Capitalism Isn’t Working As Capitalists Are Now More Risk-Averse Than Ever

It doesn’t take an IQ of 160-plus to tell us that capitalism isn’t working; or at least it is not working for everyone in every country. If it was, socialists like Bernie Sanders or Jeremy Corbyn or even partial protectionists like Donald Trump would not have been thrown up as political alternatives in their respective countries. Nor would we have had deviant strains like Chinese mercantilist-authoritarian capitalism, Russia’s oligarchic capitalism or even the Japanese and Korean varieties of conglomerate capitalism.

But there is little doubt that capitalism is still the best way to grow wealth through entrepreneurship. Its faults are akin to democracy’s. Using Churchill’s evocative quote, that “democracy is the worst form of government except for all those other forms that have been tried from time to time…”, we need to apply the same logic to capitalism. It is the worst possible way to organise an economy, except for all those other forms that have been tried and tested and proven to be failures.

Capitalism works – where it does indeed work – because it is based on information: matching supply to demand based on the most important information of them all: price. It does not work where this information is not available or difficult to compute: for example, the future costs of environmental degradation. communism, socialism and every form of state capitalism failed because they were not based on information. They were based on command estimates of what is needed to be produced in an economy.

But there are two factors which prevent capitalism from working, and both relate to human identity issues. It is often said that capital has no nationality; it flows to countries and sectors where the potential for profit is best. But this is an oversimplification: capital itself may not have a nationality, but capitalists do. An Apple may sell iPhones all over the world, but the profits are reported in the country of the company’s incorporation, which is often the place where its owners (promoters or shareholders) reside. If deployed capital ultimately has to report a profit in one country, based either on where a company is incorporated or where its owners reside, shifting exchange rates act as a deterrent to capital flows.

The second issue relates to labour, which is needed by capitalists to generate wealth. Just as capital needs to move across borders, so does labour. It is only when both factors of production are free to move to the areas where they can be used in an optimal combination that we can generate the maximum amount of wealth. This, in turn, will give us a genuinely efficient form of capitalism. But in the case of labour, there are even greater barriers to cross-border movement, thanks to identity issues, including xenophobia.

A third issue with capitalism is fundamental: it may be the best way to create wealth, but society benefits only if this wealth is redistributed in ways where most people can benefit. Or else the social support needed to justify profit-making wanes. Taxation is one way this gets partially achieved. Charity is another. Gandhi wanted capitalists to treat themselves as trustees of the wealth they own, and in recent times, the world’s billionaires – led by Warren Buffett and Bill Gates – have been exhorting the wealthy to give away more of their wealth to benefit society. The Giving Pledge has now been taken up by 187 billionaires, who have promised to gift more than half their wealth to philanthropic causes.

This is a very good thing to do, but some counter-questions are worth raising: One, are capitalists as good at creating social value from philanthropy as they are at generating wealth from entrepreneurship? Two, is charity better than investment that offers productive jobs to people? Three, if capitalists are best at creating wealth rather than giving it away, should they focus on their strengths or their weaknesses? And four, is wealth some kind of stock that can just be given away, or is it something more dynamic, always expanding or contracting?

If Bill Gates gives away, say, 90 per cent of his shares to a charitable trust, the value of this sum will never stay constant. It depends on Microsoft continuing to generate profits and wealth; if tomorrow Microsoft fails, the wealth disappears equally fast, though a lot of the wealth may be invested in government treasury stocks and other safe investments. A recent profit warning by Apple, which makes 60 per cent of its money from just one product (the iPhone), damaged its valuations substantially. From over a trillion dollars four months ago, its valuations were down to $737 billion (17 January). Wealth equivalent to Pakistan’s annual gross domestic product just vanished in weeks.

Without in any way rubbishing charity, the simple point one is making is that wealth is not a fixed, unchanging thing. It is dynamic, and it can be lost any time due to business failure or misfortune.

Sure, this risk can be mitigated by investment in US treasury, but then you earn 2-3 per cent annually. Any toll road or cold storage chain in India would generate more than that kind of return even after adjusting for inflation differentials. So if Apple and Microsoft hold their corporate wealth in safe bonds, it implies that capitalists are getting risk-averse, and the flight to safety is as much a threat to the future of capitalism as business risk. If capitalists are busy saving instead of investing, they might as well wind up their shops. You don’t need entrepreneurs to invest in US treasury. Nor is the end-goal of capitalism charity. It is about taking risks, and investing in businesses that generate employment and growth. It is more moral and ennobling to create one new job that boosts the receiver’s self-esteem than to create one new beneficiary through charity.

The mental hurdle, as we noted earlier, is capital’s nationality. If Apple or Microsoft want to hold their profits in dollars, they cannot invest in truly transformative job-creating projects in Africa or India since they have to provide for exchange rate losses. But if notional exchange rate losses do not matter, and you invest everywhere to earn the highest return in local currency terms, you may not maximise your dollar profits, but will still do your job as a capitalist.

Sensible capitalists should make a beginning by focusing not so much on charity, but on investing their personal fortunes in the countries and areas (even in their own country, in deadbeat areas like America’s rust-belt) that need investment, and where returns will be in local currency, or even just psychic.

At a later stage, they should encourage investors in their companies to accept future share allocations from foreign investments in local currency. This way they get higher returns, even if this isn’t the case in dollar terms. In a global world, surely Americans can get better bang for their buck in rupee than in dollars, given the rupee’s much higher purchasing power parity.

Capitalists must invest, not save too much. And the minute they abandon nationalist thinking and stop worrying about how to bring the money home to the US or Europe, their returns will actually skyrocket. When capital flows where it earns the highest returns, exchange rates will also duly correct.

Bain Capital estimates that global financial capital – money already invested or available for investment – exceeds 10 times global GDP. The world is awash in capital, with the likes of Apple and Microsoft sitting on billions of dollars in cash, most of it invested in bonds earning weak returns.

Capitalism will begin to work for more people once capitalists shed their fears of exchange rate losses and invest where real returns in local currency (ie, adjusted for inflation differentials) exceed the returns they get by sitting on their butts and letting Uncle Sam borrow cheap.

In one line, if you want to know why capitalism sucks, it’s because capitalists have become risk-averse. They are happier counting their money than investing it. They are happier doing charity to stifle pricking consciences than taking big risks to create more wealth and jobs. If investors and markets are forcing managements to become risk-averse, the best way out is to hand the wealth back to investors, and let them decide now much risk they should take individually. Capitalism wasn’t invented for companies or investors to sit on piles of idle cash. The joint stock company, the bedrock of capitalism, was invented to invest, not save beyond a point.