"Capitalism in crisis"

The phrase is the title of an opinion piece in yesterday's Wall Street Journal by federal circuit judge Richard A. Posner. One comes across the expression frequently these days, and I think it is worth examining the meaning of it a little closer. Why is "capitalism in crisis?"

What is meant by the statement? The word capitalism describes a system of economic organization, in which capital is owned and controlled by private individuals and organizations in an environment of economic competition. We also refer to this system as 'private enterprise,' or 'free enterprise' or 'free market.' It is distinct from a communist economic system, where government both owns and controls the capital of a country, or a fascist system, where capital is owned by private individuals but is largely controlled by the state, or a socialist system, where a portion of the capital may be owned by the government and a sizable portion of the capital is controlled by the state. In any case, the term capitalism describes a particular economic system.

Is this system of economic organization in crisis? To the extent that much private capital in America today (GM, AIG, many large US banks, etc.) is controlled by the federal government, one can justifiably say that the system of capitalism in the US is in crisis.

Of course, what Judge Posner and everyone else mean when they say that capitalism is in crisis is, in fact, that the economy is in crisis. This is something quite different. The rhetorical confusion has a rather unfortunate consequence: instead of focusing on fixing the economy, the gut-level reaction is to change the system. This is extremely unfortunate, since capitalism is the only economic system that has a consistent long-term record of increasing people's standard of living.

Moore and Me

Today (4/1/2009) Michael Moore (the same one of "Roger and Me" and "Fahrenheit 9/11" fame) posted a letter on his website addressing the Obama's administration involvement with the US auto industry. The letter starts by suggesting that it is very inappropriate for the President of the United States to interfere directly in the business of a private corporation. It's April 1st, after all, and the punchline comes soon enough:

" 'What are we going to do about this Obama?' Not much, fellows. He has the massive will of the American people behind him -- and he has been granted permission by us to do what he sees fit."

President Obama may have the massive will of the American people behind him, except, apparently, the will of the workers at the GM Powertrain plant in Ypsilanti, MI. A relative, who drives an eighteen-wheeler, was in the plant yesterday to pick up a load. He said that the workers were so angry, frustrated, even distracted by the decision of the President (of the US, not of GM) that they loaded his truck with the wrong parts at first.

Furthermore, and Mr. Moore should know this since he has a picture of the US Constitution on his website, right above the title of his letter, the President of the United States has not been "granted permission by us to do what he sees fit." He was only elected by us to "... faithfully execute the Office of President of the United States, and ... to the best of [his] Ability, preserve, protect and defend the Constitution of the United States" (the Oath of office). Article II of the US Constitution spells out what the president can do, such as appointing ambassadors, cabinet members, even Supreme Court Justices, but nowhere does it say appointing CEOs or firing them.

Michael Moore's point later in the letter is that after all these years when GM presidents (starting with Roger Smith) laid off thousands of hard working auto workers, someone finally gave a pink slip to the president of General Motors:

"Not one of them ever thought that one day they would witness the CEO receive the same treatment. Of course Chairman Wagoner will not have to sign up for food stamps or be evicted from his home or tell his kids they'll be going to the community college, not the university. Instead, he will get a $23 million golden parachute. But the slip in his hands is still pink, just like the hundreds of thousands that others received -- except his was issued by us, via the Obama-man. Here's the door, buster. See ya. Don't wanna be ya."

Don't wanna be ya? Mr. Moore seems to miss his own point: the laid off GM workers struggled precisely because they lost their source of income. Most laid off workers would rather be Rick Wagoner with his $23 million golden parachute.

This doesn't seem to be the first time Michael Moore misses his own point. In Roger and Me (watch the movie - it's great!) he spends half the time outlining the struggles GM is facing as it attempts to adapt to global competition (which, if it had done successfully, would not have caused GM to be facing bankruptcy today) and the other half on the failures of the Flint city government to bring about economic development. It seems lost on him that while he is asking government to solve economic problems he is exposing precisely government's inability to solve economic problems.

But the points above are merely philosophical. As a practical matter, take a look at these Time magazine articles on two cars made by government-run factories: Trabant and Yugo. Though they weren't particularly environmentally friendly, they got excellent gas mileage, and with today's advanced catlytic converter technology and the right government mandates, we could make them as clean as Prius.

Lights out - now we need the light bulbs on

It was sad to see the beautiful Chrysler headquarters building outside Detroit seemingly deserted when I passed by it last Saturday evening. While office buildings normally leave many of their lights on 24/7, the only lights visible that night in the glass and steel Chrysler tower were the faint emergency exit lights. I figured it must be some cost saving measure (it is), but the momentary thought that the building might actually be vacant was jolting.

Chrysler is an American institution. Founded in 1925 by Walter P. Chrysler, the company introduced numerous innovations, many of which became industry standards. Walter Chrysler was a manufacturing and engineering genius who cut his teeth in the locomotive building business before switching to automobile manufacturing. The company is one of the "Big 3" American automobile manufacturers that survived competition and consolidation in the industry that saw literally hundreds of companies go out of business since the 1920s. None of this, of course, mandates that Chrysler must survive the current economic turmoil. On the other hand, the possible demise of this venerable American corporation is neither necessary, nor necessarily helpful.

It would be really sad, I think, if Chrysler ceases to exist. Not just for sentimental reasons, either. But the current artificial life support, the government loans with their strings attached, may not be the solution to bringing Chrysler from the brink of extinction. It seems to me that now is the time to open the floodgate for all kinds of creative ideas, as many as possible, from anywhere across America and around the world. I teach my students that modern corporations must be learning organizations in order to survive the global competitive environment. Now is the time for Chrysler to become a learning organization- to plug into as many people and other organizations as possible, to plug into any source of ideas that might flame the creative sparks, which might lead to new, innovative, creative solutions for its current predicament.

There are thousands of business and engineering school students who crave for an opportunity to put their minds to work on really challenging real-life cases, there are tens of thousands of workers (and former workers), with their ears (and noses, and eyes) close to the ground who have perspectives and experiences that the corporate executives lack, there are civic organizations and others, thousands, if not hundreds of thousands, who may be interested in solving a challenging problem like bringing Chrysler back from life support. Thomas Friedman would call this "open source innovation." It's possible, it's doable, it's a bit crazy, but it's the way the knowledge economy (fyi: that's today's economy) works. The real question is, can Chrysler plug into, and manage, such an open source innovation model, or will it just wait to hear for whom the bell tolls? Alas, the answer is out there: Its own blog rules state:

1-In the spirit of honest, free-flowing conversation...
...
11-The blog is not intended as a forum for outside suggestions, including but not limited to those which pertain to vehicle design, product attributes, marketing or advertising, and no such material will be posted.

Yes, I know, the Chrysler blog is just one out of many possible ways to plug into the open source innovation 'thing' in this flat world of ours, still... The company saves a few thousand dollars by turning the lights off at night, but what it really needs is to find a way to turn lots of light bulbs on if it should have any hope of survival. In the spirit of honest conversation, I'd like to help you out, Chrysler, really, but my entire lifetime tax dollars just went to the guy sitting over there, in the dark corner of the AIG executive cafeteria. Sorry, all I've left is advice.

This all began back in the Renaissance

A couple of months ago I was flying to Switzerland to co-teach a class on innovation to students from five continents. Coming from the United States, I would inevitably be asked about my take on the financial crisis. Formulating my analysis, I noticed the irony that while I would be commenting on the proposed government bailouts and economic stimulus packages, I would be doing so a few miles downhill from Hotel du Parc , Mt. Pelerin, site of the first gathering of the Mont Pelerin Society sixty years earlier. This group, mostly economists, had argued that government intervention in the economy leads to government monopoly, and worse. (related post)

Above the Atlantic, I was also catching up on my WSJ reading, perusing KLM’s in-flight magazine, HollandHerald, during my breaks from the Journal. I found two interesting articles.

The first one, When It Comes to Cash , A Thai Village Says ‘Baht, Humbug!’ in the WSJ (Jan 7, 2009), told the story of a village in Thailand, which decided to print its own money after the 1998 Asian financial crisis. Unable to rely on the value of the government-issued baht, the villagers started printing their own local currency, and have been using it successfully for a decade, side-by-side and in competition with the baht. The result has been local economic growth and development largely unaffected by the vicissitudes of the broader Thai economy that relies exclusively on the monopoly currency.

Therefore, if competition is better than monopoly (anti-trust legislation is almost universal) and government monopoly is worse (especially so, according to the Mont Pelerin Society), why do we have a government monopoly on money, and could that monopoly have contributed to the current financial crisis?

The second article, Douglas Rushkoff’s Futurenomics in the HollandHerald (Jan 2009), gave perhaps the easiest to understand answer to these questions. I strongly believe in the need for clear communication, thus, impressed by the clear explanation, I quote a few of the most relevant passages below, throwing in one example from US history for a good measure:

“This all began back in the Renaissance, when a waning monarchy was looking for ways to preserve its power in the face of a rising merchant class. The merchants were becoming richer than the royals. So the monarchs came up with an idea: chartered monopolies. By granting one of these new companies exclusive province over a particular industry or region, monarchs earned their undying loyalty—as well as a generous portion of shares in the enterprise. They began to write laws that favoured their chartered companies,…

Such a law was the Tea Act of 1773, which granted the East India Company, originally chartered by Elizabeth I in 1600, exclusive right to import duty-free tea into the American colonies. This mandated cost advantage gave it a virtual monopoly. Bostonians, in protest of such special privilege, boarded the company’s ships in the harbor and dumped the tea overboard. Interestingly, it may have been Benjamin Franklin who proposed that the British Government relieve the East India Company of paying duties on its tea as a way to prop up its finances. Nowadays we call that bailout.

“…such as preventing inhabitants of colonies from creating any value for themselves; they had to ship raw resources back to the mother country, where they were processed into clothes or other finished goods. This model of business-by-extraction carried over to finance as well. European towns had used local currencies for centuries. Farmers would bring their wheat to a grain store, who would in turn give them receipts for the amount of grain kept for them. These receipts served as local currency. The system was so efficient, and people were living so well, that people of this era were taller than at any time until the last few decades. By making local currency illegal, a monarch could force people to use his own more expensive ‘coin of the realm’ instead. So, rather than being earned into existence, this money was borrowed into existence.

“Over the next 400 years, the business of money slowly grew bigger than business itself. A central bank creates money and charges interest to the next bank down the line, and so on, until it gets to the business that needs to do something useful. The problem is, more value is being extracted on each level than business can produce. There are simply too many institutions—too many lenders—to be paid.

How the free market conserves limited resources

A display in a museum in Ft. Worth, Texas. This is one way, in which the free market served both the needs of the less well off and simultaneously conserved a precious natural resource, in this case--water in the Southwest.

(Photo courtesy of Ioana-Claudia Iordache, Bucharest, Romania)

Free market - use, misuse, and an explanation

In a recent editorial (Shut Up, They Said Feb 13, 2009) The Wall Street Journal claimed that Congress should not restrict companies, which receive bailout money, from using this money for lobbying Congress. A reason it gave was that it is unfair to prevent corporations from lobbying when unions, which receive bailout dollars indirectly through workers’ wages and dues, aren’t restricted from lobbying Congress. Supporting the idea that companies could use federal handouts to lobby congress for more federal handouts is decidedly not a free market principle.

‘Free market’ is an oft misunderstood notion. As I wrote in an earlier post, all markets are free. The issue here is that in much of the public’s mind ‘free market’ is essentially a fascist idea, a state of affairs in which the government supports big private businesses at the expense (it is always at someone's expense) of everyone else. The public is basically right: such was the state of economic affairs under fascism. It is wrong, however, to associate it with the ideas of individual liberty and free market capitalism as advocated by Adam Smith, Friedrich von Hayek, and Milton Friedman. The WSJ, a supposedly free-market leaning paper, contributes to the confusion by defending privileges for big corporations at the expense of taxpayers.

Free markets mean that businesses compete for consumers’ attention and dollars, and the government does not support one business or another, nor interferes in the economic activities of citizens and businesses, except to enforce the don’t lie, don’t cheat, and don’t steal laws. (Where was the government when Madoff was lying to his investors and stealing $50 billion of their savings?)

Laissez faire, that economic concept of leaving people alone refers precisely to letting companies compete for customers’ business and not having government support one corporation or another. It does not mean letting the hungry starve or letting the homeless freeze to death in winter. Free markets mean legal competition without government support for anyone. The WSJ-types who support government bailout for corporations and the use of bailout dollars for lobbying are no different than the populists and socialists who want massive government transfers from “the rich” to “the poor and the middle classes.” Both oppose free markets and competition, they just choose different beneficiaries. Here is how Friedrich von Hayek described these people and the situation in his classic 1945 book The Road to Serfdom:

What in effect unites the socialists of the Left and the Right is this common hostility to competition and their common desire to replace it by a directed economy...

Yet… the universal struggle against competition promises to produce in the first instance something in many respects even worse, a state of affairs which can satisfy neither planners nor liberals [of the classical type]: a sort of syndicalist or “corporative” organization of industry, in which competition is more or less suppressed but planning is left in the hands of the independent monopolies of the separate industries. This is the inevitable first result of a situation, in which people are united in their hostility to competition but agree on little else. By destroying competition in industry after industry, this policy puts the consumer at the mercy of the capitalist and the worker of the best organized industries. Yet…it is not a state which is likely to persist or can be rationally justified. Such independent planning by industrial monopolies would, in fact, produce effects opposite to those at which the argument for planning aims. Once this stage is reached, the only alternative to a return to competition is the control of the monopolies by the state—a control which, if it is to be made effective, it must become progressively more complete and more detailed.

A case in point: on Feb 16, 2009 WSJ reported "Bankers Face Strict New Pay Cap." In addition, the recently passed economic stimulus bill contains restrictions on hiring H1-B (professional foreign) workers by any company receiving TARP funds. Add these to the Congressional restriction on the use of bailout money mentioned earlier. These policies seem reasonable in light of the current circumstances, but they also validate Hayek's assertion that in order for government's efforts to be effective, government's control must become progressively more complete and more detailed.

The real problem of government control isn't government control per se. Nor is it, necessarily, that it will lead to total enslavement (serfdom) of the citizens by the government (although, historically, that's what happened in Soviet Russia and Nazi Germany). The more immediate problem with government control of industry is that, political ideology notwithstanding, it leads to inefficiency, fewer products, higher prices, corrupt practices, and lower standards of living. It sustains a minuscule class of super rich government-backed oligarchs and a fairly equal, in its misery, class comprising almost all of the population. Exhibit 1: most of Latin America. Exhibit 2: Eastern Europe before 1989.

Described accurately, supporting free markets is not supporting a policy to aid any one business. It is supporting a policy of competition among businesses. Such competition leads to innovation, more efficient use of resources, lower costs and greater availability for consumers, and a higher standard of living. Without competition a democratic nation will slide toward an oppressive and inefficient system, going through a corporative stage first, as Hayek very coherently explained. But perhaps such an idea of free markets and competition sounds a bit far-fetched and utopian?

Interestingly, there is one area of American life where this almost utopian laissez faire idea is both the law and the practice. Read the First Amendment of the US Constitution: “Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof;” The resulting free market for religion, where the government neither regulates nor supports one faith or another, provides Americans with the largest possible choice of religious options in the world. There are no restrictions on the number of foreign religious workers as in the case of other foreign workers, and there is practically no unemployment among them. Every church, mosque, synagogue, or temple of any kind exists, competes with all others, and flourishes despite its inability to collect taxes or to force anyone to support it involuntarily, and despite the fact that for over 200 years, through wars and depressions, no religious institution in America has received a government bailout. Consequently, America today is the most religious country in the Western world, so much so that at the dawn of the 21st century only in America does religious doctrine vie to displace science as the explanation of the physical world taught in the classroom.

Imagine if we had a 28th amendment to the Constitution that read, “Congress shall make no law respecting an establishment of commerce, or prohibiting the free exercise thereof.." and if we enforced it as religiously as we do the First... Ah, but then we'd be quixotic dreamers...

Che vive! (Che lives!) - but why?

The first condition of immortality is death.
Stanislaw J. Lec, "Unkempt Thoughts"

I recently saw the 4-hour Steven Soderberg saga Che: A Revolutionary Life. I grew up in a communist country, so Che was a hero to me when I was a teenager. I've read his biographies, one of them while doing research at Senator Margaret Chase Smith Library in Skowhegen, Maine. I've bought t-shirts with his image from street vendors in Paris. I have a poster of him in my office, right above the shelf with books by Adam Smith, Friedrich Hayek, and Milton Friedman. My relationship with Che seems to be a paradox.

And so is the fact that Ernesto "Che" Guevara, the Argentine doctor-turned-hero of the Cuban revolution is one of the most successful brands (read commercial, capitalist success) today even though he led a revolution against capitalism. As the French economist and philosopher Guy Sorman wrote recently "No teenager in rebellion against the world or his parents seems able to resist Che's alluring image. Just wearing a Che T-shirt is the shortest and cheapest way to appear to be on the right side of history."

So if Che is associated with a now-discredited political and social order, why does he continue to live in the hearts and minds of so many around the world? All the arguments against him, from the coherent (see Alvaro Vargas Llosa's excellent essay The Killing Machine: Che Guevara, From Communist Firebrand to Capitalist Brand, ) to the hateful (read Sorman's article here) do nothing to diminish the power of his symbol.

It seems to me that the detractors are barking up the wrong tree. They are historically correct: Che supported an oppressive regime, he executed people without due process, his contribution to Fidel Castro's military victory in Cuba was probably immaterial, his record as a minister of industry after the revolution was dismal; his other military endeavors, in Africa and Bolivia, were utter failures. Che did not even stay to build communism in Cuba. But Che's popularity is not related to these failures. He is not a symbol of of great military leadership, nor of just legal process, nor of economic development. He is not even a symbol of successful revolutions.

***

Che was a free spirit. He rode a motorcycle thousands of miles across Latin America, living the adventure of a lifetime that many only dream of. Budd Fox, the ambitious stock trader from the movie Wallstreet, wanted to ride his motorcycle across China. Ewan McGregor, the real-life movie actor did ride his motorcycle around the world.

Che did have a compelling B.H.A.G. (Big Hairy Audacious Goal--you Harvard MBA-types should recognize this term. For the rest, it simply means vision.) He wanted a world where most people would have a better life. He went about it the wrong way (like McKinsey consultants, he was an idea man, not much of an implementer) but his vision was one that most civilized and honest human beings share. Every politician, from the left or from the right, believes that her policies will make life better for her constituents. Every economist, whether a central planner or a free marketer believes that his theories would lead to better lives for the people. Every parent wants a better life for the children.

Che was selflessly dedicated to his vision. He suffered with his asthma during the years in the mountains of Cuba, and later in the jungles of Congo and Bolivia. He gave up his family and the cushy life as a Cuban minister of industry to lead small, disorganized bands in some of the roughest places in the world in pursuit of his vision. He did it despite the overwhelming odds against him. Ultimately, he paid with his life. Under most circumstances we call this idealism and heroism.

It was also just a coincidence that on March 5, 1960 the young, handsome, and brooding Che was captured by Alberto Korda's lens in that memorable photograph. That image has become the logo of the Che brand. Its artistic essence and impact are far better described by Trisha Ziff here. Without it "Che" would not mean the same thing. Could you imagine Nike without the swoosh and "Just Do It"? It would be just another Chinese sneaker. And Coca Cola without its cursive script and contour bottle is just another sugary drink. Coincidences, shared dreams, and misfortunes created the Che brand.

Sure, different people interpret Che differently. But for most the logo, this image, the brand have little to do with the particular political leaning of the historical person Ernesto Guevara. They have to do with the quixotic idealism and faith that, against any odds, a better life is worth fighting for. The Argentine doctor Ernesto Guevara, called Che by his friends, with all of his shortcomings, failings, and sins has long since been killed. Che--the symbol--the 20-th century Don Quixote, has taken on a distinct life of its own. And if Cervantes's character is any guide, Che will live on.