Why have capitalists lost faith in capitalism?

I’ve been following with interest the evolving crisis over the United Kingdom’s exit from the European Union, not because it affects me in any way but because it’s less depressing than the American political system which I still have to rely on for my health insurance, retirement security, food safety, and environmental hygiene.

However, the Brexit crisis has led me to ponder a question that’s just as relevant here as it is over there: why do capitalists have such little faith in capitalism? To be clear, I don’t think capitalists are wrong to have given up on capitalism, but I’m not a capitalist, so I don’t have to explain myself. What has come to baffle me is when avowedly capitalist institutions admit that capitalism doesn’t work, yet soldier on nonetheless staring straight ahead into the void.

Why should Brexit be a “crisis” at all?

As the cradle of the industrial revolution, the United Kingdom is the country enjoying either the first or second most sophisticated financial system in the world (the City of London would no doubt say the first, Wall Street’s denizens would surely insist the second).

In Walter Bagehot’s “Lombard Street,” a slender volume from 1873 that I would recommend to anyone interested in the development of financial capitalism, the author describes what is already a remarkably sophisticated system for the allocation of capital. As he tells the story, wealthy landowners in the South of England invested their agricultural profits in the North’s growing manufacturies by literally buying industry’s future receipts at a discount. This remarkable technique allowed money to flow to more productive regions and industries from relatively stagnant ones, and served as a key engine of the industrial revolution.

But if you read about the United Kingdom’s planning for Brexit, there’s simply no glimmer of capitalism to be found. If the United Kingdom currently relies on agricultural imports from Europe for its food supply, then you would expect money to be flowing into the UK’s agricultural sector to compensate for slower, more cumbersome, more expensive imports from the EU. If the UK relies on Europe’s pharmaceutical sector for its drugs, you would expect money to be flowing into the UK’s pharmaceutical sector in order to earn an outsized profit from the looming shortage of European medicines.

After all, England voted to leave the EU over 2 years ago: we’re not talking about an overnight decision or a sudden supply shock like the OPEC embargo of the 1970’s. There has been plenty of time to turn fields over from crops destined for export to the EU and into the ones needed by the domestic UK market, plenty of time to convert abandoned warehouses into generic medicine factories, plenty of time to retrain biology researchers to work as quality controllers, financiers to work as customs inspectors, etc.

Note that a “successful” reorientation of the British economy towards domestic production and away from trade would still leave the UK much worse off: global just-in-time supply chains, unified regulations with the UK’s biggest trading partners, and the free flow of labor have made the UK much richer, and losing them will make the UK much poorer.

But in 2017 the CIA World Factbook estimated the United Kingdom’s per capita gross domestic product at $44,300, the world’s 39th highest. If Brexit fully halved that to $22,150, the UK would fall to #87, just ahead of Bulgaria, a middle-income country that does not, to the best of my knowledge, suffer from shortages of medicine or food. If Brexit merely lower the UK’s per capita GDP 25% to $33,225, it would be slightly poorer than the Czech Republic, but somewhat richer than Czechia’s neighbor and former bandmate Slovakia, two lovely countries that, again, do not face serious shortages of food or medicine.

All of which is to say, capitalism isn’t some kind of magic spell that’s destined to make a country rich: there are rich capitalist countries and poor capitalist countries. The only thing capitalism is supposed to do is allocate capital efficiently, and it isn’t showing up to work in the UK or in the United States.

So that’s the question that I’ve been focused on more and more lately: what happened? Why can’t capitalism do the one thing it’s supposed to be best at, the one thing we rely on it for above all else: rapidly allocating capital to the industries where it’s most needed? And, most strangely of all, how have capitalists come to agree that they can’t be trusted to allocate capital?

I think there are three overlapping — but not entirely satisfying — answers.

Concentrated capital needs to make bigger bets to move the needle the same amount

The situation Bagehot describes in late 19th century England is a straightforward matching problem: landowners in the rich agricultural districts earned somewhat more money than they needed to finance their gambling and garden addictions, and the small workshops and factories in the North of England needed small, short-term loans in order to bring their products to market. Since all the land was already spoken for, and there were no great agricultural investments to make, landowners had no alternative if they wanted to earn a return on their profit than to lend it out to industry. Since industry was small and fractured, that meant making lots of individual loans through the “bill brokers” Bagehot describes.

But a simple mechanical problem arises when the overall level of wealth increases, and is exacerbated when that wealth is concentrated in fewer hands. There’s a very important, very boring difference between investing $1,000 and needing to earn $100 per year in profit, and investing $1,000,000 and needing to earn $100,000 per year in profit. To do the former, you need to be right on a small scale exactly once. Hell, you can earn $100 on $1,000 once a month by just keeping track of the best bank account signup bonuses.

But to do the latter, you can either be right on a small scale 1,000 times, or right on a massive scale once. If being right on a small scale doesn’t become easier, then it takes 1,000 times as long to be right 1,000 times than it does to be right once.

And that is, in fact, the exact pattern we see today: wealthier countries have much more capital to invest, but the skill and number of people charged with finding places to invest it hasn’t grown proportionally. Perhaps the most iconic case is that of Japan’s SoftBank, which has an unlimited amount of money to invest, all of which flows through a single person who has not, to the best of my knowledge, found a way to extend the day beyond 24 hours.

In other words, a more concentrated distribution of wealth worsens the allocation of capital purely mechanically by reducing the number of people working to allocate it, and vice versa. Reorienting British production to serve British customers isn’t impossible, nor even particularly difficult. Reorienting British investment to serve British customers is totally unfathomable due to the concentration of financial capital is so few hands.

Concentrated capital makes government intervention a more attractive investment

I’ve written before about “Opportunity Zones,” one of the handouts included in the Smash-and-Grab Tax Heist of 2017. Opportunity Zones are intended to spur economic activity in “marginal” census tracts: not those so poor that investment is hopeless, but also not those prosperous enough that additional investment would crowd out existing businesses.

Whatever you think about the merits of splitting up the country into “hopeless,” “marginal,” and “prosperous” areas, Opportunity Zones have an obvious defect: the unlimited tax benefit the federal government provides is available only to financial capital, and not to operating businesses. In order to qualify, all Opportunity Zone investments have to be made through “Opportunity Funds,” which means operating businesses within the Zones have to compete for workers, supplies, and profits with investors who begin with a preposterous head start.

My point is not whether Opportunity Zones are good or bad industrial policy. If I haven’t convinced you they’re bad policy by now, then you’re beyond hope. My question is, how did an idea as bad as Opportunity Zones even become possible? How did financial capital, which is supposed to exist in order to allocate money to operating businesses, secure more favorable tax treatment than the operating businesses themselves?

The answer is obvious: as concentrated financial capital struggles to find sufficiently large business opportunities to invest in, manipulating after-tax investment returns becomes more and more attractive. This has nothing to do with the availability of business opportunities in general: ten individuals might find ten investments that can yield a 10% return on $100,000 each without a single individual finding an investment that can yield a 10% return on $1,000,000. Meanwhile, the concentrated wealth of the single individual means lobbying for targeted tax benefits has an outsized return: $10,000 spent on government intervention would be the entire profit of each of the ten individual businesspeople, but just 10% of the return of the single investor.

Importantly, this is not an argument about the “influence of money on politics.” Rather, the point is that under any system of political influence, concentrated wealth will have concentrated, united interests and diffuse wealth will have diffuse, conflicting interests. The less likely individuals are to secure favorable government intervention due to conflicts with other stakeholders, the less likely they are to waste money lobbying for it. The more certain they are to achieve government intervention, the more likely they are to lobby for it and the more likely it becomes.

Business formation and the reserve army of labor

If the concentration of capital mechanically requires investors to seek out larger investments, and mechanically increases the ability of investors to create regulatory environments that put small businesses at a disadvantage, there’s a third factor that might be best described as cultural. By “cultural” I don’t mean “subjective” as opposed to “objective.” Rather, I mean the way people integrate things like laws, expectations, customs, and norms into their lived experience.

For example, the way the US federal tax code discourages business formation is not “subjective;” on the contrary, it’s as clear as day. Transitioning from employee to self-employed requires relearning how to file your taxes from scratch. Transitioning from self-employed to employer is many times more difficult than that. The gritty 2018 tax code reboot will make both even more difficult.

What that has effectively done in the United States is create a cultural expectation of employment (or failing that, unemployment), rather than business formation, an expectation that is even stronger in other Western countries. While it’s not yet illegal to start a small business, everyone understands perfectly well that it’s discouraged.

I know of no better example than Trade Adjustment Assistance, a set of programs designed to compensate the domestic “losers” from reduced barriers to foreign trade. Workers unemployed due to changes in trade policy can receive “retraining” to get a better job. They can receive increased unemployment benefits during their “retraining.” They can receive wage supplements if their new job pays less than their old job. But under no conditions can they receive assistance in starting a business to replace the one that closed and led to their unemployment in the first place!

In other words, when the federal government reduces the number of firms, and reduces the number of jobs, it will retrain workers to better compete for the remaining jobs, but will do nothing to increase the number of jobs available or to reduce the number of workers who need to find work by starting their own businesses. Whether you think this is good policy or bad policy, there’s no question that it objectively privileges employment over business formation.

The materialist reasons for this have been known since at least the 1840’s so I won’t go into them here, but I think the consequences, in conjunction with the other two factors I described, are devastating and explain much of the current crises of capitalism in the UK and the United States.

Socializing growing losses and privatizing shrinking profits

What do you get when you have concentrated financial capital placing fewer, larger bets; public policy manipulated to ensure outsized returns on those bets; and a declining rate of small business formation?

My suggestion is you get precisely what we see today: large businesses relying more and more on governments, because government is the only game left in town — capitalists losing faith in capitalism.

When Governor Scott Walker of Wisconsin wanted to spur economic development, he offered the Taiwanese company Foxconn $230,000 in state subsidies per job created at a new plant in Racine County (fortunately, the plant will never open). When Amazon decided to open an office park in Long Island City, New York promised them $3 billion in subsidies.

Whether or not you think state and local governments should be bidding against each other to attract employers, one alternative is so flagrantly absurd it was never even on the table: using state subsidies to encourage employees to form new businesses. State support is for the big businesses that know best; workers simply can’t be trusted with that kind of responsibility.

I am not a capitalist, and my preference would be for our largest industries to be explicitly socialized one by one as each collapses under its grotesque weight in turn, instead of bailed out and quietly re-privatized until the next crisis comes along and the pattern repeats. But if you do think capitalism is the ideal form of economic organization you should, perhaps ironically, be even more committed than I am to reducing the size, concentration, and influence of financial capital while removing obstacles to small business formation. The alternative, as we’re seeing today, is messier, bloodier, and poorer.