Friday, November 11, 2011

The Reason Capitalism Is Failing - Centralized Control

I’ve often noted how the United States seems to be turning into the Soviet Union it supposedly defeated – falling living standards for workers, mass surveillance of the citizenry, mass incarceration, out-of-touch elites, economics based on ideology rather than results, oppressive government regulations, huge military expenditures, foreign adventurism while decaying at home, aggressive expansionism, crumbling infrastructure, suppression of protest, controlled media, rampant cronyism, and on and on. I’ve also noted that this is the era of Authoritarian Capitalism – many of these characteristics are emerging in all capitalist economies all over the world, from Western Europe to the Middle East to Asia. Cameras on every street corner in Britain, Germany using software to spy in its citizens, Putin permanently in power in Russia, protesters tear-gassed in Greece and beaten and shot in Syria, kleptocracies in Africa, and, of course, China, the original poster child for Authoritarian Capitalism. In fact, it’s difficult to find any advanced capitalist country on earth where citizens are truly free, and government is not ratcheting up control.

But why should this be happening? Why should Capitalism, supposedly the antithesis of Communism and the paragon of individual freedom, be producing autocratic societies in nearly every nation on earth, much as Communism did? We were told by people like Francis Fukuyama and Thomas Friedman that “free” markets inevitably lead to free people, that it is even the "final stage" of history. Now that the entire world is a free market, why should popular democracy be disappearing all over the world? Moreover, why should wealth become more and more concentrated, especially in mature economies, with every passing year?

I think that John Robb, an author who blogs at the essential site Global Guerrillas has the answer. Robb’s thesis is that the reason we’re seeing a massive misallocation of resources on a global scale is that globalized corporate capitalism is a centrally planned system, just like Communism was! And just like Communism, centralized control is leading to a massive misallocation of resources on a global scale. Here’s his inaugural post on the topic. Please read it, it's important.:

http://globalguerrillas.typepad.com/globalguerrillas/2011/07/journal-central-planning-and-the-fall-of-the-us-empire.html

Robb points out that the great advantage of the market is decentralized decision making. There’s nothing “magic” about the market – it simply provides a method for decision making to be done by more people at local levels to respond much more dynamically to the needs of society. The arguments for markets are summed up nicely here:

[…] As Hayek argued, the market is, in an important range of cases, a more efficient mechanism for deciding what to produce than decisions by any central planner. This is so for two reasons. The first is the flow of information: no planner could acquire information about what consumers want to buy as efficiently as the market does. The second is capture by interests: decisions by state-owned industries are likely to be guided by the interests of those who run or work in those industries rather than by the goal of efficient overall production. Where they apply, these arguments are powerful.

Those arguments seem to have borne out by the experience of the Soviet Union. Robb argues that modern globalized corporate finance capitalism (my term) has subverted this ideal, becoming a centrally planned system of control to benefit a small oligarchy. This leads to a massive misallocation of resources. As Nobel laureate Joseph Stiglitz put it recently:

They are right that something is wrong about our “system.” Around the world, we have underutilized resources – people who want to work, machines that lie idle, buildings that are empty – and huge unmet needs: fighting poverty, promoting development, and retrofitting the economy for global warming, to name just a few. In America, after more than seven million home foreclosures in recent years, we have empty homes and homeless people.

Here’s Robb:

The parallels between the rapid growth of US government bureaucracy and the Soviet bureaucracy is straight forward. As more and more of US economy was controlled by a narrow group of decision makers allocating government resources, the more sluggish the entire economy became (most of this was due to massive growth and mis-allocation in entitlements and defense). Further, the ability of government bureaucracies to extend their decision making to remaining majority of the economy through regulatory action, is also a form of centralization. However, even with all of this government growth, it's is still not enough to account for the level of misallocation we are seeing.

There's is something else at work.

The answer is that an extreme concentration of wealth at the center of our market economy has led to a form of central planning. The concentration of wealth is now in so few hands and is so extreme in degree, that the combined liquid financial power of all of those not in this small group is inconsequential to determining the direction of the economy. As a result, we now have the equivalent of centralized planning in global marketplaces. A few thousand extremely wealthy people making decisions on the allocation of our collective wealth. The result was inevitable: gross misallocation across all facets of the private economy.

To see what this extreme wealth concentration looks like as a distribution, we don't have to look further than income distribution in the US (classic power law). The liquid wealth of those on the extreme left of the curve completely outweighs the 99.5% of the population to the right (the distribution is FAR more skewed than most people even imagine -- Republican or Democrat). This graph would also be a good way to demonstrate how decision making in a bureaucratic dictatorship in a country like the Soviet Union looked like before it collapsed.

The list of problems is endless. The misallocations range from the dangerous $600 trillion derivatives market to the destruction of the US middle class (by exporting jobs and the substitution of income with debt).

Robb’s thesis seems to have been confirmed by a study which got a lot of coverage on the Internet (at least on the sites I read). The study used a fairly advanced network mapping technique to describe just how tightly controlled and managed global capitalism has become.

Here’s Economix blogger Nancy Folbre’s excellent summary of the report (emphasis mine):

Most economists today don’t ask who rules the global economy, visualizing it as a decentralized competitive market that cannot be ruled. Yet new evidence suggests that global economic clout is highly concentrated among large interlocking transnational companies.

Three Swiss experts on complex network analysis have recently examined the architecture of international ownership, analyzing a large database of transnational corporations. They concluded that a large portion of control resides with a relatively small core of financial institutions, with about 147 tightly knit companies controlling about 40 percent of the total wealth in the network.

Their analysis draws heavily on network topology, a methodology that biologists use to good effect. An article in the British magazine New Scientist describes the research as evidence of a global financial oligarchy.

Focusing on the United States, they note that the percentage of manufacturing industries in which the largest four companies account for at least 50 percent of shipping value has increased to almost 40 percent, up from about 25 percent in 1987.

Even more striking is the increase in retail consolidation, largely reflecting a “Wal-Mart effect.” In 1992, the top four companies accounted for about 47 percent of all general merchandise sales. By 2007, their share had reached 73.2 percent.

Banking, however, takes the cake. Citing my fellow Economix blogger Simon Johnson, the Monthly Review article notes that in 1995, the six largest bank-holding companies (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) had assets equal to 17 percent of gross domestic product in the United States. By the third quarter of 2010, this had risen to 64 percent.

Large companies are often able to offer lower prices than small ones because they can take advantage of economies of scale. On the other hand, if their market power reaches a certain level, they can increase prices as much as they like. The consequences of economic concentration for consumers are complicated by more difficult-to-trace impacts on small businesses, American workers and small businesses.

Robb noted on his blog:

Capitalism's central planners. PDF: The Network of Global Corporate Control. This is the ETH Zurich paper that is getting lots of interest now. New Scientist adds some more insight with their coverage. Central planning is the underlying reason the Soviet Union collapsed so quickly. We are seeing the same central planning dynamic today, but on a global scale. NOTE: it's pretty telling that a paper of this importance to modern economics/finance wasn't written by academics in economics/finance. It had to come out of the technical field of complex systems.

Treehugger covers the study here:
The team found a core of 1318 companies (mostly financial services companies) with an average of 20 control links each amongst themselves. These 1318 companies represent only 0.7% of the TNCs but 18.7% of the revenue of all TNCs. When one adds in the 59.8% of the revenues from companies on the wing of the bow-tie controlled by those in the knot, these companies control almost 80% of the global economy.

A "super-entity" of 147 companies, or 0.3% of all TNCs, holds control over fully 40% of the economic value of TNCs. In the words of the authors:

"4/10 of the control over the economic value of TNCs in the world is held, via a complicated web of ownership relations, by a group of 147 TNCs in the core, which has almost full control over itself".
For a more critical view of the study, see this post on Marginal Revolution.(His argument is that ownership does not equal control. I don't find it convincing given global wealth distribution).

To cite one example of this at work, an important reform of the food system that involved the meat industry was defeated recently. As the author of an article about it noted:

[...] the top four companies control 90 percent of all beef processing. In the case of pork, four companies control 70 percent of the processing, while for poultry it's nearly 60 percent. When you get that kind of market power, abuse becomes rampant. Indeed, ranchers all around the country now agree that it's impossible for them to get a fair price for livestock.

Furthermore, Robb noted that capitalism's central planners share a few characteristics:

Make lots of VERY bad decisions. Wall Street and EU planners routinely attempt to sink the entire economic and financial system with excessive leverage and risk. These systemic threats have become so commonplace now, it's nearly inevitable that one will cause a major collapse.

Become morally and ethically depraved. They operate on a continuous stream of fraud and lies. Too many instances to count. These planners are unencumbered by ethical or cultural norms. They actually believe these rules are below them. In reality, by doing so, these planners are eviscerating their own decision making.

Completely arrogant and unapologetic. They are never wrong. Nobody could have foreseen it. It's a one in 10,000 year event.


So there you have it. The misallocation of resources is almost overwhelming. Corporations are paid to build new headquarters while schools crumble. Suburban mansions are built instead of rail transit (J. H. Kunstler has termed suburbia the greatest misallocation of resources in human history). People needing legal advice and medical care cannot afford it, while doctors and lawyers cannot find jobs. Ordinary people cannot afford to insulate their homes while CEO's spend 1 million dollars remodeling their office. Houses are demolished by banks while millions of people are homeless. An entire book could and should be written of these instances. And yet most people still believe we live in a "free market" that allocates money where it belongs, as if by divine magic.

Hopefully this important information will catch on. The centralized control system of globalized corporate capitalism is failing, and failing miserably, taking entire governments down with it. Will we see something like the Soviet collapse enacted on a global scale? Stay tuned.

P.S. This makes a good case for distributism.

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