The Cold War was an era of military, political and economic conflicts between the communist world led by the Soviet Union, and the Western world, led by the US. The two sides were also engaged in fierce debates about the merits of their key political and economic philosophies: the communism and one-party states of the countries in the Soviet camp, versus the democracies, capitalism and market economies of the West. These debates were settled by 1991 with the collapse and dissolution of the Soviet Union.
China, Vietnam and other countries have one-party political systems ruled by their communist parties, but in the last couple of decades they have also embraced market economies. Their economic systems look more like a kind of state capitalism, with the government behaving like one giant corporation, than anything resembling Soviet style communism. For all practical purposes, only Cuba and North Korea have remained faithful to the highly centralized style of communism once practiced in the Soviet Union. The sorry state of their economies speaks for itself.
Given that most countries around the world now have economies based on some form or another of capitalism and open markets, you would expect that the passionate ideological debates of the past are over. Not so. The economic debates in the US and many other countries are actually fiercer than ever, but they are taking place within the broad framework of capitalism. Capitalism continues to evolve, and different people have their own ideas about how that should happen.
There are many lenses through which to view the evolution of capitalism. Let me offer my reflections on the topic through a few such lenses.
The most general set of discussions starts with a version of this question: what is the role of government and government regulations in a capitalist, market economy? The answers range from the minimal role for government advocated by libertarians, to the very strong role advocated by the more socialist inclined.
Debates around these issues are typically based on ideology along the classic liberal-conservative political spectrum. I think that such ideologically based discussions can only offer us false choices. In our complex, global and unpredictable world, discussions of these highly complex questions grounded in ideology keep us from effectively addressing the issues. The terms liberal and conservative may still be alive and well when it comes to social issues, but they are increasingly irrelevant when applied to economic policy.
If not based in ideology, how do you decide on the proper balance between the role of government and that of the private sector and open markets? I think that such a balance should be based on a system of checks and balances akin to the brilliant system of governance set up by The Founding Fathers to prevent any one branch of government from becoming too powerful at the expense of the others, and to induce them to cooperate in getting things done.
The notion of checks and balances is an integral part of US culture. Not only has it endured for over two centuries, but it has done so while adapting to the vast changes that the country has undergone during that time, including its massive growth in size, population and power; the vast diversity in the composition of its people; and the highly different political beliefs, social mores and market conditions it has experienced through all that time. Its success is largely due to its built-in flexibility to adapt to vastly varying conditions. If any part of the system becomes too prominent, the other parts react to limit its powers and bring the overall system back in balance.
A system of checks and balances is particularly applicable in today’s highly complex and fast changing economic environment. And in fact, if you examine the past eighty years or so, we have started to apply such a system to shape the relationship between government and the private sector.
Prior to the Great Depression of the 1930s, government had a limited role in the US and other countries with capitalist economies. After taking office in 1933, President Franklin Roosevelt instituted a series of government programs which became known as the New Deal. The New Deal significantly expanded the role of government in response to the economic devastation and high unemployment of the Great Depression. It also instituted a set of regulations to curb the financial excesses and speculation which led to the 1929 Wall street crash.
Over the next several decades, the role of government in the US economy continued to grow. By the 1970s, many were questioning whether government had grown too big and was now overly regulating and stifling the economy. The pendulum started to swing in the opposite direction, especially after the election of Ronald Reagan in 1980. The new mood was succinctly captured in Reagan’s famous phrase uttered in his 1981 inaugural address: “Government is not the solution to our problem; government is the problem.”
Many politicians, academics and economists embraced this anti-government ideology. They believed that free markets could now operate smoothly and self-correct with minimal government oversight. Over the next thirty years, they dismantled or significantly relaxed many of the financial regulations put in place during and after the New Deal, because they believed that market flexibility and open competition on their own where our most reliable and effective safeguards against economic failure.
Then came the 2008 financial crisis, the worst since the Great Depression. Many believe that the crisis was the direct result of the prevailing anti-regulation ideology of the past few decades, which once more led to a reckless, largely unregulated behavior by financial institutions.
Our system of checks and balances has started to react to the crisis. The pendulum is now swinging in the other direction, with the Financial Reform law signed by President Obama in July of 2010. It is too early to tell whether this law will make the US financial system transparent and accountable enough to avoid another major economic crisis, as well as ensure that individuals are protected against the excesses of large financial institutions. There continues to be strong opposition to the bill, by many who are still holding on to their anti-government ideological position despite our recent experiences. These include not only politicians but also academics and economists who by now should know better.
Let me turn to another important question about the evolution of capitalism: How much of a safety net should government provide to its citizens in need, such as the poor, unemployed, sick, disabled and elderly? There is a wide spectrum of positions. At one end are the partisans of a laissez-fair, let-them-it-cake style of capitalism, who believe that government should provide minimal services. At the other end, are those who prefer a stronger government and a more nanny state style of capitalism.
This is an area under extensive debate in the US, given the valid concerns about the growing deficit, and the need to make government more productive, reduce expenses and cut back on services and benefits. Some feel that the way to do this is to return to what they consider a pure form of capitalism, where everyone is on their own and government does little for them, let alone provide any kind of safety net for those in need.
I strongly disagree, and would argue that this is contrary to the essence of capitalism. To help me make my points, let me invoke no less an authority than Adam Smith. Adam Smith is the 18th century Scottish philosopher and economist, who is generally considered the father of free-market, free-trade capitalism. Smith is most famous for The Wealth of Nations, published in 1776 and generally regarded as the first work of modern economics. He is also well known for his famous metaphor of the invisible hand – “the free market, while appearing chaotic and unrestrained, is actually guided to produce the right results by this so-called invisible hand.”
Driven by a narrow political ideology, some seem to think that Smith was an advocate of a kind of survival of the fittest style of capitalism, which I believe totally misrepresents his views. In his other major big work, The Theory of Moral Sentiments, Smith argued that sympathy, the human ability to have strong feelings of concern for another person, is required to achieve beneficial results in society.
He believed in a balanced approach to capitalism. On one side is the fierce competition and self-interest inherent in open, free markets. On the other is the supportive community behavior and sympathy found in well functioning, stable societies.
In an excellent 2009 FT opinion piece, Adam Smith’s market never stood alone, Harvard economics professor and 1998 Nobel Prize winner Amartya Sen wrote about Adam Smith and the future of capitalism after the financial crisis:
“Do we really need a new capitalism, carrying, in some significant way, the capitalist banner, rather than a non-monolithic economic system that draws on a variety of institutions chosen pragmatically and values that we can defend with reason?”, he asks, and then adds:
“This is not only the question we face today, but I would argue it is also the question that the founder of modern economics, Adam Smith, in effect asked in the 18th century, even as he presented his pioneering analysis of the working of the market economy.”
“What exactly is capitalism?,” he continues. “The standard definition seems to take reliance on markets for economic transactions as a necessary qualification for an economy to be seen as capitalist. In a similar way, dependence on the profit motive, and on individual entitlements based on private ownership, are seen as archetypal features of capitalism. However, if these are necessary requirements, are the economic systems we currently have, for example, in Europe and America, genuinely capitalist? All the affluent countries in the world – those in Europe, as well as the US, Canada, Japan, Singapore, South Korea, Taiwan, Australia and others – have depended for some time on transactions that occur largely outside the markets, such as unemployment benefits, public pensions and other features of social security, and the public provision of school education and healthcare.”
Professor Sen observes that in affluent countries, where it has been most successful, capitalism is pragmatic, not ideologically pure, and that this pragmatism goes back to the days of Adam Smith.
“It is often overlooked that Smith did not take the pure market mechanism to be a free-standing performer of excellence, nor did he take the profit motive to be all that is needed . . . People seek trade because of self-interest – nothing more is needed, as Smith discussed in a statement that has been quoted again and again explaining why bakers, brewers, butchers and consumers seek trade. However an economy needs other values and commitments such as mutual trust and confidence to work efficiently.”
A capitalist, affluent society with few safety nets will not be able to function effectively for long, especially in a democracy like the US where people will not tolerate an authoritarian regime imposing order from above.
We need to make government more efficient. We need to reduce expenses and benefits that are no longer sustainable, especially in the more advanced economies with aging populations like the US and Western Europe. We need to cut back on government entitlements that are no longer affordable, such as the ability to retire in your 50s with a large pension for life. But, having a large fraction of citizens with no health care and other safety-net benefits is an unwise position for any country to adopt, especially affluent, democratic, open societies like the US.
I want to conclude by briefly discussing the position of groups like the Tea Party and especially, that of the politicians, talk radio hosts and cable news personalities associated with the movement. I think of them as advocating a kind of tribal form of capitalism. They strongly argue that they want to significantly cut back the role of government at all levels, reduce taxes, and provide significantly fewer services to everyone. But, short of a very small number of committed libertarians, few truly embrace this position.
When you probe a little deeper, what they really mean is that you should cut services for everyone else, – especially the others from whom they want to Take America Back. But, not for them and their friends, families and communities. After all, it is their country. This was best exemplified during the heated debates prior to the passing of last year’s Health Care Reform bill, where many of the most vociferous critics of health care reform where also shouting things like keep your government hands off my Medicare. The reality is that most people, even Tea Partiers and other political conservatives, want the government to continue to provide them services, albeit more efficiently, with fewer regulations and lower taxes.
The ongoing debates about the evolution of capitalism are very important. Let us hope that the ideologically inspired, angry, irrational rhetoric of the past few years will give way to the kind of rational, civil discourse that we need to set the country in the right direction for the future
