The Commanding Heights: A Book Review 2

The first article in this series pointed out that income inequality was a non-issue from the dawn of human history until the industrial revolution created enough wealth that it was worth arguing about how the wealth should be distributed.

It's human nature to want to better oneself, and it's often easier to do that at someone else's expense instead of working.  People have always agitated for higher wages and more benefits from whoever might have the ability to give it to them.

Only in modern times, though, has the proper purview of government been thought to include enforcing a somewhat equitable distribution of societal wealth.  In this article, we'll examine the economic effects of globalization and then explains why government-run businesses generally have vastly inferior performance when compared to market-run businesses.

The First Globalization Wave

The British Empire was the first global business enterprise, but its scope for detailed micromanagement was limited because ships were wind-powered instead of being powered by steam.  The relatively high cost of bringing goods on 6-month voyages with large crews relative to the amount of cargo meant that imports such as tea remained comparative luxuries, although costs decreased over time as technology improved.

What we now call "globalization" started after WW II.  Ships were powered by fossil fuels and moved goods twice as fast as the tea clippers with much smaller crews per ton of cargo.  This reduction in transportation costs meant that goods much cheaper than tea could be shipped around the world and sold at a profit.

The Commanding Heights: The Battle for the World Economy (TCH), by Daniel Yergin and Joseph Stanislaw, covers world economic policies from just after WW II through 2000.  The book describes the ongoing battle between two competing ideas how best to organize national economies - government control or market control.

Two Competing Systems

Adam Smith's 1776 classic "The Wealth of Nations" explained how the "invisible hand" of the market punished businesses which did not respond to customer needs.  Businesses had to offer goods which customers wanted to buy in order to satisfy their greed.  Businesses which don't satisfy market demand go bankrupt regardless of the owner's greed.

After abandoning the system of royal charters, the British operated a more or less free market system until the economy grew to the point that it was worth debating how wealth should be shared.  The discussion whether to let markets control the economy or whether the government should be the dominant force took off in the mid 1800's, driven by thinkers such as Karl Marx and the Fabian socialists and animated by Charles Dickens’ stories of just how much poor people suffered from their poverty.

Commanding Heights shows that it's not possible to have a pure government-controlled economy or a pure market economy.  Markets need reliable banking systems, legal systems, and property rights to function well.  Although credit card companies define rights and resolve payment disputes in their networks, they operate within established legal frameworks.  No advanced economy has found a way to operate without government control in these areas.

Pure government control doesn't work either.  Even the North Korean government, the most control-oriented on the planet, found it necessary to allow market-based systems so that farmers would have an incentive to grow more crops than they could themselves eat, after finding out the hard way that killing farmers for under-producing doesn’t lead to more food next harvest.

The Nature of the Beasts

A market-based economy outperforms a controlled economy.

The graph of Chinese economic performance shows that a government-controlled economy produces much less economic value that a market-based economy.  Mao Tse Tung's communist government produced extreme equality of poverty except for powerful comrades who were vastly "more equal than others" and lived like emperors.

Poverty persisted, but not for lack of government effort.  Mao instituted many 5 year plans as well as the "Great Leap Forward" which were supposed to supercharge the economy, but China couldn't even feed itself.

Mao's successor Deng Xiaoping let private businesses assume a much greater role in the economy.  As Chinese President Jiang Zemin explained in Deng's 1997 funeral oration, Deng "broke with conventions."  When Deng came to power, 60% of Chinese lived on less than a dollar a day.  Reforms launched China on the growth path shown in the graph.

Between 1978 and 2000, China's foreign trade increased from $36 billion to $474 billion.  Per capita income doubled between 1978 and 1987 and doubled again between 1987 and 1996 - a rate almost unheard of in modern history.  ...

Deng did something no one else in history has ever accomplished - he lifted upward of 300 million people out of poverty in just two decades.

TCH p 204

Why can't governments successfully run an economy?  The Commanding Heights gives three reasons: complexity, complacency, and corruption.

Complexity

A modern economy is complex beyond the capability of any group of bureaucrats, no matter how well-intentioned or intelligent, to manage efficiently.

Those at the center can never have enough information to make their decisions.  Much better he [Austrian economist Friedrich von Hayek] argued, was the price system, which, in "its real function" was "a mechanism for communicating information."  For Hayek, it was nothing less than "a marvel."  He explained, "the marvel is that in a case like the scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; that is, they move in the right direction."

TCH p 125

Hayek noted that when the price of something goes up, people use less of it without having to be told.  Rationing is only needed when governments are unwilling to let prices determine who gets access to resources.  Rationing leads to inefficiencies such as rent-control laws in some American cities, with their accompanying opportunities for bribery and housing shortages.

The Soviet Union was famous for factories either running out of raw materials and shutting down or being overwhelmed when the planning system gave them more material than needed.  For all their thousands of years of experience with complex bureaucracies, the Chinese couldn't manage their economy nearly as well as the market could.

Complacency

... somehow you have to create wealth before redistribution.  Socialism started with redistribution before wealth.

TCH p 105

Very few people work any harder than they have to.  In government-managed enterprises, no employee believes that the firm can ever go under because the taxpayers will always pay more.  The more people in an office, the more the office manager gets paid, so bureaucrats have an incentive to pack in as many subordinates as possible regardless of need.

In the words of Ed Rendell, the then Democratic mayor of Philadelphia, "It became clear to me that we had an incentiveless work force.  Through work rules, and past practices, and the overall collective bargaining, and because of civil service, we had created a system of management where we had taken out every incentive for performance ... The most difficult job in Philadelphia ... was being a middle-level manager and trying to get motivation out of your work force."

TCH p 373

Lack of incentive to serve the employer's needs isn't unique to government.  Employees of large businesses often act as if they had jobs for life regardless of performance.  When this attitude becomes too common, the business fails.  About 6% of the Fortune 1000 disappear every year.  When China’s Deng Xiaoping permitted private businesses, he also told government-owned firms to lay off nonperforming employees so that businesses would have people to hire.

Considerable unrest ensued when Deng broke the lifetime "iron rice bowl" which government-owned businesses had provided regardless of cost.  Being exposed to the relentless demands of the market made people nervous, but they worked a lot harder because they had to and the economy grew.

Corruption

The more complicated a government-controlled economy gets, the more opportunities for waste, duplication, and corruption.

The experience of the past ten years teaches that, in order to reap the benefits of globalization, countries need to make the necessary investments in education, health, and social safety nets.  But this is probably not enough, because ample experience has shown that public investment, no matter how well-intentioned, does not necessarily reach its intended beneficiaries; it can disappear into the tangle of inefficiencies, corruption, and poorly adapted rules. 

TCH p 409

India adopted Fabian socialism after independence.  The economy grew rapidly for a while, but foundered on the usual difficulties with government-owned businesses.  The 1991 financial crisis brought Ro Singh to the office of Prime Minister.

India suffered, Singh said, from what he called a "functionless capitalism"; that is, "people can make a lot of money without any concern for technical progress, quality, and cost reduction."

TCH p 221

Government-owned businesses are generally set up as legally-protected national monopolies.  They have no reason to fear competition, so the "invisible hand" of the market could not punish them when they failed to win customers through superior products.  The politically-connected get coveted no-show jobs and nobody can be fired.  Argentina suffered the same malaise:

In Argentina, for example, it took over two thousand dollars to get a phone line put in - and several years of waiting.  The inflexibility was also obvious in terms of employment.  Powerful public-sector unions held an iron grip over labor practices.  In many cases, over staffing and featherbedding were endemic.

TCH p 117

With the entire Soviet Russian economy government-owned, is it any wonder that Russians workers used to say, "We pretend to work and they pretend to pay us?"

This article has discussed the early wave of globalization and explained the very different results of government-run businesses when compared to the better economic outcomes of a market system.

You'd think which one is better should be obvious, but it clearly hasn't been obvious to most voters.  In the next article we'll see how these competing ideas fought it out during the last half of the previous century.