Economic Nonsense: 50. Capitalism is unstable, subject to periodic crises, and should be replaced

Capitalism is not a fixed thing, but rather a process which develops and changes in response to changing conditions, and especially changing technology.  To say it is unstable is basically to say that it changes.  It is not by its nature stable.  The capitalism of the 21st century is very different from that which prevailed at the beginning of the 19th century.  It evolves as circumstances change, adapting itself to cope with the new realities that present themselves.

It is certainly subject to periodic crises.  The business cycle has long characterized it, with economists divided as to its ultimate causes.  Periods of growth are followed by periods of a sluggish or even contracting economy, with some observers suggesting that this is a good thing, helping to weed out underperforming businesses and redirect their capital to newer and more successful ones.

Over and above this cyclical behaviour, there are occasional crises that seem to threaten the whole basis of the capitalist economy.  The Great Depression was one such period, and the 2008 recession was another.  Critics look for some alternative that lacks these wild and damaging fluctuations.  No-one has yet produced a better system.  For all its flaws, capitalism is the best way humans have found to generate wealth and to allocate resources.  Even including its great crises, it has still produced steady average growth in developed economies for the best part of two centuries.  In less developed economies it has recently produced growth and wealth on an unprecedented scale.

Capitalism learns from these crises.  It adjusts itself.  Governments learn from the mistakes that led to them, and devise new rules to prevent the same happening again.  Capitalism develops and adjusts, renewing itself each time.

When the 2008 crisis came, critics prematurely celebrated capitalism's decline and wondered what might follow it.  The answer was capitalism, modified to prevent countries repeating the mistakes of the past.  It is certainly imperfect.  Most institutions made by humans are subject to the frailty and imperfection of humanity.  But they can improve by learning from their mistakes and adapting, and this is what capitalism does and why it endures.

Economic Nonsense: 45. Unbridled capitalism brought about the Great Depression

In the popular account the stock market went wild in the late 1920s, with people gambling recklessly on stocks and shares, often with money they didn't have.  Shares could only go up, they thought, but they were wrong.  The market crashed, people went broke, investors jumped off high buildings, and without investment GDP plunged and the Great Depression came about.  If it were true it might be a major indictment of unbridled capitalism, but it isn't.

People did overstretch recklessly, assuming the market could only rise, helped by easy money from the Federal Reserve Bank, and the Great Crash came in 1929.  It wiped out many investors, but it did not lead to the Great Depression.  That came later as a direct result of bad policy decisions.  Had those decisions not been made, the stock market crash might have instigated a cyclical downturn and corrected itself after a year or two.

The Federal Reserve Bank, observing that people had bought shares with easy credit, decided to tighten credit and restrict the money supply.  This is what you do not do in a recession, when struggling companies need credit to keep going and companies that see opportunities ahead need money to invest in expansion.  It was a disastrous mistake.

The folly was compounded by protectionist policies.  The Smoot-Hawley Tariff of 1930 shut out most foreign goods to boost home-produced goods in the name of protecting American jobs.  Its effect was catastrophic.  It sparked a beggar my neighbour trade war as other countries responded with tit-for-tat measures.  Unable to sell goods in America, they stopped buying American goods.  International trade plunged and much of the world sank into recession. 

There were other contributing factors.  Banking regulation had been clumsy and restrictive, and left American banks unable to play their part in promoting investment and expansion.  Income taxes were massively hiked in 1932, just when tax cuts could have helped.

Unbridled capitalism did not cause the Great Depression, incompetent government did.  It is another piece of economic nonsense that President Roosevelt's New Deal government activism helped America's recovery from the Great Depression.  It didn't.

The dark history of the minimum wage

We read today that the national minimum wage will increase by 20p an hour to £6.70 from October, and that this will benefit more than 1.4 million workers. What we hardly ever hear from politicians is how many people will feel the costs of this increase, in addition to the people who are already being hurt by having a minimum wage law in the first place. The problem with state-enforced minimum wage laws is pretty standard economic text book stuff: the minimum wage makes it harder for low-skilled workers to get a foot on the labour market ladder, it unfairly loads the burden on firms that employ low-wage earners (a burden that could be avoided by simply reducing the tax low-earners pay, or taking them out of tax altogether), and as a result it often causes inflation of prices and reduction in staff as firms try to recoup their losses.

With the announcement today, and with the Budget looming, I was very interested to stumble upon an article this week by Jeffrey Tucker about a Eugenics Plot Behind the Minimum Wage, in which we find out that in the early 20th century some eugenicists tried to introduce the minimum wage as a means of getting some of the lesser able people out of the employment market. Here are some relevant quotes that are bound to shock:

A careful look at its history shows that the minimum wage was originally conceived as part of a eugenics strategy — an attempt to engineer a master race through public policy designed to cleanse the citizenry of undesirables. To that end, the state would have to bring about the isolation, sterilization, and extermination of nonprivileged populations.

It was during this period and for this reason that we saw the first trial runs of the minimum wage in Massachusetts in 1912. The new law pertained only to women and children as a measure to disemploy them and other “social dependents” from the labor force. Even though the measure was small and not well enforced, it did indeed reduce employment among the targeted groups.

Leonard documents an alarming series of academic articles and books appearing between the 1890s and the 1920s that were remarkably explicit about a variety of legislative attempts to squeeze people out of the work force. These articles were not written by marginal figures or radicals but by the leaders of the profession, the authors of the great textbooks, and the opinion leaders who shaped public policy.

“Progressive economists, like their neoclassical critics,” Leonard explains, “believed that binding minimum wages would cause job losses. However, the progressive economists also believed that the job loss induced by minimum wages was a social benefit, as it performed the eugenic service ridding the labor force of the ‘unemployable.’”

So when we hear politicians make minimum wage commitments in the run-up to the election, bear in mind that those that preceded them were always fully aware that wage floors precluded people from the labour market, and that they were once deliberately implemented to expunge the demographic landscape of those they thought inferior citizens that were unworthy of earning a living. That they so readily endorse a policy that places a barrier to employment for so many people tells you just about all you need to know about the extent to which winning votes matters far more than aiding people’s job prospects.

I hope that, in my lifetime, politicians and social commentators begin to get the simple message that if you artificially remove the lower rungs on the labour ladder, you make it difficult (often impossible) for people to climb it, or in some cases, get on it at all.

The inheritance of wealth and social mobility

Many of the papers are covering the new Greg Clark paper showing that social mobility isn't quite as fast as some think. But it has to be said that the paper isn't quite showing what people think it does. It is true that the intergenerational elasticity of wealth inheritance is 0.7-0.75 as the paper defines it. But this isn't quite the same as saying that that wealth is inherited. To understand the point imagine that it is purely wealth itself that is inherited. People now are rich because their forefathers were rich and that's the only reason. OK. But that's not what this paper has proven in the slightest.

What this paper has shown is that the children (and male children only, as they're tracking surnames) of people who die rich are highly likely to die rich. That means that there is a correlation between being the child of a rich man and being a rich man. It does not show that that richness comes from having inherited the wealth.

Consider this example that is used:

Joseph Bazalgette was responsible for building the world's first sewer system in London in the 19th century, the Pepys family tree contains noted diarist Samuel Pepys, and John Bigge was a judge and royal commissioner.

They found that, compared to their relatives in 1850, those living with that surname today are almost certain to have amassed fortunes well beyond the reach of the average Briton.

For example Sir Peter Bazalgette, the great-great-grandson of Sir Joseph, is the founder of Endemol television production company which created Big Brother and Deal or No Deal.

The company was floated on the Dutch stock exchange in 2005. It trebled in value and was sold for £2.5billion in 2007.

There's a number of different options available to us to explain this. That Sir Peter inherited wealth and was thus able to invest in something that was a further success. Someone who had not inherited could not have done this perhaps. Sir Peter inherited a social position that meant he was able to have such an entrepreneurial success. Or Sir Peter had a privileged education that enabled him to do so and so on. But it's also possible that there's an entirely different explanation, that Sir Peter inherited something else that enabled his success.

It is, after all, indubitably true that intelligence is inheritable. The very concept wouldn't have arisen through evolution if that were not true.

We can even tie this in with earlier work by the very same Greg Clark. In a Farewell to Alms he makes the point that what really enabled the Industrial Revolution etc was that those who were wealthier, had those bourgeois values that created higher incomes, had more surviving children than those that didn't. And thus over the centuries those values spread further down the income bands as the descendants overwhelmed (and there's an argument there about whether it was genes or cultural education) the genes of those who did not start out with these views. Essentially his eariler argument is that it was inheritance of being bourgeois that mattered.

We're going to have an awful lot of shouting in the next week or two about this new paper. And we're prefectly willing to agree with the concept (no, this does not mean we think it necessarily true, just that we're willing to take it as a working assumption and see where it goes) that something or other is being inherited leading to the same sorts of people getting to the top in each subsequent generation. But everyone's going to have to be extremely careful in trying to tease out exactly what it is that is being inherited.

From the information we've got here it's not immediately obvious that it is wealth itself that is being inherited. After all, as the paper itself notes, there's been many different taxation regimes upon both wealth and income over the hundreds of years they study. If it were purely cash that made the difference then the results would not be so consistent over this time. And if it's something else that is being inherited then even 100% death duties aren't going to make much, if any, difference.

This isn't a rerun of 1930s poverty

Just a small reminder that whatever you see being shouted over in The Guardian and other points left this really is not a rerun of the levels of poverty seen in the 1930s. It's possible that it's a rerun of the inequality of those days (although we would vehemently disagree with that), it's possible, what with Syriza and the Front National, that certain aspects of politics are like they were in the 30s. But it really isn't true that we're anywhere near anything like 1930s levels of poverty. Here's what Dr. Barnardo's calls living in poverty these days:

Families living in poverty can have as little as £12 per day per person to buy everything they need such as food, heating, toys, clothes, electricity and transport.

In 1930s Britain the Public Assistance Committees would provide 22 shillings a week for a family of five, two adults and three children (the PACs being the safety net after eligibility for the dole was exhausted) . That is £1.50 a day per person. Yes, that's after inflation, that is £1.50 per person per day in today's money and at today's prices.

Around here we do not wish either living standard upon anyone: not that £1.50 a day which is some twice the amount that the absolutely poor, the hundreds of millions of them around the globe, still live on. Nor that £12 a day of the poor in our own society. That's why we work to improve economic policy so that the poor do get rich. Through the only economic system that has managed it on a large scale for any length of time, free market capitalism.

But the important point we want to make here is that those two numbers are obviously very different indeed. Whatever else is happening in the UK of today it just is not true that we are getting anywhere near either the living standards or the poverty of 1930s Britain. To claim so is to be entirely ignorant of the facts.

Are we innovating less?

According to Huebner (2005) the per capita rate of innovation has been falling steadily since 1873 (it doesn't look quite like that from the chart below, which is just of patents, because patent laws changed a lot during the period). He constructs an index of innovation by looking at independently-created lists of events in the history of science and technology and from US patent records and compares them to the world population.

Woodley (2012), looking at the numbers for a different purpose, compared them with three alternative indices of development, and found that they correlated well with different numbers gathered for different purposes. For example, they correlate highly (with a coefficient of 0.865) with the numbers in Charles Murray's Human Accomplishment, which quantifies contributions to science and arts partly by how much space encyclopaedias devote to particular individuals.

It also correlates 0.853 with Gary (1993)'s separate index, which was computed from Isaac Asimov's Chronology of Science and Discovery. Finally, it correlates with another separate index, created in Woodley (2012), computed from raw numbers in Bryan Bunch & Alexander Hellemans (2004) The History of Science and Technology, and divided only by developed country population numbers in case there is something special about them in creating innovation.

The result seems quite robust, although I am hoping my friend Anton Howes (who has an excellent new blog on the industrial revolution, and is working on a PhD on innovation and the industrial revolution) will construct an even better index. Should we worry?

There are a few reasons for optimism. Firstly, the population is going up, so per capita declines in innovation are being counteracted by there being more people around to innovate. For example, even if Gary (1993) is right in thinking there has been a roughly five-fold decline in per capita innovation in the past 100 years—there has been almost a four-fold increase in population, balancing much of that out. Secondly, some of the innovations we are getting will allow us to raise our IQ—including genetic engineering and iterated embryo selection—and we know that IQ is one important factor in innovation. Thirdly and finally, there are many countries (such as China and India) who have so far been too poor to have many of their population engaged in innovative activities, but who will surely soon be.

Longevity and the rise of the West

Did the Industrial Revolution happen because of improvements in institutions or because of improvements in human capital? A duo of new papers attack the question from an interesting new angle, looking at longevity, and finding that its rise precedes (by a good 150 years) the onset of the Industrial Revolution. The first, a 2013 study from David de la Croix and Omar Licandro, builds a new 300,000 strong database of famous people born from 2400BC to 1879AD (the year Einsten was born) and has four key findings (pdf) (slides):

1. On average, before the cohort born in the 1640s, there is no trend in lifespans; they stay at an average of 59.7 years for 4,000 years
2. Between the cohort born in the 1640s and Einstein's cohort, longevity increases by 8 years—this trend pre-dates the industrial revolution by generations
3. This increase occurred across Europe, not just in the leading advanced countries
4. This came from a broad shift, rather than a few especially long-lived individuals

The second, published less than a month ago by LSE economic history professor Neil Cummins, makes use of an even more innovative source of data—a collaborative project between the Mormon Church of Latter Day Saints and individual genealogical experts. Apparently the LDS is a major collector of genealogical information:

‘Baptism for the dead’ is a doctrine of the church of Jesus Christ of the Latter Day Saints(LDS). The practice is mentioned in the Bible (Corinthians chapter 15, verse 29, TheHoly Bible King James Version (2014)). The founder of the LDS church, Joseph Smith,revived the practice in 1840 and ever since, church members have been collecting historical genealogical data and baptizing the dead by proxy. The church has been at the frontier of the application of information technology to genealogy and has digitized a multitude of historical records. Today they make the fruits of their research available online at familysearch.org. The records number in the billions.

The paper draws longevity statistics on 121,524 European nobles who lived between 800AD and 1800AD to establish that the West was rising even before the marked gains seen from the 1640s, and suggesting that the roots of economic development go very deep (much deeper than institutions).

The fascinating paper is saturated with insight-nuggets. Perhaps unsurprisingly, the top ten exact death dates in the periods are all battles:

There's also extra support for Stephen Pinker's thesis of massively declining violence in society:

And here's the overall result:

Taken together, the papers seem to provide strong support for the human capital thesis, as against the idea that changes in institutions were key in allowing humans to escape from the Malthusian trap and see general rises in the living standards, for the first time ever.