Crisis of Confidence in Capitalism

Mehdi Shafaeddin

In its September Communique, the UN’s Intergovernmental Group of Twenty-Four on International Monetary Affairs and Development referred to a “crisis of confidence in advanced economies”. In other words, there is a crisis of confidence in capitalism as a system. We have been witnessing a series of crises in recent years: the financial crisis, debt crisis, commodity crisis, etc. In the meantime, unemployment and growing inequality, particularly in the USA, has led to the 99% movement, “Occupy Wall Street” and upheavals in other countries unprecedented since the Civil Rights Movement.

What has received less attention is the upheaval by economics students at Harvard University. They walked out of a “Principles of Economics” class objecting to the way economics was taught and protesting the “corporatization of higher education”. Their main point was that “the biased nature of Economics 101 [basic economics course] contributes to and symbolizes the increasing economic inequality in America..” and that  “Harvard graduates play major roles in financial institutions and in shaping policy around the world”. In other words, they implied that the crisis in capitalism and growing inequality in wealth and income is not only due to the way financial institutions (and the Wall Street) operate, but is also to a large extent, rooted in the way economics is taught.

What is wrong, then, with economics? Before answering this question let me quote a few figures to show the gravity of the situation. According to The Economist, income inequality in the USA has not increased much—when the top 1% of earners is excluded! But in absolute terms the income of the top 1% has increased fourfold between 1976 and 2007, and they have captured 58% of real economic growth (The Economist, September 24:84). Over 1979-2005 period, “executive managers, supervisors and financial professions accounted for 60% of the increase in the top 1 per cent income. Those involved in the financial sector were the main beneficiaries. According to the Congressional Budget Office, from 2002 to 2007 the increase in income inequality was mainly the result of an increase in income from capital gains (mainly speculative activities), and the top 0.1 per cent earns about half of the capital gains.

Yet the federal tax rates on capital gains was reduced from 35 per cent to 28 per cent in 1978 and to 20% in 1981; after some fluctuation it was reduced to 15% in 2003.

It is not socially sustainable that “1% of the population controls more than 40% of wealth and receives more than 20% of the income”, when the poorest strata of the population has had to pay more and more for their social services such as education and health, and when the number of homeless people in the USA has increased significantly in recent years due to home foreclosures. For example, since 1998, the system-wide student fees (excluding the campus-specific fees) in California have increased by nearly four times while the indicators of the quality of education have deteriorated. There have been more than seven million foreclosures in the USA, which is about 10% of the number of households (of course it is far greater as a share of number of house owners in the middle and lower class strata).

The top one per cent has been benefiting mainly from “business income”, i.e. income from speculation in transactions in derivatives, stock options etc., which is essentially a form of gambling.  But the burden of the losses from such activities is borne by the tax payers as the government intervenes to bail out the large financial institutions and banks (e.g. Lehman Brothers Bank, UBS, ABN AMRO, etc.) In other words, the losses (negative externalities) are socialized!

Despite such realities, the teaching of economics is undertaken by adherents of the school of “neo-liberalism”, which is totally devoid of realities. It is based on some unrealistic assumptions ranging from prevalence of perfect competition in the product and factor markets, equal distribution of wealth and income, free availability of technology, lack of risk and uncertainty, availability of perfect information, etc. It is more of a science fiction. The nature of the first assumption (perfect competition) alone is enough to make economics a science fiction. It implies that firms are small and passive and have no power in the market, and there is no economy of scale and externalities. In reality each economic activity is dominated by a small number of large firms which exercise their power in the product, factor, technology and financial markets. Their sheer large size contributes to unequal distribution of rewards to factors of production. Further, it allows the managers to influence political power-including presidential elections. Their speculative activities also affect business cycles; in fact, their speculative excess brought on the 2008 financial and economic crises.

To remedy the situation, in its “declaration”, the 99% movement has suggested measures for regulating the financial market, including taxes on financial transactions (Tobin tax), an increase in taxes on high income earners, regulation of large entities, etc. But   capitalism will not be “civilized” through such measures alone. “Gambling” in the financial market should be forbidden. More importantly, some revolutionary changes in the teaching of economics are required in order to train students to analyse the realities of the situation and propose remedies. The experience shows that “communism” is not a solution, but capitalism should be civilized.

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