Kabhi Capitalism, Kabhi Socialism…

Some of you think that I have suddenly turned socialist (or I am probably revealing my true self now) because I think that free vaccines against covid for everyone is a good thing.

Yes, I can afford popcorn at a multiplex, I can even afford the most expensive multiplex tickets in India. But that’s not the point here. The pricing strategy of vaccines is not about me or you for that matter, it is about the nation at large, and that is the context in which my writing on vaccines should be seen.

Economics to me is not mathematics as it is to many people. I believe in looking at the context and then writing what I think is right. And a free market doesn’t work in every context. 

I have explained this in my pieces in great detail (you can read them here, here and here). Those interested in an informed argument can read the pieces. Those who aren’t, well, you have already decided which side I am on. And any amount of reading won’t change that. 

Last year when the covid epidemic broke the Indian economy’s back, I suggested increased allocation to NREGA and money being put in Jan Dhan accounts, in the very first piece I wrote on rebooting the economy. 

This is not something a firm believer in free markets would suggest. But I did. Because I thought it was important in the situation we were in. The government implemented these steps (not for a moment i am saying that they did it because I suggested them). Later on, I also suggested that India needs an urban NREGA.

I also suggested that the government should cut the GST on automobiles by 10% and cut the rate of income tax, so that people would be incentivised to spend more (the government didn’t do anything like that). These would have been seen as pro-market moves. 

But all along my thinking was how can more money be put in hands of people, irrespective of whether it was socialism or capitalism. The brackets don’t interest me. 

Over the years, I have also believed that rates of taxes on all forms of incomes should be the same (for which the stock market guys have really abused me in the past). 

When covid broke out, the government decided to put a price cap on airline tickets. I didn’t see any of you free market guys saying anything against the government limiting the price of airline tickets. Why should that be done? Who travels by air in India? Do I need to specify that? All the talk about incentive now. Is incentive only important for Serum Institute? What about Indigo, Spice Jet, Go Air, Air India? Unka kya?

But a vaccine can be sold at any price.

The point I am trying to make here is that if you thought I would be doing free market free market all the time, then I didn’t lead you there. You only saw the things that you wanted to see. 

It is easier to understand someone once you have bracketed them, identified them to believe in a certain kind of ideology. I get that. But then that’s not my problem. You thought I was the right echo chamber for you, clearly, I am not. There are lots of echo chambers on the internet, you can easily find one, where you fit.

I believe in what the former Bank of England and Bank of Canada Governor Mark Carney, writes in his new book Value(s): “ideologies are prone to extremes, capitalism loses its sense of moderation when the belief in the power of the market enters the realm of faith“.

If you don’t understand what this means, I suggest you read the third volume of my Easy Money trilogy. 

I can only say that any of the isms of economics are not an ideology for me. We have all seen what strong ideological beliefs can do to any country.

If you still don’t get it, again, that’s not my problem. 

Why Capitalism Won

Âûñòóïàåò Ãåíåðàëüíûé ñåêðåòàðü ÖÊ ÊÏÑÑ Ìèõàèë Ñåðãååâè÷ Ãîðáà÷åâ. XX ñúåçä ÂËÊÑÌ. Êðåìëåâñêèé Äâîðåö ñúåçäîâ.

After the end of the Second World War, the Soviet inspired communism and socialism started to spread through large parts of the world.

Some of it (the communism bit) was pushed by the Soviets themselves with the weight of their big army. And some of it (the socialism bit) the countries adopted on their own. India is a good example of the latter trend.

In fact, for a very long time, the bet was that the Soviets would win and the Soviet economy would become larger than the American one. But that never materialised. In fact, this idea was even a part of the most read economics text book during those days, written by the American economist Paul Samuelson.

As Daniel Acemoglu and James A. Robinson write in Why Nations Fail – The Origins of Power, Prosperity and Poverty: “In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012.”

But nothing like that happened. By the time Mikhail Gorbachev became the General Secretary of the Soviet Union in 1985, the Americans and the rest of the West, had won. Gorbachev was more practical than the previous Soviet leaders and even launched the policies of glasnost (“openness”) and perestroika (“restructuring”) to get the moribund Soviet economy going.

The story goes (and it is perhaps apocryphal) that Gorbachev sent a key aide to London to learn a thing or two about what the British were doing well, which the Soviets clearly weren’t.

The British played good hosts and Gorbachev’s aide was taken for a tour of the city with places like the London Stock Exchange and the London School of Economics being on the itinerary.

As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “After a few hours, the Soviet expert burst out: ‘Just one moment, please… We have been going back and forth across London for a whole day now, and there’s one thing I cannot understand. Back in Moscow, our finest minds are working on the bread supply system, and yet there are such long queues in every bakery and grocery store.”

Gorbachev’s aide was surprised that in London there were no lines in front of supermarkets and shops for bread, even though millions of people lived in the city. The aide ended up saying: “I haven’t seen a single bread queue. Please take me to meet the person in charge of supplying bread to London. I must learn his secret.”

Of course, it need not be said, there was no one in charge for supplying bread to the city of London. And this is precisely why there were no queues. As Donald J. Boudreaux writes in The Essential Hayek: “There is no overarching—no “central”—plan for the whole…That larger outcome is… spontaneously ordered.”

This is precisely the secret of success of capitalism. Unlike in communism there was no central processing unit to supply bread to the city of London. As Harari writes: “The information flows freely between millions of consumers and producers, bakers and tycoons, farmers and scientists. Market forces determine the price of bread, the number of loaves baked each day and the research-and-development priorities.”

And this is why capitalism won at the end of the day. As Harari puts it: “Distributed data processing works better than centralised data processing, at least in periods of accelerating technological changes…When all the data is accumulated in one secret bunker, and all important decisions are taken by a group of elderly apparatchiks, you can produce nuclear bombs by the cartload, but you won’t get an Apple of a Wikipedia.”

Or even a Facebook for that matter.

The column originally appeared in Bangalore Mirror on October 26, 2016


Capitalism and the common good

thomas piketty

Thomas Piketty is a professor at the Paris School of Economics. Over the last few months he has become the most talked about economist globally with the release of the English edition of his book Capital in the Twenty-First Century (The Belknap Press of the Harvard University Press). The original was written in French.
Capital has been the second best-selling book on Amazon.com for a while now. This is a rarity for a book which is not exactly a bed time read and runs into 577 pages (without including the nearly 80 pages of notes). But that is not a surprise given the important issues the book tries to address. In this book Piketty deals in great detail about the “distribution of wealth”.
As he writes “The distribution of wealth is one of today’ most widely discussed and controversial issues. But what do we really know about its evolution over the long term? Do the dynamics of private capital accumulation inevitably lead to the concentration of wealth in fewer hands, as Karl Marx believed in the nineteenth century? Or do the balancing forces of growth, competition, and technological progress lead in later stages of development to reduced inequality and greater harmony among the classes…?”
In this interview he speaks to Vivek Kaul. Kaul is the author of the Easy Money trilogy which deals with the evolution of money and the financial system and how that led to the current financial crisis. The second book in the trilogy Easy Money—Evolution of the Global Financial System to the Great Bubble Burst releases in June 2014.


You write that “It is an illusion to think that something about the nature of the modern growth or the laws of the market economy ensures the inequality of wealth will decrease and harmonious stability will be achieved”. Why is that incorrect? Has capitalism failed the world? Capitalism and market forces are very good at producing new wealth. The problem is simply that they know no limit nor morality. They can sometime lead to a distribution of wealth that is so extremely concentrated that it threatens the working of democratic institutions. We need adequate policies, particularly in the educational and fiscal areas, to ensure that all groups in society benefit from globalisation and economic openness. We want capitalism to be the slave of democracy and the common good, not the opposite.
A major part of your book deals with how capitalism leads to inequality…
History tells us that there are powerful forces going in both directions — the reduction or the amplification of inequality. Which one will prevail depends on the institutions and policies that we will collectively adopt. Historically, the main equalizing force — both between and within countries — has been the diffusion of knowledge and skills. However, this virtuous process cannot work properly without inclusive educational institutions and continuous investment in skills. This is a major challenge for all countries in the century underway.
What is the central contradiction in capitalism? How does that lead to inequality?
In the very long run, one powerful force pushing in the direction of rising inequality is the tendency of the rate of return to capital rto exceed the rate of output growth g. That is, when rexceeds g, as it did in the 19th century and seems quite likely to do again in the 21st, initial wealth inequalities tend to amplify and to converge towards extreme levels. The top few percents of the wealth hierarchy tend to appropriate a very large share of national wealth, at the expense of the middle and lower classes. This is what happened in the past, and this could well happen again in the future. According to Forbes global billionaire rankings, top wealth holders have been rising more than three times faster than the size of the world economy between 1987 and 2013.
That clearly is a reason to worry. Why are you confident that in the years to come economic growth rate will be lower than the return on capital. What implications will that have on capitalism and the inequality that it breeds?
Nobody can be sure about the future values of the rate of return and the economy’s growth rate. I am just saying that with the decline of population growth in most parts of the world, total GDP (gross domestic product) growth rates are likely to fall. Also, as emerging economies catch up with developed economies, productivity growth rates are likely to resemble what we have always observed at the world technological frontier since the Industrial revolution, i.e. between 1 and 2% per year. With zero or negative population growth, this suggests that total GDP growth rates will fall much below 4-5%, which has been the typical value for the average rate of return to capital in the very long run.
So what is the point that you are trying to make?
My main point is not to make predictions, which by nature are highly uncertain. My main point is that we should have more democratic transparency about how the different income and wealth groups are doing, so that we can adjust our policies and tax rates to whatever we observe. As long as top groups grow at approximately the same speed as the rest of society, there is no problem with inequality per se. But if the top rises three times faster than the size of the economy, you need to worry about it.
Your book is being compared to Karl Marx’s Capital. How different is your work from his?
One obvious difference is that I believe in private property and markets. Not only are they necessary to achieve economic efficiency and development — they are also a condition of our personal freedom. The other difference is that my book is primarily about the history of income and wealth distribution. It contains a lot of historical evidence. With the help of Tony Atkinson, Emmanuel Saez, Abhijit Banerjee, Facundo Alvaredo, Gilles Postel-Vinay, Jean-Laurent Rosenthal, Gabriel Zucman and many other scholars, we have been able to collect a unique set of data covering three centuries and over 20 countries. This is by far the most extensive database available in regard to the historical evolution of income and wealth. This book proposes an interpretative synthesis based upon this collective data collection project.
Any other differences?
Finally, Marx’s main conclusion was about the falling rate of profit. My reading of the historical evidence is that there is no such tendency. The rate of return to capital can be permanently and substantially higher than the growth rate. This tends to lead to very high level of wealth inequality, which may raise democratic and political problems. But this does not raise economic problems per se.
One of the most interesting points in your book is about the rise of the supermanager in the US and large parts of the developed world and the huge salaries that these individuals earn. You term this as meritocratic extremism. How did this phenomenon also contribute to the financial crisis?
According to supermanagers, their supersalaries are justified by their performance. The problem is that you don’t see it the statistics. In the US, between two thirds and three quarters of primary income growth since 1980 has been absorbed by the top 10% income earners, and most of it by the top 1% income earners. If the economy’s growth rate had been very high, rising inequality would not have been such a big deal. But with a per capita GDP growth rate around 1.5%, if most of it goes to the top, then this is not a good deal for the middle class. This has clearly contributed to rising household debt and financial fragility.

 (Vivek Kaul can be reached at [email protected])

The interview originally appeared in The Corporate Dossier, The Economic Times on May 23, 2014 

‘Capitalism is not as smartly managed as cricket’

Roger Martin is the Dean of the Rotman School of Management at the University of Toronto, in Canada. In 2011, Roger Martin was named by Thinkers 50 as the sixth top management thinker in the world. He is the author of several best-selling books like The Design of Business: Why Design Thinking is the Next Competitive Advantage (2009), The Opposable Mind: How Successful Leaders Win Through Integrative Thinking (2007) etc. His latest book is Fixing the Game, Bubbles, Crashes, and What Capitalism Can Learn From the NFL (2011) in which Martin argues that there is a lot capitalism can learn from the world of sport. In this interview he speaks to Vivek Kaul.
Your book “Fixing the Game” is essentially a criticism of western capitalism. What’s the central idea behind the book?
The central idea is that capitalism made a conceptual error when it asserted that the interests of executives would be aligned with those of shareholders if executives were given stock-based compensation. It was a simple and elegant theory – that if shareholders did well, so would executives and if shareholders did poorly, so would executives – but it turns out to produce the exact opposite. Overall, shareholders have done less well and CEOs have done spectacularly better. There has been dis-alignment, not alignment.  The current theory threatens the future of capitalism.  It produces inauthenticity in management, volatility in the capital markets and contributes to the strength of forces detrimental to broad prosperity – in particular the hedge funds.
What is the game that needs to be fixed? And why?
The title is double entendre.  It means that there are people manipulating, or in the betting parlance, ‘fixing’, the current game of democratic capitalism and we need to fix it in the sense of repairing it. It needs to be fixed now because the current game of democratic capitalism is being undermined.  Capitalism can only take so much undermining until it is irreparably damaged.
One of the things that you talk about in your book is a real game and an expectations game. Can you take us through that?
The real game is the one in which real companies build real factories (or service operations), to make real products (or services), to sell to real customers, to earn real revenues and a real profit (or loss).  The expectations game is the one in which investors look at the real market and, on the basis of that observation, form expectations as to the likely performance of the real companies and, on the basis of those expectations, buy or sell shares which collectively sets the prices of those companies in the stock market. Since stocks tend to sell for a large multiple of present earnings – 15 times earnings for the SENSEX over the long term – most of the value of a given stock is in the expectations of future earnings rather than the reality of the current earnings.
What can capitalism learn from sport?
Capitalism can learn a lesson from all of modern sport – whether American football or Indian cricket for that matter.  Each major spectator sport actually involves a real game and an expectations game. In the real game of cricket, batsmen, bowlers and fielders take a real pitch and play real wickets, make real outs and score real runs. Eventually there is a real winner and real loser.  There is an associated expectations game: betting on cricket matches.  In this game, betters imagine what will happen when the teams take the field and on the basis of those expectations place their bets. On the basis of those bets, bookmakers adjust the odds against the favorites and for the underdogs to balance the amount of money bet on either side.
So what are you trying to suggest?
The betting odds in a cricket match are identical to the stock price in capitalism – both are products of the expectations market. But that is where the similarity ends. The world of sports is clear about the relationship between the expectations market and the real market: they must be kept separate. If they are not kept separate – i.e. if players in the real game are allowed to participate in the expectations game, they will wreck the real game.  Cricket fans know that from the 2010-1 betting scandals in cricket in Pakistan.  There key players were accused and tried for influencing the results of real games to aid bettors in making illegal profits in the expectations game. In great contrast to the world of sport, capitalism not only allows, it insists on the key players in the real market also playing in the expectations market.  CEOs and other key executives are forced to take a significant portion of their compensation by way of stock-based compensation. In doing so, capitalism threatens the health of the real game.  On this front, capitalism is not as smartly managed as cricket.
How does this entire idea of “real game and expectations game” contribute to the kind of volatility we have seen in the last ten years?

When executives have substantial stock-based compensation incentives, they focus on managing expectations rather than managing the real operations of their company. If an executive is given a stock option with an exercise price at the existing trading price of the stock (the way the vast majority of stock options are priced and given), the only way that option will have any value for the executive is if he or she raises expectations of the future earnings of the company to a higher level than what they are at the time of the stock option award. That means if expectations are already high, then the executive needs to take actions to prod those expectations even higher still – even it is takes extreme actions. And because expectations cannot rise forever because they get ahead of reality, executives know that the most profitable thing that they can do for themselves is jerk expectations up and then leave before they come plummeting back down.  This creates wild swings in the capital markets of the sort we have seen in the past decade.
Could you give us an example on how this real and expectations game would play out in a company like Google and Microsoft for that matter?
At Microsoft, its stock dropped dramatically after the dot.com meltdown like many other technology stocks.  But thereafter, Microsoft spent the next decade doubling its sales and tripling its profits for an entire decade.  Despite that spectacular performance, Microsoft stock price stayed flat over the entire decade.  That is because expectations were already high at the start of the decade and even with impressive growth and profit increase, Microsoft couldn’t increase expectations. Similarly, Google recently reported a large increase in sales and profits yet experienced a drop in its stock price because it didn’t meet its expectations.  Both demonstrate how the real and expectations markets often diverge.
What about a company like Procter and Gamble?
Like all companies, P&G faces similar schisms between expectations and reality.  At times, expectations get too high and then fall too low.  However, this is less pronounced at P&G because it has a culture of focusing more on the real market than the expectations market which has served it well over time.
So how do we separate expectations and reality in business?
It is impossible to completely separate expectations from reality.  Humans cannot help but form expectations; even animals do.  If you feed a pet dog at the same time of morning for a week, it will be pawing at your bedroom door at that exact time the next time you sleep in past the usual time. However, one form of expectations is dramatically more damaging and those are the expectations of hordes of investors, especially hedge fund managers and high frequency traders. Only publicly-traded companies are exposed to the detrimental effects of that form of expectations.  The best way to avoid exposing your company to the expectations market is to be a private company – like Cargill or Koch Industries.  Facebook prospered for a number of years as a private company, then went public and felt the wrath of the expectations market.  It is unclear whether Facebook will be able to pursue its strategy as a public company in the way it did as a private company as it faces investor wrath for having its stock price plummet after its IPO.
One of the things that comes out in your book is that despite all the regulations that have been put in place after the crisis of 2008, you still feel that it’s only a matter of time before another crisis hits us. Why do you say that?
I do not believe that the regulations that have been put in place or are being put in place the cause of the last two crashes. The theory of Sarbanes-Oxley was that lax boards and audit committees and conflicted auditors caused the dot.com crash and the Enron/WorldCom/Aldephia, etc. scandals. And theory of Dodd-Frank is that excess bank leverage and mixing of commercial banking and investment banking caused the subprime meltdown.  I do not believe that those theories are even remotely accurate. In my view, inappropriate mixing of the real market and the expectations market contributed centrally to both crashes and neither Sarbanes-Oxley or Dodd-Frank address that problem. For that reason, I think that the risk of another crash continues to build. All I am confident of is that the next crash won’t be because of an Internet-bubble or sub-prime residential mortgages.  Any other cause is as likely to precipitate a bubble/crash as it was before the various regulatory changes.
This entire about paying CEOs well in terms of the stock of the company was put forward by Michael Jensen in the 1970s. And it was lapped up left right and centre. What was the reason behind its popularity?
I believe that it was lapped up because it was incredibly simple and compellingly logical.  The alignment theory sounds so lovely – shareholders and executives win together and lose together. It was so easy to understand that people gobbled it up rather than first asked themselves to work through the consequences of it in a more sophisticated way. Essentially they ignored a logical fallacy.  The theory held that executives were gaming the system to their own advantage but implicitly assumed that they would stop gaming the system to their own advantage after the proposed change. There is nothing to suggest that such a behavioral change would occur – and indeed they have kept on gaming!
How was it responsible for the current state of things?
The central thrust of the Jensen argument was that the real market needed to be wedded directly to the expectations market through stock-based compensation.  The minute those two markets were tied together, democratic capitalism was changed from an enterprise that was primarily focused on building value in the real market to one primarily focused on trading value in the expectations market.
What went wrong with that idea?
The tool was wrong.  Attempting to increase shareholder value over the long term is not a bad idea.  Utilizing the short term stock price as a perfect measure of long term shareholder value was the error. This enabled craven executives and hedge fund managers to exploit the schism between the short term measure of shareholder value and the long term creation of shareholder value.
So is banning stock options a way out? Has any company done it?
Many companies have moved from utilized stock options as their form of stock-based compensation to deferred share units or restricted share units, which are in essence synthetic versions of the underlying stock which go both up and down with the movement of the underlying stock.  They are an improvement over stock options because they result in the executive feeling both the downside and upside of stock movements rather than only the upside.  However, it still focuses the executive on the expectations market. There is a trend toward deferring them for longer periods which also makes it harder for the CEO to exploit short-term movements.  But no public company of which I am aware has banned stock-based compensation entirely.
So what is way out? You talk about boards rewarding their employees based on real outcomes and not expectation oriented outcomes. Could you elaborate through an example?
Real outcomes are things like market share, return on invested capital, customer satisfaction, etc.  The most important real outcomes vary by company and depend on the company’s context. Most companies use these measures as part of their compensation structures.  What needs to happen is for companies to raise these measures from part of their incentive compensation packages to 100% of them.

The interview was originally published in the Daily News and Analysis on October 8,2012.
(Interviewer Kaul is a writer. He can be reached at [email protected])