How Large Scale Socialism Puts Capitalism at a Disadvantage

Thus far we have dealt primarily with private sector companies (those not owned by the government). However, it is becoming increasingly important to consider the impact of international competition amongst the private and public sectors.

Historically, we typically address this from the perspective of private companies forming to challenge public services to reduce costs. For example, the US Postal Service has seen competitors such as FedEx, UPS and DHL cut into its early dominant market share. I would contend that this is a natural and healthy interplay. As Milton Friedman discusses in Capitalism and Freedom, certain industries benefits from spreading costs publicly, others from private competition, and still others from some degree of hybrid. Roads and airports are a great example. It would make little sense for there to be two major highways running in parallel, each run by separate companies, and each charging competing fees.

As the world is growing and changing, it is important to consider this from the alternative perspective. Large socialist governments are forming companies to compete with international private companies. PetroChina and Sinopec, China's two largest listed oil firms, consistently receive subsidies from the mainland when oil prices become onerous, putting private sector firms such as ExxonMobil and Chevron at a relative disadvantage. When a country has a large trade surplus, it better equips them to spend money on such "cushions", creating larger and longer-lasting subsidies.

This leaves us with very large state-owned and subsidized companies in China and other command economies competing for resources with privately-owned companies elsewhere. If the privately-owned companies do not pursue mergers and acquisitions to continue their growth, the result is that their state-owned counterparts will become relatively larger, and have more pricing power and influence.

Although I am not advocating the supercorporation (as I hope is evident at this point), I am looking at their incentives. When viewed in light of globalization, large scale socialism incentivizes consolidation within capitalism, as corporates must grow in order to survive. As the number of players become fewer and fewer, the modes of production become more centrally controlled, leaving us with the aforementioned oligopolies.

The result is stunning. In theory, large-scale and widespread persistent socialism encourages more socialist-like behavior out of capitalism. In the extreme case, state-owned companies in countries with large trade surpluses can price away their competitors in the short run. This is a stark counterbalance to the argument that capitalist innovations challenge command economies over the long run. In order for long run arguments to hold, capitalist players must be able to survive the short run.

The Dark Side of Globalization

Given its many benefits (the case is compelling), it's not often that we hear of the deterrents of globalization. It is in many ways, an academician's dream come true: abundant supplies of international labor, a focus on core competencies and competitive advantages, and global competition all working together to, in theory, reduce friction and unfair business practices.

Corporation acquisitions are at the very heart of creating global institutions. However, as each fish is swallowed by yet a bigger fish we are left with a series of very large and very interconnected companies. The financial sector offers the clearest picture of this: through a series of derivative contracts, the well-being of nearly every major financial institution in the world was linked to the well-being of nearly every one of its competitors. This left the government with no choice but to bail out the struggling firms.

However, this does not stop at the financial sector. Both General Motors and Chrysler were deemed "too big to fail", as their many suppliers and dealers would have collapsed under the weight of their insolvency. The simple fact is that global interconnectedness up and down the supply chain, just-in-time inventory management, and round-the-clock production creates hundreds of "too big to fail" companies. Imagine the impact if Walmart faced significant solvency problems, or if Tyson had to dramatically scale back their chicken operations, or if Whirlpool had to halt washer & dryer production.

Starting yesterday, the bond markets began to identify with this (financial markets are very useful in identifying trends before the mainstream media reports on them): investors are demanding a higher yield from ten year Treasury notes than they are for ten years worth of a synthetic bucket of inter-bank risk. Some take this as the market indicating that the US government's debt isn't nearly as secure an investment as it used to be. Today the papers took note: see Debt Concerns Send Treasury Rates Higher in the Wall Street Journal. (I should note that "too big to fail" isn't the only cause of this phenomenon — the markets are expressing discontent with healthcare and broader government spending as well).

The steps leading here have been tortuous yet measured. A failure to enforce anti-trust rules has allowed for corporate players that are unseemly and large. As is usual, the matter is not as cut and dry as it appears. As we will see, however, many US businesses were responding to outward pressures from foreign competition.

I, Corporation

This next post is on something that is near and dear to my heart: the complications of corporate campaign contributions.

Although each individual has an equal right to vote, we must recognize that who is incented to vote and how they are incented to vote are determined by their social, political, and financial surroundings. Pessimistically, Noam Chomsky posits in Profit Over People: Neoliberalism & Global Order that these opinions are heavily influenced by the media. This "malleability" of public opinion was "discovered" during and post WWII as documented by Edward Bernays in Propaganda. (The concept of propaganda quickly morphed into "Public Relations").

If this line of thinking holds merit whatsoever, we find that those with the greatest financial backing can run the most permeating policy campaigns, awarding them the greatest sway over voters and political decisions. Corporate contributions had been previously limited via the so-called McCain-Feingold law, but this law has been subsequently reversed (see NYT article here). The premise of the ruling had to do with the legal "personhood" of corporations and the freedom of speech under the First Amendment.

My intent in this is not to point fingers, but rather to address the structure of incentives. People by and large behave how they are incented to (Freakonomics is a very fun read on this). As such, we must give adequate thought to creating proper incentive structures.

This becomes vitally important when incorporated with the previous few posts. As discussed, capitalism and democracy provide necessary checks and balances (financial power versus voting power). When corporate campaign contributions are substantial enough to influence voters, capitalism begins to tacitly control democracy rather than wrestle with it. Our current incentive structure encourages corporations and special interest groups to lobby for change that is narrowly rather than broadly beneficial. Furthermore, it enables them to do so. This creates a trajectory that is long-term politically unstable.

Why Capitalism and Democracy Aren't Interchangeable

Capitalism and democracy: two pillars of America that I had historically thought to be one and the same. I had considered this solely on the philosophy of freedom — while capitalism allows freedom to financial prosperity and choices, democracy allows the freedom to vote and basic human rights. However, the two are very different and both vital to function.

Throughout history, power has tended to reside in the hands of one of three spheres: the church (religious), the military (kings, queens and government), and the commercial sector. Jacques Attali addresses this in A Brief History of the Future: A Brave and Controversial Look at the Twenty-First Century: a bit pricey but one of my favorite reads (he summarizes the history of the world very neatly and moves on to social trends shaping the future). We are currently in an arena where the commercial sector is largely manning the power hub.

Now capitalism and democracy are both systems that deal with the distribution of power amongst individuals. In particular, capitalism empowers those individuals that possess greater wealth, affording them investment opportunities and corporate positions of influence. Democracy, on the other hand, empowers each individual equally, providing an important balance of power. No matter how rich you become, you are constrained to a single vote.

When properly functioning, this prevents the ultra-wealthy from taking strict advantage of the underprivileged. In the event that the income gap (the amount of money the top earners make versus the rest of the country) becomes too disproportionate, the lower- and middle-classes will vote for a redistribution of their wealth. Suppose that only 5% of workers made 90% of the income. You would quickly see the other 95% vote to tax and redistribute that wealth.

The recent backlash at the banks is a tangible demonstration of this interplay. The public felt that the bankers had become too greedy and that Wall Street prospered at the expense of Main Street. As a result, the UK has imposed a one-time tax on their bankers, and momentum is mounting to further regulate the international financial industry.

This push and pull, when properly functioning, is what allows individual greed (capitalism) to wrestle with individual freedom (democracy). Over the years, however, our system has broken down, for reasons I will discuss in the next post.

Less Free-Market Than Meets the Eye

As industry power consolidates into fewer and fewer hands, we are left with a “capitalistic” system that is ideologically different, but pragmatically similar to socialism. This is different than Karl Marx's suggestion that a series of crises portending revolution would lead communism to replace capitalism, as well as Joseph Schumpeter's inclination that intellectual climates would become ill-suited for entrepreneurialism.

Rather, this is the natural progression of an ill-regulated system of capitalism. Corporations compete with one another in a style similar to the March Madness tournament. Over time, victorious companies acquire or defeat smaller companies. As the victors grow, the barriers to entry for new participants becomes larger and larger. In the end, we are left with each industry dominated by a handful of major players. Barry Lynn addresses this nicely in his book Cornered: The New Monopoly Capitalism and the Economics of Destruction. He highlights that nine of the top ten brands of bottled water are sold by three major players: Pepsi, Coca-Cola, and Nestlé. Whirpool’s Maytag acquisition leaves them with a 75 percent share of the U.S. washer & dryer market. Meanwhile, since the 1990s, the number of large defense firms has consolidated from 107 to 5.

The result is what economists refer to as an oligopoly within industries. Whereas a monopoly consists of one key decision-maker calling all of the shots, oligopolies consist of “a few” decision makers. These oligopolies (sometimes thought of as cartels) encourage the key players to join forces (either implicitly or explicitly) in order to serve their own best interests.

What we find is that, practically speaking, American capitalism is largely characterized by the centralized planning at the heart of socialism. Wherein socialist economies this planning is executed by the state, in cartel economies this planning is executed by a few strong industry players.

This leaves us in a hybrid form of capita-socialism, with important implications for democracy.

The Rise of the Supercorporation

The tech bubble would be proud if it were still alive.

Everything we promised has come true, and more. The dreams we had. That one day you'd be able to buy your groceries from home (Fresh Direct), clear your shelves of the Britannicas (Wikipedia), and make a "video phone call" with your friends across the globe. That transparency and a hyper-competitive landscape would pave the road for an empowered and knowledgeable consumer and usher in a new wave of American entrepreneurialism.

Yet the same medium which has given rise to re-birthed capitalism in a few industries has created oligopolies (sectors dominated by only a few key players) in many others. For these supercorporations, the Internet has offered a degree of connected that facilitates coordination and round-the-clock production that heretofore was impossible. While the eighties and the nineties began domestic waves of consolidation, the noughties ushered in international mergers and acquisitions blessed by tremendous technological progress.

The result is that many corporations have productive capacity which challenges even medium-sized nation states. For example, in 2008, Exxon Mobil's gross revenues were $477 billion while Walmart had gross revenues of $379 billion (they were the two largest corporations internationally by revenue). Taken together, there were the 17th largest GDP in the world, ahead of Poland, Belgium, Switzerland and Thailand.

The point of this is not to necessarily disparage the rise of the supercorporation, but rather to highlight that companies of this size portend structural shifts of power away from the hands of the government and into corporations.

I hope to, over the next week, discuss the implications that this has on labor, governance and centralized planning. Happy reading.

La Raison d'Être

Believe it or not, there are blogs about the reasons to start a blog. Surprisingly, "because you're important and everybody should know what you think" is not on that list.

It is for just such reasons that I've hesitated for years in starting my own. I worked for a very large bank throughout the financial crisis (albeit not in a decision-marking role) and remember well the bloodbath of the equity markets into the close each day. I remember colleagues with bruised tailbones after working twenty-plus hour days through the thick of the Lehman bankruptcy. We worked hard, because we genuinely believed that we were keeping the system from collapse, each playing our part.

Through open brainstorming with friends over the years, I was one of the few that saw the crisis coming. Within weeks after the string of corporate bankruptcies in the fall of 2008, I had put together an alternate bailout package addressing the structural problems America was facing, as well as what I felt were the most cost-efficient solutions to our problems.

I sent them to many members of Congress, as well as many Senators, Republican and Democrat alike. Everything fell on deaf ears.

Over subsequent months, I found friends and family to be fearful of the future, desperately needing a framework by which to make things make sense. It is out of these conversations that this blog is born. It seeks to be both forward- and backward-looking. It will contain a compilation of current events, pertinent reads and my personal commentary.

It is my hope that through this readers will have a resource that helps them understand what they've been through, what is really going on in financial markets, and what they can expect going forward.