India’s problem of crony capitalism
The rise of modern capitalism in India in the 1990s was at first viewed in optimistic terms. A new breed of companies were born, who seemed to exhibit a new kind of competence, international competitiveness and high ethical standards. We could start putting our old mistrust of corrupt business houses behind us.
These hopes were substantially dashed by the fresh emergence of crony capitalism. Doing business in many areas in India involves an extensive interface with the government. In these areas, the weaknesses of the State generated an opportunity for crooks. At first, the financial system sent massive resources into dubious companies, with an attitude of being blind to anything but profits. When these companies controlled vast resources, and were shown the promise of even bigger valuations to come, they embarked on systematically undermining the State. Through this, we got a feedback loop: The crooks came up where the State was weak, and their activities further undermined the State.
In some cases, we saw rotten companies spring up in one part of the economy where the State was weak, and once these companies were up and running, they turned their attention to related fields and devoted themselves to undermining State institutions in related fields. Through this, the gangrene spread from one area to the next.
In the the early 1990s, we could hope that India would smoothly moving up to the ranks of middle income countries, powered by world class local companies in addition to global companies building operations here. These hopes have substantially receded. The heart of the Indian story is now about the feedback loop between rotten companies and the State. If we manage to bootstrap ourselves out of this, we have a bright future. But will be be able to bootstrap ourselves out of this? Many countries got mired in this `middle income trap‘: we shouldn’t assume that our destiny is rosy.
At first blush, stopping the rotten companies seems infeasible. These are typically efficient and competent firms in a day to day tactical sense. They are staffed with hard-driving amoral people (typically incentivised very strongly using high-powered incentives), who fully understand the weaknesses of the system and attack it. Considerable resources are invested into subverting politicians, bureaucrats, judges and the media. The Indian system is rotten and ripe for attack. It’s like computer criminals attacking Microsoft Windows. Resistance is futile. Indian capitalism is doomed.
There is, however, an array of homeostatic forces in place which are generating push back. Some crooked companies have faced enforcement actions by arms of the State. In some cases, India has had good discussions in the public domain which has generated checks and balances. In addition, while many people are devoid of ethics and will support the latest nouveau riche entrepreneur who is throwing cash around, a large number of people get revulsed by the sight of this, and quietly and doggedly refuse to cooperate.
Enforcement in India does not work perfectly. The key point of this blog post is that medium grade enforcement has far reaching implications. The key insight is to look at the way the goals of labour and capital (i.e. investors and employees) are reshaped by medium grade enforcement.
The perspective of the investor
The enforcement push back against rotten firms is yielding results. Many crooked companies have grossly underperformed the index. Some have experienced enforcement actions and have experienced jaw-dropping returns. Some have experienced dogged opposition from pockets of high ethics in the system, which have effectively led to systematic and sustained under-performance of the index over five- and ten-year periods. The stock market has become wary about ethical issues. As Shekhar Gupta says in the Indian Express yesterday:
If you draw a simple chart of the large companies that have lost the most value on the stock markets over the past three years, you’d notice that almost all of these were doing business on the same cusp of politics, finance and natural resources. To that extent, you have to admit that the market has been the first to sense the rot and has applied a stunning self-correction, severely punishing those responsible for it.
There was a time when investors used to be oblivious about ethical standards of portfolio companies. The attitude of the investor in the 1990s used to be I don’t want to know how you do business; I will hold my nose since you stink; but as long as you will produce returns, I will happily invest in you. This attitude has been thoroughly broken. The investors who pursued such strategies have often been devastated. Even if you have only 10% invested in a crooked company, if you get -80% returns on it, this generates a -800 basis point returns drag on your overall portfolio performance. As a consequence, portfolio managers have started caring about the ethical standards of portfolio companies.
Enforcement does not have to be 100% perfect for it to impact on the decision making of investors. Even if there is only a 10% chance of getting caught and thus getting -80% returns, that is a big risk from the viewpoint of the investor. From the viewpoint of the investor: Why take the risk? Why not make a thorough analysis of the ethical standards of a company one element of the security selection process?
The problem of freedom of speech
Journalism is printing
what someone else does not want printed.
Everything else is public relations.
– George Orwell.
India is supposed to be a liberal democracy, and a free press is supposed to write vigorously about misdeeds (link). By and large, this has not worked out as it was meant to be. On one hand, it is quite easy for the bad guys to corrupt the media. Whether this is done through gifts of shares to a media company, or through advertising and sponsorship, it is fairly easy to obtain a supportive media. In addition, defamation is a criminal offence in India: a legacy of colonial law that we have not yet been bright enough to undo. Putting these together, the bad guys have a nice combination of carrot (throwing money at the media) and stick (litigation).
Analysts and financial intermediaries are supposed to make a living out of spotting problems in firms. Here also, there is quite a bit of corruption which impedes speaking freely. Few are willing to go against the latest nouveau riche entrepreneur who is throwing cash around, including his efforts at buying respectability. The mainstream strategy is to participate in the gravy train, and look for ways to part the fool and his money.
This is a real shame: India should be much better than China in the role of freedom of speech acting as a check against corporations. However, the Indian media has largely caved in the face of carrot and stick: it is largely doing public relations.
At the same time, there is strong demand among investors for skills in identifying the crooks, given that this is an important investment fundamental. The problems of the conventional media and financial firms, which inhibit naming the crooks openly and in the public domain, has created a business opportunity in this space. Supply has come up to fill this demand; a new breed of companies has come up, reflecting this need. Examples of firms with these capabilities include Ambit Capital, Veritas Investment Research, Forensic Asia, and Espirito Santo. Numerous investors are building in this analysis into their portfolio process, and this is helping to channel capital away from dubious companies.
Foreign firms seem to be more prominent in this field of research and analysis from the viewpoint of ethical standards, because they are relatively immune to the problems of intimidation through courts and police in India, and because they are relatively cutoff from the reciprocity that binds everyone in the world of business in India. See Veritas’ report on Indiabulls has put in contrast the research by India-based analysts in the Economic Times by Uday Khandeparkar. But even they are not immune to the problems of the Indian legal system. Now we have a new investment tool: sell shares of the companies that embark on such litigation.
The weaknesses of freedom of speech in India have thus emphasised a greater role for information processing and analysis away from Indian shores. I am reminded of what is going on in China, where some of the most important short sellers who are bringing out the misdeeds of Chinese companies are located abroad: it’s too dangerous to do the same things within China. We in India are evolving towards a similar structure of information processing.
The perspective of the employee
In the modern world, a vital determinant of the success of an enterprise is the kind of people it is able to attract. Here also, at first, there was a relatively amoral attitude on the part of most young people: I don’t want to know how you do business; I will hold my nose since you stink; but as long as you offer me the highest wage, I will join you. But over the years, it has been demonstrated that this is a bad strategy:
- The sight of senior employees going into Tihar Jail has given out powerful messages to everyone in Indian companies that good people should not hang out with crooks.
- The second phenomenon is reputational damage. It makes business sense for an individual to engage in fair play. I have been in recruitment conversations where a person is being discussed but his name gets shot down as he has not been careful about the company that he keeps. Birds of a feather flock together. I recently heard a senior person say: “I knew XXX was a rotten firm when a bunch of corrupt people from SEBI joined it”. Low ethical standards in people and in firms go together; a cloud of mistrust envelops them.
- Gradually, as regulators develop and refine the doctrine of `fit and proper’ such people will increasingly suffer career damage. We aren’t fully there in Indian finance yet, but it will increasingly be the case that a name is shot down for a CEO position because he was part of a team that was caught doing nasty things by SEBI or RBI.
- These factors are particularly important for the best and the brightest. If you are the best and the brightest, why would you suffer even epsilon risk of going to jail? Why would you run with crooks if this could hamper your rise to CEO? Why would you suffer reputational damage, and not be able to hold your head high at your class reunion?
These factors are inhibiting the flow of talent to dubious companies. I know of several situations where a person was made an offer, and chatted about this with his friends, and turned it down. It was just too much of a risk to be seen in the wrong company.
Second rate people recruit third rate people. Once a firm is contaminated with a series of low grade staff at senior levels, it becomes increasingly hard to draw in top quality talent, which drags down capabilities all across the board.
I believe this is one of the factors which has generated systematic under-performance in the stock price of dubious companies. It isn’t just the case that they are in danger of enforcement actions. It is also the case that on an every day basis, they find it harder to operate well given that they generally fail to recruit as well as their competitors.
How might Indian capitalism develop?
If the crooks had thundered ahead producing super-normal stock market returns, and attracting the best talent, I would have been truly gloomy. What is fascinating about the Indian story is that things have worked out differently. Some dubious companies have cratered with -80% returns over short periods. Others have generated substantial under-performance when compared with the index over 5- and 10-year horizons. The best people are avoiding rotten companies. Putting these together, the bad guys are finding it difficult to obtain both capital and labour, which are seeking out better firms.
Wall Street tells Main Street what to do. At a time when the investors did not care about ethical standards of portfolio companies, and only asked for earnings growth, this sent out powerful signals into the economy (a) Favouring rotten firms and (b) Encouraging rotten entrepreneurs to setup firms so as to harvest the opportunities available by selling shares. We got a precipitous collapse of ethical standards in India in the last decade in India, partly because that is what a financial system that was oblivious to ethical standards was encouraging. Some of the most rotten companies rose to the top. Now that the investors and the employees are seeing things differently, this is sending out signals into the economy (a) Favouring healthy firms and (b) Encouraging healthy entrepreneurs to setup firms so as to harvest the opportunities available by selling shares. We will also see some chameleons turn a new leaf: You will see the oddest of characters preaching purity.
Vishal Kampani pointed out a remarkable fact to me: Some of the biggest successes of the last decade have been the old `Bombay Club’ companies. All too often, they have outperformed when compared with the hard-driving unethical nouveau riche entrepreneur. What is going on? I would conjecture that there is a survivorship bias. A large number of different strands of corporate DNA compete. Over the long run, the survivors are those where elements of policy and strategy are of a certain kind. The old rich of the `Bombay Club’ are not paragons of virtue, but they have developed certain good practices which are conducive to survival and stock market returns.
I am reminded of the mighty German Wehrmacht in the Second World War. At the level of tactics and operations, it was second to none. In the short run, it generated the most amazing achievements in battle. After the campaigns from September 1939 till December 1941, many contemporary observers thought that Germany was unstoppable. But at the same time, Germany was making profound mistakes at the levels of strategy and policy. No amount of operational art could overcome those fundamental mistakes in strategy and policy.
In similar fashion, we tend to get very impressed by the hard-driving take-no-prisoners nouveau riche entrepreneurs and their hypercharged sidekicks. Their dynamism and willingness to play dirty seems to be unstoppable, particularly given the weaknesses of politicians, bureaucrats, judges and media in India. But it appears that in India, these strengths in tactics and operations have often been unable to overcome fundamental mistakes in strategy and policy. Indian capitalism is not doomed.
Rajdeep Sardesai on the problems of law and order in Bombay. Nothing is more important in the priorities of the State than the police and the courts.
In recent weeks, we’re seeing fresh attention on the flaws of the HR processes of government. Shashi Tharoor in the Indian Express on the IFS, and Sundeep Khanna in Mint.
Trampling on the individual in India:
- Sending cartoonist Aseem Trivedi to jail is ridiculous.
- Vijaita Singh in the Indian Express about the government interfering in grants to think tanks, followed by an editorial on this.
- As Robert Kaplan says, underdevelopment is where the police are more dangerous than the criminals. Here’s a story about the police in Gurgaon.
- Meghan Davidson Ladly writes in the New York Times about the struggle for freedom that many women in Pakistan are facing. We can’t say we’re finished with this. What fraction of India faces this level of social backwardness?
N. Sundaresha Subramanian has a great first draft of history, telling the story of Sahara in the Business Standard. This is a great vindication for K. M. Abraham and C. B. Bhave, and a reminder of the importance of the recruitment process in government. Also see great reportage on Firstpost : Sahara will have to sell realty assets to pay off investors by Raman Kirpal; ROC: The dog that did not bark when Sahara came in by R. Jagannathan.
I recently blogged about checks and balances that will keep Indian capitalism safe. I guess I am picking up ideas from the zeitgeist. On related themes, see: The old India is dead. Wake up, netas and business babus by R. Jagannathan on Firstpost; A long way from 1984 by Pratap Bhanu Mehta in the Indian Express and an editorial Behind the curve in the Business Standard.
Many people in India like to invest in gold and in real estate. I would like to remind them that the analytical case for these is weak. Here is some new evidence on gold, and here are some older arguments about real estate.
Sunil S. in Pragati magazine about India’s electricity grid problem.
Mobis Philipose in the Mint writes about an intruiging development: a `Intermediaries and Investor Welfare Association (India)’ has filed a petition in the Delhi High Court alleging that algorithmic trading is bad. I wonder who is behind this.
On the theme of the transformative impact of google maps, see How Google Builds Its Maps, and What It Means for the Future of Everything by Alexis C. Madrigal.
Sebastian Mallaby has a great response (originally in the Financial Times) to the Apple-Samsung patent violation case. If you’re in the US, you need to run, not walk to buy cool Samsung equipment, or buy it when you travel abroad.
The Euro crisis is back from vacation by Adam Davidson, in the New York Times magazine.
If Xerox PARC invented the PC, Google invented the Internet by Cade Metz in Wired magazine.
Why sex could be history by Kira Cochrane in the Guardian, about a new book by Aarathi Prasad.
Some of the biology that we learned in high school is getting overturned.
As is often the case, it’s from dL, author of the Liberale et Libertaire blog. And the reason it’s the quote of the week is that brings together several things I’ve been thinking about in a way that I hadn’t managed to yet:
Our age of State Capitalism-intertwined in a million different knots with a political economy of State Security-promises to sever the remaining myth: the relationship between capitalism and opportunity, or the “opportunity society.” To be more precise, we are about to be given an object lesson that there is no logical relationship between Capitalism and Markets. The collapse of this paradigm, of course, is conveniently timed with the maturation of our State Security Apparatus. The reason you have a National Security State, of course, is largely because of a loss of legitimacy. Our era of State Capitalism will be marked by a general decline in popular sentiment regarding legitimacy. But our “bleeding heart libertarians” seek to reposition libertarianism as the legitimizing face of State Capitalism. You know the thing that served to hollow out your political freedom while reneging on its bribe of eternal economic growth. Now that’s quite a historical turn.
I’ve been kind of outlining a piece I’d intended to call “Why I am not a ‘Bleeding Heart’ Libertarian.” Now I’m not sure I need to bother.
Capitalism is currently undergoing its most serious crisis since the Great Depression. The solutions offered by the Right are the same as they were then: Do nothing and let the natural cycle of business (the invisible hand of the free market) straighten itself out. Well, that’s not going to work. Hoover did that for three years and had nothing to show for it. Rooseveldt’s [sic] approach of course made sense. Recessions and depressions mandate an activist state and its massive intervention, otherwise, you’re in Hell forever. But then, I’m a Keynesian, eh?
First, we have a little bit of term conflation to start things off. If capitalism is defined as anything approaching the free market, then what’s happening right now in America is not a crisis of capitalism. Corporatism, maybe.
Or the-electorate-wants-all-the-benefits-of-socialism-without-actually-paying-for-it-or-allowing-the-government-to-regulate-them-ism (aka magical-rainbow-unicorn-ism). At any rate, the current crisis is not one of capitalism, the free market, or laissez-faire, because none of those actually exist outside of theory in America these days.
Second, Hoover was not laissez-faire by any stretch of the imagination. Unless laissez-faire now means interventionist statism. The difference between Hoover and Roosevelt is like the difference between Bushitler and Obamao: it’s of degree, not kind.
Third, the solutions offered by the right are not, so far as I know, “do-nothing.” They might be non-interventionist, but that now requires removing market impediments (which, it should be noted, is the very definition of doing something). At any rate, most of the right’s proposals ten to be along the lines of reducing* taxes, deregulating* businesses, and reducing* spending.
There are probably other fallacies I’ve overlooked. If so, point them out in the comments.
*Note that all of these words are verbs, which are action words. In essence, each of these words means doing something.
Will you allow this question to “occupy” your minds for a moment? Seriously, what would happen to our country if we all chose to do nothing but take up space on “public” property (or even on other people’s private property as some of you have done), consume resources at other people’s expense, and spend several days in a row not producing things? Have you even thought of what might happen, if the rest of us followed your “example?”
Well, I suppose it would first depend on who all quit their jobs. If every politician, bureaucrat, and bankster quit their jobs, I would be willing to bet that everyone would considerably better off. Toss in superfluous workers that are only necessary because of government interference, like tax lawyers, compliance officers, safety managers, CPAs, etc., and suddenly this country wouldn’t be shackled in economic regression. As for everyone else, point taken.
However, it should probably be pointed out that many OWSers are able to OWS because they don’t have jobs. See, the funny thing about recessions, even those caused by massive government intervention leading to housing bubbles which are then exploited for massive profit by Wall Street banks who are defrauding home owners as well as Americans by using the Fed as an ATM machine, is that jobs tend to be more scarce. And when that recession turns into a depression, those scarce jobs don’t come back for a while. So, for the most part, Occupy Wall Street is not a matter of people quitting their jobs as much as it is a matter of people not having jobs in the first place because the government, acting as a pawn of the banks, decided to wreck the economy.
Participants in the nationwide “occupy” movement would probably be shocked to know this. But the fact is, their oh-so-important demonstrations are able to occur as they do because the majority of us in America do not think and act the way they do. In fact, to be even more precise, their choices are enabled in no small part by – gasp!- American-styled Capitalism! Yet just as those who burn the U.S. flag fail to understand that the object they desecrate is emblematic of the freedom they exercise, the occupiers fail to see that the “C-word” which they loathe is precisely what makes their occupying possible. [Emphasis added.]
Actually, it is the distinctly American form of crony capitalism, as typified by TARP and other recent bailouts, that led to the current set of choices OWSers face. The banks have looted the American economy, quite illegally, it should be noted (and note that the linked article only concerns itself with judicial rulings, not investigative allegations, which means that the assertion of fraud was either proved in a court of law or admitted to by the perpetrators!) Jobs are scarce because politicians had to tax small business and mid-sized businesses to death in order to fellate pay off the major banks that have bought them contributed to their campaigns in the past election cycles. And the cost of those taxes have been jobs that would have otherwise be filled by those currently OWSing.Quite simply, the free market is dead in America, and has been for decades. The result is exceedingly high unemployment—the U6 index indicates it’s been in the high double digits for some time—which is the direct result of massive government intervention in the economy, for the benefit of enriching the banks. This is in no way free-market capitalism. In fact, a certain someone has noted quite acutely that America doesn’t actually have a free market, in practice. Yet, said someone wants to act as if suddenly the market is perfectly free and all the decades of government intervention no longer have consequences and therefore all those who are currently OWSing are simply socialists who want to redistribute the wealth.
But yes, American-styled capitalism has not only made OWSing possible, in that it has eliminated productive jobs, but it has also made it necessary because the system is corrupt and redistributionist.
Also, in regards to the burning of American flags, could Mr. Hill please provide proof of this occurrence? I searched on Google for photographic evidence of OWSers burning the American flag, but all I could find was the occasional desecration, and a few instances of burning the Israeli flag, presumably in honor of Ben Bernanke. I would very much like proof that OWSers are actually the anti-American protestors that the conservative media make them out to be.
(For those who are interested, Karl Denninger has a rather thorough takedown of Thomas Sowell’s article on OWS.)
Like A Financial Analysis of al-Qaeda in Iraq, this book is rather technical and highly academic in approach. Unsurprisingly, it is a rather boring read for the most part. Furthermore, the book isn’t particularly insightful.
There were some who apparently claimed, presumably around the time this book was written, that capitalism was responsible for causing and perpetuating apartheid and racial division. Williams seeks to correct this misconception, and does so quite adequately by pointing out how it was government legislation that created, enabled, and perpetuated apartheid and the corresponding racism.Williams’ arguments are not unique or original, in a sense, because racial biases can, and have been, easily corrected on the free market by the “inferior” race offering lower prices for their labor. The reason this didn’t happen in South Africa was because the government forbade competition, or elsewise severely hindered it.
Williams’ book, then, is useful primarily as an academic resource. It is not easy or enjoyable to read, part of which is due to the structure of the book. For me, it only reinforced my beliefs in the general equitability of the market. I imagine that the same will be true for those who are inclined to read this. My recommendation is to only read this book if you are doing research on South Africa or apartheid.
I was talking to a preacher buddy of my dad’s a while ago, discussing my future plans, and I told him how I wanted to be an economist. Being a free-market apologist who had the audacity to challenge him on his favorable views of unions (from a historical perspective), he felt compelled to tell me that while he was pro-capitalism, he thought that some restrictions were necessary.
His argument for interfering in the market was based on how God had interfered with the free market under the old law. Specifically, he cited how God required that farmers leave remnants in their fields for the poor to borrow and how God forbade the Israelites from charging their brethren interest on loans). Unfortunately, there are at least three problems with this line of thinking.
First, God presumably possesses more knowledge than any central planner would. This difference is crucial because it means that the Old Testament theocracy is not comparable to any human-devised system. The biggest difference between the two systems would be that the theocratic system would not face near the knowledge constraints that a human system would. As such, God could be reasonably sure of the future and plan accordingly; mere mortals do not have these powers and abilities and thus would not have the ability to plan out an economy.
Second, not even God’s command was enough to ensure compliance with regulations that would work in theory. Time and again, the children of Israel ignored God’s laws. (It should be noted that usury laws and gleanings laws are not the only “economic” laws. Mandatory sacrifices have an economic component, as do the various regulations on commerce and production.) There were multiple times when the Israelites failed to keep God’s commands, which goes to show that even the laws implemented by the Lord of Hosts can be violated. If God’s laws can be violated then how can we expect any different for man’s laws?
Finally, note that some of God’s laws were intended to be signs of the Abrahamic covenant (e.g. dietary restrictions). Also note that some of God’s laws were intended to be signs of the coming Christ (e.g. sacrificial laws). As such, a good portion of God’s interference served a spiritual purpose. Not all laws that interfered with the Israelite economy had spiritual significance, but some did, and it is not always easy to discern between the two (e.g. Lev. 19:19).
At this point, it should be obvious that the argument that God’s interference in the Israelite economy during Old Testament times justifies Man’s interference in any economy today fails because it is an invalid comparison, it neglects to consider how even with God non-compliance with economic statutes was possible, and it fails to consider to consider the spiritual component of some of God’s economic laws, which is also an invalid comparison.
In tomorrow’s episode of John Stossel’s new show on Fox Business, he will address the question, “Who is Wesley Mouch?” in speaking to the parallels between Atlas Shrugged and contemporary America. As one might expect, in my view it seems as if almost all businessmen (given their predilection towards using government to destroy markets to their own advantage) in one way or another embody the qualities of Wesley Mouch.
One exception who will be on Stossel’s program is John Allison, an executive at BB&T Bank, who staunchly opposed TARP, has repeatedly refused to use the law to plunder the property of others and as one might guess is an ardent Austrian-school libertarian. In a scene reminiscent of the smoke-filled rooms of Atlas Shrugged, Allison divulged at an NYU lecture this past fall that the Feds threatened to go in and audit any bank that wouldn’t take government funds, forcing healthy banks to comply so as to cover for the fact that the government was only propping up a select few sick ones (at the expense of the solvent I might add).
In response to Stossel’s call in the aforehyperlinked column for suggestions for a follow-up show on “crony capitalism,” I posted:
If you want to talk about crony capitalism, it may pay to have Burton Fulsom who wrote “The Myth of the Robber Barons” on the program. I think the key is to delineate between political entrepreneurs and market entrepreneurs, something which he does astutely in that book.
Political entrepreneurs seek to use government decrees to profit, largely by cartelization, monopoly advantages and other barriers to entry, while market entrepreneurs generally seek to win profits in the market by merit – by producing the best product at the cheapest price.
More generally, the Mouch problem lies in the fact that while initially businessmen extol the virtues of little regulation, low barriers to entry and minimal governmental interference generally, once they become successful, out of self-interest they support any and all legislation that will cement their position in the market. They support all of those things anathema to the free market that they had used to their advantage in the first place.
This is akin to the economic plight of America as a whole. While up until the early 20th century (though some libertarians will argue that it was really only up until the time of Lincoln), America functioned under a largely laissez-faire economy, with the wealth and progress generated by this economy, we forgot about the virtues that led to our success and rewarded those tending towards failure. We created a welfare state from the riches of a relatively free state, throwing under the bus the very principles that elevated to us to our position as a great nation.
Tuesday’s Hardtalk on BBC World News (link) discussed the political, economic and social aspects of communism versus liberal capitalism with Slavoj Zizek ,a philosopher and professor at European Graduate School.
Mr. Zizek discussed the role of liberal capitalism in the modern age. He condemned communism as a failure of the mankind and reaffirmed the liberal capitalism as the greatest invention of the mankind. The topic discussed was the future of liberal capitalism. In arguable words of Mr. Zizek, liberal capitalism, although dynamic and powerful in delivering ends of political and economic freedom, is doomed to fail and it thus requires new politico-economic alternative, divisible at the intersection of market and the state. Despite the interactive debate, I would like to add some points to the discussion which were, in my opinion, either mismatched or misinterpretated.
The evolution of liberal capitalism throughout the course of human history has been emphasized by the expansion of economic, political and human freedom. The greatest inventions in human history were not conducted under dictatorial political regimes. But they were conducted during the age of limited government and free innovation environment. Anytime the powerful wit of government was enforced, innovation and discoveries suffered. Although Mr. Zizek recognizes the failure of totalitarian regimes to stimulate intellectual creativity, his analysis of liberal capitalism inherently neglects its role.
The ability of individuals and firms to pursue their own goals in liberal capitalism is enabled not because of the design of desirable goals but because the free-market capitalism evolved as an undesigned system of ideas under strong rule of law. If liberal capitalism, as Mr. Zizek argues, would be doomed to fail, the individuals never witnessed an unparalleled increase in prosperity and in the 20th and 21st century.
What has distinguished communist political regimes from liberal democracies are the institutions of economic freedom. There is a clear and remarkably positive empirical relationship between economic freedom and standard of living. The experience has shown that political liberty is a neccesary but not sufficient condition for prosperity. Both, the neccesary and sufficient condition for the pursuit of prosperity is economic freedom. Without economic freedom, when governments replace the rule of law with the rule of man, and heavily interfere with free-enterprise activity, these countries are doomed to stagnate. Totalitarian political ideology, claiming to create heaven on earth, has always turned towards the hell on earth.
During the interview, Mr. Zizek argued several times that liberal capitalism can eat itself and fail in a similar vain as communism did. The Soviet Union and the communist block certainly hadn’t failed because of the lack of technological investment, but because communist political ideology erased the system of incentives. Even today, when several politically totalitarian countries sustained high growth rates, the superiority of liberal capitalism is even more obvious. The motion behind the economic miracle of Gulf countries, such as UAE, Bahrain and Qatar, is the institutional arrangement that promotes solid economic performance under robust system of law, market economy and incentives that allocate scarce resources into the most appropriate uses. In the interview, Mr. Zizek described Dubai’s miserable labor conditions as “labor concentration camps” where workers from other countries reside. Although this view sounds very compelling to Marxist philosophers and political thinkers, no government agency forced foreign workers to go to Dubai and work there.
In fact, the economy of United Arab Emirates went through a remarkable restructuring with the creation of the robust financial and service sectors. As productivity growth and capital investment soared in recent decade, wage rates in Dubai are much higher than in other Arab countries. Still in doubt? Ask foreign workers in Dubai how many of them would leave the place and returned to work in their home countries; and why they don’t do that. In addition, in Mr. Zizek’s home country, labor conditions for foreign physical workers mostly from ex-Yugoslavia are not the envy of the world despite the most regulated labor market in the world.
There is also a wide array of case studies from recent economic history that show how economic freedom crucially determines the wealth of nations. In 1955, Hong Kong was a miserable place flooded with refugees from the mainland China. In 1960, Hong Kong’s average income per capita was 28 percent of that in Great Britain. In 1996, it rose to 137 percent of that in Britain. Neither the dictatorial political regimes led to the economic boom in Hong Kong, nor the desire to create heaven on earth. It was a set of strong rule of law of British origin, limited government spending and free markets that propelled Hong Kong to the climb up the ladder.
Mr Zizek arguably enforced the proposition that global financial crisis led to the crisis of liberal capitalism. Although the global financial crisis led to the recession, high unemployment and deflating prices, it certainly has not put the existence of liberal capitalism into doubts.
The origins of the last year’s financial crisis go back to the New Deal and presidential time of Jimmy Carter and Bill Clinton whose administrations, as benevolent social engineers, enforced numerous acts to boost home ownership. Back in 1996, president Clinton signed Community Reinvestment Act which forced banks to allocate housing borrowings to low-income neighborhoods. In the aftermath, Fannie Mae and Freddie Mac securitized risky sub-prime mortgage loans to save banks from default. Meanwhile, they inflated debt-to-equity ratio to 60:1. It means that for deposit of USD, there were 60 USD behind in debt that nobody was willing to bear.
In addition, the monetary policy of the Greenspan era kept low interest rates for too long which causeed an asset bubble and led to the decrease of mortgage values It led to the federal bailout of Bear Sternes and the failure of Lehman Brothers. It also triggered innumerable quests for federal bailout of financial institutions. Thus, it would be foolish to speak about the crisis of liberal capitalism after the financial meltdown. Is liberal capitalism to blame? Of course not. It is rather the greedy political apetite for destructive policies that compromised the stability of the world economy for the sake of short-term political goals.
Mr. Zizek wisely avoided the question of the post-communist politico-economic status of Slovenia after the collapse of Tito’s Yugoslavia. True, Slovenia’s superior economic performance in Yugoslavia was mainly due to its export orientation and higher growth compared to the rest of Yugoslavia. At the beginning of the independence in 1991, Slovenia was, by all measures, the most developed former communist country; far ahead of countries such as Czech Republic, Slovakia and Estonia. Today, Czech Republic virtually caught-up Slovenia’s level of standard of living. In 2008, Czech Republic’s GDP per capita was 94 percent of that in Slovenia. In 1991, it was merely of 60 percent of that in Slovenia. The politicians, of the same “market socialist” politico-economic beliefs as Mr. Zizek, designed the statist economic policy based on high tax rates, state-owned enterprises, weak rule of law and rigid market structures. Today, Slovenia’s economic and political system more closely resembles Russia’s mafia state than a liberal society based on economic freedom, rule of law and limited government. In a great part, thanks to the political ideology of “market socialism.”