Monday, June 27, 2011

The capital conundrum.

Is the gap between rich and poor an inevitable outcome of free societies?

If the current political rhetoric in South Africa shows anything it is how easy it is to become so locked in the past as to forget about the future. It is one thing to learn from the past. It is another to be stuck in it.

This is especially true when past perceptions were nurtured in highly emotive circumstances supported by fear and insecurity. None has been more powerful in shaping our destiny than the conflict over economic and political systems. With it have come biased dogma, emotive rhetoric and populist slogans that convert into automatic responses. Nothing could be less appropriate in the times we live in. Nothing threatens our search for balanced solutions more. Slogans such as “imperialism”, “working class”, “capitalist class”, “communism”, and “capitalism” do little to enhance our evolution. They merely lock us into preconceived prejudices.

One of the concepts within the debate is the efficient allocation of capital. It goes without saying that this plays a critical role in growth and prosperity.

I was reminded of this in reflecting on Moneyweb’s stated key intention of promoting “the efficient allocation of capital, which translates into the promotion of free enterprise and Nation Building”. There is nothing wrong with the concept. It is indeed a highly laudable ideal and is a natural component of the very basic definition of economics which is the allocation of all resources to where they are most needed and can best serve society as a whole. This raises the question in the times we live in, whether efficient as we have come to understand it is the same as appropriate.

So the argument is not about the concept itself, but rather how best to achieve it. This again throws us back to the baggage of the past. When you question self interest and the profit motive as being the best driver, you stand a good chance of being given some or other rhetorical label. If you question regulation and controls that aim to influence capital allocation, you are just as likely to be labelled in the opposite camp. And that’s where useful discussion gets stuck.

It really is time to ask whether indeed, in any system or past concept, capital has been allocated efficiently or appropriately in serving social needs. All of these past dogmas have been tried in some form or another or in some country or another. Yet, in most places you look, you will find huge imbalances that arguably relate back to capital allocation or dispersion. They include the availability of natural resources and economic growth; the unsustainable pressure on the planet and climate change and the massive disconnect between wealth and real value creation. Surely, it is time for a new theory based on a different mindset and promoting a different value system?

The greatest criticism of the allocation of capital in today’s economy is the massive disparity in wealth – the gap between rich and poor. It is also the most controversial because it automatically divides us into two vehement camps – those who believe that it is a tolerable outcome of a free society and those who believe that it is proof that economies have to be more regulated. It seems to present an inherent conflict between mankind’s most prized ideals – liberty and equality.

Whatever one’s view on causes, it is the biggest challenge of our time. An interesting conclusion reached in the book “Fault Lines” by Raghuram G Rajan, a former chief economist at the IMF, is that growing inequality particularly in the U.S., Europe and Asia was a direct contributor to the financial crash because governments responded to the disparities by creating easier credit. He called the response: “Let them eat Credit.”

This underscores a simple but very sad reality. The biggest cause of social ferment is comparisons. It creates envy and when this is added to democratic expressions you have a toxic mix in societies where disparities are huge. Rational arguments lose their effect in emotive conditions and then feed all kind of discontent, real or imagined.

Wealth disparity has always been with us and is as much written about as any other topic on humanity. It is a complex subject at many levels – political, economic, social, geographic, anthropological, and even psychological. But I do not believe it can be extrapolated as an automatic outcome of free enterprise. A friend of mine reminded me of this in forwarding me an Adam Smith quote: "No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable". More often than not, the disparities are caused not by markets being free but by interference and manipulation in them.

Let me isolate only a few of many important, if not overriding causes for the current crisis as it relates to the efficient allocation of capital.

An important one is clearly the different levels of remuneration, particularly in the “executive” category. After writing about this before, I am still to be convinced that the price of these skills truly reflects unencumbered supply and demand and whether this market is not, as Warren Buffet once put it, “broken”.

Another is the changing role of financial speculation from being a desirable instrument of equilibrium in the trading of financial instruments to being a dominant force in the creation of liquidity and allocation of capital. This has been severely exacerbated by the presence of very large financial conglomerates and banking institutions whose behaviour has often been manipulated to the advantage of an elite corps.

A third critical one is the role of capital in the creation of tangible wealth, in business and private ventures. The explosion of speculation in the allocation of capital has brought with it a need to review the concept of the supremacy of equity capital over all other resources. This has to be done without ideological baggage and seeing it as a threat to free enterprise. Capital is a resource and the cost of its use is either interest or profit. Labour is a resource and the cost of its use is wages. To have the cost of capital skewed by speculative returns is as inappropriate as having the cost of labour skewed by legislative inflexibility or inordinate trade union collusion.

What is really counterproductive is the ongoing assumption that the two are in competitive conflict with labour being the “underdog”.

Sitting in on a basic business awareness training session some years ago, I heard the trainer tell his group that the first thing you need to start a business was money. I was appalled as I watched the awestruck faces of his barely literate, minimum wage participants. Destroyed in their minds forever was the vague possibility of becoming a self supporting entrepreneur, even in the informal sector. It’s a view still prevalent today: that capital creates jobs, not an idea, making a difference, doing something meaningful for others and having a market. The latter will attract money, manpower and all the other “M’s” that that specific programme taught as the key ingredients for business.

The allocation of capital in creating tangible wealth and not singularly and purely to maximise its returns will ensure a narrowing of the distressful wealth gap. Yet the view that the market is a “resource to be exploited” still lingers. It is obscene, arrogant and inappropriate. It is the difference between being “profit-driven” and being “market driven.” It makes customers angry…like I was to discover an unannounced increase in my banking fees while having just read of the mind-boggling bonuses given to banking executives.

In “Value through Values”, I dedicated many pages to this crucial difference and how paradigms can be changed by simply changing perceptions. At the risk of sounding unashamedly boastful, it was a work that Raymond Ackerman described as “… the way of the future; the whisper of tomorrow.”

It’s actually nothing new. The creators and builders in business have known this all along and have intuitively behaved in this way.

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