Ten very good things 6: Capitalism

Although capitalism is attacked for embodying greed, with some saying it has failed, it is in fact the most benign thing people have created, having brought about more good than any of the others.  It is my good thing number six.

6.  Capitalism

Capitalism was not invented.  It developed out of the ways in which people deal with each other, and is one of the most benign things that people have done.  Wealth can be spent on present consumption, or consumption can be deferred, and wealth used to generate more wealth in the future.  When this is done the wealth is called capital, and the process of using it to create future wealth is called capitalism.

When merchants invested capital to kit out ships for trade, hoping for returns from cargoes such as spices, they would each take a share of the profits.  If they invested equal sums, they would receive equal shares, but if they invested different sums, their share of the profits would correspond to the proportion they had put in.  This is in essence how companies raise investment capital.  They sell shares in their future profits, and people receive a proportion of those returns corresponding to the shares they bought.

This kind of investment has made possible specialization, mass production and mechanization, vastly increasing the output a person can produce, and making lower prices possible.  It takes time, labour and usually machinery to embark on this process, and it is capitalism that has supplied the investment to make those things possible. 

Only in the past few hundred years has capitalism created the wealth to lift huge numbers out of poverty, starvation and grinding toil.  Capitalism has generated the wealth that has enabled diseases to be conquered, clean water and sanitation to become widespread, and has given people more opportunities and choices in their lives than any previous generation has enjoyed.

Some people and businesses use the political process to prevent the outcomes that free market capitalism would achieve.  Through rent-seeking and cronyism, they secure favours from politicians that limit the free choices people would have made.  Such behaviour is a corruption of capitalism and acts to limit what capitalism itself could have achieved without such burdens.

The achievements of capitalism in the advanced industrial economies have spread across the world as capitalism itself has spread.  More people have been lifted from starvation in the past two decades than ever before in human history, and the economic rise of countries such as China and India is bringing improved standards of living to millions.  Capitalism has achieved more for humanity than any other institution people have developed.

Ten very good things 5: Population

Many people still suppose the world will wallow and drown in over-population, unable, Malthus-style, to keep pace with the footprint they will leave upon it.  Population is my fifth good thing.

5.  Population

Some people in environmental lobbies seem to treat people as a kind of pollution.  Although happy to see plants and other animals proliferate, they seem to regard humans as a kind of blot on an otherwise 'natural' landscape.  Human beings affect the planet, and always have done.  Our hominid ancestors undoubtedly caused mass extinctions with their efficient hunting techniques, and our predecessors changed the appearance of the planet as agriculture developed.  More recently our industry and transport systems have changed it.

We are told by some that the Earth cannot support its projected population, having neither the food, the water, the energy or the space to sustain it.  None of this is likely to be true.  Just as the Green Revolution transformed agricultural output in the 20th Century, so can genetically modified crops transform food production in the 21st Century.  New techniques for water purification are developed almost annually, and the Earth is not short of water to treat.  Gas will supply abundant energy for decades, and following close behind it is the steady reduction in the cost of photovoltaic power.  And human beings, though they are found in every habitat on the surface of the Earth, occupy only a tiny fraction of its area.

As nations become richer, their people no longer need large families to supplement the family budget and to support them in old age.  Population levels off as the world becomes wealthier, and is unlikely even to approach the levels touted by alarmists.

In fact human beings are as asset, not a burden.  Their creative intelligence has created opportunities for many people to live more rewarding lives well above the subsistence level that was the lot of their predecessors.  Human ingenuity and technical skill have given us wonderful cities in which to interact and co-operate with our fellow humans.  Their intellect and creativity have given us buildings that lift the spirit, literature that inspires, music that elevates the soul, and paintings that convey insights into the human condition.

Humankind has faced problems and has used its ingenuity to solve them.  It finds ways to make resources go further, fields to produce more crops, engines that are cleaner, and advances in transport and communication that shrink the world and enable us to interact with more of our species.  Julian Simon described the human imagination coupled to the human spirit as "The Ultimate Resource."

And now it's the nef being very silly indeed

To return to one of the great questions of our times. Why is it that people are paying any attention at all to people who seem not to know the first thing about the subject of their pontifications? Our example today comes from Lindsay Mackie who is something or other at the new economics foundation. You know, the place a current Lib Dem SpAd once christened "not economics frankly".

The circling and landing of carrion birds on waste tips is common enough. These days, it is being mirrored by what you could describe as the circling of human vultures over the waste disposal industry. Biffa, the waste disposal company that carries out much local authority work, is profitable,...

Well, if it's profitable then it's got nothing to worry about then, does it. But that's not quite true:

Rather, the financial crisis intervened and the company can no longer service this crippling debt.

Oh, so it's not profitable then is it? It cannot pay the costs of doing business from its revenues. Costs are higher than revenues in fact and thus it is not profitable. For yes, the cost of capital really is a cost of doing business. So, we have a deep ignorance of the specific subject under discussion then.

This situation is an object lesson in faulty economics,

Well, yes it is, and I'm glad that you said it not me.

The rest of the piece is about how we should have all sorts of regulation to stop this ever happening again. But what happening again? Someone making a mistake in business? That, sadly, is always going to be with us. And what exactly is it that everyone is afraid of?

In August, a consortium of Chinook Urban Mining, a London recycling specialist, the private equity investor Clearbrook Capital and the American bank JP Morgan bid just £520m for the group. But so far no decisions have been made either to sell, or how exactly to re-structure the debt so that the company is less burdened.

Eh? So one bunch of capitalists have lost a fortune by making a mistake. Another bunch of capitalists are willing to risk their money picking it up and trying to make it better. The firm still exists, the firm will continue to exist, rubbish will still be collected, recycling done and the environment preserved. Err, this is what capitalists are for: screw up and you lose your shirt.

What, actually, is the problem with this system?

These social democrats are very strange you know

A very puzzling call contained in the latest little pamphlet from Compass. You know the sort of thing, the call to arms about what we must do to make this a more caring, sharing and wondrous society. And yes, I read these things so you don't have to. They insist that there should be a European minimum wage:

Europe should therefore move towards a continent wide minimum wage, based on the respective average income.

There's an awful lot of weight that rests upon that word "respective". There are two possibilities. One is that there should indeed be a European minimum wage. One single rate that applies to all jobs in the EU. Which would be either irrelevant or entirely crazed. If it's based on some sort of average of European wages then just about every job in the poorer countries would disappear overnight. Insisting on, say, 50% of German wages in Romania when that's some multiple of average wages in Romania would indeed be crazed. Insisting that Germany meet the Romanian minimum wage would simply be irrelevant.

The other meaning possible is that they think that there should be a minimum wage in each country, based on the relevant wages for that country. The problem with this is the following:

Germany, Cyprus and the Former Yugoslav Republic of Macedonia have statutory minimum wages that do not apply to all or the large majority of employees but are restricted to specific groups which are defined e.g. by sectors or by professions. These are excluded from the data collection. Also excluded are countries where there are no statutory national minimum wages: Denmark, Italy, Austria, Finland, Sweden, Iceland, Norway and Switzerland. In these countries, wages are either determined by negotiations between the social partners, at company level or at the level of each individual contract. Typically, sectoral level agreements are widely applied and have erga omnes applicability, thus constituting de facto minimum wages.

Insisting on a statutory minimum wage in Denmark, Sweden, Germany, Finland.....what effect does anyone think this will have in any manner at all?

Which leaves me really rather puzzled. I'm not sure which box to put Neal Lawson and his band of merry social democrats in. It could be that they're simply ignorant, in that they don't know that there are already minimum wages in most EU countries. It could be that they're stupid in that they don't realise that having them where they do not already exist isn't going to make a damn bit of difference as the same end is achieved in other ways. Or it could be that they really are crazed loons and that they want to impose a minimum wage based on some average of European wages. Which would immediately close down large parts of the economies of the poorer countries.

Which leaves me even more puzzled. Given that these are the only three boxes that they can be put in as a result of this call then why is it that anyone pays any attention to them at all?

Are the railway franchises on the right track?

If C P Snow was with us now, he would recognise civil servants and business people as two cultures divided by a common language, namely money.  Awarding franchises to whomever forecasts, or pretends to forecast, the highest growth in passenger traffic has finally been shown to be as daft as it is.  How the then Transport Secretary, Justine Greening, a chartered accountant who holds an MBA from one of the world’s most prestigious business schools, failed to recognise the fallacy is beyond words.

The taxpayer cost of this fiasco is reckoned to be £40M and that is before all the consultants involved in the two consequential investigations climb aboard the gravy train (sorry).

No other country uses this system.  No surprise there.  It makes it most likely that the winners will go bust. Recognising that much brings on consequential guesswork to establish the size of the bond that would then be called in.  The franchise system also ensures that UK rail travel will remain more expensive than elsewhere in Europe.

The fiasco is re-igniting the debate between those who think the railways should be re-nationalised and those who want a return to the pre-nationalisation structure where large rail companies were responsible for their own track.  Clearly the advocates of the former policy have forgotten how dreadful British Rail was. The mini-monopolies of the earlier system were not much better.  John Major’s government envisaged that competition between different train operators using the same tracks would increase quality and reduce cost.  The former has worked to some extent.  Rush hours and Network Rail failures apart, the travel experience is better but it certainly has not reduced the price.  The franchise process ensures that prices cannot be reduced because the train companies are desperate to service the cost of the franchise.

All these systems use Discounted Cash Flow whereby one forecasts the profits from the immediate years as well as one can, based on a good appreciation of what the near future holds in store.  The “out years” are all rolled into a single number called “Residual Value” and placed far away in a box on the extreme right of the Excel sheet where the calculations are done.  In theory, forecasts are made of passenger numbers, inflation etc and discounted to a single Residual Value.  It is all quite complex and naïve recipients of the results tend to look at the immediate years and not worry about the number beyond as being too complex and too far off.

Using this inattention, the scam is to put the balancing number needed to secure the contract into the Residual Value box and derive the forecasts from that.  It is hard to imagine Atkins, the transport consultant involved, being party to anything this trivial but the essence of the scam is making the out year forecasts fit the Residual Value required as distinct from deriving the values from the forecasts.  An outsider, even one as illustrious at Atkins, would have difficulty in distinguishing the two processes, especially when, as seems to have been the case, inflation has not been properly accounted for.

But the issue is not what went wrong so much as what should be done in future.  In essence a train operator should only bid for what they can control and leave the unknowns to government.  Franchising should therefore not be based on a single number but on a table showing year by year tolls for the use of the infrastructure as a function of passengers carried.  This should not be by train, as road tolls operate, because that would encourage over-crowding but by passenger mile which would encourage more trains.  Where more than one operator uses the same track, some control would also be required to ensure capacity exists.  The passenger mile fees should be on a diminishing curve so that additional passengers are more profitable for the operator and/or more price discountable.  And the bids should be at present values leaving the actual future year payments to be adjusted by inflation, defined as the inflation then relevant to train operating costs.

None of that is complex although compressing it to a single paragraph may make it seem so.  The underlying principles here are that the operator should only pay for what it can control and has an incentive both to improve the travel experience and to reduce costs to passengers.

Ed Miliband and Disraeli: paternalism and interventionism

Ed Miliband seems to have appropriated Disraeli's famous slogan about 'one nation' government. Whether this is merely a meaningless catchphrase,  an attempt to out-manoeuvre Cameron or has any real policy implications remains to be seen. Having raised the issue, it is interesting and instructive to reflect on nineteenth century government as well as what the phrase might imply for modern politics.

It is notable that Disraeli coined the phrase in 1844 as the 1840s were a decade which represents the high-water mark of Classical Liberal values in Britain and perhaps throughout the world - contemporary American and French had similar Classical Liberal features. That decade saw the repeal of the Corn Laws and Navigation Acts and the apparent defeat of mercantilism and economic nationalism in the UK. It saw the triumph of the Manchester school led by Richard Cobden and John Bright. It is worth remembering that these great strides for liberty were inspired by, amongst others, Adam Smith in the late eighteenth century.

Similar movements towards freedom were being made in the social sphere with, for instance, the abolition of slavery and Catholic emancipation. Fiscal retrenchment was the hallmark of mid-nineteenth century government, with great strides being made to pay down the national debt. How striking a contrast to today's politicians who fail to eliminate the public deficit and . Although Peel re-introduced the income tax in 1842, he and many other politicians were opposed to its use and aimed at its elimination. Peel's government also introduced the Bank Charter Act (1844) - a high-minded but ultimately misguided attempt to create stable, gold-backed currency. It is notable that both parties - Whigs and moderate Tories - were broadly sympathetic to these policies.

The most famous political slogan of that era is 'peace, retrenchment (cuts in government spending) and reform' - something which our modern politicians would do well to emulate. We cannot characterise the mid-nineteenth century as a period of true laissez faire as there was still a great deal of government intervention and whilst government spending was low, it is important to recognise that government was still very activist. There was much government intervention in social life via the Poor Laws and the education system. Nevertheless, the tone of times was towards liberty and equalitarianism (i.e. equality under the laws and the absence of discrimination by government) in general.

The 'one nation' position is one of paternalism and limited egalitarianism. Disraeli used the phrase as a political slogan in a bid to win the support of the new voters enfranchised in the 1867 Reform Act - an Act which created far more voters than its more famous predecessor. In this he was doubtless successful; instead of being destroyed by Reform the Tories successfully adapted. The Whig Party, in Britain (unlike the US) the party of small government and free trade was, by contrast, was consumed by the Liberals. The Tories shifted their position to appeal to the new voters and sought to portray Whiggism as heartless individualism.

The following era saw a gradual shift in political positions of which Disraeli's slogan is a signifier. Whilst Disraeli himself was a showman and a populist, his 'philosophy' such as it is represents an opposition to Manchester values, much as does Bismarck's. Gladstone's Liberals represented a more fiscally conservative, Whiggish position. The 1860s-1880s period should be recognised as witnessing the 'Strange Death of Whig England', the causes of which are contentious but bear a good deal of historical study.

Again, both parties in this period turned to a more interventionist style of government, albeit in a limited fashion. In the sphere of political thought, the 'New Liberals' emerged led by Green and Hobhouse. Herbert Spencer in The Man Versus the State (1884) categorised this shift as the 'New Toryism', a return of paternalist values blended to varying degrees with the contemporary collectivist ideas of socialism, imperialism and nationalism. By 1894 it was possible for the Chancellor WV Harcourt to announce that 'we are all socialists now' as he introduced death duties.

With Gladstone's death the Liberals emerged more strongly as the party of social democracy although the Conservatives, as they became, gradually adopted a more moderate version of this position. This point should not be too greatly over-stated, however; prior to 1914 government spending remained small by contemporary standards, there was little deficit spending and the currency was stable.

This gallop through history leaves much detail out, of course, but it should remind us of one or two very salient points. Ed Miliband is quite within his rights to adopt Disraeli's concept as his own as they both represent paternalism and interventionism. It is worrying, however, that both Miliband and Cameron laud Disraeli whereas very few politicians would adopt a Gladstonian much less a Cobdenite position (including the mis-named Liberal Democrats). It is interesting to observe how political parties tend to adopt slightly moderated versions of essentially the same position and actual ideological divides are rare.

In reality, all three major parties are offering greater or lesser degrees of managerialism. On a more hopeful note, it is also clear that ideas take a long time to become embodied as the prevailing doctrine. The ideas of Smith's generation took 40-50 years or more to become reality. It is our duty, therefore, to generate the ideas and methods to free ourselves from the welfare and regulatory state so that our grandchildren may benefit.  

Ten very good things 4: Imports

My fourth very good thing is imports, one of the most misunderstood.

4.  Imports

A common fallacy supposes that nations become rich by exporting more than they import.  Many governments make the effort to augment exports and diminish imports.  This usually involves subsidizing exports by means of grants and lower taxes, and discouraging imports by means of tariffs.  Both of these are more difficult to do under the rules of the World Trade Organization, but countries sometimes find covert ways of achieving these ends.

It used to be thought that a country's wealth was augmented by a positive 'balance of trade,' under which the surplus of exports over imports would bring in more gold and silver than went out, leaving the nation richer.  Adam Smith exposed this fallacy, pointing out that the wealth of nations consisted in the productive labour of its peoples rather than in bars of precious metals stored in its treasury.

In fact it is imports that make a nation richer.  By importing goods that are cheaper than those they can produce themselves, nations have cash to spare as well as the goods.  This makes them wealthier than if they were self-dependent.  Adam Smith said that Scotland could grow grapes and produce wine "by means of hot-walls and glass houses" on the slopes of Ben Nevis, but it would cost them 30 times the price of equivalent French wine.  By buying the French wine, they saved twenty-nine thirtieths of the cost and could spend it on other things.

Of course these imports have to be paid for, and exports make that possible.  We export to gain the wherewithal to enrich ourselves through imports.  It need not be manufactured goods we export.  It can be services such as insurance, skills such as design, or the returns on our own overseas investments.

The US humorist, P J O'Rourke put it succinctly: "..imports are Christmas morning; exports are January's MasterCard bill."  Imports make us richer, and exports make it possible.  The self-sufficiency which is advocated as a virtue is the road to poverty.  It denies us the specialized and skilful services of far-flung producers anxious to provide us with goods at lower prices than we can make for ourselves.

On National Poetry Day...

...here is one of my favourite poems by Ogden Nash, which is as appropriate now as it was when he wrote it in the midst of the US government's measures to prevent 'overproduction' during the Great Depression.

One From One Leaves Two

Higgledy piggledy, my black hen,
She lays eggs for gentlemen.
Gentlemen come every day
To count what my black hen doth lay.
If perchance she lays too many,
They fine my hen a pretty penny;
If perchance she fails to lay,
The gentlemen a bonus pay.

Mumbledy pumbledy, my red cow,
She’s cooperating now.
At first she didn’t understand
That milk production must be planned;
She didn’t understand at first
She either had to plan or burst,
But now the government reports
She’s giving pints instead of quarts.

Fiddle de dee, my next-door neighbors,
They are giggling at their labors.
First they plant the tiny seed,
Then they water, then they weed,
Then they hoe and prune and lop,
They they raise a record crop,
Then they laugh their sides asunder,
And plow the whole caboodle under.

Abracadabra, thus we learn
The more you create, the less you earn.
The less you earn, the more you’re given,
The less you lead, the more you’re driven,
The more destroyed, the more they feed,
The more you pay, the more they need,
The more you earn, the less you keep,
And now I lay me down to sleep.
I pray the Lord my soul to take
If the tax-collector hasn’t got it before I wake.

— Ogden Nash

Ten very good things 3: Profit

The third in my series is profits, much-maligned but essential for progress.

3.  Profits

The role of profit is much misunderstood.  Some denounce profits as if they represent money that rightfully belongs to others, but profits are the reason for the wealth-creation that has so benefited the world.  We postpone consumption so that we can enjoy more of it later.  There would be no reason to do so otherwise.  By using wealth to create more wealth in the future we can have access to more choices and opportunities.  The prospect of making a profit leads us to invest, and the investment creates new products and processes and new efficiencies.  Profit is the difference between the cost of the inputs that go to create something and the price that others will freely pay for it.

Sometimes people are envious of high profits and think them somehow unfair.  In fact the high profits encourage others to enter and start up in competition, which in turn benefits the consumer by increasing choice.  Moreover high profits motivate others to start up new ventures in the hope of doing likewise.  Thus profit is the incentive for increased economic output, as well as for the introduction of new products onto the market. 

Profits do not represent wealth taken from others, but wealth created by added value and exchange.  Without profits there would be no reason to forego present consumption by investing.  Profits thus make us look to the future and what we might achieve in it, and lift our eyes above the present gratification that would prevail otherwise.  Profits are the incentive which sets people on the road to economic expansion and the self-betterment which it makes possible.

Marxists erroneously suppose that profit represents exploitation, a price higher than the labour cost of producing goods.  They err in supposing that value derives from labour costs.  In fact it derives from demand, and is in the mind of the person contemplating the object, not in the object itself.  It is because we value things differently that we trade.  The investor hopes that people will value the goods produced more than the price that will be asked for them, and that this will be more than it costs to produce them.  Profit benefits people rather than exploiting them, and it does so by making available new goods that they value and are willing to buy.

Ten very good things 2: Bankruptcy

For the second of the very good things that tend to receive a bad press, I highlight bankruptcy.

2.  Bankruptcy

When an individual or firm goes bankrupt, a legal process is instigated to discharge debts that cannot be repaid.  In former times such debtors might have been put into a debtors' prison and languished there for years.  The process weighs assets against liabilities and allows the debts to be discharged at some fraction of their nominal value, leaving the debtor free of the burden, albeit subject to rules of financial behaviour and with a blemish on their credit record which can last for years.

While bankruptcy undoubtedly involves some social stigma that most people would seek to avoid, it does have advantages to society as well as to the individuals it releases from debt.  A discharged bankrupt is no longer burdened by the debt, and is free to work again and to earn money without it all being consumed in repayments.  If he or she went bankrupt as a result of a failed business enterprise, they become free, after the passage of time, to try again.  Some highly successful business people have failed to get it right the first time, and have experienced bankruptcy on the road to eventual success.

Most lenders who extend loans to business know that risks are higher among 'subprime' candidates, and set their repayment terms sufficiently high to cover the losses from those who go bankrupt.  While failure might be devastating and distressing for the individual, however, it has economic and social benefits.  Failure enables capital and assets to be redeployed from businesses that have not worked towards new ventures that show more promise.  It is the financial equivalent of clearing out the less hardy plants and animals and leaving their ecosphere available for the hardier strains.

The economist Joseph Schumpeter spoke of the "creative destruction" wrought by innovative ideas and businesses that led to the demise of established ones.  Bankruptcy is part of the process by which failing firms close down and are replaced by newer and more successful ones.  Although governments might try to reduce bankruptcies and failures by propping up firms in trouble, they do the economy and the prospects for future growth no favours by doing so.  The failure of some is an important ingredient in the success of others.