Capitalism & Socialism - Lecture Series - Part IV - Notes

In this note, we will talk about the third major reason that triggers a downward spiral of capitalism and socialism - manipulated and immaturely introduced policies. It will be anyone's guess that this post will be an unabashed criticism of the policies advocated by World Bank and IMF. No other organization or institution across the globe other than World Bank/IMF possibly can lead to such devastation in established structures so easily.

In letter and spirit these institutions strive to propagate wealth creation and upliftment of the poor, improvement of Global economy etc. However in reality, many of the policies pushed by the IMF in particular has resulted in deep devastation and increased the rich-poor divide in countries. So why do then these institutions claim credibility? It is because of 2 reasons. One, is that the policies pushed by IMF do result in short term success - increased GDP growth. Two, is that these institutions are front face of developed nations and are promoted heavily and control the cash flow to support developing and poor countries.

What the IMF and World Bank fail to understand is that by loaning money with lot of conditionality to open up at a feverish pace, they are not just undermining the democracy in the nation that is struggling to survive, they are also creating unhealthy growth. This is like giving the highest dose of anti-biotic to someone with regular fever. He/She will immediately respond, only to fail in the longer term. These countries suddenly see enhanced GDP growth for a maximum of 10 years, after which they fail dramatically, because of the rapid privatization and opening up of economy, which has failed to create real wealth inside the country. Adding to this, the rich poor divide increases as well... Russia is a beautiful example of such a disaster. Policies should always be tied to comparative advantage of the nation, the willingness of developed countries with absolute advantage to truly support the developing/poor nation which is under brink of collapse, history, labor power, democratic structure, geographic advantages, social structures, primary expertise and other important factors.

And of course, IMF and World Bank need to realize that helping a developing/poor nation doesn't mean just ensuring that the creditors for the country are protected. The goal should be truly to ensure elimination of poverty and prevention of collapse of social structures in the nation.

Capitalism & Socialism - Lecture Series - Part 3 - Notes

This is continuing the lecture on Capitalism & Socialism and today we will see the second reason I had listed as a cause for failure of these systems - greed & impatience. If you were to hear the campaigns of Obama and McCain, then you cannot miss the phrase "greed of wall street eating the main street" from both of them. They are not far from the truth. It is greed and a dose of impatience mixed together that actually leads to failure of any good system.

Where does this all start? It is tough to point out. But we can safely say that it possibly starts with investors who take equity stakes with the idea of making a quick buck. Make no mistake - it is NOT just retail investors like you and me who want to double and triple our holdings in few months by investing in stock market. It is even the seasoned investors, big financial institutions who want to do this. Not everyone is Warren Buffet, after all!

So when these investors want to make this urgent profit, they push corporations to show successes in their business every single quarter. Not just that, they want every corporation to better itself every single quarter. This pushes the corporations to try and do whatever it takes to be a leader in the market. They hire some of the best brains with exhorbitant salaries hoping that their innovative & leadership skills will be useful in this never ending competition.

When smart MBAs join with skyrocketing salaries and corner offices with few or no previous experience in corporations, they are under pressure to show results. And then they start innovating "bad" things - In financial institutions, this leads to innovation of bad instruments like sub-prime lending, reverse mortgages etc. which take advantage of unsuspecting human behavior (which is coupled with little greed anyway). Thus a vicious circle is formed where investors are investing in nothing continiously. And when is it found that there has been no foundation and no pillars of support, the entire building collapses, taking everyone with it.

As you can see the impatience of investors and greed of investors, coroporate management play key role in the downfall of a capitalist economy.

While greed plays a major factor in downturn of capitalist markets, impatience plays a key role in destroying socialistic structures. For wealth to be divided and a propotionate share to go to every participant, it is important that wealth be created and economy becomes rich. Any attempt to bring fairness in the system by excessive controls will result only in a temporary mirage of success. In the longer run, this arrangement will not work out as it will push the nation into backwardness and will not help poor to rise out of poverty. In addition, this will also lead to lot of unrest as control structures inherently lead to corruption, pesudo dictatorship and inefficiencies.

Thus a combination of greed and impatience has the power to ruin both capitalist as well as socialist set-ups. It is not a joke when they say "Good things come to those who wait!"

Lessons from Collapse of Golden age of 1920s

Ilian Mihov, Professor of Economics at INSEAD, on the lessons of the collapse of the ‘golden age’ of the late 1920s.

What is the biggest lesson from the Great Depression? In my view, it is that monetary policy and the financial sector play a crucial role in economic development. Let me put it more precisely: good monetary policy is unlikely to accelerate the speed of economic growth – after all we have more income year after year because mankind comes up with new ideas, with new products, with more efficient ways of producing output. However, bad monetary policy can easily derail economic development. It is true for rich and poor countries alike.

Why are financial markets and the banking sector so important? Banks fulfill a very important role in the economy by matching borrowers and lenders. When we deposit $100 in a bank, the bank keeps, at most, two to three dollars in its vaults (in fact the money is often in the central bank), the remaining $98 or so is lent to a borrower.

Most businesses require loans for their normal operations. When the banking sector does not work properly, businesses cannot get loans and they have to curtail their production and lay off workers. As they curtail production, they demand fewer products from their suppliers and therefore their suppliers have to reduce their output and fire workers. If manufacturers cannot sell their goods because the firm downstream does not need as many products as before, they cannot generate enough revenue to repay their earlier loans. Businesses go bankrupt and banks experience further problems as their balance sheet deteriorates due to non-performing loans. At this point, banks want to lend even less because of the uncertainty generated from bankruptcies. As they lend less, the vicious circle continues – with producers cutting production and firing workers. On the top of this, depositors start worrying about their deposits because the non-performing loans have made some banks go belly up – your bank has lent out your money to borrowers who cannot return it. Depositors start withdrawing their cash and banks have even fewer possibilities for lending as they have to hoard cash in case there is a run on the bank. If the financial sector does not work, the real economy can go into a deadly spiral and shrink by 30 per cent as during the Great Depression.

Capitalism & Socialism - Lecture Series - Part TWO - Notes

Before we start, on a side note, there were at least 4 mails in my inbox after the posting of the previous part which said that I have missed out one of the most important reasons for failure of economic systems - Sudden Economic or Geographic variations - If there is a wide set of people who think that this is an independent reason enough, then I guess I would still humbly excuse myself with the opinion that while it is of course a significant risk to the economy, it still wouldn't classify as a strong enough reason for failure of the overall system.

Let us have a quick look at reason - 1 - do not complement each other sufficiently. There is a very popular phrase that is doing rounds these days that sums it all - Privatization of profits and Socialization of losses. While profit making companies strive to make more money and increase their net personal gains, sometimes by hook or crook, the burden of failure unfortunately seem to exist with taxpayer money. There have been discussions and blogs and talks on the "correctness" of such actions - I have myself talked against such rescue plans for the fear of encouraging blinded risk taking by institutions who have the comfort of a couch-catch during a free fall.

However such a support is imperative. No matter what we crib about the protection being extended to foolhardy greedy behavior it is an absolute must. What is missing however is the kind of regulation that will keep blind risks in decent check in this case. Every time when excessive greed and immature policies bring about a halt in the flow of wealth creation, leading to losses and slowdown, collective responsibility steps in to smooth the fall. This has happened time and again, thanks to the voice of West in protecting the capitalist system.

The reverse support however is not happening that common. When socialistic structures crumble, the World watches reporting this downfall in full steam. The West hails this as a failure of communism and the so called World saving financial institutions like IMF and World Bank watch this as an opportunity to impose their "liberalization" policies as soon as possible into the falling nation, not worrying about the fact that the country may not just be ready to face that.

But why does this situation occur in the first place? To put it simply, everyone in the world (nation) needs to get a fair share of everything. While capitalism creates wealth and makes the human race rich, one of the many downfalls of the system is that, by itself, it doesn't do anything to the rich-poor divide other than increasing the gap. Hence a definite structure like socialism has to set in to ensure that everyone gets a fair share of wealth created. There is nothing wrong with that. But the problem comes, when people begin to question - WHEN?

How long does one wait to get a fair share before it can be distributed? Europe suffered centuries of dark ages and so does Africa today. If people today need to work tirelessly now so that wealth can be created over a period of time and then distributed, every worker will feel left out of enjoying the wealth that he/she helped create. This feeling worsens when they see some set of people (burgeoise - upper class) enjoy the wealth already. The unrest created leads to communist principles set in and socialism introduced prematurely. So now the nation tries to bridge the gap between rich and poor without proper means to do so. While initially this looks to work because of the iron hand with which this gets implemented, slowly and surely this model is bound to fail as it doesnt stand on a stable platform where wealth has been really created.

(This principle is something many of us tend to follow even though we laugh at socialism/communism. Will any of our IT Services friends reading this blog will agree to an arrangement if their company said that they will have to work for the next 20 years so that their company can create wealth and become profitable and if profits are created, they will be shared with their children later. We will crib at the top management for drawing handsome salaries while we slog around to help them make money. We will demand equal share of profits, equal salay across employees etc.)

And that is why precisely both models must work together. When capitalism is going about churning money, socialism has to step in to ensure that the rich-poor divide does not go out of control. And if prematurely induced socialism starts to crumble, there must be way to infuse wealth into the system so that the socialistic structure can hold ground.

So when the statement gets repeated that Socialism failed, one needs to understand that it is only the shortcut and premature inducing that has failed. On the other hand, capitalism will also crumble in the same account if losses were not socialized or if the rich-poor divide goes unchecked.