The conventional wisdom of free market and free trade economics is often wrong and sometimes needs to be flipped on its head. Ha-Joon Chang is a reader in the Political Economy of Development at the University of Cambridge who takes the long view on his subject matter, grounding it in history, and making it accessible to everyone.
In 23 Things They Don't Tell you About Capitalism, he explores the many myths in the narrative of free-market liberalism, starting with “there is no such thing as a free market,” because in reality supposedly free markets are all regulated in some fashion. As Chang says, there's no separating politics and market.
No “free market”
All markets are regulated by a range of rules that determine who can participate, what can be sold and bought, and how the exchange is to be conducted, hours of work, and so on. These are all things that have developed over the years. We follow existing regulations so closely that we don't see them. Apparently scientific boundaries of the market are in fact motivated politically.
For example, paying for a product or service is a regulation we must follow. Another example is the inability to receive a refund when returning an item in Italy—the store may issue a credit or exchange the item for a like value, but there's no refund as we're used to in the U.S.
Consequently, free trade doesn't make countries richer. When we study the history of economics, we find out that developing countries need protectionist trade policies to nurture young businesses—including the U.S. until World War II.
Alexander Hamilton, the first U.S. treasury secretary, led the charge on protecting nascent industries in his 1791 report to Congress, arguing that the government needed to nurture and protect “industries in their infancy,” proposing the use of tariffs to stave off competition, subsidies, and the building of infrastructure.
There's confusion about the importance of trade, and importance of “free trade” is at the root of many contemporary problems. It's not just an issue of getting history right, but of understanding how things work to deal with issues. No free ride.
As the U.S. stumbles in its role of “buyer of last resort” with the breakdown of consumer credit and the housing hangover, exporting countries like China, Japan, and Germany will need to reorient their production. Because we cannot have everyone engaging in export-led growth or we'll be left with no buyers.
This is less of a problem for countries like Japan and Germany. China however will need to start developing consumer infrastructure to stimulate consumption like shopping malls, credit cards, all hings that require a substantial investment to build. It will take some time for China to develop the welfare state to provide social safety nets to slow down savings, which is now necessary.
So that's a big obstacle. Chang then turns to the question of stockholders v. shareholders.
Long term corporate health
Companies should not be run in the interest of their owners. Many stockholders of public companies are often the least invested of all stakeholders in the long-term health and productivity of companies. Which is why brands die with a whimper and yet enormous consequences. Abraham Lenoff, chemical engineering professor at the University of Delaware says:
“It takes an enormous effort and a lot of time and a large infrastructure, especially human infrastructure, to create value in a large company like DuPont. The financial community doesn't know how to do that. Hedge-fund managers know how to extract value from a company, and leave an empty shell, so they can build their houses in the Hamptons.
DuPont had one of the premier engineering units anywhere in the world. They knew the principles and how to apply them. Without people like that you can't develop, design, and start up plants. It's an enormous loss to science and engineering.”
And that is precisely the point Chang makes. There's a question of free capital mobility.
In the relationships between stock market and corporate governance non all stockholder value is being represented. When there are hundreds, thousands, even millions of dispersed shareholders, individual shareholders have no incentives but to wait for long term results. Despite them being the legal owners, they have no incentives and are the least committed to the long term future of the company.
Other stakeholders in the company, like employees and suppliers, the local community and consumers find it more difficult to leave. This has given enormous power to the floating shareholder—the people who own pieces of the company with no long term commitment—and we now run companies based on shareholder value maximization.
This means no investing for the long term. The easiest way to generate profit in not to invest in machinery or improvements on the business like research and development, or trade, but to hoard cash and distribute it through dividends. In 1970, this was only about 35-45%, now it's more than 60%.
Companies have less cash to invest and cannot even invest it all in improvements because they have to do share buy-backs to prop up share prices. In the 1980s this counted for about 5% of corporate profits, today it's often more than 100%. None of the profit is being used for long term productivity development—companies are using it to keep shareholders happy.
Relevance of economics
Economics is highly relevant to understanding many aspects of modern society and the productive sector. Too much emphasis on technique and not enough on the history of why certain rules have been adopted and real world applications. The result is that we're not very interested in economics.
It's an important body of knowledge to help address real world issues. This was the motivation behind the publication of Economics: the User's Guide where Chang exposes the myriad forces that shape our financial world and how we are all interconnected.
We should start with the problems, then learn the techniques we can use to understand them. When we start with the techniques, they become the only point of focus. Which is unhelpful to address the issues, because “he who has a hammer sees everything as a nail.”
There are some fundamental theoretical things we need to fix, says Chang. For example, the ability to tell risk from uncertainty. In The Signal and the Noise Nate Silver summarizes the difference between the two:
Risk, as first articulated by the economist Frank H. Knight in 1921, is something that you can put a price on. Say that you'll win a poker hand unless your opponent draws to an inside straight: the changes of that happening are exactly 1 in 11. This is risk. It is not pleasant when you take a “bad beat” in poker, but at least you know the odds of it and can account for it ahead of time. In the long run, you'll make a profit from your opponents making desperate draws with insufficient odds.
Uncertainty, on the other hand, is risk that is hard to measure. You might have some vague awareness of the demons lurking out there. You might even be acutely concerned about them. But you have no real idea how many of them there are or when they might strike. Your back-of-the-envelope estimate might be off by a factor of 100 or by a factor of 1,000; there is no good way to know. This is uncertainty.
Risk greases the wheels of a free-market economy; uncertainty grinds them to a halt.
Except for “there is no such thing as a free market.” We also need to reexamine various theories of human motivation and how they're mainly driven by self interest.
To demonstrate the relevance of economics to issues, Chang created a cocktails chart to guide learners in using the principles of the nine schools of thought—Austrian, Behaviouralist, Classical, Developmentalist, Keynesian, Marxist, Neoclassical, and Schumpeterian—in combinations of two to four to understand specific issues well. These various schools contains some diverse views to look at our economy. There is just no one explanation.
What techniques can be used to solve what kinds of problems?
- On diverging views of the vitality and the viability of capitalism, take C M S I
- To discover different ways of conceptualizing the individual, take N A B
- To understand economic systems, rather than just their components, take M D K I
- If exploring how individuals and society interact is your thing, take A N I B
- For various ways of defending the free market, take C A N
- To study how technologies develop and productivity rise, take C M D S
- If you want to find out why corporations exist and how they work, take S I B
- For debates surrounding unemployment and recession, take C K
Chang includes a health warning—drinking only one ingredient may lead to tunnel vision and arrogance at a minimum. By this he means to reinforce how no one theory explains it all. It's a useful lesson to remember when approaching learning an an active pursuit.
[image via RSA animate]