Chapters 3 and 4
Study Guide by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The Future of Capitalism Main Page
Chapter 3: Plate One: The End of Communism
One third of humanity lived within the old Communist world. Their lives will change dramatically as they make decisions, face risks, and undertake activities that were never available to them in the past. Economic life in the old capitalist world will also change just as profoundly. Industries are and will be on the move geographically. For example, oil supplies from the old Communist world have already destroyed the monopoly power of OPEC and the Persian Gulf countries to set prices. Russian exports of aluminum and titanium have had similar effects on other old capitalist producers. Grain exports from the Ukraine may have similar effects when the Ukraine gets its act together. The old USSR was also a high-science society that has now become a new cheap source of very highly skilled labor. Communism had very bad economies, but very good school systems. Hundreds of millions of people know more than the average American. The effective supply of educated workers has been significantly expanded and is going to have large impacts on the wages of the educated in the old capitalist world. The old Soviet Union will have its biggest impacts on natural resource industries and scientific labor. China will have a large impact on manufacturing that employs those with low and mid-range skills. Why? Who will pay an American high-school graduate $20,000 per year when a better-educated Chinese can be hired for $35 per month?
China
China is growing rapidly and the old capitalist world is going to change dramatically as 1.2 billion Chinese are absorbed into the global economy. China's growth is constrained by industries that were heavily subsidized in the communist system that will become unprofitable in a market economy. China's growth is also constrained by the large number of Chinese (73 percent) employed in agriculture. Although abolishing the communes improved their incentive system and lead to growth in output, Chinese agricultural production has stagnated over the past 10 years. During communism, the Chinese paid only 1 percent of their household income for housing. Moving to a market system means housing and other subsidized services will be repriced requiring higher wages for Chinese workers in urban areas. Improved wages for those in the urban areas will lead to large income gaps between rural and urban workers and motivate those living in rural areas (80 percent of the Chinese) to move to urban areas to earn higher wages. But more than a billion Chinese cannot be allowed to move to the urban areas of China, predominately on the coast. So China needs to make massive investments in infrastructure (fertilizers, pesticides, machinery, transportation, communications, electrification) to shift the economic boom to the center and western parts of the country. China also needs more ports and airports in the right places. Too many of these facilities were built in the wrong places which will result in a lot of debt and unused capacity.
Although China has many problems to overcome, it is moving more rapidly and easily into a market economy than the rest of the old Communist world. There are four reasons for the Chinese success relative to the countries of Middle and Eastern Europe.
1. Although the Chinese are very poor, they voluntarily save and invest a high percentage (40%) of China's GDP.
2. China's government is effective in designing and enforcing strategies. China has abolished communes and given every peasant family their share of the land (the family responsibility system). The privatization of agriculture was followed by the privatization of services, then small-scale retailing, and small-scale manufacturing. Under communism the state owned everything, but the privatization of housing is now under way recognizing that the market economy has to begin with an initial distribution of income and wealth. The Chinese government is able to make and enforce decisions. For example, Chinese citizens will buy their current homes even though their housing cost will increase from one percent to 30 to 40 percent of their income. In Eastern Europe where governments collapsed, privatization was essentially a process where the old Communist grabbed what use to be state assets for themselves.
3. The communist management mentality is incompatible with what is needed in a capitalist system. Under communism, managers were told what to produce and received the necessary materials, components, people, and money to accomplish their assignments from the central economic plan. They never purchased anything, sold anything, negotiated with anyone, talked to a customer or worried about profits or losses. China dealt with this problem by acquiring Chinese managers who were raised in capitalist economies (Hong Kong, Taiwan, the Americas, Southeast Asia, Singapore). In contrast, Russia used the old communist managers (old army colonels) who had few if any management skills applicable to a capitalist market system.
4. It is much more difficult to move a communist economy of large-scale holdings to a capitalist market system than a communist economy of small-scale holdings. Only 18 percent of Chinese employment was in large state enterprises, while 72 percent were employed in collective farms. In Russia, giant state enterprises employed 93 percent of Russian workers while only 6 percent were employed on farms. But now the old USSR is 15 different countries, each one with too much of what it produces and not enough of what the other fourteen countries produce.
China still has to figure out how to roll the growth boom west into the interior, and how to create rural prosperity, but it will remain a major story in the restructuring of the global economy.
The End of Import Substitution and Quasi-Socialism in the Third World
The economic strategy of import substitution and quasi-socialism was supposed to be a road to economic development for third world countries. The idea was to place high tariffs and quotas on imports from the developed world, and establish government-sponsored corporations to produce what previously had been imported. But it didn't work because the quasi-private-public business firms hid behind their high quotas, tariffs, and subsidies, and made a lot of money, but never matched the efficiency of the developed world. Hong Kong, Singapore, Taiwan, and South Korea rejected this strategy and became prosperous. Other countries (Indonesia, Malaysia) are also rejecting their past ideologies and beliefs in import substitution and quasi-socialism. Today three billion people everywhere in the third world (including Mexico, Indonesia, India, Egypt) want to become export oriented. Global competition will intensify as some high-skill jobs move to these low-wage countries.
The Middle East
The countries in the Middle East have the potential to develop a successful economy if peace should exist. There are 30 million low-wage workers in Egypt, Israel has the technology, the Palestinians are the best educated of the Arabs, and there are wealthy consumers and investors in the Persian Gulf region.
Political Geography
The USSR and the United States learned during the Cold War that whenever someone moved political borders by force the bipolar power disputes came close to getting out of hand. Both sides had to maintain large armies to stabilize the situation at those borders. But today within the old Communist world new countries, new borders, and new governments are being built from the wreckage of communism. The ethnic groups of Eastern Europe are finding that they can no longer live together. Economics is driving nations to disintegrate and regions to integrate simultaneously. The geopolitical changes are startling, but they are merely the beginning of a fundamental redrawing of the political face to the earth.
No Competitors
Capitalism and democracy live in a unique period where there are no viable competitors for the minds of their citizens. There is no credible military threat to the United States, so the military has to make arguments about defending places where it is not clear who threatens them. Authoritarian dictatorships still exist, but they have no utopian ideologies (Nazism or communism) that can promote voluntary allegiance. Capitalism stands alone.
Chapter 4: Plate Two: An Era of Man-made Brainpower Industries
The Disappearance of Classical Comparative Advantage
The classical theory of comparative advantage provides an explanation for the location of industries in the nineteenth and twentieth centuries. Their location was determined by natural resources and factor proportions, i.e., the relative abundance of capital and labor. In 1900, the economy was clearly a natural resource economy. Ten of the twelve largest companies in America in 1900 were natural resource companies (related to cotton, steel, sugar, tobacco, coal, iron, lead, gas, leather, and rubber). Today only one of those twelve companies is alive (General Electric). In, contrast the most rapidly growing industries today are in the areas of microelectronics, biotechnology, new material science, telecommunications, civilian aircraft, machine tools, robots, and computers. All of these are man-made brainpower industries that could be located anywhere. Natural resources and capital are no longer the key components in the competitive equation. These new industries are located where the brainpower and leading process technologies are located. Where invention, design, manufacturing, sales, logistics, and services are seamlessly integrated to create a competitive advantage.
In the classical theory of comparative advantage there is no role for government in determining the location of industry. According to the theory, there is a right place for everything based on natural resources and factor proportions. Theoretically, free trade would not hurt anyone, transition costs would be zero, and returns would be equal everywhere. But none of this is true. Trade can cause unemployment, there are transition cost of moving people to and from industries and regions, and wages and rates of return do not equalize. There are benefits to international trade, but there are also losers, and their aggregate losses can be large.
Natural resource industries were essentially a birthright. In contrast, man-made brainpower industries have to be invented. Factor proportions have dissolved in a world of global markets and worldwide logistics. New products are introduced so frequently that there is never time for labor and capital markets to equalize. Transition cost are high and unemployment is a worldwide fact of life. The real world is now far removed from the classical theory of comparative advantage. Countries will have to make the investments in knowledge and skills that can create new brainpower industries that in turn will provide high-wages and high standards of living for their citizens. Comparative advantage is now determined by the investments a country makes, rather than the location of their natural resources.
Skills: The Only Source of Long-Run Sustainable Competitive Advantage
Knowledge and skills, particularly the process skills that can only be learned in a production environment will move around the world, but more slowly than anything else. Today's transportation and communication technologies allow skilled workers in one country to work together with unskilled workers in another country. Components can be made by skilled workers in the first world and assembled by low skilled workers in the third world. Markets can be served from production points anywhere on the globe. Multinational companies will locate their high-wage technological leadership skills in countries that offer the lowest cost of developing those skills.
In an economic environment that no longer exists, first world workers with third world skills could earn premium wages because they lived in the first world. Until the early 1970s unskilled American workers received a wage premium simply because they were American. They worked with better equipment, better technology, and more skilled coworkers than those in the third world. In the economy of the future, those with third world skills will earn third world wages regardless of where they live.
Productivity will increase as functional walls are removed and decisions are pushed down into the organization to cut out layers of management hierarchy. This will require a much better educated and skilled workforce at the bottom of the organization. Factory operatives and laborers use to be high-school graduates or high-school dropouts, but man-made brainpower industries will require new and more extensive skill sets than required in the past. With the ability to make anything anywhere in the world and sell it anywhere else in the world, business firms can select the skilled where ever they exist in the world. Workers in one country that do not work with more natural resources, more capital, more skilled complementary workers, or better technology than those in other countries, will have to work for wages commensurate with the wages of those other countries (factor price equalization).
Brainpower Technologies and the Nature of the Firm
In the past, people reporting to each other had to be located together. This resulted in command and control systems with many levels of hierarchy. Today communication technologies have transformed internal communications and made these hierarchal systems relics of the past. New systems are being developed that eliminate layers of management and push decisions down the hierarchy. This will require different workers at the bottom who are smart enough to make the right decisions, and different people at the top who communicate their companies' strategies so well that the right decisions are made at the bottom of the organization.
Values in an Electronically Interconnected Global Village
Human culture and values are being shaped by a profit-maximizing electronic media. A media (TV, movies etc.) that has replaced the family in generating values. A visual-verbal media that moves us in many ways back to a world of illiteracy where what counts is emotional appeal to feelings and fears rather than to logical rigorous thought. One has to learn to read, but one does not have to learn to watch TV. The media provides a verbal and emotive environment controlled by those who want to make money, an environment where what one believes to be true is often more important than what is actually true. Political spin provides an illustration of the clash between rational thought and emotion. The media has become the dominant force creating our mental pictures of reality. What sells is excitement and instant gratification. Modern technology promotes radical individualism and a mass culture that controls national leaders more than national leaders control the mass culture. Today's technology will lead us to a more direct rather than representative democracy.
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Go to the next Chapter. Thurow, L. C. 1996. The Future of Capitalism: How Today's Economic Forces Shape Tomorrow's World. William Morrow and Company. (Chapter 5).
Related summaries:
Graham, J. L. and N. M. Lam. 2003. The Chinese negotiation. Harvard Business Review (October): 82-91. (How to deal with China. Understand the cultural context of Chinese business style). (Summary).
Ignatius, A. 2021. "Americans don't know how capitalist China is." Harvard Business Review (May/June): 61-63. (Summary).
Martin, J. R. Not dated. A note on comparative economic systems and where our system should be headed. (Note).
Milanovic, B. 2019. Capitalism, Alone: The Future of the System That Rules the World. Harvard University Press. (Summary).
Mitter, R. and E. Johnson. 2021. What the West gets wrong about China: The fundamental misconceptions. Harvard Business Review (May/June): 42-48. (Summary).
Oser, J. 1963. The Evolution of Economic Thought. Harcourt, Brace & World, Inc. (Summary).
Porter, M. E. and M. R. Kramer. 2011. Creating shared value: How to reinvent capitalism and unleash a wave of innovation and growth. Harvard Business Review (January/February): 62-77. (Summary).