One cannot even casually peruse a
newspaper or business magazine these days without
chancing upon a diatribe or five about capitalism,
its numerous failings and supposed cures.
Commentators ranging from Martin Wolf in the
Financial Times and the redoubtable John Kay have
joined the chorus that first seemed to have
emanated from various left-wing publications in
both the United States and Europe.
Some of
the hand-wringing about capitalism seems to be
motivated by outright politics as in the case of
the shrill criticism of putative Republican
contender for president, Mitt Romney's
"egregiously low" tax rates; some of the ideas
were presented in the latest State of the Union
speech by President Barack Obama.
European
leaders sang from their self-righteous podiums about
the evils of capitalism,
and were even joined by Prime Minister David
Cameron of the United Kingdom. Elsewhere, it was
self-preservation that seems to be the main
motivation as in the case of assorted billionaires
from various emerging nations who wanted to
discuss greater equality at the World Economic
Forum in Davos, Switzerland, this week.
There were also the usual gaggle of
unintended comic performances as in the case of
the Francois Hollande of France who declared that
the financial sector was too powerful and ran an
invisible government: admittedly a rum thing for
someone from France to say given the serial
rescues of Credit Lyonnais by the French
government over the past 20 years (its latest
avatar, Credit Agricole, is also set to receive
government assistance for capital this year).
All this was a bit of deja vu for me,
having first spotted the trend and dissected it at
length in an article on these pages over three
years ago: see Deaf
frogs and the Pied Piper, September 30, 2008,
Asia Times Online, wherein I discussed at some
length the context of failures in non-market
economies and the locus of the 2008 financial
crisis being state-sponsored intervention (such as
Chinese reserves build up versus currency
appreciation).
Woe betide me, because the
Pied Piper of Humbug economics is once more upon
us; necessitating a further refresher course for
those who came in late.
Bain versus
bail Let us first examine the whole fracas
over Romney's taxes and the furor over his time at
Bain Capital. The controversy appears to hinge on
two specific aspects namely the differential tax
rates between income and capital gains ("carried
interest" in the lingo of private equity) and
secondly the process of eking out those capital
gains that involved job cuts in the name of
efficiency gains. First things first, and it
is straight forward for Romney and his cronies
(which they seem a tad coy to suggest) to state
that Romney paid exactly the taxes that were asked
of him by the country's laws. Change the laws if
you don't like the results but don't blame the man
for following the law.
Behind that
argument around tax rates though is the question
of whether such differential tax rates are
warranted. The simple reason for differential tax
rates between employment income such as salaries
and income from capital gains is that the level of
financial risk involved. In delivering certain
services against a salary, a person takes fewer
risks than a pure financial investor who may lose
their investment if the idea proved unworkable.
Then there is the second argument namely
that making money from private equity was somehow
unpalatable as it necessarily involved the process
of firing unnecessary workers and cutting costs;
in order to turn situations around and by selling
those corporate financial assets (bonds, stocks)
later at higher valuations.
The logic can
be illustrated as follows: imagine a company
making $1,000 in profit with 10 employees who each
make $100; assume no other costs and total
revenues of $2,000. Workers pay 40% taxes on their
wages, so the government collects $400 from them.
If a private equity chap came by and
bought the company for say $2,000 (or 2x profits),
he would then cut five of the workers while making
small improvements to keep total revenues at
$2,000. All told, the company's profits would now
go to $1,400 (accounting for the five jobs lost
and the $100 in new costs for machines), which
means the company would be sold for $2,800 (still
2x profits).
On this $800, the private
equity guy would pay taxes of say $100, far lower
than the 40% paid by the workers (so the fired
workers paid $200 in taxes between them). Net-net,
the government has lost $100 in revenues.
This argument is entirely logical, and
also entirely bunkum. For one thing, the obvious
gap is the difference in corporate taxes - say the
company pays taxes at 30% then the corporate tax
collections go from $300 to $420. In total, the
government is ahead by $20, not behind by $100 as
the Krugman school of idiot economists would have
you believe. That's before you count the higher
dividends that will accrue to the new owners who
purchased the company at $2,800 and will eke out
dividends for a long time. It also assumes that
the five laid off workers will never find another
job.
From a systemic perspective, it is
thus almost impossible to fault the idea of
private equity sponsored turnaround of a company.
It goes without saying that the above example is
overly simplistic in that it doesn't even start
with a loss-making company with significant
bankruptcy risks; which is the stock of
acquisitions many private equity companies
actually make.
What's left is the moral
argument namely that retaining unproductive (or
sub-productive) workers is somehow morally
superior to making more profits. That notion goes
against the grain of Ricardian efficiency that is
at the heart of modern living: if full employment
was the overriding goal then we should all be
tilling fields, tending cows, weaving cloth and
tailoring our own suits. Wages are the monetary
representation of a person's abilities given
skills, locations and competitive advantages.
In the above example, if the work of 10
people could be done by five people and a machine,
then the other five could go and get the right
wages for their skills elsewhere : either another
factory or the next town. In contrast, keeping
them in a low productivity environment ends up
entrenching inefficiencies; thereby building up
longer-term costs.
It shouldn't be too
difficult to visualize such an economy where
worker "rights" took precedence over the returns
on capital: remember the Soviet Union?
The bailout economies Socialism
is a bit like that old joke about everyone wanting
to go to heaven but no one wanting to die quite
yet. This is the other side of the equation;
namely the wonderful world of artificial stability
- ie bailout economics arising from the need to
preserve stability thereby perpetuating failed
economic ideas. The most recent (and arguably most
egregious) example of the trend was the bailout of
US and European banks since 2008.
Ostensibly the villains of the global
financial crisis, banks got a free pass from
various governments who were too scared to touch
them in case lending to the "real" economy seized
up. In the event, the banks took the bailout
money, hired a bunch more useless traders, punted
heavily in bond markets and as of end-2011 tried
to reverse all the hiring and balance sheet
expansion. Lending to the real economy did seize
up meanwhile; and debates about how much bankers
are paid have only intensified.
As France
should have learned from the serial bailouts of
Credit Lyonnais - but was prevented from doing so
due to blind nationalism and the kind of stupid
all-pervasive fear that is provoked by socialism -
the culture of bailout actually serves to solidify
otherwise unworkable business models.
Whatever be the argument of the Keynesians
and Krugman acolytes, the simple fact is that the
collapse of Lehman Brothers in 2008 did more to
reduce systemic risk than all the subsequent
action of governments keen to preserve economic
status quo.
Creative destruction, a term
coined ironically enough by a Frenchman
(Schumpeter), is like the small forest fires that
keep things tidy. Stop these fires - as others
have pointed out - and you merely lay the ground
work for an impossible-to-control conflagration
that wipes out forests and cities next to the
forests. On cue, the European sovereign debt
crisis which was in essence created by the
attempts to stabilize income levels of people at
economically impossible levels.
The worst
possible thing about socialism is the inconvenient
facts that stare you in the face: look at the
supposedly socialist economies such as France or
Italy; or Mexico and India at the other end of the
spectrum. The most remarkable thing is the
concentration of economic power in the hands of a
few individuals who are rich beyond all norms in
those countries. Indian billionaires have quite
literally constructed their billion-dollar palaces
on the roofs of shanty towns nearby, while Mexican
billionaires charge rent for every basic activity
such as making a telephone call.
Considered in that light, the fabulous
wealth of a few software and Internet
entrepreneurs, not to mention the odd private
equity guru, hardly seems either offensive or
undeserved.
Fixing
capitalism None of the above though should
be construed as my belief is laissez-faire
capitalism. Far from it, I believe that capitalism
is the best system mankind has tried, but it
remains far from perfect. The simple tale of
Mexican billionaires goes to show the unintended
effects of socialism.
All too often calls
to discipline capitalism are made by people who
previously failed to police the systems under
their supposed regulatory controls. Failing to
keep pace with technological changes and failing
to grasp the unintended effects of liberalization
(on the one end) and market intervention (on the
other), central banks made a complete meal out of
the risks in the global financial system in the
years before the financial crisis.
Asking
people with such poor skills to now introduce new
regulations and assume greater power over
economies is akin to one handing over a delicate
garland of pearls to a hungry monkey. Even so,
there is need for greater regulation and policing
of the global economy as well as its various
component parts ranging from trade to finance. The
real trouble is the absence of credible
institutions with which to execute such regulation
and policing.
Until credible politicians
come along, we will be forever at the mercy of
assorted Pied Pipers, who shall play the
sweet-sounding but meaningless tunes of stability
and equality from the land of Humbug.
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