Opinionista Dirk De Vos 3 September 2018

Understanding how capitalism really works

You have to give it to Karl Marx. Whatever your own ideological pre-disposition, there is no denying that when he set out to analyse capitalism, he really made a concerted effort to actually understand how it worked at the time and it shows. Das Kapital, published in 1867, is an enduring text because it still provides the basis for a critique of modern capitalism.

Of course, Marx got many things wrong. Among them was his labour theory of value, the impact of technology, intellectual property. Marx claimed too that capitalism as a system contained within it the seeds of its own destruction – that it produces surpluses that could not be consumed and that would eventually destroy itself. We have 150 years to show that this is wrong. To the extent that capitalism does destroy itself, it only appears to destroy parts of itself, leaving that which remains stronger. Joseph Schumpeter an economist from the older Austrian School (most libertarians are also adherents of the “Austrian School”), coined the term “Creative Destruction” to describe how new technology or processes constantly changes economic structure from within, destroying existing businesses and creating new ones to replace them.

One of the other key features of Marx’s ideas was the need for direct action to change the oppressive system of capitalism. Even though he thought capitalism would destroy itself, getting to a new epoch of a classless and equal society required a revolution and the “historical task” for undertaking this direct action would fall to the working class.

While one can pile up endless critiques of Marx, he was writing in the early stages of the first industrial revolution in what was to become a united Germany a few years later. Although Darwin’s Origin of the Species was first published eight years before Das Kapital (and which Karl Marx did read), the theory of evolution and marginal, incremental adaptations in response to competition , co-operation (both across and within species) and exploiting changes in an environment was still a new idea.

The point is that Marx, used his considerable intellect to try to understand how capitalism, as it existed at his time, actually worked. Since Das Kapital, Marxist thought has developed a rich intellectual tradition that has had a significant impact on a wide range of topics beyond just political-economy, it has also provided the foundation for spectacular failures and human misery that continue to this day in countries like Venezuela.

Most people who live in a family context (however a family is configured) live a socialist life. Household income, whoever is responsible for generating it, is redistributed roughly according to needs rather than on where it produces the best returns. It would also be fair to say that we become more transactional and self-interested with increasing distance from the home, with our friends, the neighbourhood, social clubs/schools/churches, our workplaces, towns to the nation and beyond. The old socialism v capitalism is really about at what scale socialism fails.

One feature of the left from Marx onwards is reliance on top-down direct action by the state in the economy whether in the form nationalisation, other large-scale participation in the economy via state-owned organisations or doing the same via regulation. One needs to distinguish this involvement from the state using tax and its power to spend playing a role in redistribution of income and the provision of basic social services in health, education and necessary infrastructure.

There is a misconception that socialism fails because it removes incentives to go out, take risks and produce. This is not the case. The real reason why it fails is that socialist countries create all sorts of barriers that prevent people from producing. Nationalised businesses means that nothing can happen without government involvement and this involvement brings with it entrenched interests that sabotage things from being done. Seen in this way, private firms are not vehicles for allowing capital to exploit workers to make unjustified profits but merely effective vehicles for getting all sorts of things done.

The so-called social democracies in Scandinavia demonstrate the point. These countries, which have some of the highest rates of tax and welfare spending in the world are also ranked by the conservative Heritage Foundation outrank the US in terms of property rights, ease of starting a business, openness to trade, and monetary freedom (a measure of inflation and price controls). Even Friedrich Hayek supported a robust safety net for the purposes of “providing for those common hazards of life against which few can make adequate provision”.

In general, socialists continue to favour top-down direct interventions by the state preferably supported by “evidence based” research. When decision-making follows a process of identifying a problem with the objective of solving it by reviewing evidence and evaluating options, what we mostly get instead is some predetermined solution with evidence selected to favour the pre-selected solution.

That type of policy making process is faulty because we cannot know the full ambit of what the problem is all about or that a whole number of factors will change once the policy is known. Goodhart’s Law shows the dynamics at play: Individuals who are aware of a system of rewards and punishments will optimise their actions within this system to achieve their own best outcome.

A good example of a failing policy is Broad-Based Black Empowerment (BEE) legislation and its regulations. The problem of lack of participation of black people in the formal economy and racial inequality is the problem to solve. What we get is a a complex scheme of BEE regulation and arcane rules.

The only interesting thing about BEE regulation is about they reveal about what the drafters of the rules think private firms work. Well, they don’t work in the way the BEE codes suggest they do. They work in all sorts of different ways. Still, the BEE regulations provide a system of rewards and punishments. They are also thoroughly gamed: they get manipulated by a range of actors from failing white-owned companies, specialist BEE advisers, funders, crony capitalists and those with a talent for manipulating state procurement budgets.

Of course, the original problem, namely the exclusion of the black majority and inequality has not gone away and, in some respects, the original problem has got worse.

Sadly, the response to the unsatisfactory outcome is to swap out some of the original rules, sub-rules and sub-sub rules with a whole raft of new rules that are equally misguided and arguably worse because they are combined with additional rules addressing issues of enforcement. Black empowerment won’t be advanced by better enforcement of BEE regulations. The whole scheme of BEE is wrong-headed.

This top-down directed approach to solving problems is also evident in President Cyril Ramaphosa’s drive to secure at least $100-billion foreign investment over the next five years. Once again, lack of foreign investment is seen as a problem because it prevents economic growth. The president sets about solving the problem by setting a somewhat arbitrary target.

It should be obvious why this initiative is going to be disappointing. Some types of investment are more valuable than others. For example, securing new investment in renewable energy power plants is an excellent thing to do but if this investment is also fully underwritten by the state, it is much less valuable than an investment in which the investor takes actual risks of losing its investment.

An investment by the Chinese Import Export Bank into Eskom’s debt might well be a good thing but it might also simply allow the utility to continue piling up on debt that is not repayable instead of fixing its business. Additionally, we don’t know the terms of this debt and, who knows: this investment might not be on terms that are in our best interests. The experience of a number of other African countries that have taken on piles of Chinese debt should be instructive.

John Kay, in a series of papers and then in a book recommends another approach. He says that in all complex systems, difficult problems do not lend themselves to be solved analystically or even rationally. Kay calls instead for a different approach to difficult problems: he calls it “obliquity”. It describes an approach that seeks to tackle problems indirectly and under conditions of uncertainty. As systems become bigger, they become exponentially more complex which make big systems not just different quantitively but also, qualitatively different. The main advantage of free markets is that they allow almost infinite complexity to emerge without central planning.

What if we took the view that exclusion of black people from the mainstream economy had less to do with racist prejudice and instead more about high levels of concentration in our economy as described in a recent World Bank report?

It says that In product markets, competition from new entrants or smaller rivals is impeded by barriers to entry and rivalry resulting from a combination of historical market features, unintended effects of government interventions, and anticompetitive behavior by firms, including current and former SoEs or firms that formerly benefited from state protection. A group of firms that appear to be highly vertically integrated into inputs, offtake, and distribution networks may further restrict entry by raising the risk that new entrants are unable to access inputs or supply channels.”

What if on top of that we really focused on improving the very poor outcomes in our education system?

What if instead of targeting $100-billion in new investments, the objective was to reduce our current social discount rate of 8.2% (roughly the government’s borrowing rate) to 7% within five years?

The obvious way of doing this is not in nationalising the nominal capital of the Reserve Bank but in getting two or three notches up from the minimum investment grade level of all three of the main global credit rating agencies. This is not as compelling as “a $100-billion in five years target” but it is far more likely to produce the result of, well, $100-billion in investment in five years.

Choosing to solve things obliquely is a tough thing to sell to an electorate. Most of us want to to see direct action by the government to fix the county’s many, many problems. Direct action that mostly work solving our own lives, within our families and homes have an attraction for application on a national scale. But as the system we are trying to fix scales up and becomes more complex, direct action is not only ineffective but even counter-productive.

None of this is to suggest that people committed to the broader ideals of social solidarity, non-racialism and equality abandon those ideals. If these ideals can best be achieved indirectly or obliquely, what is the harm in using these tools?

In a survey of voting patterns in Norway, younger, more qualified and richer Norwegians tended to vote for parties of the left like the Socialist and green parties. Voters for those parties also had a much higher propensity to own their own businesses. Even the start-up sector in Norway is broadly in favour of high taxes and a generous welfare system.

But if these political parties of the left were to become the government, they would still use market mechanisms to achieve their particular political programmes.

For many reasons a Scandinavian system cannot be simply replicated here – that is not the point. The point is that you don’t have to like what we call capitalism to understand that it provides powerful tools to realise outcomes that socialists would favour.

More South Africans, and especially our political leadership, should emulate Karl Marx and make a proper effort to understand how capitalism really works. Big and complex problems are mostly solved obliquely. DM

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