Category Archives: Free Market Capitalism

The economic theory from Adam Smith, through Ricardo, Say, Mises, Hayek and Friedman

Economics, Free Market Capitalism

Yesterday's Gods

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The “madmen in authority”, as Keynes characterised them, are still in thrall to “the markets” and the rating agencies. The people surrounding messrs Clegg and Cameron, as they struggle to an agreement, are more concerned that what they finally come up with will satisfy the markets, than that they will satisfy the electorate.

But, by definition, nobody understands the markets. That’s why speculative funds, such as hedges and private equity funds, can still make money out of them. Commentators can never predict future market moves, though they always explain in detail reasons for movements which have already occurred. Over the past few days it’s been repeated endlessly in the media, that the markets dislike uncertainty and want stability, but plainly that is the reverse of the truth: market volatility is what presents marketeers with the opportunity to make huge amounts of money, for which the tax payer will in the end pay. The question arises not so much as to why we still take markets seriously, but why markets should still be allowed such freedom to do damage. Surely the electorate should be given some protection.

If markets are free, protection might be expected through the credit rating agencies, Standard and Poor’s and Moody’s. But they contributed in no small way to the massive losses incurred by the electorate as a result of the credit crunch of 2007-8. The agencies gave AAA credit ratings (ie lowest risk) to the riskiest pools of loans, fuelling the sub-prime mortgage fiasco. Among many other cock-ups, they failed to notice the insolvency of the Icelandic banks and gave the Icelandic Government a clean bill of health till its economy imploded. If these were not cock-ups, they were something rather more sinister resulting from vested interests. The rating agencies offer no protection, and don’t deserve to be taken seriously.

What the “madmen in authority” need is a different economic perspective to replace the free market fundamentalism which still rules today. But there can be little expectation of that informing the Conservative / Lib-Dem negotiations.

Corporate Ownership, Economics, Free Market Capitalism

The Point about Profit

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Profit is wilThe idea of profit has caused much aggravation over the years and even today is still the source of heated debate. Marx borrowed Ricardo’s idea that profit was no more than the wages earned by labour but stolen by the providers of capital. This explained the grossly unfair divergence between the poverty of the labouring classes and the wealth of the capital owners. The neo-classical economists argued that the purpose of industry was to maximise profits, referring not so much to the theft of wages but the surpluses to be earned from industrial and business activity. Latterly, the free market fundamentalists, to which all three of the main political parties are to some extent in thrall, have argued that maximisation should apply to shareholder wealth rather than profit. This then seems to confirm again the inequity first argued by Ricardo, consolidating the position of the owner over that of the employee.

Clearly, none of these theoreticians have really understood the vital role of profit in industry and business. Adam Smith argued the self interest of the butcher, baker etc as vital to the effectiveness of their businesses, because that was how they earned a living and supported their dependents. The survival and long term prosperity of the business was what mattered, profit being some measure of that ability to survive and prosper.

The idea of maximising profit is based on a misunderstanding of business realities, which are concerned with, as Peter Drucker put it, the ‘real risk of ending up with an impoverishing deficit, and the need, the absolute need, to avoid this loss by providing against the risks’. But providing against the risks is anathema to the free market fundamentalist. They regard any such provisions against risk, such as spare or underutilised assets, as evidence of inefficiency and therefore grounds for replacing the business management with one that will maximise shareholder wealth, and this is most easily achieved through the firm being taken over and often being broken up..

Whatever profit is argued to be, it is a necessity for the survival of any business. Its theft by shareholders, or any other stakeholder, only serves to destroy the real economy.

Company Law, Corporate Ownership, Free Market Capitalism, Uncategorized

Protecting Real Economy Firms from Speculating Predators

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A number of issues relevant to postings on these pages have been raised during the campaigning for the UK general election. For example, following Kraft’s acquisition of Cadbury, the Labour government proposes to raise the voting threshold for such deals from a simple majority to two thirds of shareholder votes and to exclude from voting any shares acquired since the bid was announced. This would at least slow down some such deals, but as the Liberal Democrats claim, would go nowhere near re-imposing a ‘public interest’ test which would give ministers the power to intervene in deals deemed to be against the public interest. Such a test was abandoned in 1992 with the support of both main parties. But public interest is a vague and inadequate hurdle for such deals, especially when likely British governments will claim the preservation of free and open markets is the prime public interest. So electrical supply company Chloride, and bus and train operator Arriva, the latest targets of foreign bidders, can expect little protection. Unlike, for example, their German counterparts, whose employee stakeholders have 50% representation on the supervisory board and would be able to provide some protection against bids which were against the long term interests of the company, as opposed to the short term interests of its shareholders. UK law requires directors should take the interests of all stakeholders into consideration, not just what the government of the day regards as the public interest.

Another issue that has caused some debate in the run up to the election is the Liberal Democrats’ proposal to again separate commercial banking from hedging and speculative activities, and to tax and regulate the latter differently from traditional banking. This would have the added benefit of breaking up some firms which are currently ‘too big to fail’. The two main parties are united in their objections to this approach, presumably for fear it would reduce London’s attractions as the world’s largest hedging base, and some might leave. However, hedge funds may find the United States even less comfortable. And most G20 nations are moving in that same direction. The days when ‘socially useless’ hedging enjoys total freedom may be numbered.

Bank Bonuses, Company Law, Economics, Free Market Capitalism

Devastating Mistakes of Economics

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In 1792, William Pitt told parliament that Adam Smith’s “extensive knowledge of detail … will …furnish the best solution to every question … of political economy.” Since then it’s been downhill all the way. For Smith, the industrial firm (his famous pin factory) was the key to economic progress, with the market only serving to enable the division of labour. But economists have always given primacy to the market, almost ignoring the industrial firm, because they don’t begin to understand it. In late nineteenth century, economists adopted differential calculus to model the economy, which meant describing the firm as a “production function” comprising two variables, price and quantity, and seeking to maximise profit. This was not just stupid, but hugely damaging. Maximising one thing requires the neglect of everything else, which has done great damage to Anglo-Saxon industry. Finally, in the 1980s, still completely unable to conceive of what a firm involves, they adopted the agency idea, claiming that the managers of a firm were the agents of its shareholders and should not therefore be maximising profit but maximising shareholder wealth. It is a lie. Managers have no contract with shareholders, but with the firm which is a legal entity in its own right. Shareholders do not own the firm – if they did they would not enjoy limited liability. They own shares which entitle them to dividends and capital growth, both at risk. Maximising shareholder wealth, as required by Friedman and followers, requires neglecting everything else. When specific decisions have to be taken, notably in the case of hostile takeovers, this is crucial. It has destroyed much of what remains of Anglo-Saxon industry, the latest British example being Cadbury. It has also justified the obscenity of top executive share option bonuses, which unless reversed will be the source of what is called euphemistically, social unrest.

Economics, Free Market Capitalism, Management Practice, Public Sector

The Case for Monopoly

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Keynes said he could see no reason why a government should become involved in owning a railway. However, the result of privatizing British Rail and trying to open it to competition, suggests Keynes may have been short-sighted. Monopoly might be a bad thing when exploited by some profit maximising economist, but the case against is by no means shown to be universally true.

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Co-operation, Company Law, Corporate Ownership, Free Market Capitalism, Management History

Rape and Pillage or Co-operation

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The announcement that Gordon Brown is to put mutualism and co-operatives, such as John Lewis Partnership, at the heart of Labour’s election manifesto is surely welcome after twelve years of the rape and pillage resulting from New Labour’s unquestioning support for free market deregulation and the maximising of shareholder wealth. But what does it mean? Is it just the sentimental swan-song of the Labour government? Or does it have substance as the foundation for real action?

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Corporate Ownership, Economics, Free Market Capitalism

Alternatives to Free Market Fundamentalism

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The juxtaposition of two editorials in a mainstream broadsheet makes interesting reading. The one argues that Gordon Brown’s advocacy of a tax on global financial transactions, the so called Tobin tax, suggests that the British government has, at long last, given up its slavish adherence to ‘the ideology that believes in deregulated, untaxed, ever-expanding global capital markets as an end in themselves’. The other argues that ‘China must be held to account for its political repression’. The connection between these two lies deep within the aforementioned ideology.

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Bank Bonuses, Company Law, Economics, Free Market Capitalism

The Institutional Truth About Free Markets

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The theory which, over the past three decades, has become the ubiquitous orthodox free market wisdom, is widely assumed to be simply the current version of classical economics originally expounded by Adam Smith. Moreover, it might be reasonable to assume, it being the latest, it is the most insightful and effective, having been shaped by the errors and excesses of previous versions. The current free market model certainly includes Adam Smith in its provenance, but what makes it different from previous models is the fact it is also based on certain theoretical foundations which are demonstrably false and which previous versions did not share. It has become what J K Galbraith described as an institutional truth. That is, not a truth at all, but a downright lie, but one to which all associated must subscribe if their careers are to prosper.

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