Bill Emmott - International Author & Adviser


The future of capitalism
Voice - 2009

It can all be blamed on Karl Marx. More than 150 years ago, that heavily bearded German-born revolutionary economist was living in London, working in the beautiful surroundings of the British Museum Reading Room. As a student in the 1970s, I can remember working there myself, in what was a completely circular, wood-paneled library, situated in the central courtyard of the British Museum. Today, the old Reading Room is just an exhibition space for the museum, its library function having been moved to a modern new building. But when I was lucky enough to use it, I sometimes day-dreamed about Karl Marx working there long ago, perhaps sitting in the same seat that I was, while he worked out his theory for why the system that had brought the great wealth that paid for the Reading Room was bound to collapse. He certainly wasn´t very grateful to capitalist Britain for allowing him to live there in exile, nor to the way capitalist profits financed the great museums and educational institutions in which he worked.

In Karl Marx´s two famous books, the huge, complex and hard-to-read "Das Kapital" of 1867 ("Capital") and the shorter, clearer "The Communist Manifesto" of 1848, which he co-wrote with his fellow German exile Friedrich Engels, he forecast that capitalism would eventually collapse because of its own contradictions. There would, he forecast, be a series of "crises of capitalism", culminating in a revolution by the proletariat. One of the causes of capitalism´s crises would be inequality: according to Marx´s theory, the logic of capitalism required an ever greater concentration of wealth in the hands of the rich entrepreneurs who controlled companies and an ever increasing misery for the workers, whose wages would be held down at the minimum possible level. Another cause of crises would be instability, as greedy capitalists sought to maintain their profits in the face of rising competition by taking ever greater and more speculative risks.

Writing as he was in the mid 19th century, Marx could not have envisaged a third potential capitalist contradiction, or cause of crises, namely environmental degradation. In that era, with the industrial revolution only just getting under way, the filthy air and water of the great industrial cities of London and Manchester was just thought to be inevitable, and probably unimportant compared with all the other causes of disease, death and misery that existed at the time. Yet a modern Karl Marx would certainly include the environment. He would argue that the logic of capitalist profit-seeking requires companies to deplete the world´s finite resources, to keep on filling the planet´s atmosphere with carbon dioxide and other "greenhouse gases" and to exploit society by imposing the environmental costs of capitalist production on the lives of ordinary people. The whole idea of "sustainable development", which is so popular now with environmentalists, is based on the idea that if capitalism is left to proceed on its own course then planet´s development will not be sustainable: it will collapse, in a series of crises, just as Marx foresaw.

Fortunately for all of us, Karl Marx was a better theorist than he was a forecaster. Today, many economists are criticized for having failed to predict the global financial crisis that began in August 2007, or the global economic crisis that began with the collapse of the Lehman Brothers investment bank in September 2008. During the past 150 years, there have been many such crises, most notably the crisis of the 1930s and its Great Depression, or the bursting of Japan´s bubble economy in 1990-92. Karl Marx, however, forecast a much bigger, more fundamental crisis that has never yet occurred: the complete collapse of capitalism under the weight, as he wrote, of its own contradictions.

Despite that failure, the ideas of Marx still have some resonance with economists and other thinkers today.  Memories of communism in the Soviet Union and Mao Zedong´s China are still fresh, but also fears of a capitalist collapse remain strong. Capitalism, based as it is on greed and selfishness, has never actually been popular. That may well be why the events of 2007-09 have not just been described as a recession, or even just a financial or banking crisis: they have been described as a crisis of capitalism itself. Karl Marx lives on, at least in our minds.

The reason why Marx has been proved wrong, so far, is that capitalism is a very adaptive and resilient system. After each crisis, after each dramatic change in the circumstances of the world or of any specific country, capitalism has been able to find new forms, to find new ways to prosper and make progress. The ingenuity and ambition of entrepreneurs and corporate managers enables them not just to invent new technologies and products but also whole new ways of organizing themselves and, in particular, new ways of positioning themselves in relation to government and society.

They have been assisted in finding those new forms by government itself, the growth of which in all the rich, developed economies has softened the impact of capitalism´s crises. Government spending now is much larger compared with overall Gross Domestic Product (GDP) than it was during the 1930s, for example, in America, Europe and Japan, allowing that spending to help dampen the severity of economic cycles. That is exactly what governments have been doing since the current economic crisis began in 2007-08, with their big fiscal stimulus packages. Central banks, too, play a bigger role in economies than before, and their expansionary monetary policies have also helped to prevent the 2007-08 crisis from turning into a catastrophe. From the point of view of capitalism, government fiscal and monetary policies help to buy time for companies to plan their own adaptations, their own restructuring in response to the recession. But the adaptation still has to occur.

Another economist, Joseph Schumpeter, writing in the 20th century, called this adaptation process "creative destruction". He was describing the way in which old and inefficient companies and even whole industries may be destroyed, especially during recessions, and are replaced by new companies and new industries, with new ideas and with balance sheets that were not so encumbered by debts. In fact, Schumpeter believed, without the destruction of the old, the process of creation and adaptation could not happen properly or vigorously.

Now, amid our current global economic troubles, it has become common to ask what will be, what can be, the future of capitalism after this crisis. The first assumption behind this question is that the events surrounding the collapse of Lehman Brothers can, in truth be considered as a true crisis for capitalism as a system, rather than just a normal part of the economic cycle. Capitalism must change, following this crisis: that is the underlying thought. The second assumption, however, is a more positive one: it is that capitalism will adapt to its new circumstances, to the new rules governments may lay down for it, to the new attitudes people will hold towards it, even to the new balance of economic and political power in the world. After the destruction, there will be creation. But creation of what? That is what everyone is wondering.

Inequality, stability, sustainability

Let us be clear: capitalism is the only successful system yet invented for organizing human beings to achieve economic and technological progress. The idea that somehow we could move beyond capitalism is pure fantasy. To believe that we could do so would require us to ignore the fact that competition is inherent in the human species, even if we are also able to co-operate when it is in our interests to do so. And the period of human history during which capitalism has been most free to operate—basically, the past two centuries—has also been the period during which humanity has achieved the most rapid and sustainable advances in living standards and life-opportunities.

            But let us also be clear about the weaknesses of capitalism. During these past two highly successful centuries, capitalism has shown that it has a tendency to increase levels of inequality inside societies and between different societies in different parts of the world. That rising inequality can lead to social tension and even to conflict, which ends up disrupting capitalism itself. Moreover, as Karl Marx said, capitalism has always been unstable. It produces booms and busts, periods of growth and recession, bubble economies and then times of stagnation or even depression. And finally it does cause environmental damage, because the essence of industrial activity is the conversion of resources, using energy, into newly manufactured goods, and because the direct costs born by companies making those goods do not include any price for pollution or other environmental consequence.

Most of all, the vast increase in humanity´s use of fossil fuels—mainly oil, gas and coal—has led to the rise in global temperature that we now know as global warming. Until recently, the scientific evidence on this point was unclear: now it has been proven beyond any reasonable scope for doubt. We can and should debate about what would be the appropriate policies to try to reduce the quantity of carbon dioxide emissions and to control the rise in global temperature. But there is no longer any point is disputing whether the rise has been influenced by human industrial activity.

            Following the shocks of the past two years, these weaknesses of capitalism have come sharply back into focus. It has been popular, since the collapse of Lehman Brothers, to attack something the critics call "market fundamentalism": Yukio Hatoyama made just such an attack in the pages of Voice magazine when he was campaigning to become prime minister. It is also popular for politicians to claim that an era of free-market, neo-liberal capitalism that began with Ronald Reagan and Margaret Thatcher at the start of the 1980s has now come to an end. A new direction is needed. But no one seems to agree on what it is.

            Well, perhaps that is unfair. Some commentators have argued that they have seen the future of capitalism and that they know it works: for the future, in their view, lies in Chinese-style capitalism, led and controlled by the state. Ian Bremmer, the owner and president of a Washington-based political-risk consultancy, the Eurasia Group, argued in an article in the journal Foreign Affairs in May/June 2009 (which he is now expanding into a book) that American-style capitalism is going to face fierce competition from state capitalism, and that many countries will now be tempted to try to emulate China. Previously, they tried to emulate the United States, but the global economic crisis has discredited that effort.

            Can that be correct? Does China now offer the new model, a "Beijing Consensus" to replace the "Washington Consensus" that became dominant in the 1990s? Is that the future of capitalism? Personally, I think this is very unlikely to be true. Certainly, capitalism needs to change. But not as drastically as this idea of a Chinese model would suggest.

            After all, the "Chinese model" of capitalism is not so very different from the forms of capitalist development that have been seen all over Asia during the past half century, in Japan, South Korea, Taiwan, Malaysia, Singapore and elsewhere. In all those countries, state intervention, both as a provider of guidance and finance, and as a direct owner of companies, has played a big role. China has not invented anything new. The last time Americans were worrying that their "model" faced a severe, even existential challenge was the 1980s, when scholars and lobbyists such as Chalmers Johnson, Clyde Prestowitz and James Fallows argued that America needed to learn from the Japanese model of a government-led industrial policy. That idea soon faded. And in all the Asian economic success stories, the role of the state has declined as the economy has grown more mature and complex. The same will surely occur in China.

            The framework for how capitalism needs to change comes, in my view, not from Chinese success but rather from the three weaknesses that I outlined earlier: inequality, instability and sustainability. Thanks to the global economic crisis, and thanks to the scientific evidence about climate change, reforms are needed to address all these three weaknesses. This, however, is nothing really new. The same sort of reforms were necessary after previous crises and slumps, and similar environmental reforms have been necessary in many countries during the past 50 years, at times when pollution reached intolerable and politically unpopular levels.

These reforms can only be done by governments, for they consist of the setting of new rules of the game. Only government can do that, for only it has the legitimacy to set rules and to enforce them. But sensible, far-sighted companies should also try to participate in the formation of those rules, not to block them but to shape them in such a way as to make the new rules both economically and socially constructive. Companies, after all, do not exist separately from society. They are integral parts of society itself.

 Indeed, most citizens in modern economies devote much of their adult lives to working in companies and so they consider companies to be their main forms of social organization. They get much of their training and practical education from their companies, as well as their sense of self-esteem, of belonging to a social group. Moreover, companies typically take the lead in bringing changes to our social interactions by the way in which they invent or exploit new technologies: from the motor car to the telephone, from the mobile phone to the internet and to today´s social networking, capitalist companies have always operated in the heart of society. Companies thus have a powerful interest in working to ensure that society as a whole is in a healthy and positive condition, and that the right rules are set and followed, because that society is companies´ own market, and because society itself reaches deep inside the companies themselves.

The gap between the rich and the poor

The practical starting point for how capitalism needs to be changed, to be reformed, as a result of the global economic crisis comes from its weakness of instability. After all, that is what the language of the financial crash, of the collapse of Lehman Brothers, of the crisis implies straight away: an unstable system. All the present talk of reviewing and tightening financial regulation is a reaction to that instability, an attempt to find new ways to cope with this old problem. But despite all the immediate attention, instability is, in reality, a secondary issue the salience of which will decline once economic recovery gets strongly underway.  The true political starting point for changing capitalism is not instability but inequality.

            Inequality is inherent in capitalism, just as it is inherent in society. But Marx was wrong to forecast that capitalist societies would always become more unequal. In fact, the degree of inequality within those societies has both risen and fallen many times during the past century, whether in the United States, Western Europe or Japan. This is a complex issue, so it cannot easily be summarized in a brief generalization. Still, I will attempt to do so: the degree of inequality seems to have been most influenced by the level of unemployment, by the evolution of education, and by politics.

            Periods of full employment tend to narrow the gap between the richest and the poorest. There is no surer path to poverty than being out of a job. Access to well-paid, productive jobs, however, depends in the long-term on education, which enables the poorer citizens to acquire skills and to take on more complex tasks. Karl Marx would be astonished at the fact that the developed countries chose to provide education, at taxpayers´ expense, to the whole of their population. That decision, though prompted by political pressure from the working classes, was also eventually accepted by the rich and by capitalists as being in their interests too, for they came to realize that a well educated population is more socially stable and more productive. The benefits of publicly financed mass education have even increased as our economies have come to be more and more dominated by knowledge-intensive industries and services.

            The past couple of decades have been times of fairly high levels of employment and of the further intensification of the knowledge economy. So on that basis, you might have expected the richest nations to achieve greater equality between their citizens´ incomes and living standards during that period. But the opposite has happened. Since 1990, the gap between the rich and the poor has widened in America, Britain, Germany, Italy, Japan and many other countries.

            There has been plenty of attention given to this rise in inequality, whether by economists, trade unionists or political commentators. There has been no clear agreement as to the causes of it, but consensus has formed around a combination of factors: rising stock- and property prices, which benefit those who were already rich enough to own shares and property in the first place; the emergence of China, India and other developing countries as open, competitive economies whose low-cost exports of manufactures and of services served to depress wages of lower-skilled workers in the West; information and communications technology, which has raised the incomes of skilled, knowledge workers but replaced the jobs and so depressed the incomes of the lower skilled; and finally a growing and globally spreading belief that the top managers of companies of all kinds need to be given fat incentives to encourage them to work hard and in an ambitious or venturesome way, amid the steady emergence of an international market for top executives. All of these factors seem to have served to raise the incomes of the richest in society and to depress the incomes of the poorest.

For all that analytical attention, what has been noteworthy, however, is how little attention has been given to inequality by politicians—until the economic crisis began to hit, in 2007-08. Vice-President Al Gore did begin to try to make a noise about inequality during the 2000 presidential election campaign, but he failed to really convince voters that it was an important issue and lost to George W. Bush. In Britain when they won power in 1997, Tony Blair´s Labour Party even tried to divert attention away from their socialist supporters´ traditional interest in inequality by focusing just on poverty itself, and they promised not to raise the tax rate for richer people. In China, the old Communist hero of the Long March of the 1930s and 40s, Deng Xiaoping, proudly announced that inequality no longer mattered: "to get rich is glorious", he said. His successor as party leader, Jiang Zemin, allowed capitalist businessmen to join the Communist Party for the first time since the People´s Republic of China had been founded by Mao in 1949.

            Suddenly, however, the political mood has changed. Inequality is back as an important political issue. Barack Obama campaigned on that issue explicitly during the presidential election of 2008, and his effort to reform health care in order to provide universal coverage is firmly aimed at reducing inequality in America. Yukio Hatoyama´s attack on "market fundamentalism" in Japan was really a criticism of inequality, the rise in which has been fuelled by the relaxation of the labour laws under the Hashimoto and Koizumi administrations, which led to the creation of a two-tier labour market. The new DPJ government´s pledge to change the allocation of public spending to assist the poor and to change the labour laws is a direct response to the growing political salience of inequality. In Britain, the Labour government, now led by Gordon Brown, the former finance minister who had pledged not to raise taxes for the rich, has changed its mind and in April 2010 plans to increase the top marginal rate of tax from 40% to 50%.

            This new political interest in inequality now forms part of a major shift in politics and policy in the three biggest economies in the world, all at the same time. The United States, under President Obama, is trying to extend its welfare system by reforming health care and imposing higher taxes on the wealthy. Japan, under the DPJ, is about to try to re-allocate public spending towards social security and the poor, as well as to restore the strength of its health system. And in China, the third biggest economy, the government is expanding its spending on health, social security and education, partly to deal with imbalances between urban and rural areas but mainly to respond to concerns about growing inequality within Chinese society itself.

            The global economic crisis is the basic explanation for this new political interest in inequality. But that does not mean that the political interest will fade away as soon as economic recovery begins. For the issue of inequality was simmering away beneath the surface; what the crisis has done is to heat the issue up, to bring it to the political boiling point. Once an issue has been heated up in that way, it takes quite a while to cool down. Politicians are slow to take on new slogans and new issues, as long as the old ones continue to bring them applause and votes.

            Unemployment is in any case always a lagging indicator. Whenever there are economic recessions, unemployment carries on rising for many months, and sometimes years, after output and GDP have begun to grow again. The main reason is that in depressed conditions, companies can usually raise their production of goods or delivery of services without employing new workers, as they have plenty of spare capacity. In addition, company bankruptcies continue to occur during the early stages of recovery as firms´ still face cash flow difficulties and as the revival in demand is often limited to a few sectors. As a result, unemployment will continue to increase, focusing attention still further on inequality.

            Furthermore, the politics of inequality are destined to become blended together with the economics of fiscal consolidation. Governments all around the world have rescued their economies by expanding public spending and borrowing, leaving themselves with huge budget deficits and debt burdens. My own country, Britain, has one of the worst budget deficits, likely to be nearly 15% of GDP next year, but America´s is close behind at a forecast of around 12% and Japan also in that neighbourhood with 9% or so. As and when recovery takes hold, governments are going to have to reduce those deficits by cutting spending and raising taxes. And when they do raise taxes, many of them will feel inclined to put into reverse the trend of the past 15-20 years, namely of falling top marginal income tax rates, and instead to raise the higher tax rates in the hope of accruing more money from the rich.

            That sentiment is what lay behind the British Labour government´s decision to raise the top marginal income tax rate from 40% to 50% in April. This measure may not in fact bring in very much extra tax revenue, for there are not enough rich people and all of the rich can afford to pay lawyers and accountants to help them reduce their tax liabilities. But politically, the gesture is highly attractive. For if unemployment is rising, if public services for ordinary people are being cut back, if the pay and pensions of ordinary workers are being squeezed, then governments feel that they need to show that they are making the rich suffer too. The right-wing Conservative Party, which is widely expected to win power in the general election that Britain must hold by June 2010, has now said it will most likely keep the new 50% tax rate when it enters government.

            This political inclination is especially important in those countries where the financial crisis itself was worst: Britain, America, Ireland and Spain. In those countries, the people who have been blamed for the crisis are a very prominent section of the rich: bankers and property developers. Bankers´ greed and property developers´ recklessness is believed to have caused the problem. Now that we are all suffering from the consequences of what they did, and having to work harder or pay more taxes in order to deal with the resulting public debts, justice surely requires that the rich get punished. If other rich people get punished through higher taxes alongside the bankers and property developers, then so be it.

            Plainly, inequality is an important issue for politicians and for policy makers. The global economic crisis has put inequality back near the top of the political priority list. But will that force or persuade capitalism itself to change?

            In the sense that the policy environment for capitalism is changing, the answer is yes. By the policy environment I mean the fact that income and other taxes for higher-paid employees look bound to rise; the fact that legal benchmarks such as minimum wages are likely to be raised in several countries (including Japan) in order to boost the incomes of the poorest; and the fact that in some industries—notably finance—governments are planning to try to impose legal controls on the type of pay and incentives systems that companies are allowed to have. Companies and their owners will have to adjust themselves to this new environment, altering the way in which they pay especially their top employees.

            In addition to those changes in the policy environment, one of the hardest questions to answer is whether there will also be a cultural change, concerning the acceptability of high pay and bonuses for top executives. My suspicion is that there will not be, on a wide scale, for very long. The reason is that as long as globalization continues to be accepted politically and socially as the best arrangement possible, then the pressure from global competition for top executives will remain intense. After a short period of moderation, the trend towards rising levels of executive pay, and hence of inequality between the highest and lowest paid employees inside a company will resume.

            Japan has not had the same political experience as America and Western Europe: greedy bankers have not been blamed for the recent recession. But inequality is going to continue to be an important issue both for political reasons and for economic reasons. The political reasons are familiar: the way in which a two-tier labour market, with 30% of the workforce in part-time and irregular jobs, has driven down the incomes of the poorest and weakest in society, causing anguish among the poor but also fears of widening social divisions in the country as a whole. The economic reasons are important too, however: low and even declining incomes for the poorer elements of society drag down wages for everyone, and in turn depress household spending. That is why Japan has been trapped for so long in deflation, becoming excessively dependent on exports to drive economic growth. Falling incomes, amid widening inequality, will keep Japan trapped in that way for years to come if a solution cannot be found for it.

            This problem, of how to solve inequality while also reviving economic growth, especially in an ageing society, will lie at the heart of this book´s final chapters, on Japan and its future after the economic crisis. But before moving to focus on Japan, there remains another issue to explain and explore: the way in which financial instability has threatened the whole capitalist system, and what needs to be done about it.


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