership more and more into a fewer hands in the society and undermining the very principle that exalted markets i.e. that a large number of players would promote competition and welfare of the ordinary.

In this context, the Marxian critique of paying subsistence wages to labor also appears lively and relevant especially in terms of those companies shifting manufacturing to loosely regulated developing economies. In brief, the divide between self-interest and social interest has been widening, and fair distribution and poverty alleviation remain distant goals. Monopolies in many industries across the world are on the increase including media—an important tool in the ongoing struggle among alternative ideologies for winning the hearts and minds of people.

Finally, when national tax codes shun wealth taxation, there are no limits to capital accumulation, and there are political/strategic compulsions on capital to be invested in certain national or geographical boundaries alone, then over time the rate of profit on the real sector is suppressed unless innovation is kept at a very high pace. Alternatively, in pursuit of quick profits, wealth has to be channeled to highly speculative means. Here comes the passion of contemporary wealth with financial markets and the resulting financialization of economies over time. The large amount of capital that has been accumulated in the private sector, when partially diverted into the financial sector rather than the real sector of the economy, creates a gulf between the underlying trend growth of the real productive sector vis-à-vis growth rate in the pricing of the financial claims—bonds and equities—on the values and returns from the real sector.

This is the area where the crisis of capitalism has emerged in its most devastating form. The unconventional perspectives on the recent booms and busts in the Western economies such as those put forward by Hyman Minsky or Kindleberger attribute such crises to greed, leverage and speculation—the factors loudly condemned in dissenting strains of economics, including Islamic Economics, but completely legitimized within capitalism. Even worse are the tactics of the celebrated ‘invisible hand’ to drive itself out of the economic recessions. Notable are the confessions of the celebrated lady economist, Joan Robinson:

‘It has not been proved that recessions can be avoided, except by armament expenditures, and, since to justify armaments, international tension has to be kept up, it appears that the cure is a good deal worse than the disease.’

And

‘The requirements of the warfare state and the welfare state meet in the export of armaments, which keep industry in ex-imperialist countries prosperous and permit enmities in the ex-colonial countries, which were frozen at the level of bows and arrows or flintlocks, to breakout with bombs and tanks.’

One last but by no means least critique of the capitalism deals with its undermining the popular franchise in terms of lobbying and corrupting influence in the political domain. While voting works on ‘one person, one vote’ basis, markets work in a different way—more dollars, more power to purchase, and more power to purchase means more power to lobby, intervene, and influence political decision making process. Here, the rise in the resources under the influence of a modern corporation and its association with and capacity to influence policy makers even in a democratic set up has been phenomenal as has been alluded by Robinson in the case of interests of the military-industrial complex.

To conclude, Rousseau (1712-78 CE) rightly anticipated the direction of things to come under laissez faire when he pronounced the egalitarian ideal that ‘No one should have either so little as to have to sell himself or so much as to be able to buy someone else’. It is high time that the academicians and practitioners get together to stitch this ideology in time to save nine.

Syed Nawab Haider Naqvi

Many an economic problem that the world faces today, particularly Occupy Wall Street movement and the Great Recession of 2007-2009, needs an in-depth examination and analysis of the basic truth about capitalism—a truth that has been forgotten since the 1970’s with the advent of Thatcherism in the UK under the influence of Von Hayek, and of Ronald Reagan in the US under the tutelage of Milton Friedman of the Chicago school, which is credited with unraveling the Keynesian Revolution and re-introducing the cult of self-correcting free markets. In fact, the real world events have proved them false prophets, whose message, spread by neo-liberalists, has done incalculable damage to the well-being of the people in both the developed and the developing economies by decelerating growth and generating large unemployment.

The Occupy Wall Street movement focused on rising inequalities in the US (We Are the 99 percent). Surprisingly, the slogan epitomizes daunting facts: it is the top 1 percent who has garnered most of income gains since the 1980’s, while the rest have experienced either a much slower income increase or stagnation and even decline in real terms, resulted in large poverty pockets and the emasculation of the middle class. The most thorough study of the rising inequality is the recent report of the Organization for Economic Co-operation and Development (OECD), which finds that the ratio of the richest to the poorest has increased from 9 percent in mid-1980’s to 14 percent in mid-2000 in the OECD countries , among which the lowest increase is in Nordic countries and the highest increase in the United States and some other countries. The Gini Coefficient in the same period has risen from 0.29 to 0.316 (a roughly 10 percent increase) and the latest trends are upwards with no end in sight.

Some may argue that the ratio is still quite low by global standards; it, however, needs to be realized that once the sense of inequality and social justice becomes embedded in the basic social institutions, it is hard to eradicate and it tends to perpetuate itself. This sense becomes toxic when growth rates plummet and unemployment rates rise. The sacrifices are borne by the poor and the middle classes while the rich manage to corner a substantial proportion of reduced wealth, and the governments are sitting idly by under the intoxicating liberalist message, that these inequalities are based on merit and the unemployment rates will be corrected by free markets.

At this point, it may be worth recalling the causes of the Great Recession that has slowed down growth rates and significantly increased the unemployment rates, which have stabilized around 10 percent in Europe and have recently come down a little to 9 percent in the United States of America. Truly, this recession has wreaked havoc on world’s financial system, which has suffered dramatic failure in managing risk.

To begin with schematically, a sky-rocketing of housing prices by 124 percent during 1997 to 2006 led to an unsustainable housing bubble. This was followed by a fall in housing prices and the bursting of the bubble. It then led to the collapse of the banking system, a stock market crash, and a sharp drop in output and employment. The link between these events is as follows:

• The housing boom was fed by huge accumulation of private debt and bank debt;
• The retail banks were allowed to underwrite and sell securities based on the mortgages of sub-prime borrowers;
• The leverage ratio was increased from 10:1 to 30:1 in 2004. Housing mortgage companies Fannie Mae and Fredrick Mac were encouraged to help middle income house owners, while other mortgage companies lent at practically zero interest rates even to Ninjas: borrowers with no income, no jobs and no assets. This led to sub-prime borrowing to the extent of 100 percent of the home value and more than 6 times the wage income of the borrowers. What made the financial system rickety were the so-called financial innovations: individual mortgages were bundled together and then sliced and diced into securities to meet the needs of investors in search of higher returns. As a result, a global inverted pyramid was built on private and bank debt on sub-prime borrowers.
• Trillions of dollars worth of these toxic securities got embedded in the world banking and financial system, which when bad times struck collapsed like a house of cards.

The downward slide began in 2007 when the high prices of houses began to fall because at such high prices, houses became unaffordable to the majority of home owners; the sub-prime borrowers defaulted in large numbers; the securities held by the banks lost in value; they stopped lending to borrowers leading to a credit crunch; the fall in commodity prices began and stock market crashed in autumn of 2008. All this led to the collapse of real economy—growth rates hurtling down and unemployment rates rising sharply—leading to a worldwide slump.
Many books were titled as such and published by reputable publishers, such as the Harvard University Press published Richard Posner’s ‘A Failure of Capitalism’ and other books were titled as ‘End of Capitalism’ etc. The most comprehensive account can be found in the US government’s Financial Crisis Enquiry Commission Report, which submitted its report in January 2011. It construes that, among other things, the main culprits were the lack of regulatory oversight, lack of safeguards in lending activities of the financial system and a systemic breakdown in accountability and ethics. More importantly, it concludes that the crisis was man-made and could have been avoided by timely regulatory action.

Initially, a near-consensus got built that these events constituted a ‘market failure’ on a massive scale and that if the system is allowed to proceed without strong corrective measures, then a situation like the Great Depression would be created, when output had fallen by 34 percent and unemployment had risen to 24 percent. Fortunately, it did not happen. The main reason being the big stimulus package of 700 billion plus and a total of 7 trillion plus were pumped into the banking and financial system in the US and similar efforts were made in Britain and also in China (500 billion plus) and other East Asian Tigers economies. There was a consensus initially that these steps prevented the worst—the Great Recession was prevented from plunging into Great Depression. It was recognized that Keynes was back in the saddle and saved capitalism once again from itself. China and the rest of the fast-developing countries, who rejected the liberalist medicine, got back on their high growth path soon thereafter.

But in the US and later in the UK and the rest of Europe just as their economies started to stabilize, a ‘great intellectual confusion’ ensued. Perfectly sensible economists—mostly the Fresh Water Economists, the ones schooled in the Chicago School—argued that these packages, in fact, obstructed the economy’s revival because the long-run multiplier of these packages was negative. They argued that the real remedy lay in lowering the taxes of the rich, cutting social welfare spending and balancing the budget. In the UK and the Europe, conservative governments have argued that balancing the budget will revive the economies and that fiscal austerity would lead to economic recovery. The recent agreement among the European Union countries has sealed this perverse doctrine in the economic policies of Europe, which amounts to committing an economic suicide on a massive scale. In the US the fight is on and nobody knows the outcome just yet.

It would be interesting to re-visit the core of these liberalist ideas to understand why they cannot work anywhere—indeed, have not worked anywhere. Contrary to the Keynesian type view, the liberalist doctrine is ascendant once again, even defying common sense. Conveniently forgetting the lessons learned in the post-war years, they have again reposed their faith in self-clearing markets and minimal government. According to them involuntary unemployment cannot exist and if it does it represents the failure of labor to accept a wage cut so that wages could be lowered below their marginal productivity. Once they do accept enough cut in nominal wages so that what they produce is worth more than what they get in terms of wages, everyone seeking the job would be fully employed.

Here economic agents hold rational expectations and know all possible conditional probabilities. Since these ‘all-knowing’ private agents can anticipate government intervention, say to control inflation, so the government action would either be redundant or counterproductive. Surprising as it may seem, these views have been held widely in the academia and, through the IMF patronage and the Washington Consensus, exported to the slow-growing countries in need of external help, the fast-growing economies of Asia, Latin America and Africa having rejected these views. These ideas are not new: they existed even before the Great Depression, and yet they have been resuscitated.

This intellectual confusion contrasts with the intellectual clarity that came to prevail in the wake of the Great Depression, when it was realized that since a capitalistic economy is liable to go off the rails mainly because of the uncertainty that normally beclouds the future; the fact that economy is governed by human instincts that are both rational and irrational; and that instability is part and parcel of capitalism, which needs constant, not off and on, course correction; it needs constant government oversight, meaning thereby, a significant role of the government in economic affairs. As this lesson took roots in the Western World, after the Great Depression was ended by the large spending to fight the Second World War the Keynesian view prevailed throughout the world; and fairly long period of economic prosperity—high growth, very low unemployment rates and moderate inequalities of income and falling poverty—ensued throughout the world. These views are needed again to save capitalism from itself.

The point needs to be remembered that the capitalistic system is crisis prone and breeds inequality. It has rocked stable democratic countries like the US and Europe. To offset these de-stabilizing tendencies, it needs constant public oversight. The liberalist idea of rational individuals guided by nothing better than a selfish regard for their own interests, hell-bent on maximizing their private gains, oblivious to the effects of these decisions on others in the society is no more than a myth. Several contributions to the current debate have pointed out the need for honesty in financial matters and an ethical regard to the needs of the people whom it is supposed to serve, especially those of the least-privileged in the society, to secure  socially desirable outcomes in a  capitalistic system. In other words, the capitalistic system, based on greed and an uncontrolled love for money and without active oversight by the government, cannot, repeat cannot, function for the good of the society. The clouds of confusion that have engulfed the realm of thought and policy-making need to be decisively dispelled.

Fasih Uddin

The rich world is under persistent stress for the past several years. Along with recession some countries are under added pressure: the US is hit by corporate scandals and greed; European Union by threat to Euro; and Japan by the devastating earthquake of last summer. The gravity of the situation is heightened by protests and agitations across major cities of the Western world. Some surmise it as the fall of capitalism while others consider it as the cyclical phenomenon.

In this context, it is important to analyze the gravity of the situation and highlight some critical elements of the crisis, which would help draw some lessons for Pakistan.