Meddle with the market at your peril

Financial Times

By Alan Greenspan. The writer is former chairman of the US Federal Reserve

Controlled experiments are not feasible in economics. But we came close in the competition between East and West Germany after the second world war. Both countries started with the same culture, the same language, the same history and the same value systems. Then for 40 years they competed on opposite sides of a line. The only major difference was their political and economic systems: central planning vs market capitalism.

The experiment came to an abrupt close in 1989 with the fall of the Berlin Wall, exposing the economic ruin of decades of Soviet-bloc economics. Centrally planned East Germany had exhibited productivity levels little better than one-third those of market-oriented West Germany. Much of the then third world, absorbing the tutorial, converted quietly to market capitalism.

China, especially, replicated the successful export-orientated economic model of the so-called Asian tigers: fairly well-educated, low-cost workforces, joined with developed-world technology. Functioning in newly opened competitive markets, China and much of the developing world unleashed explosive economic growth. Between 2000 and 2007 the growth rate of real gross domestic product in the developing world was almost double that of the developed world. The International Monetary Fund estimated that in 2005 more than 800m members of the world’s labour force were engaged in export-orientated and therefore competitive markets, an increase of 500m since the fall of the Wall. Additional millions became subject to domestic competitive forces, especially in the former Soviet Union.

Capitalism, since it was spawned in the Enlightenment, has achieved one success after another. Standards and quality of living, following millennia of near stagnation, have risen at an unprecedented rate over large parts of the globe. Poverty has been dramatically reduced and life expectancy has more than doubled. The rise in material well-being – a tenfold increase in global real per capita income over two centuries – has enabled the earth to support a sixfold increase in population.

While central planning may no longer be a credible form of economic organisation, the intellectual battle for its rival – free-market capitalism – is far from won. At issue, the dynamic that defines capitalism, that of unforgiving market competition, clashes with the inbred human desire for stability and, for some, civility. A prominent European politician several years ago best expressed the widely held anti-capitalist ethos when he asked: “What is the market? It is the law of the jungle, the law of nature. And what is civilisation? It is the struggle against nature.” While acknowledging the ability of competition to promote growth, many such observers nonetheless remain concerned that economic actors, to achieve that growth, are required to behave in a manner governed by the law of the jungle. These observers accordingly choose lesser growth for more civility.

But is there a simple trade-off between civil conduct, as defined by those who find raw competitive behaviour deplorable, and the material life most people nonetheless seek? From a longer-term perspective, does such a trade-off exist? During the past century, for example, competitive-market-driven economic growth created resources far in excess of those required to maintain subsistence. That surplus, even in the most aggressively competitive economies such as America’s, has been mainly employed to improve the quality of life: advances in health, greater longevity and pension systems that go with it, a universal system of education and vastly improved conditions of work. We have used much of the substantial increases in wealth generated by our market-driven economies to purchase what most would view as greater civility.

Anti-capitalist virulence appears strongest from those who confuse “crony capitalism” with free markets. Crony capitalism abounds when government leaders, usually in exchange for political support, routinely bestow favours on private-sector individuals or businesses. That is not capitalism. It is called corruption.

The often-assailed greed and avarice associated with capitalism are in fact characteristics of human nature, not of market capitalism, and affect all economic regimes. The legitimate concern of increasing inequality of incomes reflects globalisation and innovation, not capitalism. But an additional contributor to inequality in America is our immigration law, which “protects” many high earners from skilled migrant competitors. The American H1B programme is in effect a subsidy for the wealthy, a policy that is anathema to the supporters of capitalism.

Whatever the imperfections of free-market capitalism, no regime that has been tried as a replacement, from Fabian socialism to Soviet-style communism, has succeeded in meeting the needs of its people. Capitalist practice needs adjustment. I was particularly distressed by the extent to which bankers, previously pillars of capitalist prudence, had allowed their equity buffers to dwindle dangerously as the financial crisis approached. Regulatory capital needs to be increased.

Yet I fear that, in response to the crisis, innumerable “improvements” to the capitalist model will be enacted. I am very doubtful those “improvements”, in retrospect, will appear to have been wise.

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