Posts Tagged ‘capitalism’

Michael Lewis and David Einhorn have a terrific couple of articles in the New York Times today. They cogently trace the structural causes of our current financial crisis and recommend a number of obvious fixes.

The critique which most resonated with me was the focus on short-term profits that leads to risky behavior and long-term failure. For example, starting three years ago, a private investor named Harry Markopolos repeatedly tried to sound the alarm about the Madoff Ponzi scheme, writing and speaking with S.E.C. regulators who did nothing to stop the enormous fraud. The reason no one stopped Madoff and the reason we are in this crisis is because all involved have misaligned interests.

OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.

The tyranny of the short-term manifests in credit rating agencies who make money off the firms they are supposed to rate honestly. It shows up in the S.E.C. where regulators seek good relationships with financial institutions in order to receive higher paying jobs in the private sector. It’s on display with bank executives who will be forced out if they don’t make short-term profits.

This is something about which I’ve worried for a while: how do we imbue our market-driven firms with long-term thinking? Quarterly earnings reports, expected to be better than 3 months before, seem like a good idea for shareholder accountability, but it also forces firms to make short-term decisions that may harm their long-term interests.

Lewis and Einhorn are dumbstruck that 18 months into this situation, next to nothing has been done to solve these structural problems. Although they have their disagreements with how Treasury Secretary Paulson is managing the problems (they advocate letting the banks fail), the more important, long-term problems haven’t been addressed.

Their solutions are:

1. Stop making regulatory decisions with long-term consequences in fear of their short-term effects
2. End the official status of the rating agencies – either privatize the rating or do it publicly
3. Regulate financial innovations like credit default swaps (see Bookstaber’s book for their danger)
4. Place capital requirements on banks or break up banks into parts that are small enough to fail
5. Don’t allow S.E.C. officials to work on Wall Street, but encourage the flow in the opposite direction

I’m glad sensible, structural proposals are being put forth and hope Obama and the incoming Congress heed them.

It seems the media likes nothing better than a good symbol and nothing says “Rise of China” like the Beijing Olympics. Picking up on the theme, David Brooks has an article on collectivism versus individualism where he provokes that China’s rise through collectivism is a threat to the power of the American dream.

Touching on a topic I mentioned a while back, Brooks explains the fundamental differences in worldview held by Asia and the West. While the West values individuals and their success, Asians seem to prioritize collective harmony. For example, show a fish tank to an American and he sees the biggest fish and its actions. An Asian, on the other hand, sees the relationships between the fish. In experiment after experiment, “Americans usually see individuals; Chinese and other Asians see contexts.”

For much of history, individualist societies excelled economically, but Brooks thinks the rise of China may point to a change in that narrative.

“But what happens if collectivist societies snap out of their economic stagnation? What happens if collectivist societies, especially those in Asia, rise economically and come to rival the West? A new sort of global conversation develops.

The opening ceremony in Beijing was a statement in that conversation. It was part of China’s assertion that development doesn’t come only through Western, liberal means, but also through Eastern and collective ones.”

However, I think Brooks is missing a key point. I’m not an expert on either economics or China, but my understanding of the rise of China is that it hinged upon economic liberalization led by Deng Xiaoping. By opening up to international trade and moving towards a market system, China paved the way to the double-digit growth which has characterized its recent years.

What Brooks alleges, then, is that China has embraced capitalism while maintaining a collectivist spirit. In Ted Koppel’s recent miniseries entitled “The People’s Republic of Capitalism,” he interviewed a Western-educated Chinese youth who thought government censorship and repression was acceptable because it was bringing China out of poverty and improving millions of lives. Brooks sees this sentiment, which I believe is widespread, as a collectivist capitalism.

I disagree. I think it is driven by self-interest; it is individualistic. Those suppressed are not supporting the suppression. They don’t think collective harmony for growth is good, like Brooks supposes. The Koppel interview shows citizens who are being personally benefited by markets – the selfishly driven interaction of individuals. The rise of China – an economic phenomenon of GDP growth – comes with increased individualism. My intuition is that while it may masquerade as collectivism (“all of China is benefiting from this system, so suppression of dissent is okay”), it is really individuals seeing themselves benefit and liking it. Brooks thesis, as I understand it, would be supported by an active Falun Gong member supporting his suppression because his family is richer than last year. And, although I haven’t looked hard, I don’t think that is happening.

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In January, Bill Gates delivered a speech at the World Economic Forum in Davos calling upon the audience to embrace a “system innovation” to deliver the bottom billion, those poorest people, from poverty. In his reckoning, capitalism harnesses one major human motivator, self-interest, while government and philanthropy apply the other, care for others. Gates thinks a hybrid system is needed to address the dire needs of the impoverished.

“I like to call this new system creative capitalism – an approach where governments, businesses, and nonprofits work together to stretch the reach of market forces so that more people can make a profit, or gain recognition, doing work that eases the world’s inequities.”

Creative capitalism would use dual incentives to solve hunger and disease: profits and altruism. Profit-driven firms would be more accountable while focusing on traditionally under-served markets. Take the example of “a Dutch company, which holds the rights to a cholera vaccine, retains the rights in the developed world, but shares those rights with manufacturers in developing countries. The result is a cholera vaccine made in Vietnam that costs less than $1 a dose – and that includes delivery and the costs of an immunization campaign.”

In response to Gates’s call to action, a number of prominent economists and lawyers have developed an online conversation about creative capitalism’s promise and its weaknesses. Participants include Nobel laureate Gary Becker, Judge Richard Posner and aid skeptic William Easterly. Many of the essays are critical.

Easterly writes, “Mr. Gates’ speech attacks the system that has historically done the most to alleviate poverty—traditional capitalism—in favor of an untried and implausible alternative—an illusory Third Way that mixes profits and altruism.” Posner opines that creative capitalism is nothing more than traditional PR-based charity which actually fits nicely with traditional capitalism.

After browsing the critiques, I think much of the trouble comes down to Gates’s nomenclature. The examples in his speech or C.K. Prahalad’s wonderful book, “Fortune at the Bottom of the Pyramid” are not truly a new system. Prahalad demonstrates the massive profits and opportunities open to firms which are willing to understand and enter the market of the poor.

The problem comes down to capitalism’s tendency to lead to thoughtless profit pursuit. What is needed is not creative capitalism (as Greg Mankiw said “I though capitalism WAS creative.”). What is needed is conscious capitalism. Mortgage brokers, borrowers and Wall Street investment bankers got a taste of unconscious capitalism with the subprime fiasco.

Part of the problem comes down to the way corporate governance is conducted: being under pressure to out-perform the last quarter every 3 months places an insane focus on short-term thinking. Judgement Day for those corporate officers with fidicuary responsibility to shareholders comes not once a lifetime, but 4 times a year. Accountability is good, but long-term thinking often falls by the wayside.

Joi Ito, a Japanese venture capitalist and CEO of Creative Commons, noted something similar at a recent panel. Money makes people short-sighted and when coupled with the Internet’s efficiencies, he believes “fluctuation amplification occurs.” His hope is that capitalism will be injected with long-term thinking about issues like the commons.

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As it relates to the Internet, Joi worries that a rush to mobile-based connectivity will promote carriers who do not reinvest in the ecology of the Internet and who swallow profits for short-term gain.

The same could be said of Gates’s goal. The same wholistic approach which must be taken to defend the Internet’s openness is the approach which must be taken to invest in the poorest in our world. It requires awareness of the difficulties and opportunities of capitalism. By recognizing that today’s poor are next decade’s consumers, capitalism will continue to lift out of poverty millions, but only if it is done consciously.

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