Capitalism

I have always been a firm believer in rewarding people for the risks they take but in the last few years I have had to consider this more closely in the context of the financial sector, capitalism and neoliberalism as my understanding of the definitions of each was flawed.

I always thought the concept of capitalism is that entrepreneurial risk deserves an appropriate reward for taking the risk in the first place, i.e. I decide to set up a business selling chocolate teapots and I am loss making in the early years, have pumped every penny of available funds I have into the business to the point I am struggling with my bills, putting food on the table, etc… Then one day my chocolate teapots become trendy and everyone is buying them. The years of hardship are all eventually worthwhile and I begin to make significant profits and live a comfortable life. At that stage, there is a divergence of opinion as to the appropriate amount of tax I should pay once my business succeeds but the general idea that I took a risk and was now being rewarded for taking that risk is something that I believe is essential for innovation and growth in local economies. How that innovation and growth is managed in terms of taxation and regulation is a separate matter.

Upon reading a little further on the actual definition of capitalism, I realized that it can be basically defined as follows (per http://www.investopedia.com/terms/c/capitalism.asp):

“A system of economics based on the private ownership of capital and production inputs, and on the production of goods and services for profit. The production of goods and services is based on supply and demand in the general market (market economy), rather than through central planning (planned economy). Capitalism is generally characterized by competition between producers.”

I don’t have an issue with the above, in theory, because it is basically saying that if I have an opportunity to innovate, I take a risk and invest in my idea and I am then rewarded for that risk at some point in the future (if I am successful). Alternatively, my idea fails and I take the hit on whatever investment I made in developing that idea and taking that risk.

The problem arises with the next piece of the definition:

“Other facets, such as the participation of government in production and regulation , vary across models of capitalism.”

In my naïve version of capitalism, everyone in society would have an equal opportunity to take an entrepreneurial risk and either succeed or fail with their idea. Some people may not think like an entrepreneur and will form part of the “labour force” but will still be rewarded fairly and appropriately for the work they do to ensure they live a comfortable life. However, moving between the two categories should be encouraged and facilitated.

What has actually happened is that the profitability of the successful company or individual that took the risk on Day 1 has been engulfed in this never-ending thirst for profitability and success. The difference in wealth between the entrepreneur and the labour force would likely be fairly large even in a scenario where the labour force are well paid and enjoy a comfortable standard of living and happiness – there is nothing wrong with that given the level of risk required when the entrepreneur starts out. However, in this endless thirst for profit and wealth, we now have a situation where the labour force are no longer valued and are just used as pawns in maximising wealth and profit for the entrepreneurs at the top, i.e. the labour force will likely have lower wages, few benefits, longer hours, etc. The gap in wealth increases drastically when the entrepreneur gets sucked into this thirst for excessive profit and wealth at the expense of the labour force.

However, the game does not stop there. You then have Government participation to try and regulate, drive production and tax appropriately. In theory, this should be a positive thing whereby the Government ensures that a robust system of taxation exists to ensure that the entrepreneurs are supported during their early years and that the entrepreneurs then give back through taxation when they hit the dizzy heights of success. Regulation may assist by ensuring that no company becomes a monopoly to ensure competitive pricing and a better deal for consumers. Most importantly, regulators should be there to ensure that nobody becomes “Too Big To Fail” as we have seen with the financial crisis in 2008!

Effectively, human nature has taken over to ensure that capitalism has created a platform for human greed to take centre stage. The regulators have encouraged that greed and embraced the idea that wealth creation and soaring profits for the few (1%) are a reasonable platform on which society can exist – resulting in the “Too Big To Fail” phenomenon. The taxation systems domestically and internationally have facilitated the greed by failing to follow the logic I set out above whereby entrepreneurs are assisted, encouraged, incentivized to innovate, invent, create, develop, etc. but repay that faith through the tax system when they become successful. It is not a difficult concept!

Neoliberalism – The Cuckoo of Economics

As an added kick in the teeth to the concepts set out above, let’s throw neoliberalism into the mix! Neoliberalism can be defined as follows:

“Neoliberalism is an approach to economic and social studies in which control of economic factors is shifted from the public sector to the private sector . Drawing upon principles of neoclassical economics, neoliberalism suggests that governments reduce deficit spending, limit subsidies, reform tax law to broaden the tax base, remove fixed exchange rates, open up markets to trade by limiting protectionism, privatize state-run businesses, allow private property and back deregulation.”

My naïve definition of capitalism suggests that it is a system designed for entrepreneurs to innovate, invent, develop, etc. by taking on the financial risk of failure of their business idea (if it fails) but also enjoying the reward (i.e. profitability) if the business becomes successful.

Neoliberalism does not encourage entrepreneurialism! Neoliberalism is the “cuckoo” of economics, i.e. Cuckoos don’t bother building their own nests – they just lay eggs that perfectly mimic those of other birds and take over their nests (it’s the best analogy I could come up with!). Effectively, the public sector invests in developing public assets and companies that operate for the benefit of the taxpayer, e.g. energy, transport, health, education, etc. then under the concept of neoliberalism, private companies swoon in and lobby politicians and sweeten them up, use the media to portray the weakness and poor state of these state assets, then purchase these assets (privatization) or enter into lucrative service contracts (outsourcing such as PFI) so that wealth shifts out of the public sector and into the private sector (also known as shrinking the state).

There was no entrepreneurial risk for these private companies. They did not innovate, invent, create, develop, etc. anything of value to society. They simply used their wealth to pry valuable assets from the public sector with promises of efficiency, reduced costs to consumers, etc. (which of course has been proved to be nonsense with the privatisation of assets that has taken place in the UK since the IMF bailout in the 70’s and the Thatcher era). These assets are usually purchased at below market value and the value of the assets increases in a short period following the purchase by the private company (triggering quick profits for shareholders). Neoliberalism is based purely on greed and will never benefit the majority of people in society.

Too Big To Fail

Neoliberalism is also the first step into the “Too Big To Fail” fantasy. How did this happen? Privatisation of money creation, i.e. 97% of the money created in the UK is created by the private banking sector through debt. That was the first step on the ladder to the financial sector increasing their asset values so much through derivatives trading and other casino type financial activities. Certain banks were deemed to be so high value and so inextricably linked to the economy of countries like the UK that they were deemed to be “Too Big To Fail”. Investopedia explain “Too Big To Fail” as follows:

“The idea that a business has become so large and ingrained in the economy that a government will provide assistance to prevent its failure. “Too big to fail” describes the belief that if an enormous company fails, it will have a disastrous ripple effect throughout the economy“.

As well as the casino banking tendencies, Governments have facilitated the creation of “Too Big To Fail” banks through deregulation. The extract below from a Motley Fool article written by John Maxfield is worth digesting:

Banks are too big to fail because we — or, more accurately, our representatives in Washington with the help of the financial industry’s lobbyists — made them that way. Over the last 40 years, Americans have been force-fed the notion that oversight of the financial industry was unnecessary because, as then-Federal Reserve Chairman Alan Greenspan put it in 1998, participants in financial markets are “predominantly professionals that simply do not require the customer protections that may be needed by the general public”. One year later, Congress voted overwhelmingly in favor of the Gramm-Leach-Bliley Act, which repealed what was left of the Glass Steagall Act’s prohibitions against the intermingling of commercial and investment banking activities. “We have learned that government is not the answer,” Senator Phil Gramm said at the time. “We have learned that freedom and competition are the answers”.

The deregulation that took place in London’s financial sector equally facilitated the excessive growth in the financial sector to create these “Too Big To Fail” banks. Capitalist greed had kicked in although I still struggle to see the true entrepreneurialism at play here apart from very clever people finding different ways to package and sell debts and make bets on some. Is a gambler in a casino an entrepreneur or just someone who is very skilled at their job? Probably a mixture of both.

However, once the banks have become “Too Big To Fail”, the risk element is removed because Governments will step in to bailout the banks thus making them risk free! All of the financial loss is transferred from the private banks to the taxpayers which is effectively neoliberalism in reverse! Confusing eh?!

So what is the solution? Well I would go hardcore and let the financial system crash and start afresh! If you believe in capitalism then that is exactly what should have happened! However, this infused neoliberalism means that there is a constant interaction between our Governments and the private sector whereby the citizens of a country are never at the forefront of Government policy and decision making (in the UK and USA specifically). Instead, the “labour force”, “taxpayers”, “lemmings” will be treated as inferior and will not be valued so that wealth can be stripped out of our hands and into the hands of the 1% who pull the Government and media strings!

An alternative solution proposed for the “Too Big To Fail” issue is to ensure that companies (banks in this instance) are forced to break up before they get to be “Too Big To Fail”. Almost like anti-monopoly laws. However, it would take a Government with great courage and values to regulate in this way to avoid “Too Big To Fail” organisations causing another huge shift in financial loss from the private to public sector.

There are no easy answers to these issues but hopefully this blog will provide some food for thought.

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