Friday, 11 September 2009

The Social Question

"We need some more Lehmans so we can get out of this. Over the past 20 years Messrs Greenspan and Bernanke introduced crony capitalism to the West which is leading to a lost decade[s]. Market fundamentals are that failures should collapse and be replaced by creative new forces rather than being propped up as zombies... Marx is singing in his grave there in London as the US government now controls the auto, mortgage, insurance, banking, et al industries and he has not fired a shot. Letting Lehman fail was perhaps the only thing governments have done right during this whole drama."
Jim Rogers, Chairman Rogers Holdings (recent comments)

"I take advantage of one of the beautiful flaws of capitalism which is that the capitalist will sell you the rope to hang himself if he can make a buck. So they only think about money - they do not really care what I believe, which is upsetting on some levels."
Michael Moore, when asked about how he gained the funding for his new film

"They [financial crises] are all different, but they have one fundamental source. That is the unquenchable capability of human beings when confronted with long periods of prosperity to presume that it will continue...The bankers knew that they were involved in an under-pricing of risk and that at some point a correction would be made"
Alan Greenspan, recent comments regarding the financial crisis

Questions of equality have been asked for hundreds, even thousands of years, however it was not until the Industrial Revolution that the topic became a major talking issue for many intellectuals. The emergence of competitive markets did not create equality, the opposite was observed as income gaps grew and have continued to grow as time passed. Two forms of egalitarian views emerged, the Jacobin violent revolution in which people would be educated to accept the new system imposed on them, or a gradual evolutionary process where the people would demand Socialism. In short centralised totalitarianism or through democracy. The twentieth century will be seen as a great experiment with statism, country after country have attempted to plan economies through central authorities all of which have failed. The fundamental question is not how can we make societies more equal which is mistaken as the ultimate goal, but how can we raise everyone's living standards.

The quotes given above are from a range of individuals, each with a different viewpoint on the recent events and social system we live in. One fundamental premise of an economic system is how to best use societies resources. Despite what is told from romantic socialists we live in a world of scarcity. We only have a certain amount of natural resources, a limit on the hours we work and a finite labor force. These factors mean that society needs a mechanism in which to direct all of the above in the most effective way to meet peoples needs. There are generally two sides of this coin - a free market directed by prices or a centrally planned system whereby Government can direct the above. We currently live in a combination of the two.

Another key concept of economics is the idea of wealth. What is wealth? Is it money? Material items? Spiritual enlightenment? I am not a material person however such possessions is a good measure. It may be as simple as the food that we eat. We all take this for granted where we have the option to eat ourselves to death but our ancestors as near as 150-200 years ago experienced famine on a regular basis. Karl Marx's famous Communist Manifesto was written during the 1848 European uprisings against a backdrop of crop failure and mass starvation throughout the Continent (the most infamous was the Irish Potato famine). Therefore a good economic model is to supply an adequate amount of goods and services that people wish to consume. We all have wants and desires in life. We would all like to own fancy cars, extravagant homes with endless means to consume but we can't. To obtain these goods and services we have to produce and we are all only so productive therefore have a limit to how much we can consume. So how do we get the most bangs for our bucks? This is where the two opposing systems come into play. One promotes free markets where people will be driven to do things they want on their own accord. The other, is where the government has to plan to ensure we all can enjoy equal spoils of our labor.

A free market can only deliver more material goods for us all to enjoy. Central planning, as history has shown and economic theory proves creates stagnation and falling living standards. The principle behind free markets is to lower the price of goods and services thereby increasing societies purchasing power - the true driver of wealth, which is what free markets are so good at. I can buy infinitely more than my father could when he was my age, and likewise his father. A market ensures this process will occur by enabling entrepreneurs and capital in competition to innovate thereby increasing general productivity. The incompetent fail, leaving the competent to take over, as Joseph Schumpeter put it, creative destruction. The other viewpoint is that the government can handle this process. They can centrally plan and co-ordinate resources and supply goods and services for the good of people. The problem with this system is how do you determine the competent people? How can you ensure competition and that governments will not abuse their monopoly power.

Ludwig Von Mises, one of the greatest economic thinkers in history, proclaimed that Socialism was doomed to fail before it had even begun. When various states succumbed to Communist regimes everyone agreed that you may have issues with incentivising people. How would you get people to do the less desirable jobs, say work in a dark mine in dangerous conditions - even the Socialists recognised this issue, and tried to solve the problem with honour parades and so on. However Ludwig Von Mises ignored this concept. He assumed that you could create a society in which everyone worked for the cause, the collective. He said it would fail not because people wouldn't do the work but for another more rational reason. He argued how will the government know what to tell the people to do? Without prices how would the resources be channeled? Coining the phrase 'planned chaos' he said any socialist system for a complex modern society would inevitably collapse, it was only a matter of time. This wasn't at a time we find ourselves in now, where all these systems have collapsed, this was back in the 1920's when Socialism was the in thing.

Of course this idea was challenged. Many said "Well we have equations, we will just use these" or "We will just find the entrepreneurs and place them in government positions". Von Mises rebutted the above on quite logical grounds. If you give someone a cushy government job on a regular wage you take away the entrepreneur, his capital and his capitalist instinct. When an entrepreneur sets up a company he tries to meet a consumer demand. He risks his capital and his time and for these reasons he will work day and night, always on edge to ensure he delivers quality service or products better, than his competitors as cost effective as possible. Would Bill Gates have created Microsoft if he had been in a government job. Would Microsoft have turned out the way it did if he didn't quit university, did not work late nights and did not have to risk his own capital? I doubt it. Its all this that ensures effective use of economic resources, placing the competent who prove themselves in charge of economic resources. A bureaucrat on £60,000 a year will never do as good a job as someone with no such security.

When we come to equations this is always a distraction in economics. Back when Britain was the leader of the world, the nations leading classical economists such as David Ricardo, Adam Smith and John Stuart Mill were in an age when everything was being mathematised. Science and technology was conquering the planet. With this backdrop they began trying to use mathematics to explain economics, however their models never really worked. This tradition carried on, right up until the present where economists still try and use it for the macro sphere. Economics is not a science and it never was. In micro you have concepts such as prices, supply and demand but no specifics. Then we jump into macro and all the economists tell you we can 'predict' this or 'solve' this because we have equations. If it was like science then why couldn't they predict the credit crunch? Science can predict all types of natural events to pin point precision but economists can't seem to predict the future any better than the average person on the street. The problem is you can't mathematise human actions. You can't mathematise future trends and technologies. The future is uncertain and impossible to model.

Of course many could not see this, so again Ludwig Von Mises in his typical genius fashion, just accepted the formulas for the sake of argument. He said even if you could create formulas to model the economic picture, then how would you obtain the inputs for them? Collecting data is prone to error and a time consuming activity so as soon as you get the data it is already out of date. In a constantly changing world it would be impossible to create accurate models to direct the means of production. Central Bankers acknowledge this concept today by using the famous saying for constructing monetary policy 'its like trying to drive using the rear view mirror'.

In a market with prices, the most competent who anticipate consumer demand survive, while the ones who forecast less successfully go out of business, thus releasing societies scarce resources for the competent to use. Despite what the left proclaim about 'excessive profits', profits and loss are the markets pricing mechanism. The future is uncertain, therefore profit just means you forecasted in the correct direction, losses mean you made a wrong forecast.

In history too, we can see ample examples of Capitalism pitted against Socialism. Korea, a country that was split by war is a fine example. One nation followed state planning, the other free markets. Back in the fifties the South was actually poorer however it soon caught up and then some. Now we see how South Korea has elevated its people to some of the most prosperous living standards on the Continent while North Korea continues to decline. For years the economy has been contracting. As Ludwig Von Mises states, under Communism you are in a constant depression. Recessions and depressions can only occur under government involvement.

Russians for years had product shortages as the state set prices of goods too low. Newspapers were so cheap that people bought them not to read the news but for alternative uses such as wrapping paper. Prices had been fixed by the state for decades with no relation to the actual costs of production. Russia only lasted as long as it did due to its resources. It sold anything it could to the West in an attempt to hold the country together, Oil, Gas, Iron Ore, Gold. As the commodities boom ended in the early 1980's so did Russia's income of hard currency, leading to a gradual collapse from within.

Under a year ago I visited Cuba, a country still run under Communist principles. People were under rationing, I saw queues outside closed shops, the shopkeeper coming to the door occasionally before opening with people asking him if he had any particular products (there were not many shops though, you were also lucky to get your allocated rations). University graduates were working as luggage boys or laundry maids, wasting their education as there were no other options. Rather than tipping currency for the cleaning maids, we tipped shampoo and toiletries as these are far more valuable than the governments worthless currency that can't buy any goods. After recently being hit by a hurricane they are rebuilding their homes with asbestos. Despite the health hazards society is too poor to afford the alternatives. For decades Cuba was propped up by Russia, buying their sugar for four times the market price, and practically giving them oil. After Russia collapsed Cuba could no longer get hard currency and technology, Castro's solution was to open the gates to tourism. This is what saved the regime in recent times, again a free market propping it up. They still have major issues and you could sense the bitterness the local people have towards the economic system. As one of our tour guides remarked, "This is supposed to be our Leninist-Marxist workers paradise".

The solutions many social commentators propose are just the above. Government systems and they never work, its always the free market that has to prop them up. They denounce that the rich are getting richer while the poor are getting poorer, but the poor get richer too as long as they are in a free market. As society accumulates increased capital and productivity these gaps widen as other nations fall behind under kleptocratic regimes with dictators, for example continents such as Africa. Many areas in Asia were poorer than Sub-saharan Africa 50 years ago. Asia then decided to open up their economies, respect property rights thus encouraging capital and expertise to invest there. Japan is already treated as a first world nation despite 60 years ago been seen as a basket case by the West.

When commentators such as Naomi Klein or George Monbiot argue that Globalisation exploits the poor, it does the complete opposite by alleviating poverty, in fact it enriches us all. Costs are lowered thus increasing purchasing power of developed nations, and developing nations are given access to capital, not only for machines but enhancing their human capital to raise their living standards.

"It's human nature, unless somebody can find a way to change human nature, we will have more crises and none of them will look like this because no two crises have anything in common, except human nature."

A quote again from Alan Greenspan. Despite what he says in public he knows the real cause of financial bubbles and crisis. He may blame markets or peoples irrational behaviour, but history again has shown it to be expansive monetary policy. When he wrote with Ayn Rand he lambasted central banks for their interference in markets. As time passed he became more involved in government affairs. Reveling in the role, labeled by the press as the 'Maestro', how he lies in public I do not know. Like with most bubbles throughout history you will find a central banker or a government authority behind it, creating inflationary booms and busts which we now label as the 'business cycle'. In the past it was fraudulent Gold deposit banking which governments encouraged. It was a less transparent way to debase currencies through intermediaries such as banks, there was also the added bonus of a scapegoat too. Banks also benefited as profits could be privatised in the boom, losses socialised during the bust. This trick fools many Socialists into believing capitalism is unstable, or as Marx liked to think it overproduced thus creating inevitable booms and busts. But this isn't true free market economics. Governments are the cause of recessions and bubbles through economic mismanagement. Private banks didn't under price risk, they had too much money from the central banks therefore as the inflationary boom kept going they lent it out recklessly as they don't make money by sitting on it. They had already lent to all the creditworthy borrowers but were still being thrown money by the central banks, therefore lent it to individuals that could never repay the debts.

A free market is the answer to the social question, we just haven't lived in one. Disparities in wealth should not concern individuals, as it is just a measure of how productive an individual is compared with another. Many may look enviable at rich successful entrepreneurs but they create the wealth and jobs for us all to enjoy. They increase all of our purchasing power and drive up living standards by creating new processes and markets. We help them with our labor, but at any point we are all free to become an entrepreneur. Companies are there to serve consumers and have little power, its only Governments that can give them more power then they should such as the past two decades with the banks. If people no longer wished to drink Coca Cola then the company would cease to be. Markets give people choices and treats humans as individuals, respecting ones rights. They drive living standards up across society this is the end goal, not equality. Individuals will always be 'unequal', each one of us has different talents and a free market allows individuals to make the best use of those talents. This is the answer to the Social Question. Socialism can never solve the social question it creates "equality" by impoverishing us all. It is nothing more than slavery to the state.

"Liberalism and capitalism address themselves to the cool, well-balanced mind. They proceed by strict logic, eliminating any appeal to the emotions. Socialism, on the contrary, works on the emotions, tries to violate logical considerations by rousing a sense of personal interest and to stifle the voice of reason by awakening primitive instincts."
Ludwig Von Mises

"Capitalism means free enterprise, sovereignty of the consumers in economic matters, and sovereignty of the voters in political matters. Socialism means full government control of every sphere of the individuals life and the unrestricted supremacy of the government in its capacity as central board of production management."
Ludwig Von Mises


  1. "If people no longer wished to drink Coca Cola then the company would cease to be."

    if only, the trouble is corporations such as this trample all over anyone else attempting to enter their markets when they get too big. cf another one of your examples - Bill Gates.

    in essence this is a great piece, barring a couple of excuses for banks' indiscretions.
    good governance would have simply told depositors their money was safe and wound the failed banks down. oh well

  2. Roym,

    Thank you for your kind words.

    On your first point, regarding corporations, people forget that big co-operations go bust all the time. Look at the big car makers in the US - they would have gone if it had not been the government. IBM nearly went bust during the early 90's as IT moved towards microcomputers rather than mainframes, which IBM had put their business model towards the latter.

    Regarding Bill Gates and Microsoft, your right it was a bad example. Microsoft just copied the competition, but Bill Gates was a very savvy business man. He locked IBM microcomputers into his OS and the rest is history. If Steve jobs at Apple had the same insight to not lock his OS down to set hardware I suspect Microsoft would have been killed off in the 1980's as Apple's OS was far superior.

    We may well be witnessing the beginning of Microsoft decline. IBM used to be the dominant IT player, like Microsoft now. Google may be taking the mantle.

    There is a question of morality with the banks and their individuals, but with the 'Greenspan put' and money being thrown at them, what else could they do? They had already lent to all the creditworthy individuals so they had to push the money into avenues where there would be no end return.

    In a true free market with free market money there wouldn't have the reckless monetary expansion. Therefore the capital would be too scarce to cause the housing bubble and the reckless lending. It obvious when you understand this dynamic but takes a bit to get your head round. We have been conditioned into thinking that bubbles are part of human nature.

    Good government? Even the good ones never last. They all end up as rotten as each other.