Can we save American capitalism?
A dozen Labor Days — and three presidential elections — ago, the world was in the thrall of American-style capitalism. Not only had it vanquished communism, but it was widening its lead over Japan Inc. and European-style socialism.
Today, that economic hegemony seems a distant memory. We have watched the bursting of two giant financial bubbles, wiping out the paper wealth many of us thought we had in our homes and retirement accounts. We have suffered through two long recessions and a lost decade of income growth for the average family. We continue to rack up large trade and budget deficits. Virtually all of the country’s economic growth and productivity gains have been captured by the top 10 percent of households, while moving up the economic ladder has become more difficult. And other countries are beginning to turn to China, Germany, Sweden and even Israel for lessons in how to organize their capitalist economies.
It’s no wonder, then, that large numbers of Americans have begun to question the superiority of our brand of free-market capitalism. This disillusionment is reflected not only in public opinion polls but on the shelves of American bookstores, where the subject has attracted many of the best economists in the country. Retooling American capitalism has become something of an national — and even international — obsession.
“Capitalism has always changed in order to survive and thrive. It needs to change again,” writes Martin Wolf, the uncompromisingly pro-market columnist for the Financial Times, in an essay in “The Occupy Handbook.”
It would be giving the current presidential campaign too much credit to say that it has become the forum in which Americans will decide what kind of capitalism they want, unless you count the “na-na na-na na-na” mudslinging over Mitt Romney’s outsourcing and President Obama’s welfare regulations. The closest it has come has been the discussion over the president’s inartful comment about business owners who did or didn’t “build” their success.
Although the Republican spin machine reflexively took entrepreneurial umbrage at Obama’s notion that it takes a village to create a successful company, each of the books reviewed here essentially embraces the idea. A pure market economy is an ideological fantasy; even the freest markets operate in a framework of laws, infrastructure, institutions and informal norms of behavior in which government is heavily implicated. Our challenge is in getting that framework right.
Of course, there are some who want to leave American capitalism well enough alone. They include Allan Meltzer, a conservative professor of political economy at Carnegie Mellon University, who adopts the Churchillian view that while capitalism has its deficiencies, it’s better than the alternatives. He spends much of his short book, “Why Capitalism?,” knocking down the old straw men of socialism and communism, as if anyone in America is seriously proposing them these days.
You know Meltzer is spending too much time rereading Kant and Locke when he declares that capitalism’s secret is how well it disperses political and economic power, oblivious to the new role of money in U.S. politics or the harsh realities of global competition — a view that may come more naturally to someone on a campus endowed by the Carnegies and the Mellons. It is precisely this failure to disperse wealth and power that animates our disillusionment.
Under the heading of ignoring reality, however, it would be hard to beat Edward Conard, who makes the intriguing argument that there never was a credit bubble or a housing bubble, that large and persistent trade deficits are a sign of economic strength, that booms and busts are a good thing, and that what we really need is more income inequality, not less.
It is unlikely that anyone would be giving Conard’s fantasies a moment’s thought but for the fact that he was a Romney collaborator at Bain Capital in the 1990s and that he set up a front company last year to give $1 millionto a super PAC supporting Romney. In “Unintended Consequences,” Conard contends that the past decade and a half was a golden era for American capitalism. Corporations, money managers and wealthy investors poured massive amounts of capital, much of it unrecognized by accounting rules, into new ideas and technologies. This triggered a productivity boom so strong, it allowed the U.S. economy to employ not only all willing Americans, but tens of millions of Mexican immigrants and Asian factory workers.
And while it may appear to the envious that a few people got very rich in this process, Conard’s tortured calculations lead him to conclude that 95 percent of all the economic benefit from this boom spilled over to workers and consumers in the form of higher wages, greater wealth, and cheaper goods and services.
The only way to recapture that golden era of high growth, low unemployment and booming stock markets, Conard suggests, is to eliminate all taxes on the very rich so they can make even more investments in new ideas and innovative new companies. At the same time, we should just give up manufacturing, move all the talented people into high-tech and financial fields, and leave everyone else to tend the children and gardens of the talented.
This masterpiece of faulty logic, selective data and moral vacuity is premised on misguided assumptions: that product and financial markets are perfectly competitive, that compensation is an accurate reflection of a person’s productivity and that investment is immune to the law of diminishing returns. It also reflects the intellectual arrogance of the corporate-strategy consultant and private-equity manager that Conard once was.
I suspect it would never occur to Conard to question whether more is always better when it comes to economic growth, but that is very much the issue at the heart of Robert and Edward Skidelsky’s “How Much Is Enough?”
The Skidelskys come naturally to the topic — son Edward is a philosopher at the University of Exeter, and father Robert is an economist at the University of Warwick and the best-known biographer of John Maynard Keynes. It was Keynes who predicted that by 2030, the productivity of workers in advanced economies would be so enhanced that people would be able to live better and work half as many hours. (Keynes’s projections about productivity and income have proved spot on; those about work hours, not so much.)
The Skidelskys set out several reasons for what they view as our bad trade-off between income and leisure. For starters, many of us take pleasure and meaning from our work, and because of growing inequality, there are still many among us who do not have access to all the basics.
For those near the top, happiness and satisfaction tend to be tied up with the acquisition of status goods: vacation homes on the shore, meals at the better restaurants, education for their children at elite schools. Because these goods are in limited supply, their relative price has risen faster than incomes, requiring people to work longer hours to afford them.
Meanwhile, the extra leisure we crave invariably involves expensive travel or fancy club memberships, whose costs also require us to work more.
The Skidelskys think we’d all be happier — and have a better society — if we reduce inequality (through progressive taxation and a stronger safety net), temper the arms race for status goods (through a consumption tax) and expose people to pleasures that don’t require large expenditures (through more of the traditional liberal arts education).
To an American ear, theirs sounds like a rather old-world, upper-class notion of “the good life.” And their version of “non-coercive paternalism” would quickly run afoul of our individualism and our distrust of anyone — let alone British dons or American politicians — telling us how best to spend our time and money.
A more practical reform idea comes from Roger Martin, dean of the Rotman School of Management at the University of Toronto. Once a partner at the Boston Consulting Group, Martin saw corporate America from the inside and has a pretty good fix on why it has lost its way: its single-minded focus on maximizing shareholder value.
In “Fixing the Game,” Martin argues that there are two markets in which big companies operate. There is the real market, where the company wins or loses by selling products and services. And there is the “expectations market” — the stock market — where people wager on the company’s prospects. In this market, what matters is not the company’s actual profits but whether those profits meet expectations.
As Martin sees it, the problem comes when the people who run big businesses are rewarded for winning not in the real market but in the expectations market. And what that means in practice is constantly raising expectations about future profits. Eventually, these expectations grow so inflated that they are impossible to realize without manipulating the books (think Enron) or taking undue risk (think Lehman Brothers or AIG). In either case, it requires diverting time and attention from the real market, where actual long-term value and wealth are created.
As Martin notes, it was only in the mid-1970s that winning in the expectations market — a.k.a. “maximizing shareholder value” — began to be considered the sole purpose of a corporation. That prompted companies to start offering extravagant grants of stock and stock options to top executives. Unfortunately for investors, Martin writes, the returns of the 500 largest U.S. corporations have been lower, not higher, since shareholder value became the holy grail. As for that executive pay, he calculates that it has grown eight times faster than the reported profits of the companies those executives run.
“The expectations game is beginning to destroy the real game,” Martin concludes. The way to stop it, he says, is for American business to adopt a broader, healthier definition of its purpose, and reflect that in the way executives and money managers are compensated and the way corporations are governed.
Martin’s skepticism about Wall Street is not shared by Robert Shiller, the Yale finance professor who sounded an early and prescient warning about the recent real estate bubble. Shiller is a brilliant and original thinker, but “Finance and the Good Society” is a disjointed and unconvincing argument that financial innovation can be used to tame the excesses of capitalism rather than aggravate them.
Shiller proposes to “democratize” finance with new products such as insurance that would protect homeowners against dramatic declines in their home’s value. He imagines a “dynamic” tax code in which rates shift to offset changes in the way private markets are distributing income.
The problem with such suggestions is that they ignore the key lesson from the recent financial crises: The more complex finance becomes, the greater the information and knowledge gap between the Wall Street sharks and everyone else. The growth of such information asymmetries over the past 25 years makes Shiller’s proposals look naive.
As a professor at the free-market-oriented University of Chicago, Luigi Zingales is hardly the person you’d expect to be calling for a renewed populism. But as a native Italian, Zingales has a particular sensitivity to public and private corruption. His thesis is that most of our problems stem from special interests using government policies and regulation to create a kind of crony capitalism.
“Lack of competition and the distortions created by government subsidies are the primary causes of all the problems we face in the economy today, including the declining real incomes of middle-class America,” Zingales writes in the introduction to“A Capitalism for the People.”
In this accessible and powerfully argued book, Zingales calls for a capitalism that is not pro-business but pro-market, that celebrates meritocracy but not inherited privilege, that emphasizes the accountability of economic actors as much as their freedom and discretion. The essential element of capitalism, he argues, is full and open competition, and it is only when competition is absent that you get the kind of inequality, instability and class rigidity that Americans have recently experienced.
Zingales’s diagnosis and his prescriptions — education reform, bankruptcy reform, income-based student loan repayments, tougher consumer protection and antitrust enforcement, limits on corporate lobbying and campaign contributions, stronger investor control of corporate governance and executive compensation, wider whistleblower protections and class-action remedies — are strikingly similar to those offered by Joseph Stiglitz, the Nobel Prize-winning Columbia University economist who comes from the other end of the ideological spectrum.
Although better known in academic circles for his work on market imperfections, Stiglitz’s doctoral dissertation was on how too much income inequality reduces economic growth. He updates that theme in “The Price of Inequality,” showing how inequality undermines productivity, leads to wasteful competition for status goods and allows the rich to convert their wealth into political power, which they use to further tilt the playing field in their favor.
The threat of plutocracy — a democracy taken over by the wealthy and run for their benefit — is a theme running through not only Zingales’s and Stiglitz’s analyses but a number of the other books as well. They raise the specter of the country being sucked into a dangerous spiral in which inequality, class rigidity and economic instability breed more of the same.
“The basic premise of the ‘mixed economy’ is that market dynamism can be combined with democratic equality,” Columbia University economist Jeffrey Sachs writes in “The Occupy Handbook,” a collection of essays prompted by the Occupy Wall Street protests and written by authors from across the ideological spectrum. “The overriding political and financial power of corporate capitalism has nearly obliterated the functioning of the mixed economy, with the state in retreat or mainly serving corporate interests.”
“In the absence of a properly functioning set of protections, the bazaar (the sphere of the market) consumes the forum (the sphere of politics),” adds the Financial Times’ Wolf in the same volume. “The outcome is rule by affluent vested interests or, quite simply, plutocracy.”
Were he alive today, no less a free-marketeer than Adam Smith would readily acknowledge that a capitalist system forfeits not only its economic rationale but its moral justification if all its benefits are captured by a tiny slice at the top of society.
What’s been lost from American capitalism is any sense of a larger purpose, of how it fits into and serves society, broadly speaking — or as the Skidelskys would put it, how it contributes to a “good life” that is both individual and collective.
In the current, cramped model of American capitalism, with its focus on output growth and shareholder value, there are requirements for financial capital, human capital and physical capital, but no consideration of what Stiglitz calls “social capital,” Zingales calls “civic capital” and Martin calls the “civil foundation.” It is this trust in one another that gives us the comfort to conduct business, to lend and borrow, to make long-term investments and to accept the inevitable dislocations of the economy’s creative destruction.
Whatever you call it, societies do not thrive, and economies do not prosper, without it.
This erosion is most visible in the weakening of the restraints that once moderated the most selfish impulses of economic actors and provided an ethical basis for modern capitalism. A capitalism in which Wall Street bankers and traders think it is just “part of the game” to peddle dangerous loans or worthless securities to unsuspecting customers, a capitalism in which top executives have convinced themselves that it is economically necessary that they earn 350 times what their front-line workers do, a capitalism that puts the right to pass on unlimited amounts of money to undeserving heirs above the right to basic, life-saving health care — that is a capitalism whose trust deficit is every bit as corrosive and dangerous as its budget and trade deficits.
As Zingales notes, American capitalism has become a victim of its own success. In the years after the demise of communism, “the intellectual hegemony of capitalism led to complacency and extremism: complacency through the degeneration of the system, extremism in the application of its ideological premises,” he writes. “Money — regardless of the way it was obtained — ensured not only financial success but social prestige as well. ‘Greed is good’ became the norm rather than the frowned-upon exception. Capitalism lost its moral higher ground.”
So where is a blueprint for a new American capitalism likely to come from? Probably not from economists or journalists, or even from politicians in Washington or on the campaign trail. As Meltzer would say, the genius of democratic capitalism, and democracy, is that the new norms of economic behavior are likely to emerge from executives and entrepreneurs, workers and consumers, money managers and bankers who find the courage to demand something better of themselves and others.
Steven Pearlstein is a business and economics columnist at The Washington Post and the Robinson professor of public and international affairs at George Mason University.