Wednesday, 2 December 2009

How To Fix Capitalism

The recession and the crisis and banking are the least of the reasons for thinking that we need reforms. the crisis of capitalism goes much deeper: the influence big business has on governments (and the warped policies this leads to), increasing central control of the economy and the general move away from free markets.. I have some modest proposals on how to fix capitalism.

Break up monopolies and oligopolies

Under existing competition (anti-trust in American) laws, it is necessary to prove abuse of the monopoly. This allows a business to avoid competition, because it has not been proved to have used particular practices. Competition may be locked out (for example, by network effects) and consumers may suffer from a lack of innovation or product quality, but none of that is illegal.

The solution is to assume that monopolies are harmful and should be broken up. Either this should be an invariable rule, or it should be up to the monopolist to prove that the monopoly is somehow beneficial. An exception should be made for natural monopolies, but the price of that should be tight regulation, nationalisation, or (best of all) mutualisation.

That still leaves the problem of oligopolies. The answer is simple: break up any company with enough market share to have a noticeable influence on prices — say more than 5% nationally or 10% at a city/county level. Again, they would need to make the case of exceptions.

Doing this would also mean that there would be no "too big to fail" banks, so a financial crisis would be easier to solve: let them go bust and nationalise the assets and liabilities.

Remove barriers to entry

Abolish patents. They have not been proven to speed progress: the evidence seems to be to the contrary. They definitely increase costs, are an inefficient way of funding R & D and allow oligopolists to block competition.

Reduce the copyright term to the optimal length suggested by research of about 15 years. It ought to be obvious that works produced in the reign of Queen Victoria should not be in copyright in the 21st century.Exclude works distributed with DRM from copyright to ensure that copyright works do fall into the public domain when the copyright expires. Reduce the copyright term on computer software to two years, and make copyright contingent on disclosing source code (so others can alter the software when it comes out of copyright). Abolish region of origin rules. It should be legal to describe a Cava (when selling it) as having been made in the same way as Champagne. Abolish unnecessarily restrictive licensing. Many US states require people to be licensed to work as interior designers or hairdressers. I can understand requiring doctors or auditors to be licensed, but these are just barriers to entry.

Reduce bureaucracy

The best example of the problem (or opportunity from his point of view) that I have heard, is something Ted Tuppen, the founder and CEO of the huge British pub chain Enterprise Inns, said. I may not have got the wording exactly right, but, as I remember it, it was:

There will always be pubs available to buy because owners of free houses are driven out of the business by the amount of bureaucracy.

Small businesses cannot cope with tight regulation. Big businesses can hire teams of lawyers and paper-pushers. This is one of the many problems with patents. The government, far from discouraging oligopolies, is actually encouraging their formation.

Stop being "business friendly"

People seem to be thinking much less clearly about this now than they did in the 18th century. Back then, the business friendly ideology was called "mercantilism", and this was the primary source of opposition to free markets. Now, governments profess to be in favour of free markets and "business friendly".

Of course, businesses sometimes want free markets, for example they do not want to regulated. On the other hand they also want to minimise competition, reduce costs, receive subsidies and form cartels. Businesses are usually in favour of free markets in general, but not in the specific case of their own industry.

The new mercantilism is the root cause of the problems most of my other proposals seek to solve. It has also lead to a failure to regulate properly. The obvious examples are the clear failures in the regulation of banks (such as allowing deposit takers to have high risk investment banking operations), but there are others: the US broke up Standard Oil and AT & T, but failed to break up Microsoft, reflecting the general trend towards letting businesses do as they like.

New mercantilism has dropped the one aspect of the 18th century form that I find has some redeeming features: economic nationalism. Democracy is compromised by the economic pressure tyrants can bring in a globalised economy. I also find it extremely odd that governments will minutely examine an applicant for a holiday visa, but allow a dubious foreign tycoon to gain great influence within their country by buying influential businesses.

New mercantilism is dishonest. It does not openly oppose free markets. Instead it relies on conflating free markets with capitalism.

Financially penalise large businesses

This idea is simple. Tax big companies more. This will discourage mergers except where there are clear gains. British tax law already has lower rates for small companies, but this does not go far enough. The rates should keep increasing as companies get larger (at the moment there are no further increases on companies with profits greater than £1.5m: I would suggest bands at say £15m, £150m and £1.5bn as well). Obviously, we would need similar systems in all major economies.

The size criteria should not be based on profit. It should be based on value added: so a big company that has a bad year would not see its tax rate reduce (obviously taxes paid would do down in proportion to profit).

Give shareholders control

Shareholders are supposed to the owners of a company, but in the case of large listed companies this control is limited. This does lead to problems:

Shareholders have to resort to expensive and disruptive means such as accepting hostile takeover bids to replace incompetent management — this also tends to encourage consolidation where there is no real economic benefit. Management have an incentive to focus on the short term. They can take their bonuses and leave, while accumulating problems for the future. Management tend to overpay themselves. As J.K. Galbraith said: "The high salary of the chief executive of a large corporation is not a market reward for achievement. It is frequently in the nature of a warm personal gesture from an individual to himself." Management indulge their egos, buy engaging in exciting takeovers, and risky businesses, rather than getting on with the humdrum but reliably profitable. It is impossible to prove what people were thinking, but it is hard not to believe that this contributed to the destruction of GEC/Marconi

Reject the corrosive "greed is good" ideology

Adam Smith never intended that the idea of the "invisible hand" should be interpreted as meaning that people should pursue their own interests, and that this would lead to an optimum outcome. He wrote extensively on morality.

The reason for those troublesome bonus schemes for directors is that it is assumed that they would not run the company as well as they could unless they were "incentivised" with payments for success. This contradicts management theory: Herzberg classifies pay as a "hygiene factor", a poor motivator compared to, for example, job satisfaction.

What is even worse is that by telling people that they are expected to be selfish, they become more selfish. Economics students become more selfish because they are repeatedly taught to expect that people are rational and selfish: the association between the two can only strengthen the effect.

Society is permeated, especially in business, politics and economics, with the idea that is people pursue their own interests, this will automatically lead to the best outcome, and that, therefore, people should be selfish. This cannot be fixed by endless incentives to align interests: life and business is too complex for that to work. A free market is not a substitute for integrity.

Break the loop

What matters most is the rejection of the new mercantilism, which will at least stop things getting worse, but we still need to undo the legislation and the structures that have been put into place at the behest of the mercantilists. The two go together: the rise of the new mercantilism is partly the result of the lobbying power of large corporations. Break them up and reduce their power and they lose their influence.

Education is also important. Most people cannot, at the moment, distinguish between capitalism and free markets, or see the parallels between the original and the new mercantilism.

Via Graeme