Capitalism by a Better Name: Sweeter Still

Karl Marx is usually credited with coining the term “capitalism” to describe the economic system of our age.  The prior system, feudalism, accorded power and wealth to those that controlled the land.  Marx observed that power and wealth had shifted to those that controlled capital.  The irony of describing today’s economy as capitalistic is that for Marx capitalism, as he thought of it, was only a small portion of the overarching system that really set him off.

The plain fact is that prosperity and productivity had nothing to do with Marx’s ire.  The Communist Manifesto contains arguably the greatest paean to the productivity of the new system ever penned to paper:

Marx3“The bourgeoisie, in its reign of barely a hundred years, has created more massive and more colossal productive power than have all previous generations put together.  Subjection of nature’s forces to man, machinery, application of chemistry to agriculture and industry, steam navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalization of rivers, whole populations conjured out of the ground – what earlier century had even an intimation that such productive power slept in the womb of social labor?”

Wow!  After that you would think Marx would be wild about the bourgeoisie reign.  Note that Marx did not refer to a capitalist system, but to actions and accomplishments of a class of people.  Indeed they were an entirely new class of people eschewing the status of birth for the status of wealth, relentlessly pursuing profit.

This all suggests something deeper and broader for Marx’s negative sentiments found in his manifesto.  In what I believe is the greatest paragraph in all of English nonfiction prose, the Communist Manifesto contains the answer.  Having read both Capital by Marx and Conditions Of The Working Class In 1844 by Engels, I believe the following ideas are from Marx, but the words were Engels’:

“Constant revolutionizing of production, uninterrupted disturbance of all social relations, everlasting uncertainty and agitation, distinguish the bourgeois epoch from all earlier times.  All fixed, fast-frozen relationships, with their train of venerable ideas and opinions, are swept away, all new-formed ones become obsolete before they can ossify.  All that is solid melts into air, all that is holy is profaned, and men at last are forced to face with sober senses the real conditions of their lives and their relations with their fellow men.”

This is powerful stuff.  The context of this text embedded in the Communist Manifesto is clearly negative in its thrust.  Yet, a free market objectivist like me can only be moved by its eloquence, perception and accuracy.  Unlike Marx, I revel in this new state of affairs.  Unfortunately most are not unlike Marx.

In the narrowest sense, Marx preferred the old status based system because it favored lazy intellectuals like him.  Later in the Communist Manifesto he notes that professionals, intellectuals, artists etc. merge into the working class and:

“[L]ive only so long as they find work, and … find work only so long as their labor increases capital.  These workers, who must sell themselves piecemeal, are a commodity like every other article of commerce, and are consequently exposed to all the vicissitudes of competition, to all the fluctuations of the market.”

Heaven forbid!  Intellectuals, professionals and artists have to actually work for a living providing something people actually want and for which they will pay.  Dare I say it, they must be commercial!!!

More broadly and fundamentally, Marx strikes a deeply harmonious cord with the evolutionary base of the human psyche.  The new system, which the word “capitalism” does not fully encompass, is as much about actions and change as it is about a market economy, laissez faire and globalization.  Marx was the first to fully understand this.  He was the canary in the coalmine of the industrial revolution noting that the new system brought constant, even accelerating change.

Humans are wired to detest change.  For all of the history of life on earth change was always bad.  Organisms strive to be in a place where they met their needs, and once there any new development was surely negative.  This is why, despite the colossal productive prosperity all around us we are far from content, let alone happy.

Slow motion legs of business people walkingWe live in The Age Of Angst!  Ours is the only truly unique age in all of history – future as well as past.  Until yesterday, from a historical perspective, a person would be born, live and die in a world essentially unchanged.  That is why ancient structures were built to last forever (and more than a few succeeding in that aim).

Therefore the correct word to describe the past’s prevailing world view was not cyclical, but circular.  Details differed here and there, but everything eventually returned to its original position.  Pestilence and war commonly caused havoc.  Technology caused minor lifestyle differences.  The world remained the same.

That world view has been obliterated.  In my lifetime the world has been turned upside down and inside out not once, but going on twice.  Historical processes that changed fundamental cultural traits like manners, dress, attitudes toward sex and women, marriage, family and religion used to take centuries and now take decades or less.

It is more than ideas and opinions that are swept away.  We are in the only age where there is no cultural consensus about anything.  People are making it up as they go along because there is no cultural point of reference.  Until our age the notion of a fulfilling marital relationship or being a good parent had no meaning.  You rose at dawn, worked like hell all day, hopefully ate afterword and dropped of exhaustion at dusk.  There was not time or energy for anything else.

In a few hundred years or so humanity will probably sort this all out bringing a close to this only real age of change.  We need a new word or phrase to denote this system impelling accelerating change referred to by Marx as the reign of the bourgeoise.  The concept of the free market is incomplete.  Liberty and law may be better.  Any suggestions?

Karl Marx Photo Credit:


The Soloist & Efficient Markets

The chaos in the L.A. streets was artistically depicted in the recent film about poverty in America: The Soloist.  It is the tale of an L.A. newspaper reporter that takes an interest in a homeless person that is a gifted musician. In the course of the film, the reporter – played by Robert Downey, Jr., takes an honest look at the issue of poverty in America through his friendship with the homeless man, played by Jamie Foxx.  BoyPovertyDirector Joe Wright tackles this issue with sensitivity and grit, while at the same time, avoiding the trap of either idealizing or demonizing those who have found themselves in this situation.  I bring this movie up not with the intent of reviewing the film, but rather as a pointer to a vehicle that viewers can use to become more aware of this pressing problem, not only in America, but around the world.

Rarely will you see an essay that merges the theme of an esoteric economic theory with a socio/political issue like poverty as depicted in a recent movie, but here you will see it.  This is because the two issues are intricately linked.

The July 18th-24th issue of The Economist had two good articles on how the entire discipline of economics is going through a major overhaul as a result of the 2008 financial meltdown.  Macroeconomics in particular has been largely discredited; in large part because the models are too simplistic and their usefulness for guiding public policy has been severely compromised.  The inability of the current models to predict the credit and liquidity conditions after the failure of Lehman Brothers has given pause to many people who were so convinced they were right.  Similarly, in the field of financial economics the much touted Efficient Markets Hypothesis (EMH) is now undergoing great scrutiny. Sophisticated methods of financial engineering emerged from EMH, many of which were implicated in the meltdown. So called institutional frictions led to certain inefficiencies that challenged the very basis of the model. These frictions that emerged in the form of toxic assets in the syndicated mortgage lending market were indeed inefficient.

Not only that, there was more than just the theoretical debris.  There has been a form of human debris that is represented by the increasing number of unemployed people and people living under conditions of poverty.  And, this is occurring not only in the U.S., but worldwide, with some countries hit harder than others.

It is within this context that the new conditions for thoughtful living takes place in the world. Certain economists, like Andrew Lo of the Massachusetts Institute of Technology (MIT) are developing models that reflect both behavioral and rational points of view. A behavioral approach is one that reflects the actions of irrational human beings, those that use herding behaviors, like those we have seen on Wall Street and on Main Street over the past few months. A rational approach is the straw man that has been used throughout the history of economics to characterize a value-seeking individual that acts in their own self-interest to maximize profits.  Andrew Lo’s work is premised on the idea that humans use trial and error as a basic decision-making tool.  It is within this context that institutional friction and societal learning takes place. This new “adaptive markets hypothesis” is one that takes into account the imperfections of the system; in the case of the world economy now, that includes the human debris.

The metaphor of a homeless musician playing Beethoven on the streets is an apt one for our time. He wrote his 9th Symphony at a time of great upheaval in the socioeconomic context of 18th century Europe. I wonder if the musicians of our time will be remembered by those living on the streets in the future. Don’t you think it would be better if we could build a society where everyone had a room to go to, like the Jamie Foxx character ends up doing in the movie?

ISE Proposal for Financial Market Reform

The International Securities Exchange (ISE) has issued a proposal for reform to the the U.S. securities markets. The proposal is based on the premise that there are currently significant overlapping areas and regulatory gaps between the Securities Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC).

They are proposing a new risk-based framework that includes 3 components:

  • Financial Systemic Risk: financial and capital matters involving commercial and investment banks, as well as futures commission merchants, investment companies and hedge funds.
  • Disclosure: disclosure/risk analysis for investors, which would cover corporate issuers, investment companies, and product-specific risk.
  • Financial Industry Operations: operation of financial markets, trading platforms and financial service providers, including but not limited to the services traditionally provided by brokerdealers, investment advisors, hedge funds and futures commission merchants.

To execute this framework, there would be a new U.S. Financial Markets Commission (FMC) that oversees all activities. A transitional authority would be set up for 18 months to facilitate the merger.

See the full proposal at:

Antidote for Green Protectionism: Fair Trade

The policy mantra in leading up to the planned December, 2009 Copenhagen negotiations on a global climate agreement has been “common but differentiated responsibilities.”  This refers to the important inclusion of several critical fast-growing and large emerging markets in the agreement; unlike that of the Kyoto Protocol. Climate change analysts are looking forward to the reopening of genuine talks on establishing emission caps; nonetheless, there is some trepidation among many going into these talks about the role the current global financial crisis will play in moderating the outcomes.  There is, however, an even more subtle, but potentially contentious item that could influence the outcome.  Negotiators need to be aware of a subtle, but insidious threat lurking in the background that may sabotage any progress made in the negotiations.  This is the impact of growing formal and informal forms of trade protectionism that has infected the public policy agenda in many countries since September, 2008.

colstripIn March, 2009, the Center for Economic Policy Research (CEPR) in London issued an insightful eBook entitled ‘The collapse of global trade, murky protectionism, and the crisis: Recommendations for the G20’ edited by Richard Baldwin and Simon Evenett (2009).  There are a number of hard-hitting essays and recommendations to G20 leaders on how to avoid the protectionist tendencies that are creeping into public policies in response to the global financial crisis.  It is a serious piece of scholarship written in record time in response to the events of the 4th quarter of 2008.  Importantly, it includes an essay by Simon Evenett and John Whalley on how to resist what has come to be known as green protectionism. A working definition of green protectionism can be given as “the deliberate use of environmental policy initiatives to discriminate against foreign commercial interests, including subsidiaries of companies owned or headquartered abroad.”

A similar call to resist regulatory arbitrage was made by the World Bank in its recent report ‘Global development finance: Charting a global recovery’ (2009).   They conclude that

“The international spillovers of the crisis in the financial area presently provide a powerful incentive for harmonization, because concerns over stability temporarily outweigh the urge to seek advantages for the ‘home team’.”

Standards Harmonization

Harmonization has been, in the financial and trade arenas, the driving force behind much of the progress made in the past 20 years to open markets and further progress in increasing efficiencies in global supply chains.  This has had a significant effect on lifting millions of people throughout the world out of poverty. This is not to say that there is no inequality in incomes, or that the digital divide has not been widened. This is an issue that will be addressed in a separate essay. The issue here is how the optics of a ‘green’ agenda has given new impetus to those who seek to protect domestic markets at the expense of consumers and global trade. The progress made toward harmonization in trade and financial sectors is threatened now as more and more national governments install provisions in bailout legislation and crisis management initiatives that give preference to in-country procurement. Similarly, governments in many different regions are instituting higher tariffs and implementing other non-tariff measures to protect domestic industries.

And yet, harmonization of global emission standards and approaches to taxation of carbon inputs in production is, undoubtedly, a key objective of the Copenhagen negotiations. Indeed, harmonization of global environmental standards has been included in the General Agreement on Trade in Services (GATS), the Agreement on Technical Barriers to Trade (TBT), among others. And, the principles embodied in these multilateral agreements are seen in several regional agreements, notably, the North American Free Trade Agreement (NAFTA).  But from a trade policy perspective, the environmental agreements that are seen to be least distorting are those that are preferable for a new Copenhagen Protocol.

Nonetheless, many critics of emission caps and global negotiations on climate issues claim that measures committed to by national governments within the context of climate change amelioration will impair business development and progress.  This is a worn out argument that has been used for years in response to Kyoto Protocol pressures. But now, in the post 2008 financial crisis era, these arguments seem to have been given new impetus.  However, the linkage of downturns in global trade, and the associated impacts to economies around the world to the deleterious effects of protectionist measures has rarely been made.  It is these protectionist trends that threaten to take the planet back to a mercantilist regime as was practiced in the 1800s.  And when trade protectionism is coupled with green technologies advocacy, a dangerous condition is set forth that can lead to a vicious downward spiral in the global situation.

It has been documented by the World Bank that since September 2008, governments around the world have proposed or enacted 78 different trade measures that are protectionist in intent.  Furthermore, 17 of the G20 countries are included in the list of offenders.  Importantly, this includes the United States where the global crisis had its genesis due to the syndication of risky mortgages.  Don’t the critics of climate change talks see this more threatening form of regulatory arbitrage as a harbinger of a shrinking global system?  Wouldn’t it make sense to address this problem as part of the climate change agenda?  In this way the potentially contentious negotiations on emissions caps, technology subsidies, and/or tax offsets can be tackled from a proactive point of view within a win/win framework.

Climate Change Control and Retaliatory Actions

Carbon control techniques being discussed among climate changes specialists include a consumption tax and a production tax.  Although the consumption tax is deemed to be fairer, calculating it is complicated by the complexity of global supply chains and rules of origin (RoO) in many countries.  As a result, the fallback position is a carbon production tax. But, as Evenett and Whalley argue

“To offset this adverse effect on competitiveness some proponents, including the high-profile Lieberman-Warner bill that recently failed in the US Congress, have argued for the introduction of taxes on imports from those jurisdictions with lower carbon taxes. Ultimately, it is feared that unilateral and regional measures will induce defensive protectionist pressures that will manifest themselves in measures to limit imports to the detriment of trading partners in particular from those poorer countries, that to date have expressed less interest in reducing carbon usage” (pg. 94).

Indeed, defensive measures in the form of complaints filed with the WTO under the TBT provisions are up 9% in 2009; another form of quantitative proof that these concerns are more than conjecture.

Climate Change and Trade

Other than Evenett and Whalley, advocates of a global climate change agenda have not addressed the trade factor in the ongoing discussions leading up to Copenhagen 2009.  The trade aspects, which include the need to address WTO Doha Round agenda items, as well as progress toward the Millennium Development Goals (MDGs), must be seen systemically just as the earth’s atmosphere is being viewed.  Importantly, the fact that over 3 billion people live on less than US$2/day should be taken into account as a key factor in moving forward (Prahalad, 2006).

This is where the antidote comes in. And it is coming from a most unlikely source; the grassroots movement known as the ‘fair trade’ movement.  If the multi-dimensional human element (as defined so eloquently by Muhammad Yunas in his book ‘Creating a world without poverty: Social Business and the future of capitalism’ [2007]) is factored in, then alternative strategies can be formulated. These alternative strategies would take into account the need to foster social businesses that both meet a market efficiency goal while at the same time satisfying a social goal, that of productive employment for workers in the budding new ‘green’ manufacturing industries.  However, these jobs may not necessarily be located in the countries that are now sounding the battle cry for supporting only their domestic industries. This could be a reason for easing trade restrictions and getting back on track with financial harmonization.

Alternatively, if business models guiding the development of technologies to implement programs for carbon capture and sequestration and/or alternative energies based on renewable resources must be built on the profit motive premise, then the pyramid-to-diamond transition argued so forcefully by C.K. Prahalad in his book ‘The fortune at the bottom of the pyramid: Eradicating poverty through profits’ could guide public policy discussions (2006).  His reference to the pyramid-to-diamond transition is his way of describing how, through focus on developing suitable products for those people living at the bottom of the pyramid (BOP), while at the same time, building the infrastructure to support the productive growth of this sector, a large segment of the population can be lifted from poverty.  In the context of climate change discussions, appropriately sized technologies based on renewable resources could offset some of the carbon emissions from the millions of people that still rely on coal and firewood burning for heat and cooking.

These two approaches to reducing global poverty rely on a harmonized trade and financial services regime; much like the one that was in place before September, 2008.  And, although global trade has declined precipitously, and economies are shrinking on the order of several percentage points (as measured by gross domestic product [GDP]), free trade is not in total retreat.  There is a solid foundation upon which to build.

Climate Change and Fair Trade

This is where a fair trade approach to production in carbon control and sequestration technologies can come into play. With a systematic approach to global climate change talks that guard against green protectionism and, at the same time, seek to enhance efforts to design appropriate energy sources for the BOP segment, whole new markets for products and services can be created.  Importantly, with a premise that seeks as a primary goal to use climate change progress as a mechanism for empowering those people who will be most affected by the energy resources that will be used as substitutes for fossil fuels, the creative and entrepreneurial power of these individuals can be unleashed to help design systems for carbon capture.

This approach can help negotiators from becoming schizophrenic in the Copenhagen meetings; allowing them to avoid opposing protectionist measures to the financial crisis, while at the same time, advocating for policies that would limit imports on the basis of RoO or TBT.

How this will work is still a bit murky.  It is, right now, just a germ of an idea.  But, by voicing the potential for this nexus, it is my hope that techniques for merging climate change and trade policy with practical, implementable solutions can be formulated. Then the empowered people from all countries can become part of the global trading system, rather than sitting outside watching the sky get smoggier with each passing year.

Ethnocentricity and Free Trade

Der Speigel recently printed a poll of former East Germans. In it 49% say: “The GDR had more good sides than bad sides. There were some problems but life was good there.” Another 8% say “Life there was happier and better than in reunified Germany today.” A full 57% defend a totalitarian, police state!

Typical of those polled is Thorsten Schon a 51 year old master craftsman who lives in Strasland on The Baltic Sea. Since reunification he has purchased a Porsche, traveled to Africa and by all measures has benefited from the fall of communism. “I’m better off today than I was before, but I’m not more satisfied” he says. He misses “that feeling of companionship and solidarity” and laments the rise in crime. “People lie and cheat everywhere today” and “today’s injustices are simply perpetrated in a more cunning way than in the GDR.”

Are these opinions merely looking back thru rose colored glasses? Or do they represent real questions we need to consider when assessing capitalism’s benefits and weakness’s.


Living in the southwest I’m often in contact with native American cultures. I once asked a Navajo gentleman what his definition of success was. A new car? A big house? “No” he said. His definition of success was to be “a good member of my clan.” Material things meant little to him. Family, friends and community were far more important.

He also felt that democracy was a mistake in native cultures. The corruption of so many tribal officials was a result of it. He felt native peoples would be better off if they returned to the old system of chieftains. His answers are remarkably similar to those of the former citizens of the GDR.

The poll reminds us not to be so judgmental when assessing a trading partners economic and political system. While human rights need to be adhered to, values may be very different. Modern capitalism has many benefits, but they come with a high price, a price that others with different value systems may not be willing to pay.

Supply/Demand and Profits: The Case of Oil

The most fundamental thing we all understand about economics without taking a course, the law of supply and demand, is flawed and incomplete. We intuitively feel that increased demand bids up prices, which then brings on new supply. Other things being equal, this works reasonably well. Other things are almost never equal.

Let’s take oil and gasoline as an example.

Gasoline prices may be rising, but if crude oil prices are rising faster than gasoline prices no new supply will come onto the market.  OilPumpSmallIt is even possible that supply may be reduced because crude prices rise so rapidly that refining and distribution costs are not covered, resulting in losses for gasoline producers. So, in order for rising prices of gasoline to bring on a rising supply, producers must be showing a profit.

This is not good enough. Hefty profits alone are not sufficient to bring on rising supply or increased competition. Wal Mart makes huge profits, but we do not see competitors flooding into the market to compete with them. The reason is that Wal Mart works on razor thin profit margins.

If prices are rising while profit margins are declining it is unlikely that new supply will be forthcoming. Therefore, new supply may be expected only when rising prices signals entrepreneurs to take a look, and rising profit margins induce them to wade in. In fact, there are plenty of examples where increased supply keeps coming even in the face of declining prices such as in the computer industry today. The higher the profit margins the greater the flood of new supply. I call this The Reiss Rule of Obscene Profit Margins: Relatively high and rising profit margins (not rising prices) result in increased supply.

Profit margin analysis is old hat to financial professionals, but apparently alien territory for economists. As proof I cite the windfall profits tax enacted under the Carter administration and recently re-proposed by certain policy analysts when oil prices were soaring. On the other side of the ledger I cite the special tax breaks enacted early in W’s administration when oil was in the $25 range. If you had any clue about what you just read, then it would have been obvious that we did exactly the wrong thing in each case.

When oil soared and profit margins rose for oil production in the 70’s the market signals screamed for more supply. By enacting a new “windfall profits” tax on producers plus a raft of onerous and costly regulations we did more than punish success. The windfall profits tax had a devastating effect on production because it led to sharply shrinking profit margins and severely dampened the market’s signals to potential investment by new oil producing entrepreneurs. This only exacerbated the problem.

Dollar sign 50

This is just one example of how those with the hubris to believe they know better than everyone else how the markets should behave actually do things that distort market signals and make things worse. Prices, profits and losses are the market mechanisms that transmit the information necessary for producers and consumers to make decisions that most efficiently allocate available resources. All the smartest guys in the room armed with all the computers in the universe can do no better.

Parenthetically, if one must interfere with the market when oil prices are high, then it follows that measures taken should increase incentives to produce more oil, not less. Therefore, reducing taxes on oil producers would be a better policy response to high oil prices than the typical, politically motivated, knee jerk reaction for higher taxes.

Is The U.S. Doomed To Years Of Slow Economic Growth?

Maybe not!

shoppingMallGreenFor decades the US consumer has fueled the fires of economic growth. Spending like drunken sailors the consumer has drained savings and run up a mountain of debt. Today with their savings depleted, their investments pillaged and their homes devalued, it will take a decade before they can spend again. We must pay the piper and are doomed to a lost decade. Or so goes the current economic mantra.
But in a new report entitled “The New Normal Will Likely Be ….Normal“, Wells Fargo’s Chief Investment Strategist Jim Paulson argues our economic recovery will be far better than expected. Paulson argues the seeds of our recovery were planted in the midst of our decadence. In short:

A: For almost two decades US consumers have spent far beyond their means. But that spending has helped jump start third world economies around the globe. We helped create a new world of consumers who have jobs, savings and aspirations for a better life. As we destroyed our savings, we created an emerging class of consumers around the world.

B: During the last expansion (2003-2006) overall real GDP growth averaged 3 to 3.5 percent. That was comprised of about 3% from the household sector, 1% from the business sector and a “net loss” of about 1% from our trade deficit. Let’s say that in the next expansion consumer spending drops to 1% of GDP. Business still contributes 1%, but rising exports now contribute 1%. Overall, GDP growth still remains at 3%, but its composition has changed.

Paulson argues several things must be put in place to make this happen:

1. Emerging world economies must no longer be allowed to continue currency pegs at cheap (below market) levels. Many emerging nations currencies are undervalued and would appreciate considerably were this to happen. China immediately comes to mind.

2. Emerging economies must no longer be able to treat workers like indentured servants. Worker protections, minimum wages and benefit packages must be enforced.

3. Environmental laws will need to be enforced worldwide.

A more level playing field will be created.

Should these things happen, the absence of the US consumer need not be a “death knell” for future economic growth. To read the article in it’s entirety, go to