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Luigi Zingales on Threats to the Future of American Capitalism:

Prominent finance economist Luigi Zingales has an excellent essay outlining some of the dangers facing us as a result of the political response to the current economic crisis [HT: my colleague Josh Wright]:

While everyone benefits from a free and competitive market, no one in particular makes huge profits from keeping the system competitive and the playing field level. True capitalism lacks a strong lobby.

That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one, though American capitalism has always managed this tension far better than most....

We thus stand at a crossroads for American capitalism. One path would channel popular rage into political support for some genuinely pro-market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can introduce limits to the power of the financial industry — or any business, for that matter — and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.

The alternative path is to soothe the popular rage with measures like limits on executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism in the long run. They also reinforce the very practices that caused the crisis. This is the path to big-business capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism.

Unfortunately, it looks for now like the Obama administration has chosen this latter path. It is a choice that threatens to launch us on that vicious spiral of more public resentment and more corporatist crony capitalism so common abroad — trampling in the process the economic exceptionalism that has been so crucial for American prosperity. When the dust has cleared and the panic has abated, this may well turn out to be the most serious and damaging consequence of the financial crisis for American capitalism.

The distinction between a "pro-business" agenda and a pro-market one is a crucial point that I have often emphasized myself (see here and here). Unfortunately, it is routinely ignored or misunderstood. For the reasons Zingales points out, business interests regularly lobby in favor of government intervention whenever they think it might protect them from competition or secure government-provided privileges.

Such lobbying is of course routine. But it is particularly dangerous in the midst of a crisis atmosphere, when the combination of fear, voter ignorance, and government officials seeking to expand their power creates unusually attractive opportunities for interest groups to lobby for special privileges for themselves under the guise of emergency measures. I discussed these issues in greater depth in a series of posts last fall (see here, here, and here). So far, little has happened to alleviate my concern that the combination of economic crisis, voter ignorance, interest group lobbying, and united Democratic control of the federal government is likely to lead to a dangerous expansion of government power over the economy. In many cases, that expansion is taking the form of measures that benefit big business and other powerful interest groups at the expense of the general public.

AccountingProf:
I don't think an entirely cynical view of regulation and government intervention is appropriate. Many regulations are instituted with the best of intentions, to prevent systemic harm (too big to fail) or to prevent individual harm (consumer protection). However, by increasing the size of government, these regulations also induce self-interested lobbying to tilt the playing field.

This leaves us with a classic dilemma in ethics. Are you really willing to let something terrible happen right now (systemic failure, individual catastrophe, death) in order to protect against vague (but greater) future harm with uncertain victims?

There must be a name for this dilemma, but I am just an accountant....
9.11.2009 7:50pm
TGGP (mail) (www):
I did some nitpicking of Zingales' essay at my blog.
9.11.2009 8:06pm
Harry Eagar (mail):
'While everyone benefits from a free and competitive market'

Not me. I'm not benefitting.
9.11.2009 10:23pm
Tim Nuccio (mail) (www):
Great essay. I plan to respond to it on my blog as well.
9.11.2009 10:29pm
Randy R. (mail):
"One path would channel popular rage into political support for some genuinely pro-market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can introduce limits to the power of the financial industry — or any business, for that matter — and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses."

Can't agree more. BUt in order to do that, the gov't is going to have to institute many reforms that will trample on certain freedoms and free market principles. Therefore, there is a set of people in this country -- rich, well connected and in power -- who will not allow such curtailments. And that breeds resentment.
9.11.2009 11:29pm
BGates:
Not me. I'm not benefitting.

Thanks for taking the time out from subsistence farming to dictate that message to somebody who owns a computer.
9.12.2009 5:26am
Destructo (mail):
Interestingly, "securing government-provided privileges" may actually consist of "evading government interference" to which your competitors are subject, or even "sicking the government on the other guy," which pretty much describes the Microsoft persecution of the 90s.

The answer is to limit the power of government and hence the tempation to use it as a crutch, battering ram, or proxy.
9.12.2009 8:49am
subpatre (mail):
Destructo writes, "The answer is to limit the power of government and hence the tempation to use it as a crutch, battering ram, or proxy."

Actually, limiting the power of government reduces the amount of damage it can cause a business' competitors. It is the reduced effectiveness as a weapon (crutch, battering ram, or proxy) that reduces the temptation to use it.
9.12.2009 11:31am
T Gracchus (mail):
"meritocracy, a direct link between reward and effort"
Markets are not meritocratic. There is no external measure of merit, nor set of qualities which markets reward or can be expected to identify and reward. There is no merit in a market. An important part of markets is that there is no valuation of activity or person other than success within the market. For related reasons, it is just false that there is a direct link between reward and effort in markets. Labor theory of value otherwise. These are pretty basic mistakes about the nature of markets.
9.12.2009 11:41am
byomtov (mail):
Zingales' distinction between pro-business and pro-market is valid, but I don't see why we are "at a crossroads" on the issue. This tension has been there for quite a while, and will likely remain.
9.12.2009 11:56am
ChrisTS (mail):
Accounting Prof: There must be a name for this dilemma

As you suggest, this is a classic problem for any utilitarian approach, precisely because such approaches provide no indpendent principles for determining the preferable distribution of burdens and benefits. Generically, this ind of problem is referred to as a 'distribution' problem; more specifically, it is regarded as a problem of justice in distribution.

We usually think about this problem when considering the simultaneous consequences of policies, but it is even more sticky when we have to take into account stages of consequences for what might be regarded as distinct 'generations' of persons affected. In the latter kind of case, ethicists often speak of 'future generations' problems; of course, the 'generations' in a given case may not be all that far apart in time.
9.12.2009 11:57am
SuperSkeptic:
Largely a good essay, hit a few nails on the head; however, Tiberius' point about the lack of meritocracy in markets in one sense is poignant. The rationale for much/most market intervention is to conter-effect the lack of a "moral" connection (from gov't/public standpoint)between any particularly successfully functioning market and the social darwinism that seems to prevail when markets function "perfectly" to the detriment of some/many. Pure economics is amoral, but politics isn't.

As for the "ethical dilemma:" - Zingales cites Jackson/Biddle bank controversy approvingly in that Jackson took the long-view, saving capitalism as an example of such an ethical dilemma being addressed. I personally think that that is the ethical answer 9 times out of 10.
9.12.2009 1:11pm
methodact:
Pure Socialism robs incentive. Pure Capitalism ends in monopoly. Monopoly must necessarily eliminate surplus populations.

For all of his understanding with his complex economic theories such as on the velocity of money and on wages to capital and about the various banking machinations, Marx didn't get the absolute eugenics part of pure Capitalism.

Many people take umbrage at calling Corporatism by its more familiar name: Fascism. But by packing the courts with corporatists, we know absolutely, that the eventual result can be no other than eugenics.

And as but one example, mandatory "Universal" Health Care, may start off ostensibly to protect life, but under monopoly, it must eventually serve eugenics.
9.12.2009 2:02pm
Harry Eagar (mail):
T. Gracchus gets it.
9.12.2009 2:24pm
SuperSkeptic:
Methodact,

I agree with the thrust of your post, but you say:

And as but one example, mandatory "Universal" Health Care, may start off ostensibly to protect life, but under monopoly, it must eventually serve eugenics.

As everyone knows, government itself is a monopoly of force. Using your logic, although it "may start off ostensibly to protect life"/liberty/pursuit of happiness, under monopoly, must then the very existence of government itself "eventually serve eugenics." ?
9.12.2009 2:43pm
Blake Masters (mail):
I'm not so sure T. Gracchus gets it.

When people like Zingales say that markets are meritocratic, they aren't invoking some labor theory of value or other "objective" and external set of value to determine merit.

Rather, they are saying that the successes and failures of the market can be viewed as a meritocratic mechanism, precisely because value is subjective. He or she who produces the goods and services that other folks want, at prices they can afford, succeeds. In that sense, we recognize that no such standard exists, so the array of subjective values exchanged and as illustrated in a market (by profits, prices, etc.) is not only the only good standard we have, but a pretty darn effective one, too.

I understand your point about effort not necessarily causing success. No one argues that success is guaranteed in markets. But surely the two are correlated. Was it Jefferson with the (probably apocryphal) quip that "the harder I work, the more luck I seem to have."?

I would like it if you would elaborate more on your claim that markets aren't meritocratic, if only so I can better understand why you frame the point as you have.
9.12.2009 5:16pm
Mark N. (www):

When people like Zingales say that markets are meritocratic, they aren't invoking some labor theory of value or other "objective" and external set of value to determine merit.

I can't speak for Zingales, but I suspect that for a large proportion of Americans, an assumption that market economies reward a separately determined set of meritorious qualities does underpin a lot of the support for the free market. The widely held meritorious qualities are roughly some combination of intelligence, creativity, skill, and industriousness. I suspect most people who support the market economy believe that it, by and large, leads to a meritocratic system in which such things are rewarded--- while sloth, ignorance, etc., are not. This underpins some of the view that wealth discrepancies are acceptable, because the wealthy earned it, while the poor could have but did not. There's a whole set of nice stories along those lines too, from the grasshopper/ant fable to the Horatio-Alger-style ones.

If a large proportion of people were to lose that belief that market forces at least approximately reward intelligence, creativity, skill, and hard work, I suspect public support for capitalism would be much weaker.
9.12.2009 6:39pm
SuperSkeptic:
You just did speak for Zingales because that's essentially what the essay says. That and that the rachet effect of the government's response lessens that essential perception of capitalism by aligning the public perception of corruption/corporatism (instead of merit) with market success.
9.12.2009 7:01pm
T Gracchus (mail):
In response to B. Masters:
Markets are exchanges and nothing more. In effect, you get more by selling what others want to pay for, either in amount or quantity. There is no sense of merit which that tracks. 'Winners' in a market are not better in any useful sense. There is no connection between market success and - well just about anything. Effort, dedication, intelligence, morality, religiosity, sociability, and so on are not rewarded. No doubt we like to think there are connections -- I like the idea that my intelligence and effort are rewarded in the market I compete it, but it just isn't so. (Nevertheless, I act as though they are; I feel better and it is easier to motivate the work, but that does not make it true.) There is not even a weak connection between any intelligible account of merit and market success. As to rewarding hard work, that is, to be blunt, ridiculous. Low income jobs require far more effort for much less reward. It is a mistake to think that high rewards in financial industries tie to effort. Market ideologies retail these stories, and it is hard not to commit to them, but they have no empirical foundation. Another way to think about it is to identify the role of luck -- you get to the same place.
So when Zingales talks about merit, he either is engaging in a sales effort (fine, we all pitch ideologies from time to time) or he misunderstands some pretty basic stuff about economics.
Bill Gates is extraordinarily wealthy. He is not smarter than the rest of the world; he does not work harder than the rest of the world; he made some bets that turned out really well -- but that is all.
I hope that helps clarify.
9.12.2009 7:42pm
methodact:
SuperSkeptic:

There's the problem with a too large central government. There's the problem with a New World Order.

Government that serves monopoly uses its authority to enrich that monopoly. The corporatists on the Court probably are compartmentalized enough to not appreciate that eugenics is the net result of too much fealty to corporatism. If they do, then they probably don't care.

Likely though, all they know is that they have been loyal to corporatism and they have been installed into their positions of power because corporatism feels they deserve it, hence their "merit".

In Raich, the Court found a Commerce Clause nexus
even in the cases where literally no commerce exits. They abstracted it in. Yet the blatant buying of elections is argued "free speech", not commerce.

Capitalism is a wonderful engine of incentive and innovation. But Lord Acton's axiom applies equally well to monopoly as despots.
9.12.2009 9:19pm
JHU BME:
why isn't it meritorious to serve others by producing what they desire?
9.12.2009 10:12pm
Allan Walstad (mail):

The distinction between a "pro-business" agenda and a pro-market one is a crucial point...business interests regularly lobby in favor of government intervention whenever they think it might protect them from competition or secure government-provided privileges.

Exactly, and a substantial theme of Adam Smith's in the Wealth of Nations.

T Gracchus gets it. In a free market, incentives tend to reward those producers who best satisfy consumer demand, according to the consumers themselves through their choices. Whether you want to call that meritocratic is irrelevant.

Mark N. suspects that "for a large proportion of Americans, an assumption that market economies reward a separately determined set of meritorious qualities does underpin a lot of the support for the free market." But it seems to me that there is at least as strong a current of dislike for the market on the assumption that success is achieved through dishonest or unfair practices or dumb luck. The bottom line is that a lot of people don't understand markets too well, unfortunately.
9.12.2009 10:58pm
Harry Eagar (mail):
'Thanks for taking the time out from subsistence farming to dictate that message to somebody who owns a computer.'

The reason I am not a subsistence farmer is that I take advantage of improvements in technic. These are not in any way related to markets.

Improvements in technic are unevenly distributed geographically, but the differences do not correlate even vaguely with the kind of market relations in the different areas.

It is a matter of deep faith of marketeers that markets encourage innovation, but there is no evidence that this is so. As the history of the Concord grape demonstates, it can often work the other way around.
9.13.2009 12:38am
Bob Dole:
@methodact
"Pure Socialism robs incentive. Pure Capitalism ends in monopoly. Monopoly must necessarily eliminate surplus populations."

No, No, No!
Pure capitalism doesn't end in monopoly, in order to have monopoly you must have some form of government protection of that monopoly, otherwise smaller more nimble competitors begin to destroy your monopoly ability.
The constitution specifically gives congress the power to grant monopolies for limited periods of time, however in the form of "letters patent." Copyrights and patents are a form of this power.
9.13.2009 3:48am
Mark N. (www):

in order to have monopoly you must have some form of government protection of that monopoly, otherwise smaller more nimble competitors begin to destroy your monopoly ability.

I'm not sure there are many economists who hold that to be an eternal truth. For one, monopolies can emerge naturally in a number of ways. And once they've emerged, they can be extraordinarily hard to displace, because a company earning monopoly profits and in complete control of a market has a lot of tools at its disposal. In a world with no antitrust laws, they can cut exclusive licensing deals to cut off supply and markets from any potential startups, dump products to destroy the start-up's cash flow, threaten to cut off anyone who even does business with the startup, etc.
9.13.2009 5:31am
Allan Walstad (mail):

...monopolies can emerge naturally in a number of ways. And once they've emerged, they can be extraordinarily hard to displace, because...[etc]

From some armchairs it may look that way. History tells us otherwise. The big, persistent monopolies are and have been government-run or government-fostered. The most striking thing about free-market monopolies has been their rarity.

Really, it is discouraging to hear the same hoary myths about monopoly being trotted out again and again.
9.13.2009 11:28am
Ken Arromdee:
Interestingly, "securing government-provided privileges" may actually consist of "evading government interference" to which your competitors are subject, or even "sicking the government on the other guy," which pretty much describes the Microsoft persecution of the 90s.

Microsoft wouldn't be able to do what it did if it didn't have intellectual property, which is a government-created monopoly--that is, government interference.
9.13.2009 12:22pm
ChrisTS (mail):
Mark N:

If a large proportion of people were to lose that belief that market forces at least approximately reward intelligence, creativity, skill, and hard work, I suspect public support for capitalism would be much weaker.


And, isn't this part of the so-called 'populist' blowback against the financiers? It is difficult to tell whether people are more bothered by the extent of the reward differential or more bothered by the sense that the financiers blew it, but I think the latter is at least a part of that rage.
9.13.2009 12:57pm
ChrisTS (mail):
JHU BME:
why isn't it meritorious to serve others by producing what they desire?

Some 'others' want heroin, kiddie porn, and assistance in committing suicide.

One might think any or all of those are morally neutral 'goods' that should be provided by the market to any willing buyer. But, you can see the point that there might be some dispute about the merit of selling them.
9.13.2009 1:00pm
Harry Eagar (mail):
If markets are so great, how come airlines, which were deregulated 30 years ago, have made less than no money since then?
9.13.2009 2:36pm

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