Thursday, 21 March 2013

Socialism operating in the capitalist world

It has been along time between posts - I know. But it is a little hard to be creative or discuss something unique when on a daily basis we are bombarded with articles about economic and business topics that get rehashed and reconstituted with a slightly different spin. Albeit, it is not always bad to be exposed to this replicated material because out of sheer boredom it forces us to explore different topics and makes us consider what are the big issues. 

So during the summer break I stopped reading publications like Macro Business and The Economist and set about reading a book called Capitalism Socialism and Democracy written by the late great Joseph Schumpeter. It is a behemoth piece of literature that covers all aspects of social and economic theory and is one of the most famous texts ever published on social and economic theory, specifically socialism. 


The task of reading and digesting the content of this books is nothing short of an economic marathon. The foot notes alone require a cup of coffee and 30 minutes of your time. The overall schema is as complex as a spiders web where every proposition discussed is as integral to the structure as the former and latter propositions; so no speed reading. And at the pillar of this text is the prediction that the capitalist world has an inherent propensity to become socialist in some way or form. 


Although he did not put a time frame on socialism, there is no denying that capitalism has been extremely resilient to date. This is partly because it is the best vehicle we have for increasing the welfare of the greatest number of people. Although the gap between the top 1% and the middle class within developed countries has grown, the gap between developing nations and developed nations is shrinking.

In addition, I also think think capitalism is partly resilient because it subsumes many socialist components. Heaps of Schumpeter's predictions that were made over half a century ago have occurred.  However rather then transitioning to full blown socialism, developed nations in my opinion have moved more and more closer to a socialist system operating within the strata of a capitalist system. Something that he had identified as a possibility.

Whether or not socialism will ever be reached is not something that I really want to discuss because I am pretty sure we will all be dead if that ever does occur. Rather I want to show how the self destructing components of capitalism that Schumpeter identified have mutated into either new capitalist systems or quasi capitalist/socialist systems, which have effectively allowed capitalism to thrive.

1. The first point that really made me stop and think went something like this. As the cost of production decreases by virtue of more efficient production methods and better technology goods become cheaper. Hence a growing number of people have the ability to consume these goods because they are offered at a lower price. If this tendency continues to take place we would end up at a point in time where every one can achieve a fairly equal quality of life and there would be no incentive for individuals to get promotions, invest or simply make more money because they can satisfy all their needs and wants at their current level of income. This tendency would destroy one of the main cogs of capitalism - the drive to create wealth.

I read this and went shit there are a lot of bogans within Australia with brand new HSV Holdens watching Biggest Loser on there LCD TVs, which are nested in the back of their driver seats. Schumpeter assumed since they have the same goods as others making much more money then them the incentive to work would decline. 


But what Schumpeter failed to see was how capitalism would adapt to this. Most developed economies are service based economies, meaning large proportions of GDP are produced via services. Within these economies there still remains an incentive to increase income and wealth so that more services or better quality services can be consumed.  I can’t imagine the owner of that HSV listening to a musical or eating at a fancy restaurant.


In addition, premium branded and priced products will always carry a greater level of relative satisfaction and status. An extreme example is taking place within China where there is a stigma developing around counterfeit products. I read about a case where friends were actually out-casted from groups because they had bought counterfeit products.

Finally new products and patents will always be created. In the infant stages these products will always be more expensive until the technology becomes wide spread. The product and utility attached to the product will only be accessible to a certain proportion of consumers that can afford it, for example Dyson Fans with no blades.

2. The second salient point he made was that the ownership of shares and other financial instruments will eventually become meaningless. That is to say investors are only interested in the expected return of an investment and offsetting the return of other investments within their portfolio, in contrast to actively optimising the entity they are invested in. Consequently investors do not monitor the use of their invested capital which can lead to capital being misallocated.

On a grand scale this could lead to the unravelling of the capitalist system yet it would seem that when ownership becomes irrelevant and due diligence is not conducted asset bubbles occur, which are followed in extreme cases by a recession.  I present to you Exhibit A The US recession; where people around the world effectively lent money to home buyers within America, yet due to the complexity of the arrangement they had no idea what buyers they lent to or what homes provided the collateral. Ownership and investment can not become much more meaningless and inefficient then this, but capitalism still thrives. 

Why you ask? High volumes of public spending provide a quasi socialist fix to this issue at all points of the business cycle (before and after recessions). While admittedly public spending is typically viewed as a macro economic tool rather then a socialist tool.  Under the strictly capitalist viewpoint public spending should be minimal. But this is not the case. What we observe is that public spending has been steadily increasing relative to GDP in many developed nations around the world. Within the USA the ratio is in the order of 40% and in many Nordic countries it sits above this figure.

This high volume of public spending ensures capital is invested in new technologies that have not been developed within the private market due to inefficiencies.  To date it has brought you such things as the internet, wifi, space travel and Google maps, which have inadvertently facilitated inventions and business growth within the private sector.

3. Off the back of this point it becomes apparent that there is a past and observable tendency of rising public spending within developed nations.  It is therefore a possibility public spending may eventually comprise 100% of GDP and developed nations would become socialist.  Schumpeter implicitly argued this and at this point he suggested it would become impossible to resist a transfer to a socialist system. However, recent history would show us that countries with too high public debt and public spending will be faced with a recession rather then a socialist transition i.e. Greece, Spain Ireland and Portugal.

The point that I am trying to make is that while public spending especially the level that we see around the world now can be viewed as a quasi socialist tool, which promotes investment in infrastructure and inventions that have not been provisioned within the private sector. There is a limit to the amount of public spending and debt which can be sustainably provisioned. Economists such as Paul Krugman put that limit somewhere between the US public spending/debt ratio and the Nordic public spending debt ratio.

Perennial Gale

Schumpeter’s forecasting abilities were uncannily accurate. Yet while many of the situations that he extrapolated from past observable tendencies have come to fruition within the modern capitalist world – the world remains capitalist. And although he put no deadline on when the world would be come socialist there is no denying capitalism has been resilient to date. Based on these resiliencies it does not look like changing any time soon.

In addition, since his passing the world has experienced China’s rise which could be described as an economy with a socialist structure and capitalist mechanics. What ever way you view the world it would appear that the modern system requires components of capitalism and socialism to thrive.

Joseph Schumpeter once described economic mutation as the process that “revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”….yet it would seem the process of mutation looks vastly different if the old system is not destroyed.

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