Back to Capitalism and Free Markets, Pretty Please

I think I understood the concept of capitalism before I ever learned it in school. It’s probably because my Pop’s made sure I understood the value of a dollar. I knew from jump, if I wanted my first PlayStation or a new speaker system in my car, I’d have to get after it and be enterprising.

The opposite was true of my failures. My parents weren’t going to abandon me; but, I’d have to own and face my problems without any expectation of a bailout. My parents were tough but loving. It was clear that everyone in the household was responsible for their own actions. That is one helluva statement when you form your perspective as a kid.

This is a hard article for me to write because I like to flow. I’m not much for writing think pieces or academic papers. I can sure talk you to death though. I’m going to do my best to delineate facts and my opinion, but the larger point is that you can understand the bigger picture for how the world is functioning now and maybe let that anger you. Just a little bit.

Photo by Paul Fiedler on Unsplash

Understanding Capitalism

“Capitalism is an economic system in which private individuals or businesses own capital goods. The production of goods and services is based on supply and demand in the general market — known as a market economy — rather than through central planning — known as a planned economy or command economy. Functionally speaking, capitalism is one process by which the problems of economic production and resource distribution might be resolved. Instead of planning economic decisions through centralized political methods, as with socialism or feudalism, economic planning under capitalism occurs via decentralized and voluntary decisions.” (source: Investopedia)

You have the textbook definition, but let’s blow by that for a second. Capitalism means that I can decide tomorrow I want to be in the business of selling bread (the good ole’ COVID-19 pastime). With my savings, I can find a physical space to rent and then I can purchase ingredients, machinery, and other supplies so I can bake and sell my treats. I will allocate my money and resources to where I think they will return the most profit.

Maybe, I have the capacity to make loaves, doughnuts, and danishes. I soon realize that while I sell all three, customers are really only digging the sweet treats. Even when I lower the price on the loaves, they end up wasting away on the shelf and getting thrown out. I have a demand issue, so I reallocate my capacity and production investment to make more of the sweet treats and stop producing the loaves all together. (Try to remember this example for the rest of the article.)

In America, we don’t have pure capitalism. We have a mixed capitalist system with varying degrees of government regulation in each industry. Everyone has their belief about how much or how little regulation is needed, which is partly why our economy is incredibly political. There are a couple of other reasons government intervention is a “rational” development to the system:

• “Capitalism depends on the enforcement of private property rights, which provide incentives for investment in and productive use of productive capital.”

In the terms of our new bakery: If a competitor opens up next door and decides to copy my logo and my menu — I need to be able to lawfully prevent them from this type of unethical competition. This stipulation of private property rights (et al.) helps establish a trust factor in the system.

• “Pure capitalism can be contrasted with pure socialism (where all means of production are collective or state-owned) and mixed economies (which lie on a continuum between pure capitalism and pure socialism).”

If you’re a Bernie Sanders supporter, his ideas land somewhere in the middle of this continuum a little further towards pure socialism than where we currently exist. But, our economy is on the continuum too. Another example, COVID-19 forces our bakery to shut down but the government passes a law and requires us to start manufacturing face masks (for a price) while the country is in a state of emergency. A drastic example, but a fitting one.

• “The real-world practice of capitalism typically involves some degree of so-called ‘crony capitalism’ due to demands from business for favorable government intervention and governments’ incentive to intervene in the economy.”

Plain talk: Our bakery has expanded into a large chain of bakeries all over the southeastern US. Our success leads us to start trying to get favorable tax treatments (abatement) anywhere we decide to open a new store — we start donating to local politicians to secure favoritism for our growth strategy. You know, like Amazon’s H2 search!

This article isn’t solely about the definition of capitalism. Unfortunately, you have to understand what we have to relate to why I’m a little angry and why you should be too. In capitalism, we are supposed to let success of privately owned businesses be determined by free markets, “but instead the success of a business is dependent on the favoritism that is shown to it by the government in the form of tax breaks, government grants, and other incentives.” This isn’t the only contributing factor to success but it’s larger than you’d think.

Two more definitions and then I promise I’ll just switch to my opinion for the rest of this trip:

Rent-seeking: “an economic concept that occurs when an entity seeks to gain added wealth without any reciprocal contribution of productivity. Typically, it revolves around government-funded social services and social service programs.” It would be cool if I was good at making a flow chart but let me try to describe:

• Problematic corporate rent-seeking: Basically, a company has its “properties” where it generates revenue. Our bakeries are located in disadvantaged neighborhoods, so we decide to lobby our local government for a tax abatement for five years, or else we’re moving our locations to more affluent neighborhoods. They agree but this only applies to us. Our competitors that move-in, including mom and pop shops that grew up their whole lives in that neighborhood are subject to the full tax code. We’ve succeeded at increasing our revenue without making any investment into productivity. Not to mention, we’ve also managed to hurt our competition’s ability to compete.
• Problematic individual rent-seeking: Let’s say, in order to be a baker back in the day, all you needed was the willingness to learn and an ability to sell your product. As more and more bakers entered the scene, they decided it’s getting a little too competitive and everyone is making less money. An exclusive group of bakers gets together and creates a baker’s licensing requirement they lobby the government to pass. They pitch it as some novel way to control the quality of professional baking. They even convince the government to facilitate the program (i.e. this is paid for by our tax dollars). Now, new bakers have to go through a long, inefficient and costly process if they want to do anything more than amateur baking. The existing group of exclusive bakers has succeeded in limiting competition and driving their prices up, all at the cost of the taxpayer and with zero investment on their end.
• Barriers to entry: Let’s skip the text book stuff. It’s like I’ve described above. It’s making life harder — higher startup costs and added hurdles for competition to enter the market.

The problem with rent-seeking, crony capitalism, and the myth of the legal requirement to “maximize shareholder value” at all costs is that they all do harm to the greater public. A bigger problem is that sometimes you can see it as if it was painted on a billboard in Times Square, and sometimes it’s so insidious or subtle you’ll just never know. I didn’t explain this shareholder value thing but I’ll touch on it shortly. I’m hoping that you’ve heard this phrase uttered before on CNBC or among the BS that’s fed to us in different intellectual circles.

Photo by Brett Jordan on Unsplash

Capitalism and Free Markets are Broken

I think we have a solid background on capitalism; let’s talk about why we should be angry. I’m not going to give all the reasons just some broad brush strokes.

1. Forever Stimulus — Low interest rates and corporate welfare forever.

The Great Recession happened in 2008. Most of us know the story, so if you don’t know just click this link. This was when the concept “too big to fail” entered our literary diaspora. We abandoned capitalism — i.e. the ability for a company to own its failure. Companies directly engaged in causing the meltdown were protected against failing (going bankrupt or getting wiped out) because of the fear of more cataclysmic second order effects (such as massive unemployment or destabilization of the financial system).

Prof. Scott Galloway describes this as privatizing the gains (i.e. companies make money for themselves and shareholders in prosperous times) and socializing the losses (i.e. the government pays for the bailout of these companies with taxpayer money). You can also just call this corporate welfare for short.

What’s different about this as opposed to 2020’s COVID-19 pandemic CARE Act is that in 2008 government used convertible loans and structures that turned the bailout money into equity. In short, taxpayer’s were paid back and then some when the economy rebounded. The current bailout lacks a lot of those same mechanisms.

Something else problematic — we’ve spent that last 10 years propping up the economic with artificially low interest rates creating a superficial growth engine instead of letting free markets do what they do. For some reason, the stock market (as some analogous representation of economic activity) has just been converted into a political prop. Its health has become the most paramount thing.

We refuse to let the economy go through normal cycles of peaks and valleys. That’s not capitalism, that’s just politics. When airlines fail because nobody can travel during the pandemic, that doesn’t mean everyone loses their job for ever or even that the company goes away. The assets are still there, so a bankruptcy may wipe out shareholders (equity holders) but the company can still stand.

May I also remind you: This isn’t the first or last time the airline industry will need the public’s help. We need to get out of the way, and let them figure out how to run an all-weather business.

It’s a BS fallacy that we can’t let public companies go out of business. There will be another company out there with enough balance sheet to purchase the company, or new management will be dispatched to reorganize the company in bankruptcy and eventually save jobs and the future of the company. This is welfare for the sake of shareholders, of which the biggest class is company executives, board members, and people well enough off they can usually absorb the shock.

2. Shareholder Value At Any and All Costs

What happens when money is cheap to borrow? People borrow it. Corporations look for places to invest but it just so turns out that sometimes the best return on investment isn’t production. When that happens, companies buyback shares, similar to how you and me buy stock hoping it’ll go up. Companies allocate massive amounts of money to purchase their shares back from the public. This causes the price of the shares to rise as the supply of available shares in the market decreases. We don’t see incomes rise for workers (who contribute to massive profits), nor do we see productivity increase in exchange for this activity.

Remember what I said above about shareholder welfare? First, there is a myth that CEO’s and board members need to do everything in their power to maximize shareholder value — that is a falsehood. Secondly, government intervention of a public company’s pending doom is just shareholder welfare that doesn’t benefit the every day American because here are the facts:

• Only a little over 50% of Americans are invested in the stock market. (Source: Lexington Law)
• Of this group of invested Americans, 50% have less than $40,000 invested. (Source: The Washington Post)
• Among non-investors, 53 percent say they don’t have the money to invest and 21 percent say they don’t trust stockbrokers or financial advisors. (Source: Bankrate via CNBC)
• More adults in the United States own homes than stocks. (Source: Chicago Tribune)
• For 9 out of 10 households, even a shift in value of 10 percent — enough to qualify as a “market correction” — would “at most, have a 1 or 2 percent impact on their wealth holdings.” (Source: Edward N. Wolff via The New York Times)
• Here’s a big one: Foreign multinational and other investors own 35 percent of all United States corporate stock, up from 10 percent in 1982. That share of the pie exceeds the single slice owned by taxable American shareholders. (Source: The New York Times)
• Oh, remember that welfare stuff I’m yapping about: In 2017, when stock options were taken into account, chiefs at the 350 largest U.S. companies received an average of $18.9 million for their services — a nearly 18 percent increase over the previous year, and 72 percent since 2009. (Source: Economic Policy Institute)
• The richest 1 percent of households controlled 50 percent of the total value of stocks in 2019. (Source: Goldman Sachs via Yahoo)

Remind me again, why we care if the stock market crashes? Oh, because the people who stand the most to lose are in direct opposition to the market doing its thing, organically. To be absolutely clear, this isn’t a bash on the wealthy, it’s just clarity on incentives in the system.

If you’re curious, in order to enter the top 1% as of 2017, you needed an annual income of $515,371 (AGI, adjusted gross income). There were roughly 1.6 million people that could claim status in the top 1%. Contextually, there are estimated to be about 206 million people that are in the civilian workforce out of 328 million people in the US.

I hate using the word Millennial, but between us and Gen Z, we are the cohorts being shafted by political behavior and shareholder welfare. Saving companies from failing, share buybacks, an artificially propped up economic growth through quantitative easing (interest rate suppression) are all the stuff that is benefiting mostly one class of people. Thanks greed. Not only are we transferring wealth to one socioeconomic class, we’re also setting ourselves up for larger and larger financial crises going forward.

Lastly, an extra piece of evidence for you to snack on. When a company goes belly up, usually the shares get vaporized and anyone who owns them loses money. CEO and other executives have the largest percentage of their compensation in company stock, not base pay. Do share repurchases, bailout requests, managing a company for maximum earnings per quarter regardless of long-term harm, and lobbying for government favoritism make sense now?

3. Short-term vs. Long-term Thinking; i.e. F*ck the Climate

If corporate governance only exists to keep share prices inflated, and we take the temperature of corporate success quarterly, why the hell would we care about what happens in 6 months let alone a decade from now?

Remember, being CEO at a public company doesn’t last forever. And, with the exception of a forever-Congress, elected officials like the president only last 4–8 years. We manage to these short time frames because that’s in our best interest of staying in power or generating present-day wealth. It stands in direct opposition with how the common person is told to grow her wealth over the next 20–40 years of her working life until retirement.

Our system incentivizes power and concentrations of assets to be concerned mostly with today instead of tomorrow. That’s a systemic problem. Have you ever noticed how in most cases, it’s easier for an executive or successful entrepreneur to turn to charity or societal causes after their reign of power and wealth accumulation instead of during? And the ones that do it during their reign, they have their motives as well.

Hell, charitable giving and philanthropy is mostly provided by individuals and corporate entities that can steer the message and the distribution of that aid in a way that guarantees their ability (dare I say protection) to continue to amass revenue and wealth without impediment. Stated more simply, philanthropy with the condition of a protection of status quo. (Book recommendation: Winners Take All by Anand Giridharadas)

Photo by Christina @ wocintechchat.com on Unsplash

Too Long, Didn’t Read

This is a lot to read, and I’m incredibly thankful for your patience. The idea was not just to spew my distaste without providing a grounded rational and context for why this distaste exists in the first place. Here’s the TL,DR:

• Governments and Corporations need to wake up and realize shareholders aren’t their largest constituency. Shareholders are a slice of a much larger piece of societal (civilian) stakeholders. Without turning our attention to the sustainability of the earth and the true health of the economy instead of purely corporate and classist-individual wealth creation, we truly miss the bigger picture of long-term survivability in all areas of concern.
• Governments shouldn’t be preoccupied with the survival rate of public enterprises. We may not want an entire system to fail, but we can definitely afford to let members of the system explode in all their glory.
• Bankruptcy doesn’t mean death, and it doesn’t mean permanent unemployment either. It means restructuring, new management, and the wiping out of shareholders (which is largely concentrated risk for the wealthiest of our society).
• The government’s need to consistently force growth into the economy through (expansionary monetary policy:) suppressed interest rates, availability of credit, (expansionary fiscal policy:) tax cuts and governmental spending is only a ticking time bomb resulting in deeper pain each time a crash occurs. Not to mention, we continue to transfer the opportunity for wealth creation from the youth in the form of asset inflation for the wealthiest of our country. We get the debt, they get a solid retirement plan. And, guess who has to pay the bill eventually?

Conclusion

We are in a state is disrepair. Unfortunately, since politics are broken too, there’s no a lot of hope for getting the train back on the tracks soon. However, as you vote for elected officials, or assume the ranks as an executive at a corporation…or maybe as you become the founder of the next unicorn startup — I hope you can think about the world (politics and economics) with clarity. I hope you can contribute to the conversation and transformation being equipped with the knowledge of what’s broken and why.

Capitalism and free markets aren’t a failed experiment. However, many of the mechanisms are broken and the original spirit is strained from too much bending under interference and influence. We can have economic system where people can get rich by adding outsized value to the world, while simultaneously not leaving generations of our citizens stranded without economic opportunity and participation.

We should be concerned with lifting the bottom up instead of maintaining the wealth at the top. The public shouldn’t be footing the bill for corporate losers or the wealthy’s downside protection. The entire underpinnings of capitalism, free markets, and private property rights is that you own both sides of the deal — success and failure. Taking risks and suffering the consequences is literally what makes taking your shot so damn exciting.

You can find more from me at Freelancekills.com.