23 Things They Don't Tell You about Capitalism

by Ha-Joon Chang

  To free-market economists, public officials – politicians and government bureaucrats – pose a unique challenge in this regard. Their pursuit of self-interest cannot be restrained to any meaningful degree because they are not subject to market discipline. Politicians do face some competition from each other, but elections happen so infrequently that their disciplinary effects are limited. Consequently, there is plenty of scope for them to pursue policies that heighten their power and wealth, at the cost of national welfare. When it comes to the career bureaucrats, the scope for self-seeking is even greater. Even if their political masters, the politicians, try to make them implement policies that cater to electoral demands, they can always obfuscate and manipulate the politicians, as was so brilliantly depicted in the BBC comedy series Yes, Minister and its sequel, Yes, Prime Minister. Moreover, unlike the politicians, these career bureaucrats have high job security, if not lifetime tenure, so they can wait out their political masters by simply delaying things. This is the crux of the concerns that the World Bank economists were expressing in the meeting in Japan that I mentioned at the beginning of this Thing.

  Therefore, free-market economists recommend, the portion of the economy controlled by politicians and bureaucrats should be minimized. Deregulation and privatization, in this view, are not only economically efficient but also politically sensible in that they minimize the very possibility that public officials can use the state as a vehicle to promote their own self-interests, at the cost of the general public. Some – the so-called ‘New Public Management’ school – go even further and recommend that the management of the government itself should be exposed to greater market forces: a more aggressive use of performance-related pay and short-term contracts for bureaucrats; more frequent contracting-out of government services; a more active exchange of personnel between the public and the private sectors.

  We may not be angels, but . . .

  The assumption of self-seeking individualism, which is at the foundation of free-market economics, has a lot of resonance with our personal experiences. We have all been cheated by unscrupulous traders, be it the fruit seller who put some rotten plums at the bottom of the paper bag or the yoghurt company that vastly exaggerated the health benefits of it products. We know too many corrupt politicians and lazy bureaucrats to believe that all public servants are solely serving the public. Most of us, myself included, have goofed off from work ourselves and some of us have been frustrated by junior colleagues and assistants who find all kinds of excuses not to put in serious work. Moreover, what we read in the news media these days tells us that professional managers, even the supposed champions of shareholder interest such as Jack Welch of GE and Rick Wagoner of GM, have not really been serving the best interests of the shareholders (see Thing 2).

  This is all true. However, we also have a lot of evidence – not just anecdotes but systematic evidence – showing that self-interest is not the only human motivation that matters even in our economic life. Self-interest, to be sure, is one of the most important, but we have many other motives – honesty, self-respect, altruism, love, sympathy, faith, sense of duty, solidarity, loyalty, public-spiritedness, patriotism, and so on – that are sometimes even more important than self-seeking as the driver of our behaviours.1

  Our earlier example of Kobe Steel shows how successful companies are run on trust and loyalty, rather than suspicion and self-seeking. If you think this is a peculiar example from a country of ‘worker ants’ that suppresses individuality against human nature, pick up any book on business leadership or any autobiography by a successful businessman published in the West and see what they say. Do they say that you have to suspect people and watch them all the time for slacking and cheating? No, they probably talk mostly about how to ‘connect’ with the employees, change the way they see things, inspire them, and promote teamwork among them. Good managers know that people are not tunnel-visioned self-seeking robots. They know that people have ‘good’ sides and ‘bad’ sides and that the secret of good management is in magnifying the former and toning down the latter.

  Another good example to illustrate the complexity of human motivation is the practice of ‘work to rule’, where workers slow down output by strictly following the rules that govern their tasks. You may wonder how workers can hurt their employer by working according to the rule. However, this semi-strike method – known also as ‘Italian strike’ (and as ‘sciopero bianco’, or ‘white strike’, by Italians themselves) – is known to reduce output by 30 –50 per cent. This is because not everything can be specified in employment contracts (rules) and therefore all production processes rely heavily on the workers’ goodwill to do extra things that are not required by their contracts or exercise initiatives and take shortcuts in order to expedite things, when the rules are too cumbersome. The motivations behind such non-selfish behaviours by workers are varied – fondness of their jobs, pride in their workmanship, self-respect, solidarity with their colleagues, trust in their top managers or loyalty to the company. But the bottom line is that companies, and thus our economy, would grind to a halt if people acted in a totally selfish way, as they are assumed to do in free-market economics.

  Not realizing the complex nature of worker motivation, the capitalists of the early mass-production era thought that, by totally depriving workers of discretion over the speed and the intensity of their work and thus their ability to shirk, the conveyor belt would maximize their productivity. However, as those capitalists soon found out, the workers reacted by becoming passive, un-thinking and even uncooperative, when they were deprived of their autonomy and dignity. So, starting with the Human Relations School that emerged in the 1930s, which highlighted the need for good communications with, and among, workers, many managerial approaches have emerged that emphasize the complexity of human motivation and suggest ways to bring the best out of workers. The pinnacle of such an approach is the so-called ‘Japanese production system’ (sometimes known as the ‘Toyota production system’), which exploits the goodwill and creativity of the workers by giving them responsibilities and trusting them as moral agents. In the Japanese system, workers are given a considerable degree of control over the production line. They are also encouraged to make suggestions for improving the production process. This approach has enabled Japanese firms to achieve such production efficiency and quality that now many non-Japanese companies are imitating them. By not assuming the worst about their workers, the Japanese companies have got the best out of them.

  Moral behaviour as an optical illusion?

  So, if you look around and think about it, the world seems to be full of moral behaviours that go against the assumptions of free-market economists. When they are confronted with these behaviours, free-market economists often dismiss them as ‘optical illusions’. If people look as if they are behaving morally, they argue, it is only because the observers do not see the hidden rewards and sanctions that they are responding to.

  According to this line of reasoning, people always remain self-seekers. If they behave morally, it is not because they believe in the moral code itself but because behaving in that way maximizes rewards and minimizes punishments for them personally. For example, if traders refrain from cheating even when there is no legal compulsion or when there are no competitors ready to take away their businesses, it does not mean that they believe in honesty. It is because they know that having a reputation as an honest trader brings in more customers. Or many tourists who behave badly would not do the same at home, not because they suddenly become decent people when they go back home but because they do not have the anonymity of a tourist and therefore are afraid of being criticized or shunned by people they know and care about.

  There is some truth in this. There are subtle rewards and sanctions that are not immediately visible and people do respond to them. However, this line of reasoning does not work in the end.

  The fact is that, even when there are no hidden reward-and-sanction mechanisms at work, many of us behave honestly.
For example, why do we – or at least those of us who are good runners – not run away without paying after a taxi ride?2 The taxi driver cannot really chase us far, as he cannot abandon his car for too long. If you are living in a big city, there is virtually no chance that you will meet the same driver again, so you need not even be afraid of the taxi driver retaliating in some way in the future. Given all this, it is quite remarkable that so few people run away without paying after a taxi ride. To take another example, on a foreign holiday some of you may have come across a garage mechanic or a street vendor who did not cheat you, even when there really was no way for you to reward her by spreading her reputation for honest dealings – particularly difficult when you cannot even spell the Turkish garage’s name or when your Cambodian noodle lady, whose name you cannot remember anyway, may not even trade in the same place every day.

  More importantly, in a world populated by selfish individuals, the invisible reward/sanction mechanism cannot exist. The problem is that rewarding and punishing others for their behaviours costs time and energy only to the individuals taking the action, while their benefits from improved behavioural standards accrue to everyone. Going back to our examples above, if you, as a taxi driver, want to chase and beat up a runaway customer, you may have to risk getting fined for illegal parking or even having your taxi broken into. But what is the chance of you benefiting from an improved standard of behaviour by that passenger, who you may not meet ever again? It would cost you time and energy to spread the good word about that Turkish garage, but why should you do that if you will probably never visit that part of the world ever again? So, as a self-seeking individual, you wait for someone foolish enough to spend his time and energy in administering private justice to wayward taxi passengers or honest out-of-the-way garages, rather than paying the costs yourself. However, if everyone were a self-interested individual like you, everyone would do as you do. As a result, no one would reward and punish others for their good or bad behaviour. In other words, those invisible reward/sanction mechanisms that free-market economists say create the optical illusion of morality can exist only because we are not the selfish, amoral agents that those economists say we are.

  Morality is not an optical illusion. When people act in a non-selfish way – be it not cheating their customers, working hard despite no one watching them, or resisting bribes as an underpaid public official – many, if not all, of them do so because they genuinely believe that that is the right thing to do. Invisible rewards and sanctions mechanisms do matter, but they cannot explain all – or, in my view, even the majority of – non-selfish behaviours, if only for the simple reason that they would not exist if we were entirely selfish. Contrary to Mrs Thatcher’s assertion that ‘there is no such thing as society. There are individual men and women, and there are families’, human beings have never existed as atomistic selfish agents unbound by any society. We are born into societies with certain moral codes and are socialized into ‘internalizing’ those moral codes.

  Of course, all this is not to deny that self-seeking is one of the most important human motivations. However, if everyone were really only out to advance his own interest, the world would have already ground to a halt, as there would be so much cheating in trading and slacking in production. More importantly, if we design our economic system based on such an assumption, the result is likely to be lower, rather than higher, efficiency. If we did that, people would feel that they are not trusted as moral agents and refuse to act in moral ways, making it necessary for us to spend a huge amount of resources monitoring, judging and punishing people. If we assume the worst about people, we will get the worst out of them.

  Thing 6

  Greater macroeconomic stability has not made

  the world economy more stable

  What they tell you

  Until the 1970s, inflation was the economy’s public enemy number one. Many countries suffered from disastrous hyperinflation experiences. Even when it did not reach a hyperinflationary magnitude, the economic instability that comes from high and fluctuating inflation discouraged investment and thus growth. Fortunately, the dragon of inflation has been slain since the 1990s, thanks to much tougher attitudes towards government budget deficits and the increasing introduction of politically independent central banks that are free to focus single-mindedly on inflation control. Given that economic stability is necessary for long-term investment and thus growth, the taming of the beast called inflation has laid the basis for greater long-term prosperity.

  What they don’t tell you

  Inflation may have been tamed, but the world economy has become considerably shakier. The enthusiastic proclamations of our success in controlling price volatility during the last three decades have ignored the extraordinary instability shown by economies around the world during that time. There have been a huge number of financial crises, including the 2008 global financial crisis, destroying the lives of many through personal indebtedness, bankruptcy and unemployment. An excessive focus on inflation has distracted our attention away from issues of full employment and economic growth. Employment has been made more unstable in the name of ‘labour market flexibility’, destabilizing many people’s lives. Despite the assertion that price stability is the precondition of growth, the policies that were intended to bring lower inflation have produced only anaemic growth since the 1990s, when inflation is supposed to have finally been tamed.

  That’s where the money is – or is it?

  In January 1923, French and Belgian troops occupied the Ruhr region of Germany, known for its coal and steel. This was because, during 1922, the Germans seriously fell behind the reparation payments demanded of them by the Versailles Treaty, which had concluded the First World War.

  Had they wanted money, however, the French and the Belgians should have occupied the banks – after all, ‘that’s where the money is’, as the famous American bank robber Willie Sutton allegedly said, when asked why he robbed banks – rather than a bunch of coal mines and steel mills. Why didn’t they do that? It was because they were worried about German inflation.

  Since the summer of 1922, inflation in Germany had been getting out of control. The cost of living index rose by sixteen times in six months in the second half of 1922. Of course, the hyperinflation was at least in part caused by the onerous reparation demands by the French and the Belgians, but once it started, it was entirely rational for the French and the Belgians to occupy the Ruhr in order to make sure that they were paid their war reparations in goods, such as coal and steel, rather than in worthless paper, whose value would diminish rapidly.

  They were right to do so. German inflation got completely out of control after the occupation of the Ruhr, with prices rising by another 10 billion times (yes, billion, not thousand or even million) until November 1923, when Rentenmark, the new currency, was introduced.

  The German hyperinflation has left big and long-lasting marks on the evolution of German, and world, history. Some claim, with justification, that the experience of hyperinflation laid the grounds for the rise of the Nazis by discrediting the liberal institutions of the Weimar Republic. Those who take this view are then implicitly saying that the 1920s German hyperinflation was one of the main causes of the Second World War. The German trauma from the hyperinflation was such that the Bundesbank, the West German central bank after the Second World War, was famous for its excessive aversion to loose monetary policy. Even after the birth of the European single currency, the euro, and the consequent de facto abolition of national central banks in the Eurozone countries, Germany’s influence has made the European Central Bank (ECB) stick to tight monetary policy even in the face of persistently high unemployment, until the 2008 world financial crisis forced it to join other central banks around the world in an unprecedented relaxation of monetary policy. Thus, when talking about the consequences of the German hyperinflation, we are talking about a shockwave lasting nearly a century after the event and affecting not just German, but other European, and world, hi
stories.

  How bad is inflation?

  Germany is not the only country that has experienced hyperinflation. In the financial press Argentina has become a byword for hyperinflation in modern times, but the highest rate of inflation it experienced was only around 20,000 per cent. Worse than the German one was the Hungarian inflation right after the Second World War and that in Zimbabwe in 2008 in the last days of President Robert Mugabe’s dictatorship (now he shares power with the former opposition).

  Hyperinflation undermines the very basis of capitalism, by turning market prices into meaningless noises. At the height of the Hungarian inflation in 1946, prices doubled every fifteen hours, while prices doubled every four days in the worst days of the German hyperinflation of 1923. Price signals should not be absolute guides, as I argue throughout this book, but it is impossible to have a decent economy when prices rise at such rates. Moreover, hyperinflation is often the result or the cause of political disasters, such as Adolf Hitler or Robert Mugabe. It is totally understandable why people desperately want to avoid hyperinflation.

  However, not all inflation is hyperinflation. Of course, there are people who fear that any inflation, if left alone, would escalate into a hyperinflation. For example, in the early 2000s, Mr Masaru Hayami, the governor of the central bank of Japan, famously refused to ease money supply on the ground that he was worried about the possibility of a hyperinflation – despite the fact that his country was at the time actually in the middle of a deflation (falling prices). But there is actually no evidence that this is inevitable – or even likely. No one would argue that hyperinflation is desirable, or even acceptable, but it is highly questionable whether all inflation is a bad thing, whatever the rate is.