Analytics, Economic History, Economics, EU – Baltic States

The word “capitalism” was popularised by Karl Marx in the middle of the 19th century to describe a world characterised by, among other things, “roundabout” methods of production involving growing industrial structures, e.g. factories, railways, steamships, etc. It was the period of so-called industrial capitalism in its “classic” initial stage of development.

Some critics at the present critical stage turn to these classic essentials; no wander that K. Marx’s theories are becoming more and more popular.

There have been numerous pros and cons, e.g. those who declared the capitalism’s system immoral and those who predicted dramatic reforms in capitalism, as well as those who predict its inevitable collapse.

Some myths about capitalist system postulate that it is mostly about markets and prices. However true about market activities and supply-demand progress, successful capitalism has required a great deal more of regulations, including those of social nature.

First of all, it requires a basis for long-term “social contracts”. Such contracts in turn require the rule of law. It means generally understood rules of the game so that economic agents can make plans that will not be undermined by unpredictable political intervention, state intervention, criminal action or any other destabilising activity.

Second, it requires a minimum of trust so that entrepreneurs and other undertakings can initiate and run projects without authorities constantly looking over their shoulder to see that business activity is observed. On the other hand, commercial partners are not looking for ways to renege on obligations or to twist their meaning.

Third, capitalism depends in great part on private ownership – not necessarily the whole – of the means of production, distribution and exchange. Joseph Schumpeter, in a postscript to his path-breaking book (Capitalism, Socialism and Democracy, the UK edition in 1986), remarked that only the nationalisation measures of the postwar Labour government counted as genuine socialist steps. All the rest, such as wage and price controls, trade restrictions or attempted “economic planning”, whether wise or unwise, could be found in many capitalist societies. The temporary state ownership of some banks does not count as state socialism so long as private banks are not prevented from starting up.

Some reformers have envisaged a market society based on workers’ co-operatives rather than traditional private ownership. This, for example, is what John Stuart Mill meant by socialism. Whether that is correct is a semantic matter. Although there have been individual successful examples of employee-owned enterprises in Britain (retail partnership), in Spain’s Basque Country (fruit producing and processing), in Denmark (agro-sector) and in other countries. However in European history there have been quite a few such examples where governments and societies operated on these lines, outside the very special circumstances of former “socialist” Yugoslavia under Tito’s governance.

Fourth, capitalism works best when there is competition between producers; the degree of competition varied immensely in Europe and only EU competition policy tried to make a “uniting difference”. Businessmen do not in practice always welcome competition and an entrepreneurial activity can be pro-capitalist without being pro-business. Free trade is best treated as part of the competition agenda, which the EU competition policy has proved right.

Fifth, successful capitalism requires a good deal of economic freedom, although not necessarily laisser faire. The defects of capitalism are often called market failures: things such as environmental overspills or inadequate provision of public services. Moreover, a market system does not even pretend to provide a just distribution of income and wealth. At different times observers have claimed to detect trends both to increasing concentration of income and wealth, and towards a leveling of differences. Vilfredo Pareto, the early 20th-century economist, claimed that in the very long run the pattern of pre-tax distribution is surprisingly stable. Contrary to what zealots claim, taxes and benefits can influence income and wealth distribution provided that care is taken not to kill the goose that lays the golden eggs.

Sixth, the capitalist system requires at least the possibility of separating ownership from control. This has been facilitated by the rise of limited liability laws since about the middle of the 19th century. But the practice also gives rise to what modern economists call the “principal agent problem”, i.e. how the owners can control the managers.

Seventh, although there is a variable and often high degree of ploughed-back profits, there must be provision for a capital market in which savers can lend to enterprises (and governments) whose investment needs exceed their own resources. Such arrangements, in turn, require a secondary market in paper titles to wealth, nowadays called stock exchanges with banks serving as important intermediaries, often playing powerful separate roles.

The present credit crunch leaves more or less unaffected the arguments for and against the first seven principles affecting what is sometimes called the “real” side of the economy.

Eighth, any market system requires functioning money-currency means, both to avoid the wasteful complications of barter and to serve as a standard of value. It does not require literally zero inflation but cannot well cope with unpredictable wild fluctuations.

And ninth, capitalism also requires depositary financial institutions where people can store their money without hoarding it under the mattress.

Crisis periods, i.e. “boom and bust” have been a feature of capitalism from its initial stages, originating partly in the alternation of moods of pessimism and optimism. Not all recessions originate in the financial sector but those that do have, on average, been more than twice as severe as those that do not.

Some of the abovementioned items might be called the “financial side” of the crisis being however the essential ingredients of capitalism. The mutual entanglement of savings and investment decisions, money creation and deposit banking, it all has caused much harm and there have been numerous ideas for “functional separation” (e.g. about “narrow” banks that can hold only assets in cash, deposits with the central bank or short-term government securities and are therefore safe against a series of performance.

Clearly, there are signs for trends toward more regulated type of capitalism, but not all the regulation might be wise. The perennial problem of regulation is the concentration of producer interests, which makes for successful lobbying, and dispersion of consumer and general citizen interests, which are therefore more difficult to organise. Moreover, much discussion is vitiated by the assumption of omniscient and benevolent government instead of balancing market failure against government failure.

There is a vast literature on something which is called a “public choice”, however real truth is that while capitalism has become presently a global system but its regulatory premises are still within the reach of national governments.  

The most difficult issues, however, arise on the capitalism’s social side or its moral issues involved. The assumption that the pursuit of self-interest within the rules and conventions of society will also promote the public interest is not likely to survive (if only because the content of these rules is up for any group to take). But it is all too likely to be succeeded by a mushy collectivist pseudo-altruism, in which jealousy and envy are given a free ride.

Something can be learnt from the social market theorists of the postwar “German economic miracle”: it was generally guided by the government intervention but had firm capitalist principles regarding its nature, purpose and duration. Modern trends on business ethics and corporate social responsibility are of the same matter and they can be easily taken into account at the present crisis and the ways to recovery.