The Crisis Of Capitalism: What Martin Wolf Got Wrong

Some people are famous because they are famous, and important because they meet with other important people, although not everyone can remember why they were famous in the first place, particularly when they write long sprawling books that are hard to absorb. Such was the case with Thomas Piketty’s Capital in the Twenty-First Century in 2014 and such is the case with Martin Wolf’s new book, The Crisis of Democratic Capitalism (Penguin Press, 2023).

The End Of the World Is Near, Or Is It?

Wolf began writing his new book in 2016 at the time of Donald Trump’s political ascension. Back then, it seemed that the U.S. was sliding into authoritarianism, and might take the rest of the world with it. As Wolf explains in the Acknowledgements, he expected to complete his book in two years. In fact, it took five.

Writing a book often takes longer than the author hopes, but in this case, the delay reflected the need to revise some of his thinking. This might have included the fact that the demise of the U.S. looked increasingly implausible. Trump did not win re-election. His efforts to overturn the election were rebuffed. Multiple processes to hold accountable those responsible for wrongdoing are under way. Extremists did not triumph in the 2022 mid-term elections. On the contrary, Democrats did better than expected, as President Biden had accomplished more legislatively in his first two years than any recent president.

“On balance,” Wolf writes, “people have shifted toward a desire for competent authoritarian government.” Yet where is the evidence? Republicans have lost the popular vote in the presidential election every year since 2004. Although no one can predict the future, the book’s fundamental political argument is being undone by America’s continuing political resilience.

Wolf’s Economic Thinking: The Rentiers Are Coming

The economic argument of the book also raises questions. Wolf believes that capitalism is in trouble because productivity is declining, inequality is increasing, and distrust in leaders is mounting, so that even support for democracy itself is at risk.

Above all, Wolf, like Piketty, sees the economic problem as one of “rentiers.” This is the idea that today’s capitalists are like landed gentry of Jane Austen’s novels, who were doing little but investing in government bonds and idly living off the rents of their tenants, with an occasional sortie to the West Indies.

“Capital is never quiet,” wrote Piketty, “it is always risk-oriented and entrepreneurial, at least at its inception, yet it always tends to transform itself into rents as it accumulates in large enough amounts— that is its vocation, its logical destination.”

Wolf agrees with Piketty: capitalism’s destination is about generating rents. The current slowdown in productivity is a sign that the rentiers have arrived. Wherever Wolf finds large profits, he sees rentiers and excessive unearned income.

Why The Rentiers Have Arrived

According to Wolf, one reason for the emergence of rentiers is “the emergence of winner-take-all markets. The digital world of zero marginal costs, platform economics, and big data allows the most successful businesses to dominate global markets…. In brief, a small number of winners that held strong monopoly positions seemed able to shape both the present and the future.”

“As a result,” writes Wolf, “US markets have become less competitive; concentration is high in many industries , leaders are entrenched , and their profit rates are excessive…. this lack of competition has hurt US consumers and workers: it has led to higher prices, lower investment, and lower productivity growth.”

Why Tim Cook Is Not Mr Darcy

In Wolf’s thinking, the principal villains are the digital giants. “The profits of the big technology companies” he writes, “Amazon, Apple, Google, Facebook, and Microsoft—are in large measure due to monopoly rent.” Here Wolf is equating the profits of the digital winners with the unearned income of the idle landed gentry of the 19th century. Really? Tim Cook is the new Mr Darcy?

The possibility that the high profits of the digital winners might reflect the fact that the firms are providing highly valued products and services to customers is not discussed. The fact that the products and services of these firms might be the result of superior innovation is not even hinted at. The possibility that the high market capitalization of the digital winners might reflect a stock market judgment that the rate of innovation and growth in sales of these firms is likely to continue in future is not considered.

For Wolf, the digital winners are lucky monopolists who will be forever free from competition. Therefore, government must step in. Wolf does not consider the possibility that today’s digital winners may not be winners in perpetuity. In fact, the digital winners are in a daily battle with other innovators for survival. Yesterday’s success in the brutally competitive digital marketplace is no guarantee of winning tomorrow.

Thus, Wolf has no explanation for:

· why the valuation of Netflix abruptly collapsed, once the stock market grasped that Netflix’s revenue growth was not as promising as forecast; or

· why Meta’s stock price collapsed when its investments in the metaverse were considered too large and too risky, or

· why Google’s current dominance in search might be jeopardized if Microsoft’s Bing makes better use of AI.

Thus, in the rapidly innovating digital economy, “victory” can be short-lived. The idea that the imaginary absence of competition in the digital economy gives government the right to intervene and cut the winners’ profits is preposterous.

In any event, the digital economy is no more than 16% of the overall economy and cannot be responsible for inequality economy-wide.

The Real Villain Of Decline: Maximizing Shareholder Value

Wolf is strangely silent about the productivity decline of firms in the industrial economy which constitute the remaining 84% of the economy. Unlike the digital winners, who are mainly focused on creating value for customers, these firms, particularly in the U.S. have for the last half-century committed themselves to maximizing shareholder value and making short-term profits, at the expense of innovation. To survive these firms use lobbying power and financial engineering, such as share buybacks, to appear more valuable than they are. This is the main source of the economy’s decline in productivity.

These firms have been slow to master digital technology. Many of them are attempting “digital transformation,” but they have yet to make the needed paradigm shift in management needed to take advantage of the digital technology. (Figure 3 below)

Even giant technology firms like IBM failed to make the managerial transition and went into decline. (Figure 1)

The Financial Sector

Among all the sectors, the prime offender in failing to create value for customers is the financial sector which spends much of its energies in creating, not just a vast global gambling casino with more than a trillion dollars of derivatives in play, but a rigged gambling casino, in which the house has advance notification of which bets will win, while the real economy suffers.

When the financiers are busy “making money out of money” and acting like “rats in the granary” as Charlie Munger has put it, it should be no surprise that economic growth in terms of real goods and services is imperiled. These are not rentiers fulfilling capitalism’s true destiny of providing rents. These are “rats in the granary” who need to be gotten out of the granary and focused on activities that are actually useful to the economy.

What Would It Take To Fix The Problem?

Fixing the root cause of the problems of inequality and slowing productivity means fixing the root cause of the decline and changing the way these firms are managed, as shown in Figure 3 below. None of Wolf’s tax proposals as shown in Figure 2 can do it for them.

This is Management 101 for the digital economy. The digital economy is still only 16% of the whole economy but it is growing more than twice as fast as the rest of the economy. The corporations that have mastered the paradim shift in management have been remarkably successful. This is the future.

Time that macro-economists found out about it.

And read also:

What Thomas Piketty Got Wrong

Microsoft CEO Nadella’s Brilliant Depiction Of The Digital Age