Friday, 21 February 2014

Capitalism Deniers: The myth of 'market failure'

Nicholas (Lord) Stern, former World Bank chief economist and author of the 2006 British government-commissioned Report on the Economics of Climate Change, reared his ennobled head again last weekend to point out that the fact that roughly a third of Southern England lay underwater was “a clear sign” of climate change.

The flooding in England is likely to play a similar role to that of Hurricane Sandy in the US – nature’s way of cutting through ideological conceits in a fashion that no amount of rational debate can achieve. Milton Friedman’s “brute experience” is trumping ideological preference again, though in ways he never imagined.

Stern’s intervention was, nonetheless, seen as a rational retort to the angry band of climate deniers, and on a more unconscious level, a reassurance that, beyond the media flotsam, those in the higher echelons of power really do “get it”. However, despite his reputation as the voice of reason, Stern, I believe, is a leader of a different band of unreasoned deniers – those that deny the effects of capitalism. And, disturbingly for the future of the planet, this band has far more adherents than the ones who think the polar ice caps are melting because of increased heat from the sun.

“Climate change is the greatest market failure the world has ever seen,” proclaimed Stern famously in his 2006 report. The headline use of the phrase might seem, on the surface, to mark Stern out as an enlightened critic of capitalism. Indeed, since he effectively minted the term for general use, meaning examples of markets working against, not for human welfare, “market failure” has become a meme, trotted out with metronomic regularity whenever instances of markets damaging general welfare occur. And that means a lot of trotting.

In early February when revelations broke that a third of the food consumed in Britain may not be what it claims on the packet, the man in charge of the government’s review of the horsemeat scandal, warned that the nation was at risk of “market failure”. The spiralling of inequality, which has seen just 85 people in the world controlling more wealth than half the world’s population, is frequently portrayed as an outbreak of market failure. The neo-Keynesian economist Ha-Joon Chang says that the managerial classes “manipulate the market” guaranteeing themselves enormous executive pay rises that bear no relation to performance. Last October, the New Statesman magazine encapsulated falling wages, a few companies controlling the energy market and extortionate housing rents as “market failure on a grand scale”.

But, in truth, “market failure” is a superlative example of newspeak that would have made George Orwell proud had he coined it. For these market failures are not, as is implied, regrettable aberrations requiring governmental correction, but simple and predictable market outcomes.

Market outcome No. 1 – Climate change

“When free markets do not maximise society’s welfare,” opined an article in The Guardian newspaper in 2012, “they are said to fail and policy intervention may be needed to correct them. Many economists have described climate change as an example of market failure.”

The reason is that greenhouse gases are an externality. A company may produce a product people want but as a result of producing it, or transporting it, will emit greenhouse gases. And the effect of these emissions will fall on people on the other side of the planet or future generations. That is why Nicholas Stern said climate change was the greatest market failure the world had ever seen. The gaping hole in this argument is that externalities, of which greenhouse gases are a prime example, are not by-products of capitalism that can be washed away by government regulation. They are an integral and unavoidable part of its functioning. A report for the UN in 2010 found that one third of the profits of the world’s top 3,000 companies, some $2.2 trillion, would be wiped out if they were forced to pay for the use, loss and damage to the environment they cause. And more than half of that $2.2 trillion total, was attributed to damage caused by the release of greenhouse gases. Force corporations to give up a third of their profits and you will essentially destroy them – no-one will invest in them because the profits will be so meagre. That is why no government or pan-government authority, like the EU, will ever insist that corporations pay for all externalities, or they stop producing all externalities.

This has been brought into sharp relief by the immensely fragile state of the world capitalist economy. The priority of government policy around the world is not to impede economic growth, even if growth stubbornly refuses to return to anything like the levels of 40 years ago, which only, ironically, strengthens the desire not to impede growth. It is for this “reason” that the UK government has backed such fundamentally anti-environmental policies such as the car scrappage scheme and fracking. And most people, under this system, have clear incentives to support such short-term, growth friendly policies, overriding any concerns they have about climate change that is now happening all around them. Executives just work for the profit maximising interests of their corporate employers. The interests mean constantly inventing new needs and requiring consumers to upgrade to new technology. In 2006, the late Apple boss, Steve Jobs, the man who “anticipated technological desires you didn’t even know you had”, urged customers to buy an iPod every year to keep up with advancing technology.

The vast majority, meanwhile, simply need jobs and incomes so are materially dependent on the success of those corporations. “Economic growth is in the immediate interest of virtually every sector of society – growth in the straight-forwards sense as measured by GDP,” notes American mathematician David Schweickart in his book, After Capitalism. That’s why leftists say the problems caused by capitalism are systemic. They are not the result of greed or stupidity.

Growth is thus endemic to a capitalism that functions remotely effectively. It is illuminating that carbon emissions fell for the first time in 50 years in the immediate aftermath of the financial crisis, when growth stopped happening, but have since started rising again as a fragile recovery has taken hold. Growth of 3% a year means a doubling of the size of the economy every 23 years and, according to a professor at London’s Imperial College, “each successive doubling period consumes as much resource as all the previous doubling periods combined.” 3% growth may seem ambitious for western countries, but it isn’t for “emerging economies”. About a dozen have grown at around 7% a year for the past quarter century. Since 1978, since the beginning of its transformation from communism to capitalism, the Chinese economy has trebled in size.

The dangerous fiction peddled by capitalism deniers such as Nicholas Stern is that you can have economic growth and reduce greenhouse gas emissions at the same time. Stern says the world needs a low carbon industrial revolution, which is undoubtedly true, and that China is leading the way in developing low carbon technologies. But China also boasts 16 of the 20 most polluted cities in the world and chronic air pollution – two-thirds of urban residents in China are breathing air that is severely polluted. China occupies a pivotal place in the world’s capitalist market economy, whereby its factories assemble the parts and components made in other countries (like the iPhone) in order to export finished products back to the West. If you want to impede global warming, never mind halt it, that process, I would suggest, has to be severely curtailed. But it is at the crux of many corporations’ supply chains because Chinese workers are so much cheaper than those in the West. Under a globalised market, growth and global warming will inexorably continue.

Stern, who is chair of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics, would do well to listen to the man who founded that Institute, the investor (and arch capitalist) Jeremy Grantham. “There is no such thing as sustainable growth” he said in 2011. “You have to make a pick. You can have sustainability or you can have growth, but you can’t have both.”

Market outcome No. 2 – Inequality

A new book by the French economist Thomas Piketty, Capital in the Twenty-First Century, “defies left and right orthodoxy”, says the New York Times “by arguing that worsening inequality is an inevitable outcome of free market capitalism”. Analyzing data from over 20 countries, Piketty concludes that that the owners of capital inevitably become increasingly dominant over, and richer than, those that own merely their own labour. Only “confiscatory tax rates” can reverse this trend in mature economies. A division between those who own capital and those can only sell their labour (the system of wage labour), it should be noted, is the essence of capitalism.

Piketty says that inequality is driven by a structural feature, integral to capitalism: returns on capital exceed, usually, the rate of economic growth. The more “perfect” the market, he says, the higher the rate of return on capital and the greater the resultant inequality.

This analysis cuts through orthodox economic thinking in two ways. Firstly, it contradicts the conservative faith that the free market will naturally distribute “the fruits of economic progress among all people.” It won’t, as is becoming abundantly clear. Secondly, Piketty says that traditional liberal or social democratic antidotes to inequality – public spending, taxation and regulation – won’t dent it. Government can’t, even if it wanted to, reverse this form of market failure. You have to go, I would suggest, to the root of the issue; the lack of power most people have when bargaining for pay from employers.

Inequality has become extreme in many western countries, notably the US and UK, as trade unions have been edged out, or forcibly removed, from the picture. Trade unions are the grit in the ointment of pure free market capitalism. They entail collective, as opposed to individual, bargaining. Countries that have not destroyed trade union influence, and thus retained collective bargaining, have far less inequality. Chief executives in Norway, for example, earn less than double the average wage. 70% of workers are covered by collective bargaining there, compared to 29% in the UK.

So individual bargaining - the ‘tao’ of a free market - leads to grossly inflated inequality. While it is portrayed as paying people what they are worth, individual bargaining merely results in the wages and salaries that people are able to negotiate. Those at the top of society have the negotiating strength to insist they are paid, not what they are worth, but vastly more than their contribution to company or organisational performance. “When pay setters set their own pay, there’s no limit,” says Piketty. FTSE chief executives can negotiate ever-rising pay settlements, while wealthy investors sit back and receive the fruits of the returns on their investments.

This is not about the manipulation of the market, but a reflection of where market power lies. It is not a market failure, not a 'power grab' by the wealthy as Oxfam imagines, nor a “perversion” of the market, as right-wing journalist Charles Moore would have it. It is a market outcome. The same imbalance of power means that the “confiscatory tax rates” that Piketty posits as a redress to inequality will not be allowed to happen.

Market outcome No. 3 – Oligopoly

Oligopoly means the dominance of a small number of firms in particular markets that work to prevent smaller firms entering it, as a result of their strong position, and hike up prices to captive consumers. As the New Statesman magazine observed in 2013, the energy market in Britain is the epitome of an oligopoly. Six companies rule the roost and have presided over increases in electricity prices of 120% over the past decade. While energy costs have risen by less than inflation over the past year, the typical bill has shot up by more than £100.

The problem with ascribing this state of affairs to market failure is that it’s a pretty ubiquitous kind of failure. Oligopolies are also conspicuous in the UK in public transport, car manufacture, banking, outsourced government services and supermarkets – to name a few areas. The value of mergers and acquisitions, globally, hit a peak of over $4 trillion in 2007. The effect of mergers and acquisitions is to create larger and larger corporations and strengthen oligopoly. The process is, in other words, is getting worse. “The result of all this merger activity has been a decline in the number of firms controlling major industries,” write the authors of The Endless Crisis, a book about how monopoly capitalism causes economic stagnation.

It was one Karl Marx who first noticed the pronounced tendency towards concentration in capitalism. Competition leads firms to either drive their rivals to the wall or take them over and thus results in its antithesis, monopoly and oligopoly. It is possible for the government to insist that oligopolistic markets are broken up – the British Labour party wants to introduce more competition into a banking system in which five banks possess 85% of current accounts, for example. But should this fragmenting occur, the counter-veiling market trend will immediately kick in. Competitive markets are not natural to capitalism.

A strange philosophy

The market failure doctrine shines a light on the intellectual dead-end of European social democracy and American liberalism. They recognise – how could it be otherwise? - the anti-social impacts of markets but can’t surmount a fatalistic acceptance that those anti-social impacts, like the poor, will always be with us. Only a benevolent state, it is believed, can intervene to mitigate the situation. Social democracy is a ‘bonkers’ way of running an economy, Doreen Massey, co-founder of the Soundings journal, said recently. “First you produce a problem, then you try and solve it”. Is it too utopian to suggest that you should endeavour not to produce the problems in the first place?

This practical utopia requires radically re-organised systems of production and markets. I don’t want to underplay the problems. The externality issue that is central to the dilemma of climate change would not be resolved by worker-controlled firms or companies that involve the local community in how they are run. If the effects of global warming fall on people on the other side of the world or not yet born, there is no inherent reason why these firms should be attentive to them. But climate change will never be addressed by the globalised market economy of corporate capitalism. The interests of the environment and the interests of shareholder-owned  corporations, legally obliged to maximise profit, are in irresolvable conflict.

What the centre-left offers, at best, is the state as fireman, dousing the flames wherever they arise yet remaining oblivious to who is setting the world on fire. It is time to recognise that the fireman, even if he has an unwavering commitment to duty, is not up to the task.


  1. Brilliant piece - made me laugh aloud whilst wincing at the insanity and injustice of it. A good approach to make us laugh through our tears! Lots of killer facts here - how long did it take you to put together? And how did you know to go for the UN report, were you already familiar with it? It rather sweeps the carpet from under the feet of Stern et al...

    1. Many thanks for the comment, I'm glad somebody reads the blog! The UN report I just read about in the paper when it came out and kept the link. If my local library hadn't stopped buying the Financial Times two years ago, this blog would be better informed. I think it took about a day or two to write. Writing's not a problem but assembling the facts and links takes time. Wish I had the time to post more.