Capitalism and its discontents

Joseph E. Stiglitz discusses the urgent quest for ethical economics

JOSEPH E. STIGLITZ

By now it is clear that something is fundamentally wrong with modern capitalism. The 2008 global financial crisis showed that the system as currently constructed is neither efficient nor stable. If a slew of data hasn’t already convinced us that during forty years of slow economic growth in advanced economies the benefits overwhelmingly went to the top 1 per cent – or 0.1 per cent – the anti-establishment votes in the United States and United Kingdom certainly should. The mainstream economists, central bank governors and “centrist” Blairite and Clintonite politicians who set us on and maintained this dismal course and confidently pronounced that globalization and financial-market liberalization would bring sustained growth and financial benefits for all, have been soundly discredited.

Considering the devastation wrought by misguided financial policies over the past decade in particular, one might reasonably have expected a revolution in the economics profession akin to the Keynesian one in the aftermath of the Great Depression. But we tend to forget that, back in the 1930s, as the economy sank ever deeper into depression, many economists in the US and UK stuck to laissez-faire. Markets would correct themselves, they said; no need to meddle. And even after John Maynard Keynes brilliantly articulated what was wrong, and how government actions could set things right, a great number of economists did not want to follow his prescriptions, out of ideological fear of excessive government intervention. So it is no surprise, really, that the economics profession’s response to the 2008 crisis has been slow and halting.

That’s the way the discipline operates. Five years before the crisis, the Nobel Prize-winning economist Robert Lucas captured the spirit of the profession when he proudly claimed that “macroeconomics … has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades”. To be clear: by that, Lucas didn’t mean the problem had been solved by Keynes and his disciples, but by the followers of another Nobel laureate, Milton Friedman, in what came to be called “new classical economics” and “real business cycles” (essentially the idea that economic shocks are efficient market responses). And while many of these Friedmanite economists have stayed remarkably quiescent in the aftermath of the crisis, the ideology and sets of beliefs they pushed and that bear significant responsibility for the crisis remain alive and well.

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That is why these three well-written books by eminent scholars are so welcome. Taken together they mount a convincing attack on the established orthodoxy – convincing, at least, to those who are not wedded to the discredited theories – and propose remedies to correct some of its failings. Their ideas, many of them original and intriguing, provide a basis for the much-needed reform of both our economy and the economics profession. Paul Collier, for instance, in The Future of Capitalism: Facing the new anxieties proposes a tax not only on urban land – on the rents that accrue as a result of the increased productivity from economic agglomeration in our thriving cities – but on the high-income urban workers who share in that prosperity (see Collier’s own article in the TLS, January 27, 2017). Still, even taken together, these ideas are far from comprehensive or sufficiently fleshed out to provide an alternative paradigm to the neoliberal economic doctrines that have predominated in recent decades.

Our current economic system is often referred to as capitalism, a term – as Fred L. Block points out in Capitalism: The future of an illusion – that the left once used pejoratively and the right now champions as if it’s an unchanging and noble framework that delivers miraculous, never-ending growth from which everyone benefits, or would if only government didn’t interfere. But all the underlying premisses of this blanket term are wrong: no economy, and certainly no modern economy, has a private sector that functions in a vacuum. The government is right there alongside it, enacting rules and regulations, enforcing trading standards, backing up the banking system and stabilizing the market economy. Capitalism isn’t one, rigid system. It’s ever changing. And the promises made by its most reductive advocates – that deregulation, privatization and globalization will bring wellbeing to most citizens in all countries – have proven to be horribly wrong. (Globalization, to its credit, has contributed to the enormous decrease in global poverty: the successes in East Asia, in particular in China, where some 740 million have been moved out of poverty, wouldn’t have been possible without it. Still, mismanaged and inequitable globalization, with large agriculture subsidies for corporate farms in the advanced countries, has hurt the poorest of the poor: rural workers in the least developed countries.)

Two other crises accompany the crisis in our economy. The first is a crisis in our democracy, for the two are inseparable. It is through our political system that the rules of the economy are set, and when the outcomes of those rules are unacceptable – as in the 2008 crisis – the consequences must be addressed, and addressed through radical change. And those kinds of changes have to be made through the political system – otherwise, matters will only get worse, especially when a third interconnecting crisis is taken into consideration: the environment. Unfortunately, none of these books faces up to our system’s failure to address the existential question of the moment: climate change.

At one level, I empathize with Collier’s call to turn away from ideology and extremism, and his emphasis on pragmatism. He is a strong, morally driven, left-leaning centrist, and he rails against the excesses of both extremes. After all, any student of revolution knows where these ideologies almost inevitably lead. But it was pragmatism – the pragmatism of Tony Blair and Bill Clinton, supported by what they would call “evidence-based policies” – that helped to get us into the current mess, and incrementalism won’t get us out. When their generation and their parents’ generation were growing up, America’s progressive era and the New Deal brought on radical (though, for all the epithets hurled at them, far from revolutionary) changes from which we all benefited enormously. So too, in Britain, did the reforms made during Clement Attlee’s postwar Labour government. The same goes for Keynesian macroeconomics. All of these policies transformed our concept of the role of the state, and showed us the possibilities, even the necessities, of collective action. Imagine how much worse today’s malaise would be were it not for those radical actions of previous generations.

Collier begins his book with a forceful description of the divides tearing asunder so many developed countries, divides between prosperous cities such as London and New York and provincial towns and rural areas, and between the educated elites and citizens with limited schooling. Not long ago, the prevalent economic theory was “convergence”. This argued that there were underlying economic forces that would reduce discrepancies in incomes between different places as capital moved from rich countries to poor ones, workers moved from poor countries to rich ones, and trade drove up unskilled wages in developing countries and down in developed countries. The latter point was seldom emphasized – for it foretold that globalization on its own, without significant government interventions including redistribution, might leave large parts of advanced countries worse off. But the reasoning was straightforward, and it should have been obvious to anyone who had taken a beginner’s course in economics: labour, and especially unskilled labour, was relatively abundant in developing countries and emerging markets, which meant that such countries would be net exporters of labour-intensive goods (especially goods requiring unskilled labour) to advanced countries. As the production of these goods declined in advanced countries, so too would the demand for labour (and especially unskilled labour), leading to lower wages and higher unemployment. As Collier shows us, rather than the predicted overall convergence, the evidence now suggests a more complex picture, with emerging markets converging towards the advanced countries, while gaps widen between the poorest and richest citizens both within and between countries.

Robert Skidelsky, whose Money and Government: A challenge to mainstream economics is targeted more at economists than the other two books under review, centres his attention on macroeconomic failures – the inability of the economy to avoid episodic downturns and their corollary, high unemployment. The 2008 crisis vividly showed that Lucas had been wrong. The fluctuations that have been part of capitalism since the beginning were still with us. While economists on the right, such as Friedman, had long blamed government for these fluctuations – and in the US they did so again after 2008 – the overwhelming evidence shows that the misdeeds of the private financial sector were responsible for bringing on the global recession. Of course, what the government did and did not do shaped the consequences of the private sector’s failures: the US government’s refusal to bail out Lehman Brothers triggered the financial crisis while subsequent decisive government intervention prevented the crisis from turning into another Great Depression. Those like me who criticize the bailout do so because of the way it was done, not the fact that it was done. We could have saved the banks and their depositors without bailing out the bankers and their shareholders and bondholders. Skidelsky makes a compelling case that the downturn would have been managed still better if Conservatives in the UK and Republicans in the US had not then shackled fiscal policy. With negative real interest rates (interest rates adjusted for inflation) in the midst of the crisis, this was precisely the time for robust public investment. In the early weeks of his administration, in February 2009, Barack Obama did sign off on a Congress-approved $787 billion stimulus measure, which included significant infrastructure spending, and followed this with several smaller measures, but given the scale, scope and likely duration of the downturn, this was unlikely to return the economy quickly to full employment. (I said so at the time, and subsequent events proved this to be true.) While under Labour, the UK had more modest expansionary measures, which were then reversed under David Cameron’s coalition government from 2010. Even if the actual “austerity” was sometimes less severe than what was claimed, it constituted a move in absolutely the wrong direction, and the UK suffered as a result, taking a long time to emerge from recession and then recording years of sluggish growth. The notion of an “expansionary contraction” proved to be the chimera that economists like Skidelsky said it would be. There would have been a double dividend – higher incomes today and in the future.

Even America’s Republicans agreed that such investment was badly needed. Allegedly, they worried about the resulting deficit, which is what held them back; and yet it was not the deficit but ideology that drove their opposition to fiscal policy: they wanted to stop the state from taking on an increasing role. Despite Donald Trump’s much-vaunted promise to invest in infrastructure, this doesn’t seem to be something that he, and certainly his Republican colleagues, have taken seriously, and his most recent (as-yet-unrealized, and with virtually zero prospect of its ever being realized) proposal, in February, to inject $200 billion falls well short of the various trillion-dollar-plus promises he made on the campaign trail. By contrast, when, in the first year of Trump’s presidency, Republicans had the opportunity to cut taxes for billionaires and corporations, they did so with alacrity – even when it increased the deficit enormously: by 2022, the US is expected by the Congressional Budget Office to have deficits of $1.1 trillion dollars, amounting to almost 5 per cent of GDP. And while the official estimates put the total increase in the deficit over the next ten years at around $1.5 trillion, these were based on rosy growth scenarios that are already losing their credibility. If growth proves to be weaker than the rosy numbers, the deficits and debt will balloon.

All three books give prominence to the role of the battle of ideas, explaining how misguided theories have won out from the era of Reagan and Thatcher onwards. Block, for example, details the role played by several misconceptions about our economic and political system, beginning with market fundamentalism (what I refer to in my book, Globalization and Its Discontents, 2002, as the almost religious belief that markets, on their own, are efficient, stable and in some sense fair). He rightly shows that, without government constraints, the rich and powerful shape capitalism to give themselves the advantage, undermining competition and exploiting others, eventually undermining the capitalist system itself. Adam Smith recognized this, but his latter-day followers often seem to forget it.

Here, Skidelsky joins in with his macroeconomic analysis: there is no presumption, Skidelsky argues, that market economies get the right balance – i.e. just enough aggregate demand to ensure full employment without inflation, a kind of Goldilocks economy of not too little, not too much. Jean-Baptiste Say asserted in the 1800s that markets do achieve this Goldilocks economy; history has shown that he was wrong. Keynes, following a host of earlier writers, including John Stuart Mill, explained the fallacies in Say’s theory. Skidelsky adds to this refutation with a clear and helpful exposition: individuals, especially when facing high levels of uncertainty about the future, may decide to convert the purchasing power they earn from the production of goods into holding money, or for that matter, into any non-produced good, such as land. In that case, the aggregate demand for produced goods will be less than the supply. Modern macroeconomists “solve” the problem by assuming it away: the standard models assume that somehow the economy is in equilibrium, with demand for labour and goods somehow just equalling supply. That we achieve this beautiful equilibrium is, like the belief in market efficiency itself, a matter of deep religious conviction, and the path we take to get there a matter of mystical revelation. If a problem crops up in this all-encompassing theory – if there is unemployment, for example – the response is simple: blame the victim, meaning workers, for demanding too-high wages, or migrants, for flooding the job market. If only wages were sufficiently flexible, the theory goes, or borders sufficiently forbidding, the economy would always be at full employment. And if all else fails, blame the government, for mucking things up.

As Block puts it, there is an illusion that democracy threatens the economy; it will lead government to inevitably muck things up. Friedman tried to blame the Great Depression on the misguided policies of central banks: their contraction of the money supply, he argued, was what brought down the economy. His analysis is now understood to be specious. And what happened after the collapse of Lehman Brothers may provide the most convincing proof. No one could have imagined the extent to which central banks around the world expanded the money supply in 2008 and 2009, and yet the world experienced a deep recession. So, too, the right today has tried to blame the 2008 recession, with its origins in the subprime crisis, on government’s encouragement of home ownership. And again the arguments have been refuted: no one forced the banks to make bad loans, to lend an amount that was beyond homebuyers’ ability to repay – in fact, even as it encouraged home ownership, government also encouraged prudence. The Financial Crisis Inquiry Commission, appointed by Congress to investigate the causes of the crisis, concluded these home ownership programmes were not what gave rise to the financial crisis; it was the misdeeds of the private financial sector.

By showing that government intervention can prevent the worst excesses of unemployment, Keynes arguably saved capitalism, and the same should be true today. The misshapen capitalism in which incomes soar for those at the top while wages stagnate and quality of life disintegrates for most citizens – a state of affairs only heightened since 2008 – is not politically or socially sustainable. If capitalism is to be saved, government will have to show that it can be reformed, that capitalism can deliver prosperity for all, or at least for most, citizens.

There are many elements of this “reform” agenda. Collier rightly takes modern corporations to task for their single-minded focus on shareholder value – which all too often simply means lining the CEO’s own pockets. And Block rightly criticizes the “greed is good” doctrine, an idea that actually has some intellectual pedigree. This came about through an extension of Adam Smith’s invisible hand theorem – that individuals’ and firms’ pursuit of their self-interest would lead, as if by an invisible hand, to the wellbeing of society. (As we have noted, Smith understood the limitations of unregulated markets, observing, for instance, the tendency of firms to conspire to raise prices.) Thus it followed that corporations should simply maximize their stock market value, come what may. For economists such as Friedman, it was wrong, almost immoral, for firms to engage in corporate responsibility, to fail to push down wages. This notion played a pivotal role in the reshaping of the norms and legal framework around capitalism. It was again a political agenda, with strong consequences for growth and distribution. Firms focused on what they could do to increase share value today, with little thought for the future. That led both to creative accounting – misleading investors to believe that the firm’s future prospects were better than they in fact were – and to lower investment in plants, equipment and people. The focus on short-term returns – thanks to Friedman’s ideas – led to slower growth. A company can’t have long-term growth based on short-term thinking.

Friedman’s analysis was based on superficial arguments that, at the time he pushed them, had already been discredited by concurrent advances in economic theory. For instance, the “greed is good” doctrine had been refuted by work (done in the second half of the last century by Kenneth Arrow, Gérard Debreu, Bruce Greenwald and me) that showed that the conditions under which Smith’s invisible-hand theorem was true were so restrictive that they made the theorem irrelevant as a practical matter. In short, this research showed that markets were not in general efficient whenever information was imperfect and markets incomplete – which is always. If one needed empirical evidence that unbridled greed was bad for the economy, one only had to look at the actions of the bankers in the run-up to the 2008 recession: their voraciousness brought the global economy to the brink of ruin. Again, policymakers, lawmakers and pro-business politicians on the right paid no attention: their economic arguments were simply a façade, a means to a less regulated market that would give them more opportunities for profits, more chances to exploit and take advantage of others.

A strength of these three books is that they break out of the narrow boundaries of economics. This approach is natural for Block, who comes from a sociology department and whose outlook is deeply rooted in the work of the Viennese thinker Karl Polanyi. But it’s also no surprise for Collier, a pre-eminent development economist who is particularly interested in conflict and post-conflict reconciliation. Collier recognizes that economic breakdown is cause and consequence of social breakdown; but he is too quick to blame paternalism, utilitarians and globalists for society’s maladies. There are deeper reasons for that – for instance, the breakdown of civic engagement and the pervading sense of isolation. There are many structural explanations that I find more plausible than those that Collier focuses on, including the impacts of many of the new technologies, the extremes of individualism stressed by Reaganism/Thatcherism and dominant strands of neoliberalism, and the decline in public trust brought on by events such as the Iraq and Vietnam wars and Watergate.

Collier believes that a catastrophic lack of morality – evidenced by the greed-is-good doctrine – lies at the core of modern capitalism. He calls for an ethical family, an ethical firm and an ethical globalization. This is the correct approach, but while we may quibble with whether he has defined these concepts adequately, or even provided sufficient philosophical foundations, the core question is: how can we achieve this ethical society? Collier doesn’t persuasively answer this, nor does he go far enough in exposing the ethical lapses of twenty-first-century capitalist economies and societies. What, after all, can we say about the ethics of a society that appears to be willing to jeopardize the health and well-being of future generations by wantonly consuming more carbon-intensive material goods today? The yellow-vest protesters in Paris, as they clamour against a progressive green tax intended to ensure the future of the planet, are rightly wondering how they are going to have enough money to make it to the end of the month. Which shows that a truly ethical capitalism must simultaneously address structural inequality and the environment. Time is not on our side. The sort of pragmatism and centrism espoused by Collier will not do the trick if we are to respond prudently to the real risks we face. The Green New Deal proposed by a group of young Democrats in the US is closer to the mark: a mobilization of resources of the magnitude that is up to the task, and done in a way that restructures the economy so that the world’s “yellow vests” are no longer living the precarious lives they have been. I believe these young Democrats are right. Indeed, there would be an enormous increase in national income if we eliminated discrimination and unemployment, reformed our labour markets to make it easier for more women and older workers to participate on equal terms in the workplace, and reduced the distortions arising from firms with market power. This increased income would go a long way towards providing the necessary resources for the Green New Deal. We would undoubtedly need to do more: redeploying resources – including by reducing the excessive and conspicuous consumption of the wealthy through more progressive taxation and downsizing the military (global security is the real threat to security in the long run). This agenda would achieve not only greater growth but a more equitable and sustainable prosperity.

Collier is right to worry about extremism, and the nativism and ugliness epitomized by Trump – what Collier calls “exclusionary nationalism”. But his diagnosis of the chief cause is misguided. He concludes his book with the following argument: “By eschewing shared belonging, and the benign patriotism that it can support, liberals have abandoned the only force capable of uniting our societies behind remedies. Inadvertently, recklessly, they have handed it to the charlatan extremes, which are gleefully twisting it to their own warped purposes”. This position seems unfair. These are not the liberals I know, who have fought to enrich the collective life of our nations. One can be a citizen of the world, a citizen of one’s country, and of one’s city all at the same time. Economists – and especially liberals – have long recognized the importance of social capital and trust, the glue that not only holds society together but makes the economy work.

It is not inevitable that our mixed-market economy will continue in its current form in the UK and US. Indeed, we can look at a more tempered capitalism in Scandinavia and, at least from time to time, elsewhere: New Zealand’s present government is showing the way. Even its budget is formulated in terms of national “well-being”. The US and UK have perhaps led the wrong way in creating an extreme version of capitalism, often in the name of seemingly “centrist” and pragmatic neoliberal doctrines. There is little doubt in my mind that we can create a more ethical capitalism, designed to shape a more selfless society – and the result will be a society less populated by selfish individuals. But that won’t happen on its own. And it won’t happen by lecturing corporations on social responsibility. Corporations are experts in greenwashing, or falsely claiming to be environmentally responsible because it’s good business. Apple and Starbucks talk about corporate responsibility, and in some spheres they do act responsibly. But the underlying truth is this: where Collier emphasizes the importance of mutual obligation, Apple, Starbucks and many other multinationals are willing to take but not to give back in like measure. The first element of social responsibility is paying your taxes, and these companies and others like them have employed the same ingenuity they have used to produce better products to avoid taxation.

This is why creating this new system will only happen through politics – which, in turn, is why the future of capitalism, our democracies and the world are inextricably linked. We’ve seen what misshapen capitalism has done to democracies in the US and elsewhere, and how the resulting electoral perversions then distort our economies. The sad reality is that matters could get worse. President Jair Bolsonaro of Brazil is merely the latest authoritarian on the global scene.

If we are to achieve an ethical capitalism, we need an ethical politics, which respects the basic tenets of democratic values. Again, that’s not likely to happen on its own. We can see this clearly in the US, where the right has been engaged in a systematic agenda of disenfranchisement and disempowerment – limiting voting for citizens who oppose the right’s ideas, limiting (through gerrymandering) opponents’ ability to translate votes into political power, and limiting what can be done should their opponents achieve political power (or as Nancy MacLean has put it in her book of that title, by putting “democracy in chains”; see TLS, July 6, 2018). This is especially easy in the US, where highly politicized Supreme Court justices on the right read into the Constitution new rights for the wealthy and fewer rights for ordinary citizens: for instance the right of rich corporations to make unbridled campaign contributions while circumscribing the rights of workers to organize or individuals to sue corporations who have abused them. Even were Democrats somehow able to overcome the electoral disadvantages posed by gerrymandering, the US Senate (in which populations in small states are overrepresented) and the electoral college (which has ensured that both the Republican presidents elected this century assumed office with a minority of votes), they could change these and other policies only by getting new Supreme Court decisions.

These three books naturally ascribe a key role to the power of ideas. But interests matter as well. Economics is about growth but it is also about distributive battles – and as Trump’s devastating Tax Cuts and Jobs Act of 2017 illustrates, the latter proved more important than either ideas or growth. A small state is a handmaiden to these interests. Citizens with economic power simply don’t want a state that would prevent them from exercising that power. Businesses that exploit others don’t want a government capable of preventing them from engaging in nefarious activities, or of redistributing their ill-gotten gains. Oil, chemical and coal companies don’t want a state powerful enough to stop them from destroying our planet.

In its attempts to circumscribe the state, the right also destroys the ability of a nation to do what it must for all its citizens to prosper. The enormous increases in our standards of living over the past 250 years are based on advances in knowledge – the foundation of which is basic research – a public good that must be publicly provided through universities and other publicly funded research institutions. Our prosperity rests, too, on social organization, our rule of law, democracy and systems of checks and balances, all quintessential public functions. In their selfishness, even those at the top may be hurting themselves: they would be better off with a smaller share of a larger pie, and they, like everyone else, would benefit from a more stable and sustainable economy and society. Not to mention a habitable planet.

It is now time to find a path between incrementalism on the one hand and violent revolution on the other. A radical change in economic and power relationships is possible. It is also existentially urgent. This is the only thing that will save capitalism from itself and from the capitalists who would unwittingly destroy it, and the Earth along with it.

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