4 February 2015

10 things capitalism needs but cannot provide

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Capitalists need a theory of the state and a theory of society. In order for free markets to function they need to understand what roles limited but strong states and free societies play in building vibrant economies. It’s something that Legatum Institute’s Prosperity Index measures every year. As well as looking at fundamental economic freedoms, the Index also examines the contribution of state-funded services and of social capital to delivering “wealth and well-being”. Friends of capitalism should never deny the contributions that non-market institutions and values can make, they should define them and protect them. Those that insist that the state has almost no useful role are as unappealing to voters as those who want the state to do nearly everything.

I’ve identified ten functions of non-market institutions below. They’ll be at the centre of a new project I’m running for the Legatum Institute, entitled “A Vision of Capitalism”. They’re first thoughts and I’d be grateful for your views on what I’ve got right, what I’ve got wrong or what I might be missing. I can be contacted via tim.montgomerie@li.com

1. Vigorous virtues: So much political debate focuses on whether we should be increasing tax to build a bigger state or whether there should be more privatisation. It’s all State Versus Market. Almost no attention is given to thinking about whether we are building the kind of adult citizens that underpin successful markets. Margaret Thatcher would be disappointed at this poverty of the public discourse. In a chapter about virtue in her 1995 book The Path to Power, Margaret Thatcher warned that “it is far from clear that a capitalist economy and a free society can continue to function if substantial minorities flout the moral, legal and administrative rules and conventions under which everyone else operates.” She then spelt out what she meant: “Company executives are unwilling to move to areas of high crime and delinquent schools. The explosion of spending on one-parent families forces social security budgets – and ultimately taxes – inexorably upwards.  Above all, there are fears that the growing welfare dependency will demotivate and demoralise young men and women on whose contributions in the workforce industrial expansion and advance depend.  Even hard-nosed men of the world, more interested in growth rates than crime rates, are having to take social policy seriously.” For Thatcher, wrote Shirley Robin Letwin in her 1992 book The Anatomy of Thatcherism, the ideal citizen was “upright, self-sufficient, energetic, adventurous, independent-minded, loyal to friends, and robust against enemies”. The good citizen possessed, in other words, what Letwin called the “vigorous virtues”. These are the virtues that propel societies forward. They are different from ‘softer’ virtues, such as “kindness, humility, gentleness, sympathy, cheerfulness”. How do we promote vigorous virtues? It’s a question we should spend a lot more time with. For Jonathan Sacks, Britain’s former Chief Rabbi, they come from beyond the market. “A Liberal Society,” he wrote, “depends on the existence of non-liberal institutions. Without them we erode the ecology of civil society without which order can only be sustained by the leviathan of the state”.

2. Public order: The importance of law, order, security and of anti-corruption measures being available to every member of a society can be taken for granted in the more prosperous parts of nations like Britain and America but it never should be. The decline of the US city of Detroit was a textbook example of how dysfunctionality of a municipal state can kill all chance of prosperity. When the city went effectively bankrupt it was taking an average of 58 minutes for the police to respond to any emergency or routine call. This average hid the fact that the best response time was still an appalling 31 minutes and the worst 115 minutes. Only a third of Detroit’s 38 ambulances were functional on an average day. Some of the ambulances had as many as 300,000 miles on the clock. The city had become incredibly inefficient, as Forbes reported: every Detroit payroll check cost an average of $62 to process. $62! Who would want to set up a business in such a Gotham-like city with no Batman to rescue it?

3. A minimum, guaranteed safety-net: Inequality is the current obsession of the anti-capitalist Left, but friends of capitalism should worry most about poverty. Inequality doesn’t kill, or make people hungry or cold but poverty most certainly does. A job provided by a strong market economy is the best financial provider but there will always be times when jobs are scarce and some people will always struggle to be employable. While private philanthropy is often superior to state care because of its tailored, innovative nature and its speed, it is also sometimes patchy and unreliable. Few voters see it as an adequate alternative to a basic, guaranteed state-provided safety-net and those voters are correct. While government should be limited in size a night watchman state cannot be sold to contemporary electorates.

4. Competition: It is one of Adam Smith’s most famous quotes: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” The state has a central responsibility to combat oligopolistic activities but also to ensure that its own policies don’t stifle competition. Only larger firms, for example, can afford to implement expensive regulatory regimes. Smaller firms can be bankrupted by health and safety and compliance regimes. As Zac Tate noted yesterday in the context of Britain: “The top five companies’ market share in a number of industries is worryingly high: airlines (89%), banking (85%) and energy (76%). Regulators should double down on structural issues and predatory practices that reduce barriers to entry into these industries.”

5. Non-market redistribution: The amount of money that emigrant workers remit from their work in richer countries to their families back home in poorer countries is more than three times bigger than the philanthropic aid that also reaches those nations according to the annual Index of Global Philanthropy. Although most of a mum’s care for her children is unquantifiable, the Salary.com website had a go. For Mothering Sunday it calculated that a mum is worth $112,962 if you had to replace all that she did. So much of the financial and non-material care provided by voluntary institutions goes unmeasured (some of it is impossible to measure) and is therefore undervalued by policymakers. Most redistribution, however, and most welfare is done by organic, voluntary institutions like the family – especially in its extended, multi-generational form. If public policies and business practices don’t heed family stability then public demands for replacement forms of social assistance by the state grow. We end up with more taxes on business and an inferior welfare state which cannot match the personalised, holistic care provided within loving human relationships.

6. Long-term research and investment in infrastructure: Go to Africa to see what happens to economies when the state isn’t providing basic infrastructure. There are all sorts of reasons why private businesses would not produce adequate roads, railways and energy capacity if left to their own devices. Too many private companies are short-termist because of bonus regimes, quarterly reporting cycles and performance metrics for CEOs that are based on share prices. Systems of corporate governance can be improved to encourage more long-termism but one of a government’s most important functions is to at least create a climate in which private companies will invest in infrastructure. Additionally, the British Chancellor of the Exchequer George Osborne is far-sighted in wanting to rebalance the British state so that it spends more on pure scientific research (which business struggles to support) and infrastructure.

7. Regulation of pollution and other externalities: We learnt from the communist era what happens to the environment when there are no property rights and when economic underperformance drives politicians to short-term and dirty growth measures. But free market capitalism also pollutes. Businesses need to be forced to pay for the costs of the environmental impacts of their activities. This is basic externality theory and regulation of pollution is a central function of public policy.

8. Equality in the democratic sphere: Capitalism – as wonderful as it is – cannot provide equal civil rights. Equality before the law. One person, one vote. Protection of minorities and fundamental human rights. A constitutional democracy needs to be constructed so that powerful economic interests cannot extend their power into the courts and legislatures. Senator Rand Paul’s campaigning against “crony capitalism” is one of the most important developments on the political centre right in recent years. Ross Douthat has written about this development, which has been dubbed ”libertarian populism”. Crony capitalism should not be seen as entirely a problem of the state – especially when it underwrites corporations that it sees as “too big to fail”. Cronyism is an inevitable desire of larger corporations, too. It needs to be curtailed by democratically-elected politicians and clean judicial systems.

9. Demerit goods: Some goods like cigarettes, drugs and pornography (at least harder forms) cause social harm. This does not mean they need to be banned but most societies will want them regulated, taxed or in other ways minimised.

10. Local, regional and national identity: This final point may sound a bit woolly but different nations will choose different priorities. Nigel Farage, leader of the United Kingdom Independence Party, once said that he would accept a small reduction in national wealth if immigration could be curtailed. Although he did not explain himself fully he was almost certainly suggesting that there were issues of culture and cohesion that, for him, were more important than materialist considerations. Free market capitalism and the immense wealth it produces isn’t the priority for everyone – and especially not for higher income groups and communities. Different societies will choose different mixes of wealth, cultural conservatism, local identity and environmental protection. And so they should.

During the last presidential election Barack Obama got into trouble – not least from Mitt Romney – for suggesting to wealth creators that “you didn’t build that” on your own. But even Governor Romney knew that President Obama was partly correct. Ten years earlier, when addressing and celebrating Olympians, he noted how we all owe any success we enjoy to others as well as to our own efforts:

“You Olympians, however, know you didn’t get here solely on your own power,” said Romney, who on Friday will attend the Opening Ceremonies of this year’s Summer Olympics. “For most of you, loving parents, sisters or brothers, encouraged your hopes, coaches guided, communities built venues in order to organize competitions. All Olympians stand on the shoulders of those who lifted them. We’ve already cheered the Olympians, let’s also cheer the parents, coaches, and communities. All right! [pumps fist].”

Capitalists must build a society where the chances of prosperity for all are maximised. They can’t do so without a strong, limited state and a strong, free society.

Tim Montgomerie is a columnist for the The Times and a Senior Fellow at Legatum Institute