How To Bring Back Capitalism
"Capitalists seem almost uninterested in Capitalism" is how Clayton Christensen describes the paradox of our recovery-less recovery. In an excellent NYTimes Op-ed, the father of the Innovator's Dilemma comments that "America today is in a macroeconomic paradox that we might call the capitalist’s dilemma."
Whatever happens on Election Day, Americans will keep asking the same question: When will this economy get better?
In many ways, the answer won’t depend on who wins on Tuesday. Anyone who says otherwise is overstating the power of the American president. But if the president doesn’t have the power to fix things, who does?
It’s not the Federal Reserve. The Fed has been injecting more and more capital into the economy because — at least in theory — capital fuels capitalism. And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations. Billions in capital is also sitting inert and uninvested at private equity funds.
Capitalists seem almost uninterested in capitalism, even as entrepreneurs eager to start companies find that they can’t get financing. Businesses and investors sound like the Ancient Mariner, who complained of “Water, water everywhere — nor any drop to drink.”
So businesses and investors are drowning in Fed-sponsored liquidity but are endowed with what he calls the Doctrine of New Finance - where short-termist profitability guides entrepreneurs away from investments that can create real economic growth.
... the Doctrine of New Finance is taught with increasingly religious zeal by economists, and at times even by business professors like me who have failed to challenge it...
His three forms of 'innovation' (empowering, sustaining, and efficiency)...
- "empowering" innovations. These transform complicated and costly products available to a few into simpler, cheaper products available to the many.
- "sustaining" innovations. These replace old products with new models.
- "efficiency" innovations. These reduce the cost of making and distributing existing products and services.
Empowering innovations create jobs, because they require more and more people who can build, distribute, sell and service these products. Empowering investments also use capital — to expand capacity and to finance receivables and inventory.
Efficiency innovations also emancipate capital.
...typically operate in a recurring circle but in their current state, the dials of these three processes are forced incorrectly as "efficiency innovations are liberating capital, and... this capital is being reinvested into still more efficiency innovations" creating fewer empowering innovations.
Empowering innovations are essential for growth because they create new consumption. As long as empowering innovations create more jobs than efficiency innovations eliminate, and as long as the capital that efficiency innovations liberate is invested back into empowering innovations, we keep recessions at bay. The dials on these three innovations are sensitive.
Christensen perfectly analogizes our perspective when he notes:"It’s as if our leaders in Washington, all highly credentialed, are standing on a beach holding their fire hoses full open, pouring more capital into an ocean of capital."
We are trying to solve the wrong problem.
Our approach to higher education is exacerbating our problems.
Efficiency innovations often add workers with yesterday's skills to the ranks of the unemployed. Empowering innovations, in turn, often change the nature of jobs — creating jobs that can't be filled... our leaders are wasting education by shoveling out billions in Pell Grants and subsidized loans to students who graduate with skills and majors that employers cannot use.
There is a solution; it's complicated, but Christensen offers three ideas to seed the discussion:
CHANGE THE METRICS We can use capital with abandon now, because it’s abundant and cheap. But we can no longer waste education, subsidizing it in fields that offer few jobs. Optimizing return on capital will generate less growth than optimizing return on education.
CHANGE CAPITAL-GAINS TAX RATES Today, tax rates on personal income are progressive — they climb as we make more money. In contrast, there are only two tax rates on investment income. Income from investments that we hold for less than a year is taxed like personal income. But if we hold an investment for one day longer than 365, it is generally taxed at no more than 15 percent.
We should instead make capital gains regressive over time, based upon how long the capital is invested in a company. Taxes on short-term investments should continue to be taxed at personal income rates. But the rate should be reduced the longer the investment is held — so that, for example, tax rates on investments held for five years might be zero — and rates on investments held for eight years might be negative.
Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue. So the near-term impact on the budget will be minimal. But over the longer term, this policy change should have a positive impact on the federal deficit, from taxes paid by companies and their employees that make empowering innovations.
CHANGE THE POLITICS The major political parties are both wrong when it comes to taxing and distributing to the middle class the capital of the wealthiest 1 percent. It’s true that some of the richest Americans have been making money with money — investing in efficiency innovations rather than investing to create jobs. They are doing what their professors taught them to do, but times have changed.
If the I.R.S. taxes their wealth away and distributes it to everyone else, it still won’t help the economy. Without empowering products and services in our economy, most of this redistribution will be spent buying sustaining innovations — replacing consumption with consumption. We must give the wealthiest an incentive to invest for the long term. This can create growth.