Types of Capitalism

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Capitalism is an economic system dominated by free markets and private ownership of wealth, assets and business. Within the broad church of capitalism, there are different forms – from unregulated ‘Turbo-capitalism’ to ‘responsible or ‘social welfare capitalism.’ In practice, all ‘capitalist economies have a degree of government intervention.

types-of-capitalism

Turbo Capitalism

This refers to an unregulated form of capitalism with financial deregulation, privatisation and lower tax on high earners.Turbo-capitalism involves:

  • The absence of regulation for banking /finance system. This encourages banks to take risks and pursue profit through complex financial derivatives rather than basic principles of attracting deposits and lending.
  • Less regulation on abuse of monopoly power.
  • Lower income tax and lower capital gains tax giving greater rewards to high income earners.
  • An unregulated labour market, where it is easy to hire and fire workers, and very limited regulation about working conditions.

The term ‘turbo capitalism’ was coined in 1989 by Edward Lattwak, a senior fellow at the Center for Strategic and International Studies, in his book “Turbo-Capitalism: Winners and Losers in the Global Economy“, (New York, 1999). It reflected on the changes to capitalist societies such as US and UK since 1980. The 1980s were a period of financial deregulation, privatisation and tax cuts for the wealthy. Arguably, this led to rising income inequality and also the financial deregulation played a key role in the unsustainable credit bubble of 2001-2007.

  • Turbo capitalism could also be referred to as Unrestrained capitalism or free market capitalism

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Economic Growth UK

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Economic growth measures the change in real GDP (national income adjusted for inflation; ONS call it chained volume measure of GDP) Since the end of the great recession (2008 – 2009) the UK economy has grown in fits and starts. It has been a relatively weak economic recovery compared to previous recessions. 2019 has seen …

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Inflation and Exchange Rates

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fall-in-price-of-sterling-pound

Readers Question: Why is it that the value of the exchange rate falls when there is higher inflation? How inflation affects the exchange rate A higher inflation rate in the UK compared to other countries will tend to reduce the value of the Pound Sterling because: High inflation in the UK means that UK goods …

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Profit Maximisation

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profit-maximisation

An assumption in classical economics is that firms seek to maximise profits. Profit = Total Revenue (TR) – Total Costs (TC). Therefore, profit maximisation occurs at the biggest gap between total revenue and total costs. A firm can maximise profits if it produces at an output where marginal revenue (MR) = marginal cost (MC) Diagram …

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Bank Runs

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run-on-the-banks

Bank run definition A bank run occurs when there is a sudden demand to withdraw money from a bank, that the commercial bank struggles to meet. The first signs of ‘bank panic’ will encourage other depositors to also try and withdraw their savings, causing a further ‘run on the bank.’ In a bank run, investors …

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Macroeconomic objectives and conflicts

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macroeconomic-objectives
A look at the main macroeconomic objectives (economic growth, inflation and unemployment, government borrowing) and possible conflicts between these different macro-economic objectives.

The main macro-economic objectives

  1. Economic growth – positive and sustainable growth (The UK, long-run trend rate is around 2.5%)
  2. Low inflation (UK target 2% +/-1) –
  3. Low unemployment / Full employment (e.g. around 3%)
  4. Current account – balance of payments. Satisfactory position (i.e. avoid unsustainable current account deficit)
  5. Low government borrowing/public sector debt.
  6. Exchange rate stability

Some economists also consider:

  1. Issues of equity (avoid inequality)
  2. Environmental factors (long-run environmental sustainability)

Conflicts of macro-economic objectives

possible-macro-conflicts

1. Economic growth vs inflation

One macro-economic conflict can come between economic growth and inflation (which leads to a similar conflict between unemployment and inflation). If there is rapid economic growth, it is more likely that inflationary pressures will increase. Inflation is particularly likely to occur when growth is above the long run trend rate, and AD increases faster than AS.

When the economy is growing very quickly, firms have difficulty employing sufficient skilled labour; this can lead to wage inflation and higher wages cause higher prices. Also, if demand grows faster than supply, firms will respond to shortages by putting up prices.

Inflationary growth

ad increase - inflation

In this diagram, there is an increase in AD, when the economy is close to full capacity. We get an increase in real GDP but also an increase in the inflation rate.

Example of conflict between economic growth and inflation

In the late 1980s during the Lawson boom, the UK experienced a high rate of economic growth (4-5% a year). This growth rate was above the long run trend rate of growth but caused inflationary pressures to increase. Also if growth is very quick, there may be supply constraints pushing up commodity price increases.  This economic boom of the 1980s proved unsustainable and ultimately led to the recession in 1991 (as the government increased interest rates to try and control inflation.

The rapid economic growth of 1986-1989 led to inflation increasing to nearly 1%. It required interest rates of 12% and the recession of 1991/92 to bring inflation under control.

Low inflationary growth

However, it is possible to have economic growth without causing inflation. If growth is sustainable – if it is close to the long run trend rate, then LRAS will increase at the same rate as AD, and therefore, we will not see inflation.

long-run-economic-growth-LRAS-AD

Economic growth without inflation. AD and LRAS increasing at the same rate.

The UK between 1993-2007, had a long period of economic expansion. But, this prolonged economic growth did not cause inflation. This is sometimes known as the great moderation.

economic-growth-inflation-80-15

The UK great moderation from 1992 to 2008 – low inflation, positive economic growth.

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Effect of the exchange rate on business

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Readers Question: What are the effects of the exchange rate on UK businesses?

The exchange rate will play an important role for firms who export goods and import raw materials. Essentially:

  • A depreciation (devaluation) will make exports cheaper and exporting firms will benefit.
    • However, firms importing raw materials will face higher costs of imports.
  • An appreciation makes exports more expensive and reduces the competitiveness of exporting firms.
    • However, at least raw materials (e.g. oil) will be cheaper following an appreciation.

Effect of depreciation in the exchange rate

winners-losers-depreciation-table

If there is a depreciation in the value of the Pound, it will make UK exports cheaper, and it will make imports into the UK more expensive.

In this example:

euro-pound-spot-07-12

  • At the start of 2007, the exchange rate was £1 = €1.50.
  • By Jan, 2009, the Pound had fallen in value so £1 was now only worth €1.10 (a depreciation of 26%)

Impact on British exporters

Suppose a British car costs £4,000 to build and sells for £5,000 in the UK.

  • In 2007, the European price of this car would be €7,500 (5,000 *1.5)
  • In 2008, the European price of this car would be €5,500 (5,000 *1.1)

The 26% depreciation means that European consumers now find British goods much cheaper. The cost of producing the car stays the same (assuming parts are not imported), but the effective market price in Europe has fallen. This should increase demand for British goods.

Increase profit margin or reduce the foreign price?

A British firm has a choice, it can reduce the European price from €7,500 to €5,500; this should lead to an increase in the quantity sold, and increase UK exports.

Alternatively, the firm could keep the price at €7,500 and just make a bigger profit margin. It is a good choice for exporters to have – reduce European price and sell more or keep price the same and make a bigger profit margin.

Impact on importers of raw materials

The downside of a depreciation is that British firms who import raw materials will see an increase in the cost of buying raw materials. If the British car company imports engines from Germany to make the car, it will have to pay more to buy the engines. This will reduce its profit margin.

Suppose an engine costs €1000 to import from Germany. In 2007, this costs £666 (1,000/1.5). In 2009, with the fall in the value of the Pound, they will have to spend £909 (1,000/1.1) to buy the same German engine.

Impact on incentives

In the long term, it is argued that a depreciation may reduce the incentives for exports to cut costs. The depreciation enables an ‘easy’ increase in their profit margin. As a result, there may be less incentive to cut costs and boost productivity. If a firm is facing an appreciation, then they may face a greater incentive to cut costs.

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Stock market explained

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The stock market is a place where traders buy and sell shares, government bonds and other assets. The stock market shows the price of shares and facilitates companies to raise revenue from issuing shares. Investors buy shares for both dividends and the prospect of capital gains. the US stock exchange based in NY (NYSE) has …

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