Young Economics.

Do you know Capitalism, or just judge it?

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One of the most important questions floating around these days is what the financial crisis implies for the future of Capitalism. What strikes me as odd is how little is understood about this term. It seems to have morphed into something that could mean the market, materialism, freedom or greed depending on who you ask. So what is it?

This is tough question, especially for those under 30, because Capitalism is basically life as you know it. You are born into a society up and running with a belief system firmly in place. As you grow you see the outcomes and feel the restraints of the system, but what isn’t immediately apparent is the idea behind it all. But that’s all Capitalism is. Not the outcomes or the implications, but the idea.

Unfortunately it’s an idea that’s hard to judge on one side or the other. It seems like those in tough spots seem to really dislike it while those doing well fully embrace it. Can we say whether it’s good or bad thing? In my opinion, we can’t. Many hold that history has proven capitalist societies are more successful in the long run, but that’s the past. Our setting has changed in a big way over the last little while. Corporatism has taken over the business world, monopolizing most of our R&D work. Globalization and trade have linked countries together, implying national choices are now felt beyond borders.

Another important question is whether the metrics that history makes judgements upon still have relevance today. We hold up economic growth as our measure of success, but with a blossoming population of 6 billion+ is this really the best thing to look at?  It seems odd that North American investors cheer on sales explosions in yoga wear while the developing world goes hungry.  There’s a disconnect here.  The world is beginning to talk up sustainability,  however economists still revile at the thought of stagnation. Do these words not mean the same thing, but looked at in different ways?

So I suppose this post is just big questions with no answers. Unfortunately, that sort of sums up where the world is today in terms of this debate.  However, to get anywhere I believe we all need to know what we’re actually thinking about, and that’s why I wrote this piece. The Financial Times has been running a series of articles on the future of Capitalism, and this one by Nobel Laureate Edmund Phelps is truly special (link). In it, he attempts to define the system and then goes on to map its run to where we are today. Here’s the excerpt (it’s long but good):

Capitalism is not the “free market” or laisser faire – a system of zero government “plus the constable”. Capitalist systems function less well without state protection of investors, lenders and companies against monopoly, deception and fraud. These systems may lack the requisite political support and cause social stresses without subsidies to stimulate inclusion of the less advantaged in society’s formal business economy. Last, a huge social insurance system, with resulting high taxes, low take-home pay and low wealth, may not hurt capitalism.

In essence, capitalist systems are a mechanism by which economies may generate growth in knowledge – with much uncertainty in the process, owing to the incompleteness of knowledge. Growth in knowledge leads to income growth and job satisfaction; uncertainty makes the economy prone to sudden swings – all phenomena noted by Marx in 1848. Understanding was slow to come, though.

Well into the 20th century, scholars viewed economic advances as resulting from commercial innovations enabled by the discoveries of scientists – discoveries that come from outside the economy and out of the blue. Why then did capitalist economies benefit more than others? Joseph Schumpeter’s early theory proposed that a capitalist economy is quicker to seize sudden opportunities and thus has higher productivity, thanks to capitalist culture: the zeal of capable entrepreneurs and diligence of expert bankers. But the idea of all-knowing bankers and unerring entrepreneurs is laughable. Scholars now find that most growth in knowledge is not science-driven. Schumpeterian ¬economics – Adam Smith plus sociology – captures very little.

Friedrich Hayek offered another view in the 1930s. Any modern economy, capitalist or state-run, is a great soup of private “know-how” dispersed among the specialised participants. No one, he said, not even a state agency, could amass all the knowledge that each participant “on the spot” inevitably acquires. The state would have no idea where to invest. Only capitalism solves this “knowledge problem”.

Later, Hayek fleshed out a theory of how capitalism makes “discoveries” on its own. He had no problem with the concept of an innovative idea, for he understood that, even among experts, knowledge is incomplete about most things not yet tried. So he felt free to suppose that, thanks to the specialised insights each acquires, a manager or employee may one day “imagine” (as Hayek’s hero, David Hume, would have put it) a commercial departure – one that could not be inferred or envisioned by people outside the individual’s line of work. Then he portrays a well-functioning capitalist system as a broad-based, bottom-up organism that gives diverse new ideas opportunities to compete for development and, with luck, adoption in the marketplace. That “discovery procedure” makes it far more innovative than the top-down systems of socialism or corporatism. The latter are too bureaucratic to learn about ideas from below and unlikely to obtain approval from all the social partners of the ideas that do get through.


Written by jk

April 18, 2009 at 6:39 am

One Response

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  1. Later in the article he talks about over-leveraging and that reminded me to say something about the “leverage cycle” which they talk about in the latter half of this talk by Yale Economists on the current crisis:


    April 18, 2009 at 1:20 pm

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