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Thursday, April 4, 2019 Leer en Español

Saving Capitalism from the Capitalists

Objections to capitalism are primarily objections to crony capitalism, in which some manage to extract special treatment from government.

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Americans are in an era of increasing attacks on capitalism, although surveys never define it, which means they reflect what people think of something that may have little to do with capitalism (and similarly for socialism) or even be at odds with it.

For instance, Representative Alexandria Ocasio-Cortez recently said “Capitalism is an ideology of capital—the most important thing is the concentration of capital and to seek and maximize profit,” making it “irredeemable.” She buys into Marx’s goal in naming capitalism—implying that owners of capital gain at others’ expense. But capitalism is a system of private ownership of resources, including one’s labor, as well as capital, coordinated by voluntary arrangements.

That prevents invasions of life, liberty, and property without consent, preventing aggression by the strong against the weak. It prevents predation by protecting others’ rights. Unlike every variant of socialism, requiring workers’ consent prevents exploitation.

Capitalism vs. Crony Capitalism

But objections to capitalism are primarily objections to crony capitalism, in which some manage to extract special treatment from government, which necessarily infringes on others’ rights and privileges (e.g., freedom of association and freedom of contract), tilting markets toward government favorites. But that is not really capitalism, even though many of those seeking special treatment are those who have been successful capitalists but then seek to lock in their gains against others who might well outcompete them now or in the future.

Capitalism is blamed for a host of ills, both by those who do not understand it and those with an agenda for their own benefit.

Further, that crony capitalism sought by those capitalists who have already been successful but feel threatened by potential changes is nothing new. But that provides us the opportunity to learn from earlier upswings in anti-capitalist intensity in dealing with those issues now, because in this regard, “the more things change, the more they stay the same.”

A good illustration of analyzing the current situation, with increased criticism of capitalism, which is confused with crony capitalism and the one-time capitalists who seek to manipulate it, is a 2003 book, Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity, by Raghuram G. Rajan and Luigi Zingales. Given that I reviewed this book in The Freeman, June 2004, it might be worth another look to educate us for the present.

In an era of misguided attacks on capitalism, Saving Capitalism from the Capitalists has about the most promising beginning imaginable: “Capitalism, or more precisely, the free market system, is the most effective way to organize production and distribution that human beings have found.” The authors—Raghuram Rajan (newly named as the International Monetary Fund’s chief economist) and Luigi Zingales (of the University of Chicago’s Graduate School of Business)—also recognize that capitalism is blamed for a host of ills, both by those who do not understand it and those with an agenda of deflecting blame or capturing the political apparatus for their own benefit.

Capitalism often serves as a scapegoat for economic distress because, the authors observe, “the forms of capitalism that are experienced in most countries are far from the ideal. They are a corrupted version of it in which vested interests prevent competition from playing its natural healthy role. Many of the accusations against capitalism. . . relate to the corrupted, uncompetitive systems that exist rather than a true free enterprise system.”

Rajan and Zingales argue that once a government has been largely restrained from violating property rights and the institutions of capitalism have begun to develop, the greatest threat to the system comes from those who already have positions of economic power (“the incumbents”). With no interest in enabling competition that would erode their dominant market positions, they use their concentrated interests to control the rules in their favor. Those are the capitalists capitalism needs saving from.

Dominant domestic producers use their clout to create protectionist policies to control competition, particularly from those outside the country, who have little if any domestic political power. This is why the authors emphasize free international trade as a constraint on inefficient government restrictions to protect domestic incumbents. This problem is particularly troublesome in recessions, when the incumbents channel the anger of the distressed to achieve their protectionist ends through legislation and regulation, which can then persist for many years after the immediate crisis is over. (This persistence argument is so reminiscent of Robert Higgs’s Crisis and Leviathan that I cannot understand its absence from the book’s bibliography.)

The authors emphasize that it is even more important to keep incumbents, particularly in an underdeveloped financial system, from freezing out improved institutions and innovations; the denial of access to capital is the most general barrier to entry and competition.
Moreover, it is easier to undermine potential rivals’ access to capital by thwarting the development of the institutions necessary for arm’s-length markets than by promoting more visible and therefore harder-to-justify barriers to free trade.

Rajan and Zingales use many examples to illustrate the importance of the external competition they emphasize, particularly in finance. These range from the erosion of banking restrictions and the evolution of the market for corporate control in the United States to the role of the gold standard and the collapse of the Bretton Woods system in international trade and finance. They also include many illustrations from other countries and times, such as the undermining of the Japanese Bond Committee and the destruction of the Knights Templar as early bankers.

Unfortunately, however, when the authors turn from their useful contributions on the importance of free competition in product and financial markets to how they propose to protect capitalism from its vulnerability to political abuse, they seem to lose their bearings. They propose policies ranging from added government safety nets to heavier inheritance taxes and substituting property taxes for income taxes. Alas, they fail to see that such proposals themselves undermine the property rights that form the necessary basis for capitalism.

Further, their proposals are inconsistent with their analysis. For example, if incumbents, who control most of the existing property, dominate political competition in a country, how could it successfully convert from income to property taxes and impose steeper inheritance taxes, given that those changes would directly target those incumbents?

Saving Capitalism from the Capitalists is valuable for recognizing the importance of free trade, especially open competition in financial markets, not just for their direct benefits, but for the damper they put on governments’ ability to protect incumbents against the potential entrants and innovators who most threaten their interests. It is also valuable for its wide range of international, as well as domestic, illustrations. Unfortunately, the book overstates the government role necessary for financial markets to develop, and its proposals to save capitalism are highly suspect.

But those flaws don’t keep the book from standing head and shoulders above most recent “contributions” to the understanding and analysis of capitalism.

  • Gary M. Galles is a Professor of Economics at Pepperdine University and a member of the Foundation for Economic Education faculty network.

    In addition to his new book, Pathways to Policy Failures (2020), his books include Lines of Liberty (2016), Faulty Premises, Faulty Policies (2014), and Apostle of Peace (2013).