Crony Capitalism - the convenient explanation for our evasive times

In Spain they suffer from amiguismo. Greece is fatally afflicted with rousfeti. Japan has never outgrown the effects of keiretsu. In South Korea chaebols have been a perennial blight.

Beyond the superficialities of debt, bank collapse, and government bail-outs, these are the real causes of economic distress. In a London Observer article last week, John Carlin explained the Spanish “infantile” attitude to work and rampant “amiguismo” – “friendism” – were the “root cause” of economic collapse and an unemployment rate in the mid-20s.

In English, this malaise is known as crony capitalism.

The “Spanish disease”, Carlin said, is an economic system where advancement depends on who you know. Greece is similarly benighted by “rousfeti”, which means according to a 2011 BBC article, “political favours and cronyism”.

In Italy, so says the Wall Street Journal, even emergency room doctors get promotion on the basis of their political affiliation. Apparently, “one routinely finds highly intelligent people employed in menial jobs while mediocre people often hold distinguished positions,” (which actually sounds like bog standard capitalism).

Like a receding tide, economic recession has merely exposed these countries’ integral failings, the argument runs.

Crony capitalism and Europe’s economic miracle

History is good at placing contemporary explanations in perspective and Tony Judt’s 2010 Postwar: A History of Europe Since 1945 systematically exposes the truth about crony capitalism. Unfortunately there is scant solace for believers in the cancerous effects of crony capitalism. Because if history is any guide, as far as capitalist economic health is concerned, the cronier the better.

Judt explains how Austria was governed in the 1950s and ‘60s, a system known as “Proporz”. “At almost every level jobs were filled, by agreement, with candidates proposed by the one of the two dominant parties [People’s party and Socialists],” he writes. “Over time, this system of ‘jobs for the boys’ reached deep in Austrian life, forming a chain of interlocking patrons and clients who settled virtually every argument either by negotiation or else through the exchange of favours and appointment.”

Judt is clear this arrangement didn’t just apply to public services and the media, but “much of the economy” as well.

In Italy, the story was similar, possibly even more extreme. “Jobs and favours were created and delivered proportional to local, regional, national political clout,” Judt tells us “…. From the point of view of Economic Man the system was grossly wasteful, and inimical to private initiative and fiscal efficiency.”

What were baleful economic effects of this grossly wasteful system? Well, in Austria, Judt relates, per capita (per head) GDP rose, between 1950 and 1973, from $3,731 to $11,308. GDP per head in France grew by 150%. “The Italian economy, starting from a lower base, did even better.” Spain, then labouring under the time-warp of Franco’s clerico-Fascist dictatorship as well as doubtless rampant amiguismo, saw GDP increase from $2,397 to $8,739. These were, for all their sclerotic cronyism, “golden years” economically.

At the end of the twentieth century, in the wake of the East Asian economic crisis, the same underlying “reasons” were uncovered. And they made as much sense then. South Korea chaebols – family-owned corporations where “the managers are brothers and cousins and in-laws who steer business one another’s way and cover up mistakes”, according to the New York Times in 1998 – were blamed for an “outmoded form of crony capitalism”.

But this outmoded system had, prior to the 1990s, produced the highest rate of economic growth of any country in the world for three decades.

Infantile attitude to work

In his Observer article, Carlin says the Spanish “infantile” attitude to work is behind the country’s dreadful economic situation. Young Spaniards, he says, have flocked to London, where “pure merit” is rewarded. But, disaster! A similar malaise is eating through the work ethic in the UK. Most people, according to the new breed of Tory MPs, would rather spend half the day in bed obsessing about celebrities, that do a decent day’s wealth creation. This regrettable attitude explains poor productivity. Britons should be more like hard working East Asians, who doubtless have been victorious by now in banishing the predations of crony capitalism.

The trouble is, celebrity obsessions aside, things were even worse in the past. To return to Tony Judt, Britain’s economy, in the post-war era, suffered from the blights of innumerable craft unions each demanding separate pay rate and demarcating activities, terrible labour relations, and mediocre management that would not invest in research and development.

But despite these impediments, economic growth was much more successful. The British economy grew at an average annual rate of 3% between 1950 and ’73. After 1980, when the power of trade unions was destroyed, the rate has been 2.2%. Productivity growth – output per worker – has been 1.9% between 1980 and 2008. Between 1961 and 1973 – an era of awful labour relations and frequent strikes – it was 2.95%. In the three day week of 1974 production hardly declined at all.

Dissolve the people and elect another-ism

As far as I can see, three conclusions are possible from an honest appraisal of this comparative economic performance. One, attitudes to work and crony capitalism make absolutely no difference to economic success. Two, post-1980 changes, the war against trade unions, privatisation, the dominance of finance, have, despite eliminating inefficiencies in production, damaged the economy. Three, capitalism as an economic system is declining. It is simply less able to deliver economic growth, jobs and prosperity for most people.

But rather than face these issues, the right-wing (and not just the right-wing), unconsciously echoing Bertolt Brecht’s desire to “dissolve the people and elect another”, blames people for just not being good enough for the demands of the economy. The real tragedy is that, while this agenda dovetails perfectly with the corporate desire for a more efficient and obedient workforce, it obscures the causes of economic distress, which annoyingly, will not go away.

You supply the "reforms", we'll demand the revolution

There is a word that has been clasped with ideological zeal in the response to the current economic impasse, yet one with a decidedly retro feel: supply.

“It has now been more than thirty years since the supply-side revolution conquered Washington,” writes Thomas Frank in Pity the Billionaire, a book about the resurgent Right in the US. “And yet, as I write this, the most effective political response to these events is a campaign to roll back regulation, to strip government employees of the right to collectively bargain and to clamp down on federal spending.”

In Britain, there are the same rejuvenated supply-side obsessions: make millionaires and corporations richer and make it easier for employers to fire workers. All that is missing is a Spandau Ballet revival.

Supply has its familiar counterpart, demand. In simple terms, supply means the regulations and taxation affecting employers. Demand is the ability of people, mainly employees, to spend and consume.

But like a neglected sibling, demand is left to make its own way. While supply is lauded with gifts, demand is confronted with insurmountable obstacles. In the UK, real wages are dropping, benefits and tax credits are being cut and public spending is being slashed. The cost of gas and electricity has more than doubled in the past five years.

Only four years ago, demand, which had developed a chronic borrowing habit to keep pace with supply, faltered, plunging the Western world into economic crisis. But after a bracing cold shower, it obviously won’t make the same mistake again.

In economics, the conviction that if you nurture supply, demand will obediently follow, has a very long history. Back in the 1820s, it was known as Say’s Law – “supply creates its own demand”. But repetition doesn’t make it true. “All the supply-side solutions in the world will do little to aid recovery in the absence of growing demand for goods and services,” said the economist Ann Pettifor of George Osborne’s budget. “Nothing will happen if customers (of banks, firms, shops) simply cannot or will not walk through the door.”

The supply reflex is unfortunately not an Anglo-American delusion. Both Spain and Italy, aside from demand-choking austerity, are changing their labour laws to bring about more “flexibility”, a classic supply-side measure.

In Spain, labour market “reform” is taking place amidst some of the lowest wages in Europe and a 23 per cent unemployment rate (almost the same as the US during the Great Depression). “There's little doubt that in the context of a downturn, more flexibility means more lay-offs, more short-term contracts and lower wages,” writes one Spanish commentator, Miguel-Anxo Murado. “This will have the immediate effect of increasing earnings for employers, but this will come back to haunt them as households will have less disposable income. The employer's "wish-list" may turn into an employer's last wish.” A perfect example of supply-side reforms strangling demand - in economic terms, eating your own tail.

If a historical case-study was required, the same newspaper, The Guardian, provided one. The economist Ha-Joon Chang wrote of what happened in his home country, South Korea, in the aftermath of the Asian financial crisis of the late ‘90s. Economic deregulation was combined with a relaxation of labour laws. Employers, writes Chang, gained “a decisive upper hand over their workers. Many employees were sacked and re-hired as "agency" workers, doing the same jobs at lower wages.” Economic growth slowed from 6-7 per cent a year to under 4 per cent.

If another supply-side revolution makes no economic sense, then why do it? Murado believes that Spain’s newly elected right-wing government has to be seen to be doing something, even if that something is completely counter-productive. The familiar is a refuge from the unknown. The UK Conservative government has embraced again the prized policy of the 1980s, the “Right to Buy” council houses. The fact that now only 20 per cent of council house tenants are in full-time employment and it has been only five years since the sub-prime mortgage disaster hasn’t acted as a deterrent. It speaks, to put it politely, of an unwillingness to get to grips with reality.

But from the point of view of the controllers of this society, the senseless is also dangerous. If capitalism ceases to deliver rising living standards, its intrinsic features – a slave-like work discipline and exploitation (you work, they get) – will appear less and less tolerable. The management consultant Peter Drucker said in 1939 that “depression shows man as a senseless cog in a senselessly whirling machine which is beyond human understanding and has ceased to serve any purpose but its own”.

A system that has ceased to serve any purpose but its own, is an apt description of contemporary capitalism.

Most of all you've got to hide it from the kids

Review of 23 Things They Don’t Tell You about Capitalism

By Ha-Joon Chang

 It may have been uttered in 1980 but the meaning of Margaret Thatcher’s mantra, ‘there is no alternative’ is only now becoming clear. For the global elite there really is no alternative to corporate capitalism, even when that system is entirely discredited. Privatise, drive the sick into non-existent jobs, outsource public services to the private sector. More of the same medicine that nearly killed the patient in the first place.

Albert Einstein said a long time ago that you can’t solve a problem with the same kind of thinking that created it. As a matter of interest, Einstein was a socialist

Chang's 23 Things is an attempt to rouse the sleepers from their ideological slumbers. It is a sustained attack on the assumptions behind the economic thinking that has been dominant for the past 30 years. But it is not an anti-capitalist manifesto. It is an argument for a different kind of capitalism. 

Here is Chang talking about the ideas of the book:

Noam Chomsky once said that before you can change the world you have to understand it. He has described Chang as a “fine economic historian” and his respect stems from the fact that Chang doesn’t believe in convenient myths, such as the fallacy that rich countries have always believed in free trade 

In 23 Things the myth Chang attacks is that neoliberalism works. The raft of policies that constitute neoliberalism – tax cuts for the rich, degregulation for the financial sector, privatisation, dismantling of all protection against the  freedom to speculate in things like food and currencies – were sold as a pill that had to be swallowed because everyone would benefit in the end. But the result turns out to be all pain and no gain, or only gain for a minority.

Chang’s point is that neoliberalism, the way the world has been run economically for the last 30 years, has resulted in slower growth. In the 1960s and 1970s, when countries protected native industries and speculation was heavily restricted, the world economy grew at 3 per cent a year. In the post-1980 neo-liberal era, the growth rate is 1.4 per cent.

Britain, which exported many of neoliberal practices to the rest of the world, grew economically by 1.7 per cent between 1990 and 2009. But during the 1960s and ‘70s, when the country suffered from the “British Disease” of high taxation of the rich and strong trade unions, the growth rate was 2.4 per cent. Economically, neoliberalism is a confirmed flop.

Chang says that this failure has been masked by a huge expansion of borrowing and the fact that both partners in a household invariably work now. In the US, average hourly wages are barely more than they were in 1973.

The failure is even more dramatic in poor countries where a lack of democracy meant neoliberal policies could be imposed in a purer form. In the 1960s and ‘70s Sub-Saharan Africa grew at 1.6 per cent a year. But after 1979 these countries, through the World Bank and IMF, were forced to adopt neo-liberal policies.

Industries collapsed because of foreign competition. Countries were forced back to exporting basic commodities like cocoa and coffee and the large increase in supplies caused a collapse of prices. During the 1980s and 1990s income in Sub-Saharan Africa fell by 0.7 per cent a year. Only after this failure of neoliberal policies, Chang says, did excuses for African underdevelopment, such as laziness and too much ethnic diversity, gain currency.

The core justification for neoliberalism, that if you give corporations maximum freedom and make rich people richer, everyone will benefit in the long run, turns out to be just plain wrong. “We have to question an assumption that has dominated economic thinking over the last three decades” he says, “The belief that maximising market freedom is the best way to generate wealth.”

The economic rationale was that the investing class (corporations and the very rich) have to keep more of their money or they won’t invest. In plain terms, you have to create wealth before you distribute it.

In line with this dogma, there were tax cuts for the rich, exemplified by New Labour's cutting of capital gains tax to encourage investment. In the UK, after 13 years of a Labour government the richest   10 per cent paid less tax than everyone else. More money to shareholders only interested in short-term gains and executive salaries went through the roof.

But through it all, Chang says, investment fell rather than rose. Investment, as a proportion of national output, has dropped in all G7 countries and in most developing countries. “The rich got a bigger share of the pie all right, but they have actually reduced the pace at which the pie is growing,” he says.

Neoliberalism was also supposed to make the economy more stable. It was an alternative to the turbulence of the 1970s. But it’s feted taming of inflation was bought at a price of more instability. 

The financial crisis that has engulfed the world since 2008 did not “fall out of a clear blue sky" in the words of Bank of England governor Mervyn King. Despite what Gordon Brown wants us to believe, it was not the first crisis of globalisation but the latest.  

There were virtually no banking crises, Chang points out, between the end of the Second World War and the 1970s. In the 1980s, 5-10 per cent of countries had a banking crisis. In the 1990s, it was 20 per cent. After the latest financial crisis, the figure went up to 35 per cent of countries.

Why are banking crises more frequent? Because it is far easier to move capital around the world in search of quick financial gain than it was before the 1980s.

Job insecurity and intensity have increased. One in five private sector workers in the UK are employed by a company owned by a private equity firm.The purpose is to “restructure” the firm, frequently through mass job losses so it can be sold again for a profit.

As Chang shows, the logic of these economic changes, though presented as benefiting the majority, are just self-serving. The beneficiaries are the holders of financial assets. Greater labour market “flexibility” is needed because hiring and firing workers more easily enables companies to be restructured and sold more quickly. Capital mobility is required because higher returns are depended upon the ability to move financial assets around at speed.

But 23 Things is not anti-capitalist. Capitalism run in the interests of capitalists doesn’t work, says Chang, but it can deliver the goods if controlled in the public interest. Companies should be owned by shareholders interested in long-term investments. The shareholders might be representatives of the government or the workforce.

Governments should reassert their capacity to direct the economy. He gives the example of the South Korean government in the 1960s banning the LG group from going into the textile industry, as it wanted to, and compelling it to enter the electric cable industry. The result, decades later, is world-famous mobile phones.

Most of all finance should be reined in because it weakens productivity growth by directing resources to short-term gains. Complex products like derivatives should be banned, hostile company takeovers made more difficult, and restrictions reintroduced on the cross-border movements of capital.

If the “machine” of capitalism is properly regulated, says Chang, it can be force for good. Chang, a South Korean, can’t help but point to the success of the “Asian Tiger” economic model, before it dismantled after the 1997 Asian financial crisis. South Korea was a prime example with the highest economic growth rate of any country in the world for three decades.

The “Korean model” was based on preserving domestic ownership of its business conglomerates and joint planning between Korean banks and government ministries.

Chang points to the income growth rate of Asian Tiger economies (of which South Korea was one) of 6-7 per cent a year between the 1950s and mid-1990s. This “deserves to be called a miracle”, he says.

The only comparable country now is China. But, as Chang says in the introduction to the book, China, while liberalising its economy, has not introduced full-blown free-market policies.

Here lies the flaw in the Chang approach. 23 Things is an extremely lucid, persuasive account of why free-market economics fails on its own terms. Why corporations, shareholders and the very rich benefit, but investment is reduced and economic growth and productivity held down. In short, why neoliberalism is an ineffective form of capitalism.

The problem is that the world cannot take a miraculous form of capitalism. China has achieved double digit growth rates but it is also, according to the Guardian newspaper "the world's biggest greenhouse gas emitter, number one energy user and arguably most polluted nation on earth".  But if Chang’s prescriptions were adopted there would be 10 or 15 Chinas, in economic terms, around the globe. If what we have now is capitalist economic failure, thank heavens we don’t have success.

The limits of Chang’s thinking are seen in his take on Soviet communism. The communist central planning system failed because there were no markets, no-one knew what consumers really wanted. Many unwanted things were produced and the second largest cause of fires in Moscow in the 1980s was exploding televisions. There were, Chang says, many dedicated managers and workers who tried to make the system work. Despite this, it failed because of its unavoidable inefficiency. It was, institutionally, flawed.

Quite true, but what about capitalism? There are lots of dedicated managers and workers toiling away for corporations who don’t want to destroy the biosphere and who want to represent the interests of consumers. But what do they end up doing after their efforts are filtered through the profit-dedicated institutions that they work for?

It’s one of the things that they don’t tell you about capitalism that the needs of consumers aren’t represented by it. But Chang chooses not to contest this convenient myth. As economist Harry Shutt has noted conventional economics says that competition between enterprises means the customer gets the best deal because nobody buys bad products. In a market system, restaurants that serve terrible meals don’t survive.

 However the truth is that the customer is not always king, but there to soak up as many products as possible. The imperative is not what the consumer wants, but what he or she can be persuaded to buy. To that there is no limit. The aim is always to raise the level of consumption to the maximum that production will allow for, by advertising and credit, rather than adjusting production to satisfy what consumers need and want.

And despite the myth-busting quality of 23 Things there is one way in which Chang give credence to an idea that has become a convenient excuse for an establishment that wants to change as little as possible.

This is the idea of free-market economics that, in order to make its models work, treats all people as if they were purely calculating and selfish.

But self-interest is not all that counts. ““The bottom line is that companies, and thus our economy, would grind to a halt if people acted in totally selfish way, as they are assumed to do in free-market economics,” says Chang.

Chang gives the example of the work to rule, which reduces output by 30 to 50 per cent, to conclude that production depends on workers’ goodwill, and that they will go beyond what is required by their contracts.

This idea, that the roots of the economic crisis lie in a denial of capitalism’s moral dimension, has been expounded by UK Conservatives like Jessie Norman (see review below).

It has been seized on by people like Bank of England governor Mervyn King who has obviously read Norman’s book. Nissan, in Sunderland, asks all its workers how to raise productivity, he says.

Chang, as a supporter of Japanese and South Korean capitalism, would agree. But the obvious question is how do workers who help raise the profit levels of corporations like Nissan, benefit in return? The answer is that they don’t. It’s a one way exchange of give and then give some more.

People, who are workers and consumers, are naturally moral agents. Corporations aren’t. They are institutionally selfish institutions only interested, as institutions, in making profit. But humans, acting in moral way, keep the system working, and permit inhuman institutions to flourish.

It was the economic historian, Karl Polanyi, a great influence on Chang, who pointed out the obvious. He said that if workers followed faithfully the free market doctrine of only selling commodities at the highest price you can get, they should almost permanently be on strike. Because what they are selling is their labour and they should get the highest price for it.

The problem with capitalism isn’t that people are too selfish but that they are not selfish enough. Of course if people were truly selfish, capitalism would grind to a halt. Which would be a terrible shame.

The most pithy response to this question was made by the American community organiser, Saul Alinsky. He was asked by the President of a US corporation why he saw everything in terms of power and conflict instead of goodwill and cooperation, when he seemed such as nice guy personally.

"When you and your corporation approach competing corporations in terms of goodwill, reason and cooperation instead of going for the jugular, then I'll follow your lead," was his answer

But this is one lacuna in Chang’s assault on the triumphalism of neo-liberalism. His answer is that we should look back to the state capitalist economies of Japan and South Korea, and to the welfare economies of Scandinavia.

23 Things is an assault on conventional economics. But another unconventional economist, Harry Shutt, argues that we can’t go back. That capitalism, the incessant search for returns on investment, has become dysfunctional. For the sake of taxpayers and consumers, we need a more rational economic system. To his ideas, we turn in the next review.