The Future of Capitalism

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A need to reconnect
By Francesco Guerrera in New York

Published: March 12 2009 20:20 | Last updated: March 12 2009 20:20





In different times, the offer from the check-in attendant would have been accepted with alacrity. But in the midst of the worst economic downturn since the Great Depression, with an angry public, populist politicians and an aggressive press baying for a crackdown on Wall Street’s “excesses”, the senior banker paused for thought when he heard those usually welcome airline words: “Sir, you have been upgraded to first class. Please follow me.”

Finally replying, “I am fine in coach, thank you”, he gave up the better seat and opened another chink in the armour of beliefs and practices that corporate America had built and spread around the world over decades.

Once hailed as examples of an American dream that rewarded success with large pay cheques, lavish perks and popular admiration, executives and their companies have been caught in the grip of a storm that will revolutionise business. The deep freeze of capital markets, the implosion of financial groups and the resulting rise in governments’ sway over the private sector have called into question some of the foundations of Anglo-Saxon capitalism.

Long-held tenets of corporate faith – the pursuit of shareholder value, the use of stock options to motivate employees and a light regulatory touch allied with board oversight of management – are being blamed for the turmoil and look likely to be overhauled. “We are in uncharted waters,” says Jack Welch, the former General Electric boss who embodied an era when the untrammelled interplay of market forces, domineering chief executives and the laser-like focus on quarterly earnings rises reigned supreme.

EUROPEAN INDUSTRY:

‘I hope some of the lecturing will die down now’

European business got through previous crises with a mixture of restructuring, denial and government intervention, writes Richard Milne. A similar outcome seems likely from this crisis even if the speed and scale of the downturn are testing companies as never before.

Take German private engineering companies, renowned for conservatism, which even in the middle of last year were bullish and saw their orders rising by 2 per cent. By November the monthly growth was minus 30 per cent; by January minus 42 per cent. Now, the groups are cutting jobs, investment and fighting for survival – as they are across Europe.

For many big European companies, the most significant event in the last decade was the shift in ownership from governments or other national companies to private, often foreign, shareholders. This has seen a big rise in stakes held by US and UK investors, leading in turn to a broad push for more “Anglo-Saxon” corporate policies, as many continental Europeans call them.

According to Gerhard Cromme, chairman of Siemens, foreign capital “revolutionised the way Germans do business”. Across Europe, companies were forced to adopt more shareholder-friendly strategies and boards came under pressure over corporate governance issues, prompting investor revolts at the likes of Eurotunnel, the channel tunnel operator, and Deutsche Börse, Germany’s stock exchange. Financing arrangements changed as local lenders proved less willing to prop up domestic groups and foreign banks flooded in.

How much of that is now likely to be rolled back? Already – as in most parts of the world – the state is more active, both in taking stakes in companies and prodding them to do what the authorities would like, such as a French suggestion that carmakers should close no domestic factories. Foreign lenders have withdrawn from many countries and banks are being encouraged to lend locally again.

Restructuring is likely to be a dominant theme, with millions of jobs to be cut as profits slide. The question is how radical that restructuring will be. Although the automotive industry may be prime among those needing a shake-out, government support could stymie that. “I am worried that a lesson could be just that ‘you are too big to fail’, like Opel [General Motors’ European arm], rather than ‘you are too good to fail’,” says a director of one carmaker. But big names will still disappear across the continent, as Woolworths has from UK retailing.

Strategy will be made with an eye not just on shareholders but also on what governments and workers want. Wendelin Wiedeking, chief executive of Germany’s Porsche, hopes the days of shareholders seeking to tell companies what to do are over: “Nobody’s system is perfect but hopefully some of the lecturing will die down now.”

The UK is also showing signs of a change. Jeremy Darroch, chief executive of BSkyB, the broadcaster controlled by Rupert Murdoch’s News Corporation, accepts that short-term financial return is not all. In almost continental European terms, he adds: “I think that means having a focus on our customers, it means having a focus on our employees and it means having a focus on the broader stakeholder groups.”

Corporate governance improvements could, however, be reversed. “There is a danger that corporate governance slips down the agenda,” says Hans Hirt of Hermes, the influential UK investor. Others fret that state intervention could slow the internationalisation of boards that Europe needs, leading instead to more national appointees.

Hubertus von Grünberg, chairman of ABB, the Swiss industrial group, fears a time of “Eurosclerosis” in which businesses muddle through rather than reinvent themselves. “Europe, instead of finding something new to get out of the crisis like the US and Asia will do, could in fact go backwards.”

If, as it has become painfully apparent, the value system and operating principles that informed the corporate psyche since at least the end of the cold war were found wanting, what should replace them?

Business leaders are by instinct glass-half-full type of people but, this time, few believe their companies’ future lies in their own hands. The financial sector’s role in causing the shocks that have jolted the world economy has had a big side-effect: the debate on the future of corporate governance is no longer confined to the boardroom. Stakeholders ranging from trade unions to activist investors and government itself are claiming the right to draw the boundaries of a new corporate order. In the words of one union leader: “The time for corporate dictatorships is over. This is our time.”

Such pressure, combined with an internal reassessment of companies’ priorities precipitated by the crisis, is starting to crumble one of the cornerstones of the previous corporate edifice: the cult of shareholder value.

Since Mr Welch made the concept famous in a speech at New York’s Pierre Hotel in 1981, the short-term goal of rewarding shareholders by increasing profits and dividends every quarter has become a mantra for companies around the world. With the share price of GE and other shareholder-focused companies soaring, executives from all over the world took up the credo Alfred Rappaport spelt out in his 1986 book, Creating Shareholder Value: “The ultimate test of corporate strategy, the only reliable measure, is whether it creates economic value for shareholders.”

Fund managers encouraged this attitude, as pressure from their own quarterly reviews addicted them to the periodic improvements in earnings and stock prices promised by the prophets of shareholder value.

Today, that focus on the here and now is seen as a root cause of the world’s economic predicament. “Immediate shareholder value maximisation, by itself, was always too short-term in nature,” says Jeffrey Sonnenfeld at Yale School of Management. “It created a fleeting illusion of value creation by emphasising immediate goals over long-term strategies.” Even Mr Welch argues that focusing solely on quarterly profit increases was “the dumbest idea in the world”. “Shareholder value is a result, not a strategy,” he says. “Your main constituencies are your employees, your customers and your products.”

Like many other business figures, Mr Welch wants the task of charting a new course away from short-termism to fall to directors and executives. But unions, regulators and government authorities argue that a drive for change led by the same corporate elite that helped bring about the turmoil would not remove the contradictions that undermined the previous regime. “We don’t feel companies should be run in the interest of short-term investors and executives who are hell-bent on making a killing regardless of the risks and leave taxpayers and real long-term holders to pick up the pieces,” says Damon Silvers at the AFL-CIO, the US union federation.

Unions and “socially responsible” investors argue that the focus on short-term profits should be replaced not just by long-term strategic thinking but also by attention to issues such as the environment and the needs of customers and suppliers. The corporate social responsibility movement, on the rise before the crisis, is likely to receive fresh impetus from an investor recognition that companies’ narrow search for profits was not always the best strategy.

Many business leaders object to what they regard as the growing encroachment by the state and other interest groups on their ability to run the company. “If there is a danger in the current situation, it is that we don’t know how to exit from this little adventure in socialism so that the private sector can do what it does best – which is to innovate, grow and create job,” says John Castellani, president of the Business Roundtable, the lobby group for some of America’s largest companies.

But the arrival of President Barack Obama at the White House on the heels of a Democratic majority in Congress has, coupled with increased public antipathy towards plutocrats, already resulted in big wins for unions and other campaigners. Reforms that activist investors had demanded for years without much success, such as an (albeit non-binding) annual vote on executive pay, have already been approved by Congress. Others such as “proxy access” – the right for shareholders to nominate candidates to the board and vote down underperforming directors – are on the way, while the bonus caps imposed on the banks that took government funds have sent chills down many an executive spine.

These moves give campaigners new ammunition in the first big battle to reshape the rules of the business game: executive compensation. The failure of Wall Street’s high-risk, high-reward model is set to bring about change on two main fronts: top management’s pay and the use of stock options.

After years of soaring pay, business chieftains in America can expect to reap relatively meagre rewards in the coming years. As the downturn moved from Wall Street to Main Street, even companies that have not received federal aid, such as GE, FedEx and Motorola, have joined those on government life support in slashing top executives’ compensation.

Many are also re-examining the gap in pay between executives and other employees. In America, the discrepancy between the compensation of those at the top of the corporate tree and those further down the trunk has grown steadily for decades, reaching an estimated 275 times the average in 2007 and contributing to rising wealth inequality in the country.

A significant portion of the blame for rocketing executive remuneration and managers’ obsession with short-term goals is being pinned on stock options and other forms of incentive pay. Hitherto praised as a tool to align executive compensation with shareholders’ gains, options have been increasingly discredited for rewarding executives for stock market rises that have nothing to do with them. In banking, end-of-year awards of options and stock had the added drawback of remunerating staff well before the company or its shareholders could find out whether their bets had paid off.

Several banks have announced plans to claw back future bonuses from employees whose deals sour in later years. But the fallout from what one executive calls “an era of rewarding ourselves with other people’s money” will be felt beyond the financial sector. Regulators and investors look certain to strengthen the link between pay and long-term performance by introducing measures such as a ban on the sale of shares and options until after retirement, or even a straight pay cap.

Fred Smith, the founder and chief executive of FedEx, spoke for many corporate leaders in December when he predicted: “Some of the fantastic outsized gains that were offensive to people will be increasingly less likely. At board level ... things will not be looked at as costless to the shareholders.”

Boards themselves will be in the line of fire. The losses suffered by financial groups have exposed the belief that directors were the knowledgable guardians of shareholders’ interests as a fallacy – one that will not be lost on angry investors and fee-hungry lawyers. As a result, the composition of boards is likely to change dramatically.

Russell Reynolds, the doyen of American headhunters, says directors will have to be both more knowledgeable and more selfless. “Gone are the days when directors played a good game of golf but did not understand the risk-reward ratio of the business,” he says. “And yet the current environment calls for people who can devote time to the business for relatively little pay. It is almost a charitable act.”

Investors such as Bob Pozen, who runs MFS Investment Management, believe that listed companies’ boards should become more like their private equity-owned rivals: smaller, nimbler and more competent. “The directors on those boards have the expertise, the time and the incentive to fully understand the company’s issues,” he says.

Jeffrey Immelt, who has presided over a fall of about three-quarters in the price of GE’s shares since succeeding Mr Welch in 2001 and this week saw the removal of its triple A credit rating by Standard & Poor’s, recently lamented: “Anybody could run a business in the 1990s. A dog could have run a business.”

Unfortunately for Mr Immelt and his contemporaries, these are not the 1990s and nor are they like the several years that followed. As business structures that were thought to be indestructible collapse in the meltdown, the corporate sector will have to give up a lot more than first-class seats.

Additional reporting by Justin Baer



Copyright The Financial Times Limited 2009


The Future of Capitalism

Read the big four to know capital’s fate

By Paul Kennedy
Published: March 12 2009 20:42 | Last updated: March 12 2009 20:42



US presidents, in confronting crises, have often let it be known that they are serious students of history and biography. George W. Bush, an unusually voracious late-night reader, devours books on the lives of Great Men, including his hero Winston Churchill, (who in turn liked to read about his illustrious ancestor, Marlborough). Barack Obama looks to biographies of Abraham Lincoln for inspiration.
Given the enormity of the banking, credit and trade crisis, might it be worth suggesting to Mr Obama and his fellow leaders that they study the writings of the greatest of the world’s political economists, instead? After all, we may be in such a grim economic condition that the clever direction of budgets is a greater attribute of leadership than the stout direction of battleships.
Since today’s leaders cannot possibly read all the major works of political economy, let us help them by selecting four of the greatest names from Robert Heilbroner’s classic collection The Worldly Philosophers : The Lives, Times, and Ideas of the Great Economic Thinkers: Adam Smith, the virtual founder of the discipline and early apostle of free trade; Karl Marx, that penetrating critic of the foibles of capitalism, and less reliable predictor of its “inevit-able” collapse; Joseph Schumpeter, the brilliant and unorthodox Austrian who was certainly no foe of the capitalist system but warned of its inherent volatilities (its “perennial gale of creative destruction”); and that great brain, John Maynard Keynes, who spent the second half of his astonishing career seeking to find policies to rescue the same temperamental free-market order from crashing to the ground.
Perhaps the supremely gifted playwright Tom Stoppard could put those four savants on stage and offer an imaginary weekend-long quadrilateral discourse among them about the future of capitalism. Failing such a creative work, what might we imagine the four great political economists would say about our present economic crisis?
Smith, one imagines, would claim that he had never advocated total laissez faire, was appalled at how sub-prime loans to fiscally insecure people contradicted his devotion to moral economy, and was concerned at the deficit spending proposed by many governments. Marx would still be badly bruised by learning of Lenin and Stalin’s perversion of his communistic theories, and by the post-1989 withering-away of most of the world’s socialist economies; yet he might still feel pleasure at modern financial capitalism foundering on its contradictions. The austere Schumpeter, by contrast, might be lecturing us to swallow another decade of serious depression before a newer, leaner form of capitalism emerged again, though with lots of evidence of severe gale-damage (the end of the US car industry, the decline of the City of London, perhaps) in its wake.
And Keynes? My own guess is that he would not be very happy at today’s state of affairs. He might (only might) regard it as fine that he was quoted or misquoted millions of times in today’s media, but one suspects that he would be uneasy at parts of Mr Obama’s deficit-spending scheme: at the US Treasury’s proposal to allocate more money to buying bad debts and rescuing bad banks than investing in job creation; at a Washington spending spree that seems unco-ordinated with those of Britain, Japan, China and the rest; and, most unsettling of all, at the fact that no one is asking who will purchase the $1,750bn of US Treasuries to be offered to the market this year – will it be the east Asian quartet, China, Japan, Taiwan and South Korea (all with their own catastrophic collapses in production), the uneasy Arab states (yes, but to perhaps one-tenth of what is needed), or the near-bankrupt European and South American states? Good luck! If that colossal amount of paper is bought this year, who will have ready funds to purchase the Treasury flotations of 2010, then 2011, as the US plunges into levels of indebtedness that could make Philip II of Spain’s record seem austere by comparison?
In the larger sense, of course, all four of our philosophers would be correct. Capitalism – our ability to buy and sell, move money around as we wish, and to turn a profit by doing so – is in deep trouble. No doubt Smith, as he watches the collapse of Iceland and the Irish travails, is reconsidering his aphorism that little else is needed to create a prosperous state than “peace, easy taxes and tolerable administration of justice” – that did not work this time. By contrast, rumbles of satisfaction might be heard coming from Marx’s grave in Highgate cemetery, causing excitement for the still-considerable numbers of Chinese visitors. Meanwhile, Schumpeter will have due cause to mutter: “This is not a surprise, really.” As for Keynes, we might imagine him sipping tea with Wittgenstein at Grantchester meadows, pursing his lips at the incapacity of merely normal human beings to get things right: at our tendency to excessive optimism, our blindness to the signs of economic over-heating, our proneness to panic – and our need, every so often, to turn to clever men like himself to put the shattered Humpty-Dumpty of international capitalism back together again.
All these political economists instinctively recognised that the triumph of free-market forces – with the consequent elimination of older social contracts, the downgrading of the state over the individual, the end of restraints upon usury – would not only bring greater wealth to many but could also produce significant, possibly unintended consequences that would ripple through entire societies. Laissez faire, laissez aller was not only a call to those chafing under medieval, hierarchical constraints; it was also a call to unbind Prometheus. Logically, it both freed you from the chains of a pre-market age, and freed you to the risks of financial and social disaster. In the place of Augustinian rules came Bernie Madoff opportunities.
By the same instinctive reasoning, most sensible governments since Smith’s time have taken precautions against citizens’ totally unrestricted pursuit of private advantage. States have invoked the needs of national security (therefore you must protect certain industries, even if that is uneconomic), the desire for social stability (therefore do not allow 1 per cent of the population to own 99 per cent of its wealth and thus provoke civil riot), and the common sense of spending upon public goods (therefore invest in highways, schools and fire-brigades). In fact, with the exception of the few absurdly communist states such as North Korea, all of today’s many political economies lie along a recognisable spectrum of more-free-market versus less-free-market arrangements.
But what has happened over the past decade or more is that many governments let down their guard and allowed nimble, profit-seeking individuals, banks, insurance companies and hedge funds much greater scope to create new investment schemes, leverage more and more capital on the basis of increasingly thin real resources and widen dramatically the pool of gullible victims (silly, under-earning individuals, hopeful not-for-profits, Jewish charities, friends of a friend of an investment manager, the list is long), thereby creating our own era’s spectacular equivalent of the South Sea Bubble. As in all such gigantic credit “busts”, many millions more people – the innocent as well as the foolish – will be hurt than the snake-oil salesmen and loan managers who perpetrated these so-called “wealth creation” schemes.
What, then, is capitalism’s future? Our current, damaged system is not, despite Marx’s hopes, to be replaced by a totally egalitarian, communist society (such arrangements might be there in life after death). Our future political economy will probably not be one in which Smith or his present-day disciples could find much comfort: there will be a higher-than-welcome degree of government interference in “the market”, somewhat larger taxes and heavy public disapprobation of the profit principle in general. Schumpeter and Keynes, one suspects, will feel rather more at home with our new post-excess neocapitalist political economy. It will be a system where the animal spirits of the market will be closely watched (and tamed) by a variety of national and international zookeepers – a taming of which the great bulk of the spectators will heartily approve – but there will be no ritual murder of the free-enterprise principle, even if we have to plunge further into depression for the next years. Homus Economicus will take a horrible beating. But capitalism, in modified form, will not disappear. Like democracy, it has serious flaws – but, just as one find faults with democracy, the critics of capitalism will discover that all other systems are worse. Political economy tells us so.
The writer is professor of history and director of International Security Studies at Yale University, is the author/editor of 19 books, including The Rise and Fall of the Great Powers (Vintage). He is writing an operational history of the second world war. To join the debate go to www.ft.com/capitalismblog







































The audacity of help

By Chrystia Freeland
Published: March 11 2009 20:40 | Last updated: March 11 2009 20:40

On inauguration day, after the euphoric mass celebration on the Mall and before the black-tie balls that evening, leading Democrats gathered for dinner in Washington’s Park Hyatt Hotel. It was a crowd including Paul Volcker, former head of the Federal Reserve, Lawrence Summers, incoming head of the National Economic Council, and three future cabinet secretaries.
But the first person to speak was the last Democratic occupant of the Oval Office – Bill Clinton. And in his brief comments the former president sketched a passionately optimistic view of the political implications of the current crisis. “We are at a pivotal moment in this country,” the politician who taught the American left how to win elections in the age of Ronald Reagan exulted. “I think there will be a progressive majority in this country for the next 30 years.”
For the Main Street families losing their homes and their jobs, and for the Wall Street firms that have been facing collapse, the economic crisis has felt like a natural disaster. The economy, as the investor Warren Buffett put it this week, seems to have “fallen off a cliff”. But Mr Clinton urged his listeners to perceive in the cataclysm a once-in-a-lifetime chance. President Barack Obama and his administration have “an enormous opportunity”, he said with a note of wistfulness. “They will have more freedom to do it than any other team in a long time.”
After barely 50 days in office, it is clear the administration perceives the watershed identified by Mr Clinton and intends to exploit it. This determination to turn the world’s deepest economic downturn since the Great Depression into the beginning of a new era of progressive politics in America is the most important political consequence – and the biggest political gamble – of the crisis of capitalism in capitalism’s homeland.
Rahm Emanuel, the president’s chief of staff, likes to say that a crisis is a terrible thing to waste. Mr Obama, characteristically, provides a more stirring spin. Beginning with his inaugural address, he served notice that he intended to be a consequential president, rebutting future critics even as he laid out his plans: “There are some who question the scale of our ambitions – who suggest that our system cannot tolerate too many big plans ... What the cynics fail to understand is that the ground has shifted beneath them ... The question we ask today is not whether our government is too big or too small but whether it works.”
The echo of Reagan – remember when government was the problem and not the solution? – is meaningful and intentional. Early in the primary fight, Mr Obama ruffled Clintonian feathers by naming Reagan as the most significant president of modern times. Mr Obama hopes to have a similar impact. According to former Reagan staffers, the Obama team has gone so far as to get in touch with detailed questions about the mechanics of the Gipper’s White House and how they choreographed his first 100 days.
Nor is it just the hope-drenched Obama-ites who see in the economic downturn a chance to change America’s political weather. Grizzled Democratic warriors see the opportunity, too. “I have been in government for 35 years and this is the most exciting time. You really feel you are making history,” says Charles Schumer, New York’s senior senator. “In every generation there are tectonic elections which redefine the role of government. Obama has a chance to create a new generation of Democrats.”
“I have never seen a shift in public opinion like the one we’ve had now,” agrees Barney Frank, the influential congressman. Mr Frank believes the long era of “Republican ascendancy”, which he dates to Richard Nixon’s election in 1968, has been replaced by a period of Democratic dominance.
Republicans, too, admit their era of setting the terms of the political debate has come to an end. “The only question is whether the Obama era lasts two years, four years, or eight years,” says Newt Gingrich, the former House of Representatives speaker who is re-emerging as powerful intellectual force in the party. “The question is whether this is a new era or an interregnum.”
The Obama era, if that is what it becomes, will be built on the two defining political and economic shifts of the past six months: the evident and acknowledged failure of “market fundamentalism” and the response by Hank Paulson as Treasury secretary.
Ideologically, the manifest failure of market fundamentalism is the starting point. There are, to be sure, some hardcore Republican hold-outs: Mr Gingrich argues that the current crisis “is a government problem, not a market problem”. But the consensus view is that, as Alan Greenspan, former Fed chairman, confessed in his influential congressional testimony in October, there was a “flaw” in the model.
Mr Summers, a strong defender of free markets, likewise has concluded: “The view that the market economy is inherently self-stabilising, always, has been dealt a fatal blow ... This notion that the economy is self-stabilising is usually right, but it is wrong a few times a century and this is one of those times.”
The central political consequence of this market failure, Mr Summers says, is that there “is a need for extraordinary public action at those times”. As he put its: “The debate over whether you can love your country and hate your government has been settled with a negative answer.” This rehabilitation of intervention in the economy as not just acceptable but essential is the second foundation for Mr Obama’s new progressive agenda.
Usefully for the Democrats, it was the outgoing administration that brought the state back in with a vengeance. “Paulson is the champion nationaliser of all times. He managed more nationalisation than any man on the planet,” says Fred Bergsten, director of the Peterson Institute for International Economics. “It is maybe a bit of protection for Obama.”
Mr Paulson said his purpose was to save capitalism. Mr Obama wants to do much more than that. Over the past few weeks, he has unveiled a sweeping progressive agenda aimed not merely at sorting out the market economy’s travails but addressing a deeper failing in the current manifestation of American capitalism. That flaw, in his view, is the rising income inequality and median wage stagnation of the past three decades – it is this central idea that unites his ambitious project.
. . .
Education, one of Mr Obama’s three main initiatives, is all about fixing what economists identify as a leading cause of income inequality. Healthcare reform, the president’s second big initiative, would lighten one of the main burdens on the falling-behind middle class.
Only energy and environmental reform, his third mission, is not directly connected to income inequality – but, as with the other two, its proposed financing is built on the view that income inequality is a central fact of America today. Mr Obama unapologetically advocates a shift to a more redistributive tax system: he wants the very rich to pay for the programmes that he hopes will alleviate the stagnation of wages of those in the middle.
Campaigning on class has long been political poison for the Democrats. As recently as the Democratic primaries, economic inequality did not seem to work as a central campaign theme. Americans’ reluctance to vote according to their apparent class interests became a truism of politics and a source of considerable hand-wringing on the left. In What’s the Matter with Kansas? Thomas Frank attributed it to the right’s skill at playing up cultural issues. George Soros, the hedge fund manager and active Democrat, says it was because Americans, unlike Europeans, did not envy the super-rich – they hoped to emulate them.
The credit crunch exposed a more hard-nosed reason for the political quiescence of the stagnant middle class. As is now being discovered, the era of cheap money allowed families to consume far more than they produced. All of those home equity loans, vendor-financed car deals and credit card purchases may have masked the reality that real incomes were falling behind.
The financial crisis has turned that old political logic upside down. As the recession deepens, cultural issues pale in significance next to economic ones. Public anger towards Wall Street – late-night comedians have taken to calling for Chinese-style public executions – has transformed the Masters of the Universe from heroes to villains. The end of cheap credit seems meanwhile to have shattered middle America’s illusion that it too was partaking in the prosperity of the second Gilded Age.
The result is that class and redistribution are no longer dirty words in American politics. “John Kerry [the 2004 Democratic presidential candidate] was intimidated out of talking about economic redistribution because it was class warfare,” says congressman Frank. Now, by contrast, “people are very aware that in the good times they weren’t getting any, that income maldistribution greatly increased”.
This shift may be why the right’s most strident criticisms of the new president – that Mr Obama is a “socialist” or even a “Manchurian candidate” with a secret plot to destroy capitalism – are making little headway with the public. Instead, the accusations underscore an important and little-noted aspect of the American left’s reaction to the crisis: for all the bold reach of the progressive agenda Mr Obama has laid out, neither the president nor anyone in the Democratic mainstream is challenging the tenets of the market economy. Indeed, the Democratic White House has been more allergic to the idea of nationalising banks than have some leading Republicans.
At a time when historical analogies are popular, one anniversary is not much talked about in the US: the fall of the Berlin Wall 20 years ago. But even as it goes largely unacknowledged, the collapse of communism is helping to define the debate about the most significant crisis of capitalism in 80 years. During the Great Depression it was possible for some American progressives to look to the Soviets and wonder whether they had it right. Today, that option does not even get a hearing.
Mr Obama, the most ambitious president since Reagan, is determined to use this pivotal moment to advance an agenda on income inequality he began to talk about before the credit crunch began. But even as he lays out bold – many would say too bold – plans for the long term, he and his team recognise that their first and necessary step is to patch up America’s faltering capitalist engine. According to Mr Summers: “It is periodically the task of progressives to, ironically, save the market system from its own excesses.”














The Future of Capitalism

Agitation as middle-class Europe struggles to cope

By John Thornhill
Published: March 11 2009 21:40 | Last updated: March 11 2009 21:40


Economics is convulsing European politics. Governments have fallen in Iceland and Latvia; strikes or protests have erupted in Greece, Ireland, France, Germany, Britain, Lithuania, Ukraine and Bulgaria. Financial turmoil has shaken even the continent’s furthest-flung outposts: the French Caribbean island of Guadeloupe has been ravaged by violent strikes, while Russia flew riot police into ice-bound Vladivostok to quell street protests.
This spasm of unrest was hardly expected when the crisis broke in the summer of 2007: many Europeans believed they would be spared the worst effects of a disaster forged in the suburbs of the US. Since then, as the crisis has spread, initially sanguine forecasts have given way to ever more gloomy predictions: European Union finance ministers this week revised down an already grim outlook issued barely 10 weeks ago.

Beyond the economics, there is now a gnawing concern that Europe may be only at the beginning of a far more tumultuous cycle of instability. Whereas the administration of Barack Obama in the US may be looking to exploit the political upside of the crisis, Europe’s leaders are more concerned with limiting its downside. The region’s democracies, as well as the institutions of the EU itself, are being stress-tested as never before.
The proudest achievements of the 27-member organisation – a single market, a common currency and the convergence between west and east – are under strain. “There is no doubt we are living through the greatest financial and economic crisis in living memory,” says José Manuel Barroso, president of the European Commission. As governments take often unpopular action to salvage their economies, anger is mounting as a result of rising unemployment, pay curbs, bail-outs for devastated banks and falls in house prices and the value of pension funds.
Juan Somavia, director-general of the International Labour Organisation, a United Nations agency, has warned that social unrest could worsen if stimulus packages are not seen to benefit ordinary people, saying: “There’s a sense that it’s ‘billions for bankers but pennies for the people’.”
For the moment, it is impossible to predict what the political aftershocks of the economic earthquake will be. The left should be the natural beneficiary. Yet many of Europe’s socialist parties seem more concerned with defending the partisan interests of their supporters rather than devising a holistic response. Trade union leaders recall ominously that it was the far right rather than the moderate left that gained power in much of Europe in the 1930s during the last catastrophe of capitalism.
Some observers, such as Emmanuel Todd, a French sociologist, are predicting the end of democracy, or at least its significant erosion, as populist rightwing leaders including Silvio Berlusconi, Italy’s prime minister, and French President Nicolas Sarkozy become increasingly demagogic and authoritarian. Others forecast a reversion to nationalism and protectionism as countries abandon the European ideal and look to defend their own.
In this view, the EU may increasingly be seen as part of the problem rather than the solution, the “Trojan horse of globalisation” in the words of Mr Sarkozy. Along with other national leaders, he has been spearheading the response to the crisis, leaving Brussels bureaucrats to fret about infringements to state aid and competition rules and the trashing of the eurozone’s fiscal rules.
But in spite of heated rhetoric, the national political impulse and the traditional muddle of EU policy, the bloc’s political leaders have not yet broken ranks over the sanctity of the single market or the imperative of collective action. After a hesitant start, the Commission is taking the initiative in developing pan-European financial regulation and helping the most vulnerable member states. It is still possible that the crisis will result in deeper integration rather than disintegration.
Different countries are responding in different ways depending on the vulnerability of their economies, their political systems, their leaders and their national cultures. Yet one feature common to almost all is that it is the middle classes who are suffering the most in this recession. Even before the turmoil, some sociologists were talking about the emergence of “hourglass societies” in Europe as globalisation sifted the winners from the losers.
“The middle class – at least in Germany – is shrinking now. This is a completely new situation for Germany. You have much more upward mobility and downward mobility from the middle class. I assume that the financial crisis will accelerate the process,” notes Stefan Hradil, a German sociologist. That analysis is resonant in Britain too, where the media have highlighted the plight of the “coping classes”, those once self-assured professionals who are now financially stretched.
Perhaps the most explosive political moment will come when Europeans are presented with the bill for today’s rescue packages. Governments will be able to rebalance their public finances only by cutting spending and raising taxes on the struggling middle class.
Wouter Bos, Dutch finance minister and leader of the Labour party, says the crisis has killed the myth of “happy” globalisation, in which everyone benefits. Politicians will have to do more to protect the losers from globalisation if they want to maintain support for open markets and free trade. That will mean that the “visible fist” of government will be increasingly used alongside the “invisible hand” of the market. Effective regulation and social justice are going to become priorities.
But Mr Bos has no doubt about the scale of the challenge: “For the first time in post-world war two history we have a generation that seriously doubts whether the next generation is going to live better than themselves.”
Additional reporting by Hugh Williamson






















A survival plan for global capitalism

Published: March 8 2009 18:28 | Last updated: March 8 2009 18:28

J.K. Galbraith wrote that 1929 stood alongside 1066, 1776, 1914, 1945 and 1989 in its importance. The world today was shaped by the efforts of governments to overcome the economic meltdown of the 1930s – and the consequences of their failures. Even if this economic crisis is not as bad as the Great Depression, it will have epoch-moulding consequences. This week the Financial Times starts a series on the Future of Capitalism. Much, however, depends on the success of next month’s meeting of the Group of 20 in London and how successful governments are at ending this worldwide crisis.
The intellectual impact of the crisis has already been colossal. The “Greenspanist” doctrine in monetary policy is in retreat. It no longer seems clear that it is easier for central banks to clean up after asset price bubbles burst than to prick them when they are small. Monetary authorities will need to be more concerned both about financial stability and global imbalances which allowed a few countries to build up vast surpluses while a few others ran yawning deficits.
Finance has already changed irrevocably. The grand investment banks which once strode alone have either collapsed, or joined the flock of retail banks. Governments are now borrowers, lenders, investors and insurers of last resort for much of the financial system. The future of finance will be determined by their efforts to disentangle themselves from the thickets of guarantees they have been forced to make. The depth of the crisis will determine how easily they manage it.
The fiscal cost of this episode is unclear. In some countries, it may be state-busting. Some nations will need to cope with extraordinary fiscal tightenings in the coming years. The domestic impact of government spending – and its geopolitical ramifications – could yet be colossal. Again, much depends on how soon the downturn ends.
There is one certainty. While recessions are inevitable, deep depressions or slumps – or whatever you call them – are neither necessary nor welcome. They destroy wealth, sap happiness and crush old certainties. What is more, increasing poverty is a grave threat to world stability and democracy. Revolutions often start as bread riots, and economically-stagnant countries make belligerent neighbours. Growth must be restarted.
In 1933, during the last comparable fight to restart the world economy, 66 governments met in London with tariffs and hackles raised. Franklin Roosevelt, newly-elected as US president, sent delegates to the “Economic and Monetary Conference”. But rather than being a staging post for recovery, the conference collapsed. The London G20 meeting must not suffer the same fate. Participants must agree on three points.
First, world demand is in freefall. Stimulus is necessary. The surplus countries with the most leeway to increase domestic spending – Japan and Germany, in particular – are not yet doing enough. They can afford to encourage serious spending and are, in any case, suffering the steepest contractions. In addition, if these habitual exporters were to become serious importers, it would be politically easier to hold back protectionism.
Second, governments must take responsibility for dealing with their financial systems. The toxicity which started in mortgage-backed securities is spreading through the world’s banks as ever more assets go bad in the recession. Politicians must make sure that their banking systems are adequately capitalised and deal with the illiquid securities at the heart of this crisis.
Third, governments must agree to put aside more money for the International Monetary Fund. The recession would enter a new, dreadful chapter if a rash of financial crises broke out across eastern Europe, Asia or South America. The fund’s current funds are clearly inadequate. The idea of a large issuance of SDRs – the IMF’s own reserve asset – is an excellent one. Changes in voting-weights, to raise Asia’s share and lower Europe’s, are also both inevitable and desirable.
What matters is that there is agreement on these three issues so that politicians – even those in weak governments, as in Japan – are given the political cover to do what is necessary. A united front is, therefore, essential. Big questions about the shape of the broad future of the world economy can wait until we are certain that there is a future for globalisation. An impartial commission could be appointed to mull them over. If spats over minutiae – such as the regulation of tax havens or bankers’ pay – were to stand in the way of a deal, the verdict of history would be damning. Electorates are unlikely to be more forgiving. The aim now is simple: end this brutal recession.

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The consequence of bad economics

Published: March 9 2009 20:23 | Last updated: March 9 2009 20:23

As a shell-shocked world tries to fathom how its economic collapse happened, commentators are busily outbidding each other with claims about the exceptional nature of this crisis. But the most astounding fact is how familiar its physiognomy and physiology look compared to past financial crashes.
No one can read the chronicles of those earlier crashes without sensing – with a chill – that history is repeating itself. The story of the modern capitalist economy is a rhythmic repetition of cycles, syncopated by eerily similar crises. These crises, while their details differ, are but variations on the same theme. Easy money, geared up by leverage, floods the financial system through innovative products. This simultaneously pumps up asset prices and obscures their speculative nature, with euphoria usurping the place of analysis. Until, one day, something triggers a loss of confidence in the continued rise of prices, and the whole leveraged edifice crumbles.
Today’s collapse has followed the same pattern – as outlined on Tuesday in the FT’s series on the future of capitalism. Easy money came from global macroeconomic imbalances that generated enormous capital inflows into deficit countries. Those flows helped drive interest rates down and increase access to credit, fuelling a leveraged asset bubble. Many leaders in the affected countries – in particular the US – knew this: Alan Greenspan himself spoke of “irrational exuberance”. And yet they did not understand how they had to act to prevent a replay of the past.
Today’s disastrous outcome is testimony to those leaders’ intellectual failure. Most fundamentally to blame is their unwillingness to see (or their wilful ignorance of) what markets need in order to produce good outcomes for society.
Every first-year economics student learns the conditions for an unregulated market, in theory, to function efficiently. The most important are full information, enforceable property rights and contracts, and the absence of “externalities” – effects of economic transactions on third parties. These conditions are never fulfilled, but many markets come close enough that participants’ self-interested actions achieve good outcomes for all.
When these conditions are absent, markets malfunction; the way they do so is one of the great topics of economic theory. It tells those who care to listen that when a market is too opaque, or when the effects of market transactions are too inter-dependent, the pursuit of self-interest can make everyone worse off, or unfairly land some with the losses caused by others, or – in extremis – make markets disappear altogether. Nowhere are these problems greater than in financial markets.
Finance expands our economic possibilities by enabling us to shift funds between the present and the future, and between different outcomes of risky ventures. For that reason, confidence in future values is everything for a financial product: if confidence is lost, the market collapses. But in a non-transparent financial sector, unwarranted valuations will often occur, which, when they fail, can destroy confidence throughout the financial system. And the more implicated the economy is in the financial sector, the wider are the repercussions of such dysfunctions – to the point where financial failures can threaten the economic system as a whole.
Economic policymakers could have limited these dangers, but they did not do so. Instead, they allowed the bubble to inflate and let financial transactions become increasingly opaque and ever more leveraged. As in previous bubbles, value came to rely on the perception of value itself: growth pulling itself up by its own leveraged bootstraps. Many assets were not even priced through market trading but valued by complex formulas – akin to peddling tulips with equations.
People were not unaware of the risks, but both regulation and private risk management were based on the faulty premise that if each entity looks after its own risk, no one needs to worry about systemic risk. The great mistake was to rely merely on self-interest in as imperfect and as important a market as the financial sector. The huge profits bankers reaped reinforced their collective blindness to the illusory value of the assets they traded.
Those who sound the death knell of market capitalism are therefore mistaken. This was not a failure of markets; it was a failure to create proper markets. What is to blame is a certain mindset, embodied not least by Mr Greenspan. It ignored a capitalist economy’s inherent instabilities – and therefore relieved policymakers who could manage those instabilities of their responsibility to do so. This is not the bankruptcy of a social system, but the intellectual and moral failure of those who were in charge of it: a failure for which there is no excuse.

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Now is the time for a less selfish capitalism

By Richard Layard
Published: March 11 2009 20:02 | Last updated: March 11 2009 20:02

What is progress? The Organisation for Economic Co-operation and Development has been asking this question for some time and the current crisis makes it imperative to find an answer. According to the Anglo-Saxon Enlightenment, progress means the reduction of misery and the increase of happiness. It does not mean wealth creation or innovation, which are sometimes useful instruments but never the final goal. So we should stop the worship of money and create a more humane society where the quality of human experience is the criterion. Provided we pay ourselves in line with our productivity, we can choose whatever lifestyle is best for our quality of life.
And what would that involve? The starting point is that, despite massive wealth creation, happiness has not risen since the 1950s in the US or Britain or (over a shorter period) in western Germany. No researcher questions these facts. So accelerated economic growth is not a goal for which we should make large sacrifices. In particular, we should not sacrifice the most important source of happiness, which is the quality of human relationships – at home, at work and in the community. We have sacrificed too many of these in the name of efficiency and productivity growth.
Most of all we have sacrificed our values. In the 1960s, 60 per cent of adults said they believed “most people can be trusted”. Today the figure is 30 per cent, in both Britain and the US. The fall in trustworthy behaviour is clear in the banking sector but can also be seen in family life (more break-ups), in the playground (fewer friends you can trust) and in the workplace (growing competition between colleagues).
Increasingly, we treat private interest as the only motivation on which we can rely and competition between individuals as the way to get the most out of them. This is often counterproductive and does not generally produce a happy workplace since competition for status is a zero-sum game. Instead, we need a society based on positive-sum activities. Humans are a mix of selfishness and altruism but generally feel better working to help each other rather than to do each other down.
Our society has become too individualistic, with too much rivalry and not enough common purpose. We idolise success and status and thus undermine our mutual respect. But countries vary in this regard, and the Scandinavians have managed to combine effective economies with much greater equality and mutual respect. They have the greatest levels of trust (and happiness) of any countries in the world.
To build a society based on trust we have to start in school, if not earlier. Children should learn that the noblest life is the one that produces the least misery and the most happiness in the world. This rule should apply also in business and professional life. People should do work that is useful to society and does not just make paper profits. And all professions – including journalism, advertising and business – should have a clear, professional, ethical code that its members are required to observe. It is not for nothing that doctors form the group most respected in our society – they have a code that is enforced and everyone knows it.
So we need a trend away from excessive individualism and towards greater social responsibility. Is it possible to reverse a cultural trend in this way? It has happened before, in the early 19th century. For the next 150 years there was a growth of social responsibility, followed by a decline in the next 50. So a trend can change and it is often in bad times (such as the 1930s in Scandinavia) that people decide to seek a more co-operative lifestyle.
I have written a book about how to do this and there is room here for three points only. First we should use our schools to promote a better value system – the recent Good Childhood report sponsored by the UK Children’s Society was full of ideas about how to do this. Second, adults should reappraise their priorities about what is important. Recent events are likely to encourage this and modern happiness research can help find answers. Third, economists should adopt a more realistic model of what makes humans happy and what makes markets function.
Three ideas taught in business schools have much to answer for. One is the theory of “efficient capital markets”, now clearly discredited. The second is “principal agent” theory, which says the agents will perform best under high-powered financial incentives to align their interests with those of the principal. This has led to excessive performance-related pay, which has often undermined the motive to work well for the sake of doing a good job and introduced unnecessary tension among colleagues. Finally, there is the macho philosophy of “continuous change”, promoted by self-interested consulting companies, which disregards the fundamental human need for stability – in the name of efficiency gains that are often not realised.
We do not want communism – as research shows, the communist countries were the least happy in the world and also inefficient. But we do need a more humane brand of capitalism, based not only on better regulation but on better values.
Values matter and they are affected by our theories. We do not need a society based on Darwinian competition between individuals. Beyond subsistence, the best experience any society can provide is the feeling that other people are on your side. That is the kind of capitalism we want.

Lord Layard is at the London School of Economics Centre for Economic Performance. He has written ‘Happiness’ (2005) and co-authored ‘A Good Childhood’ (2009)

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Adam Smith’s market never stood alone

By Amartya Sen
Published: March 10 2009 20:15 | Last updated: March 10 2009 20:15



Exactly 90 years ago, in March 1919, faced with another economic crisis, Vladimir Lenin discussed the dire straits of contemporary capitalism. He was, however, unwilling to write an epitaph: “To believe that there is no way out of the present crisis for capitalism is an error.” That particular expectation of Lenin’s, unlike some he held, proved to be correct enough. Even though American and European markets got into further problems in the 1920s, followed by the Great Depression of the 1930s, in the long haul after the end of the second world war, the market economy has been exceptionally dynamic, generating unprecedented expansion of the global economy over the past 60 years. Not any more, at least not right now. The global economic crisis began suddenly in the American autumn and is gathering speed at a frightening rate, and government attempts to stop it have had very little success despite unprecedented commitments of public funds.
The question that arises most forcefully now is not so much about the end of capitalism as about the nature of capitalism and the need for change. The invoking of old and new capitalism played an energising part in the animated discussions that took place in the symposium on “New World, New Capitalism” led by Nicolas Sarkozy, the French president, Tony Blair, the former British prime minister, and Angela Merkel, the German chancellor, in January in Paris.
The crisis, no matter how unbeatable it looks today, will eventually pass, but questions about future economic systems will remain. Do we really need a “new capitalism”, carrying, in some significant way, the capitalist banner, rather than a non-monolithic economic system that draws on a variety of institutions chosen pragmatically and values that we can defend with reason? Should we search for a new capitalism or for a “new world” – to use the other term on offer at the Paris meeting – that need not take a specialised capitalist form? This is not only the question we face today, but I would argue it is also the question that the founder of modern economics, Adam Smith, in effect asked in the 18th century, even as he presented his pioneering analysis of the working of the market economy.
Smith never used the term capitalism (at least, so far as I have been able to trace), and it would also be hard to carve out from his works any theory of the sufficiency of the market economy, or of the need to accept the dominance of capital. He talked about the important role of broader values for the choice of behaviour, as well as the importance of institutions, in The Wealth of Nations ; but it was in his first book, The Theory of Moral Sentiments, published exactly 250 years ago, that he extensively investigated the powerful role of non-profit values. While stating that “prudence” was “of all virtues that which is most helpful to the individual”, Smith went on to argue that “humanity, justice, generosity, and public spirit, are the qualities most useful to others”.*
What exactly is capitalism? The standard definition seems to take reliance on markets for economic transactions as a necessary qualification for an economy to be seen as capitalist. In a similar way, dependence on the profit motive, and on individual entitlements based on private ownership, are seen as archetypal features of capitalism. However, if these are necessary requirements, are the economic systems we currently have, for example, in Europe and America, genuinely capitalist? All the affluent countries in the world – those in Europe, as well as the US, Canada, Japan, Singapore, South Korea, Taiwan, Australia and others – have depended for some time on transactions that occur largely outside the markets, such as unemployment benefits, public pensions and other features of social security, and the public provision of school education and healthcare. The creditable performance of the allegedly capitalist systems in the days when there were real achievements drew on a combination of institutions that went much beyond relying only on a profit-maximising market economy.
It is often overlooked that Smith did not take the pure market mechanism to be a free-standing performer of excellence, nor did he take the profit motive to be all that is needed. Perhaps the biggest mistake lies in interpreting Smith’s limited discussion of why people seek trade as an exhaustive analysis of all the behavioural norms and institutions that he thought necessary for a market economy to work well. People seek trade because of self-interest – nothing more is needed, as Smith discussed in a statement that has been quoted again and again explaining why bakers, brewers, butchers and consumers seek trade. However an economy needs other values and commitments such as mutual trust and confidence to work efficiently. For example, Smith argued: “When the people of any particular country has such confidence in the fortune, probity, and prudence of a particular banker, as to believe he is always ready to pay upon demand such of his promissory notes as are likely to be at any time presented to him; those notes come to have the same currency as gold and silver money, from the confidence that such money can at any time be had for them.”
Smith explained why this kind of trust does not always exist. Even though the champions of the baker-brewer-butcher reading of Smith enshrined in many economics books may be at a loss to understand the present crisis (people still have very good reason to seek more trade, only less opportunity), the far-reaching consequences of mistrust and lack of confidence in others, which have contributed to generating this crisis and are making a recovery so very difficult, would not have puzzled him.
There were, in fact, very good reasons for mistrust and the breakdown of assurance that contributed to the crisis today. The obligations and responsibilities associated with transactions have in recent years become much harder to trace thanks to the rapid development of secondary markets involving derivatives and other financial instruments. This occurred at a time when the plentiful availability of credit, partly driven by the huge trading surpluses of some economies, most prominently China, magnified the scale of brash operations. A subprime lender who misled a borrower into taking unwise risks could pass off the financial instruments to other parties remote from the original transaction. The need for supervision and regulation has become much stronger over recent years. And yet the supervisory role of the government in the US in particular has been, over the same period, sharply curtailed, fed by an increasing belief in the self-regulatory nature of the market economy. Precisely as the need for state surveillance has grown, the provision of the needed supervision has shrunk.
This institutional vulnerability has implications not only for sharp practices, but also for a tendency towards over-speculation that, as Smith argued, tends to grip many human beings in their breathless search for profits. Smith called these promoters of excessive risk in search of profits “prodigals and projectors” – which, by the way, is quite a good description of the entrepreneurs of subprime mortgages over the recent past. The implicit faith in the wisdom of the stand-alone market economy, which is largely responsible for the removal of the established regulations in the US, tended to assume away the activities of prodigals and projectors in a way that would have shocked the pioneering exponent of the rationale of the market economy.
Despite all Smith did to explain and defend the constructive role of the market, he was deeply concerned about the incidence of poverty, illiteracy and relative deprivation that might remain despite a well-functioning market economy. He wanted institutional diversity and motivational variety, not monolithic markets and singular dominance of the profit motive. Smith was not only a defender of the role of the state in doing things that the market might fail to do, such as universal education and poverty relief (he also wanted greater freedom for the state-supported indigent than the Poor Laws of his day provided); he argued, in general, for institutional choices to fit the problems that arise rather than anchoring institutions to some fixed formula, such as leaving things to the market.
The economic difficulties of today do not, I would argue, call for some “new capitalism”, but they do demand an open-minded understanding of older ideas about the reach and limits of the market economy. What is needed above all is a clear-headed appreciation of how different institutions work, along with an understanding of how a variety of organisations – from the market to the institutions of state – can together contribute to producing a more decent economic world.

*An anniversary edition of ‘The Theory of Moral Sentiments’ will be published by Penguin Books this year, with a new introduction in which I discuss the contemporary relevance of Smith’s ideas

The writer, who received the 1998 Nobel Prize in economics, teaches economics and philosophy at Harvard University. A longer essay by him on this topic appears in the current edition of The New York Review of Books
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