Ha-Joon Chang: 23 Things They Don't Tell You About Capitalism

Aug 13, 2015

I picked up this book because I’ve heard praise of another book by this author but this one was available at the public library. While I assumed, I’d learn something interesting, it turned out to be an exercise in patience and identifying logical mistakes and fallacies the author uses. Right now, the book is making its round among my friends and relatives and their sentiment is pretty close to mine.

The structure of my notes mirrors the structure of the book - it goes chapter by chapter, point by point. Many of the chapters infuriated me because of the tone and dogmatism employed. The only thing I don’t know is whether this is intentional provocacy prompting readers to argue their positions or it’s a genuine belief. I hope for the former.

In the introduction, Change blames the 2008 crisis on free market capitalism and continues to outline the 23 unspoken things about capitalism and claiming, that free market doesn’t exist.

1 - Free market doesn’t exist

Every market has some regulations therefore free market doesn’t really exist. Ok, if you want to be nit-picky, but no one means absolutely no rules when saying free market. For example private property rights are fundamental to free markets. Then he lists some regulations which limit almost all markets, specifically child labour and other regulations of the job market. Again, nobody is in favor of child labour, why doesn’t he pick some regulations which are debatable and not universally accepted? The only relevant point is that the level of desired regulation is a matter of personal taste.

Then he claims that the Fannie Mae and Freddie Mac buyouts is a free market transaction. WTF? He states that more and more things are banned from market or at least regulated (but mixes market self regulation like fair trade with legislative regulation) and concludes by stating that since the limits of the markets are subjective desire to widen them is as valid as to tighten them. Once again, who’s saying it isn’t?

2 - Companies should not be managed in line with owners’ interests

The myth here is that “shareholders are taking risk, their revenues aren’t guaranteed, that motivates them to get the management to run the company to maximise profits which also maximizes wider societal good”. Who thinks that? The relationship between management and shareholders is problematic and needs continuous alignment of incentives. Naturally, managers are motivated by their pay being dependent on the dividends payed to the shareholders. Is that the best thing for all stakeholders? Not for employees, probably not for suppliers.

The problem becomes more pronounced in the absence of a majority shareholder who would steady the course. Chang bonifies states which keep majority ownership of major companies but skips over the fact, that not all companies have to be joint-stock companies and even if they are, they don’t have to be publicly traded and even then a majority shareholder might keep a tight hand on the steering wheel. Is it tragic that many companies are driven to short term goals which are advantageous for shareholders who can easily pull out, sure but no one is forcing them to be run that way. Is it tragic that companies which derived the bonuses of managers from profit let them grow to absurd amounts? Sure, but again it doesn’t mean that the scheme has to fail.

Cheng doesn’t offer any hint of better arrangement, but mentions a system I haven’t heard about. Apparently, some companies in Japan hold each other’s stocks to keep some sort of balance.

3 - Most people from rich countries are paid more than they deserve

The assumption being busted in this chapter is that people in rich countries are inherently more productive and deserve higher pay for the same job. The example used is a Swedish bus driver who is paid fifty times more than his Indian counterpart.

With this contrast, Cheng tries to persuade the readers that the only reason for such a huge disparity are immigration restrictions which is pretty accurate. However, he omits the locality of most jobs - if you need a bus driver in Sweden, he’ll probably live in Sweden. Of course, if bus drivers are prohibited from moving to Sweden, it artificially limits the supply and drives prices up. The major thing not mentioned are the transaction costs of moving, learning a language, fitting into the society etc.

I think that in a world without any immigration restrictions the inequality in pay would persist but it would move across the globe much faster, in order of decades, not centuries because of the aforementioned reasons.

Another point mentioned are programs for brain drains from developing countries, which move the brightest minds from their poor countries to the rich ones and leave the rest behind. Morality of these schemes is dubious, but I have the feeling that many of those people later come back to their homeland and employ their experience and contacts to improve it. It’s definitely not all of them, but what is the alternative? Banning them from leaving and damping all ambitions?

4 - Washing machines changed the world more than the Internet

This chapter makes much more sense then the first three. The assumption is that we live in a post-industrial world where communication technologies cross all borders, make all changes faster and require more flexibility on society’s part and freer markets. The counter argument used is a washing machine and other home appliances which greatly increased productivity, freed a large portion of the labour force from service or helper positions and ultimately enabled women to leave their homes and enter the labour market.

The whole chapter stands on measuring the impact of the Internet by the time it takes to get a message across the Atlantic compared to a telegraph and a paper letter before that. Even though this specific measure might yield a better result for the telegraph, I see it as a very narrow definition (it doesn’t take into account the volume of communication to say the least). However, his point about the recency bias which leads us to overestimate the importance of the most recent event is a good one.

5 - Assuming the worst of people gets you the worst

This chapter returns to mischaracterization of liberalism by claiming that personal interest and greed is the only motivator of human behaviour. The author illustrates his point by trust between people (for example within a company), by public servants, Italian strikes (absolute adherence to workplace regulations and instructions) and moral behaviour.

In turn: some trust is rational and beneficial even when you know your partner can betray you (look at the game theory). Public servants might not maximise their financial income but they get comfy positions from which they can hardly be fired (the author even mentions Sir Humphrey Appleby from Yes, minister but fails to see the point). Politicians don’t go into politics to serve people, they get money, connections and prestige if they manage to pull out before a scandal. Again, nobody is saying that greed is the only motivator. It’s closer to a limit motivator. We have the luxury to live in a society where we can be generous and honest but when push comes to shove, self interest wins.

6 - Macroeconomic stability doesn’t lead to stability of the world economy

In this chapter, Cheng critises the Western obsession with keeping inflation low. I have to say I was surprised by the numbers cited for the inflation in Brazil and SE Asia. On the other hand, I don’t see inflation control as a free market mechanism but as a tool for governments how to lessen their tragic spendings.

7 - Poor countries only rarely become rich thanks to free market

Cheng comes back to making sense in chapter 7, in which argues that very few countries, if any at all, got rich because of a free market. Exemplary countries like USA and UK have turned free market only after they became rich by protecting their own industries for decades or centuries. Now, they force free market upon poor countries via international organizations like IMF. The numbers seem to be on his side I have to agree with him. However the free market concerns are still applicable to poor countries. When we admit that governmental protection of developing industries can be beneficial for young economies before maturing and opening up to foreign companies, the question shifts to when is the point to open up? If the country subsidises its companies and nurtures them, it needs to set some parameters of when the process will be finished.

8 - Capital has nationality

In this chapter, the author tries to prove that companies tend to invest more in their country of origin (or region) and that it matters. The arguments for why companies are less likely to cease or reduce their operation in the country of origin are persuasive - work force can’t be moved easily, relationships and supplier networks can’t move, culture and mentality are very specific. These arguments presume that the company has to operate the same way everywhere which doesn’t have to hold (but then raises the question whether it’s still the same company). However he makes a good argument for some regulation.

9 - We don’t live in a postindustrial world

This chapter is a return to nonsense and irritation. The starting point is a claim that the decline of industry in relationship to services is natural and inevitable and developing countries should skip industry and manufacturing and jump straight to service-based economies. I’ve never heard such a claim and see it as yet another straw man.

Cheng nicely explains that the decline of industry should be a concern, because it serves as a basis for international trade which is inevitable unless the country is fully self-sufficient. So far so good. Then he goes on to show that the shift in employment and total size of the industry measured by proportion of GDP is mostly an optical illusion caused by measurement methodologies, classification of companies, outsourcing and faster growth of productivity in industry than in services (which are by nature of person to person contact limited). The most annoying point here is that he can’t even add up the percentages of these effects correctly which leads him to overestimating the effect of real decline of the industry (which is worrysome) and then in turn claim that the total decline is much smaller than normally presented because of how it’s measured. Come on, decide which way you want it!

The second part of the chapter about developing countries skipping industry is reasonable.

10 - USA don’t have the highest standard of living

Really? Who didn’t know this? One of the greatest income inequalities, crazy crime rates, health care in shambles, longer work hours - nothing new. However only the longer work hours caused by fewer restrictions on the labour market can be easily tied to free market.

11 - Africa isn’t destined to be poor

This chapter is a rehash of chapter #7 focused on Africa. Cheng presents economic growth numbers before 1980 when free markets started to be forced upon African countries by international organizations and after. They seem convincing, although I feel like he goes too far in dismissing the role of climate. I haven’t finished Jared Diamond’s Guns, Germs and Steel yet, but his point is that Africa has disadvantageous position with respect to climate and agriculture: not without any chance of overcoming it but very unfavorable.

12 - Governments can choose winners

In this chapter, Cheng attacks a non-existent opinion which would say that governments can’t choose winners. On examples like South Korea, he illustrates, that governments can choose winners with a long term perspective in mind and even unpopular decisions might benefit the country and therefore all its companies eventually. To his credit, he lists examples of failure, e.g. Concorde, as well.

There are two problems with this chapter. First is that it mixes two groups of projects/companies into one - (visionary) development of a new industry and established industries. The second is that absolutist wording - no one denies that governments can choose winners but, but many say they are less likely to do so than markets. The chapter even ends by stating that every one, governments and markets alike, sometimes win and sometimes lose.

13 - When rich get richer, it doesn’t mean that everyone is better off

We’ve arrived to a criticism of trickle-down economics which basically boils down to: when you “give” money to the rich, you need to make them invest it so that others benefit as well. What a surprise.

14 - American managers are overpayed

Really? Who would have guessed? The author illustrates the rapid growth of managers’ incomes in relation to those of average employees and goes on to show that it’s not related to a growth in productivity as if that was the only determiner of cost of labour. There is a second major component and that’s the relative price of other managers which gives candidates better negotiating position. However, the companies hiring them could easily get out of the problem - hire managers who are willing to do the job for less money. The reason they don’t do it is that they use price as a status symbol, but hiring a cheaper manager can be framed as saving money which can be put to a better use instead.

15 - People in poorer countries are more entrepreneurial

First example of this chapter is completely nonsensical. People, including children, in poor countries are depicted as highly entrepreneurial because they do small jobs like carrying luggage, waiting in lines, shoe shining etc. just to stay alive and where do you see such this spirit in the developed world? A child trying to do some small job like this would be looked upon with or at least tolerated, but any adult would be either bogged down by permits, records of sales, bureaucracy and taxes or labeled as criminal if trying to avoid those.

As a second argument the percentage of entrepreneurs is compared. It clearly shows that there are at least three times more entrepreneurs in the developing countries (30-50 % on average) than in the developed countries (12 %). As if this is a useful measure. The question which should have been asked is how many people are employed by small businesses (including solo entrepreneurs).

The later part of the chapter is a criticism of microfinancing which is shown to stimulate only one-person operations. There is a limited number of markets where those can operate and easily become saturated with abundance of microfinancing which drives individual profits down. Only tiny fraction of people grow their business to involve more people and become more self-sufficient. So again he undermines the data he uses just few paragraphs earlier.

16 - We’re not smart enough to entrust everything to markets

In this chapter, Chang discusses a lot of concepts from the field of behavioural economics: choice paralysis, irrationality and bounded rationality, herd mentality etc. His conclusion is that we cannot entrust everything to markets because they’re not rational, therefore entrust everything to just a few people who are irrational.

17 - Countries don’t get rich thanks to education

This chapter nicely expresses my concerns about higher education. Education is championed as the only avenue to brighter future: the more people learn the more productive they are. While this is true for basic skills like literacy or algebra, the relationship between higher education and personal productivity is at best weak. The amount of training necessary for some disciplines is larger than for others but not necessarily qualitatively different. This topic gets very complicated when different national educational systems and fields are put together. In any case, the developed world suffers from title inflation which is often sponsored by tax payers, but yields only personal benefit for the student. I think that the core of the problem lies in how we perceive education and all the ingrained assumptions and prejudices about it.

18 What is good for GM doesn’t have to be good for the USA

What a surprising name for a chapter in which Chang argues that permits and bureaucracy is good because it makes people and businesses proof that they really are keen to enter the market. While there are types of regulations which have sense and their place, regulations for regulations’ sake are just absurd.

19 - We still live in a planned economy

Now, Chang tries to claim that we live a planned economy which doesn’t differ from the socialist model. His arguments are that every enterprise plans ahead, stakes out milestones and invests accordingly; also governments create plans for the future developments and use policies to shape the economy plus they invest into research and development. The greatest error in this argument is the equation put between centrally planned economy and plans of individual participants of the market. Of course, businesses plan but it’s definitely not the same as one committee planning the whole economy for five years ahead. The distribution of decisions and plans makes the whole more resilient to failure, because it’s local, not global.

The government planning reiterates chapter 12 but also makes a huge assumption that governments have any vision beyond re-election which also includes well-being of the citizens of their countries. That’s a giant if and even though this optimistic belief in people is cute, it doesn’t affect the real life. The most reasonable idea in this chapter is about R&D where governments are the biggest investors in any country. Recently, I saw a chart showing how much R&D is co-funded by industry and China was leading with some 25 - 35 %; then a huge drop off to European countries and the USA. This however ties closely to the role of higher education (chapter 17) and how we perceive it. While education and research are not the same thing, there is a tight relationship between those two. Moreover any research funded by industry is in the field of the investor and if anything comes out of it, it’s often perceived as biased by others. The government in this case serves as a neutralizer of interests - therefore its major role in research funding can be viewed as beneficial.

20 - Equal opportunities don’t have to be fair

Chang argues, that having an equal economic opportunity is good but not enough if you can’t take the advantage - you’re poor, lack education, have to have more jobs just make ends meet etc. This is a reasonable argument in accordance with humane and civilized society. However his predictable solution is to include the government to stack the opportunities so that everyone has the same starting position. This sentiment goes against the natural understanding of equal opportunity, but if argued carefully, can be framed and promoted. The trouble lies in the involvement of governments which have the tendency to stomp in and create forms and bureaucracy around everything in which the original intent gets easily lost and no one benefits. If governments take any action in this field, the policies should be tightly coupled with the intent and provide mechanisms to evolve and eventually disappear over time.

21 - People are more open to changes when they have big governments

Last three chapters, ufff. Here, Chang argues that big governments are better for change. What he means is for switching careers because people without a job can get unemployment support and have access to re-education in large social states. Citizens in countries like South Korea or the USA look for stable professions they can stick to for their whole lives, e.g. medicine in South Korea.

I’m not completely sure about this point. For starters the concept of switching careers is rather new one and while I can see the individual benefits there are also see people who jump around and never really do anything. I accept this fact with the assumption that having a choice and getting a second chance is a good thing and can see how unemployment support can help with that. However, there are people who choose to live off the support (and nothing will change that), there are people who do labor intensive unskilled work who don’t really need re-education and then the rest. When they switch careers out of their own will, they have enough foresight to plan for it and don’t really need that much support; otherwise they are the real beneficiaries of this system. Cheng, however, argues more radical opinion: switching careers is change and it is good. While I understand, it can help people who loose their job, I don’t think one can call it a change and look to the bright future.

22 - The efficiency of financial markets has to be lowered, not increased

In the next to the last chapter, Chang again makes sense. He describes how deregulation of financial sector in Iceland led to its huge growth (where the amount of money turned over reached multiples of GDP) and less stability. There’s hardly anything one can argue about. Maybe the means how to achieve stability. He includes the ideas from chapter 8 about the nationality of capital and also suggests some sort of regulatory body for financial instruments, similar to FDA. While this makes sense, I can’t imagine how the proposed testing process would work. I think, that a better approach would be disallow all the branches of governments and government sponsored programs, e.g. pension funds, to use the new instruments until they are considered to be understood and proven by the government. This would enable those who can and want to risk to still do so and serve as a laboratory, while keeping the government related institutions safe from the new unproven instruments. The key question is how large would these two segments be and whether the restricted one would be large enough. If such a policy was adopted in a significant number of countries, it would definitely lead to a shrinking of the financial sector but I believe that the well-understood instruments would still form a significant chunk of the market. Significant enough to work.

23 - Good economic solutions don’t need good economists

This last chapter points to economists as a source of many problems, not that the previous chapters didn’t poke at them already. Chang illustrates that many successful developments of economy in the last century were designed by non-economists, e.g. lawyers and engineers in South Korea, Japan and other south-east Asian countries, while countries whose economies were shaped by economists failed miserably, e.g. Venezuela and other countries of South America. While this is true, it boils down to our praise of complexity even though simple solutions are at least more understandable if not better every time. It’s natural that personal interests of economists who are in power affect their decisions and that unrestrained powers often lead to disastrous results. However, it’s not a flaw unique to economists.

All in all this book was aggravating. Even though there are few interesting points mixed in, the overall presentation, dogmatism and straw man arguments make it really hard to be sympathetic with the author.