23 Things About Capitalism – Things 6 to 8


This is the third in our series on 23 Things about Capitalism, by Ha-Joon Chang. Today we’re covering things 6 to 8.

Thing 6 – Macroeconomic stability is not world economic stability

People old enough to remember the 1970s will tell you about the oil price shock, the strikes and the 3-day week, and inflation.

Inflation was a massive problem in the 1970s, producing economic instability and discouraging investment and growth.

  • But new government policy and independent central banks have reduced inflation to close to the typical 1-2% pa target. ((In fact, persistent low inflation is currently the problem – if one that is likely to be fixed in the UK by the Brexit vote’s impact on sterling – but Ha-Joon couldn’t have foreseen that back in 2010 ))
Thing 6b – The world economy is shakier

Ha-Joon would prefer that we focused on “full” employment and economic growth rather than inflation.

  • He doesn’t approve of “labour market flexibility”.
  • I agree with him that losing your job is traumatic, but the days of a job for life are gone, and they aren’t coming back.
  • Today’s insecure job is more likely to be replaced by tomorrows “gig economy” or replacement by robots and software automation.

Labour market flexibility is a good thing – you only need to compare the responses to the 2008 crisis from the US and the UK with those from France, Italy and Spain.

Employment is certainly something that could be added to the central bank’s targets, as could GDP.

  • I’d like to see the definition of the latter modified somewhat to more accurately reflect what’s actually going on inside a country.

Ha-Joon also laments the large number of financial crises – particularly banking crises – that persist.

  • I’m with him on this – the 2008 crisis in particular could have been at least mitigated had either the toxic US property lending been avoided or isolated, rather than being mixed into widely traded derivatives.
  • But apart from 2008, there hasn’t been a banking crisis in the UK since the inflation ended in the 1980s.

It’s clear that targeting a range for inflation is a good thing.

  • We might debate what that range is, but capitalism doesn’t work well with very high or non-existent inflation.
  • Germany between the wars is a good example of the former (others included Argentina, Hungary and Zimbabwe) and Japan since the 1990s is a good example of the latter. ((The German experience has had lasting effects, with German governments and central banks being very reluctant to operate loose monetary policy ever since ))

Capitalism relies on predictable prices, which hyperinflation destroys.

  • Low inflation ((Or financial repression, with low interest rates – as we have today )) leads to allocation of capital to the wrong projects.
  • It’s also the case that nominal wages (and welfare payments) are “sticky” (hard to reduce) and so need to be slowly reduced by some inflation.
  • The same applies to debt interest.
  • Negative inflation undermines capitalism by removing the incentive to spend money today (since it will be worth more tomorrow).
Higher inflation targets

Ha-Joon suggests that inflation is benign until it gets up towards 8%-10% pa.

  • He cites some examples of countries with high growth and high inflation (eg. Brazil and South Korea in the 1960s and 1970s).
  • He also notes that higher real interest rates introduced in Brazil (and later, South Africa) to control the subsequent high inflation has also lowered growth.

Unfortunately, I can’t see the read-across from the developing world into the developed one.

  • Inflation and growth are often correlated, but the point is how much of each do you want?
  • In a developed country, it seems fair to aim for something like 2% inflation and 4%-5% nominal GDP growth (2% to 3% real GDP growth).

We may indeed see some higher inflation targets soon, since low-growth is currently a problem.

  • The issue is really whether any central bank feels confident that it can maintain inflation in the 8%-10% pa range.
  • Banks seem to prefer 2% pa as a target, and I can’t see which country would want to be the first to experiment with significantly higher targets.
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So this may be a good idea, but the proof of the pudding is in the eating, and no-one wants to take the first bite.

Thing 6c – Conclusions

Ha-Joon’s title for this one is misleading.

  • It suggests a focus on instability, but really he’s mostly discussing labour market flexibility and inflation targets in developing countries.

He argues against the policies that are needed to control inflation (high real interest rates that reduce the prospects of investment projects returning more than they cost).

  • I would say that the best way to avoid these is to prevent inflation getting so high that they are needed.
  • Once an economy has gone through the pain of getting inflation under control, it seems reckless to rinse and repeat.

I concede Ha-Joon’s point that low inflation, capital mobility and labour market flexibility (or as he calls it, job insecurity) are “geared towards the interests of the holders of financial assets”.

But what does he expect?

  • That the world should be organised to suit those with no money and no power?
  • Through what agency would that happen?
  • I think a democratic government would struggle to get elected on that platform, and I can’t see a benign dictator choosing it as a policy programme.

I’m giving Ha-Joon zero on this one, taking his score to 2 out of 6, or 33%.

  • In his defence, his focus on developing economies is largely responsible.
  • There may be some truth in his prescriptions for the third world, but the rest of us would be better off sticking with low but positive inflation.
Thing 7 – Free-market policies don’t make poor countries rich

I don’t think this Thing will detain us for too long.

  • Free-market policies aren’t supposed to make poor countries rich.

Each country is (in theory) free to trade on whatever terms it chooses, with whoever will trade with it.

  • We have to trust the government of each country to work in its own best interests. ((By which I mean the country’s best interests, not those of the despots in charge ))

To begin with, a lot of newly independent countries reacted against their capitalist masters, adopting non-capitalist, non-free market policies.

  • Many have since changed their mind in the face of poor results, and are now doing better.

Ha-Joon thinks that developing countries did better during their “period of state-led development” that they are doing since their “market-oriented reform”.

  • In the post-colonial era, this seems entirely a matter for those countries.
Thing 7b – Ancient history

There’s some interesting stuff in this chapter on how most countries – including the UK and the US – used protectionism and subsidies to get rich.

  • There’s a long section on the attitudes to trade of many early US presidents, for anyone who’s interested in that sort of thing.

Ha-Joon also compares 1880s USA to modern-day China, showing how protectionist countries can grow.

  • But they are both outliers, being very large countries.
  • The US benefited from lots of natural resources, a large internal market and plenty of hard-working immigrants.
  • And it’s far from clear that China will enjoy the century of global domination that the US has.

Slightly embarrassingly, Ha-Joon also defends the policies of Venezuela’s Higo Chavez.

  • Six years later, with Chavez dead, the oil price below $50 a barrel and Venezuelans looting stores to avoid going hungry, that looks a bit naive.
  • Growth in Venezuela is -8% pa, and inflation is 482% pa.
  • Unemployment is 17% and rising.
Thing 7c – Conclusions

I don’t have an ideological dog in this fight – developing countries are free to adopt such policies or not, as they see fit.

  • In principle, I believe in free trade – though not free movement of labour – for the UK, because I think it will make us richer.
  • But this has to be balanced against UK unemployment, and the type of society that we want to live in.

I don’t deny Ha-Joon’s point about the benefits of free trade potentially accruing to countries which already dominate the global economy.

  • But the corollary – that developing countries will necessarily prosper if they adopt protectionist policies – doesn’t follow.

To prosper, you need to compete, and win.

  • It may well make sense to protect “infant industries” but at some point those industries need to grow up and fight.

I’m going to give Ha-Joon half a point on this one, mainly because we have no point of engagement here.

  • That takes him up to 2.5 out of 7, or 36%.
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I simply don’t care whether a particular country adopts free trade or not, other than the UK.

  • And I don’t see the point of free trade as being to make poor countries rich.
  • Indeed, I fear that we may be at the end of the period of any more countries getting rich (in the sense of catching up with the richest – I expect world GDP to rise and to float all boats).
Thing 8 – Capital has a nationality

We may be on more solid ground with this Thing, because Ha-Joon is not a fan of multi-national corporations, and neither am I, up to a point.

The “free-market” argument is that if you discriminate against foreign capital then it will avoid your country.

  • If the multi-nationals are the most efficient firms globally, this is a bad thing.

Ha-Joon argues that multi-nationals are really still just “national companies with international operations”.

  • The high-end work (R&D, strategy) gets done at home, and the key decision makers are usually home-country nationals.
  • Home country jobs and factories are usually the last to be cut in bad times.

And most importantly, the benefits (profits) flow back to the home country.

I’m going to put a slight caveat against that last point.

  • Here in the UK I can buy shares in multi-nationals from most countries (particularly the US, where a lot of them come from) and share in these profits.
  • This opportunity may not be available in every country, but it still needs to be pointed out.
Thing 8b – A good deal?

Whether or not the host country gets a good deal is a different question.

  • Foreign investment is still an investment and will increase output and create jobs.
  • Restrictions (banning investment in `strategic’ industries, forbidding majority shares, insisting on technology transfer – all of which are more common in developing countries) may mean that the money and jobs and wealth go elsewhere.

One problem is that most foreign investment is “brownfield” – the acquisition of existing firms that doesn’t necessarily create new jobs and output, and may over the medium term transfer jobs abroad. ((The recent acquisition of ARM by SoftBank is – despite assurances to the contrary – a good example ))

  • It’s always possible that the new owners will fix and grow a failing firm, but this is less common.

Even with greenfield investment (new jobs and capacity) the impact on the future of the national economy needs to be considered.

  • As Ha-Joon puts it: “”we cannot pretend that it does not matter whether you produce potato chips, wood chips or microchips”. ((Here again the ARM deal is relevant – this was the last world-class tech firm in the UK, and perhaps should have been protected ))

As well as the risk that only low-tech work will be created, Ha-Joon cautions against the short-term horizons of private equity capital (compared to the potential long-term aspirations of a buyer from within the industry).

  • He cites the notorious asset stripping of Rover by the “Phoenix Four” as an example.
  • Within industry purchases – such as that of Saab by GM – can have the same effect, especially when the acquiring firms (like GM and GE) have been “financialised”, and earn more from finance than their original
Thing 8C – conclusions

I’m going to give Ha-Joon the full point here.

  • That gives him 3.5 out of 8, or 44%.

Foreign investment is a tricky area.

  • Rejecting all foreign money is not smart – a single country can’t be good at everything, and it makes sense to have some foreign experts operating on your soil.

But there has to be a balance.

  • Every successful country will need it’s own multinationals to operate abroad.

Here in the UK, we have plenty of multinationals (Shell, BP, Unilever, HSBC, Glaxo, AZN, Vodafone, BAT, Reckitt Benckniser, Diageo) but they are mostly in industries whose best days are behind them.

  • We could do with protecting and growing some tech giants.

We’ll be back in a couple of weeks with another three Things.

Until next time.

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 40 years, with some success.

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23 Things About Capitalism – Things 6 to 8

by Mike Rawson time to read: 7 min