The end of the world as we know it

Is a natural disaster, which destroys land and property and lives, whether by fire, flood, storm or some other catastrophe, a good thing?

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Obviously not you might think but economically, by the measures we commonly use, it’s not so clear. The most common measure of economic growth, “gross domestic product” or GDP, actually benefits from disaster.

"Capitalism is not coming to an end. The small-L liberal, free market capitalism which delivered higher life expectancy, improved standards of living and wealthier societies over the three decades of the “great moderation” may be however.

That’s because it does not measure the cost of the cataclysm – the billions of dollars of destruction or the thousands of human lives – in terms of value lost, only in terms of lost production. So it doesn’t measure the cost of flood (except to the extent the flood will stop some production) but it does measure the reparation – the infrastructure works, the rebuilding, the goods sold to replenish what was ruined.

GDP is not a great measure of human welfare and we have seen governments around the world, more recently in Australia and New Zealand, attempt to go beyond raw economic numbers to gain a better sense of how society is delivering for its members.

So too in the corporate world. The concept of ESG reporting – measuring performance in terms of environmental, social and governance outcomes – is growing in significance.

Google trends data on “ESG” as a search term worldwide

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Source: Google Trends

This is not a new phenomenon. Over decades, the corporate world has struggled with how it measures its impact on all stakeholders, not just shareholders, with concepts such as the “triple bottom line” or “corporate social responsibility”.

All these measures at least recognise the long term sustainability of a business depends upon more than maximising short term rewards to shareholders. To flourish it must also contribute more broadly, to customers, staff and society. Otherwise customers and staff will leave and society will levy penalties.

Nor is the challenge of a better measure than GDP new. Many alternative models have been proposed, perhaps most notably by the Nobel Prize-winning economist Joseph Stiglitz. Stiglitz’s view is captured in his oft quoted line from “Making Globalization Work” when he said “development is about transforming the lives of people, not just transforming economies.”

But just as concepts such as ESG gain new prominence, there is a not unsurprising backlash, from both the liberal side of politics and the reactionary. The most pernicious backlash has come, ironically for a country that was the bastion of free market capitalisation, in the United States where far right-wing politicians have actively campaigned against this more sophisticated understanding of capitalism for their own political gain.

The Oliver Wyman Forum calls this a “corporate culture war”.

“Recent years have seen a trend in favor of stakeholder capitalism, which calls on companies to have a ‘sense of purpose’ …  and work for the benefit of customers, employees, suppliers, and communities, not just shareholders,” the consultancy said in a paper called “Wake Up CEOs”, before noting “a backlash against perceived ‘woke capitalism’ is growing.”

However, less venially, growing wealth disparity and social inequality, together with environmental damage and intrusions on privacy have also fueled growing suspicion of free market capitalism. This is despite the evidence we don’t actually have a better way to organise economies for greater overall welfare.

Capitalism works. It has reduced poverty and improved the welfare of societies around the world, vastly more than any alternatives currently tried, notably central planning. McKinsey suggests comparing West Germany and East Germany; South Korea and North Korea; Costa Rica and Cuba.

Nor should we think capitalism – in its essential form of exchanging goods and services – doesn’t exist everywhere. It’s in school yards where kids trade whatever the latest collectable is, based on desirability and rarity, and it’s in North Korea where the black market and indeed the state-controlled black market dwarf the “official” communist economy.

The challenge with capitalism is not the system itself, it is the mechanics of its operations and human nature. In a simple market, say a vegetable market, potential customers get to view and compare the produce and choose what they’ll buy based on price and quality.

But in more complex markets, this transparency is often dulled or blocked. Cartels conspire on prices, governments tilt markets with regulation and subsidies, the nature of the product may be unclear. We call this “information asymmetry” - one party has a clearer picture than the other.

In a fair market, producers of goods and services would pay for the costs of what they offer – raw materials, wages, rents - but also by-products, so-called “negative externalities” such as pollution or environmental damage.

Where information asymmetries exist, most notably when it comes to the power imbalance between large companies and individual consumers, we rely on regulation by the state or other authorities to prevent price gouging and other abuses of power.

But, notably since the financial crisis of 2008, capitalism has not delivered broadly enough. Not because markets don’t work – they always “work” – but because transparency has been eroded, price signals have been skewed, risk and return have been exploited to deliver excess profits to some and diminishing returns to others who are bearing greater risk.

Capitalism does have a lot to answer. The problem is the lack of alternative systems that are better. Moreover, capitalism is threatened by more than just sand in the system which could be addressed by regulation and transparency and taxation.

It is a victim of geopolitical tensions between states and vested interests opposed to paying the price to offset climate change – from which they have benefitted.

Globalisation is a good proxy for free market capitalism. When trade is more open and markets more pervasive, more goods and services are traded internationally to reflect the competitive advantage of different states.

It is in decline.

Global merchandise trades as a share of GDP (%)

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The Financial Times’ learned economics writer Martin Wolf is not optimistic about the future of open markets – and hence for humanity itself.

“Deglobalisation is most unlikely to be the outcome of carefully calibrated and intelligent decoupling,” he writes.

“People might pretend deglobalisation has something to do with reducing inequality. That is nonsense, too: the more open economies are frequently relatively equal.”

He concludes: “We are not headed towards a benign localism, but towards negative-sum rivalry.”

This is not a market failure or the fault of capitalism, it is the all more pervasive nature of human greed and power plays.

Capitalism is not coming to an end. The small-L liberal, free market capitalism which delivered higher life expectancy, improved standards of living and wealthier societies over the three decades of the “great moderation” may be however. In stark contrast to that era, inflation and interest rates are rising, the threat of world and even nuclear war is growing, great state tensions are unnerving and the climate is changing rapidly in ways that will guarantee more natural disasters.

The McKinsey Global Institute believes we on the cusp of a new global era: “Without question today’s world is better, but with this growth there is also much more disruption to established constituencies, more pangs of imbalance, and more powerful new players asserting their place at the global table.”

Those forces don’t naturally lead to more open and transparent markets, equitable returns on risk taken and a proper price on rents – which is what a fairer, more sustainable capitalism requires.

Eye of a hurricane, listen to yourself churn
World serves its own needs
Don't mis-serve your own needs
Speed it up a notch, speed, grunt, no, strength
The ladder starts to clatter
With a fear of height, down, height
Wire in a fire, represent the seven games
And a government for hire and a combat site
Left her, wasn't coming in a hurry
With the Furies breathing down your neck

-        R.E.M, “It's the end of the world as we know it (and I feel fine …)”


Andrew Cornell is the Managing Editor, bluenotes, ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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