Bad Capitalists?

Posted by on 08/05/11 in America, Debt, Entrepreneurship, Governance, Philosophy, Risk

Are Americans bad capitalists? As we confront the consequences of an unsustainable economic model, it’s a question we must consider.

Bad capitalists:

· misallocate assets

· lock themselves into a cycle of perpetual borrowing to finance operations

· lack a plan to meet debt obligations (other than refinancing it)

· maintain insufficient cash reserves

· lose the confidence of their stakeholders

· manipulate lenders and investors to keep them engaged

· do not acknowledge that their strategy is fundamentally flawed

· argue that time will solve their problems, or minor adjustments on the margins, or one more chance, or more of the same

Worst of all, bad capitalists undermine capitalism. They say to the world, “Human beings are too greedy, selfish, careless, and irresponsible to be entrusted with an economic system that requires discipline, self-sacrifice, hard work, and a long view.” An already skeptical world is often quick to buy that argument, ignoring its inaccuracy.

At the business level, a bad capitalist eventually looses wealth or goes out of business as it competes with good capitalists who invest more intelligently, adapt better to changing market conditions, attract and retain more talented employees, and otherwise strive for financial sustainability. But what if a nation’s economy is based upon and rewards poor capitalistic practices? We all recognize that the capitalist business cycle includes periodic failures at the business level; but, have we adequately considered the implications of failing as capitalists at the macro-economic level?

In some quarters, posing such a question would amount to heresy, for critiques of our economic model are too often viewed as criticism of capitalism rather than as a desire to improve our practice of it. The distinction is everything. And when society is rapidly losing the confidence of its neighbors and its own citizenry, a little heresy is necessary.

So where does one turn to critically examine at least some of the practices of bad capitalists? To the Marxists, of course. Countless theoretical discourses have been written since Karl Marx and Friedrich Engels published “The Communist Manifesto,” in 1848. Most critiques of capitalism have focused on how owners (a.k.a. capitalists) allegedly “exploit” employees (a.k.a. labor). But there have been economic philosophers who have focused on matters outside of capitalist-labor tension, issues that are relevant today.

In 1923, Hungarian economist and political theorist, György Lukács published his treatise, History and Class Consciousness. As a founder of what is known as “Western Marxism,” Lukács’ concluded that capitalism is inherently flawed, a conclusion with which we disagree. That said, elements of his critique are timely for those concerned with enhancing the sustainability of our economic system.

Lukács explores the concept of “reification,” which implies that capitalism is an abusive fiction that unperceptive—and unaware—participants have bought into without recognizing its true ugliness. The concept is reminiscent of the illusory world in the Hollywood trilogy, The Matrix, a fictionalized world in which citizens have been fooled into believing the visual reality around them without realizing that they are just oblivious players in a massive computer simulation.

Lukács presents capitalism as an artifice constructed by those most able to profit from moving funds around without adding genuine value. In his construct, capitalism constantly requires new participants and new monies which can feed those already in the system, seeming to create wealth but really just moving it from one unwitting owner to a more powerful one. Lukács presents capitalism as similar to a Ponzi scheme (though he does not use that term); in his worldview, people with the greatest power and influence profit from the wealth (i.e. labor, resources, monies) of those who possess less influence or control.

Defenders of capitalism might counter that capitalism creates new wealth by using public and private credit markets to facilitate the launching of new endeavors that otherwise could not happen. In effect, they argue, capitalism sets up a series of arbitrage opportunities through which someone can borrow from others at a lower rate than they expect to make by investing the borrowed funds in a venture. Much of the difference represents “new wealth” created, wealth that circulates through the economy through profits and wages that are converted into consumer spending, tax revenue, and ultimately, further opportunities to invest.

Defenders of capitalism also could look to public and private equity markets as opportunities to create new wealth by enabling owners to sell their stakes to others. The buyers expect their ownership will be rewarded through gains and income or by selling their ownership stake in the future for a premium over the purchase price. Buying and selling ownership (or expanding the ownership base through diluting current owners) can be generative if it enables new investment that adds value to the venture and its stakeholders.

So, why should capitalism’s defenders feel defensive? Don’t they adequately address Lukács’ accusation that the capitalist economy is an artifice? Aren’t credit and equity markets excellent examples of how capital can create more capital and thus generate new wealth throughout the system?

In theory, the capitalists have a sound argument; in practice, however, practice gets in the way. What happens, a Lukács advocate might ask, when one uses credit without any intention of repayment? Is a society creating new wealth when it rolls its debt over again and again with no intention of paying it back? If there is no intent to settle the debt, then can one really recognize the scenario as constructive arbitrage? If society’s functioning requires borrowing it will not repay in order to “stimulate” spending that makes it appear the economy is expanding, then hasn’t that society affirmed its members are willing participants in a Ponzi scheme?

Or look at the equity side. What happens if changing ownership is not a generative process but simply represents a transfer of wealth between parties? What if one party buys ownership, leverages up the company by borrowing beyond what is reasonable for the company to pay back, then sells it off to other public or private owners at a value inflated by the leverage it now carries but cannot repay? In this instance, there is not wealth creation for the broader economy, merely a profit for the seller that is paid for dollar for dollar by the other parties (and then some if debt financed). In this scenario, there is simply the appearance of appreciated value and wealth creation. Ideally, no one would engage in such a transaction, but if a society such as ours richly rewards buyers to perpetuate the cycle of artificial economic value generation, then the game will be played until, like any Ponzi, the jig is up and someone gets caught holding the rather expensive bag.

These observations deserve more thoughtful consideration than these few lines allow, and yet raise essential questions for us today. What action is society taking to ensure that we are not willing (or unwilling) participants in a Ponzi scheme? What sacrifices are we making so that we borrow only when we intend to pay it back with near-term assets? How do we mitigate the risk of being a society of bad capitalists? What systems or cultural shifts are necessary to increase the likelihood that we practice good capitalism?

When companies that have been “bad capitalists” fail, society absorbs those losses and enables the people impacted to try again as owners and/or employees of other ventures. However, whole societies that have been “bad capitalists” have no such safety net. If a society becomes economically unsound, it simply fails. Such failures hastened the ends of Ancient Rome, the British Raj, and the Soviet Republic. Societies that practice bad capitalism create fear and economic uncertainty amongst their citizens, causing people to distrust individual initiative, risk-taking, and the free flow of capital just when such behavior is most needed to stimulate the economy and make investments that can generate new wealth.

Lukács is wrong. We are not ignorant dupes participating in a massive Ponzi scheme; and yet, we must not willingly propagate a system that confuses perpetual leverage with sustainable growth. We stand together at a critical decision point. Generations from now, will we be remembered as bad capitalists? Or will we be honored as those who did what was necessary to preserve and improve the world’s most effective system for fostering personal freedom and opportunity?