Entrepreneur and the profit motive

The first Prime Minister of independent India, Pandit Jawaharlal Nehru, wrote 75 years ago: “It would be absurd to say that the profit motive does not appeal to the average Indian, but it is nevertheless true that there is no such admiration for it in India as there is in the west. The possessor of money may be envied but he is not particularly respected or admired. Respect and admiration still go… to those who sacrifice themselves... for the public good.”

Three quarters of a century later, when one sees huge Indian corporates such as Infosys, Wipro, Reliance, Tata, Godrej, Mittal, etc., one wonders whether Pandit Nehru’s statement still holds true.

The respect for renunciation, for those who sacrifice, is probably still a valid concept, not only in India but in most of South Asia. But seeking profit – amassing wealth by investment in capital and capitalists who invest money in an enterprise with the objective of receiving more in return than what was originally invested – is also alive and well in India and the rest of south Asia.

Capitalism and colonisation

Capitalism came into being with the industrial revolution in Britain and Europe. It expanded worldwide with the advent of European colonisation. In the pre-industrial world, economic activity was driven in the settled agricultural villages on the great river valleys such as the Indo-Gangetic plain, in city states, pastoral tribes who moved with their herds following the availability of grasslands for fodder, hydraulic civilisations based on irrigation water management schemes and trading empires such as the ancient Phoenicians, the Greeks, the Aryans, the Carthaginians, the Arabs and the Chinese.

During these times the dominant system of political and economic organisation was feudalism. Most numerous were the peasants, who farmed the land owned by the ruler or a feudal master in exchange for rendering homage and service – including a portion of what they grow. In return the rulers and the land owners were obligated to render protection to their cultivator tenants.

With the development of trading and the expansion of great cities, which provided trading hubs, where the surpluses from the rural areas were traded, migration took place, where more and more people moved into cities and urban conglomerations. Trading systems developed, so also money lenders, financiers and bankers.

Great ports which hosted fleets from the world over, especially along the Spice Route from Malacca in today’s Malaysia and Batavia on the Indonesian islands, through Galle in Sri Lanka, Goa on India’s western coast , the Cape of Good Hope and Europe, and overland and routes such as the famous Silk Route from China to Europe across central Asia.

These entrepreneurial traders not only carried goods in their caravans and fleets, but also facilitated a massive cultural and religious exchange between the different cultures of Asia, Arabia and Europe. A system of mercantilism evolved due to this trading, the theory underlying mercantilism was that economic prosperity depended on the acquisition of gold and silver, the value of which could be secured by ensuring a positive balance of trade with the rest of the world.

Mercantilism encouraged foreign trade and the opening of new markets, the encouragement of domestic industry and agriculture to produce goods and crops for sale in those markets. Trading companies such the Dutch V.O.C. and the British East India Company developed to participate and control this trade.

Colonisation took place as a way ensuring access to raw materials and trade-able goods as well as for access to markets. Naval power and armies were expanded to protect sea routes and land routes from rivals. The profit motive drove all these ventures.

The industrial revolution

By about the year 1750, the industrial revolution began in Great Britain, with the invention of the steam engine and its initial application to the textile industry. Development of industries followed; a person with money could invest it in a leading edge technological invention and develop a more efficient factory. Investors could amass wealth much quicker than in the past.

This method of amassing wealth through investment was called capitalism; a capitalist invests money in an enterprise with the objective of receiving more in return than was initially invested. The industrial revolution brought about a substantial dislocation of agricultural populations, destruction of natural environment and very harsh working and living conditions for workers in the industrial establishment.

The unprecedented productivity of capitalist systems combined with the social ills of exploitation of labour, urban slums and other excesses brought about a reaction in the emergence of a variety of socialist ideas, as an alternative to capitalism, in the late 18th and the early 19th century. The notable among these was the creator of cooperative communities Robert Owen and Karl Marx, who along with Friedrich Engels conceived the theory and tactics of revolutionary proletarian socialism, which became known as Marxism.

Marx was primarily concerned with the dynamics of capitalism and the historical laws he believed would cause its replacement. His most famous work, co written with Engels in 1848, was the ‘Communist Manifesto,’ which contained a theory of class struggle and the revolutionary role of the proletariat.

His greatest work was ‘Das Kapital,’ published in three volumes in 1867, 1885 and 1894. Marx’s doctrine influenced the creation of numerous communist states and their associated command economies, where all economic decisions were dictated by the government and the political party which ruled the one party state.

Some multi party democracies, like Pandit Nehru’s India also became enamoured with a Fabian type of socialism, in which the government dominated the heights of the economy. Central planning was fashionable. Everything was decided by government quotas. Small wonder that Nehru had difficulty in reconciling the average Indian’s ‘Bania’ and ‘Kirana’ traders’ profit motive with the planned economy and its Indian Institutes of Technology, which in Nehru’s Fabian dream would provide the brain power to drive India towards its planned socialist paradise.

Many other nations dominated by the socialist powers such as the USSR and the People’s Republic of China, and nations emerging out of colonialism became enamoured with this economic model of statist dominance. In the realm of foreign affairs, this economic philosophy was reflected in the ‘Pancha Seela’ of non alignment, steering clear of both the powerful capitalist and socialist big powers, with a discernable tilt towards the socialists.

Worldwide division

By the early 1960s a de facto worldwide division existed between what may be called capitalist and command economies and their acolytes, who mixed and blended such part of those ideologies which they found most utilitarian and useful to perpetuate themselves in power and throw sops (bread and circuses) at their people, to placate them and put up with their misrule and corruption.

All earlier divisions of the world market were transcended; two basic methods for distributing resources dominated the world’s economies. The first, capitalism, has as its essential determinant the market. A market very different from that envisaged by 19th century free trade ideologies and one very far from being perfect. Drawbacks in regulation and the legal regime which moderated market activity created imperfections which were unfairly exploited. The system of governance was broadly democratic.

The second, communist command economies and their statist acolytes, implemented selected parts of Statism, which benefited the rulers. Political authority was paramount and dominant. Corruption was rampant. There were hardly any checks and balances on political power. This distinction between the systems of economic management and distribution of resources was a fundamental of world economic life from after World War II up to the ignominious retreat of the Soviet Army from Afghanistan in 1989.

While neither system remained wholly unchanged during this period, international trade went on between the two systems. Capitalism came to be dominated by the USA and Communist Socialism by the USSR. They were seen as alternative models for economic growth. Their competition was inflamed by the Cold War, which helped to spread the antagonism between the two sets of nations, with the nonaligned movement trying or pretending to be the impartial in between.

Liberalisation

The event that changed this economic landscape of the world was a meeting between President Reagan of the USA and General Secretary Gorbachev of the USSR’s Communist party at Iceland in 1986. In 1985 when Gorbachev took office, he introduced two words into the Soviet Union’s political lexicon – Glasnost (openness) and Perestroika (restructuring). This combination has been translated into English as ‘liberalisation’.

The Soviet leader was at last recognising that the command economy model could no longer sustain its military might, its commitments to its allies abroad and improve the living standards of its people. Reagan had launched a Star Wars initiative to develop a technology to shoot down Soviet missiles in outer space. The USSR was unable to afford to develop a counter and Gorbachev realised that the country was vulnerable to an attack from the USA and decided to enter into arms reduction talks.

In 1987 an agreement over intermediate missiles was entered into. The obvious weakness and vulnerability of the USSR combined with Gorbachev’s liberalisation policy had a huge impact on the Eastern European satellites states. They had long resented domination by the USSR and also the inefficiency of the command economy.

Poland was the first to rise in revolt. The three Baltic republics of Latvia, Lithuania and Estonia soon followed suit. Azerbaijan and Soviet Armenia also rose up; their case was complicated by the shadow of fundamentalist Islamic activity. All over Eastern Europe communist governments were exposed as having no legitimacy in the eyes of their subjects. Hungary, Czechoslovakia and Romania also rose up. Germany reunited, with the destruction of the Berlin Wall. The command economy model was discredited in Europe.

China and India

In the People’s Republic of China, after the demise of Mao in 1976, after a few years of political turbulence, the dominating figure in the gerontocracy which ran China was seen to be Deng Xiaoping. His name was associated with economic liberalisation. Modernisation was slowly seen to be taking precedence over socialism.

In 1985 the family farm was restored as the dominant form of rural production, collectivisation was abandoned. The natural entrepreneurial instincts of the mainland Chinese were unleashed. The Chinese economy grew by leaps and bounds. The world’s manufacturers located in China to access the cheap labour and the world class infrastructure. The ‘China Price’ was something other nation’s manufacturers struggled to match.

Even India, the place about which Pandit Nehru noted that ‘it would be absurd to say that that profit motive does not appeal to the average Indian,’ accepted this basic truth and abandoned the License Raj and liberalised its economy under the economic management of Prime Minister Narasimha Rao’s team of Manmohan Singh, Chiddambaram and Montek Singh Ahluwalia. For decades India had set its face against foreign ownership of local assets and enterprises was now vying with the rest of the world to attract foreign investors.

Regulation

The profit motive in capitalism has been accepted as the only driving force which will bring about economic growth. However this cannot be taken to mean that capitalism must not be regulated. Regulation is essential. A rule based system within which investors can operate, which is transparent and fair, where the rule of law applies is a fundamental requirement.

Some nations still seem to place their faith in state capitalism. The massive flaw here is that the lack of the disciplining force of the need to make a profit, distorts the enterprise. The state-owned enterprise, especially when it is a monopoly, with no incentive to make a profit, turns into a huge loss-making burden on the tax payer. Sri Lanka’s experience with water, power, transport, plantations and petroleum establish this fact beyond doubt.

Further, the basic instinct of the managers and employees to seek rent and make a private profit for themselves when the profitability of the enterprise ceases to be a concern, cannot be suppressed, especially where there are serious drawbacks in accountability and transparency.

Rent seeking results in happenings such as malfunctioning power plants, contaminated diesel and petrol, non-potable drinking water and loss-making plantations, etc., and crony capitalism, by which regulators play favourites, awarding licenses and contracts in a non-transparent way, as in India in the power generation, mining and property sectors, businessmen pursue corrupt opportunities in collusion with the political class and make vast fortunes.

Neither state capitalism nor crony capitalism can deliver results. On the other hand entrepreneurial capitalism, which in India, dominates the knowledge-based industries, capital markets and consumer goods, where innovation and rising productivity have driven growth, job creation and wealth generation, has established track record of excellence.

Government policy must rest on three pillars: to unshackle the entrepreneurial energies of their people by making markets more competitive, to reduce corruption by simplifying regulation and making it more transparent and to use tax revenues from higher growth to develop an efficient welfare state that supports the poor and the marginalised.

Viability of the capitalist system

However, the current financial crisis has led some people to question the viability of the capitalist system. It is beyond doubt that the appeal of communism and socialism has faded even in countries which were once their champions such as Russia, China and India. Even Cuba is undertaking market-oriented reforms.

In the recent past, however, capitalism also has had its difficulties. Crashing financial markets, bank bailouts and high unemployment have all added to a growing nervousness about a system that is based on private ownership of resources.

Allan Meltzer, a professor of economics at Carnegie Mellon University, in Pittsburgh, USA, in a recent book titled ‘Why Capitalism?’ argues that capitalism’s core strength it that it is the only system that leads to freedom and economic growth. He argues that failure is an inherent part of capitalism; capitalism cannot ensure virtue or stability.

Meltzer says that “capitalism without failure is like religion without sin. It doesn’t work very well.” Meltzer identifies too much state power as the cause of problems even in a capitalist system.

The sins attributed to capitalism, such as corruption, fraud and greed are brought about by an ever-expanding network of regulators, bureaus and agencies which are supposedly put in place to enhance fairness. This fairness often results in incurring debt today, which becomes a liability for future taxpayers through unfunded subsidies put in place by bureaucrats.

Luigi Zingales, a professor at the Booth School of Business, University of Chicago, in his book ‘A Capitalism for the People: Recapturing the Lost Genius of American Prosperity,’ argues that the virtue of capitalism is that it enables the creation of wealth and that creation of wealth benefited the poor and the marginalised.

Profits were taxed and redistributed. The system was regarded as being fair and equitable. However, the unnecessary involvement of the state, through complex subsidies and anti competitive regulations results in a collaboration among, politicians, bureaucrats and businessmen, resulting in crony capitalism.

If the government wants to favour business, it should aim to create favourable conditions for the market, rather than for particular businesses. When interventions are made to assist particular businesses, distortions are caused by select companies making profits while at the same time imposing costs on society as a whole. This is just what good regulation should be designed to prevent.

Zingales wants protected sectors of the economy opened up for competition, such as education and healthcare. Tax policy should be changed so that subsidies provided and their cost be made transparent. Tax deductions on mortgages should be accepted as in effect a tax on renting. Subsidies on diesel, as a tax on petrol. Tax should also be used as a substitute for regulation and charged against areas that cause cost to society, such as pollution.

Zingales says that the political debate on capitalism has been appropriated by special interests and people who have no faith in a real market-based system. This causes the present crisis in capitalism.

A colleague of Zingales at the Booth School of Business, University of Chicago, Raghuram Rajan, former chief economist of the IMF, professor of Finance, has been appointed as the senior economic advisor to the prime minister of India, Manmohan Singh. In a recent speech to the Indian School of Business in Hyderabad, he said: “Even as the world becomes more competitive, India’s star dimmed in the last few months, as our governance is besmirched by corruption scandals and our macroeconomic health has deteriorated. Our politicians seem unable to come together to vote for growth-enabling reform, even while they are willing to join hands in every populist vote… The Government does too much of what it should not do, and too little of what it should do, even while being capricious and unaware of its limitations.”

The middle path

It is the appeal of profit that motivates a human being to be productive. Pandit Nehru accepted this point, while extolling the virtues of renunciation. Profit making has to be regulated. But the regulator has to be fair and not overbearing. Government has its limitations, especially when politicisation is rampant.

A dominant government and excessive politicisation kills the entrepreneurial spirit and the result is economic stagnation. This is as bad, if not worse than, under-regulation that allows capitalists to unfairly exploit economic opportunities in connivance with bureaucrats and politicians.  Overregulation kills initiative and the hunger to profit. The middle path is the way forward, for capitalist economies to recover, and the Government has to renounce domination of the economy and facilitate accountable, transparent and reasonable regulation. There is no other alternative.

(The writer is a lawyer, who has over 30 years experience as a CEO in both government and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)