23 Things About Capitalism – Things 21 to 23

Capitalism

Today’s post is our eighth look at 23 Things They Don’t Tell You About Capitalism. We are on the home straight, looking at things 21 through 23.

Thing 21 – Big government is a bad thing

Standard thinking (with which I agree) is that big government is bad for the economy.

  • A welfare state funded by high taxes on the rich removes the incentives for the poor to work at all and for the talented to work hard and become wealthy.
  • The rich won’t invest to create wealth and jobs because they won’t see the benefits.

See Soviet Communism, Cuba and more recently Venezuela for evidence.

  • Or compare present-day France with the UK, or for a more damaging comparison, with the US.

[hr]

I should make it clear at this point that I don’t have a moral argument against big government, just a mathematical one.

The evidence shows that the UK struggles to raise more than 37% – 38% of its GDP as tax.

  • So for me, that’s the maximum size of government spending (since we don’t want to run a deficit over the long run).
  • Big government to me is anything more that that, since it’s unsustainable.

The population is free to vote for whichever party allocated that 38% in the way that they prefer, but we shouldn’t pretend1 that we can spend as much as we like.

I think that high taxes and high welfare are disincentives, but the more pressing problems are the demographic headwinds:

  • “essentials” like the old age pension, the NHS and free education will take up an increasing share of that 38%, leaving less and less for welfare
Thing 21b – Big government makes people more open to change

This is another Thing where we are doomed not to see eye-to-eye.

Ha-Joon is off on one:

  • He thinks that the safety blanket of the welfare state encourages people “to take chances with their jobs and be more, not less, open to changes.”

I wonder if he ever gets out of the university classroom.

  • I have never heard anyone say “I think I’ll take a chance on a new career / new business, because if I fail, I know that the welfare state will take care of me.”

Please let me know in the comments if you do know people like this.

[hr]

Ha-Joon’s evidence comes from the Scandi countries like Sweden, Norway and Finland.

Admittedly these countries have done well, but there are a few non-welfare state reasons for that:

  1. they are all small countries, which in my view are easier to manage centrally
  2. it’s easier to move the needle on a small economy – one hit sector or even firm can make a difference (witness Norway’s oil, Nokia in Finland, and IKEA and Abba in Sweden)
  3. even if you don’t agree with these points, comparing Sweden with the US is unfair – the true comparators are France and Italy
  4. until recently, they were ethnically homogenous, leading to the high social cohesion necessary for welfare states to be widely approved of2

[hr]

He also quotes the market for doctors in his native Korea.

  • Korea has high job insecurity and a small welfare state for a rich country.
  • So all the bright kids want to be doctors because it means that they can’t be sacked in their forties by the big companies.
  • This is driving down the pay of doctors and starving other professions of brainy kids.

Once again, I don’t recognise this behaviour.

  • I haven’t met a teenager who worries about what will happen in their forties and fifties.
  • Trying to get a kid in the UK to thing long-term is impossible.

Nobody hits university worrying that they will rely on the state when they are old.

  • Everyone expects to be rich and successful.

I think its rather sweet how Ha-Joon values science and engineering over medicine, and I wish this view was more popular in the UK and US.

  • But I don’t believe that the small welfare state is holding back Korea.

[hr]

Ha-Joon’s third argument centres on the bankruptcy laws.

  • Bankruptcy is a recent invention, mostly from the nineteenth century.
  • Until then, profits from new businesses were used to pay off debts from an old one.
  • This clearly made it very risky to start a business in the first place.

Ha-Joon’s version of bankruptcy sounds more like the limited liability of companies to me.

  • This is clearly a good thing3 but I think the analogy with a failed career in a doomed industry is stretching things.
See also:  23 Things About Capitalism - Things 9 to 11

More worker protection against changes in the industrial mix would be a good thing, but this does not imply big government in general.

Thing 21c – Conclusions

Big government doesn’t make things better, however much we might wish that it were so.

  • We have a century of evidence against this notion.

Ha-Joon’s ideas about how a welfare state should influence workers’ behaviour make sense in theory, but in the UK at least, are not observed in practice.

I do agree with Ha-Joon that in these dynamic times, workers need more protection against their industry being decimated by foreign competition (or increasingly, by robots and software automation).

  • But that’s not the same thing as big government.

I’m going to give Ha-Joon nothing on this one. That takes him to 9 out of 21, or 43%.

Thing 22 – Financial markets need to be efficient

Liberal and efficient financial markets allocate resources and capital correctly and quickly.4

  • The US and the UK (London) are the best examples.
Thing 22b – Financial markets need to be less efficient

Oh dear, another Thing we’re going to fall out over.

Ha-Joon is writing in the aftermath of the 2008 financial crisis, which he is going to pin on “instability” in the financial system due to new financial instruments that arise from the new efficiency.

  • The 2008 crisis was down to lending money to people who couldn’t pay it back.
  • This has been a recipe for disaster down through the millennia.

Things were made worse by some dodgy maths that implied that chopped up and blended dodgy debts could miraculously become un-dodgy.

  • The credit rating agencies have a lot to answer for here, too.

It then became clear than when banks refuse to lend to other banks they perceive as risky, the risky banks become unviable.

  • And to top it all, nobody could work out what the impact of letting the dodgy banks collapse should be.

So 2008 uncovered problems in the financial system, but which of these is down to extra efficiency?

  • Let’s work out how to safely close down non-viable banks, and let’s make sure that lending decisions stick to the lender, but let’s not deliberately reverse centuries of progress in making access to capital markets cheap and quick (for want of a better word, more democratic).

[hr]

Ha-Joon also makes the case for “patient capital” that can be used for the long-term development of firms.

I agree with him on this.

  • The markets as a whole are too short-term.
  • But the way around this is to incentivise long-term holdings, especially in smaller, earlier-stage companies – as does the VCT structure in the UK5 – rather than to cripple short-term trading.

Liquidity is essential to investment.

  • If you can’t get out of something quickly, why would you get in in the first place (unless there is an incentive)?

[hr]

Ha-Joon also covers the downfall of Iceland, but for me it’s another case of “small country problems” (Iceland’s population is only 300,000 smaller than many towns in the UK).

  • Iceland’s banking sector was enormous compared with its GDP.
  • So were net foreign debts (250% of GDP).

Ireland is a similar, and bigger, story, but still not big enough.

Ha-Joon’s focus is developing nations, so for him these are cautionary tales.

  • But we don’t need to worry about this happening to Britain.

[hr]

Ha-Joon’s fourth argument is that the financial sector in deregulated countries (starting with the UK and the US) hangs on to an increasing and too-high share of profits.

Along with this, manufacturing firms have “financialised” themselves because the profits are so much better in the sector.

  • GE in the US is the classic example here.

This was true enough at the time the book was written, though not necessarily a serious problem for any economy.

But since then, eight years of low interest rates and increased regulation have flattened profits for banks and insurance companies.

  • GE has wound down its financial arm.

[hr]

Ha-Joon doesn’t like derivatives either, worrying about the ratio of financial assets to GDP.

  • But of course, he’s looking at gross positions, rather than net ones.

His narrow point – that the MSBs, CDOs, CDOs squared and CDOs cubed were all doomed to fail in 2008 if the underlying mortgages went bad – is true.

  • But the real problem was that dodgy maths obscured that point and meant that they were bought by unsuitable people.

The true lesson is never invest in anything that you don’t understand.

  • Caveat emptor (buyer beware).

I wouldn’t buy these things because I don’t know how to work out what their price should be.

Non-equity investments should ideally be boring and predictable (infrastructure, debt), or at least random (uncorrelated to equities – property, commodities).

  • That’s their job.

[hr]

And once again, I’m failing to make a connection here with efficiency.

See also:  23 Things About Capitalism - Things 15 to 17

Basic derivatives (future and options) are essentially neutral entities (like short selling).

  • It’s what you do with them that counts.

And they improve the efficiency of markets.

  • Which is a good thing.

[hr]

Ha-Joon would like to introduce a Tobin tax (a tax on financial transactions) to slow down the markets.

  • Back in 2010, Gordon Brown was also keen, but thankfully he didn’t last long.

Ironically we already have one in the UK – a 0.5% stamp duty on share purchases.

  • People get around it by buying ETFs and AIM stocks, and by using spread betting instead.

I’m against all transaction taxes.

  • The lock-up at the top end of the property market in the face of six-figure stamp duty payments is a good example of what will happen eventually.

Ha-Joon also wants to ban hostile takeovers and short selling, increase margin requirements and introduce cross-border capital controls.

  • How about getting rid of that new-fangled electricity while we’re at it?
Thing 22c – Conclusions

I have many areas of disagreement with Ha-Joon here:

  1. Efficiency didn’t cause the 2008 crisis.
  2. Patient capital can be achieved through incentives – we don’t need to impede efficiency.
  3. What happened to Iceland and Ireland won’t happen to the UK.
  4. Financial activities are no longer too profitable.
  5. Derivatives and short selling are neutral things, not bad ones by definition.
  6. Tobin taxes are bad, and we already have a massive one in the UK (stamp duty).

So once again, Ha-Joon scores nothing here. His score is now 9 from 22, or 41%.

Thing 23 – Good economic policy requires good economists

This Thing is another that arises from Ha-Joon’s developmental focus, and it need not delay us unduly.

Conventional thinking is that “the success or otherwise of government policies depends in large part on the competence of those who design and execute them.”

  • The problem for Ha-Joon being that “in developing countries, government officials are not very well trained in economics”.
  • The implication being that developing economies should stick to free-market policies.
Thing 23b – Good economists are not required to run good economic policies.

Ha-Joon’s evidence against this comes from previous “economic miracles”:

  • Japan and Korea were run by lawyers
  • Taiwan and China were run by engineers

Meanwhile, Latin American countries, plus India and Pakistan have either well-trained economists from the US, or their own indigenous experts, but have not had the same economic success as the East Asian countries.

Thing 23c – Conclusions

Ha-Joon also tells the story of Queen Elizabeth II asking the professors at the LSE why nobody – meaning the economists – could foresee the financial crisis.

Leaving aside the fact that forecasting is not necessarily the goal of economics, quite a lot of people did see it coming.6

All that talk of “the great moderation” and “an end to boom and bust” meant that economists were bound to cop it the next time there was an economic collapse.

[hr]

Ha-Joon knows a lot more than me about the economics of developing countries, and I’m not going to take him on on this one.

  • It’s a narrow point as to whether a lack of economists should force a (developing) country towards free markets.
  • I think free markets are best and Ha-Joon disagrees, but the quality of economists shouldn’t be the deciding factor.

This chapter is really a trojan horse for Ha-Joon to rail against his own profession, and its dominant ideology.

  • Despite this, Ha-Joon gets his point for this Thing.

That makes his final score 10 out of 23, or 43%.

[hr]

We’ve made it through all 23 things.

I’ll be back in a couple of weeks with a summing up of what we’ve learned, and some external commentary on Ha-Joon’s book.

  • Plus we have Ha-Joon’s recipe for how to fix the world economy to look forward to.

Until next time.

  1. As Labour did from 1997, and are doing again []
  2. The same thing can be said of the UK, over a longer timescale – the Welfare State was very popular in the UK at the time of its introduction, but as Britain has become more multicultural and less socially cohesive, trust from non-beneficiaries that the system is working as planned has been eroded []
  3. I’m not in favour of personal bankruptcy laws []
  4. Unless central banks impose “financial repression” via too-low interest rates, as has been the case since 2008 []
  5. Interestingly, something that has been targeted by the EU as a form of “state aid” []
  6. I was working in the City at the time, and several people predicted the collapse of the US mortgage market, though it was difficult to see how far the ripples would spread []

Mike Rawson

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 35 years, with some success.

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23 Things About Capitalism – Things 21 to 23

by Mike Rawson time to read: 8 min
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