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Economics February 15, 2018

Is capitalism obsolete?

By ESMT Video Series and Giacomo Corneo
Transcript of the Open Lecture presentation made by Giacomo Corneo at ESMT Berlin on January 23, 2018.

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Giacomo Corneo


After communism collapsed in the former Soviet Union, capitalism seemed to many observers like the only game in town, and questioning it became taboo for academic economists. But the financial crisis, chronic unemployment, and the inexorable rise of inequality have resurrected the question of whether there is a feasible and desirable alternative to capitalism. Against this backdrop of growing disenchantment, economist and author Giacomo Corneo presents a refreshingly anti-dogmatic review of economic systems, taking as his launching point a fictional argument between a daughter indignant about economic injustice and her father, a professor of economics.


So is capitalism obsolete?

Well, at least in Germany, many people think it is. Polls regularly find that more than half of the respondents claim that capitalism is not the best possible economic system for our times. So why is capitalism so unpopular, even in a country like Germany that is fairly prosperous and egalitarian?

Well, because capitalism is inefficient, unjust, and alienating.

Inefficient: capitalism wastes our scarce resources. Suffice to think about mass unemployment, idle machinery, empty flats, and the abuse of the natural environment.

Unjust: capitalism distributes neither according to merit nor according to needs. In order to realize it, just compare the economic welfare of an average person in Africa with the one of an average person in Europe.  Even within Germany, the inequality in income distribution is hardly justifiable. Why should a household of the top percentile dispose of as much income on average as eight average households?

Alienating: work is an essential part of life for most people, but many people are unhappy at work. They feel exploited by their bosses; they develop burn-out syndromes; others develop the opposite pathology, workaholism, which also seriously impairs their social and family lives. So I think there are several compelling reasons why we should be longing, as the majority of respondents in polls, for a truly humane, just, and efficient economic system.

But during the last couple of decades, the search for economic alternatives to capitalism has been banned from public discourse. In the mainstream, alternatives to capitalism are thought to be a non-topic, because serious citizens should not deal with something that once was tried. That is to say, it was tried to create a paradise on earth, this turned earth into hell; and, using this argument, the search for systemic alternatives is relegated to something for outsiders or gurus or science fiction authors.

So I think that this taboo is an intellectual shame and politically deleterious.

It is an intellectual shame because if capitalism is indeed the best economic system for our times then these claims should be logically proven. If we cannot manage to do this, then we are likely to learn something useful from looking at systemic alternatives. This is why this taboo is also politically counterproductive. It artificially shrinks the range of actually available policy options. But the current state of affairs in capitalism in these perspectives are by far not so rosy that we can afford such an intellectual self-castration. So I think it is high time to look in a rational way, without ideological blindness, to systemic alternatives. So let me explain to you briefly how I tried to attack this issue in this book.

The book begins with dialogue, with an email exchange between a father and his left-wing daughter. Daughter actually criticizes capitalism and pledges for its demise. The father answers that her conclusion seems to be premature because she has not dealt with the outside options. It could be that the very imperfect system like capitalism does not allow for any superior viable alternatives. Luckily enough, humanity in the course of its history has produced a number of interesting alternative blueprints; and the father would like to tell the daughter about those blueprints. And then there are ten internal chapters in which as many different alternative economic systems are presented and played through in those experiments. At the end of the book, the daughter and the father meet and within a dialogue they sketch a possible pathway towards the truly improved economic system.

In those ten internal chapters, my aim is to assess whether there is an alternative economic system that can generate at least as much economic welfare as the social market economy. So, how can you assess whether a hypothetical, very complex thing like an economic system, can be economically viable in this sense?

Well, first of all, I have to be clear about concepts.

What is an economic system? An economic system is a collection of views that determine the production and consumption behavior of members of society, thereby allowing for its material reproduction. Capitalism is the economic system in which the private ownership in the means of production and the market are the key economic institutions. The social market economy, in turn, is a variant of capitalism in which the government interferes with market processes, especially in order to reduce the uncertainty and inequality of personal incomes.

So how can we assess the viability of alternative economic systems? Economic systems must, as a rule, solve two fundamental problems. First of all, they have to motivate people to accomplish the economic tasks that are assigned to them. I call this the cooperation problem of economic systems. Secondly, it must generate tasks that are economically meaningful, leading to a sufficiently efficient allocation of resources – and this I call the allocation problem of economic systems. I define an alternative to capitalism as promising if, and only if, it can solve those two problems, at least as satisfactorily as the social market economy.

That is to say, for every alternative I check, first of all, whether it can motivate people to actively participate according to their skills, to the production process in society and if they are prepared to restrict their consumption so as to make it consistent with overall economic possibilities. And, secondly, I check whether the system generates tasks that lead to the minimization of economic waste so that as many needs as possible can be satisfied. This produces a double test to which all alternatives are subject. While performing this double test I always assume that every alternative, at least in its beginnings, must work with humans as they are now. That is to say, people who are not completely selfish but also no angels. And it’s also not a blank slate on which you can write whatever motivation structure you wish.

So what are the key insights from these thought experiments? Well, first of all, I consider a few fascinating economic systems that are based not like capitalism on individual pursuit of material self-interest but on people’s ability to experience empathy and solidarity. That is to say, those systems are based on a gift exchange logic. What are those systems?

Well, first of all, the system of common ownership that was described by Thomas Moore 500 years ago, and anarchist communism, described by Pyotr Kropotkin more than 100 years ago. So in these systems, people donate their work to the community and receive goods that were produced thanks to the work of others. People, together, decide how much they should produce, and consume. Correspondingly, they announce democratically established work and consumption norms; and everybody voluntarily abides by those norms. So for instance, if they enter those warehouses in which all goods can be found that have been produced by society, they take away only the goods that are assigned to them according to their corresponding consumption norms.

So the prevailing opinion about those economic systems based on a gift exchange logic is that they are truly utopian. That is to say, the prevailing opinion is that people would shirk, would not work as they are supposed to do, and if they enter the warehouses, they would take away all goods that they want without caring about those who are going to enter the warehouse after them. In the terminology that I just introduced, the prevailing of opinion is that such systems fail to pass the cooperation test.

I arrive at a more optimistic conclusion – namely, that even with humans as they are now, we could solve the corporation problems in these systems. However, three conditions must be fulfilled. First of all, people should live their entire life in relatively small communities, where everybody knows everybody else, which creates social control and social pressure to comply with the norms. Secondly, the polity should make use of information technologies in order to closely monitor the economic activities of everybody, in order to detect norm violation very soon, and to punish it, so as to avoid that norm violation spreads in society like an epidemic. And, finally, education and cultural policies should be geared from the early stage on to promote moralism and identification with the community, so that people who violate the norms feel guilty when doing this.

So those three conditions entail far-reaching restrictions to personal freedom, as we are accustomed to, so that I don’t think many people in this room would be ready to accept those conditions in exchange for their hoped-for advantages from the system of common ownership. However, independently of your normative judgment, those systems fail to pass the second part of the test  –, the allocation test – because the proponents of those systems did not propose any explicit coordination device in order to make very different economic activities consistent with each other. They just propose tradition or spontaneous agreements in order to allocate resources, which would be maybe enough for the economic structures that we had before the industrial revolution but that, in our case, would lead to a drastic reduction in the division of labor, hence lack of civilization, hence lack of technological progress.  It would be a disaster.

The system that is a centrally planned economy can be thought of as the attempt to reply to the failure of common ownership to pass the allocation test, because the idea of central planning entails such a coordination device, namely the central plan. In the division of the socialists of the nineteenth century, the central plan was the instrument thanks to which humanity should have become a master of its social destiny. Now, the twentieth century has not been very kind to this vision, otherwise we would not be in this building, but this doesn’t mean that central planning could not be a promising alternative for the twenty-first century because a very different central planning could be imagined, if compared to the one that existed in real socialism.

First of all, one could imagine central planning embedded in a democratic political process, in which competing parties propose different plans, and the electorate democratically determines which party, which plan, will come to power. Secondly, one can imagine a pure planned economy, which really does not make use of money in markets that existed in real socialism. And, finally, a central planning that makes use of more sophisticated systems of planning like those that were proposed by mathematical economists and Nobel Prize winners Arrow and Hurwicz many years ago.

Now, even in the case of a central planned economy modernized in this way, in the book at the end I come to a negative conclusion. Again the Achilles heel of the system is the allocation problem. In times of product differentiation where we have millions of different products with many variants, in times of unlimited technological innovation, the introduction of central planning – because of its institutional burden – would cause substantial efficiency losses that, over time, would accumulate so as to make the situation unbearable. So that even central planning modernized like this is not a promising alternative.

And then at this point, I come to an important conclusion in the middle of the book, which is that, for complex economic structures like the ones in which we live, markets are necessary in order to arrive at fairly reasonably efficient allocation of resources. Markets have to be cleverly regulated, but without markets I think that we cannot arrive at an efficient social allocation that is the only way in order to reach the level of economic welfare that we are accustomed to.

And that’s the reason why, in the second part of the book, I focus on so-called hybrid economic systems. Remember, I defined capitalism as the combination of private ownership in the means of production and the market so that, if the market is necessary, we have to look at alternative economic systems that keep the market, but combine it with a non-capitalistic elements.

What are those systems? First of all, the system of self-management. Here in the market we have on the supply side many independent production units; those production units are not capitalistic firms, but are under the control of the people who work in those firms. That is to say, workers have the power to decide about their working conditions and they receive the entire surplus that is generated by their work.

Market socialism: here, again, we have a market economy without capitalists but the independent firms are run by managers who are accountable towards the polity. And by the same token, the profits of the firms are accrued to the general public budget.

The system of basic income: here we retain the two key institutions of capitalism but they are complemented by a third one, namely a universal right to a sufficient income in order to fully integrate in society, so that nobody’s forced to sell their labor power in order to finance a living, which, of course, radically changes the nature of the wage relation.

The system of stakeholder society: here people do not receive a regular income from the state, but once in life, when they enter adulthood, they receive a starting capital which is of course much higher than the basic income and which creates a kind of equality of opportunity along this dimension and, in this way, eliminates the kind of dynastic privilege that is common under capitalism.

And, finally, shareholder socialism to which I will say more in a few minutes.

So to make a long story short, all those hybrid economic systems, with one exception, failed to pass the cooperation and allocation tests. The only system that passes this double test is shareholder socialism.

So what is this alternative to capitalism?

Well in shareholder socialism, all large firms are publicly quoted firms who are wholly or in majority ownership of the polity. Novel institutions dilute the economic power of the government and allow the trade of ownership titles on a socialized stock market. The stock market is really key in these alternative economic systems. On the one hand, it allows for the design of a meaningful incentive contract for the managers of those large public firms; on the other hand, it contributes to an efficient allocation of capital in the overall economy.

The advantage of shareholder socialism with respect to our social market economy is that, under shareholder socialism, there exists no moneyed elite that can control the large corporations and, in this way, exert a disproportionate influence on the political process. And by the same token, the profits of those corporations do not accrue to a rich minority but to the overall population. The disadvantage of this system is that it requires a set of complex novel institutions, and we cannot be as confident that they will really work as proponents hope.

So, in order to conclude what is the policy message, after this journey through various alternative economic systems. Well, I think that I cannot point to any alternative economic system that is clearly superior to the current one that we have, say, in Germany or Western Europe. I think that a pluralistic market economy with a strong welfare state is the best possible economic system that is within our reach. However during the last couple of decades, we are not moving toward that system, but rather we find ourselves on a slippery slope towards a polarized form of capitalism. And that is why I propose, at the end of the book, a double strategy that consists of upgrading the welfare state and enhancing the role of public capital in our economic system.

Very briefly the first strategy behind it is the idea that the combination of capitalism and welfare stare need not be a stable one. In order to stabilize that combination, I propose three basic policy perspectives: first of all, a deepening of democracy, entailing the gradual introduction of more direct democracy; secondly, a much stronger attention to the quality of public services (quality not quantity), especially is the realm of healthcare and education; and thirdly, renewed attempts to coordinate tax policy on the international framework.

So behind the second strategy – which is I think also quite interesting and open to discussion and then I will close – is the idea that the institutions that gave capitalism a human face after the Second World War, which are trade unions shaping the wedge formation process, and a tax transfer system redistributing incomes so as to make the distribution of secondary incomes more egalitarian – those two institutions have reached their limit. And in the foreseeable future they will not be strong enough to stop the increasing trend of polarization, especially due to the robot revolution, to the introduction of artificial intelligence in the production processes, and due to the extent of globalization.

So because of the limited scope of those two key institutions in order to contain inequality, I argue that in our times some redistribution should occur at the level of primary incomes from capital, and this is possible as soon as a sufficiently large fraction of the capital stock is publicly owned, because then the corresponding returns can be distributed uniformly to the population, for instance.

So the basic question is how can we manage public capital in a way which is both democratically legitimate and efficient? And here I come to the notions that have been developed by those who have dealt with the system of shareholder socialism; and based on those notions, I propose a two-step approach, creating two institutions in a chronological order that could comply with the task – that is, create an efficient and democratic way to manage public capital.

The first institution would be a distinguished sovereign wealth fund that would invest in the worldwide stock market and whose net returns would be earmarked to finance a social dividend, a transfer payment universally received by everybody. And this institution would have the meaning that everybody could participate in the higher rates of return that are generated by the world stock market, which is very different from the current situation. So that acting as a collective frontier such an institution would reduce, in the future, the inequality of incomes in the population, even if, because of the robot revolution, the labor share will continue to decrease. So this first institution, public capital, plays a passive role.

The second institution I propose would activate public ownership in some selected domestic firms, with the aim to challenge capitalistic control. The idea is that private ownership is clearly superior to public ownership with respect to small and medium-sized firms. But for large corporations, there is a chance that an open demised government structure in the public sector could beat capitalists on their own terrain in terms of rates of return. And challenging the power of the moneyed elite in the control of corporations would mean that this would drastically reduce the risk that we see in the USA, how far it goes, that democracy turns into plutocracy.

So I think that such an institution, which I call the federal shareholder, would then disputably devise in order to arrive at substituting a capitalistic control of large corporations with democratic contro. And the dividends of those firms would be earmarked along with the net returns from the first institutions to finance the social dividends, so as to reduce inequality.

So very briefly to my conclusion. This whole journey through alternative economic systems and reasonings about the possible instability of capitalism and welfare state leads me to the following key conclusions.

The first one is that markets and entrepreneurs are necessary for economic welfare but not sufficient. They’re not sufficient, and what we need is, on the one hand, a modernization of the social market economy. Such a modernization would mainly refer to the rejuvenation of democracy and increase attention paid to the quality of public services and to a more efficient international coordination of tax policy. But then what we also need – because the tax transfer system cannot do a lot in a globalized world, and because the robot revolution is likely to reduce the labor share – what we need is an enhanced role of public ownership of capital within a market economy. And for this we have to start the process of institution creation, and I think that institutions like the sovereign wealth fund and the federal shareholder I described, would be suitable for this aim. And, once we do this, I think we would have a program that substantially reduces economic inequality, increases participation, and promotes a more pluralistic market economy – one more attuned to the democratic values of a truly open society.

Thank you very much for your attention. 

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