Capitalism is alive and well and living in Guangzhou and Bangalore

I have meant to post something along these lines for some time, and it may seem unduly negative, but I hope that it strikes a chord or two. Every time a BBC or Sky reporter talks about the economy for more than 5 minutes they usually get round to the issue of whether capitalism has "failed", without explaining what they really mean by failure.

Do you want the good news or the bad news? The good news is that what we see in the financial markets is not a crisis in the sense of an abrupt event that will lead to uncertainty and a deterioration of the financial and social position of the civilised world.  The bad news is that what we are seeing is part of a continuing process that preceded the last financial crisis and will continue into the future.

But it is not capitalism that has failed. Capitalism is alive and well, but not in the West - it has gone East. The spirit of capitalism - risk-taking, saving, investing, hard work - are to be seen in China, India, Indonesia, Korea and Japan.  In the 1960's we thought that those countries would be stuck in poverty, but while the last has risen to Western standards of prosperity the other four are growing fast.

Capitalism hasn't failed. Rather, just as water flows inexorably downhill, capitalism seeks out the greatest return on investment.  That doesn't necessarily mean seeking out the lowest cost but it does mean seeking out the sources of production that give the greatest return.  In simple terms, the West will not be able to compete with the East in some industries because the cost base in the East is much lower.  Until standards of living have grown in the East (and fallen in the West), then those industries will take place in the East.

What sort of industries are we talking about?  Well, most manufacturing including high value goods such as electronics.  Show me a telephone handset that was made in Europe or the United States and it will probably have been built in the 1980s.  Any western finishing is likely just to be customisation.

Show me a large factory in this country that has been built in the last 10 years, and chances are it will be involved in food processing, recycling or a similar industry that has to function locally.

So what is the problem in the West?  On the one hand, Western banks though the economy would grow for ever and were proven wrong, hence the massive number of bad housing loans.  But the bigger problem, which now hangs over Europe is the fact that politicians who were happy to open their borders for free trade failed to spot that this inevitably meant that their countries' own standard of living would inevitably be undermined.

At first it was easy to turn a blind eye, and just think that Eastern countries were backward places that were unlikely to compete with the West.  But inevitably, with their immeasurably higher populations and their improving standards of education, the West was going to be put under pressure by the lower costs in the East.  Westerners who were complacent about their prosperity failed to understand that although they were in the richest 10% of the world population, their position was not guaranteed.

The real failure, of course, and you won't hear this on the radio or TV, is not Capitalism but Socialism. We all learnt at the time of the collapse of the Berlin Wall that Socialism was unsustainable.  Unfortunately Western politicians on the left side of the spectrum didn't listen.  They found that companies didn't invest  when they put up taxes, and in fact moved all their new investment to other parts of the world.  In order to keep their captive voters happy, they borrowed heavily to finance present government consumption, which they erroneously called "investment". Leaving aside the Italian Cosa Nostra basket case, Greece, Portugal, Ireland and Spain,  the most heavily over-borrowed of the Eurozone countries, have all had one thing in common for the last 10 years: left of centre governments.  Just like the UK, currently the most over-borrowed of the lot.

You won't hear it on the BBC, but the real problem is that Western social welfare has placed an impossible burden on states, which is why the UK has a current annual deficit of €200 billion.  On its own this is 20% of the amount of funding sought by the EFSF, but worse than that, it is a recurring shortfall for which the UK government has to find funding every year.

How has this arisen?  Quite simply because in order to maintain the myth of never ending growth, Western governments have lavished stupendous salaries on their public sector workers and munificent largesse on welfare recipients, at the same time that private sector workers have seen their pay restricted largely by the pay levels of workers in the East.  Western workers naturally want to be paid more to maintain their living standards, but if they want to be paid more than their equivalent in Asia, their jobs probably aren't going to be around for long.

This was never a consideration for public sector workers who have long expected ever improving pay for the same productivity and performance, and have been largely insulated from and ignorant of the long term connection between private sector profitability and their own incomes.  Now that there is downward pressure on their pay because governments have really run out of cash public sector workers threaten strikes and riot.

Doctors expect to be paid hundreds of thousands of pounds to provide cradle-to-grave healthcare for many who have never and will never pay much into the state coffers, while civil servants expect six figure salaries, generous pensions and early retirement, all paid for by a private sector that is constantly undercut by overseas competition. In the long run, none of them should have any reason to expect to be paid much more than their Chinese or Indian equivalent as the economies of the East align themselves closer to those of the West. 

If the governments of Greece, Italy, Spain, Ireland, Portugal or the UK were companies, their respective cash shortfalls would have pushed them into insolvency years ago.  Their problems will continue until their spending is cut to realistic levels.