On Capitalism

It is said that “capitalism is the worst economic system except for all the others,” a concept that Ha-Joon Chang embraces fully in his book 23 Things They Don’t Tell You About Capitalism.

Capitalism has done much for the world, providing decades of economic growth and giving humanity the highest standard of living it has ever seen, but Chang argues that the dogmatic free-market version of capitalism that has dominated the last thirty years leaves much to be desired, and is the culprit for slowing growth, financial crises, growing income inequality, and many other ills facing the world today. The idea that markets, if left alone, will produce the most efficient and just outcome is simply not feasible, and has not delivered on its promises. In 23 short essays, Chang explores various aspects of how capitalism really works in today’s society and presents ways in which it can be made to work better.

One pillar of capitalist ideology Chang attacks is the notion that a “free market” exists at all. Every market, he argues, has some rules and boundaries that restrict freedom of choice. Whether a market is “free” or not is in the eye of the beholder. Child labor laws, for instance, are a restriction on markets, but because we agree with them morally, we tend to disregard the intrusion. Differences in the understood levels of government restrictions between countries lead to imbalances and inequities such as workers in China receiving low wages and unacceptable working conditions. Government regulation is also present in ways that are vital to the very functioning of markets, including patents, copyrights, and the enforcement of contracts. It is generally believed that government interventions such as these are within the acceptable boundaries of “free markets,” but Chang argues that the very existence of these boundaries proves that the very notion of a free market is rife with ambiguity and that striving toward a nebulous idea of a perfectly government-free market is counterproductive.

Chang gives several examples of free market policies actively damaging the global economy. For example, contrary to most narratives, growth in poor countries has actually slowed as a result of recent market liberalization policies. Removing government support prevents the flourishing of new industries in poor countries, and many forget that government subsidies played a large role in the early development of now-rich countries like the US. The free market idea that companies should be run purely in the interests of shareholders is also damaging. Shareholders are often the most transient stakeholders in a business, and their interests are often not in line with the broader economy.

Deference to shareholders, Chang argues, has led to too much focus on short term profits at the expense of long term growth, and an undue preference toward cash distributions rather than productive reinvestment.

A major reason why free markets fail to work as advertised is that human rationality is severely limited. While people in theory always act in their best interests — and thus the best interests of the economy as a whole — in practice, this is far from the case. In instances where people will act in predictably irrational ways, it can be beneficial for the government to intervene. Chang’s biggest example of this is financial regulation. Humans do not have the capacity to rationally assess complex financial instruments and thus, without regulation, are prone to creating unsustainable situations such as those that preceded the 2008 financial crisis.

Chang’s essays also explore the failures of so-called “trickle-down economics” and the economic benefits of an increased welfare state. Rather than providing a disincentive for work, he argues, welfare spending provides a backstop that actually encourages risky business activity, as individuals are less afraid of a huge decline in living standards should their risks not pay off. A strong welfare state is like bankruptcy in this regard — it provides security in the event of failure as well as promotes second chances.

Going forward, one question remains: how do we fix the economy? The truth of the matter is that there is no easy fix; however, the following eight principles should guide our thought process when redesigning and rebuilding our economic system.

1. Capitalism is the best economic system;

2. We should build our new economic system on the recognition that human rationality is severely limited;

3. We should build a system that brings out the best, rather than worst, in people;

4. We should stop believing that people are always paid what they ‘deserve’;

5. We need to take ‘making things’ more seriously;

6. We need to strike a better balance between finance and ‘real’ activities;

7. Government needs to become bigger and more active;

8. The world economic system needs to ‘unfairly’ favor developing countries;

The past three decades have shown us that current free-market economics do not work. If we do not make immediate and drastic changes to the current conditions of billions suffering in poverty and insecurity, especially in developing countries, we will inevitably meet the same global disaster we witnessed in 2008. Difficult choices may lay ahead for the global economy, but with change comes hope.

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Josh Rohleder.