Can capitalism save itself this time around?

This post is more a question rather than a statement or rant. Can capitalism save itself this time around?

I have four reasons for having to ask.

1. Economic power and wealth are now more concentrated among fewer people. A key component of capitalism is competition. To gain competitive edge against competitors, many market participants engage in strategies and activities that increase their monopolistic power. All this is well and good when it translates into better products for the consumer.

But a private, for-profit company’s objective is first and foremost to make a profit. If the company’s shareholders happen to be of the shareholder value maximization school, they will want to maximize profits first and foremost. Any gains in monopolistic power that translate into greater economies of scale can therefore lead to greater opportunities for these same players to further increase their gains over competitors.

Moreover, because of the downward effects of the globalization of processes, many of the displaced and existing workers in the developed countries could no longer demand increasing wages from their employers. Thus power shifted from many competitors and market participants, and from the masses of employees, to a few select large corporations able to shift resources and processes anywhere it suits them best.

This development undermines a key component of capitalism – free market competition.

2. Asymmetrical information abounds in most economic transactions. Wikipedia defines this as transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry. This undermines a key component of capitalism – perfect competition.

And because of both economic concentration and asymmetrical information, there are now, more than ever, opportunities for moral hazard. Moral hazard is defined as instances where the ignorant party lacks information about performance of the agreed-upon transaction or lacks the ability to retaliate for a breach of the agreement. This also refers to instances where market actors can act with impunity, with the expectation of relatively low downside due to societal bailouts of failure. This was the case in many of the recent financial transactions that have recently undermined the capital markets.

Moral hazard undermines a most key component of capitalism – trust, which leads to the third…

3. There seems to be massive investor and consumer capitulation this time around. In environments of decelerating or contracting economies, everybody cuts down on consumption. Everybody wants to save. Everybody wants to earn cash inflow, but do not want cash outflow.

Everybody’s individual behavior, taken into the aggregate, results in further decelaration or contraction of economies. Businesses run out of clients. Businesses without clients lay off their workers. Laid off workers cut down on their spending further.

Nobody wants to invest in economic enterprises, and everyone prefers to take a wait and see stance. No one want to move first, for fear that nobody else will follow, and they will end up the only ones outside when the door of the free market completely closes.

This undermines a key component of capitalism – confidence in the viability of economic transactions.

4. A significant chunk of the world population is now in danger of a coordinated financial armageddon. This time, the world has come to realize that it is more and more inter-connected, and that mistakes made in one sector of one country can affect the economies of entire nations. If a major US institution falls, whose links with large institutions worldwide are too great, the ripples and after-effects to other economies globally could sink the world into a deep recession.

And with the US finally forced to follow the same economic growth formula as the rest of the world, which is to rely on a growth strategy where others are supposed to buy your goods, we are now missing a key ingredient to keep the global growth engine humming – the willing and able consumer. This comes at a time when the rise in energy and food and materials prices earlier this year had already resulted in significant demand destruction in many economies.

This undermines a significant component of capitalism – the ability of markets to self-heal.

With so many crucial components of capitalism seemingly absent, I ask again, can capitalism save itself this time around? Or do we need something more drastic, even than market intervention?