AMERICAN FUTURE

“Gross inequality is not a new phenomenon, but the fact that this year’s survey respondents selected severe income inequality as the most likely global risk to manifest in the next 10 years suggests that concern about its consequences is growing.”

– World Economic Forum, “Global Risks 2012”

Reporting from the World Economic Forum in Davos, the FT’s Gillian Tett takes note of the unprecedented concern at the conference about growing income inequality. In “Income disparity tops list of concerns,” she says:

That is a striking turnround. Until this year the issue of inequality never appeared on the risk list at all, let alone topped it. In the past, Davos delegates have worried about the risks posed by “asset price collapse”, “oil price shock”, “natural resource shortages” or “banks”. But in Wednesday’s debates it became clear why income disparity now appears on the WEF list of concerns. Apart from the fact inequality has been thrust into the political debate in the US, UK and France, the question of social stability has leapt on to the agenda as a result of the Arab spring. Even before the delegates arrived, a report from the World Economic Forum showed that the risk Davos delegates believe is most likely to cause turmoil this year is “income disparity”.

From the report:

On an unprecedented scale around the world, there is a sense of receding hope for future prospects. Gallup polling data in 2011 reveal that, globally, people perceive their living standards to be falling, and they express diminishing confidence in the ability of their government to reverse this trend. Their discontent is exacerbated by the starkness of income disparities: the poorest half of the global population owns barely 1% of the global wealth, while the world’s top 1% owns close to half of the world’s assets.⁶. Figure 13 provides a global snapshot of inequality, while Figure 14 shows a rise in inequality across many developed economies.

Figure 13

[Note that the United States is second only to Mexico in income inequality among OECD countries]

Figure 14

This is the Session Summary of the debate to which Tett refers:

TIME Davos Debate on Capitalism

Wednesday 25 January

Is 20th-century capitalism failing 21st-century society?

In partnership with the World Economic Forum, Time magazine hosts this debate focusing on the uncertain future of capitalism.

Key Points

• Some critics of capitalism argue that growing income inequality and high unemployment indicate that the capitalist economic system has failed society and needs to be reformed.
• Others argue that income inequality is driven not by corporate power but by factors including technological development and the emergence of a highly interconnected global market.
• To make capitalism fair, focus should be on investing in education and promoting innovation and creativity.
• Young people, especially young entrepreneurs, can drive the transformation of capitalism so that it better serves the needs of society.

Synopsis

The financial and economic crisis that has roiled the world for more than three years unleashed a torrent of criticism against large financial institutions. They are irresponsible risk takers concerned only with maximizing profits, the detractors argued, adding that global banks enjoy unfair advantages because they are too big to fail or let fail. As unemployment, particularly among young people, has risen sharply, the debate over the role of the banks has widened. Growing income inequality in both developed and developing economies has raised questions about the dominance and power of corporations and how well businesses are meeting their social responsibilities.

Is 20th-century capitalism failing 21st-century society? Sharan Burrow, General Secretary, International Trade Union Confederation (ITUC), Brussels; Global Agenda Council on Employment & Social Protection, thinks so. The business community “has lost its moral compass,” she reckoned. “We must redesign the model. We must reset it. Stop the greed. Unless employers and workers sit down with governments, the system will continue to fail.” Companies fight against increasing the minimum wage, even though doing so would only slightly reduce their profits, she asserted.

Other panellists disagreed with Burrow’s view that business lacks morals. “The business community has not lost its moral compass,” asserted David M. Rubenstein, Co-Founder and Managing Director, Carlyle Group, USA. “Capitalism may be the worst economic system except for any of the others.” Businesses do not think about ways to reduce wealth and jobs, he added. To ensure that capitalism is fair, focus on improving laws and regulations, investing in education and promoting innovation and creativity, Rubenstein advised.

Growing income inequality is fuelled not by bad corporate governance but by “far deeper forces”, including the development of technology, the emergence of a global market and the need for innovation, Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, Booth School of Business, University of Chicago, USA, explained. These forces are increasing the demand for skills and pushing pay higher. “These are not going to be affected by corporate governance,” Rajan told participants. “The right debate is about how we get the innovation and creativity we need.”

Ben J. Verwaayen, Chief Executive Officer, Alcatel-Lucent, France, and a World Economic Forum Foundation Board Member, concurred: “We need to talk about innovation, real sustainability and reforms – not about corporations and greed. It’s about decision-making. We suffer from nostalgia. We are not going back to the world that we knew. We have to go for transformation. We have to talk about job creation, not job security.”

From the floor, a critic of capitalism called for vision, not nostalgia. Old institutions and ways of thinking have to be disrupted, he said. A Global Shaper from Egypt said that it is important to establish platforms that allow young people to create jobs for themselves so they are not waiting for jobs to be created for them. “We absolutely need young entrepreneurs and they should be supported,” Burrow replied. But she cautioned against dismissing “the old industrial age”. Technology, especially innovations developed by skilled young people, will be needed to improve the way the “old” economy works, she remarked.

These days, many corporations and other organizations including the World Economic Forum are concerned about what young people are thinking and doing, Rubenstein observed. “Corporations recognize that change is coming from young people.” Noted Verwaayen: “You don’t have to wait for permission. Maybe in the past it was asking; today it’s just doing.”

Other Key Takeaways

Responding to the criticism that irresponsible lending contributed to the global financial crisis and that large banks enjoy unfair advantages, Brian T. Moynihan, Chief Executive Officer, Bank of America, USA, said that banks are global and large in size because they reflect the breadth and presence of their customers. “Our power, size and capabilities come from our clients. Our revenue is representative of the economic activity taking place. We are big because our clients are [global] and we support them.”

Contributors

Sharan Burrow, General Secretary, International Trade Union Confederation (ITUC), Brussels; Global Agenda Council on Employment & Social Protection
Brian T. Moynihan, Chief Executive Officer, Bank of America, USA
Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, Booth School of Business, University of Chicago, USA
David M. Rubenstein, Co-Founder and Managing Director, Carlyle Group, USA
Ben J. Verwaayen, Chief Executive Officer, Alcatel-Lucent, France; Foundation Board Member

The former President, who presided over the Roaring Nineties, says that “Charity needs capitalism to solve the world’s problems“:

Charity alone will not solve the world’s problems. Capitalism can help and at the same time put people back to work. There has always been a gap between what the government can provide and what the private sector can produce, a gap charities have long helped to fill. But as our world and economies evolve, we have an opportunity and a responsibility to reconsider how to fill this gap – to rethink the relationship between economic and social challenges, so that benefits and opportunities are available to more people.

First, this rethinking is necessary because people are demanding it. From Zuccotti Park to Tahrir Square, people are standing up and saying that for too many citizens the current systems are not working.

Second, the financial crisis has made plain that the path we were on was unstable and unsustainable. While our global economic system has brought benefits to many, it has also exacerbated inequalities, both within and among countries. Too much inequality not only hurts the poor and stifles the dreams of the middle class, it also hinders productivity and growth.

Finally, our increasing interdependence strengthens the link between our prosperity at home and prosperity abroad. It is hard to sell things people cannot afford to buy. Also, economic privation breeds political resentment with all its costly consequences. We therefore have a vital stake in the fates of others – a stake that extends beyond compassion to political stability and economic security.

How do we change course, to merge social and economic progress? Haiti offers us some lessons. Earlier this month, when I travelled there to mark the second anniversary of its devastating earthquake, I could feel a palpable change in the country. Much of this has to do with the focus and drive of the new government. But a lot of it is also due to the approach of Haiti’s friends and partners – an approach driven more by empowering people and communities than by imposing external solutions. My good friend Denis O’Brien and the Digicel Group not only employs 70,000 Haitians, they also rebuilt the famed 19th-century Iron Market bazaar, one of the capital’s landmarks, to create jobs for others, and give charitably to education to ensure that there will be a better educated, more employable workforce. Another example from Haiti is an innovative fund set up by the Carlos Slim Foundation and Frank Giustra to invest in entrepreneurs – giving them a hand up, not a handout.

We are starting to see the success of this new approach in other countries and sectors as well, in the approach of the Bill and Melinda Gates Foundation, in companies such as Walmart, Google and Procter & Gamble that have shifted their corporate culture from promoting social responsibility to increasing shared value.

This is the lesson that we learnt while working to solve the Aids crisis, when the pharmaceutical industry moved from being a low-volume, high-margin business to a low-margin, high-volume one with guaranteed payments. Today, this system is providing millions of people around the world with lifesaving HIV/Aids treatments at much lower costs while also improving the profitability of the companies involved. Similar lessons were learnt from our work with farmers in Africa: by helping them access the fertilisers, seeds and markets they need, we could provide them with a fundamentally more sustainable way to lift their families from poverty than we could ever hope to achieve through traditional charity. The lessons of this work and the benefits of boosting productivity are clear.

The common thread through all this evidence is that private wealth can effectively advance the public good when governments, businesses and non-governmental organisations work together to share expertise and implement lasting solutions. When our bottom line is more about strengthening the future than maintaining the present, and when our financial interests are aligned with our social ones, we will be closer to the kind of world we want all our children to live in.

One of the ways in which I have been trying to support the work of leaders around the world as they rethink our approaches to global problems is via the vigorous discussions and diverse commitments that are generated through our Clinton Global Initiative. To date, members of CGI have made more than 2,100 commitments that have already improved, or are now helping, the lives of nearly 400m people in 180 countries. Many of these commitments reflect the new approach to problem-solving by better aligning the interests and objectives of private corporations, governments and non-governmental organisations. Beyond their specifics, the goal of these projects is to work ourselves out of a job – not to generate perpetual aid dependence.

These efforts benefit both the communities they target and the corporations and philanthropists involved, diversifying their businesses, expanding their markets, training more potential workers and helping to create a culture of prosperity. All this enhances profits, increases economic inclusion and gives more people a stake in a shared future.

Because of these developments, and in spite of current economic conditions, I am hopeful for the future. The problems we face are solvable: we have the means. What we need is innovation, imagination and commitment. The most effective global citizens will be those who succeed in merging their business and philanthropic missions to build a future of shared prosperity and shared responsibility.

PIMCO‘s CEO and co-chief investment officer says that the crisis “raises legitimate questions about capitalism itself“:

Coming from very different perspectives, the columns in the ‘Crisis in Capitalism’ series have each provided insights and identified steps that, in their opinion, could make things better. But, is there a way to reach a clear overall conclusion? I think the answer is yes, although the implications are disconcerting.

The majority of writers agree that the crisis in capitalism is caused by two distinct failures: the inability of the system to deliver sustained prosperity through economic growth and jobs; and the perception that it is grossly unfair and socially unjust.

To fail on one count is a problem. Yet many would have probably glossed over that, especially those who – erroneously in my view – believe that there are rigid trade-offs between efficiency and equity. However, to fail on both counts, and to do so in such a spectacular manner, is indeed a “crisis.” It raises legitimate questions about the model itself.

There are three main reasons for this.

Firstly, capitalism has always, and will always be, prone to traditional market failures. The answer is to accept this, and work harder at reducing the chances of a catastrophic failure reaching the few areas that amplify the good and bad aspects of the system.

Finance is clearly one of these. In the last decade, five countries in particular (Iceland, Ireland, Switzerland and most importantly given their systemic role, the UK and US) lost sight of the fact that finance is not a standalone industry but, instead, depends on its ability to serve the real economy. This failure was compounded by the view held by some that finance could even constitute the next phase in the natural evolution of capitalism (from agriculture to industry, services and, ultimately finance).

These illusions were aided and abetted by patchy prudential regulation, bad incentives and horrid compensation practices. They coincided with the revolution in structured finance, an innovation that suddenly and dramatically opened up new global credit windows.

Society as a whole produced and consumed too much finance, especially through a disruptive technology that was insufficiently understood and tested. The result was the mother of all capitalistic overdoses, the implications of which are enormous and will be felt for years to come.

Secondly, during the past decade, in another part of the world, a set of countries embarked on their own capitalist economic revolution. This enabled them to pull millions of their citizens out of poverty. In the process, they added considerable productive capacity to a global economy, which only partially understood the consequences.

Countries such as China used the mix of technology catch-up, low wages, and quality improvements with great success. But imbalances inevitably reached unsustainable levels.

Lastly, too many of the institutions that are critical for the smooth functioning of capitalism utterly failed to deliver when they were needed most. They were hindered by poor governance, uneven global representation and partial information. This is true for both the private and public sectors.

Each of these areas can be corrected. Theoretically at least, what has occurred is less a calamity of the system as a whole, and more an issue of how it was run. Yet, four years into the crisis, little has been done to repair the damage coherently and comprehensively and to safeguard the real victims, let alone counter the risk of further costly dislocations. Until this is done, it will be difficult to convince the world that capitalism itself is not the problem.

Shades of the 1930s:

“this gap between the supply and demand for governance that fuels popular discontent, and gives impetus to the temptation for states to look in on themselves. It explains the rise both of rightwing populism and the anti-capitalist movements of the left, and risks fuelling a dangerous revival of the politics of identity on both sides of the Atlantic. The response of many governments has been to turn inwards and seek to defy the realities of interdependence by elevating narrow definitions of national interest. Old concepts of mutual interest and solidarity have cracked even in the eurozone, the most closely integrated group of rich nations.”

“The danger is that what started out as a crisis of financial capitalism will give way to a new age of nationalisms – a backlash against globalisation and a return to zero-sum politics.”

The Financial Times is continuing to add to its “Capitalism in Crisis” series. The latest addition is by Philip Stephens.

Leaders Who Generate Diminishing Returns

Three years on, the markets call the shots. Rating agencies humiliate the mighty US government and also strip France of its cherished triple A credit status. The implosion of financial capitalism has become a crisis of political authority in the west. Behind this lies an unequal contest between a globalised economy and politicians struggling to answer the demands of national electorates. “It is not the ratings agencies that dictate the policies of France,” François Baroin, that country’s finance minister, declared after the Standard & Poor’s downgrade. To some it seemed a statement of hope as much as fact.

Confidence in capitalism has fallen. A recent opinion poll conducted by GlobeScan indicated that support for the free enterprise system had fallen to about 60 per cent in the US. Ten years ago it was at 80 per cent. Mitt Romney, frontrunner for the Republican nomination in this year’s presidential contest, once boasted of his success in building Bain Capital, the private equity business. Now, a career at the sharp end of capitalism’s creative destruction may prove a political liability.

Ironically, the poll found that faith in the market was significantly stronger in China. There were higher scores, too, in Brazil and Germany. Capitalism, leaders of most political colours seem to agree, is still the only show in town – but must it be unfettered?

In Europe, the debts of the banks have been piled on to the deficits of governments, turning a financial crisis into one centring on sovereign debt. The storms engulfing the euro threaten the continent’s most ambitious project. Angela Merkel, German chancellor, warns with only slight hyperbole that the euro’s failure would imperil decades of European integration. On the other side of the Atlantic, an initial fragile consensus in Washington on rescuing Wall Street has given way to political gridlock. Barack Obama faces a constant struggle with Republicans in Congress to secure enough money to keep the federal government running.

All the while, the Tea Party, the Occupy movement and, in parts of Europe, rightwing populists shout from the sidelines. Greece and Italy have lost elected politicians to technocrats. Elsewhere, presidents and prime ministers more closely resemble victims than masters.

In 2009, things looked as if they would be otherwise. Surveying the nationalisation of a slew of US financial institutions and Washington’s takeover of the automotive industry, a senior Chinese official remarked laconically that he detected “socialism with American characteristics”. In Britain, the crash obliged the government to take controlling stakes in two of the biggest banks and to prop up several smaller ones. What had seemed be a life-threatening event has become a chronic illness – not so much a crisis of capitalism but of the capacity of politicians to manage it.

The banks’ losses have been nationalised. Billions of dollars of toxic assets that once sat on the books of financial institutions have piled further pressure on public deficits already swollen by recession.

Governments badly need growth. The US economy shows signs of life, but its recovery has been anaemic. Mr Obama’s hopes of a second presidential term rest critically on a sustained fall in unemployment. In Europe, growth has all but disappeared. The eurozone’s peripheral economies – Greece, Spain, Portugal and Ireland – are on life support and the continent’s banking groups are kept afloat on a sea of liquidity provided by the European Central Bank.

The pervasive sense of political powerlessness is a western rather than a global phenomenon. China, India, Brazil and the rising rest are not immune from the troubles of the rich nations but their economies have continued to grow. For most Asians, today still feels better than yesterday and tomorrow looks better still. American and European politicians have discovered that capitalism no longer belongs to the west. Instead, the troubles faced by the advanced economies have crystallised the wrenching shift in the balance of global economic power. The Chinese, Indians, Turks and Brazilians now have a say in setting the terms of exchange.

. . .

Politicians of the left and centre-left saw opportunity in the crash. The Washington consensus, the organising idea behind the global advance of laisser-faire financial capitalism, had been discredited. The demise of market liberalism, the socialists and social democrats assumed, would rehabilitate the role of government as the pivotal actor in economic management. Popular fury with the bankers would translate into renewed faith in the efficacy of the state. As things have turned out, the centre-right has all but swept the electoral board.

Policy Network, the progressive think-tank, has an explanation. The mistake of the centre-left was to misread the anger at the excesses of the market as a return of public confidence in the state. The organisation’s opinion surveys show that the crisis has come to be seen in the minds of voters as one of public borrowing and debt as well as of bankers’ greed. Voters do not think the answer to spiralling deficits is more government borrowing. “It is the question of the state – its size, its role, its efficiency – that has become the central issue, not the inherent instability and free-market ideology,” Policy Network observes. Put another way, if capitalism needs fixing, Europeans have decided to leave the task to the politicians who best understand the marketplace.

The Occupy movement that has sprung up across American and European cities has drawn sympathy from beyond the protesters’ natural constituency. But its many threads – some anti-capitalist, some anti-globalisation and many social democratic – have fallen short of a coherent prospectus. On the populist right the themes are sometimes complementary, as in opposition to immigration, but as often as not contradictory. The Tea Party has harnessed Americans’ scepticism about the role and motives of the federal government: Washington is the big danger. In France, the Netherlands, Finland, Hungary and beyond, parties of the far right have targeted global capitalism as the enemy – with the International Monetary Fund and the European Union at times thrown in as co-conspirators.

Waning public confidence is in part simply a reflection of the brutal economic facts. The financial crash inflicted huge losses on the innocent. Unemployment has risen sharply and living standards have stagnated or fallen. Yet even as they have been swept along in treacherous currents, politicians have not helped themselves. The west is not blessed by decisive leadership. Mr Obama lacks the temperament of a Franklin Roosevelt. Ms Merkel’s almost pathological caution has significantly raised the cost of rescuing the euro – if such a rescue remains possible. Nicolas Sarkozy, the French president, has energy and rhetorical ambition but lacks clarity and concentration.

Missing, too, has been a convincing prospectus. The regulation of financial institutions has been tightened. The US has its Dodd-Frank Act and Volcker rule; Britain has its Vickers commission on banking. Germany and France are plotting a financial services tax. Mr Obama promises less Wall Street and more Main Street, Britain’s David Cameron less financial engineering and more of the real sort. The talk of “responsible” capitalism, of rebalancing economies and constraining the rewards of the super-rich, falls short of anything resembling a grand plan. The ambition is to make do and mend.

. . .

Behind all this, however, lies the structural problem – the mismatch between global economics and local politics. States have been shedding power to globalisation. The big lesson has been about the extent to which globalised capitalism has outstripped the capacity of national governments to manage it.

Governments have ceded power to mobile capital, to cross-border supply chains, to instant global communications and to rapid shifts in comparative advantage. Citizens expect their politicians to protect them against the insecurities of the age – whether economic or physical. Yet governments no longer have the tools to provide such a shield. “Inequality is being driven by globalisation,” one senior minister in Mr Cameron’s government says of the wage stagnation faced by the middle classes. “And there is not a lot we can do about it.”

The same might be said of the rise in structural unemployment in most rich economies as comparative advantage has moved rapidly eastwards.

It is this gap between the supply and demand for governance that fuels popular discontent, and gives impetus to the temptation for states to look in on themselves. It explains the rise both of rightwing populism and the anti-capitalist movements of the left, and risks fuelling a dangerous revival of the politics of identity on both sides of the Atlantic. The response of many governments has been to turn inwards and seek to defy the realities of interdependence by elevating narrow definitions of national interest. Old concepts of mutual interest and solidarity have cracked even in the eurozone, the most closely integrated group of rich nations.

Ms Merkel says German voters cannot be held responsible for the feckless behaviour of their spendthrift European cousins. Politicians on the continent’s troubled periphery rail against German selfishness. The effect has been to recast the euro crisis as a zero-sum game. What Greece, Portugal, Spain and Italy stand to gain, creditor nations such as Germany, the Netherlands and Finland must lose.

The signal this sends to rising states is equally counterproductive. The sense of collective interest visible at the post-crash meetings of the G20 has dissipated. If states so politically integrated as those in the eurozone are so reluctant to act in concert, why should China, India or Brazil invest their faith in co-operative global governance? It is a question to which western leaders have yet to find an answer.

Charles Kupchan, a professor of international relations at Georgetown University, says the political breakdown – political stasis in the US, a fracturing of solidarity in Europe and a merry-go-round of prime ministers in Japan – adds up to a crisis of governability. The diffusion of power in the international economic system has diluted the efficacy of traditional policy tools. There are answers to the malaise, he says, including more government activism in the provision of infrastructure and training, and drives to improve competitiveness and weaken the special-interest groups that have captured some of capitalism’s commanding heights.

These, though, are not quick fixes. The danger is that what started out as a crisis of financial capitalism will give way to a new age of nationalisms – a backlash against globalisation and a return to zero-sum politics. The better route would be an effort to extend and refurbish the multilateral order to match economic integration with great global governance. But, for the moment, we are as far from that as from a serious attempt to remake the rules of capitalism.

Growing income and wealth inequality is a central theme of the articles published in the Financial Times under the “Capitalism in Crisis” banner. The FT isn’t alone in taking note of the widening gulf between the haves and the have-nots. Included in the current issue of Foreign Affairs are several essays that address this issue, among others:

• Gideon Rose, “Making Modernity Work: The Reconciliation of Capitalism and Democracy.”
• Francis Fukuyama, “The Future of History: Can Liberal Democracy Survive the Decline of the Middle Class?”
• Charles A. Kupchan, “The Democratic Malaise: Globalization and the Threat to the West”
• Shlomo Avineri, “The Strange Triumph of Liberal Democracy: Europe’s Ideological Contest”

These articles are below the fold. Before reading these articles, I suggest that you take a look at the summary section of a recent report by the Organisation for Economic Co-operation and Development:

Continue reading ‘The Crisis of Capitalism, No. 2’ »

Two articles have been added at the bottom of this post.

Notice that the title of this post doesn’t conclude with a question mark. The reason for its absence is that, since early this month, the Financial Times has been running a series of  articles asserting that there is — rather than asking whether there is — a crisis of capitalism. It’s always been evident to me that the philosophical/ideological divide between London’s Financial Times and New York’s Wall Street Journal is greater than the geographical distance between the two financial centers. The WSJ never has and never will claim that anything is wrong with capitalism; instead, it’s government’s growing involvement in the private sector that’s preventing capitalism from functioning properly.

As some of you know, I’m a retired Wall Street analyst. As such, I’m one of capitalism’s beneficiaries. Notwithstanding that fact, I believe that — to use Churchillian words — capitalism is the worst economic system, except for all the others. More to the point, my judgment is that capitalism’s flaws have intensified during the past 30 years. The most important of these flaws is the unrelenting increase in the concentration of income and wealth in the United States. I’m convinced that, if this trend is not reversed, it will eventually undermine the social stability that we all take for granted. As yet, there are no alternatives to capitalism, as there were during capitalism’s last great crisis in the 1930s. It would be both presumptuous and dangerous, however, to conclude that our country will forever be immune to discord resulting from an ever-widening gulf between the few “haves” and the many “have-nots.”

With the posting today of a video interview of two of the paper’s top columnists, this strikes me as the right moment for me to post the articles from the FT’s “Crisis of Capitalism” series. Below the fold are the contributions to this series.

Continue reading ‘The Crisis of Capitalism (UPDATED)’ »