Is Capitalism in Crisis? Posner

With the collapse of British socialism and Soviet (and satellite) communism, and the rapid economic growth of countries like China and India when they took significant steps toward a free-market economy, it seemed that capitalism had triumphed. But today, in the wake of the financial collapse of 2008 and the ensuing worldwide economic downturn, there are a growing number of doubters. 

As Becker points out, and as I have pointed out in my writings on the economic crisis of the past three and a half years, a combination of unsound monetary policy and regulatory laxity (nourished by the complacency of many influential macroeconomists) triggered a sudden, broad, and deep weakening of the banking sector (defining “banking” broadly to include any financial intermediary, whether or not it is regulated by banking agencies), a sector that is fundamental and pervasive in modern economies. Banking is inherently risky, because the basic model of banking is borrowing short and lending long (to create a spread, because interest rates are higher the less liquid the loan; without a spread a bank has no income). By 2008 most bank capital, though indeed short-term (much of it, indeed, borrowed overnight), was not insured by government. So the collapse of the U.S. housing market, in which that capital was heavily invested, precipitated a series of runs, and the runs froze credit, which disrupted the nonfinancial economy, leading to a downward economic spiral (layoffs by financial and nonfinancial firms alike, resulting in lower spending by consumers, in turn resulting in more layoffs, and so on). 

Banking is fundamental to capitalism, and financial instability is an inherent danger in banking, and a banking collapse can create widespread and persistent economic distress, and this combination helps to explain why the worldwide depression of the 1930s generated unprecedented support for socialism and communism. But socialism and communism have been discredited, and so there is no longer an alternative to a capitalist system—and thus no alternative to sensible monetary and regulatory policies that would avert a repetition of the 2008 and earlier financial crises. 

I think there may be a looming crisis of capitalism, though one that has nothing to do with banking, but rather with technological progress, and specifically with the effect of that progress on income inequality. Technological progress in recent decades has included not only the well-known advances in computerization, communications, and medical treatment, but also important advances in marketing, including political influence and manipulation, and management. The overall effects of these advances on many fronts have included a sharpening of competition, an increase in government debt to finance middle-class entitlements, particularly medical, a reduction in the demand for manual labor, and an increase in the financial returns to IQ and to higher education (which are correlated). These developments seem to be increasing the inequality of income and wealth and creating sharper class divisions than the nation had become accustomed to in the decades following the end of the 1930s depression. 

There is nothing in the economic logic of capitalism, any more than in the biological logic of evolution, that drives an economy toward income equality. The basic logic of both systems is competition, and competition produces losers as well as winners. A class of workers can become extinct, just as a species can. The difference is that the combined effect of envy and democratic politics can result in policies that distort competition in order to increase the welfare of the losers in the competitive struggle. Such policies tend to be inefficient and thus to retard the smooth operation of capitalism as an economic growth engine. Evidence for this proposition is found in the sluggish economic performance of many European nations. 

Growth-impairing policies that might reduce economic inequality include restrictions on the immigration of wealthy persons and highly educated persons, the promotion of unionization, heavy business taxes, high marginal rates of personal income taxation, government subsidization of business activities (“picking winners”), high government debt, a generous safety net that reduces incentives to work, and heavier government financing of education for members of lower-middle-class families. Such policies—most of them involving turning back the clock to the 1950s—would probably reduce the rate of economic growth. Could the impact of that reduction on future welfare be offset by gains in social peace? At present, the answer seems to be “no,” but if signs of social unrest, such as the Tea Party and Occupy movements, grow, the answer may at some point need to be reconsidered.

Comments

[TANSTAAFL]

Posner hits the bullseye. Capitalism itself is not the problem. "Envy and democratic politics" are a toxic mix, fueling a feedback loop of sorts that hinders economic growth and will reduce Americans to squabbling over how to carve up a stagnant pie.

[Mitchell K.]

Posner asks, "Could the impact of... reduction on future welfare [via growth-impairing policies that reduce economic inequality] be offset by gains in social peace?" He says that the answer seems to be "no." If the European experience is any indication then the answer is a resounding "no" (perhaps it is "NO!").

Reducing economic inequality by impairing growth may purchase short-term harmony, but it also fosters government dependency and a political class that promotes dependency (and class envy) to enlarge its political power. Social unrest during this recession has been far worse in Europe in spite of (or perhaps because of!) equality-friendly welfare policies.

Of course, some wealth redistribution in a capitalist society is politically inevitable (especially in an envious one). However, when society pervasively uses redistribution to appease the envious and purchase social peace then it will likely become an envious society if it is not already.

[Thomas Rekdal]

Economic contractions, no matter how severe, do not portend a crisis of capitalism, unless there is some more promising alternative; and Judge Posner is right, I believe, in pointing out that none seems to be on offer.

What we face is not a crisis of public confidence in capitalist institutions, but a crisis in the political culture of all modern democratic states. The early critics of democracy, in the late 18th and early 19th centuries, frequently expressed the fear that the lower orders, once they grasped the possibility of voting themselves benefits at the expense of others, would continue to do so until the state itself went bankrupt. These fears have been dismissed, along with Marx's prediction of the increasing pauperization of the the laboring classes, because they have not been borne out by history. But over the last forty years an entitlement mentality does seem to have developed in most democratic states which makes any rational system of public finance nearly impossible. Perhaps democracy's early critics only got the timing wrong.

[Ricardo Sanchez]

As a corporate attorney, I can confirm Judge Posner's great fear regarding wealth redistribution through government action. The United States for the last 30+ years has institutionalized a massive redistribution of wealth...to big business and inherited capital! Yet, it has been shown that 70% of NEW jobs are created by small business.

Individual incentive and entrepreneurship is the engine of the American economy. Apple computer, the most valuable company in the world, was started in a small garage and was personally financed through middle class wages. Mr. Becker correctly identifies China's competitive disadvantage. They have succeeded despite the government picking big winners. I would hope that Judge Posner revisit his understanding of capitalism. Everyone should revisit Adam Smith's "Wealth of Nations", as relevant today as ever not to mention his "Theory of Moral Sentiments."

[Stan in Michigan]

We're in a competition with China and other low wage countries, and if we're to hold our own we need as well educated a workforce as possible. So I find Richard Posner's inclusion of heavier government financing of education for members of lower-middle-class families in his list of growth inhibiting policies to be a real puzzle. If spending more on educating the middle class and the working poor is bad, would spending less be good? As George Will said in another context, the question answers itself.

[Just a first year law student]

The most prominent examples of government "picking winners" I can think of - subsidizing fossil fuels and mega farms - do not reduce economic inequality, they exacerbate it. And I find it unfortunate that the only result of the "combined effect of envy and democratic politics" referred to is distortion towards welfare of losers with no mention of how the same is often used to artificially prop up winners; although in the latter case it would be more appropriate to call it the "combined effect of greed and undemocratic influence peddling."

[air jordan 1 for cheap]

@-@ I won't forget you, still believe

[Stephan Wehner]

Not giving up the dream, are you? Very stubborn.

Seems to me that whatever measures you're suggesting have been applied in the past (Thatcher / Reagan), but without any impressive results.

Cheers,

Stephan

[burberry outlet]

I would agree with the other side aswell, great work

[NEH]

Although, I am mostly in agreement with our Host's analysis of current crisis, it mostly deals with microeconomic issues as opposed to more macroeconomic issues which are of vital importance to understanding and correcting the current crisis. Such that, we need to view social, political and economic phenomena operating on a sliding scale or a "pendulum system" someplace between two extremes. Keep in mind that this "scale" can be represented by "Capitalism" at one extreme, followed by "capitalism", then "socialism" and finally "Communism" at the other extreme and at any point in time the pendulum is moving through any of the positions on the scale.

Yet, what is causing this continual movement? Perhaps it is the phenomenon known as Kondratiev Waves in action. Such that, the socio-economic order truly operates on a cyclical basis between booms and busts. which goes far in explaining the economic cycle. See Schumpeter's "Business Cycles" and Keyne's "General Theory of Employment, Interest and Money". Yet, there is something else going on in this Crisis and I attribute it to the phenomena of "Hoarding of Capital". All economic systems operate on the principle of "Trickle Down/ Trickle Up". A dynamic system operates with Trickle Down and Trickle up working in unison and the end result is an egalitraian distribution of "wealth". When the system is broken (which it appears to be at present) Capital or wealth accumulates in one sector of the cycle stagnating. Which causes the overall economic system to lock up.

As for breaking up this economic dead lock and recreating a dynamic egalitarian socip-economic system one needs only look to F.List's development of the "National System of Innovation", A.Hamilton's various reports to Congress, especially the one on "Manufactures", H.Carey's "The Harmony of Interests" and fundamentally principles espoused in the "American School and Theory of Economics".

But for success, as has often been said, "We can succeed only by concert. It is not "can any of us imagine better?" but, can we all do better?" The dogmas of the quiet past are inadequate to the stormy present. The occasion is piled high with difficulties, and we must rise - with occasion. As our case is new, so we must think anew and act anew. We must disenthrall ourselves and then we shall save our country."

[TANSTAAFL]

Kondratiev waves? More likely "it is the very error of the moon; she comes more nearer earth than she was wont and makes men mad."

[NEH]

affl, Your very question points to a lack of training and understanding of the field of General Systems Theory and it's application to Economics. As for the rest, it seems too be remeniscent of the Ancient's Anthropomorphic World View where Fortune, Destiny and Lot were controlled by a plethora of Gods and Goddesses... ;)

[Jack]

"the promotion of unionization"

.......... these guys really have a "case" of it.

Do "we" know that unions, especially of the private sector cost us money? One the one hand "the market" likely offers "someone" at a cheaper hourly rate.

But! unions offer those who've committed to the trade, typically went through a multi-year apprentice program to not only learn their craft but to work safely (many will note the soaring costs of Workmen's Comp insurance) and! surely there are benefits in the prospective employer simply calling the union hall, rather than hiring and firing those who show up after running an ad.

BTW...... does Posner agree that perhaps second only to the AMA or the Dentists Assn that the Bar Assn is the strongest trade union in the nation? Why would we not allow one of those doing the grunt work of para-legals the option to hang out a shingle offering his services for simple divorces, wills for most of us, or handling small claims issues?

[Jack]

Thomas? Almost completely contradictory to the evidence.

The first that of capitalism, the system or engine, not being in crisis. So far we're not likely to toss the baby with the bath, but our "capitalism" suffers a host of maladies from anti-competitive special favors, laws and subsidies as to no longer be recognizable. For Exhibit A the 20 years of pawning off false flag "derivatives" and the corruption of the "financial sectors". Crisis? ask those of the long week-end when they woke up.

And... agreed, it turned out that the working folk have been too far from the centers of power to vote themselves nation tanking benefits...... that has been left to the wealthy who designed most of it for themselves and the corporations.

Marx? and the pauperization of those doing the work? To the benefit of the "owner class?" And which Marx predicted would tank the system.

Here's the graphs of the, now forty year trend:

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

......... do you see an "entitlement mentality" in these graphs? other than in the top couple of percent?

Lastly, looked around? or listened to the honest economists? What we have is a D E M A N D starved crisis in which 80% of our work force can supply all that is demanded, as those of long stagnant incomes, and lately no incomes suffer with unmet needs and wants that for the lack of any discretionary income are not turned into economic demand.

Crisis? We're about one fifty buck "Oil Shock" or another gob of "toxic assets" tumbling out in plain sight, from a complete death spiral. And.......... as in the last Depression, what effect on "capitalism" is such a failure likely to have?

[NEH]

Burberry (nice clothes, a little pricey though), FDAASDFDFEW? May I suggest an Acronym translator tag? See Strunk & White. ;)

[TANSTAAFL]

TANSTAAFL confesses envy for the impenetrable FDAASDFDFEW acronym.

[John]

Economic growth for what? To what end? these are the questions that Posner refuses to consider. It is only when we are explicit about the ends of economic growth, and not just the means of economic growth, that we can fairly argue whether redistributionist policies are counter-effectual.

[Jack]

John....... as near as I can tell, after 30 plus years of working folk not participating in the "rising tide" it's just more of the ALL FOR THE RICH agenda that, apparently, is a great flaw in unregulated "capitalism" and greatly exacerbated by "GOP" tax bennies for the richest among us.

BTW...... little has been made of the inducement of tax deductible interest on homes, coupled with NO cap gains on remodels, flips and appreciation gains as a means of laundering high incomes as a tax dodge.

[TANSTAAFL]

John's emphasis on "the ends of economic growth" -- unspecified ends, at that -- has the noxious stench of Marxism.

[Paul Smith]

Merci beaucoup pour votre article.

[سسسسسسس]

thank you a lots

قسم
تفسير الاحلام ناقة

[NEH]

affl, Name Calling again as insightful analysis? When was the last time you washed your clothes and took a shower? Is this the "Noxious Stench" of "TANSTAAFL"? ;)

[Dan]

I really do not understand why "banking is fundamental to capitalism". For me that is absolutely not true. Even bankers have often a hard time trying to explain what value for society (meant as our capitalistic model here) they contribute.

They do not contribute, except for work for their employees.

What they do is suck out the "system". And I am no leftist.

I would argue that money is created by the people. All people in some way doing something create the GDP. QEx aside, the central bank (being a private bank in the US - hello?) should print money to keep this exchange of goods and services flowing and at equilibrium.

But have you ever tried to go to your local branch of the central bank and get the money you personally created?

No, you have to go to a private bank and ask politely for the money - created by the people - at often outrageous interest rates. While the bank gets it for a much cheaper price. And today they keep it, because their system is not sustainable, just to survive. It is not sustainable, because they can create endless money which does not exist. All fine, until there is a crisis.

No, they are not fundamental to socuiety. They suck up growth by charging for something they do not own. I call this parasitic.

Dan

[Jack]

Tans? Down through history hasn't the fall of capitalism and the rise of socialism or your "Marxism" often correlated with the over consolidation of wages and wealth in the hands of the very few, leading to collapse and chaos?

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

[NEH]

Jack, Touche! The majority of socio-economic revolutions and their intellectual precedents of the Nineteenth and Twentith centuries can be attributed to just such a phenomena. From the excess's of the French Revolution through the Russian Revolution to the rise of the NRA and the WPA here in the States during the 1930's as an alternative to the Russian experiment... ;)