A Capitalism for the People

This anger has surfaced in many spontaneous movements: the demonstrations in front of executives' houses, the activism of the Tea Party, the Occupy movement. Though these movements are united in their opposition to the status quo, one searches in vain among their writings and platforms for a workable alternative. While the Tea Party has successfully channeled the anger against government, it has failed to do so for the resentment against bankers. While the Occupy movement proclaims that it fights for the 99 percent, it has been unable to figure out how to conduct that fight.

Most Americans today are likely to respond negatively to all these questions and for good reason: the evidence supports their pessimistic view. Yet despite this generalized dissatisfaction, the mainstream political debate ignores these questions. The reason is simple: neither of the two main political parties can provide a satisfactory response. The traditional Left and Right division has lost much of its meaning. Is it a Right or a Left policy to tax heavily the young to protect the privileges of the old? Is it a Right or a Left policy to eliminate the subsidies to industry and farming? Is it a Right or a Left policy to reduce the obstacles to competition created by the heavy lobbying of large incumbent firms?

This book was written not only to expose what it is not working in America, but also to provide a new direction on how to fix it. It was written to change the nature of the political conversation in America from an excessive focus on partisan policies aimed at addressing short-term problems to proper attention to the fundamental choices that determine the future of America. Since the time this book was written, the need for such a change in the political discourse has only grown. The unique brand of American capitalism—which in the last sixty years has created tens of million jobs, lifted out of poverty millions of immigrants, and inspired the world over—seems to be losing its luster, slowly degenerating into a form of crony capitalism that undermines both our prosperity and our democracy.

Americans who are lucky enough to have been born in this country may fail to appreciate how different American capitalism has been from the various flavors of it prevailing in most of the world. At its best, American capitalism has been a fiercely competitive system, where the state ensured that the playing field remained level. It is a meritocratic system where everyone is offered an opportunity to succeed. It is a fully democratic system that guarantees that this engine of growth works for everyone's benefit. In the great words of Abraham Lincoln: "Nowhere in the world is presented a government of so much liberty and equality. To the humblest and poorest amongst us are held out the highest privileges and positions. The present moment finds me at the White House, yet there is as good a chance for your children as there was for my father's."¹

I believe that only an immigrant like myself can fully appreciate how rare this brand of capitalism is. In much of the world the rule of the day is a dangerous marriage between an economic elite, made politically powerful by their wealth, and a political elite, made economically powerful by an overly intrusive government. This Faustian pact between powerful politicians and powerful businesspeople reshapes the playing field to the benefit of the incumbents, creating space for corruption and cronyism. It suffocates the creative spirit that generates growth. It denies to the have-nots a chance to succeed. It undermines the very values this great nation was built upon. If one wants to get a glimpse of where this policy leads, one has to look no further than my native country, where a spiral of low (even negative) growth and excessive debt are leading the country to a collapse.

The secret ingredient of this unique brand of "capitalism for the people" has been a balance between the redistributive tendencies of a democratic system and the plutocratic risks of an autocratic capitalism. By its very nature, a democratic system tends to redistribute wealth from the few to the many—even at the cost of violating property rights and thus possibly killing incentives to create wealth. By contrast, an autocratic capitalism tends to protect the interests of few incumbents at the expense of the hoi polloi, even at the cost of suffocating competition, which is the ultimate source of generalized prosperity. Unfortunately, once they begin, both these degenerations trigger a negative spiral from which it is difficult to emerge. Once a government has developed a reputation for expropriating its citizens there is little cost in living up to that reputation because the risk of it has been built into the expectations. So expropriation leads to more expropriation. Similarly, lack of competition leads to nepotism and cronyism because, in the absence of fierce competition, incumbent firms can afford to appoint their friends and still survive. Once an incompetent appointee finds himself in a powerful position, he tends to hire only subordinates of equal or lower quality, because talented people pose a threat to him. After a few years, a firm's human capital becomes so eroded that it is not able to compete without some form of protection. The more protection it gains from the government, the greater the possibility of cronyism, which in turn makes protection even more necessary.

For this reason, it is very important to stop this degeneration early on. As an immigrant from Italy, I have seen the tragic end to this devolution and am therefore sensitive to early signs. But the signs in the United States are becoming increasingly clear. More money is made on K Street than on Main Street. Young entrepreneurs develop a lobbying strategy before a business one. Even innovative Silicon Valley firms find the need to develop their lobbying department. Consequently, between the years 2000 and 2010 lobbying expenses more than doubled, rising from $1.56 billion to $3.55 billion.² In the meantime, the total cost of the presidential campaign, which was "only" $1.4 billion in 2000 rose to $2.6 billion in 2012, and the cost of all the congressional races leaped from $1.7 billion in 2000 to $3.7 billion in 2012.³

Lobbying does not involve political donations alone. As a report from the US House Committee on Oversight showed, infamous mortgage lender Countrywide offered cut-rate mortgages to elected officials as a lobbying tool. Congressional members, staffers, and even judges received fast loan processing and, most importantly, preferential terms. In exchange for what? Although the committee cannot prove any quid pro quo, these statistics suggest an obvious benefit: influence.⁴

Former Senator Chris Dodd, who was for many years the chairman of the Senate Banking Committee, received several discounted loans from Countrywide. Coincidentally, in June 2008 Dodd proposed a housing bailout program that would have helped lenders like Countrywide. Similar VIP treatment was given to Kent Conrad, chairman of the Senate Budget Committee.

From the industry's point of view, this was money well spent. The financial industry, the largest political fund contributor, survived untouched in the aftermath of the 2008 financial crisis. Although CEOs, corporate presidents, directors, and officers were prosecuted and convicted after the savings and loan crisis, they were not after the 2008 financial crisis. The Justice Department no longer keeps score of boardroom prosecutions because—as a commentator said— "it would be really embarrassing."⁵

Similarly, the pharmaceutical industry, the second largest political contributor, succeeded in obtaining what it wanted: preventing free trade in drugs. As recent revelations un covered, President Obama, the same Obama who as a candidate denounced the excessive role played by the pharmaceutical industry in the 2003 Medicare Modernization Act, bought off the consensus of big pharmaceutical companies to his Affordable Care Act by suppressing free trade in the drug market. Far from being ashamed of this, many of his fellow Democrats saw in this alliance with big business a key strategy to win elections.⁶ Unfortunately, the Republican Party has done even worse: defending indefensible farm subsidies to rich farmers while at the same time cutting food stamps for the poor in the name of budgetary considerations.

Not surprisingly, as capitalism becomes more cronyistic and corrupt, popular resentment against it rises; the economic pie does not grow fast enough and its division is perceived as increasingly unfair. Yet there is an additional element that contributes to the rising populism: the increasing tightness of the fiscal budget. Since World War II, Western democracies have maintained a high degree of consensus thanks to relatively high real GDP growth rates and little government budget constraint. When per capita GDP doubles every ten years, even a repressive regime like that in China can enjoy wide support. Western governments have maintained consensus as growth rates have slowed by borrowing against the future. These structural deficits, which shift the burden of repayment to future generations, are made possible by positive population growth and real GDP growth rates. Debt-financed deficits do not really burden future generations when future generations are richer and more numerous: they will hardly feel the burden. But when the population curve starts going negative and real GDP stalls, then the get-now-pay-later game ends. In fact, it sometimes starts to work in reverse when the current generation has to start repaying the debt past ones dumped on them.

Greece, Portugal, and Italy now find themselves in this situation, and most Western democracies (including Japan) will be there soon. In this context traditional Left-leaning policies lose their appeal: there is no money to spend. And if key social programs have to be preserved, the only solution is taxation, taxation, taxation. Facing this bleak prospect, voters are lured by dangerous forms of Left-leaning or Right-leaning populism. In the last Greek election 45 percent of voters supported radical extremist parties. In Italy a majority did, including the 25 percent of voters who were for a new anti-establishment party run by a professional stand-up comedian. These results are a clear sign of a crisis that is slowly affecting all Western European democracies and starting to show its ugly head in the States.

As these premises, which I make clear in the book, increasingly show themselves to be true, my main thesis becomes even more valid today than when the book was first published. Instead of rejecting these populist movements, we should understand them and so help to direct their destructive force toward the crony component of capitalism, not capitalism itself.

This book provides a road map for doing so. It does not lay out a platform for the next election, but rather a coherent set of policies for the next twenty years. I have to admit that in the current political environment most of my proposals have no chance of succeeding. The lack of immediate success, however, does not mean these policies are not useful. In fact, their small chance of success today almost proves their validity. In the current political environment proposals need a powerful interest group to advocate for them. The easiest way to obtain this support is to tilt a proposal so as to benefit one powerful group at the expense of everybody else. Proposals like mine, which try to distribute fairly both benefits and costs, stand the least chance of being adopted. Indeed, this political game is so well known that many economists already design their proposals with the aim of subtracting resources form the uninformed many to give to the informed few—thereby transforming themselves from impartial advisers to advocates of vested interests. Not I.

If my proposals are not easily implementable today, are they irrelevant? I do not think so. Rome wasn't built in a day, as the saying goes, and the radical transformation I propose cannot take place overnight either. Yet it is important to devise a plan to fix the perpetual problems we face. My plan, as originally laid out in A Capitalism for the People, may not be an easy path to recovery but it is a coherent one.

I am confident that in the long term good ideas prevail over entrenched interests, over the tyranny of the status quo, over less valid ideas. Only time will tell if the solutions I lay out in this book are able to solve all our problems. I certainly hope so. But I want my ideas to be evaluated on their merit, not on whether the current political environment deems them feasible. After all, if good ideas cannot be implemented in the current political environment, it is probably because the political environment needs to be changed, not the ideas.

I hope this book provides an inspiration on changing that environment.

This anger has surfaced in many spontaneous movements: the demonstrations in front of executives' houses, the activism of the Tea Party, the Occupy movement. Though these movements are united in their opposition to the status quo, one searches in vain among their writings and platforms for a workable alternative. While the Tea Party has successfully channeled the anger against government, it has failed to do so for the resentment against bankers. While the Occupy movement proclaims that it fights for the 99 percent, it has been unable to figure out how to conduct that fight.

What can I bring to this discussion? In theory, I am one of "them": a professor of finance at a leading university and fortunate enough to be in the top 1 percent of the income distribution. Yet I am angry, too, and scared. Angry because the idea of free markets has been increasingly taken over by entrenched business interests, fundamentally altering the equilibrium of American democracy. Scared that Americans, in their justifiable anger about the way things have gone, will choose a path that brings an end to American capitalism as we know it. For all its defects, that capitalist system offers the best hope for the most people. It is a model that defenders of freedom all over the world look to for guidance.

While my academic training gives me a special understanding of American capitalism (including what is wrong with it), it's another part of my experience that drove me to write this book. I am an immigrant to the United States. I came here in 1988 from Italy because I was trying to escape a system that was fundamentally unfair. Italy invented the term nepotism and perfected the concept of cronyism, and it still lives by both. You are promoted based on whom you know, not what you know. Americans were recently exposed to the corruption of the Italian system by Silvio Berlusconi, the tycoon-turned-politician who ran the country for nearly two decades. While Berlusconi represented an extreme, even by Italian standards, he was not an accident but the product of a degenerate system. I emigrated to the United States because I realized that it offered me an inestimably brighter future than my native country. And when I got to America in 1988, I wasn't disappointed; I experienced for the first time the inebriating feeling that any goal was within my reach. I had finally arrived in a country where the limits to my dreams were set only by my abilities, not by the people I knew.

Wherever you stand on the political spectrum, whether you're a conservative Republican or a liberal Democrat or somewhere in between, I would gently suggest that you have no idea what it's like to live in a country where there is virtually no meritocracy and competition is considered a sin. Even emergency-room doctors in Italy are promoted on the basis of political affiliation instead of ability. Young people, rather than being told to study, are urged to "carry the bag" (fare il portaborse) for powerful people, in the hope of getting back some favors. Mothers push their daughters into the arms of the rich and powerful, seeing it as the only avenue of social promotion. The talent selection process is so broken that you easily find very smart people employed in very menial jobs and very mediocre people in powerful positions. Until 1990, companies in Italy could openly and legally collude to defraud their customers; they still collude today, but they are less open about it. The best way to get rich is to be politically connected and receive a government contract.

The only protesters against this system came from the radical Left, which was less interested in changing the system than in replacing it with a socialist one. In a country full of privileges based on birth, the Left, instead of fighting for equality of starting points, fought to eliminate all selection mechanisms, viewing them as discriminatory against the have-nots. One consequence of this was that universities were not selective in admissions. Regardless of your grades, you could get into any college you wanted, forcing all colleges toward lower standards. The unintended consequence of this egalitarianism was that it produced an undifferentiated mass of mostly ignorant graduates. Companies seeking workers resorted to hiring on the basis of the only system that works in the absence of credible sorting: personal connections.

While in college in Italy, I developed an interest in economics and hoped to study it at the graduate level and to become an academic. For the average college graduate in the United States, such a goal might require practicing for the GREs and analyzing various rankings to figure out what the best graduate programs were. Not in Italy. Many people, including my father, told me that if I wanted to have a university career, I had to pay my dues to some local professor—to carry his bag—which meant essentially working for free not only on his academic projects but also on his consulting ones. I decided instead to apply to universities in the United States. But even that plan did not seem promising, because I was unable to secure a letter of recommendation from the most famous professor at my college. When I had asked him to supervise my undergraduate thesis, he had declined, saying that he lacked the time—despite my excellent grades, and despite the fact that he had found the time to supervise a classmate of mine, who had the support of an influential person. When I later approached this professor for a recommendation, his secretary told me that he wrote letters only for the people he had advised. Thus, I was out of luck. I studied extra hard for the admissions tests, however, and I made it into MIT. In spite of my less than positive experience, I considered returning to Italy upon receiving my PhD from MIT. At the very time the University of Chicago was hiring me, an Italian professor asked me to withdraw my application from national competition for Associate Professor in Italy. I knew it was a long shot, but if I made it in Chicago as an assistant could I at least try to compete for a position as an associate in Italy? The worst that could happen to me was that my application would be discarded, right? No. I was told that they would write a terrible report on me that would stay on my record forever. The real reason—I suspect—was that in spite of my young age I had a better record than the local candidate who had paid his dues (after all, my father was right). They did not want me in the race, so they resorted to not-so-veiled threats.

I realized Italy was not for me. After six years, I received tenure at the University of Chicago. In Italy, the process would have taken more than twice as long. I was able to build a career without needing to trade on family connections—or, worse, flattering people just because they had seniority. I owe more than my success to this country: I owe my life. I would not have survived the humiliations and frustrations of the Italian system.

And so, until the financial crisis of 2008, I was fairly disengaged from the American political debate. With all its defects, the US system looked so much better than the Italian one that I was not inclined to do much more than appreciate my good fortune. I felt that I could add more by being involved in the public square in my home country, where the problems are so much greater and the system hobbles the few competent people it hasn't driven away.