Wednesday, 2 October 2013

Markets v. capitalism

Writing at the blog of the Adam Smith Institute Tim Worstall says,
Forgive me but this is going to be a bit of a rant on one of my bugbear themes: why is it that the British left simply cannot understand markets? Here we've got Martin Kettle describing one of David Sainsbury's ideas:
As a result, says Sainsbury, in opposition Labour now needs to embrace a new form of political economy – the progressive capitalism of his title – in order to govern better and better understand the future. That means embracing capitalism in two particular ways – the recognition that most assets are privately owned and the understanding that goods and income are best distributed through markets.
Neither of those two things are in fact capitalism. Capitalism does indeed describe a method by which assets (and more particularly, productive ones) are owned but it means that they are owned by the capitalist, not simply privately. The opposite to private ownership is State ownership. It's entirely possible to have privately owned assets but which are not owned by capitalists as the various flavours of mutual ownership show us. John Lewis and Mondragon by the workers in those companies, the Co Op or building societies by the customers for them and so on. Private ownership of assets is not necessarily capitalism.
Tim calls his piece "Why cannot the British left understand markets? I would argue that the problem is more general than title may suggest. Is not just the British and its not just the left that don't understand markets and capitalism. Most people everywhere miss the point Tim is making.

In popular discussion worldwide the distinction between "market economies" and "capitalist economies" is not often drawn. It may not surprise many than the distinction is not made since the association between markets and capitalism is so common place. Ownership rights do tend to be assigned to the providers of capital in western style developed economies such as the U.K, the U.S. and even New Zealand. But, as Henry Hansmann notes,
[...] investor ownership is not a logically necessary concomitant of free markets and free enterprise.
In fact one of the most interesting points about ownership of firms in a market economy is just how varied it is. As Martin Ricketts has written,
The assignment of ownership rights to workers, for example, can be found in some industries - the ply wood industry in the United states is a frequently cited case. More significantly, many professional partnerships in law and accountancy are owned by the people who work in them. In the United Kingdom, worker ownership can be found in retailing. The John Lewis 'partnership' has 37,000 worker partners who elect representatives to a central council which in turn provides 5 members to the Board of Directors. Similarly, consumer ownership has a significant history in retailing. The Rochdale Pioneers in 1844 began a working class movement which was taken up later (in 1864) by the middle classes when the Civil Service Supply Association was formed. The Co-operative Wholesale Society is still in existence with sales in 1997 in excess of £3 billion. Agricultural supply co-operatives for seeds, fertiliser and other farm inputs are important in the United States as are electric utility co-operatives in rural areas.

Mutual ownership, that is the sharing of rights between all participants in a club, is still very common in the area of financial services. The origins of this structure go back far into social and economic history. In life insurance, the Amicable Society (now the Norwich Union) was set up in 1706 as a simple club. Members paid a premium at the beginning of the year and the collected sum was distributed at the end of the year to the dependents of members who had died. By the middle of the 18th century, 'modern' characteristics were appearing such as differing premiums depending upon age and a specified sum assured. The mutual form was crucial however. In spite of advances in actuarial science the calculations were so uncertain that investor ownership would have resulted either in the risk of bankruptcy if premiums were set too low. or enormous profits to investors if premiums were set too high. The 'club' was therefore a fairly 'natural' response to these problems in the 18th century When investor ownership developed in the 19th century, this was always linked to profit sharing with policy holders. The Deed of Settlement of the Prudential in 1853, for example, determined that periodic valuations of new profits would be made and that 80 per cent of these would go to policy holders and 20 per cent to shareholders.

The building society movement represents another classic example of the evolution of mutual governance in the area of financial services. Fire insurance companies also initially adopted a mutual structure of governance - the 'Hand-in-Hand' (1698) providing an early example in London. Stock exchanges, popularly regarded as centres of financial 'capitalism', have historically been organised on principles of mutuality. The London Stock Fxcthange is still owned by its members rather than outside investors as are many other exchanges such as the International Petroleum Exchange (IPE) or the London International Financial Futures and Options Exchange (LIFFE). It may turn out that, under modem conditions, the days of mutual governance for these financial organisations are numbered. But the historical existence and durability of mutual arrangements in a market setting is not in doubt. Other examples taken almost at random include motoring organisations such as the Automobile Association (AA) and Royal Automobile Club (RAC) which have recently 'de-mutualiscd'. as well as the Silverstone Racing Track.

Sometimes the distribution of surpluses is ruled out by an organisation's constitution. Such organisations can thus be said to have no owners. They exist within market settings even if we would not expect them to be very common. Education and health care are areas in which non-profit enterprises compete with profit making organisations. At the so-called 'private' University of Buckingham there are no residual claimants and 'ownership' of the assets is no more clearly defined than in some bureaucracies. The same could be said of many other charitable organisations. Early examples of savings banks in the United Kingdom and in the United States, designed to encourage thrift amongst the relatively poor, were charitable rather than mutual organisations. In the modern world BUPA, which provides care homes, hospitals and occupational health facilities, employs over 30.000 people and retains all surpluses within the organisation.
So in a modern market economy firm ownership may be dominated by investor-ownership but you also have producer-ownership, employee-ownership, customer-ownership, non-profits ans mutuals.

So why so many types of firms. Put simply, one size dos not fit all. First, it is argued that all other things held equal, costs will be minimised for a firm if ownership is assigned to the class of patrons for whom the problems of market contracting--that is, the costs of market imperfections--are most severe. Thus, if the cost of contracting with workers is higher than the cost of contracting with suppliers, customers, etc., in a particular economic sector, then theory would predict that employee ownership would be the dominant form of ownership.

However, the story is further complicated by a second major factor: the cost of governance. The more diverse the interests of a patron group, the higher the costs of politically mediating those differences through the structure of the firm. As a result, the optimal form of ownership in an industry is that which minimises the sum of all of the costs of a firm's transactions. That is, it minimises the sum of (1) the costs of market contracting for those classes of patrons that are not owners and (2) the costs of ownership for the class of patrons who own the firm. In different situations different ownership structures will minimise these costs.

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