WHAT WENT WRONG WITH CAPITALISM? Based on the book by Ruchir Sharma
Capitalism means "economic freedom," and the government's role is expected to be minimal and pro-competition.?
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CAPITALISM IN USA
About a century ago, the Government's role was initially limited to delivering mail and Defence.? For about 200 years, the cost of government was approximately 3% of GDP, and the Government did not interfere in business and business cycles.?
The equity market crash of 1929 was after the excesses of the roaring 1920s, including in Consumerism and the Stock Market. The Smoot-Hawley Tariff Act imposed by the US on agricultural and industrial imports caused global trade to fall by 66%, which added to the global recession.? President Roosevelt's New Deal was about government programs in projects, financial reforms, etc., but only after? World War 2, which created many new jobs, did growth in the US start again.? This was the first instance of interference by the Government to stimulate the economy.?
Over the years, there has been more significant Government intervention in the Economy. There is an Opiate pandemic in the USA - and the same pain management in business cycles.? It started with the bailout of Continental Illinois in 1984, during the Reagan Presidency, which was meant to be a pro-laissez-faire government. The stock market crash of October 1987 started the policy of bailing out the stock investors by injecting liquidity into the market. This tendency came to be called the "Greenspan Put," where the investor enjoyed the upside, and the downside of the equity market was protected by the Government injecting liquidity.?
Productivity in the US and the Developed world has declined since 2010 despite the tech boom.? The Government now wants to manage the business cycles, has an impulse to bail out and inject funds, and interferes in all?aspects of the economy, which has resulted in stunting the economy’s productivity, rising inequality and the feeling that the system is not working.? The term Zombie companies were coined in?Japan after the?collapse of the Japanese bubble in?1991. Zombie companies are businesses worth less than they owe and cannot repay their debts. At that time, in the US, only 2% of companies were Zombie companies. Now that has gone up to 20% of all listed companies and is a great contributor to the falling productivity by keeping alive all the dead wood and crowding out new investments.?
Other effects of Government interference:?
1.? Government spending now amounts to 36% of the GDP.?
2.? ?Earlier, the Government ran a deficit of 3% of GDP, in line with the rest of the developed countries. Now, the US is running a deficit of 6% of GDP, and that too at a time when the economy is in good shape. If there is a downturn, it will go up to 9 -10%, which is not sustainable.?
3.? The US feels it can go on spending without consequences. Its debt-to-GDP ratio is 130%, the third highest in the developed world after Japan and Italy. ??
4.?? There is a disconnect in the US, where America accounts for about 26% of the global GDP but over 50% of the market capitalisation—a by-product of all the liquidity injected into the economy.
5.? ?America introduces 3000 new regulations a year, which helps large businesses eliminate new entrants. Regulations are always pro-incumbent. ?
6.? ?About 16% of working time is spent on Compliance requirements, which increases costs and reduces productivity.? ??
7.? Lawyers per capita is the highest in the world in the US.? ? ?
8.? Start-ups have been declining due to the pandemic.
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The consequence of this is that all the liquidity has caused asset bubbles in the Real Estate, Private Credit, and Stock Markets. The ordinary man is not a part of this wealth creation. Young people cannot now afford to purchase a home.? Ten years ago, it took 3 years to save for a down payment for?a house; now, it takes 19 years. Many of the youth are still living with their parents.?
Hence, despite the massive wealth creation in the US - both in the stock market and in real estate - 2/3rd of the population feels left out and is living pay check to pay check. They resent that although there is Capitalism in profits when there is a hint of trouble, the large companies get bailed out, which is paid by the taxpayers – hence, Socialism protects the downside.? They resent the wealthy depositors in? Silicon Valley Bank being bailed out when small rural, regional banks were allowed to go bust. Further every time the stock market wobbles, liquidity is infused, which benefits the rich only. Companies are allowed to take disproportionate risks with the confidence?that the Government will step in if there is a problem,
In a survey, the youth in the US indicated they would prefer Socialism to Capitalism. Capitalism is when the individual has power, authority, and freedom to make his own decisions and has economic freedom. Socialism is when the Government decides the direction you take, and the US is moving towards a bigger and larger Government.?
Conclusion: Capitalism has not failed—it has been?ruined by Government interference, excessive regulations, and bailouts.?There is an arrogance that the world will keep on buying dollars. But unless there is an apparent crisis, there is no?will to change.
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CAPITALISM IN INDIA
India started off as a socialist economy where everything was regulated. After Independence, a huge amount of political freedom was given, but we were not given economic freedom. The Licence Raj was extremely restrictive. It is only when India?faced the Balance of Payment crisis in 1991 that India had to open its economy. It has progressively been getting freer and moving up the Ease of doing business ladder. India believes in its democratic tradition, and along with Capitalism, it is a winning proposition.?
In most countries, people first gained economic freedom, and then, after reaching a certain per capita income, they gained Political Freedom. This was true in Singapore, South Korea, and even in developed nations like the UK, as during the Industrial Revolution, voters were restricted, and women were totally excluded.? ?
The USA started with economic and Political freedom together, and that is why it initially raced ahead. Eighty percent of the world's population is in emerging markets, which had a lot of cleaning up to do after the boom of the 2000s. The emerging economies are now growing their per capita GDP faster than the US.?
?As Reforms have not been at the pace of China as it has Democracy compulsions,? India is not likely to grow at 9-10% but will remain in the 6-7% range. Inflation, too, has to be kept in control because no Government can win an election if inflation is high.?
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In India:
1.? Government spending as a percentage of GDP is 15%. In France, it is over 60%.
2.? ?Fiscal deficit at percentage of GDP - 5.6%
3.? ?Government debt as a percentage of GDP - 81%
4.? ?No country has produced as many billionaires as India has this decade. Billionaire wealth today is 26% of the economy—it was 10% a decade earlier. There are more than 200 billionaires currently—only China and the USA have more, and their economies are many times our size. Further, it has been broad-based—even manufacturing has created the largest number of new billionaires.?
5.? ?Financialization of assets has become widespread, and this paradigm change has resulted in a true, broad-based Bull Market.?
EQUITY MARKET
The Federal Reserve cut interest rates in the US, and with the resultant fall of the Dollar Index - money has moved to Emerging markets, including India. Purchases in India by FIIs were about Rs. 58000 cr in September - whereas in August, it was around Rs. 7000 cr, and in some early months, FII flows were negative. FII flows mean that large-cap funds will outperform. There are 3 causes of an up move?in the stock markets - Valuations, which are expensive, and Liquidity and Sentiment, both of which are positive. As long as the US has a soft landing and there is no general global slowdown, there is not likely to be any meaningful correction in equity in the Indian markets.?
DEBT MARKETS
Although the RBI has not yet cut interest rates, the 10-year GSec has started drifting lower, mainly due to lower oil prices and a fall in the US federal rates. Further, government borrowing for the second half of the year should be announced shortly, and it is expected to be lower than expected because of the high GST and Direct tax flows and benign Oil prices. This, too, is positive for lower interest rates.??
GOLD/SILVER
Gold prices have reached an all-time high again due to the Federal rate cut and the weakening dollar.? Geopolitical tensions are also positive for Gold. Silver prices, too, are rising fast. Governments continue to buy gold, and even in India in August, RBI bought over 10 tons of Gold. Gold reserves have reached a record high of 854 tons, which is 9% of its total foreign reserves
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