Modern capitalism’s problem is too much prosperity
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Edward Chancellor
LONDON, July 19 (Reuters Breakingviews) -Since the 1970s the average rate of growth in the world’s income per person has fallen from nearly 3% a year to under 1%. Economists scratch their heads at this productivity puzzle. It is possible, however, that the root of the problem lies in humans' natural response to the unprecedented comforts of modern life in the developed world. After all, an earlier experiment with mice colonies reveals that rodents also have trouble coping with prosperity.
In the late 1960s the American ethologist John B. Calhoun ran an experiment in which he placed four breeding pairs of mice in a large enclosure containing ample quantities of food, water, and nesting material. Initially, the mouse population took off. Within 10 months, however, growth started to drop off. There followed what Calhoun dubbed a “behavioural sink” as the male mice became solitary, and the females stopped breeding. Within 30 months the last mouse had expired. Some scientists believe this colony's extinction occurred because the mice no longer faced the usual threats from predators and resource scarcity for which they were adapted by evolution.
What has this to do with collapsing productivity growth among humans? Well, consider how capitalism has changed over the centuries. At the outset of the industrial revolution, economic life was brutal: severe downturns were frequent, competition among businesses was fierce, defaulting debtors were thrown into prison and government provided minimal support for those suffering economic hardship.
On the other hand, economic recoveries were usually rapid and productivity growth remained robust over long periods. For contemporaries, this torrid boom-bust cycle was a source of economic vitality. As the 19th century French economist Clément Juglar wrote: “paradoxical as it may seem, the riches of nations can be measured by the violence of the crises they experience.”
The ethos of this earlier version of capitalism is best characterised by U.S. Treasury Secretary Andrew Mellon’s advice to President Herbert Hoover after the 1929 stock market crash: “Liquidate, liquidate, liquidate.” The motto of the 21st century, Ruchir Sharma argues in his latest book “What Went Wrong with Capitalism” is “liquefy, liquefy, liquefy.”
Modern developed governments, he says, now constantly intervene to alleviate economic hardship. American businesses are swathed in red tape. The Code of Federal Regulations has grown more than 10-fold since the 1960s - its index alone requires five volumes, containing some 700,000 entries. The U.S. tax code stretches to nearly 7,000 pages with an additional 68,000 pages provided by the Internal Revenue Service. Businesses have responded by becoming more bureaucratic: in the United States, there is now one manager for every five workers. The centre of corporate power has shifted towards human resources, resulting in what New York Times columnist David Brooks styles “death by a thousand paper cuts.”
After the global financial crisis of 2008, central banks turned to ultralow interest rates and large-scale purchases of financial assets to boost employment and revive the markets. Bailouts were extended to various sectors, from Wall Street to Detroit automakers. These interventions have undermined capitalism’s vitality, according to Sharma. Ultralow rates distorted the allocation of capital and kept zombie companies on life support. Joseph Schumpeter’s process of “creative destruction”, which the Austrian-born economist saw as the essential feature of capitalism, was arrested. The rate at which jobs are created and destroyed has also declined.
Easy money made it easier for large companies to gobble up smaller ones. Lax antitrust implementation further encouraged industry consolidation. Sharma suggests that excessive regulations benefitted incumbent firms by creating barriers to entry for potential competitors. Corporate lobbying has abounded. The result is that corporate profits have become bloated. Since the turn of the century, we have no longer witnessed the return of profitability to a long-term average level that is the hallmark of a truly competitive economy.
Capitalism, says Sharma, “has lost its dynamism, suffering fewer recessions, thanks to constant stimulus, each with less cleansing effect, thanks to bailouts, leaving behind more bad monopolies, more corporate deadwood. The result is that productivity growth is more and more disappointing, slowing overall growth, and leaving the capitalist system with less and less potential to advance the greater good.”
For the past fifty years, the U.S. federal government has run near-constant deficits. A budget surplus during the last year of President Bill Clinton’s second term is the sole exception. Fiscal profligacy reached its apogee during the pandemic year of 2020, when stimulus by the government and the central bank topped a combined 35% of GDP. The U.S. national debt has returned to levels last seen at the end of World War Two. And this excludes vast contingent public liabilities such as pension and healthcare commitments, as well as state guarantees for bank deposits, residential mortgages and the like.
As the government’s direct and indirect involvement in economic affairs has expanded, productivity growth has declined. More and more government debt is needed to generate growth: by 2022 it took $3 of debt to produce an extra $1 of GDP – three times the level of the 1970s. Research by Swedish economists Andreas Bergh and Magnus Henrekson shows that an increase in government size by 10 percentage points is associated with a 0.5% to 1% lower annual growth rate.
In their book, “This Time is Different: Eight Centuries of Financial Folly” Carmen Reinhart and Kenneth Rogoff argue that governments do not have to worry about debt crises if they run large budget surpluses; maintain low debt levels; borrow at longer maturities; and don’t have off-balance sheet liabilities. The U.S. government meets none of these conditions.
The Bank for International Settlements is warning that fiscal consolidation by Western governments is an “absolute priority.” Already, bond vigilantes are anticipating further borrowing if former President Donald Trump returns to the White House, which could push up both inflation and bond yields.
Sharma believes the turning point will only come when the government runs out of money. He likens the advance of state-directed capitalism to the so-called “revolution in pain management”, which saw doctors hand out synthetic opioids for even moderate injuries. A change of culture is required. We need to accept, he says, that some degree of economic suffering is inevitable. If we continue to evade pain at any cost, our fate may be as grim as Calhoun’s unfortunate mice. And there’s no financial trade to hedge against that outcome.
Follow @Breakingviews on X
GDP per capita has soared in the developed world https://reut.rs/46dbGWJ
US government debt has risen sharply https://reut.rs/3LvHyMY
Editing by Peter Thal Larsen and Pranav Kiran
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