23 Things They Don't Tell You About Capitalism

highly regarded economics departments in the world. When given a presentation by one of the professors there, Professor Luis Garicano, on the financial crisis that had just engulfed the world, the Queen asked: ‘How come nobody could foresee it?’ Her Majesty asked a question that had been in most people’s minds since the outbreak of the crisis in the autumn of 2008.

During the last couple of decades, we were repeatedly told by all those highly qualified experts – from Nobel Prize-winning economists through world-class financial regulators to frighteningly bright young investment bankers with economics degrees from the world’s top universities – that all was well with the world economy. We were told that economists had finally found the magic formula that allowed our economies to grow rapidly with low inflation. People talked of the ‘Goldilocks’ economy, in which things are just right – not too hot, not too cold. Alan Greenspan, the former chairman of the Federal Reserve Board, who presided over the world’s biggest and (financially and ideologically) most influential economy for two decades, was hailed as a ‘maestro’, as the title of the book on him by the journalist Bob Woodward of Watergate fame had it. His successor, Ben Bernanke, talked of a ‘great moderation’, which came with the taming of inflation and disappearance of violent economic cycles (see Thing 6).

So it was a real puzzle to most people, including the Queen, that things could go so spectacularly wrong in a world where clever economists were supposed to have sorted out all the major problems. How could all those clever guys with degrees from some of the best universities, with hyper-mathematical equations coming out of their ears, have been so wrong?

Learning of the sovereign’s concern, the British Academy convened a meeting of some of the top economists from academia, the financial sector and the government on 17 June 2009. The result of this meeting was conveyed to the Queen in a letter, dated 22 July 2009, written by Professor Tim Besley, a prominent economics professor at the LSE, and Professor Peter Hennessy, a renowned historian of British government at Queen Mary, University of London.[2]

In the letter, Professors Besley and Hennessy said that individual economists were competent and ‘doing their job properly on its own merit, but that they lost sight of the wood for the trees’ in the run-up to the crisis. There was, according to them, ‘a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole’.

A failure of the collective imagination? Hadn’t most economists, including most (although not all) of those who were at the British Academy meeting, told the rest of us that free markets work best because we are rationaland individualisticand thus know what we want for ourselves (and no one else, possibly except for our immediate families) and how to get it most efficiently? (See Things 5 and 16.) I don’t remember seeing much discussion in economics about imagination, especially of the collective kind, and I’ve been in the economics profession for the last two decades. I am not even sure whether a concept like imagination, collective or otherwise, has a place in the dominant rationalist discourse in economics. The great and the good of the economics world of Britain, then, were basically admitting that they don’t know what has gone wrong.

But this understates it. Economists are not some innocent technicians who did a decent job within the narrow confines of their expertise until they were collectively wrong-footed by a once-in-a-century disaster that no one could have predicted.

Over the last three decades, economists played an important role in creating the conditions of the 2008 crisis (and dozens of smaller financial crises that came before it since the early 1980s, such as the 1982 Third World debt crisis, the 1995 Mexican peso crisis, the 1997 Asian crisis and the 1998 Russian crisis) by providing theoretical justifications for financial deregulation and the unrestrained pursuit of short-term profits. More broadly, they advanced theories that justified the policies that have led to slower growth, higher inequality, heightened job insecurity and more frequent financial crises that have dogged the world in the last three decades (see Things 2, 6, 13 and 21). On top of that, they pushed for policies that weakened the prospects for long-term development in developing countries (see Things 7 and 11). In the rich countries, these economists encouraged people to overestimate the power of new technologies (see Thing 4), made people’s lives more and more unstable (see Thing 6), made them ignore the loss of national control over the economy (see Thing 8) and rendered them complacent about de-industrialization (see Thing 9). Moreover, they supplied arguments that insist that all those economic outcomes that many people find objectionable in this world – such as rising inequality (see Thing 13), sky-high executive salaries (see Thing 14) or extreme poverty in poor countries (see Thing 3) – are really inevitable, given (selfish and rational) human nature and the need to reward people according to their productive contributions.

In other words, economics has been worse than irrelevant. Economics, as it has been practised in the last three decades, has been positively harmful for most people.

How about the ‘other’ economists?

If economics is as bad as I say it is, what am I doing working as an economist? If irrelevance is the most benign social consequence of my professional actions and harm the more likely one, should I not change my profession to something more socially beneficial, such as electronic engineering or plumbing?

I stick to economics because I believe that it does not have to be useless or harmful. After all, throughout this book I have myself used economics in trying to explain how capitalism really works. It is a particular type of economics – that is, free-market economics as it has been practised in the last few decades – that is dangerous. Throughout history, there have been many schools of economic thinking that have helped us better manage and develop our economies.

To start from where we are today, what has saved the world economy from a total meltdown in the autumn of 2008 is the economics of John Maynard Keynes, Charles Kindleberger (the author of the classic book on financial crises, Manias, Panics, and Crashes) and Hyman Minsky (the greatly undervalued American scholar of financial crises). The world economy has not descended into a rerun of the 1929 Great Depression because we absorbed their insights and bailed out key financial institutions (although we have not properly punished the bankers responsible for the mess or reformed the industry yet), increased government spending, provided stronger deposit insurance, maintained the welfare state (that props up the incomes of those who are unemployed) and flushed the financial market with liquidity on an unprecedented scale. As explained in earlier Things, many of these actions that have saved the world are ones opposed by free-market economists of earlier generations and of today.

Even though they were not trained as economists, the economic officials of East Asia knew some economics. However, especially until the 1970s, the economics they knew was mostly not of the free-market variety. The economics they happened to know was the economics of Karl Marx, Friedrich List, Joseph Schumpeter, Nicholas Kaldor and Albert Hirschman. Of course, these economists lived in different times, contended with different problems and had radically differing political views (ranging from the very right-wing List to very left-wing Marx). However, there was a commonality between their economics. It was the recognition that capitalism develops through long-term investments and technological innovations that transform the productive structure, and not merely an expansion of existing structures, like inflating a balloon. Many of the things that the East Asian government officials did in the miracle years – protecting infant industries, forcefully mobilizing resources away from technologically stagnant agriculture into the dynamic industrial sector and exploiting what Hirschman called the ‘linkages’ across different sectors – derive from such economic views, rather than the free-market view (see Thing 7). Had the East Asian countries, and indeed most of the rich countries in Europe and North America before them, run their economies according to the principles of free-market economics, they would not have developed their economies in the way they have.

The economics of Herbert Simon and his followers has really changed the way we understand modern firms and, more broadly, the modern economy. It helps us break away from the myth that our economy is exclusively populated by rational self-seekers interacting through the market mechanism. When we understand that the modern economy is populated by people with limited rationality and complex motives, who are organized in a complex way, combining markets, (public and private) bureaucracies and networks, we begin to understand that our economy cannot be run according to free-market economics. When we more closely observe the more successful firms, governments and countries, we see they are the ones that have this kind of nuanced view of capitalism, not the simplistic free-market view.