23 Things About Capitalism – Things 12 to 14

Today’s post is our fifth look at 23 Things They Don’t Tell You About Capitalism. We are up to things 12 through 14.

Thing 12 – Governments can’t pick winners

Most people are against what used to be known as industrial policy – the government `picking winners’ within industries.

• It remains to be seen what exactly new British PM Theresa May has in mind, but she has created a new department of industrial strategy, so she must be planning something.

In general, there’s no reason to believe that the government has special information that enables it to outperform the market in working out which are the best companies.

• The risk is that prestige and power will drive government ministers to make poor industrial choices.
• They might pick the wrong companies, or even worse, the wrong industries to get behind.

There’s plenty of evidence of this in developing countries run by egomaniac dictators, not only in terms of the highway to nowhere, and the monument to the head of state, but in some cases where hi-tech industries beyond the reach of the country are chosen for support.

• In developed countries, the risk is just as great that government will waste money propping up declining industries (eg. steel) for sentimental and political (vote-winning) reasons.

The job of the government should be limited to ensuring that there is a level playing field for all companies, and if necessary, encouraging good firms to merge in order to reach internationally competitive scale, where they can operate as “national champions”.

Thing 12b – Oh yes they can

Ha-Joon of course believes the opposite:

• that governments can and do pick winners,
• that their inferior information is no setback (he thinks that the best informed people can be “too close” to a situation to make the best decisions)
• and that decisions which are good for firms may harm the overall national economy.

He is somewhat biased, because South Korea has had some success with unpromising industries supported by the government, such as integrated steel mills (Korea has no natural iron ore or coking coal, which had to be imported from five thousand miles away).

• LG is another success story with government backing and direction.
• Taiwan and Singapore are similar East Asian success stories, as was Japan before them, and China after them.

From my narrow UK national perspective, I see no read-across from post-war developing Asian nations to the UK in 2016.

• During the same period of history as Korea’s success, in our own country we had loser (but prestige) projects like Concorde (which never operated at a profit) and the disastrous (and sentimental) nationalisation of the British car industry to attempt to fight off superior foreign competition.

A better argument is that the US implicitly directs American industry through support for R&D, often military led.

• There’s some truth in this, though few free-marketeers would object to government support for university-led R&D which can be later opened up for commercial exploitation.
• This kind of government support is increasingly common in Britain, though the commercial exploitation lags far behind that in the US, partly because of the different approaches of the two venture capital industries, and partly because of the “cluster effect” of Silicon Valley.

Thing 12c – Conclusions

I remain unconvinced by Ha-Joon’s argument.

• In a choice between those motivated by political power and ego, and those motivated by money, I will always back the money.

Of course, there are many instances of business leaders being just as motivated by power and ego.

• This is something that as private investors we need to be constantly vigilant for.
• It’s also a major reason why so many mergers and acquisitions fail to create value for the acquirer.

There is also the problem that multinational companies will care less for the local host economy and more for their own home country’s prosperity.

• This is a real problem for governments to grapple with, but not one that can usually be solved by creating a government backed competitor.
• Unless you are China, that is.

For the UK, the real problem is that our borders and culture are so porous to US firms in particular, and European firms to a lesser extent.

• That’s a much bigger issue than whether the government should pick winners.
• I doubt that from where we are at present, the UK government would be able to pick or create a winner in most industries.

I’m all for governments supporting infrastructure and R&D, and in certain circumstances – when an industry is reaching international or global scale – I can even support the government encouraging the formation of a national champion within the UK.

But in general, the government should keep out of markets, and let them – and their suppliers and customers – work out which company is the best.

• I worry particularly that government will prop up dying industries at the expense of growing ones, since this is likely to be popular with the electorate.

I’m going to give Ha-Joon zero on this Thing.

• That makes his score 5 out of 12, or 42%.

Thing 13 Making rich people richer doesn’t make the rest of us richer

I think we may be on firmer ground with this one.

• I don’t believe in the general theory of trickle-down economics, and I’m sure that Ha-Joon won’t.

There’s some scope for disagreement about our definitions of rich, but the basic point is that the very rich can’t spend all their money (at least on themselves) and so that money is “wasted”.

Using UK prices from 2016, a decent house in a nice part of London costs about £2M, and you would need a pension / ISA pot of £1M to £1.5M to retire comfortably.

• So maybe personal wealth of £4M in total can be justified as simply wanting a nice life.

But what do you do with more money than that?

• Would you spend it or hoard it for your descendants?
• How many servants can you employ?
• How many expensive clothes and dinners can you consume?

We can hope that the rich invest their excess wealth in productive enterprises, but we can’t force them to do that. ((I suppose that technically we could do that, but I’ve yet to see a proposal from any political party to cap personal wealth and invest the surplus, and it would just lead to a mass exodus if implemented ))

In contrast, poor people have to spend almost all of their money simply to live.

• And in spending it, they put it in the pockets of the people who provide the products and services that they need.

So it is a good thing for the rest of us that so much wealth is tied up by people with more than, say, £4M?

• I can’t see that it is.

We could do more with incentives for investment.

• Existing schemes (like VCTs and EIS in the UK) have an annual cap of several hundred thousand pounds, and are restricted in terms of the companies they can invest in by EU state aid rules.
• These schemes could be relaxed and extended post-Brexit.

Bolder still would be a wealth tax on all money not held in government tax shelters (SIPPs, ISAs, VCTs and the extended VCT scheme) or in your primary residence.

• The French rate of at least 0.5% pa on everything above €800K (rising to 1.5% above €10M) should do, though since we’ve exempted so much already, we could start at £100K.
• Like all taxes, it would run the risk of scaring the rich away, but it’s worth a try.

Thing 13b – entrepreneurs and taxes

The picture becomes a little more complicated when we look at entrepreneurs.

• Most companies (which means at root most jobs) are started by clever and talented people, who thereby become rich, clever and talented people.

The societal good (jobs, and great new products and services) has happened by the time they first become rich, and making the owner(s) ever more richer won’t necessarily produce more good for the rest of us.

I’m not convinced that it’s the already rich who are responsible for most of the innovative thinking and doing in the world (though there are obviously exceptions – Elon Musk, Jeff Bezos etc).

• But we do need entrepreneurs, and they need to be incentivised.

Executive pay is another issue entirely (see the next Thing for more on this).

• I have no understanding whatsoever why hired managers need to be paid millions of pounds each year simply to do their jobs.
• Some kind of wage cap linked to median salary within the company – say 20 times, as suggested by Will Hutton in his review of public sector pay – would be a very good idea.

It gets even more complicated when you look at the question from the other direction.

• The ability to become rich is one of life’s great incentives, and taking it away would probably reduce the amount of innovation – and hard work – that takes place.

Raising taxes – unless globally coordinated – would simply move progress to a more favourable jurisdiction (“the future is already here, it’s just unevenly distributed”).

• The globalisation of the world over the past 30 years has made this truer than ever.

There’s also not a lot of evidence that capping wealth (or aggressively redistributing it in order to reduce inequality) leads to a dynamic, growing economy.

• So while I don’t think that making people rich is the goal, I find it hard to understand how to make the overall pie as big as possible without making quite a few people “filty rich” (as Peter Mandelson would say).

Thing 13c – Conclusions

I’m going to give Ha-Joon half a point on this one.

I agree that trickle-down doesn’t work as well as its supporters claim, but I can’t see a superior system for growing the economy that doesn’t involve some people getting very rich.

• I don’t want so many people to get quite so rich, but neither do I want to regress to the living standards of Soviet Russia (or modern-day North Korea, Cuba or Venezuela).

It’s the old “democracy is the worst system of government, apart from all the others”. For democracy, read free-market capitalism.

That takes his score to 5 and a half out of 13, still at 42%.

Thing 14 – US managers are over-priced

This is another promising Thing.

• I think that most managers are overpaid, but US managers are the worst offenders.

The idea that the talent pool is limited and firms need to compete for the best managers doesn’t wash with me.

• What I can’t understand is why the shareholders (now dominated by pension funds and asset managers) don’t do something about it.

Apparently Theresa May has plans to limit executive pay in the UK.

• We shall see.

Thing 14b – Comparatives

Ha-Joon points out that US managers are overpaid relative to their predecessors.

• As a multiple of their workers’ average wages, they are paid 10 times as much as bosses in the 1960s, despite that being a much more successful time for companies.
• The multiple is now typically in the 300-400 range, a long way from my earlier suggestion of 20 times.

They are also over-price compared to managers in other rich countries.

• Depending on the measure used, they earn up to twenty times more (when stock options are included).
• In simple salary terms, US managers earn double what German managers make, and four times what Japanese managers get.
• In contrast, the differentials between workers’ pay in these countries are small, and German and Swiss workers earn more than US workers.

And US managers are not punished for poor performance.

• Sometimes they are sacked, but they usually get a big severance cheque.

Thing 14c – Conclusions

I’m going to give the Ha-Joon the full point on this one.

• I think that executive pay is out of control across the globe, and it’s a topic I will return to in the future.

That gives Ha-Joon 6 and a half out of 14, or 46%.

Today’s three things were a bit better than the last set – more interesting topics, and more areas of broad agreement than last time.

• We’ll be back in a couple of weeks with another three things – we still have nine to get through.

Until next time.