Transcript The Anglo-Saxon Model of Capitalism

The Anglo-Saxon Model of Capitalism
The American Economy: Market Capitalism
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I.
Models of Capitalism
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The Anglo-Saxon model
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Originated in England in the 18 century and it is patterned after the classical
liberal ideas of A. Smith; uses common law, which operates with lay judges,
broader legal principles, oral arguments
Based on the principle that government intervention in the economy should be
limited
Best real-world example-USA
The European model
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Is patterned after the econ principles from the 19 century in France and
Germany that places less faith in the invisible hand and call for more state
intervention in econ activity, including more state ownership
Uses civil (roman) law, which is based on professional judges, legal codes and
written records.
Best real-world examples-France, Germany and Sweden
The Asian model
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Is closer in its institutional arrangements to the European model; it focuses on
high rates of capital formation;
Exists in variety of forms and involves a considerable amount of
experimentation
Best real-world examples-Japan, South Korea, Taiwan, Hong Kong, Sigapore.
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II. The U.S. Economy
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Constitutional Foundations
• The legal foundations of the US economy is the US
Constitution:
– was ratified in 1787
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the original intent of the US Constitution was to limit the
power and scope of the federal government
the US Constitution specifies three brunches of
government-executive, legislative, and judicial, each of
which represents a substantial check over the others.
We study the US economy as an example of the Anglo-Saxon
model. The US economy is large and wealthy economy that
has enjoyed a considerable success. It relies predominantly
on markets with less government intervention. It is also the
most technologically advanced economy.
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2. The Environment
• Large size and rich natural resources—7% of world land area, and
5% of world's population.
• Philosophy of Individualism
– Individuals can have significant impact on society; success through
individual hard work.
– Encourages higher education; discourages welfare spending.
3. Changes in the Structure of the Economy.
– Agriculture was most important employment sector until 20th
century. Industry was dominant 1900-1930.
– The service sector employs 75% of the US labor force. Expansion moved
from wholesale and retail trade to public services, and finally the non-profit
services, education and health, accounting, finance, insurance, and computer
programming. (“Industry output and employment projections to 2014”)
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4. The Private Sector.
• Business Organization
–Forms
• Sole proprietorship
– owned by 1 individual who makes all decisions, absorbs profits/losses
– Important in agriculture, retail trade, services
• Partnerships
– owned by 2 or more partners who make all decisions, and share
profits/losses
– Finance, insurance, real estate, services
– Advantages
» Relatively simple
» Their profits are taxed only once
– Disadvantages
» The owners are personally liable for the debts of the business
» The ability to raise capital is limited, dependent on the owner’s
ability to borrow against personal assets
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•Corporations
– owned by its shareholders and act as a legal person. A board of
directors, elected by the stockholders, appoints management to run
the corporation
– Advantages:
» The owners (stockholders) are not personally liable for the
debts of the corporation (limited liability)
» The management can be changed if necessary
» It has more options for raising capital (sale of bonds and
additional stock)
– Disadvantages:
» The income is taxed a second time when corporate profits are
distributed to stockholders as dividends.
» Double taxation gives American corporations to reinvest
earnings rather than pay out dividends.
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Distribution of US enterprises according to the legal form of business
organization. Corporations about 20% of total number, account for 90 % of
business revenues.
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• Corporate Governance
– Is concerned with the issue of for whose interest a corporation is
operated. In theory, the corporation can be run in the interests of:
• Shareholders
– owners
• Stakeholders
– those who participate in the corporation as managers, employees, workers,
suppliers or buyers, but not as owners.
• The community
– The task of the manager is to maximize shareholder value, the
value of the corporation in stock mkts as measured by its mkt
capitalization.
• The mkt capitalization of a corporation is the product of the number of
shares outstanding and its stock price as determined in the stock mkt where
it is listed, such as the NY exchange, etc.
– Large corporations are characterized by separation of ownership
and management
• The managers of large corporations own only a small fraction of shares.
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The bulk of the shares are owned by individuals either directly or indirectly
or through private pensions and retirement funds
– Control in widely held corporations--managers act in their own
interest
• The potential problem The principal-agent problems -how to
motivate managers to max shareholders value is solved through
two approaches:
– The Market for Corporate Control -a market wherein rival management
teams have the opportunity to buy control of the corporation from its
owners (threat of takeover as disciplining device for management)
• As many citizens began investing in private pension funds; these funds began to
inquire and control significant shares of large corporations. E.g the CREF Teacher’s
retirement fund currently has more than $100 billion investment in stock.
• Corporate riders—individuals as Warren Buffet or investment banks targeted
corporations that were not realizing their potential and developed a business plan,
showing that with new management the corporation could earn higher profits. The
corporate raiders then would offer a price above the current stock price to
shareholders to replace the current management with a better management team.
• The US mkt for corporate control became quite complex and effective in 1980’s and
1990’s, using instruments such as the purchase of one company with shares of
another
– AOL’s purchase of Time Warner, largely with AOL shares 2001
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– Corporate Incentives -US executives receive a fixed salary and a
bonus based on the performance of the corporation. In the 1990’s
corporations began introducing more direct incentives to ensure that
corporate executives are motivated to max shareholder’s value
• Stock option
– Executives are granted the right to buy a designated number of shares of the
company at specified price
– Stock option would direct executives to think about the company's long term
performance
• To match any employee contribution to their 401K retirement accounts that were
invested in the corporation’s own stock
– The management to accumulate shares in their own corporation and they will
have a personal interest to see the price of shares increase.
• Golden parachute
– The provision for a limited number of executives to receive generous
severance bonuses if their company is taken over by a new management team
– The purpose is to prevent existing management resisting corporate takeovers
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• Preoccupation with shareholder’s value is a hallmark of the AngloSaxon model
• Criticism of the Anglo-Saxon model
– It neglects the interests of stakeholders (managers, employees), who may
have worked for the company for decades
• Max of shareholder’s value will periodically engage in cost cutting and
downsizing; hence loss of jobs
– Max shareholder value can create distortions in stock markets that require
accurate info to operate efficiently
• Top executives will withhold negative info to prevent the decline in the
share price, as in 2001-2002 scandals involving Enron, Arthur Anderson.
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5. Capital Markets
• The market in which businesses raise investment finance trough the
issue of stocks, bonds and bank borrowing.
• Brings together users and suppliers of credit
• Well organized and efficient (new information is very quickly
reflected in share prices)
– stock markets
– bond markets
• A capital market could be:
– Primary
• The corporation sells (issue) new shares of stocks or bonds to buyers, called
Initial Public Offering (IPO).
• Investment financing is created in the primary mkt
– Secondary
• Secondhand mkt in which shares of stock or bonds that have already been
issued are traded by one owner to another.
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• The American capital mkt is one in which new shares are sold to
private investors by underwriters who organize the initial sale of
shares. The stock exchanges are private organizations that have
established operating rules and have the power to punish
underwriters, brokers or companies that violate their rules.
– Insider trading laws—stock exchanges and security commissions have more
strict laws against insider trading; all insider transactions must be reported to
the security and exchange commission for publication. Insider trading occurs,
but if it discovered, is punishable.
– Strict accounting standards that require transparency
• Features:
– The operating principle of major US stock exchange is full financial
disclosure—the potential buyers of new stocks need to have a full info about
the company
– In US more investment is financed by the issue of stock and bonds than
through bank financing. The financing of investments through stock mkt is
characteristic feature of the Anglo-Saxon model
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– Separation of those who finance from those who manage. In the
European and Asian models, which rely heavily on bank financing, the
bank is closely associated with the corporation and would be reluctant to
withhold financing from closely related company. The separation of
financing from management has the advantage that a generally impartial
decision will be made whether a company deserves additional financing.
– In the US capital mkt promotes dynamic change over relatively short
period, by its willingness to move capital quickly from one sector to
another and from one corporation to another. If one sector develops a
new technology and another sector’s technology lag, the capital mkt will
automatically direct capital to develop the new technology. If consumer
taste change, new capital will flow to the sector with rising consumer
demand
• Table 8.2 shows the dramatic changes in ranking over relatively short period
of time
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2009 RankCompany
Revenues ($ millions)
Profits ($ millions)
1.Exxon Mobil
2.Wal-Mart Stores
3.Chevron
4.ConocoPhillips
5.General Electric
6.General Motors
7.Ford Motor
8.At&T
9. Hewlett-Packard
10.Valero Energy
442,851
405,607
263,159
230,764
183,207
148,979
146,277
124,028
118,364
118,298
45,220
13,400
23,931
-16,998
17,410
-30,860
-14,672
12,867
8,329
-1,131
Source: Fortune 500
http://money.cnn.com/magazines/fortune/fortune500/2009/full_list/index.html
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•The opponents of the Anglo-Saxon model of investment finance argue
that stock mkts are too volatile and are dominated by emotion. They
believe it is better to have knowledgeable bankers deciding who should
get investment financing. A disadvantage of the bank financing is that
tends to get too closely linked to the corporation to make impartial
investment decisions. The US capital mkt punishes corporations that
fail in their business plan.
•Financial crisis started at the end of 2007
•The new innovations had allowed the banks to hide much of their
bad lending to move it off their balance sheets, to increase their
effective leverage. The new instruments (credit default swaps)
allegedly for managing risk but in reality as much design for
deceiving regulators, were so complex that they amplify risk.
•The mortgages had high transaction costs and variable interest
rates with payments that suddenly could spike, but with no
protection against the risk of job loss. The designers of these
mortgages focus on maximizing their revenues and their efforts
produced a whole range of complicated mortgages that made them
a lot of money in the short run and led to temporary increase in
homeownership, but at a great cost to society as a whole
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6. Competition in the product market
• Resource-allocation arrangements depend on the degree of mkt
power in different product mkts. There is no accurate measure of mkt
power but the most frequently used measure is the CR
a) Concentration ratios (CR)
• percent of total domestic output of largest 2, 4, 8,…, n firms
– e.g. 4-firm concentration ratio of 85% means that the 4 largest firms
account for 85% of the industry sales
– Low CR – competitive industry
– High CR—”oligopoly”
b) Increased competition from global market
• consider auto industry
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7. Regulation
• Another important part of the institutional infrastructure that supports
a mkt economy.
• The constitution of the US was designed to protect private property
from the government regulation.
– The federal government can make decisions affecting businesses through the legislature,
in which a bill is passed by congress and signed by the president, or by executive order or
regulation.
• Regulation of the private business evolved for the purposes of
protecting the public interest, as evidence by almost 30 different
regulatory bodies.
– Environmental Protection Agency has control over what substances business can release
into air or water.
– Food and drug administration approves new drugs.
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•Regulation has been exercised by a wide variety of local, state and
federal agencies. Government regulation can be classified as:
Social-regulation of health, safety, and environment (consumer product safety rules;
environmental protection etc.) is used to protect public safety and health EPA, FDA.
Economic-gov’t involvement in mkts, such as setting prices, restricting corporate
decision-making, and controlling competition (utility rates, the setting of local taxi
rates)
•Both econ and social regulation impose costs and creates benefits
--Costs
One of the costs is compliance cost, the associated paper work, etc
2002 the cost of business regulation was approx. $1 trillion or 9% GDP (large
costs)
The Fed register, which publishes all federal regulations has reached 100,000
pages per year
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– Benefits
• Substantial progress in cleaning air, water and land
• Reducing automobile emissions
• Improvements in automobile safety
• A regulation is economically and socially beneficial if it yields
benefits in excess of its costs.
– Complications in evaluating the costs of regulation:
• Capture only the direct costs of federal regulations. Indirect costs, called unfunded
mandate, is a regulation such as handicap-assess regulations, that the private business
must pay for out its pocket without government assistance
• Absence of counterfactual info-it is presumed that improvements in car safety, gas
mileage are due to government regulation. But this ignores the fact that private
businesses might have been motivated by profit-max to produce the same results
without regulation.
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8. Deregulation
• In the 1960’s and 1970’s the high cost and percieved inefficiencies of
regulation prompted a movement to deregulation
• The reduced incidence of gov’t regulation of business and the return
of decision-making to the private business themselves
• The deregulation in the American economy began in late 1970sairlines, railroad, transport
– The Airline Deregulation Act signed in 1978, allowing the airlines rather than
the Civil Aeronautics Board to set fares and routes
– Much of the deregulation was motivated by the message of microecon theory—
the development of competitive mkts could provide benefits that would
outweigh associated costs.
• Effects from the deregulation (The consumers are the prime
beneficiaries of deregulation)
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Increased competition
Improves efficiency in an industry
More business uncertainty and volatility, which is characteristic of capitalism
Lower prices for most (but not all consumers)
• Consumers in small mkts characterized by high costs are no longer protected and
now have to pay prices closer to costs.
– increased diversity of services offered to consumers (more choices)
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– The most controversial area of expansion in deregulation is the
electricity mkt
• Under deregulation, local utilities would serve as common carriers
obligated to transmit electricity purchased from various supplies to the
national power grid.
• 2001 utility deregulation under intense scrutiny. California passed
deregulation legislature that froze the retail price of electricity while
allowing the wholesale electricity be purchased in short-term forward
mkts, forbidding purchases in long-term forward mkts. As energy prices
and electricity prices rose unexpectedly in world mkts, CA electricity
retailers found that their retail prices did not cover their wholesale prices
and to avoid massive bankruptcies, the state of CA had to cover the price
differentials through the state budget, which was thrown in a severe deficit
as a consequence.
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9. The Labor Markets
• The US corporations managed to max shareholder value not
stakeholder value. The major stakeholder are managers, workers.
Their interests are regarded as less important than those of the
shareholders. Therefore, should be less job security in the American
labor market than the European where the stakeholder rights are
higher.
• Market allocation (wage rate equals supply and demand for labor)
with influence from unions, government, and discrimination.
• The impact of unions
– In all industrial democracies, union power grew with the rise of large scale
industrial enterprises. We have labor and trade unions—organizations of
employees and workers of a company, occupation or branch that come
together for the purpose of affecting conditions of work and pay
– less than 15% unionized.
• In the US government employees account for the majority of unionized workers.
• Most American unions are associated with the American federation of LaborCongress of Industrial Organization (80% of the union members)
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– weak compared to Europe (European unions politicized)
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-effects on productivity
•Negative (strikes; work rules; distortion on union-nonunion wage)
•Positive (training; reduced turnover and higher moral)
-effect on wages
•unions increase unionized wages about 15-18%
•increased wages cause reduction in quantity of labor demanded in unionized sector
•thus supply of labor in non-unionized sector increased
•thus non-unionized wages depressed
Union
Non-Union
$
$
S
Perceived
Supply w/
union wage
floor
S'
S
Wuf
Wn1
Supply w/o union
wage floor
Wue
Wn2
D
Ln1
Ln2
Labor
D
Luf
Lue
Labor
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• The impact of government
– licensing
– In long run it affects the supply of labor through government policies toward
public education and job training
– Moreover, anti-discrimination regulations affect employment practicies
• hiring quotas
• minimum wages (minimum wages cause unemployment)
The Effect of Minimum Wages
$
Excess supply
I -- Better off (working at higher
wage than before)
Wm
II -- Worse off (were working,
now unemployed)
We
III -- Frustrated (would like to
work at higher wage but
can’t find work -- counted
as unemployed)
0
I
Ls
Le
Lm
II
Labor
III
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– much more limited degree of government regulation in American labor
markets then European
• The US employers are regulated by several acts:
– The Fair Labor Standards Acts of 1938, establishes the standards for min wage,
overtime pay, child labor
– The Occupational Safety and Health Act of 1970—sets health and safety standards and
conduct inspections to ensure safe and healthful workplaces.
– But these regulations did not dictate hiring and firing procedures
The government intervenes the labor market with ant discriminatory policies
• Discrimination against:
– Women
– Minorities/ race
– Potential effects
• exclusion from certain occupations/channeling into certain occupations
• reducing wages of women and minorities
– Most work indicates that discrimination does exist but affect on wages small
• Unemployment rate—US unemployment lower than European
since 1982. Although 2009 is 9.5%
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The US economy consists of private and public sectors.
10. The Public Sector
• Small relative to other industrialized countries
– Especially small given large defense needs
– Government expenditure about 35% of GDP (Germany and France about 50%)
– 24% federal
– 11% state
In the pure Anglo-Saxon model the state is not responsible for the income and security
of its citizens. But no country can ignore the income and security of its citizens
11. Welfare
• In the US, government public assistance has been limited to public
education, some low cost health care for the poor, social security,
disability and unemployment.
• FSP, TANF
• Limited welfare assistance
• promoting self-reliance thru the acquisition of job skills
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12. Income Distribution
• Relatively unequal compared to other industrial nations.
• Lorentz curve—compares family income by rank with percentage share of
income either before or after taxes
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• The government plays a modest role in the redistribution of income in
the US.
• The taxation system has little effect on distribution, but transfer
payments have a significant effect. In 2003, taxes and the earned
income credit reduced the Gini index by only 4.6%, but transfer
payments reduced it by 17%.
13. Providing for Income and Security
• Principle of self-reliance
• The state is not responsible for the income and security of its citizens
• Social security act, 1935, created a social insurance to the retired
workers aged 65 or older.
– 1956 Medicare
• Educational system
– Public and private educ. In the US education is more a personal rather than
social investment
• Health care system
– Medicare, Medicaid, health care costs are increasing
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14. Privatization
• the shift of the economy from the public sector to the private
• publicly owned facilities, such as airports, roads, water systems
• there is substantial amount of private initiative in the provision of local services.
In the US privatization is more likely to consist of government contracting for the
private production of traditionally public sector goods and services such as trash
collection, local transportation services, etc.
15. Macroeconomic Planning is limited to:
• use of indirect tools of monetary and fiscal policy
• The FED established in 1913, the Federal Reserve system consists of 12 federal
reserve district banks coordinated by the Board of Governors in DC.
– The functions of regulating the money supply through open market, setting reserve
requirements. The FED is in charge of formulating monetary policy.
– Authority over fiscal policy is diffused among the various executives and legislative
bodies in charge of government spending and taxation.
• National budget is prepared and proposed by the executive branch; examined,
amended, and approved by the Congress; and signed into law by the President.
• No formal use of indicative planning or industrial policy.
• On the whole, the distinctive feature of econ planning in the US is its absence.
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16. The current financial crisis 2007-2009
has forced us to rethink our common ideas about capitalism. It was
long thought that the “invisible hand” of the markets would keep
everything in check—full employment, a growing economy, and
minimum governmental regulation. But watching people lose their
homes, the stock market plummeting further everyday, retirement
savings shrinking, and massive unemployment numbers, it seems
the “invisible hand” has been amputated. Greedy mortgage brokers,
blind faith in rising home prices, panic selling, poor consumer
confidence—or what Keynes called “animal spirits”—move
economies in irrational ways. These powerful psychological forces
are imperiling the wealth of nations today.
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•The term "animal spirits," popularized by John Keynes
in his 1936 book "The General Theory of Employment,
Interest and Money:"
"Even apart from the instability due to speculation, there is the
instability due to the characteristic of human nature that a
large proportion of our positive activities depend on
spontaneous optimism rather than mathematical expectations,
whether moral or hedonistic or economic. Most, probably, of
our decisions to do something positive, the full consequences
of which will be drawn out over many days to come, can only
be taken as the result of animal spirits - a spontaneous urge to
action rather than inaction, and not as the outcome of a
weighted average of quantitative benefits multiplied by
quantitative probabilities.“
•is related to consumer or business confidence, but it
means more than that. It refers also to the sense of trust
we have in each other, our sense of fairness in economic
dealings, and our sense of the extent of corruption and
bad faith. Then, consumers do not want to spend and
businesses do not want to make capital expenditures or
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hire people.
“Animal spirits: How Human Psychology Drives the Economy” 2009
• George Akerloff and Robert Shiller challenge the econ wisdom that
got us into this mess, and put forward a new vision that will transform
economics and restore prosperity.
• The authors reassert the necessity of an active government role in
econ policymaking by recovering the idea of animal spirits, a term
Keynes used to describe the gloom and despondence that led to the
Great Depression and the changing psychology that accompanied
recovery.
• Like Keynes, Akerloff and Shiller know that managing these animal
spirits requires the steady hand of government –simply allowing
markets to work won’t do it. They detailed the most pervasive effects
of animal spirits in contemporary economic life—such as confidence,
fear, bad faith, corruption, a concern for fairness.
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Fiscal policy adjustments are what almost all the econ policy
advisers have in mind when they say now is the time to pursue
Keynesian policies. Especially now, when conventional monetary
policy is ineffective, since short-term interest rates on safe assets are
close to zero, Keynesian theory would argue that the government
should have a fiscal target. If spending would otherwise be less than
full employment GDP, the government should put more money into
people's pockets.
A critical aspect of animal spirits is trust, an emotional state that
dismisses doubts about others. In talking about animal spirits, Keynes
sought to convey the message that swings in confidence are not
always logical. The business cycle is in good part driven by animal
spirits. There are good times when people have substantial trust and
associated feelings that contribute to an environment of confidence.
They make decisions spontaneously. They believe instinctively that
they will be successful, and they suspend their suspicions. As long as
large groups of people remain trusting, people's somewhat rash,
impulsive decision-making is not discovered.
Unfortunately, the recent period showed that confidence was
blind. It was not based on rational evidence. The trust in the mortgage
and housing markets that drove real-estate prices to unsustainable
heights is one of the most dramatic examples of unbridled animal38
spirits.
Furthermore, while animal spirits have been high over a very
long period of time, a whole new system for the granting of credit had
been generated. Some 30 or 40 years ago there was much less
intermediation in financial markets. But then along came financial
innovation and a new financial system, not just in mortgages and
housing but throughout the credit system, with complicated strategies
of securitization and use of derivatives. The more complex the
transaction the more trust is needed to sustain the transaction.
Then too, over the past several decades a vast "shadow" banking
sector developed that engaged in the purchase and sale of such
securities. To a great extent these traders borrowed short term at low
interest rates against collateral of asset-backed securities, of which
residential mortgage-backed securities would be just one example.
What enabled them to do that? It was the animal spirits. Those who
loaned short to the shadow banking sector were confident. They
thought they would be repaid. (They also thought they could insure
against loss by the purchase of derivatives). They were trusting. But
as soon as these lenders lost their confidence they were no longer
trusting. It was like a classic bank run, but this time not on the formal
banking sector but on those who borrowed short, and loaned long -on the shadow banking sector. Lenders to the shadow banking sector
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wanted to be the first not to renew their loans.
The trust in the innovative lending practices was excessive; now
that trust is replaced by deep mistrust.
So what to do to revive our animal spirits and economic growth?
– Need programs to solve the current financial and economic crisis are large
enough, and targeted broadly enough, to impact public confidence.
• need a fiscal stimulus
• government action is also needed to take the place of the credit markets that
seemingly worked so well when animal spirits were high.
• The Treasury and the Federal Reserve not only need a fiscal target, they also need a
credit target (how the credit markets should behave). The goal should be that those
who would normally receive credit in times of full employment can once again find
it easy to do so, at rates with realistic risk premiums.
• to meet the credit target, the expansion of special loan facilities, recapitalization of
banks, and use of government institutions to grant credit where it has dried up must
be on a scale great enough to overwhelm further doubts about the economy.
The role of the government is not to harness animal spirits but really
to set them free, to allow them to be maximally creative.
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