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The Birth of a New Economy in the Aftermath of Crisis
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In memory of my late parents, Jacob and Esther Kaletsky, who experienced true calamities and crises—the Russian Revolution, the two world wars, the Holocaust, the purges of Stalin—but whose joyful and indomitable spirits lived on.
THE WORLD DID NOT END. Despite all the forebodings of disaster in the 2007-09 financial crisis, the first decade of the twenty-first century passed rather uneventfully into the second. The riots, soup kitchens, and bankruptcies predicted by many of the world's most respected economists did not materialize—and no one any longer expects the global capitalist system to collapse, whatever that emotive word might mean.
Yet the capitalist system's survival does not mean that the precrisis faith in the wisdom of financial markets and the efficiency of free enterprise will ever again be what it was before the bankruptcy of Lehman Brothers on September 15, 2008. A return to decent economic growth and normal financial conditions is likely by the middle of 2010, but will this imply a return to business as usual for politicians, economists, and financiers? Although globalization will continue and many parts of the world will gradually regain their prosperity of the precrisis period, the traumatic effects of 2007-09 will not be quickly forgotten. And the economic costs will linger for decades in the debts squeezing taxpayers and government budgets, the disrupted lives of the jobless, and the vanished dreams of homeowners and investors around the world.
For what collapsed on September 15, 2008, was not just a bank or a financial system. What fell apart that day was an entire political philosophy and economic system, a way of thinking about and living in the world. The question now is what will replace the global capitalism that crumbled in the autumn of 2008.
The central argument of this book is that global capitalism will be replaced by nothing other than global capitalism. The traumatic events of 2007-09 will neither destroy nor diminish the fundamental human urges that have always powered the capitalist system—ambition, initiative, individualism, the competitive spirit. These natural human qualities will instead be redirected and reenergized to create a new version of capitalism that will ultimately be even more successful and productive than the system it replaced.
To explain this process of renewal, and identify some of the most important features of the reinvigorated capitalist system, is the ambition of this book. This transformation will take many years to complete, but some of its consequences can already be discerned. With the benefit of even a year's hindsight, it is clear that these consequences will be different from the nihilistic predictions from both ends of the political spectrum at the height of the crisis. On the Left, anticapitalist ideologues seemed honestly to believe that a few weeks of financial chaos could bring about the disintegration of a politico-economic system that had survived two hundred years of revolutions, depressions, and world wars. On the Right, free-market zealots insisted that private enterprise would be destroyed by government interventions that were clearly necessary to save the system—and many continue to believe that the crisis could have been resolved much better if governments had simply allowed financial institutions to collapse. A balanced reassessment of the crisis must challenge both left-wing hysteria and right-wing hubris.
Rather than blaming the meltdown of the global financial system on greedy bankers, incompetent regulators, gullible homeowners, or foolish Chinese bureaucrats, this book puts what happened into historical and ideological perspective. It reinterprets the crisis in the context of the economic reforms and geopolitical upheavals that have repeatedly transformed the nature of capitalism since the late eighteenth century, most recently in the Thatcher-Reagan revolution of 1979-89. The central argument is that capitalism has never been a static system that follows a fixed set of rules, characterized by a permanent division of responsibilities between private enterprise and governments. Contrary to the teachings of modern economic theory, no immutable laws govern the behavior of a capitalist economy. Instead, capitalism is an adaptive social system that mutates and evolves in response to a changing environment. When capitalism is seriously threatened by a systemic crisis, a new version emerges that is better suited to the changing environment and replaces the previously dominant form.
Once we recognize that capitalism is not a static set of institutions, but an evolutionary system that reinvents and reinvigorates itself through crises, we can see the events of 2007-09 in another light: as the catalyst for the fourth systemic transformation of capitalism, comparable to the transformations triggered by the crises of the 1970s, the crises of the 1930s, and the Napoleonic Wars of 1803-15. Hence the title of this book.
The first of these great transitions—the period of social and economic upheaval that started with the political revolutions in America and France and the industrial revolution in England—created the first era of modern capitalism, running roughly from the British victory over Napoleon in 1815 until the First World War. This long period of relative systemic stability and rising prosperity ended with the First World War, the Russian Revolution, and finally the Great Depression in the United States. These unprecedented political and economic traumas destroyed the classical laissez-faire capitalism of the nineteenth century and created a different version of the capitalist system, embracing Franklin Roosevelt's New Deal, Lyndon Johnson's Great Society, and the British and European welfare states. Then, forty years after the Great Depression, another enormous economic crisis—the global inflation of the late 1960s and 1970s—inspired the free-market revolution of Margaret Thatcher and Ronald Reagan, creating a third version of capitalism, clearly distinct from the previous two. Forty years after the great inflation of the late 1960s, the global economy was hit by another systemic crisis, in 2007-09. The argument of this book is that this crisis is creating a fourth version of the capitalist system, a new economy as different from the designs of Reagan and Thatcher as those were from the New Deal. Hence the birth of a new economy in the subtitle of this book.
The concept of capitalism as an evolutionary system, whose economic rules and political institutions are subject to profound change, may seem controversial and even subversive from the standpoint of precrisis thinking. The Thatcher-Reagan revolution of the early 1980s was widely proclaimed as a rediscovery of true capitalism after the cryptosocialist heresies and deviations of the Keynesian period—and this worldview is still held by most conservative politicians and business leaders. In the great scheme of things, however, the dominance of free-market fundamentalism from 1980 until 2009 was just one thirty-year phase in the long history of modern capitalism's development since the late eighteenth century. Viewing recent events in this historical perspective reveals the crisis and its consequences in a new light.
Many politicians and business leaders consider, for example, that any government interference with market forces is inimical to the free-market system. They oppose all such interventions on principle as the thin end of a socialist wedge. Given the long and triumphant history of capitalism before anyone had heard of Reagan and Thatcher, this is an absurdly narrow-minded view. The changing relationship between government and private enterprise, between political and economic forces, has been the clearest feature of capitalism's evolution from one phase to the next—first in the early nineteenth century, then in the 1930s, then in the 1970s, and again today. And after each of these evolutions, the capitalist system has emerged stronger than it was before. To understand the new politico-economic model emerging from the crisis, it helps to consider the changing relationships of governments and markets in these three previous phases.
In the classical laissez-faire capitalism that dominated the world from the early nineteenth century until 1930, politics and economics were essentially distinct spheres. The interactions of government and markets were confined to collecting taxes, mainly to pay for wars, and erecting tariff barriers, mostly to protect powerful political interests. Then, from 1932 onward, came the New Deal and the social democratic European welfare states. In reaction to the Russian Revolution and the Great Depression, this second version of capitalism was defined by an almost romantic faith in benign, all-knowing governments and an instinctive distrust of markets, especially financial markets. The third version of capitalism, created by the Thatcher-Reagan political revolution of 1979-80, took the opposite view. This version romanticized markets and distrusted government. The last variant of this species—the financially dominated market fundamentalism described in this book as Capitalism 3.3—took this position to its extreme. Capitalism 3.3 did not just distrust governments; it demonized government, ridiculed regulation, and treated public administration with open contempt. This extreme antigovernment ideology, not only in politics but also, and just as importantly, in theoretical economics, triggered the 2007- 09 crisis. As Karl Marx might have predicted, Capitalism 3 was destroyed by the contradictions of its own antigovernment ideology.
The self-destruction of Capitalism 3.3 has left the field open for the next phase of politico-economic evolution: the emergence of Capitalism 4. As in the 1930s and 1970s, this transformation will redefine the relationship between politics and economics, between governments and markets. The dominant ideology from the 1980s until the 2007-09 crisis assumed that markets were always right and governments nearly always wrong. The previous phase of capitalism, from the 1930s until the 1970s, assumed that governments were always right and markets nearly always wrong. The most distinctive feature of capitalism's next era will be a recognition that governments and markets can both be wrong and that sometimes their errors can be near-fatal.
This recognition of fallibility may, at first sight, seem paralyzing. In fact, it should be empowering. It creates scope for leadership, creativity, and experimentation in both politics and business—concepts that the preceding version of capitalism was reluctant to accept. Acknowledging that both governments and markets make mistakes implies a collaboration between politics and economics, rather than the adversarial relationship of Capitalism 3. The extraordinary opportunities created by technology, globalization, and social change in the dawning era of Capitalist 4 suggest that, if the rising generation of American and European politicians and business leaders play their cards well, the new economic model will be more prosperous than the last one. Perhaps it will one day be described as Obamanomics. If not, however, and America and Europe cannot show the ideological flexibility required to make Capitalism 4 succeed, the political economy of the coming decades will probably be shaped by China and other authoritarian neocapitalist nations, instead of by Western democracies.
If the West is to rise to this challenge, the 2007-09 crisis, along with its antecedents and its aftermath, need to be seen as a phase in the dynamic process of capitalist evolution. This is the picture presented in Part I.
Part II then discusses the crisis and the boom that came before it from this historical and evolutionary perspective. This book rejects the conventional wisdom that the global boom in housing and credit before the crisis was simply a debt-fuelled illusion. Instead, Part II argues that much of the increase in consumer borrowing and asset values from the early 1990s onward was a rational response to benign economic trends that began in the late 1980s. All these trends were driven ultimately by four tremendous technological and geopolitical transformations that converged in 1989: the breakdown of communism, the reemergence of Asia, the revolution in electronic technology, and the worldwide acceptance of pure paper money that was not backed by gold, silver, foreign exchange reserves, or any other objective symbol of value.
The benign trends of the precrisis period inspired excessive speculation and produced a damaging boom-bust cycle, but this in no way contradicts the argument that most of the growth in credit and asset prices before the crisis was fundamentally justified and will prove sustainable in the long-term. Boom-bust cycles have always been and will continue to be a feature of the capitalist system. The events that led up to the crisis were quite typical of previous boom-bust cycles and less extreme than many in the past. Why then did this particular boom-bust cycle climax in such a severe disaster?
This is the question addressed in Part III. The explanation centers on an exaggerated and naïve interpretation of economic theory that took to absurd extremes the free-market economic policies applied more pragmatically in the Thatcher-Reagan and Clinton periods. This market fundamentalist approach to economic policy turned a fairly standard, if severe, boom-bust cycle into the greatest financial crisis of all time. More specifically, market fundamentalism was behind the unforced errors of the Bush administration, especially of its treasury secretary, Henry Paulson, that were the proximate cause of financial catastrophe. How could the most powerful and best-resourced government in the world have made so many ruinous mistakes? Much of what went wrong could be attributed to a pernicious interaction between academic economics and political ideology, which magnified each other's faults and biases, like a pair of distorting mirrors. As a result, the classical economics of Adam Smith and David Ricardo were turned into the ludicrously exaggerated doctrines of efficient markets, rational expectations, and monetarist central banking that monopolized economic thinking in governments, regulatory institutions, and financial businesses worldwide. Part III concludes with the argument that new forms of economics, moving beyond the mathematical pedantry and ideological assumptions of rational expectations and efficient markets, need to be urgently invented if a reformed model of capitalism is to succeed.
On the foundations established by reinterpreting the past and present, Parts IV and V examine how Capitalism 4 is likely to evolve in the decade ahead. What will be the main features of the new system?
If one common theme linked many of the troubles that converged on the world economy in the autumn of 2008, it was the quasi-religious doctrine of perfect markets and the related belief that effective government and free markets are Manichaean opposites, unable to coexist in the same world. After the worldwide bank bailouts and the U.S. government's takeover of General Motors, the dogma that government intervention is always inimical to private enterprise can no longer be sustained. Freer markets and smaller government can no longer be presented as a credible answer to every challenge facing the capitalist system.
The symbolic confirmation that, for serious policymakers, the love affair with market fundamentalism was over came in August 2009, in the famous Congressional testimony of Alan Greenspan, a proud disciple of the quintessential free-market ideologue, Ayn Rand. Asked whether his free-market beliefs had proved dangerously flawed, Greenspan replied: "Yes, I have found a flaw. I don't know how significant or permanent it is, but I've been very distressed by that fact . . . Yes, I found a flaw. That is precisely the reason I was shocked, because I'd been going for forty years or more with very considerable evidence that it was working exceptionally well . . . Those of us who have looked to the self-interest [of private companies to promote the capitalist system]—myself especially—are in a state of shocked disbelief."1
Appropriately enough, the nature of this flaw was identified by Ayn Rand herself in an essay on her objectivist philosophy that had inspired Greenspan and other American conservatives for two generations: "The ideal political-economic system is laissez-faire capitalism . . . In a system of full capitalism, there should be (but, historically, has not yet been) a complete separation of state and economics, in the same way and for the same reasons as the separation of state and church."2
Most serious political philosophers, sociologists, and economic historians have long realized that the opposite is true. Any society driven purely by market incentives will fail catastrophically, in economic as well as political terms. The freest, most incentive-driven market economies in the world are not the United States or Hong Kong or even tax havens such as the Cayman Islands but failed states and gangster societies such as Somalia, Congo, and Afghanistan.3 The overriding importance of political institutions in creating the conditions for successful capitalism has been established in great works of social scholarship going back to Adam Smith's Theory of Moral Sentiments and Max Weber's Protestant Ethic and the Spirit of Capitalism.4 But after the Thatcher-Reagan revolutions of the 1980s, business leaders, academic economists, and conservative politicians decided to ignore the historical realities described by sociologists and political scientists in favor of the oversimplified assumptions of market fundamentalist ideologues such as Ayn Rand. The result was the quasi-religious dualism between politics and economics that finally became unsustainable during the Lehman crisis.
Politicians forced to support private banks with public money could no longer deny that government safety nets are a natural and necessary feature of social reality, whether in financial markets, or fire fighting, or the provision of defibrillators in public places.5 Banks driven to the brink of failure could no longer pretend that their reckless disregard for risk and "eat what you kill" bonus culture was purely a private matter between their shareholders, directors, and employees. Investors ruined by relying on theories of efficient and rational financial markets could no longer pretend that market-based financial regulations and accounting rules were always more reliable than political and regulatory judgments.6 The upshot was that the market fundamentalist opposition between government and private enterprise could no longer be seriously maintained.
The new kind of capitalism now emerging will essentially reverse Ayn Rand's objectivist ideal. Instead of separating the State and private economy, Capitalism 4.0 will bring them into a closer relationship. If markets and governments are both imperfect mechanisms for achieving social objectives, systems of checks and balances reflecting both private incentives and political decisions will often give better results than market or public mechanisms on their own.
Capitalism 4.0 will recognize that governments and markets make mistakes not only because politicians are corrupt, bankers greedy, businessmen incompetent, and voters stupid, but also because the world is too complex and unpredictable for any decision-making mechanism to be consistently right, whether it is based on economic or political incentives. Experimentation and pragmatism must therefore become the watchwords in public policy, economics, and business strategy, even if this means a loss of consistency and coherence.
The ability to operate by trial and error, to correct mistakes before they do too much social harm, is the greatest virtue of the market system. A similar pragmatism will have to be extended in the years ahead to political decisions and to the interaction of government with business. Political and business leaders already seem to be embarking on this learning process. Jeffrey Immelt, the chairman of General Electric, for example, reacted to the crisis by calling on his managers to "become systems thinkers who are comfortable with ambiguity."7 Meanwhile, President Obama has advocated "a new, more pragmatic approach that is less interested in whether we have big government or small government [than] in whether we have a smart, effective government."8 But while political and business leaders are recognizing the shift from a world of rationalist predictability to one characterized by ambiguity, unpredictability, and fuzzy logic, economists will be more stubborn in defending the precrisis ideas of rational and efficient markets. The gap between economic theory and business practice is therefore likely to widen before it begins to contract.
Mainstream economics before the crisis assumed that competitive markets move automatically toward equilibrium, that financial cycles have little or no effect on long-term economic performance, and that a properly functioning private-enterprise economy will always remain near full employment, leaving only one important role for government macroeconomic policy, which is to keep inflation under control. The crisis has refuted all these market fundamentalist assumptions. The world will now have to recognize that financial cycles, occasional banking crises, and self-reinforcing economic slumps are natural and recurring features of any market system. And that, in turn, implies that governments and central banks will have to take greater responsibility for managing growth and employment, as well as maintaining financial stability and keeping inflation under control.
These enormous new responsibilities might suggest that government will grow ever larger, at the expense of taxpayers and private businesses, but the opposite is likely to happen in Capitalism 4.0. The size of government will have to shrink, even as its responsibilities and influence expand. Part of the reason is simply the size of deficits created by the crisis and the political resistance to taxes, which appear to be approaching the limits of public acceptability in many countries. A deeper cause of the shrinkage of the public sector in Capitalism 4.0 will be the inability of bureaucratically inflexible big government to meet society's ever-changing demands. These complex demands, ranging from universal health care and energy independence to stable mortgage financing and rising wages, can be satisfied only by the profit motive acting through competitive capitalist markets. What will change, however, is the role played by government in managing these markets and creating incentives for profit-seeking businesses to achieve politically favored objectives.
Clearly financial regulations will be tightened, but Capitalism 4.0 will mean a host of other reforms and shifts in the boundaries between the market and the state. Black-and-white dividing lines between the responsibilities of government and business will be turned into shades of grey. Making the picture even more complex, governments and markets will move in different directions in different countries. In America, for example, more government regulation will be required to bring exploding health costs under control. In Britain, by contrast, health care will have to become more market-oriented, with more private financing and market competition. Mortgage financing will need more regulation in Britain but less government intervention and subsidy in the United States. Education is likely to become more market-driven in every advanced country (with the possible and ironic exception of supposedly socialist Sweden and Denmark, where private schooling is widespread), whereas in developing countries such as China, India, Brazil and South Africa, free state education still has a long way to expand.
Some of these paradoxes, for example, the convergence of health care toward a mixed public-private model, may suggest a bland Third Way approach that simply splits the difference between America's market system and Swedish social democracy. But this is not the case. The idea that some countries or sectors may need more market and less government in a particular historic context while others need less market and more government is no more paradoxical than the idea that a kitchen needs both a refrigerator and a stove.
Creating appropriate criteria for the government's relations with the market—for example, in subsidizing alternative energy without unacceptable inefficiencies, regulating trade without resorting to outright protectionism trade, or regulating health care and education without denying free choice—will create big problems for public policy in Capitalism 4.0. And although there will be no simple answers, the problems of rebalancing public and private interests will have to be confronted if Western democracy is to overcome the challenge from a different model of capitalism rising in the East.
China's tremendous economic growth and the gain in international prestige for its state-controlled economic model after the 2007-09 crisis have cast doubt on the theory that capitalism and democracy will always be mutually supportive. The optimistic slogan of the Thatcher-Reagan period that "free markets create free people" can no longer be taken for granted. The hopes of a durable convergence between the Chinese and Western models of capitalism also appear increasingly illusory. Whether we look at business practices, economic policies, political rights, or geopolitical interests, China and the West appeared to be drifting apart after the crisis. Serious conflicts might not occur for years or decades, but the two models of politico-economic development are proving incompatible in many ways. In business practices, Chinese regulations and industrial strategies increasingly favor domestic industries over Western investors and exporters. In economic policy, China's determination to run huge trade surpluses and maintain an undervalued exchange rate while it offers cheap products to American and European consumers implies ever-rising international debts and the continued loss of semiskilled manufacturing jobs. China's economic self-assurance is making it more stubborn in its rejection of Western-style democracy and human rights. Finally, and perhaps most seriously, China's growing confidence in its model of authoritarian, government-led economic development is creating inevitable frictions with Western geopolitical interests and offering emerging nations a genuine alternative to democratic market-led development.
The West thus has a choice. We can accept the Orientalist view that China has been a more cohesive, durable, and successful society than Western Europe or America for most of the five-thousand-year span of recorded history. From this perspective, twenty-first-century China is merely reclaiming a natural position of global leadership for its cultural values and national interests. Or we can follow the alternative course assumed in this book: We can demonstrate by our actions that Western democratic capitalism is more adaptive and durable than the Chinese authoritarian version. To do this, however, the West will have to acknowledge the challenge to its entire worldview presented by a self-confidently authoritarian China and recognize that, after the 2007-09 crisis, a reinvention of the Western socio-political model is required.
- On Sale
- Jun 28, 2011
- Page Count
- 448 pages