Captialism & Socialism - Mini Lecture Series - Parts I thru V

Re- posting notes from Capitalism & Socialism - Mini Lecture Series (I thru V).

• Part I - Introduction
  
• Part II - Failure to complement
  
• Part III - Greed & Impatience
  
• Part IV - Immature policies
  
• Part V - Liquidity Trap
  

Capitalism & Socialism - Lecture Series - Part V - Notes

Today's post is about the infamous liquidity-trap. When I gave the lecture, this part was very well discussed with lots of interesting questions around this subject. If you are a fan of Prof. Krugman, you dont have to necessarily continue reading this post, as he has been too vocal about this for the past many months. 

But before stepping into the trap, let us look at one important factor - savings. Generally savings is a virtue and people are encouraged to save more. If there were no government intervention in the world (a free market capitalist dream), then this is what would happen - consumers will save more, which means they will spend less. This will automatically result in lower production of goods which reduces efficiency as well as workforce numbers and profits for companies. As a result, salaries will get lower for consumers and in turn, because of this, consumers will start saving even more. This will only detoriorate the situation further, giving rise to a vicious circle. 

However in reality, there are governments. And when there is lot of savings trying to pull down the economy, governments lower interest rates thereby boosting investments. These investments ensure that there is sufficient liquidity in the markets. Thus even though consumers save, the situation is not all that bad, as government tries to balance the act from supporting the investment angle.

Now let us come to the crux of the topic. What if consumers are continuing to save, there is little liquidity in the market and the interest rates are too low that they cannot be cut any more (or cutting them down wouldn't make much of a difference)? Such a situation is called the liquidity-trap. This is what Japan has found itself in; this is what the US is probably heading towards. The interest rates in Japan are already hovering around 1%. The US interest rates are also similarly at 1%. Even if Ben Bernanke of the Fed decides to cut the interest rates, how much can he? If he makes it to 0%, will that be sufficient to boost the economy?

This is a trap as we can see, which gives no clear traditional routes to help the economy bounce back. In such situations, bailout packages become clearly necessary and that is when socialization of losses occurs. (The free market capitalists do believe in these kinds of socialistic principles as it suits them!). Remember that we are not talking about a third world impoverished country here. We are talking about America, the world's superpower. And this is a nation that will not hesitate to initiate a World War III if it only means that it will boost their economy.

The advocates of free market capitalism fail to address clearly such complex situations. While in theory, everything is a resource and can be scaled up and down as the situation demands, it is just theory. In reality, such corrections do not occur so easy and so fast. An example is wages. While wage increase is a demanded norm (in any market), wage decreases to support the economy are not and they tend to be sticky. And I think this may be a good time to start thinking about what Keynes said.

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!"

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.

Capitalism and Socialism - Lecture Series Part -1 Notes

(Considering several questions around some of my thought process around liberalization, wealth creation and growth for all, I am going to present a condensed form of my lecture on this subject in "2 minute digest" series. This is the first part. Comments are welcome here or in any other forum as appropriate).

Capitalism and Socialism are 2 essential pillars of human eco-system. There is no one one model fits all in the Universe and both models back each other up. The obvious definition explains it all - Socialism ensures that everyone gets a fair share and Capitalism ensures that wealth is created so that it can be distributed. If it all that simple, then why do systems fail?

Systems fail because:
1. They do not complement each other sufficiently
2. Greed and impatience that is inbuilt in human instinct
3. Manipulated and immaturely introduced macro-economic policies

In the longer term, all three reasons play a equal role in failures; just that at some touchpoints one of them is highlighted more. In subsequent passages I will explain each one of them in detail.

Before we examine the structures of socialism and capitalism, it is imperative to understand that these social structures did not necessarily come out in the seventeenth century. While they have existed in preliminary forms (Robinhood was an early socialist!), both these structures came out as a fallout of the industrial revolution. As the industrial revolution laid the foundation to capitalism, it also led the way to a severe rich and poor divide, thus leading to a strong belief in socialism.

The second important fact is to realize that there has to be constant balance of one over the other. If either of the system progress on its own is unchecked, it will ultimately lead to a collapse because of a bunch of factors - most of which can be directly correlated to the three reasons stated above.

And the third important fact is to understand that International politics and diplomacy are not considered clearly in the underlying theories of these systems.

In the next part let us discuss the reason-1 in detail.