Wednesday, August 12, 2009

Capitalism and Ethics II: Ethics as Capital

Introduction In this essay, I will attempt to present the case that ethics may be considered as a form of capital and look at some of the insights such a consideration will provide. I will briefly describe the principles of economic growth and wealth creation, how ethics fits into this model, and look at how consideration of ethics as capital can help explain some high-profile economic phenomena. I will conclude with a summary and what this line of reasoning reveals about the likely course of future events. The Wealth of Men and Nations The accumulation of wealth occurs through a rather simple mechanism. Wealth is the product of human industry, or effort; without industry, there can be no wealth. Other things being equal, greater industry results in greater wealth. That which multiplies human effort also multiplies the generation of wealth. We call those factors which increase the output of human effort capital, and so the accumulation of wealth over time is achieved through the accumulation of capital. Capital can materially consist of many things, including physical tools, education, and improvements in infrastructure. The erosion of capital or a reduction in human industry necessarily leads to an erosion of wealth. Capital itself is accumulated through thrift, which is the curtailment of consumption for the purpose of saving or investment. Investment is the acquisition of capital through the purchase of a capital good and increases the productive capabilities of some economic actor or actors. Saving also results in the acquisition of capital by other economic actors, as it leaves resources available in the marketplace which may be devoted to other purposes. This activity can benefit the saver through the collection of interest. Higher levels of thrift result in both lower interest rates as savers compete with one another to attract interest-payers, i.e., investors and entrepreneurs, and in lower prices of resources in the marketplace as greater quantities of resources are left unconsumed. Thrift is a measure of the availability of surplus resources and its action results in the allocation of resources away from consumer goods and towards the acquisition of capital goods, which will allow greater future production and consumption. The degree of the presence of these three qualities, industry, capital, and thrift, broadly define the propensity for the accumulation of wealth. The Emergence of Trade and the Division of Labor Finite beings like humans have limited capabilities, and the increasing demands of more complex and more productive capital structures demand that they focus time and attention on activities that are ever more limited in scope. This tendency limits the capacity for individuals to satisfy their own varied consumer wants and needs through their own individual efforts; specialization necessarily comes at the expense of self-sufficiency. Trade with other economic actors becomes increasingly necessary, as individuals focus effort to increase productivity in specialized fields and exchange the fruits of their labor with other highly productive, highly specialized economic actors. A more highly capitalized, wealthy society is therefore necessarily a society in which individuals become dependent on trade with one another for the satisfaction of their needs. Over time, the accumulation of wealth, and therefore capital, results in a restructuring of economic and social arrangements as participating actors become increasingly specialized in their productive activities. The specialization of productive activities, restructuring of social and economic arrangements, and the trade that emerges in response to the accumulation of capital is called the division of labor. A high division of labor is typically associated with a wealthy society. Maintenance of Wealth and Capital Both accumulated wealth and capital require maintenance. Parts wear out, materials rust and decay, and machinery grows old and obsolete as new technologies are developed. Even our own minds become feeble as we age and forget the lessons of our education and experience past. The forces of chaos and erosion are perpetually at work. As an economic actor increases his capital and wealth holdings, greater and greater portions of output will have to be devoted to maintenance of present holdings, reducing that portion available for further capital and wealth acquisitions. The greater the property holdings, the greater these responsibilities become until the point is reached that no greater holdings can be managed sustainably. An economy with a high division of labor will have higher maintenance costs relative to a lower division of labor economy. Resources and Technology Two facets of economic development which are often erroneously cited as the principle source of wealth differentials are resources and technology. Resources which are themselves the products of wealth-generating economic activities, for example, foodstuffs and other finished goods, can hardly be considered the principle causes of said wealth; therefore, in considering resources as a principle cause of wealth, we will limit the discussion to natural resources, those naturally occurring resources which are extracted from the natural world and are not primarily a result of human labor, though some labor may be expended in gathering them together or putting them to use. The tendency to identify natural resources as a principle contributor to wealth probably arises from the observation of highly visible material prosperity in certain locations such as the oil-rich Middle East. It certainly is true that there is a good deal of observable wealth that could reasonably be expected to have resulted purely from the extraction of natural resources. However, it is not true that an absence of natural resources will result in an inability to accumulate wealth, as there are almost always ways of achieving high productivity even in the absence of material resources. For one thing, it is often the case that one resource may be substituted for another, such as the substitution of coal or natural gas as a source of energy for oil. Desired resources may also be obtained through simple trade, or even rendered entirely unnecessary by technological development. The widespread availability of wireless phones has rendered interconnecting communication lines, and the materials needed to produce them, virtually unnecessary for this application in a very short time, freeing up these materials for other uses. The spectacular economic success of resource poor Japan and South Korea is a testament to the ability of economies to develop despite shortcomings in natural resources. These nations import natural resources from more resource rich areas, convert them to final products, and then sell these value-added goods profitably. In effect, they are trading their own labor in exchange for natural resources. Conversely, resource rich Africa and Russia, which have lagged economically behind the West for centuries, are examples of resource rich areas which have historically lagged behind other economies in their degree of development, tragically so in the case of Africa. Examples such as Saudi Arabia tend to be transiently wealthy. Saudi Arabia has had oil deposits for centuries, yet only became wealthy in the last 60 years or so when demand for oil from foreign countries with developed economies began to increase rapidly. It was not able to use its oil resources to enhance wealth on its own, and will probably return to relative impoverishment when the West no longer demands as much oil or when the oil runs out. Both facts point not to oil as the source of wealth in this particular case, but to the developed foreign economies which have devised ways of mobilizing this resource to satisfy consumer demand. Saudi Arabia prospers by happenstance of geography and on the shoulders of the industry, thrift, and capital of others. Technology is the practical application of knowledge to achieve specific ends. Technologically more advanced economies are capable of greater output as their applied capital is more effective at increasing a given input of human labor. However, this statement itself should reveal the falsehood of the assertion that technology is a principle cause of wealth accumulation: technology is itself a form of capital. Technology is one of the results of the accumulation of wealth; highly capitalized and wealthy societies are able to fund the development of better technologies, so again, the result of a well-developed economy can hardly be named a principle cause. Further, most technologies are readily transferable from one population to another, and what is available to one should in principle be available to others in due time. Computers were not invented in China, but they are produced in vast quantities by China today. So, technology and natural resources are both important, but are not in-and-of-themselves the primary, fundamental causes of wealth generation. Ethics as Capital Previously, we saw that proper ethics are critical to the development of a capitalist economy. We saw that in the absence of adherence to an ethical code:
  • capital becomes increasingly difficult to accumulate due to persistent erosion through theft and violence and disincentives for its accumulation, resulting in lower productivity
  • industry and thrift are discouraged, resulting in lower output and investment
  • the division of labor contracts as ethical breaches cause individual actors to find it increasingly difficult to trade or otherwise interact in a constructive, mutually beneficial manner, reducing overall productivity as actors seek greater self-sufficiency
  • greater resources are devoted to the maintenance of capital and wealth, which is at greater risk of loss
When viewed in this light, it becomes clear that the possession of a strong, functioning ethical code has the result of increasing the output of human industry. In practice, an ethical code requires the devotion of resources to its maintenance to ensure its fidelity and proper function. Such an economic analysis of ethical codes reveals that it might be constructive to view ethics as capital. In fact, an economy's ethical code might be properly regarded as its most fundamental capital asset, as it is this capital asset which allows the others to function properly and efficiently and will eventually determine the limits to which an economy can develop by placing limits on trade, capital accumulation, and the division of labor. Artificial Divisions of Labor: Command Economies In principle, the above discussion applies equally to both market economies and command economies. In a market economy, individual economic actors attempt to maximize the benefits of trade by producing products and services in highest demand by other economic actors. This is an expression of consumer sovereignty, i.e., forces of production and the division of labor are marshaled towards satisfying consumer demand as a result of the free, voluntary decisions of participating economic actors. In a command economy, production and the division of labor are structured by decree of the state. Consumer sovereignty is replaced by state sovereignty in the marketplace. Many theories have been proposed to explain the relative outperformance of command economies by market economies. One of the more important is the role that prices play in allocating resources and investments. A command economy generally has difficulty structuring prices in such a way that resources are allocated efficiently. Pricing systems that result from individual actors assessing their own, personal situations typically function better than pricing systems that result from the economic calculations of so-called experts working on behalf of the state. This theory and other similar theories have merit, however, as this discussion is concerned primarily with non-monetary aspects of economics, they will not be considered further. Another frequently cited problem faced by command economies is "corruption." In a command economy, conflicts of interest will arise more frequently as those with decision-making power will be less likely to have individual ownership over the resources in question, and are therefore more likely to make wasteful decisions as the losses incurred by these decisions will be borne by others rather than suffered by the decision maker himself. Along similar lines, I would propose that command economies suffer from an artificial division of labor which is insensitive to considerations of ethical capital. In a market economy, each actor has a strong incentive to minimize potential losses to himself and will therefore refrain from interactions with others that place his own capital and resources at risk of loss due to ethical breaches, such as theft, fraud, negligence, waste, and the like. If such a relationship is entered into, once discovered it will rapidly be adjusted or eliminated altogether to reduce such risks; if it is not, the actor in question will have his economic "footprint" eroded over time, and others will take his place in importance to the economy. The overall economy thus takes ethical capital into account in determining its eventual production structure and the division of labor. Such constraints are much weaker in a command economy, as decisions are typically made on the basis of political considerations. Command economies also typically have large administrative structures as part of their division of labor which are much reduced or absent in market economies. The result is a politically driven division of labor structured more independently of considerations of ethical capital and which is far less flexible and more difficult to reform when discrepancies between proper behavior and actual results are observed to occur. These structures will typically have much higher maintenance costs that take the form of various corruptions, waste, and inefficiency. These costs reduce productivity, and more importantly, sap the available thrift, reducing resources available for capital investment. Economic stagnation results from this failure to account for shortages in ethical capital. Most, if not all, of these theories are likely contributing factors to the relative under-performance of command economies, as they are not mutually exclusive. China's Thrift Conundrum Economists the world over are in awe of China's spectacular economic growth over the last 20 years. In truth a great deal of this growth is a legitimate reflection of improvements in basic social attitudes and ethics. The revolutionary fervor of such destructive episodes as the Cultural Revolution has died down, and a more pragmatic mindset has since begun to prevail. Greater latitude in individual ownership of property and its disposition has become the accepted standard of behavior over time, and this has naturally resulted in more capital accumulation, increases in productivity, greater industry, and economic growth. However, it is equally true that a great deal of this growth is a reflection of contrived arrangements with the rest of the world which were unsustainable. Manipulations by the central bank have had the effect of distorting monetary exchange rates, causing Chinese exports to appear far more competitive in foreign markets than they actually are. Mobilizing China's high levels of thrift to extend artificially generous credit terms to foreign buyers further fueled exports at a level that would not have been achieved on an open market. Both of these strategies have resulted in extensive growth in very narrow markets that would not have been achieved otherwise, and I believe it is likely that this strategy was specifically chosen by the Chinese government as a way to achieve a level of industrialization and technological advancement that would not have been possible had the market been left to its own devices. The West had been urging the Chinese to cease market manipulations, which would presumably have had the effect of turning Chinese productive capabilities towards satisfying consumer demand in domestic markets rather than foreign markets. China has now decided to adopt this strategy, and has also started a massive increase in infrastructure development, since the credit lines of her former buyers have now run out and many of the industries which were formerly developed to satisfy foreign demand have become idle. I believe this strategy will not work, at least with anything resembling the present levels of division of labor. Why? I believe the answer lies once again with ethical capital. Have you ever been in a room full of loud and rambunctious people who were suddenly quieted when a particular person entered the room? Perhaps they sat up straighter in their chairs, and looked around nervously or sullenly at one another. The person who entered the room might have been their supervisor, an older relative, or one of those "churchy" people. In any case, the effect was a sudden increase in discipline of the rowdy group, presumably out of fear of incurring the judgment of the "straight man" who had just entered the room. I believe a similar phenomenon took place between Western markets and Chinese producers. By using foreign markets as "straight men," China was able to "piggyback" on top of Western ethical capital. It tapped into foreign distribution and financial systems which were less prone to corruption than its own, stacking its own production structure on top of well-developed foreign divisions of labor that would not tax its own ethical capacities and would therefore require less discipline on its own part to profitably produce and market such goods. It leveraged foreign market discipline for its own purposes. More importantly, in serving Western customers, Chinese products were subjected to far more rigorous and less corruptible quality control systems. Because of such detailed inspections, and the relative sureness of getting caught in a violation, a far higher level of discipline was enforceable than would have otherwise been possible, straightening out behavior far up the supply chain. Even a normally corruptible market actor enforces a strong ethic on himself and on others if he is sure to be punished in the event of getting caught in a violation. It is usually easier to bribe inspectors and purchasing agents than it is to produce quality goods at a low price that sell themselves, but when the bribery option becomes unavailable, the only alternative is to play by the rules or go out of business. In short, the costs that come with a high division of labor in an ethically corrupt environment were vastly reduced by contact with relatively more disciplined foreign markets, thus "ethically subsidizing" China's division of labor in highly focused markets far beyond what would have been feasible if left to the country's own devices. Without the demand of foreign "straight men" as a large share of China's economy, I do not think that China can continue with its present level of division of labor without substantial ethical reform. Maintenance costs of its production structure will be far too high to operate profitably, and the system will collapse. China displays an abundance of the traits associated with wealth generation, namely, industry, capital, and particularly thrift. However, I believe the absence of a strong, disciplining code of ethics as a reliable source of ethical capital absorbs and wastes away a tremendous share of the benefits that should be conferred by China's other virtues. China's high thrift implies high capital investment and a highly productive economy with a high division of labor, but it is not matched with strong market ethic and therefore goes to waste in paying the costs of corruption. The present "stimulus" program and mass monetary inflation taking place is one visible manifestation of this effect. I hope this changes for the better. Evidence From the Index of Economic Freedom In previous discussion of the Index of Economic Freedom, it was noted that there appears to be evidence of a significant relationship between the degree of libertarian-oriented policies and economic outcome that corresponds well with the expected fraction of the population that subscribes to a libertarian economic model. Even more revealing is an analysis of each individual component of the index. Several showed very little correlation with per-capita GDP: "Fiscal freedom" is a measure of the "soundness of money," primarily a reflection of measured inflation, and government size is a measure of the size of government in relation to the economy. The low visible correlation is likely due to either poor measurement criteria, a relationship which is overwhelmed by other, more important determinants, or to the absence of a causal relationship altogether. Given the importance of both these factors in the functioning of an economy, the first two alternatives are the more likely reasons that a clear relationship is not visible. Several of the other index components give somewhat more clear correlations: However, the relationships are still murky and there is still considerable "noise" in these data. Two components of the index show the highest correlations: Although the exact mathematics have not yet been worked out, the "freedom from corruption" index has consistently given the highest correlations by the methods I have tried, with "property rights" coming in second. Both leave the other components far behind. This result tends to support the contention that the "ethical climate" of an economy is the key determinant of economic outcomes, even more so than libertarian leanings. Economies which are relatively free from corruption and in which property rights are respected have a strong tendency to perform better than economies which do not. In fact, the consideration of ethics as an important determinant of economic outcomes helps to explain the otherwise unexpectedly high performance of several relatively unfree economies, particularly Scandinavian countries such as Norway and Sweden. These countries have highly planned, socialist economies, yet have per-capita GDP's that are similar or even higher than many economies which are considerably more free. They also typically score in the very lowest levels of corruption. This analysis would tend to suggest that because corruption in these countries is so low, the maintenance costs of an artificial division of labor are much reduced and the economies perform better than they would under more typical circumstances. Religion, Philosophy, and Ethical Capital Religion and various philosophies have long served as as the primary caretakers of ethical codes and their expression in societies throughout history. Several have distinguished themselves for having produced exceptional economic achievements in their followers, implying that, on average, these belief systems contribute to human productivity more so relative to others. China under the influence of the philosopher Laozi achieved spectacular success in ancient times, surpassing in wealth all its contemporaries. One of the principle beliefs espoused by this ancient philosopher was the concept of wuwei, or "action through inaction." Success was best achieved through respect for the autonomy of others and the forces of nature. The idea of the futility of coercion no doubt did much to promote the development of ancient China, as it encourages economic actors to seek mutually beneficial cooperation rather than coercive power in persuading others to help them attain their goals. When this philosophy was eventually replaced by a more regimented, feudal mindset, economic growth stagnated. Similarly, other religions and philosophies through history have proven to have widely varying influences on the tendency of their practitioners to achieve material prosperity. In modern times, two religions in particular have distinguished themselves more than any other in this regard: Judaism and Christianity. Several of the important characteristics of Judaism that contribute to this tendency are the importance of the keeping of covenants, i.e. contracts, a strong emphasis on observance of moral codes, and the composition of those codes themselves. The Ten Commandments, for example, contain three very economically significant prohibitions: covetousness, theft, and fraud, or "bearing false witness," are all strictly forbidden. Other, more specific codes include the keeping of honest weights and measures and equal judgment before the law. As a result of their ethical beliefs and the behaviors they produce, Jews throughout history have become so overrepresented in positions of high prominence and material wealth in proportion to their makeup of the population that it has almost become conventional wisdom to believe that, as a religion, they must have conspired together to "take over the world." They have frequently become targets of mistreatment and violence throughout history for just this reason. As inheritors of the Jewish tradition, Christianity maintains many of Judaism's ethical traditions, but has been markedly more successful at evangelizing foreign populations and in producing prosperous societies more so than individuals, as in the case of Judaism, which has not generally produced expansive nations but isolated islands of success spread across many different nations. Conclusion Economic growth and increase in material prosperity are primarily driven by industry, capital accumulation, and thrift. Technological advancement is part and parcel of capital accumulation, and the possession of vast natural resources generally has little bearing on the longer-term economic development of a nation; therefore, these two aspects of economics are not to be considered principle determinants of wealth generation. Increasing capital accumulation as a result of thrift results in specialization and trade. Both of these activities are critical to increasing individual productivity and furthering economic development. They describe the division of labor which makes up the structure of an economy. Ethics can be considered a capital asset as it displays many of the properties associated with capital. It is a critical component to the activities of accumulating and maintaining other forms of capital, trade, and developing a more complex, more productive division of labor. Observation that lower corruption and respect for property rights predicts higher economic development far better than many other measurable characteristics supports this theory. Command economies suffer from artificial divisions of labor that are typically driven by political concerns rather than legitimate economic concerns, including conflicts of interest and ethically suboptimal relationships between actors. This results in waste and corruption which saps the available thrift and causes economic stagnation. China in particular suffers from these effects, and has used contact with foreign markets to temporarily overcome some of these shortcomings. These relationships have recently become untenable, therefore China will likely not grow as much as mainstream economics would predict purely on the basis of traditional capital, thrift, and industry considerations. It is more likely to suffer a short term economic collapse and stagnation without substantial reform. Specific religious beliefs and their ethical codes have had very different economic outcomes. Among the more successful, Judaism and Christianity stand out as the most successful religions of the modern world for producing prosperous individuals and societies. Biblical ethics provides a strong foundation for economic development along capitalistic lines. Final Thoughts These observations tend towards an inescapable conclusion. We live in a world of ethical cause and effect, where beliefs have consequences. As Biblical ethics have slowly been eroded in the West over the preceding century, and continue to erode, the West has experienced a string of economic calamities, including the Great Depression, two World Wars, and the present crisis. Unlike China, the West has become accustomed to a high division of labor, which puts its standard of living at greater risk in the face of an erosion of ethical capital. A severe contraction in the short term is unavoidable at this point, and without significant and immediate reform, the West is likely to experience decline rather than stagnation in the longer term.

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