13 November 2014

Capitalists would be crazy to ignore inequality


Tim Morgan explains why supporters of capitalism should welcome the debate over inequality – and must never allow it to appear synonymous with unfairness.

Ever since the publication of Capital in the 21st Century, prominent supporters of capitalism have rivalled each other in their denunciations of Thomas Piketty’s egalitarian thesis. In so doing, they have fallen head-long into a trap that will delight the enemies of the market economy, who surely desire nothing more than a self-acceptance that capitalism is synonymous with inequality.

The assertion, or even the acceptance, that inequality is an intrinsic characteristic of the market economy is as dangerous as it is mistaken. Those of us who favour popular capitalism need to engage with the egalitarian argument, demonstrating that neither history nor logic supports a connection between capitalism and inequality. Rather, capitalism is the most tried-and-tested beneficiary of the majority. Inequality results not from too much capitalism, but from too little.

Inequality in human societies long pre-dates the market economy. Virtually all pre-feudal systems were grotesquely unequal, and many endorsed slavery. Feudalism enshrined inequality in custom and law. In more recent times, Communist regimes in Russia and China have presided over extremes of inequality.

Inequality runs like a sine-wave through human history. Today’s defenders of inequality should note that, whenever a system becomes too closely associated with inequity, its downfall becomes inevitable.

Popular revolt against inequality cares little for theories. There may or may not have been solid intellectual foundations for the divine right of kings, and Marie Antoinette may even have meant well when she urged the poor to “eat brioche”, but 1789 happened just the same. Extremes of inequality and unfairness brought revolution to Russia, China and Cuba in ways which owed little or nothing to philosophy. To ally capitalism with inequality is to court its overthrow.

By contrast, free market systems have an unrivalled record for the betterment of the majority. Indeed, capitalism created the middle class in Europe, America and beyond, and is doing the same today in a gamut of emerging economies. That inequalities have widened in recent years is undeniable, but this reflects, not the triumph of capitalism, but its subversion.

The very basis of capitalism is competition. Any system in which competition is stifled or evaded is a deviation from it. Though Adam Smith is customarily regarded as the intellectual founder of market economics, his Wealth of Nations is actually a treatise on the evil of uncompetitive practices. Smith is at his most vituperative when he confronts monopoly, oligopoly and cartels.

Smith realised that competition is the well-spring both of progress and of the betterment of all. Its genius lies in harnessing individual ambition for the common good. Entrepreneurs who wish to enrich themselves strive to develop better products, and to invent more efficient methods of production, to the ultimate benefit of society as a whole. A company wishing to expand its market share must offer better products and better value than its competitors, a process from which customers benefit. A business wishing to attract the most productive and most innovative employees must offer better terms of employment than its rivals, and workers benefit from this competition for their services. An enterprise seeking to expand must offer investors superior profits, a process which drives returns on all savings upwards.

In short, competition should benefit everyone, as should a market economy founded on competitive principles.

Problems arise when competition is stifled. Left to itself, any business will try to weaken or absorb its opponents in ways which reduce competition and thus increase profitability. One of the roles of government is to save capitalism from itself, by maintaining a competitive environment. Most obviously, the authorities must counter excessive concentration, as America famously did with Anti-Trust legislation. But the authorities must also promote the free flow of information, and act vigilantly to stop malpractice.

Free market economics is not anarchy, and works best in harness with a state which protects the market system from its own excesses. For reasons of practicality as well as theory, believers in capitalism need to accept the importance of a vigilant state.

Excessive concentration has been accepted. States weaken competition when they hand out huge amounts of “corporate welfare” to large companies to the detriment of smaller competitors, and they compound this when “in work” benefits subsidise low-wage employers.

When banks (and, unnecessarily, bankers too) are rescued from the consequences of their own follies, the free market is subverted. When actions which, at a smaller level, would be punished as fraud, are instead labelled more innocuously as “miss-selling”, the principles of ethical markets are betrayed. When shareholders, rather than the individuals responsible, are punished for corporate malfeasance, the authorities are conniving at the subversion of free and fair markets.

The miss-statement of the relationship between capitalism and unfairness is encapsulated when governments accept, and indeed subsidise, a low-wage economy. If a low-wage strategy brought prosperity, Ghana would be richer than Germany, and Somalia wealthier than Switzerland. As Henry Ford well knew, low wages correspond to diminished purchasing power, and only well-paid employees could afford to buy his cars. So, whilst an individual business might benefit from driving real wages downwards, all businesses, and the economy as a whole, suffer when low wages, becoming the norm, undermine consumer demand.

Essentially, the modern developed economy is driven by consumers, and their ability to consume can be derived only from one of two sources. In a high-wage, high-productivity economy, consumption is driven by incomes. In a low-wage economy, however, there is an inevitable recourse to debt to support consumption. That is why countries with an avowedly low-wage strategy almost invariably find themselves falling ever more deeply into debt. A low-skilled, low-wage economy uses private debt to finance consumption, and public borrowing to compensate for low levels of tax.

A healthy economic policy, therefore, needs to be founded on a vigilant attitude both to competition and to malpractice. It should promote a highly-skilled, well-remunerated workforce capable both of consuming and of paying taxes.

In the promotion of competition, innovation, skills, productivity and strong consumer incomes, there is no room for the endorsement of more inequality than is acceptable, and that arises naturally from individuals’ differing abilities and efforts.

Far from being the source of inequality, real capitalism has been, and remains, its greatest solvent.

Tim Morgan was global head of research at Tullett Prebon plc from 2009 to 2013, and is author of Life After Growth (Harriman House, 2013), and numerous influential papers published by the Centre for Policy Studies including A Shower, not a Hurricane: the Modest Nature of the Proposed Cuts (2010), Five Fiscal Fallacies (2011), The Quest for Ideology: how to fill the centre-right ideology gap (2012), Oil, Finance and Pension: why Scots should say No and Countering The “Cost Of Living Crisis” (both 2014).