III Can capitalism succeed?Its economic and political crises:

what policies could help?1 Evolutionary success of institutional frameworks

2 Possible crises of capitalist economies

3 Possible policies

4 An extra view: the rationality-allocation problem

5 The rationality-allocation role of financial sector: how it can fail, and what regulations could help

6 Political obstacles: vested interests and limited knowledge

1 Evolutionary success: a sustainable institutional framework (set of rules)

An IF’s success: avoiding economically costly and socially disruptive falls of old rules, risky search for new ones (“transformations”), their painful learning, new mistakes? – economic evolution

Two necessary conditions: a successful IF must be- economically efficient enough (above all adaptively), must allow industrial development and adjustments to world markets and nature- politically acceptable by the population, both its rules as such and the outcomes

Not all IFs pass: no socialist & not all capitalist

2 Possible economic crises of capitalism

Cyclical (“macro-”):- inherent instability of markets, flock behaviors- cumulating bad debts, financial crises- cycles: simple vs. chaotic risk of “tsunami”- low growth(macro-policies: may help but often harm)

Structural (“micro-”):- wrong development wrong industries- wrong firms: little productive or maladapted(industrial policies: may help but often harm)

NB: crises may but need not be caused by policies

Political crises

Fall of government vs. fall of institutional framework

Triggered by dissatisfaction with:

- low economic output, high unemployment …

- and/or income and wealth inequalities, poverty

Dissatisfaction depends on values (culture), importance on work/leisure preferences, envy

The danger of excessive demands: economic crises political crises economic crises …

Recent crises: economic or political?

An economic cause: misbehaving investors (e.g., sub-prime mortgages, their hiding & spreading)

A political cause: misbehaving governments (growing state debts, their hiding, wrong regulations)

But interrelated:- e.g., government hindered by law investors from discriminating - e.g., investors encouraged governments to borrow by buying their papers

Avoid ideological biases, accusing only one side

3 Possible policies

Macro: monetary & fiscal

- Why is considering macro-policies not enough?

- Types of taxes? types of spending? subsidies?

- Saving or spending? by whom? on what?

Institutional: legislative changes of formal IRs

- Private vs. public sectors, hard vs. soft budgetary constraints

- Conditions for entrepreneurship, bankruptcies …

- Labor law, corporate law, financial regulations …

- Legally permissible scope of macro policies

A note: the main obstacles to EMU

Differences in IRs, both formal and informal, and in economically relevant value-judgments (culture)

Needed: not common fiscal policy, but common fiscal discipline: have as much welfare as you wish, but pay for it (e.g., North vs. South)

and common competiveness (entrepreneurship, job creation … e.g., again North vs. South)

4 An extra view: the rationality-allocation problem (Pelikan, 2010)

• Unequally rational individuals with imperfect knowledge of how rational they are, including themselves; the less rational, the less they know

• Rationality-allocation works by organizing the economy into a network of markets, firms and government, designing differently difficult jobs assigned to differently rational individuals

• Two success indicators: (1) the relevant rationality of the individuals selected for top jobs; (2) the losses from competence-difficulty gaps across the network

Two results

Market IRs compared with government IRs in agent-selection & c-d-gaps-correction (cf. the usual resource-allocation among given agents)

Result 1: markets have the potential for selecting far better entrepreneurs and investors & keeping c-d-gaps much smaller than government, but may fail to realize it

Result 2: government has the potential for making markets realize their potential, but may fail, too: no regulations or the wrong regulations

Narrow road to “salvation”: the right regulations, but: what are they? how to realize them?

Two lessons for policy analysis

L1: greater value of market competition: not only resource-allocation among given agents, also agent-selection-cum-rationality-allocation

L2: stronger constraints on the sizes of firms (opposing the weaker constraints of transaction-costs analysis): emphasis on continuation of competition, limited impact of individual firms’ failures, corrections of c-d-gaps

5 The rationality-allocation roles of the financial sector

Usual roles: allocating investment; spreading risks; providing liquidity; limiting volatility

Rationality-allocation roles: selecting entrepreneurs & investors; minimizing risks; doubly minimizing c-d-gaps

Wanted: fundamentalist investors able to select best entrepreneurs – not trend-traders!NB: micro-fundamentalists, concerned more with specific firms than with entire markets

Possible failures of financial markets

F1- Financial firms: overgrowing, becoming too big to fail, hindering market selection, protecting rent-seeking and/or managers causing c-d-gaps

F2 - Financial instruments: growing too complex, too opaque c-d-gaps, interconnectedness & failure-spreading (if one fails, many fail)

F3 - Macro-development: overgrowth of the entire sector (diminishing “useful output / volume of financial transactions” ratio), excessive volatility with excessively deep crises

F4 - Selection criteria: distorted, favoring & encouraging trend-traders, flock behavior volatility selecting the wrong investors

Some of the causes

F1: Faulty corporate governance of financial firms, weak corrective feedback limiting their growth

F2: Weak corrective feedback on innovations of financial instruments, increasing information asymmetries, allowing cheating, hiding c-d-gaps

F3 & F4: Trend trading, especially HFT distorted incentives, more rewards for trend-trading than for fundamentalist investing = a new case of the old public-goods problem

Regulations supported by rationality-allocation analysis

R1: Corporate law, excluding proven bad CG-rules, imposing proven good ones, but leaving space for promising governance innovations

R2: Financial instruments: limit their complexity, decouple, maximize buyers’ information

R3: Antitrust, preventing M&As leading to “too big to fail firms,” splitting such firms, forcing specializations (e.g., retail vs. investment)

R4: Tobin micro-tax, to discourage trend-trading, especially HFT, help fundamentalists succeed

R1: Corporate law, excluding proven bad CG-

6 Political obstacles : vested interests and limited knowledge

Politicians:- gaining votes for social policies, but less for financial regulations (although this is changing)- oppose regulations that decrease GNP, collected taxes, and their powers

Private investors and their employees:- oppose cutting down their firms (but not all)- oppose shrinking the financial sector- dislike taxes hindering their trades

Knowledge: rational long-term egoism, but will it work?