THINKING AND MANAGING ETHICALLY

The Business System: Government, Markets And International Trade

Dr. Keith Y.N. Ng
Ph.D., MBA, MCIM

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Globalization

The process by which the economic and social systems of nations are connected together so that goods, services, capital and knowledge move freely between nations.

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Economic System

The system a society uses to provide goods and services it needs to survive and flourish.

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Economic Systems
The economic system accomplishes two basic economic task:
The task of producing goods and services, which requires determining what will be produced, how it will be produced and who will produce it. The task of distributing these goods and services among its members which requires determining who will get what and how much each will get.

To accomplish these two tasks, economic system rely on three kinds of social devices:
Tradition-based societies Command economy Market economy
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Economic Systems Tradition-Based Societies

Small and rely on traditional communal roles and customs to carry out the two basic economic tasks. Individuals are motivated by the communitys expression of approval or disapproval and the communitys productive resources - such as its herds are owned in common
E.g. Bushman, the Inuit, Kalahari hunters and Bedouin tribes.

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Economic Systems Command Economy

Based primarily on a government authority (a person or a group) making the economic decisions about what is to be produced, who will produce it and who will get it. Productive resources such as land and factories are owned or controlled by government and are considered belong to the public.
E.g. China, Vietnam, North Korea, Cuba, former Soviet Union run their economies primarily on the basis of commands.

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Economic Systems Market Economy

An economic system based primarily on private individuals making the main decisions about what they will produce and who will get it. Productive resources like land and factories are owned and managed by private individuals. Essentially on Supply and Demand
E.g. most countries

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Free Markets

Markets in which individuals are able to voluntarily exchange goods with others and to decide what will be done with what he or she owns without interference from government.

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Free Markets And Rights : John Locke

John Locke (1632-1704), an English political philosopher developed the idea that human beings have a natural right to liberty and a natural right to private property. The two natural rights that free markets are supposed to protect are: the right to freedom the right to private property Free markets preserve the right to freedom for each individual to voluntarily exchange goods with others free from the coercive power of government. Free markets preserve the right to private property for each individual to decide what will be done with what he/she owns without interference from government.
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Lockes State of Nature

All are free and equal

each individual would be equal to others free from constraints

Each person owns his body and labour, and whatever he mixes his labour into. People agree to form a government to protect their right to freedom and property.
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Lockean Rights
The right to life, liberty and property Individuals have an absolute right to do whatever they want with their property and the government has no right to interfere with or confiscate an individuals private property even for the good of society (Fifth Amendment of US Constitution)
E.g. Land Acquisition Act

When a person expends labor/effort to create or improve something, that person acquires property rights over that thing
E.g. writing a book, software programs
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Criticism of Lockean Rights (1)

Lockes critics focus on four weakness in his argument: 1. The assumption that individuals have natural rights: This assumption is unproven and assumes that the rights to liberty and property should take precedence over all other rights. If humans do not have the overriding rights to liberty and property, then the fact that free markets would preserve the rights does not mean a great deal.
2. The conflict between natural (negative) rights and positive rights: Why should negative rights such as liberty take precedence over positive rights? Critics argue, in fact, that we have no reason to believe that the rights to liberty and property are overriding.
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Criticism of Lockean Rights (2)

3. The conflict between natural rights and justice: Free markets create unjust inequalities, and people who have no property/who are unable to work will not be able to live. As a result, without government intervention, the gap between richest and poorest will widen. Unless government intervenes to adjust the distribution of property, large groups of citizens will remain at a subsistence level while others grow ever wealthier.
Individualistic assumptions and their conflicts with the ethics of caring: Locke assumes that people are individuals first, independent of their communities. But humans are born dependent on others, and without caring relationships, no human could survive.
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Free Markets And Utility : Adam Smith (1)

Second major defense of unregulated markets rests on the utilitarian argument that unregulated markets and private property will produce greater benefits than any regulation could. In a system with free markets and private property, buyers will seek to purchase what they want for themselves at the lowest prices they can find: Private businesses will produce and sell what consumers want; Sell at lowest possible prices, The free market coupled with private property, ensures that the economy is producing what consumers want, prices are at the lowest levels possible and that resources are efficiently used. The economic utility of societys members is maximized.
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Free Markets And Utility : Adam Smith (2)

Adam Smith (1723-1790), the father of modern economics is the originator of this utilitarian argument for free market. According to Adam Smith, the market competition that drives self-interested individuals to act in ways that serve society.

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Free Markets And Utility : Adam Smith (3)

In a competitive market, a multiplicity of private businesses must all compete with each other for the same buyers. To attract customers, each seller is forced to sell what the consumers want and to drop the price as low as possible. The competition produced by a multiple of self-interested private sellers serves to lower prices, conserve resources, and make producers respond to consumer desires.

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Free Markets And Utility : Adam Smith (4)

Smith argued that a system of competitive markets allocates resources efficiently. Examples: When a supply of a certain commodity is not enough to meet demand, the buyers need to pay a higher price than the natural price. Producers of that commodity will reap profits higher then those available to producers of other commodities. The higher profits will induce producers of other products to switch their resources into the production of the more profitable commodity. As a result shortage of that commodity disappears and the price sinks back to its natural level.
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Free Markets And Utility : Adam Smith (5)

Supply of a commodity is greater than the quantity demanded, its price falls, inducing its producers to switch their resources into production of more profitable commodities.
The market allocate resource so as to most efficiently meet consumer demand thereby promoting social utility.

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Free Markets And Utility : Adam Smith (6)

According to Adam Smith, the best policy of a government to advance public welfare is to do nothing to let each individual pursue self-interest in natural liberty. Any interventions in the market, by the government can only interrupt the self-regulating effect of competition and reduce its many beneficial consequences.

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Criticisms of Adam Smith

Smith's utilitarian argument is criticized for making unrealistic arguments: 1. Assumes no one seller can control the price of a good. Though this may have been true at one time, today many industries are monopolized to some extent. 2. Assumes that manufacturer will pay for all the resources used to produce a product, but when a manufacturer uses water and pollutes it without cleaning it, someone else must pay to do so. 3. Assumes that humans are motivated only by a natural, self-interested desire for profit. This is clearly false. Many are concerned for others and act to help others, constraining their own self-interest. Market systems, say Smith's critics, make humans selfish and make us think that the profit motive is natural.
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Keynesian Criticism of Adam Smith (1)

Most influential criticism of Adam Smiths classical assumption came from John Maynard Keynes (1883-1946). Smith assumed that without any help from government, the automatic play of market forces ensure full employment of all economic resources including labour. Keynes argued that the total demand for goods & services is the sum of the demand of three sectors of the economy: household, businesses and government (aggregate demand). The aggregate demand of these three sectors may be less than the aggregate amounts of goods and services supplied by the economy at the fullest employment level.
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Keynesian Criticism of Adam Smith (2)

This mismatch between aggregate demand and aggregate supply will occur when household prefer to save some of their income in liquid securities instead of spending it on goods and services. When aggregate demand is less than aggregate supply the result is a contraction of supply. Businesses realize they are not selling all their goods and services they will cut back on production causes cut back on employment. As production falls the incomes of household also fall but the amount households are willing to save fall even faster: The economy reaches a stable point of equilibrium at which demand equals supply but at which there is widespread unemployment of labour and other resources.
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Keynesian Criticism of Adam Smith (3)

According to Keynes, government can influence the propensity to save which lowers aggregate demand and creates unemployment. Government can prevent excess savings through its influence on interest rates and it can influence interest rates by regulating the money supply. The higher the supply of money, the lower the rates at which it is lent.

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The Utility of Survival of the Fittest: Social Darwinism (1)

The doctrines of social Darwinism named after Charles Darwin (1809-1882), who argued that the various species of living things were evolving as the result of the action of an environment that favored the survival of some things while destroying others. Social Darwinism - belief that economic competition produces human progress.
Individuals whose aggressive business dealings enable them to succeed in the competitive world of business are the fittest and are the best. Free competition enriches some individuals and reduces others to poverty will result in the gradual improvement of human race.
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The Utility of Survival of the Fittest: Social Darwinism (2)

Social Darwinist argued that:

If Government interfere with the competitions they would unintentionally be impeding progress. Government must not lend economic aid to those who fall behind in the competition for survival and if these economic misfits survive, they will pass on their inferior qualities and human race will decline Economic competition ensures the best firms survive and the economic system will gradually improve.
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Free Trade and Utility: David Ricardo (1)

Countries differ in their ability to produce goods. One country can produce a good more cheaply then another and it is said to have an absolute advantage in producing that good. These cost differences may be based on differences in labour costs and skills, in climate, in technology, in equipment, in land or in natural resources.

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Free Trade and Utility: David Ricardo (2)

David Ricardo (1772-1823), a British economist, said that even if one country has an absolute advantage at producing everything, it is still better for it to specialize and trade. Comparative advantage
A situation where the opportunity costs (costs in term of other goods given up) of making a commodity are lower for one country than for another.

One country may be more efficient in making one product while another country will be more-efficient in making another product.
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Criticisms of Ricardo (1)

Ricardo makes a number of assumptions do not hold in the real world:

1. Assume resources used to produce goods (e.g. labor, equipment, factories) do not move from one country to another.
Today multinational companies can easily move their productive capital from one country to another.

2. Assumes that each countrys production costs are constant and do not decline as countries expand their production (i.e. no economies of scale) or as they acquire new technology.
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Criticisms of Ricardo (2)

3. Assumes that workers can easily and costlessly move from one industry to another.
In reality re-trenched workers often cannot find comparable jobs and need retraining to stay employable.

4. Ignores international rule setters.

International trade inevitably leads to disagreements and conflicts and so countries must agree to abide by some set of rules and rule setters. Main organizations that set the rules that govern globalization and trade are World Trade Organization, IMF, World Bank.
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Marx and Justice : Criticizing Markets and Trade (1)

Karl Marx (1818-1883) during the Industrial Revolution was the harshest and most influential critic of the inequalities that private property institutions, free markets, and free trade are accused of creating. Suffering and misery that capitalism was imposing on its workers: exploitative working hours Pulmonary diseases Premature deaths caused by unsanitary factory conditions.
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Marx and Justice : Criticizing Markets and Trade (2)

According to Marx, capitalist system offers only two sources of income: Sale of ones own labour; and Ownership of the means of production (buildings, machinery, land, raw materials)

Workers cannot produce anything without access to the means of production so they are forced to sell their labour to the owner in return for a wage.

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Marx and Justice : Criticizing Markets and Trade (3)

The owner does not pay workers the full value of their labour, only what they need to subsist. The difference (surplus) between the value of the labour and the subsistence wages becomes the source of the owners profits. Those who own the means of production becomes wealthier and workers becomes relatively poorer. Capitalism promotes injustice and undermines communal relationship. Marx held that human beings should be enabled to realize their human nature by freely developing their potential for self-expression and satisfying their real human needs.
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Alienation (1)

In Marxs view capitalism alienates the lower working classes by not allowing them to develop their productive potential nor to satisfy their real human needs nor to form satisfying human relationship.

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Alienation (2)
According to Marx, capitalist economies alienate workers in four ways:1. In capitalist societies, products that workers produce are taken away by the capitalist employer. Capitalism forces people into work that they find dissatisfying and unfulfilling and that is controlled by someone else. Capitalism alienates people by instilling in them false views of what their real human needs and desires are. Capitalist societies alienate human being from each other by separating them into antagonistic and unequal social classes that break down community and caring relationship.
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2.
3. 4.

The Real Purpose Of Government

According to Marx, the actual function that governments have served is that of protecting the interests of the ruling economic class. According to Marx, society can be analyzed in terms of its two main components:
economic substructure; and social superstructure
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Economic Substructure (1)

Consists of the materials and social controls that society uses to produce its economic goods. Marx refers to the materials (land, labour, natural resources, machinery, energy, technology) used in production as the forces of production. Marx called the social controls used in producing goods (ie. the social controls by which society organizes and controls its workers) the relations of production.
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Economic Substructure (2)

Two main types of relations of production:

Control based on ownership of the materials used to produce goods; and Control based on authority to command

In modern industrial society, capitalist owners control their factory laborers because:
The capitalist own the machinery on which laborers must work if they are to survive. Laborers must enter a wage contract by which they give the owner (or manager) the legal authority to command.
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Social Superstructure
Consists of its government and its popular ideologies. Marx claim that the ruling class created by the economic substructure inevitably controls this superstructure. The members of the ruling class will control the government and use it to protect their position and prosperity and will popularize ideologies that justify their position of privilege.

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Replies from Proponents of the Free Market

Defenders of free market counter Marx criticism by: Marx criticism wrongly assume justice means either equality or distribution according to need. Re-emphasizing that justice means distribution according to contribution
E.g. when markets are free and functioning competitively, workers will be paid according to their value and contributions as they add to the output of the economy

Even if private ownership causes inequalities, the benefits of the system are greater and more important than the incidental inequalities.
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Mixed Economy (1)

The debate for/against free markets, free trade and private property has been spurred on by recent world events:
The collapse of several communist regimes such as former Soviet Union; and The emergence of strong competitors in several Asian nations, such as China, Japan, Singapore and Taiwan.

Collapse of communist regimes around the world has shown that capitalism with its emphasis on free markets is the clear winner. The resulting amalgam of government regulation, partially free markets and limited property rights is referred to as mixed economy.
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Mixed Economy (2)

Mixed economy retains a market and private property system but relies heavily on government policies to remedy their deficiencies. Government transfers (of private income) are used to get rid of the worst aspects of inequality by drawing money from the wealthy in the form of income taxes and distributing it to the disadvantaged in the form of welfare. Minimum wage laws, safety laws, union laws, and other forms of labour legislations are used to protect workers from exploitation.
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Mixed Economy (3)

Monopolies are regulated, nationalized or outlawed. Sweden, Germany, Denmark, Japan, the Netherlands, Belgium, Norway, Finland, Switzerland are all mixed economies with high levels of government intervention.

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