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Can capitalism continue to provide wealth?

Published at: 19-07-2020

Posted on: July 19th, 2020 by RaduC No Comments

I am talking this week with Lucian Croitoru, advisor to the NBR governor, whose views, however, do not express the official position of his institution.

RC: Lucian how outrageous is it that after we got out of the tragic experiment called communism, we ended up talking about the extent to which capitalism provides prosperity.

LC: I find it incredible that a society that went through all the suffering communism entailed looks back nostalgically to what happened then. Two things I want to point out. The first is that ironically, the most nostalgic are the elderly who most likely had difficulty finding their way into the labor market after 1989 and became nostalgic.

On the other hand, and this hurts the most, many young people share these egalitarian views. I reckon that not having gone through the [communist] experience, they only hear about such ideals of equality, social justice also dubbed distributive justice and imagine that it can actually be done. Let us note that this is not a trend limited to Romania alone. Particularly after 2008 it spread across the globe.

RC; Indeed, it is a topic discussed in earnest in the rich world. Understandably so. These are the countries that have seen their middle class diminish to a significant degree and a rise in social polarization. Don’t you agree?

LC: True, the crisis has seriously dented the individual wealth of many. But this is how capitalism works: it gets rid of unsustainable elements and it sometimes inflicts considerable pain in the process.

We do need, however, to make the following distinction. Capitalism, in general, is a way of organizing the society. It is the society itself. You cannot retain some features of this society that you like and do away with capitalism that you decide that you do not like. We cannot talk about the society as it stands and completely ignore capitalism because it is as if talking about the whole while getting rid of the very whole.

Capitalism has two major components: democracy and liberalism. The problem worldwide relates to liberalism. Nobody contests democracy. A democracy, however, cannot sustainably be a source of well-being without liberalism. This is what my experience has taught me so far, in practice and in theory. When liberalism comes under attack, it is the very engine that produces well-being that takes the hit.

RC: I agree. Nevertheless, liberalism and democracy are not a purpose in itself. They are means that people use to achieve a certain level of well-being, development and happiness. When these goals are not attainable anymore, wouldn’t a reassessment of these tools that no longer seem to be working be justified?

LC: You were right to say “seem to be working”. It is democracy that has severely deteriorated and tends to clash with liberalism. The issue with democracy is that there is no clear distinction between the majority and the minority. Although by constitution the majority cannot be used to restrict the rights of the minority, some practices in the society create problems.

And Romania provides a very clear example. A majority made up of people pining for the past can impose its will on the minority. This “tyranny of the majority” has no place in a democracy steeped in liberal values. Sadly, we have yet to properly understand these values.

For example, if a 40% rise in pensions is on the agenda and a majority of MPs manages to force it through, because there is no money to fund the increase long term, the same majority can impose a progressive tax system on anything, from personal income to profits and wealth. In an extreme case, the majority can take almost everything. But progressive taxation is a measure imposed by a majority that does not apply on itself the same rules that affect the minority. Lower taxes on most people and higher taxes on a minority of people. To use a more colorful expression, a majority can live large on other people’s money.

To function properly, a democracy needs general rules to guide everyone when they use the knowledge acquired through experience and studies in the pursuit of their individual goals. If it worked on this basis, democracy would ensure the preservation of all kinds of liberties. Similar to driving a car. Irrespective of position or wealth, everyone abides by the same road rules. The same goes for a society: rules need to be general in nature, not target individual goals. Hayek explained that all too well.

RC: Well, there are countries with progressive tax systems …

LC: Exactly. The West has them. A majority imposes on the minority rules that are different than what it complies with. Constitutions should prohibit that. But the public stopped believing in principles and the “pragmatic” approach has become very popular in putting together public policies. “Pragmatic” as in not informed by principles, and therefore, when employed, pragmatism can take you anywhere with no clear control by those designing the policy over the direction. Pragmatism, a seemingly easy and preferable reality in the short term, is, ironically, the enemy to reaching goals.

RC: Looking back over the past 60 years, two economic periods stand out: the time after WWII, consisting of 20 – 30 years when capitalist government was able to generate a strong middle class and wealth followed by accelerated globalization during which the pursuit of generalized well-being got lost on the way. Hence the current resistance …

LC: Most democracies in the aftermath of the war, except for the United States, were not dominated by liberalism. Even Great Britain, with a long liberal tradition, was governed based on non-liberal capitalism after the Second World War, irrespective of who ruled the country, Conservatives or Labour until Margaret Thatcher took office. What I mean is that there were no liberal societies until the ‘70s.

RC: And yet, they created wealth …

LC: Wealth whose growth was much slower in relation to what followed. It generated economic growth, but it was not until the second half of the ‘80s that wealth was beginning to be visible as inflation was starting to drop due to a general set of rules to which central banks were adhering. Before, inflation was eating into most wealth.

RC: So in which decade did the economy fare best?

LC: After the ‘70s with the stabilization of inflation, wealth began to spread from the developed economies to other countries. That lasted until 2008 and it is my belief that capitalism continues to generate wealth, but also a lot of disgruntlement because of existing inequality. Coupled with the illusion that it can be reversed, inequality leads to economic and social policies which can make everybody equal rather in poverty and under no circumstances in wealth. Socialism proved it. This is something easier to understand.

It is harder to understand, though, that too much welfare spending in capitalism reduces the ability of the economy to adjust rapidly and amplifies discontent which ironically is blamed on too much economic liberalism and not too little.

RC: Why is inequality rising?

LC: It is also caused by how democracy in the West started to erode. Democracy requires two types of rules: general rules, that the Parliament protects and specific rules that allow governments to follow through with their programs. Unfortunately, democratic societies started to be more and more divided into groups of interest, in the broad sense of the term which back the government. We thus started to abandon most of the general rules.

And let me give you an example of what was forcefully attempted in Romania and thank God, failed. They tried to set up that Sovereign Investment Fund by taking funds from companies, including pension funds with a handful of people in charge of deciding what to do with the money.

That went against the Constitution because it fails to apply a general principle that equally refers to everyone. The Constitutional Court blocked the project and explained to the government that it was an illegitimate specific purpose. And if they were set on carrying on, they had to pass a law through Parliament with a much comprehensive scope. The deviation from the principle was too obvious. This is an example of how the majority can act as a “dictatorship” over a minority.

RC: Lucian I see two alternatives here. One the one hand we may say that a distorted democracy has adverse economic implications  by leading to poor decisions, but, on the other hand, we may argue that, on the contrary, a worsening of the economic situation pushed the public to poor political choices, i.e. populist movements.

LC: They both share the same thing, namely the abandonment of principles. Essentially, populism also involves abandoning principles. By principles I mean the general applicable rules which are result-oriented in the long term even though, in the short run they may create inconveniences for some groups in the society. This, I think, is the main problem: giving up principles.

RC: When and how did that happen?

LC: In the field of thought. Hayek says that this started to happen as early as 1860, when William Stanley Jevons, an economist, posited that we can lay down no hard-and-fast rules, but consider each case on its merits. That gave great impetus to pragmatism. These ideas can also be found at John Stewart Mill, a socialist sympathizer, or Max Weber, who talks about “practical rationality” (for details see Hayek, Law, Legislation, and Liberty).

Generally speaking, the harshest critics of ideology as a concept are the Socialists. According to them ideology is bad because it impairs reason. Benjamin Constant, a well-known representative of traditional liberalism, the author, if I am not mistaken of the Laissez-faire, laissez-passer expression, used to say that liberalism is a coherent set of principles. The liberal ideology, construed as a set of principles, is useful because it enables general values, such as freedom, to guide reason and action.

In contrast, the socialist ideology is not consistent, in terms of principles. It has conflicting principles. More seriously, however, it encroaches on freedom. The liberal thinking is beneficial because it places in its system of principles freedom as its core value, alongside other compatible values. Whenever ideologies did not center on freedom, they turned into nazism, fascism, communism.

RC: Because you made this comparison between socialism and capitalism, how would you comment on the fact that once the communist block collapsed, and with it the ideological competition against capitalism, the latter no longer felt the need to prove that it is a better provider of wealth. In other words, it lost its motivation to demonstrate its superiority and that was when the middle class started to lose its wealth.

LC: You are right to say that the competition is gone, if we are talking about socialism as the school of thought intent on achieving social equality, a basically illusive purpose, by seizing the production means from individual entrepreneurs. However, even within capitalist societies, there are left leaning opinion leaders who do not advance, like the Communists, production means nationalization as a way towards distributive equality, but the seizure through progressive taxes of earnings achieved by more affluent members of the society for redistribution. In the US, for example, welfare spending used to be around 4-5% of GDP in early ‘60s to now reach 15% in some cases. In some European states it goes up to 20% of GDP.

This means that welfare spending grew faster than production, resulting in a massive redistribution of earnings within the society. As I said already, with this percentage of welfare spending of GDP, it is extremely hard to perform any adjustments that the society may need. It delays the recovery from recessions and requires increasingly generous interventions by governments or central banks with every recession. It is reaching the point at which it ceases to be sustainable.

You mentioned the middle class … Who is the main receiver of welfare expenses in, for example, the US? The middle class, although it is not this social category that is in real need of this type of assistance. It follows that the practice is excessively used. This happens in many Western states. How could the middle class reverse this tendency that is eating away at capitalism’s productive power? It has no interest to support a slowdown in the process and the setting of lower levels so it focuses on those who genuinely need it.

R C: What can be done? Does the capitalist state stand any chance of returning to principles or will we further succumb to populism which lacks any economic basis but advances equality? Do we need a revolution?

LC: No, there will never be a revolution, in the form of a violent uprising in support of capitalism. We will continue down this downward path of the illusory ideals of equality, populist approaches or pragmatism, i.e. lacking principles, until liberalism diminishes to the degree that it leads to the disappearance of wealth. This will provide some political forces with enough support to change direction.

It will take time. Capitalism, however, basically requires market order, to quote Hayek, the coordination of means done in an impersonal manner, but influenced by everyone’s endeavor to reach a series of goals every day. If the market order is stifled, capitalism will no longer generate the past levels of wealth.

RC: Lucian, thank you very much for your views.


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