Capitalism: Seeds of Its Own Destruction

Please read this outstanding analysis by Martin Wolf in today’s Financial Times: FT.com / Columnists / Martin Wolf – Seeds of its own destruction

Here in a nutshell is why we are where we are.

The Reagan era here in America has ended in failure. That means much of what we thought of a good ideas are now exposed as being wrong. For instance the role of government has to be re-thought. Reagan made fun of government. He pilloried it as being ‘the problem’. One of his legacies is to cripple the Obama administration: in our time of need we remain locked in Reagan’s wrongheaded thinking and incapable of marshaling the full resources of our government to overcome the failures of the marketplace.

In Reagan’s vision markets always corrected themselves. Thus there was no need for governments to tinker with them. On the contrary, governments were supposed to absent themselves from any market activities. Deregulation became the key to success. Free markets when allowed to flourish were said to bring innovation and wealth creation such that the entire society would benefit. Attempts to allocate wealth through government programs were deemed futile because they prevented the full flowering of the marketplace.

Economic theory went one step further: it stated that government interference was futile because the efficiency of the market would anticipate and offset the effects of that interference. So government programs, we were told, were doomed from the get go.

The 1980’s through last year were a golden age for advocates of these kinds of ideas. The Reaganite vision seemed to have delivered hugely on its promise of endless growth and wealth creation. Not only did it seem to power us out of the 1981/82 recession, but subsequent recessions were minimal inconveniences rather than worrisome downturns.

Alan Greenspan became the poster child of this attitude. Milton Friedman was its intellectual godfather. Ronald Reagan brought it into politics.

All those who came of age during these years were groomed to accept the tenets of free market faith as a revered revealed truth. This opinion was reinforced by the apparent victory over the Soviet Union; the collapse of communist systems worldwide; and the embrace of capitalism just about everywhere.

But it was an illusion.

There was an alternative narrative that also explained those same events.

The apparent failure of Keynesian economics in the 1970’s was not due to its inherent error, but to the shifting balances within the global economy. The awakening of China; the opening up of India; the emergence of Japan from its World War II devastation; the loss of American energy independence due to its over-consumption of oil; and the surge in world population during the 1950’s and 1960’s all contributed to the creation of a new environment that the policies of the 1970’s failed to adapt to. During the latter part of the 1970’s economic malaise and inflation – ‘stagflation’ – strangled growth. Reaganism seemed to offer a way out.

But all it did was to gloss over the underlying shifts. China did not retreat. India did not return to protectionism. Japan extended its manufacturing capability. South Asia exploded onto the scene as an economic power. Europe integrated its economy. And energy remained as a long term problem. All Reaganism did was to ignore these factors by pushing America into a debt fueled binge. No longer the only economic powerhouse, America relied more and more on borrowing to shore up its standard of living. The free market delivered a vast burst of wealth that flowed mainly to a few, those who could influence it, but the many, now abandoned by government had no recourse other than to debt to fulfill the mythic ‘American Dream’.

A whole bevy of imbalances slowly grew malignant: personal debt loads; a lack of savings; vast government deficits; lax monetary policy; huge trade deficits; and an explosion in the financial service sector way beyond levels seen before. None of these were properties of an economy in long term health. But all were ignored because the anti-government mantra prevented intervention. On the contrary deregulation actively added to the emerging problems.

The lower and middle classes, having been sold the anti-government medicine as a palliative for the 1970’s became the bulwark preventing change even while they were being crushed by the weight of unresolved issues like the lack of solutions for retirement and health care. Everyone sat back and waited for the market to conjure up its magical solution.

So when the market revealed itself to be hopelessly irrational during the two great asset price bubbles of the Reagan era, no one acted. It took the most egregious and insane greed of the market to bring us back to reality. It devoured itself. It has come perilously close to taking us down with it.

$50 trillion dollars of wealth has been destroyed so far during this downturn. And we are not yet done. That’s an expensive way to learn that free market economics is a folly.

There are plenty of alternative ideas.

We need to place economics in context, in what I call its ‘basis’; embed policy within an institutional and social framework rather than view those things as adjuncts or even hindrances to economics; manage our businesses towards a balance with society; assert the primacy of knowledge as our chief economic driver; and eliminate the notion that markets are either efficient or rational without the necessary limits that an array of support and restrictions that legislation, regulation, institutional and ethical boundaries enforce.

The free market era is dead.

What replaces it we are now seeking to learn.

As Keynes said: we need new ideas.