The Bear’s Lair: Becoming more Confucian

Eamonn Fingleton, in The American Conservative, recently wrote a piece “The Confucian Model” about East Asian economies, the analysis in which I thought made sense. However, I disagreed with his conclusion, that, now that this “Confucian” model has been invented, authoritarian societies have a built-in economic advantage over democracies. To me, the benefits of “Confucianism” can be attained without much difficulty in democracies, provided only we have governments that adopt the right policies. Of course, that is the tough part!

According to Fingleton, the Confucian Model is protectionist, allowing domestic producers to reap high prices at home with which they can subsidize exports. By suppressing consumption, it mandates high savings, which provide the capital for businesses to expand. Its businesses manage on a long-term basis; with the expansion capital they generate they can maximize productivity growth, the key to growth in wealth and living standards.

On the human resources side, the Confucian Model mandates companies to avoid layoffs in business downturns, thereby preserving skilled employment for the next business cycle. Labor costs are treated as a fixed expense in business accounting, making the variable costs of extra production correspondingly lower and allowing the “dumping” of extra product in overseas markets.

Finally, the Confucian Model allows producers to form cartels, which work together against foreign competition, for example agreeing between them which company should take on which research project, thus maximizing bang-for-the-buck in research and development.

Fingleton ends by claiming that East Asian autocracy (such as in China) is essential to producing a Confucian Model economy, so that the West is destined to lose the geopolitical battle. I disagree with both those statements. An autocracy such as China’s is extremely inefficient, because the government allows itself to meddle continually in business decisions (for example, China’s harassment of Jack Ma and Alibaba Corporation (NYSE:BABA)). Even a Russian non-democracy, corrupt and state-oriented though it is, may well in the long run be more efficient than the Chinese model, because much of the economy is run by the private sector, with relatively hands-off regulators and a blessed “flat tax” income tax rate of 13%.

However, China has done very well so far, while Japan’s success over the longer term has been even more spectacular (though Japan is in no way an autocracy). It is therefore worth considering whether a “Confucian Model” economy can be generated in the West, and if so, how. It should be noted that several though not all of the elements in the “Confucian Model” were present in the British policies that generated the Industrial Revolution. There is considerable evidence that both Xi Jinping and Vladimir Putin are more aware of the policies that brought capitalist success 200 years ago than are the Western leaders of today. The objective therefore is to find ways of emulating the best of those policies, without emulating the corruption, thuggery and totalitarianism of today’s China and Russia.

One element in the Confucian Model that is easy to emulate is the high savings rate. It is utterly absurd for Western societies that have pursued artificially low interest rates for two decades or more to express shock when those artificially low interest rates produce very low savings rates and grossly excessive leverage throughout the economy. The solution is simple: restore interest rates to their historically normal level of around 2% above the inflation rate, so in today’s market about 8-9% on the 10-year Treasury bond.

That will collapse the gigantic asset bubble, reducing countless billionaires to mere millionaires, a thoroughly beneficial outcome. Naturally, that collapse will cause economic pain, especially among the richest in society who are most able to use media and other means to make their squawks heard. Hence, we must devise a mechanism to ensure that interest rates remain safely positive in real terms for the future, and that no more left-wing journalist wives of Fed chairmen can subvert their husband’s duty to the U.S. economy. The best way to achieve this is a Gold Standard, though 1920s experience showed that, with the Fed mechanism available to make trouble, even that was not enough. Legislation is thus required even with a Gold Standard, some equivalent of Sir Robert Peel’s 1844 Bank Charter Act (which was too restrictive, having to be suspended three times in its first 20 years of operation). Alternatively, we could operate without a Gold Standard, but with some legislation designed to “Volckerize” the Fed – make it operate as it did under the late Paul Volcker in 1979-87. Abolition of the Fed’s “dual mandate” against inflation and unemployment is necessary, giving the Fed a single purpose of maintaining the value of money constant (i.e. no 2% “inflation targets” – the target is zero), but it is nowhere near sufficient.

Protectionism is another “Confucian Model” policy the U.S. could easily adopt – for one thing, it is entirely in line with U.S. Republican traditions, represented most happily by the McKinley Tariff of 1890. The benefits of free trade are very oversold by economists; for one thing they fail to account for the need to fund government, and to raise other taxes if a tariff is abandoned. Tariffs raise revenue from foreigners, whereas income taxes, sales taxes and property taxes raise revenue from domestic sources. Thus, even though a moderate tariff may reduce the volume of world trade and outsourcing, it obviates some of the need to tax domestic incomes directly, which also has an adverse impact on the economy, possibly a greater one.

The McKinley Tariff, indeed, served very much the same purpose as Chinese protectionism today; it enabled U.S. producers of steel in particular to build their scale on the back of high domestic prices, and therefore undercut their foreign competitors on the world market. Of course, the Smoot-Hawley Tariff of 1930 showed that this approach can be overdone, but then then the hollowing out of the British economy after 1860, very similar to the hollowing out of the U.S. economy after 1994, showed that free trade can also have huge costs if pursued excessively.

Higher interest rates will themselves change the behavior of business, focusing their efforts on long-term growth rather than short-term goosing of the stock price. This effect can be magnified by repealing the foolish 1993 law that made stock options tax-deductible while base salary over $1 million wasn’t; the ideal remuneration structure would have only modest stock options, but would instead focus top management’s attention on steady increases in their base salary, encouraging them to remain at the company and manage for its long-term growth. Emerson Electric (NYSE:EMR) which had only 3 CEOs between 1954 and 2020, is the model to follow; the tax structure should be modified so as to produce more Emersons (and lower top management compensation generally by reducing its variability and risk to recipients).

By getting close to eliminating stock options and making management more focused on the long-term, we will reduce the risk of layoffs, which tend to occur in over-leveraged companies that have pursued foolish acquisition strategies. The balance can be tilted further towards long-term hiring by making companies establish escrow accounts with say 2 years’ compensation for each employee with more than 3 years’ service (with an appropriate scale-up provision to prevent employers from playing games). Those escrow accounts will then be forfeited to long-term employees who are laid off; it is monstrously unjust that the costs of incompetent short-termist management are borne by employees whose life-patterns are damaged by the need to find another job. By this means, employee remuneration will become almost entirely a fixed cost, allowing it to be accounted for as such.

Finally, as the 19th century discovered, cartels are inevitable if not prevented by anti-trust regulations. Severely scale back anti-trust regulations, and companies in the same industry will be able to collude on sharing research costs, etc. (a weakening of patent protections would also be helpful here). Anti-trust activity limiting collusion should be limited to those few cases in which there is genuinely no substantial foreign competition, such as the Silicon Valley and entertainment behemoths. Higher interest rates and less over-remunerated top managements will reduce pointless takeover activity, in any case.

The above fairly simple changes would turn the United States into a Confucian Model economy, or a reasonable facsimile thereof. If we then keep the U.S. advantages of democratic pluralism and limited government, the country’s global economic hegemony should be restored within a decade or so, to the great benefit of all except the Chinese Politburo.

As an economic manager, Confucius was no match for Lord Liverpool!

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)