The capitalism, taken apart

My big thanks to professor Marek Garbicz from Warsaw School of Economics for a big dose of factual knowledge and critical approach.

I appreciate every opportunity to come up against the wacky or peculiar outlooks on the economic system. The extreme examples, both from the right (in economic terms the radical liberalism) and from the left (socialism, verging on communism) sometimes make me laugh, sometimes infuriate, but they are the most valuable, when they bring me on to reflections or egg me on to gainsay them. In Polish, there’s a adage that says the truth lies in between. In truth, it lies where it really lies and nowhere else.

This time we’ll dwell on the contents of “Let’s Make Money” film, released in 2008 (in Poland in 2009, at cinemas from September). Unlike many of such films it hasn’t been shot by an American leftist intellectual, but it’s a work of an Austrian director.

In brief, it’s a bit longish attempt to harp on the vexed questions of development economics (Why do some countries develop faster than others? Why are some of them rich and the other poor?) and more or less deft depiction of the impact the globalisation has on different countries.

The most apparent is the issue of beneficiaries and losers of the process. The world has been ruled by the superpowers for centuries. They arranged it, set the rules, conquered new lands, competed against one another, shared their spheres of influences. In the twentieth century they set up organisations, aimed at maintaining peace, rule of law, democracy and for economic stability. I’m not naïve, I lean towards the view of Adam Smith, who said people are driven mostly by their egoism. Well-developed countries will firstly pursue their own interest, just later on they’ll mind the performance of poorer countries, whenever it’s advantageous to them. For instance, if a poor country is abundant in natural resources or they could profit from trade partnership.

What can be done to help the poorer countries grow? Can they catch up with the most developed ones? Is the convergence hypothesis true? If I can suggest anything, look at the development as on a dynamic process. What underlies the current economic situation is rooted in the past and can be dated back to renaissance era. Those countries which are better equipped in physical capital, human capital, knowledge and institutions (what in economics means “rules of the game”) have a head start, so maybe a divergence instead?

There are many schools of handling economic growth.
Firstly, a separation from the world economy. It didn’t work out, as the technologies in the countries where it had been implemented had been too poor.
Secondly, an export strategy – boost your exports, prohibit imports, protect your own industry, fight through competitiveness. This approach has been rather successfully adopted in the East Asia.
Thirdly, one in line with Washington Consensus, followed also by Poland, time will tell if it was a correct decision, now it’s still too early to judge it.

The third one is (as the wikipedia entry also shows) the most controversial. For me, its assumptions are praiseworthy, only officiousness in the implementation can wreak the economy. The film points at four aspects of Washington Consensus recommendations.
1) Deregulation – which is generally beneficial is the policymakers don’t make one step too far. Hence, there are the justified fields, where a certain dose of regulation is essential to preclude a bigger disaster.
2) Liberalisation – in the long term favourable to everyone, but the film director points out that unconstrained capital flows are the biggest evil. Indeed, the speculative money is used to make more money and its contribution to tangible output and social benefits from liberalised capital markets are tiny.
3) No state intervention – here they misrepresented the assumptions or followed the visions of some market fundamentalists. State’s activity should stimulate growth, draw in foreign investors, so the education or infrastructure provision shouldn’t be handed over to private sector. Even the early night-watchman concepts (as the first one, by Adam Smith) postulate active role of the state in these fields.
4) Privatisation. Quite important, but not the most. Even Milton Friedman, who twenty years ago advised to privatise, privatise and privatise, in the last days of his life admitted the most important role in the transitional economies should’ve been played by institutions. What lack of good rules of the game means? Just look at the example of Russia – mob and oligarchy (or state) have a hold over the country’s richness.

When is a privatisation good then?
- When state property is not sold in haste.
- When the rules (tenders, etc.) are transparent.
- When state property is sold for decent price.
- When the industry will be more efficient after turning private. It’s a paradigm, but how about the markets when there’s room for only one supplier and every citizen is obliged to consume them, like waterworks, sewerage. The state enterprise is likely to be run worse, for some built-in reasons, but, if provided by law, it won’t be profit-oriented, so it will deliver more goods at lower price.

“Buy when the blood spills on the trading floor”. What’s so reprehensible in this approach? Every speculator knows the best moment to buy is when the stocks are undervalued. Those who spotted a turning point in February or March won! When should we buy then? When the bull market ends? Someone has to do it, but those are mostly the small, inexperienced investors, who join the game when it’s actually over. It don’t get where the authors of the film saw the cynicism of that statement.

“Three million empty flats and houses on Spanish coast”. The property bubble grew robust in Spain, real estate prices would go up by more than twenty per cent per year. Investments in real estate are considered safe and profitable, in the long term. Long term profitability is one of those entrenched dogmas. Investments in stocks are according to the past data the most profitable – you’ll hear it from any financial advisor (they get the highest commission when they sell products linked to equity investments). Why then, some economists (like prof. Sławiński) easily undermine this assertion by pointing out that in the long term the probability of a big bull market is higher?

Back to real estate – I’m wary of this kind of capital investment. The reason is simple – every man needs a dwelling, but the speculation drives the property prices up and makes them unaffordable for many people. Much depends on the source of the speculative capital. If like in Poland between 2005 and 2007, prices soared because of domestic demand, situation is not that bad. In such a scenario, domestic demand is stimulated by low interest rates and liberal credit policy, what leads up to what the author of this blog has devised and described as “affordability paradox”. Let’s consider the following example. A buyer wants to buy a flat which costs 200 000 zlotys, but he has amassed only 120 000, what stands for 60% of the price. Creditworthiness criteria are tight and he cannot get a loan, he has to put aside money, the money he saves still works on the compound interest principle, some time later he can buy a flat without running up debts. But there’s a catch. This reasoning is correct only if the restrictions on access to credit are not lifted. If it happens, the same flat may soon cost 400 000 zlotys (the better access to mortgage loans has created additional demand) and our buyer can afford to buy that flat, even though it’s two times more expensive. A lot of economists claim everything’s alright. Prices are higher but he can afford a flat. But who sees a burden of a huge loan which will be being paid off for twenty five or thirty years? Repayments will decrease his discretionary income, so he will consume less for all that time. The credit is sometimes ball and chain – what if Mr buyer loses his job or his child goes down with an illness which would require a costly therapy? Would a bank take into account his unfavourable situation or would it foreclose his flat and turn him out?

In Poland, I’ve heard many times that flat prices are prohibitive. Indeed, five years ago, a person with considerable, but not very high savings could afford to buy a flat or house without taking out a loan, today it’s hardly ever possible. In Berlin, a square metre of a flat in a panel building block, similar to many in Warsaw, costs around 800 Euro, in Warsaw, on average two and a half times more (let alone the purchasing power of a Berliner and a Varsovian – I wonder how many square metres of a flat in a high-rise from the eighties can the former and the latter buy for their monthly salary). The price in Berlin probably reflects the intrinsic value of a property. In Warsaw the prices have been put up both by insufficient supply and excessive demand.

Back to Spain, those flat and houses, all in luxurious estates, in the prestigious coastal areas, are uninhabited. They were built and bought not to be dwelled, nor even to hire, but to earn on their growing market value. Any asset that should fetch a real profit has to be cashed in, so those who sold their properties off to the other fools, raked the profits in, the ones who bought before the bubble popped, were left with useless flat in Spain. Meanwhile millions of domestic buyers found the real estate in their country unaffordable – they were the victims of speculation… In a few years, property market will get back to its equilibrium. The huge supply of empty flats will bring the prices down and they’ll be bought sooner or later for a reasonable price.

And finally the tax havens. I strongly believe the existence of such spots stems from the common perception of the taxes, not only from greed. For centuries they have been perceived as the biggest possible evil, tax avoidance has not been treated as misdemeanour, people have sought ways to reduce their taxable incomes, what led to many absurdities. Before the Poland’s accession to the EU, many firms were inflating their costs, just to have a smaller profit and a smaller tax. Then, when they put in for grants from the EU or for bank loans, their applications were rejected, cause nobody wanted to finance unprofitable businesses. Few people realise that what they get for paid taxes are public services like infrastructure, education, health care. The other point are the costs of redistribution, its justice or effectiveness, let alone the quality. But the fact is that we get something from the state. Nothing’s for free, but some crafty fellows try to take advantage at the other’s expense, this is called free riding.

But look at it from the tax haven’s perspective. A country attracts zillions and even if taxation rates are very low, the revenues they take are not to be sneezed at, so that they can fare very well. On the other hand, the money taxed in a tax haven is not collected in the country of its origin. Consequently, the budgets of those countries the capital flees suffer, governments run up higher debts which will have to be paid in taxes by the next generations.

At long last. THE END.