Is Modern Capitalism Sustainable?

Kenneth Rogoff


CAMBRIDGE – I am often asked if the recent global financial crisis marks the beginning of the end of modern capitalism. It is a curious question, because it seems to presume that there is a viable replacement waiting in the wings. The truth of the matter is that, for now at least, the only serious alternatives to today’s dominant Anglo-American paradigm are other forms of capitalism.

Continental European capitalism, which combines generous health and social benefits with reasonable working hours, long vacation periods, early retirement, and relatively equal income distributions, would seem to have everything to recommend it – except sustainability. China’s Darwinian capitalism, with its fierce competition among export firms, a weak social-safety net, and widespread government intervention, is widely touted as the inevitable heir to Western capitalism, if only because of China’s huge size and consistent outsize growth rate. Yet China’s economic system is continually evolving.

Indeed, it is far from clear how far China’s political, economic, and financial structures will continue to transform themselves, and whether China will eventually morph into capitalism’s new exemplar. In any case, China is still encumbered by the usual social, economic, and financial vulnerabilities of a rapidly growing lower-income country.

Perhaps the real point is that, in the broad sweep of history, all current forms of capitalism are ultimately transitional. Modern-day capitalism has had an extraordinary run since the start of the Industrial Revolution two centuries ago, lifting billions of ordinary people out of abject poverty. Marxism and heavy-handed socialism have disastrous records by comparison. But, as industrialization and technological progress spread to Asia (and now to Africa), someday the struggle for subsistence will no longer be a primary imperative, and contemporary capitalism’s numerous flaws may loom larger.

First, even the leading capitalist economies have failed to price public goods such as clean air and water effectively. The failure of efforts to conclude a new global climate-change agreement is symptomatic of the paralysis.

Second, along with great wealth, capitalism has produced extraordinary levels of inequality. The growing gap is partly a simple byproduct of innovation and entrepreneurship. People do not complain about Steve Jobs’s success; his contributions are obvious. But this is not always the case: great wealth enables groups and individuals to buy political power and influence, which in turn helps to generate even more wealth. Only a few countriesSweden, for example – have been able to curtail this vicious circle without causing growth to collapse.

A third problem is the provision and distribution of medical care, a market that fails to satisfy several of the basic requirements necessary for the price mechanism to produce economic efficiency, beginning with the difficulty that consumers have in assessing the quality of their treatment.

The problem will only get worse: health-care costs as a proportion of income are sure to rise as societies get richer and older, possibly exceeding 30% of GDP within a few decades. In health care, perhaps more than in any other market, many countries are struggling with the moral dilemma of how to maintain incentives to produce and consume efficiently without producing unacceptably large disparities in access to care.

It is ironic that modern capitalist societies engage in public campaigns to urge individuals to be more attentive to their health, while fostering an economic ecosystem that seduces many consumers into an extremely unhealthy diet. According to the United States Centers for Disease Control, 34% of Americans are obese. Clearly, conventionally measured economic growth – which implies higher consumptioncannot be an end in itself.

Fourth, today’s capitalist systems vastly undervalue the welfare of unborn generations. For most of the era since the Industrial Revolution, this has not mattered, as the continuing boon of technological advance has trumped short-sighted policies. By and large, each generation has found itself significantly better off than the last. But, with the world’s population surging above seven billion, and harbingers of resource constraints becoming ever more apparent, there is no guarantee that this trajectory can be maintained.
Financial crises are of course a fifth problem, perhaps the one that has provoked the most soul-searching of late. In the world of finance, continual technological innovation has not conspicuously reduced risks, and might well have magnified them.

In principle, none of capitalism’s problems is insurmountable, and economists have offered a variety of market-based solutions. A high global price for carbon would induce firms and individuals to internalize the cost of their polluting activities. Tax systems can be designed to provide a greater measure of redistribution of income without necessarily involving crippling distortions, by minimizing non-transparent tax expenditures and keeping marginal rates low. 

Effective pricing of health care, including the pricing of waiting times, could encourage a better balance between equality and efficiency. Financial systems could be better regulated, with stricter attention to excessive accumulations of debt.
Will capitalism be a victim of its own success in producing massive wealth? For now, as fashionable as the topic of capitalism’s demise might be, the possibility seems remote. Nevertheless, as pollution, financial instability, health problems, and inequality continue to grow, and as political systems remain paralyzed, capitalism’s future might not seem so secure in a few decades as it seems now.
Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.

Bank funding

The dash for cash

Europe’s troubled banks are running out of money

Dec 3rd 2011

USUALLY it is banks that put customers under a microscope before lending them a penny. But in Europe banks are the ones now facing scrutiny before investors, companies and savers will lend them any cash. Faced with an investor strike, banks are putting a halt to new loans and selling or pawning all they can. Unless the investor strike lifts soon, Europe risks a credit crunch. At worst, there may even be bank runs and failures.

In one sense, a slow bank run is already taking place in the market for bank bonds, which in happier times provide the long-term and stable funding that allows bank regulators to sleep peacefully at night. Since July these markets have frozen up almost completely for European banks. Bond issuance has plunged (see chart) and has shifted towards secured bonds, which are backed by assets that investors can grab if the bank defaults.

David Lyon of Barclays Capital, an investment bank, reckons that just €17 billion ($24 billion) in unsecured European bank bonds have been sold since the end of June, compared with €120 billion in the same period a year earlier. “In the context of the requirement, this is a paltry amount of funding,” he says.
The run on European bank-funding markets in some respects mirrors the one taking place in some government-bond markets. This is to be expected given the links between banks and governments. During the 2008 crisis, governments propped up their banks. Now, governments are leaning on banks to keep buying their bonds. As a result even the strongest banks from peripheral euro-area countries such as Spain or Italy (where yields on an auction of three-year government bonds surged to an unsustainable 7.9% on November 29th) are finding it hard to borrow from investors.

Yet the bond-buyers’ strike afflicting banks is more worrying than the sovereign one. No banks are regarded as havens in the way that British and German government bonds provide a refuge for investors. Even strong banks in “coreeuro-area countries are being frozen out of markets.

A second vital source of funding is borrowing through short-term interbank markets or tapping money markets. Both of these are also drying up. American money-market funds, which were a big source of dollars for the European banking system, have reduced loans by more than 40% over the past six months.
Banks are reluctant to lend to one another except for the shortest possible time, usually overnight. Every night for the past few months [chief financial officers of big banks] have been getting reports saying they are short of a few billion,” says one banker. “They take the phones and start calling all the other banks to ask if they can borrow €100m here and some there.”

For now, this is keeping the system ticking over, partly because a bank lending money overnight knows it may have to ask for the favour to be returned next week. Euro-area central banks are also leaning heavily on their biggest banks to keep supporting the smallest with interbank loans.

An area of particular vulnerability, the “nightmare scenario” in the words of one banker, is that the trickle of deposits leaking from banks in peripheral countries turns into a full-flood bank run. The risk that savers will lose faith in banks seems remote for now. Yet it is not unthinkable.
Greek depositors have been shifting their money for the past year. Savers in Italy and Spain now appear to be starting to do the same. And large corporations, which are able to shift deposits easily, are seeking relative safety, either with large banks in core countries or further afield.
Tighten belts and brace yourself
Max Warburton, an analyst at BernsteinResearch, notes that German carmakers are now buying German government bunds or are quietly moving their money directly to the European Central Bank (many of them already have banking licences because they provide car loans). “We don’t believe they are at the stage of buying gold but perhaps it’s not far off,” he wrote in a recent report.
Banks are responding by desperately hoarding the cash they have, selling assets and slowing new lending. The most recent survey of credit conditions in the euro area shows a sharp tightening in September. The effects are being felt far more widely than in the euro area. In central and eastern Europe borrowers fret about regulatory changes that are encouraging banks in Sweden and Austria to cut their cross-border exposures. In Asia, too, the withdrawal of European banks is likely to drive up borrowing costs and restrict the availability of credit, according to analysts at Morgan Stanley, an investment bank.
Yet unless funding markets reopen, even aggressive deleveraging by banks will probably not allow them to shrink their balance sheets quickly enough.
This suggests a need for more action by central banks. On November 30th a group of central banks introduced new measures to ease a shortage of dollars in the banking system (see article). That will ease the pressure, but banks also need help raising longer-term debt. The ECB currently offers one-year loans, but these give little comfort to banks, which generally lend to their clients for longer periods and are reluctant to write new loans unless they can find matching funding. Another option could be for governments to guarantee bank debt, but strained national accounts probably rule this out.
Inaction could be disastrous. The longer banks are unable to raise funding, the greater the chance that one may fail. As one banker ominously puts it: “you are getting further along the train tracks towards the buffers.”

The 70% Solution

J. Bradford DeLong


BERKELEY – Via a circuitous Internet chainPaul Krugman of Princeton University quoting Mark Thoma of the University of Oregon reading the Journal of Economic Perspectives – I got a copy of an article written by Emmanuel Saez, whose office is 50 feet from mine, on the same corridor, and the Nobel laureate economist Peter Diamond. Saez and Diamond argue that the right marginal tax rate for North Atlantic societies to impose on their richest citizens is 70%.
It is an arresting assertion, given the tax-cut mania that has prevailed in these societies for the past 30 years, but Diamond and Saez’s logic is clear. The superrich command and control so many resources that they are effectively satiated: increasing or decreasing how much wealth they have has no effect on their happiness. So, no matter how large a weight we place on their happiness relative to the happiness of others – whether we regard them as praiseworthy captains of industry who merit their high positions, or as parasitic thieves – we simply cannot do anything to affect it by raising or lowering their tax rates.
The unavoidable implication of this argument is that when we calculate what the tax rate for the superrich will be, we should not consider the effect of changing their tax rate on their happiness, for we know that it is zero. Rather, the key question must be the effect of changing their tax rate on the well-being of the rest of us.
From this simple chain of logic follows the conclusion that we have a moral obligation to tax our superrich at the peak of the Laffer Curve: to tax them so heavily that we raise the most possible money from them – to the point beyond which their diversion of energy and enterprise into tax avoidance and sheltering would mean that any extra taxes would not raise but reduce revenue.

The utilitarian economic logic is clear. Yet more than half of us are likely to reject the conclusion reached by Diamond and Saez. We feel that there is something wrong with taxing our superrich until the pips squeak so much that further taxation reduces the number of pips. And we feel this for two reasons, both of them set out more than two centuries ago by Adam Smithnot in his most famous work, The Wealth of Nations, but in his far less discussed book The Theory of Moral Sentiments.

The first reason applies to the idle rich. According to Smith,

“A stranger to human nature, who saw the indifference of men about the misery of their inferiors, and the regret and indignation which they feel for the misfortunes and sufferings of those above them, would be apt to imagine, that pain must be more agonizing, and the convulsions of death more terrible to persons of higher rank, than to those of meaner stations...”

We feel this, Smith believes, because we naturally sympathize with others (if he were writing today, he would surely invokemirror neurons”). And the more pleasant our thoughts about individuals or groups are, the more we tend to sympathize with them. The fact that the lifestyles of the rich and famousseem almost the abstract idea of a perfect and happy stateleads us to pity that anything should spoil and corrupt so agreeable a situation! We could even wish them immortal...”

The second reason applies to the hard-working rich, the type of person who

devotes himself forever to the pursuit of wealth and greatness....With the most unrelenting industry he labors night and day....serves those whom he hates, and is obsequious to those whom he despises....
[I]n the last dregs of life, his body wasted with toil and diseases, his mind galled and ruffled by the memory of a thousand injuries and disappointments....he begins at last to find that wealth and greatness are mere trinkets of frivolous utility....Power and riches....keep off the summer shower, not the winter storm, but leave him always as much, and sometimes more exposed than before, to anxiety, to fear, and to sorrow; to diseases, to danger, and to death...”

In short, on the one hand, we don’t wish to disrupt the perfect felicity of the lifestyles of the rich and famous; on the other hand, we don’t wish to add to the burdens of those who have spent their most precious possession – their time and energypursuing baubles. These two arguments are not consistent, but that does not matter. They both have a purchase on our thinking.

Unlike today’s public-finance economists, Smith understood that we are not rational utilitarian calculators. Indeed, that is why we have collectively done a very bad job so far in dealing with the enormous rise in inequality between the industrial middle class and the plutocratic superrich that we have witnessed in the last generation.

J. Bradford DeLong, a former assistant secretary of the US Treasury, is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research.

December 2, 2011

Will China Stumble? Don’t Bet on It


HARDLY a day goes by without news of yet another economic problem facing China. A frothy real estate market. Quickly rising wages. A weakening manufacturing sector. Tightening lending standards. The list can seem endless and frightening.

But after a recent visit to China, I remain staunchly optimistic that it will continue to be the world’s greatest machine for economic expansion. While developed countries bump along with little growth, China’s gross domestic product is expected to increase by 9.2 percent in 2011 and an equally astonishing 8.5 percent next year.

The country pulses with energy and success, a caldron of economic ambition larded with understandable self-confidence. Visit the General Motors plant on the outskirts of Shanghai and watch Buicks churned out by steadily moving assembly lines almost indistinguishable from those in plants in Michigan.

That shouldn’t surprise, as G.M. strives for uniformity across its Chinese facilities. Perhaps more startling is that G.M. achieves American levels of productivity, quality and worker safety — with pay that is a small fraction of levels in the United States.

This illustrates China’s great strength: its ability to relentlessly grind down costs by combining high labor efficiency with wages that remain extraordinarily low. At Foxconn’s largest plant, in Shenzhen, 420,000 Chinese earning about $188 per month assemble electronic components for megacustomers like Apple, Hewlett-Packard and Dell.

Often criticized for just being a nation of “assemblers,” China has been increasing the value it adds to exports as more components are produced there. G.M., for example, uses 350 local suppliers.
China’s economic success is colored by its opaque political system, repressive and riddled with corruption. But the unusual mix of authoritarianism and free enterprise should continue to work because of its ability to deliver rising incomes, satisfying a populace that appears more interested in economic advancement than in democracy.

China has a plethora of tasks on its economic to do list, but none are impossibly daunting. Just as in the United States a century ago, jobs are needed for vast numbers of rural migrants moving into cities. Inefficient state-owned companies must be restructured (as they were in recent decades in many European countries). The other evident stresses, like the indisputable property bubble, are manageable and far short of what brought down the American economy.

Meanwhile, an opportunity lurks in China’s seeming inability to create innovative products with international identities. In an era of global corporations, a country that reveres brands, especially luxury ones like BMW and Louis Vuitton but also Starbucks and Häagen Dazs, has yet to give birth to its first.

Lenovo, one of the best-known Chinese companies, has achieved limited success with its 2005 acquisition of IBM’s personal computer business. Astonishingly, Chinese auto companies have the lowest share of their home market of any major country. So China has emphasized building products like ships, where brands don’t matter.

Not unlike the United States in the 19th century, China’s early stage of industrialization has brought with it an unsavory wild West flavor, from cronyism to fraudulent accounting, that justifiably worries investors. But behind those distractions is a country that is investing substantially in its future — about 46 percent of its gross domestic product, compared with 12 percent in the United States.

And while total government debt in China is high — by some estimates, higher than in the United Statesmuch of the Chinese debt was incurred for investment rather than consumption, far better for longer-term growth.

Notwithstanding accounts of “roads to nowhere,” China has vastly improved its core infrastructure. Its government arguably does better than ours at allocating capital.

The antipathy of Chinese households toward personal debt (a quarter of homes are bought with cash) has resulted in a savings rate of nearly 40 percent of income, compared with less than 5 percent for Americans.

Underpinned by a reverence for entrepreneurship, China has made starting new businesses easier, paving the way for the accumulation of vast fortunes; there are more billionaires in China than in any country except the United States. (China’s income inequality also rivals that of the United States.)

A gradual move toward reform appears evident. Controls over interest rates, foreign exchange, cooking oil and gasoline, to name a few, are being liberalized. There is even attention to the environment, with tax subsidies for fuel-efficient autos and limits on new-car purchases in the largest cities.

The frustrating mercantilist approach taken by China — it manipulates its currency and trade rules with abandon — has served it well. It has accumulated vast foreign currency reserves ($3.2 trillion and rising) while blocking access to its market and gaining competitive advantages internationally in everything from solar panels to toys.
Congressional saber rattling notwithstanding, China is likely to continue to get away with reforming only slowly.

While China hardly lacks challenges, I am betting on its continued success.
Steven Rattner, a contributing writer for Op-Ed, was a counselor to the Treasury secretary and lead auto adviser. He is a longtime Wall Street executive.

France and the euro crisis

The ratings game

The perils for Nicolas Sarkozy in trying to preserve a credit rating

Dec 3rd 2011
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THE choreography has become wearisomely familiar. For the fourth time this year, European leaders are holding a summit, this one in Brussels on December 8th and 9th, at which they are promising a “comprehensive package” of measures to solve the euro crisis. The French president, Nicolas Sarkozy, and the German chancellor, Angela Merkel, are trying once again to produce a joint plan. They badly need to persuade wary investors and their own unsettled voters that, this time, it is for real.

Yet the two leaders are, as ever, at odds over exactly what to do. And Mrs Merkel, set on fiscal discipline, the avoidance of moral hazard and preserving European Central Bank independence at any cost, seems in no mood to give ground.
With the euro zone hurtling into uncertainty and maybe towards a nasty end, irritation over German inflexibility has prompted a new sense of urgency. Radek Sikorski, Poland’s foreign minister, this week called it “the scariest moment of my ministerial life”, and said “we are standing on the edge of a precipice.” Jacques Attali, head of an economic commission that advises Mr Sarkozy, said “chaos is staring us in the face”, adding that he could not be sure the euro would survive until Christmas. In a speech on December 1st, Mr Sarkozy was expected to try to calm the panic, and to persuade voters that surrendering budgetary powers would be beneficial.

Mr Sarkozy is doing his utmost to appear as a joint commander of the “Merkozy rescue mission. He invited Mrs Merkel, along with Italy’s new prime minister, Mario Monti, to a pre-summit summit in Strasbourg on November 24th. The unspoken message was: we, the leaders of Europe, welcome you, the Italians, back to the virtuous core. Facing a tough re-election bid next spring, the French president has to show that he is in charge.

And in some ways, it suits outsiders to have him play the role of cajoler-in-chief. When it comes to urging the Germans to support the ECB’s purchases of government bonds, for instance, Mr Sarkozy, unlike hectoring voices in Washington and London, has a better claim to Germany’s ear. “We need the French, or else this will be seen as Germany bossing everybody else,” notes a German official.

Yet as the crisis deepens, an alarming prospect looms: that France’s own status could lapse, and thus its clout at the heart of the euro zone. France is by far the most vulnerable of the zone’s six AAA-rated countries. It has the highest level of debt as a share of GDP. Its banks are particularly exposed to the troubled periphery, especially Italy. The spread of French over German bonds recently hit its highest level since the launch of the euro (though it has fallen back a bit), suggesting that traders are already anticipating a downgrading. Moody’s, a ratings agency, has put France’s AAA rating under surveillance, with a reassessment due in January. Guillaume Menuet, an economist at Citigroup, expects a negative outlook on French sovereign debt within weeks, followed by a formal downgrade in 2012.

Yet despite such alarming signs, senior French officials seem almost disconcertingly calm. There is a palpable sense of frustration with German intransigence, but senior officials dismiss all talk of a downgrade as scaremongering. They point out that Britain, which is also rated AAA, has a bigger budget deficit and higher ratios of debt to revenues and of interest payments to revenues than France.

The French government may not have balanced its budget since 1974, and it has big debts, but it manages them well and has not defaulted in modern times. Even Moody’s acknowledges that the French treasury has exploited strong markets in 2009, 2010 and the first nine months of this year to lock in historically low rates. Twice since the summer, as the economic outlook has worsened, the government has responded with emergency budget-austerity measures.

If there is a lack of confidence in the markets, say French officials, it touches all top-rated euro-zone sovereigns, even Germany, and not just France. “We think there is no objective reason for a downgrade or negative outlook on France’s credit rating,” comments one. “We have absolutely no worries about raising our debt.”

Yet in today’s miserable euro zone such a tone of confidence could turn out to be chillingly complacent. The OECD this week cut its 2012 GDP growth forecast for France from 2.1% to just 0.3%, well below the 1% on which the government based its latest austerity plan. French firms are facing a credit squeeze, as banks cut lending in order to meet new capital requirements. Some economists are forecasting outright recession.

The chances are that France will need even more budget savings early next year—which means just a couple of months before the presidential election. Mr Menuet reckons that the government will need to find another €6 billion. France could be further stretched by commitments to the euro’s bail-out fund, the European Financial Stability Facility (EFSF) and to any potential bank rescue. “Under a stress scenario”, concluded Fitch, a (French-owned) ratings agency, last week, “France’s AAA-rating would be at risk.”

Were it to be lost, the consequences would be felt not just in the markets, but politically too. Within the euro zone, the knock would be considerable. The credit rating of the EFSF, which rests on the six AAA countries, would be at risk. The relegation of France from top table to scullery would be an historic post-war shift. Already, despite the façade of parity, Germany dominates the relationship that has traditionally set the agenda in Europe. A loss of market credibility, which is difficult to reverse, would tilt the balance even more firmly towards Germany.

For Mr Sarkozy, it would also be a huge personal setback. Despite periodically railing against all ratings agencies, he has made much of his determination to hold on to France’s AAA status. In a recent television interview, he explained clearly how a top-tier rating protects the French from higher borrowing costs and therefore further austerity. His main hope for 2012 has been to seem like a steady hand of experience in a crisis, next to an opponent, the Socialists’ François Hollande, who has never been in government and has offered few thoughts on how to solve the euro crisis. Recent polls suggest that this was starting to lift Mr Sarkozy’s numbers. But by raising the stakes over the AAA rating, Mr Sarkozy has set himself up for a potentially devastating blow that could strike at any time before voting begins in April.