Ca ilalis111 in Crisis

Is Modern Capitalism Sustainable?
By Kenneth Rogoff

December 2, 2011
CAMBRIDGE - I am often asked if the recent global financial crisis marks the beginning of the end of modern capitalism. It is a curious question, because it seems to presume that there is a viable replacement waiting in the wings. The truth of the matter is that, for now at least, the only serious alternatives to today's dominant Anglo-American paradigm are other forms of capitalism. Continental European capitalism, which combines generous health and social benefits with reasonable working hours, long vacation periods, early retirement, and relatively equal income distributions, would seem to have everything to recommend it - except sustainability. China's Darwinian capitalism, with its fierce competition among export firms, a weak social-safety net, and widespread government intervention, is widely touted as the inevitable heir to Western capitalism, if only because of China's huge size and consistent outsize growth rate. Yet China's economic system is continually evolving. Indeed, it is far from clear how far China's political, economic, and financial structures will continue to transform themselves, and whether China will eventually morph into capitalism's new exemplar. In any case, China is still encumbered by the usual social, economic, and financial vulnerabilities of a rapidly growing lower-income country. Perhaps the real point is that, in the broad sweep of history, all current forms of capitalism are ultimately transitional. Modern -day capitalism has had an extraordinary run since the start of the Industrial Revolution two centuries ago, lifting billions of ordinary people out of abject poverty. Marxism and heavy-handed socialism have disastrous records by comparison. But, as industrialization and technological progress spread to Asia (and now to Africa), someday the struggle for subsistence will no longer be a primary imperative, and contemporary capitalism's numerous flaws may loom larger. First, even the leading capitalist economies have failed to price public goods such as clean air and water effectively. The failure of efforts to conclude a new global climate-change agreement is symptomatic of the paralysis. Second, along with great wealth, capitalism has produced extraordinary levels of inequality. The growing gap is partly a simple byproduct of innovation and entrepreneurship. People do not complain about Steve Jobs's success; his contributions are obvious. But this is not always the case:

great wealth enables groups and individuals to buy political power and influence, which in turn helps to generate even more wealth. Only a few countries - Sweden, for example - have been able to curtail this vicious circle without causing growth to collapse. A third problem is the provision and distribution of medical care, a market that fails to satisfy several of the basic requirements necessary for the price mechanism to produce economic efficiency, beginning with the difficulty that consumers have in assessing the quality of their treatment. The problem will only get worse: health-care costs as a proportion of income are sure to rise as societies get richer and older, possibly exceeding 30% of GDP within a few decades. In health care, perhaps more than in any other market, many countries are struggling with the moral dilemma of how to maintain incentives to produce and consume efficiently without producing unacceptably large disparities in access to care.
It is ironic that modern capitalist societies engage in public campaigns to urge individuals to be

more attentive to their health, while fostering an economic ecosystem that seduces many consumers into an extremely unhealthy diet. According to the United States Centers for Disease Control, 34% of Americans are obese. Clearly, conventionally measured economic growth- which implies higher consumption - cannot be an end in itself. Fourth, today's capitalist systems vastly undervalue the welfare of unborn generations. For most of the era since the Industrial Revolution, this has not mattered, as the continuing boon of technological advance has trumped short-sighted policies. By and large, each generation has found itself significantly better off than the last. But, with the world's population surging above seven billion, and harbingers of resource constraints becoming ever more apparent, there is no guarantee that this trajectory can be maintained. Financial crises are of course a fifth problem, perhaps the one that has provoked the most soulsearching oflate. In the world of finance, continual technological innovation has not conspicuously reduced risks, and might well have magnified them. In principle, none of capitalism's problems is insurmountable, and economists have offered a variety of market-based solutions. A high global price for carbon would induce firms and individuals to internalize the cost of their polluting activities. Tax systems can be designed to provide a greater measure of redistribution of income without necessarily involving crippling distortions, by minimizing non-transparent tax expenditures and keeping marginal rates low. Effective pricing of health care, including the pricing of waiting times, could encourage a better balance between equality and efficiency. Financial systems could be better regulated, with stricter attention to excessive accumulations of debt. Will capitalism be a victim of its own success in producing massive wealth? For now, as fashionable as the topic of capitalism's demise might be, the possibility seems remote. Nevertheless, as pollution,

financial instability. health problems. and was formerly chief economist at the IMF. and inequality continue to grow. Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University. . capitalism's future might not seem so secure in a few decades as it seems now. and as political systems remain paralyzed.

turmoil in the Middle East.Is Capitalism Doomed? By Nouriel Roubini August 15. Japan's earthquake and tsunami. which hold most of the increasingly shaky government paper. indeed. but it will be too little too late. and America's fiscal problems (and now its rating downgrade) have led to a massive increase in risk aversion. Then growth slumped to below 1% in the first half of 2011. the United States. Fiscal stimulus.The massive volatility and sharp equity-price correction now hitting global financial markets signal that most advanced economies are on the brink of a double-dip recession. Even in the US. and Japan are all idling." ring-fencing of bad debt. two rounds of" quantitative easing. their sovereign risk is actually fueling concern about the health of Europe's banks. Now they have run out of rabbits. Another round of bank bailouts is politically unacceptable and economically unfeasible: most governments. But the subsequent recovery has been anemic and sub-par in most advanced economies given painful deleveraging. state and local governments. Last year's $600 billion QE2 and $1 trillion in tax cuts and transfers delivered growth of barely 3% for one quarter. A financial and economic crisis caused by too much private-sector debt and leverage led to a massive re-leveraging of the public sector in order to prevent Great Depression 2. . Quantitative easing is constrained by above-target inflation in the eurozone and UK. QE3 will be much smaller. are cutting expenditure and reducing transfer payments. Now a combination of high oil and commodity prices. 2011 NEW YORK . and trillions of dollars in bailouts and liquidity provision for banks and financial institutions: officials tried them all. emerging Asia. eurozone debt crises. and Latin America). near-zero interest rates. the eurozone. Nor could monetary policy help very much. they will be raising taxes. and will do much less to reflate asset prices and restore growth.0. The US Federal Reserve will likely start a third round of quantitative easing (QE3). and export-oriented economies that rely on these markets (Germany and resource-rich Australia). are so distressed that bailouts are unaffordable. especially in Europe. Economically. Until last year. Fiscal policy currently is a drag on economic growth in both the eurozone and the UK. and now the federal government. the United Kingdom. policymakers could always produce a new rabbit from their hat to reflate asset prices and trigger economic recovery. Even fast-growing emerging markets (China. Soon enough. are experiencing sharp slowdowns.

lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks. breaking up too-big-to-fail banks and oligopolistic trusts. So relying on exchange rates to influence trade balances is a zero-sum game. reduction of the debt burden for insolvent households and other distressed economic agents. But cutting jobs reduces labor income. Both are broken. unless the EFSF pot were tripled . and stricter supervision and regulation of a financial system run amok. poverty. with Japan and Switzerland engaging in early battles to weaken their exchange rates. and hopelessness. and redistribution of income and wealth from labor to capital could lead capitalism to selfdestruct (though his view that socialism would be better has proven wrong). too.the only option left would become an orderly but coercive restructuring of Italian and Spanish debt. Italy and Spain are now at risk oflosing market access. Currency wars are thus on the horizon.are all driven by the same issues and tensions: growing inequality. It also requires more progressive taxation. Even the world's middle classes are feeling the squeeze of falling incomes and opportunities. Then. unemployment. But. we need to return to the right balance between markets and provision of public goods. it seems.Currency depreciation is not a feasible option for all advanced economies: they all need a weaker currency and better trade balance to restore growth. Others will soon follow. Meanwhile. Firms are cutting jobs because there is not enough final demand. although the process of deleveraging has barely started. with financial pressures now mounting on France. more short-term fiscal stimulus with medium. The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. the EFSF's €440 billion ($627 billion) war chest could be depleted by the end of this year or early 2012. But Italy and Spain are both too big to fail and too big to be bailed out. from the Middle East to Israel to the UK. . Recent popular demonstrations. if Italy and/or Spain lose market access. financial intermediation run amok. and rising popular anger in China . was partly right in arguing that globalization. To enable market-oriented economies to operate as they should and can. debt reductions will become necessary if countries cannot grow or save or inflate themselves out of their debt problems.and soon enough in other advanced economies and emerging markets . That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states.a move that Germany would resist .and long-term fiscal discipline. So. in the eurozone. the European Central Bank will purchase some of their bonds as a bridge to the eurozone's new European Financial Stabilization Facility. increases inequality and reduces final demand. as has happened in Greece. So Karl Marx. For now. Coercive restructuring of insolvent banks' unsecured debt would be next. but they all cannot have it at the same time.

depression. financial crisis. and massive social and political instability. .like in the 1930s .unending stagnation. Professor of Economics at the Stern School ofBusiness. The alternative is . and co-author of the book Crisis Economics.Over time. New York University. be flexible and thrive in a globalized economy. skills and social safety nets to increase productivity and enable workers to compete. capital controls. sovereign insolvencies. Nouriel Roubini is Chairman of Roubini Global Economics. currency and trade wars. advanced economies will need to invest in human capital.

Bush's administration to giving . there will be a deficit. Unaffordable tax cuts and wars. In the US. Indeed. Stiglitz July6. a powerful ideology. growth could continue only through consumption financed by a mounting pile of debt. On the contrary. Moreover. as always.Just a few years ago. A decade ago. With so much of US national income going to so few. over the course of this ideology's 30-year ascendance. stronger regulation. and a better balance between the market and government. to cut back expenditures now.fueled in part by the commitment of George W. Even in its hey-day.The Ideological Crisis of Western Capitalism By Joseph E. output growth in the United States was not economically sustainable. that has not been the case. once again threatens the global economy. the US faced a surplus so large that it threatened to eliminate the national debt. would inevitably simply prolong the downturn.not allowing the national debt to increase forces expenditures to be limited to taxes. is threatening to force a default on the national debt. by ideology and special interests. driven.brought the world to the brink of ruin. in the midst of an ongoing crisis brought on by free-market ideology. where these ideas continue to flourish. somehow. this right-wing resurgence. whose adherents evidently seek to repeal the basic laws of math and economics. This leaves open the question of which expenditures get priority . I was among those who hoped that. a resurgence of right-wing economics. 2011 NEW YORK. in the midst of an economic boom. most Americans saw their incomes decline or stagnate year after year. a default is inevitable. American-style deregulated capitalism brought greater material well-being only to the very richest in the richest country of the world. a major recession.or at least the economies of Europe and America. and soaring health-care costs. Alas. and that deficit has to be financed.and if expenditures to pay interest on the national debt do not. from the early 1980's until 2007.the belief in free and unfettered markets . Moreover. the right seeks to use a sledgehammer . If Congress mandates expenditures that exceed revenues. Rather than carefully balancing the benefits of each government expenditure program with the costs of raising taxes to finance those benefits. the financial crisis would teach Americans (and others) a lesson about the need for greater equality.

but increasingly it appears that we will have to endure another one nonetheless. the financial markets and right-wing economists have gotten the problem exactly backwards: they believe that austerity produces confidence.even if the major emerging-market countries have attained selfsustaining growth. and the author ofFreefall: Free Markets and the Sinking of the Global Economy. the US financial sector has been lobbying hard to free itself of regulations. a Nobel laureate in economics. and raise taxes. On both counts. Growth would restore confidence that Greece could repay its debts. such as unemployment benefits. A failure of either Europe or the US to return to robust growth would be bad for the global economy. and elsewhere. But the right will have none of this. at least on the very rich. and a downward spiral is set in motion. and instead is pushing for even more tax cuts for corporations and the wealthy.quickly transformed a huge surplus into record peacetime deficits. ways. and that confidence will produce growth. unless wiser heads prevail. Unfortunately. Stiglitz is University Professor at Columbia University. and it will fail in Europe this time around. causing interest rates to fall and leaving more fiscal room for further growth-enhancing investments. Indeed. disastrously carefree. that is the way the world is heading. Meanwhile. which will merely leave the countries that embrace them poorer and more vulnerable. But matters are little better in Europe. and Greece. . rein in military and drug costs. A failure in both would be disastrous . even with government money at stake . As Greece and others face crises. or at least yielding less improvement than austerity's advocates promise. Regrettably. And the confidence that this engenders leads to still further growth. Latin America. This medicine failed in East Asia. Latvia. the medicine du jour is simply timeworn austerity packages and privatization. confidence is undermined. too.drug companies free rein in setting prices. worsening the government's fiscal position. together with expenditure cuts in investments and social protection that put the future of the US economy in peril and that shred what remains of the social contract. Growth itself increases tax revenues and reduces the need for social expenditures. it has already failed in Ireland. Joseph E. Do we really need another costly experiment with ideas that have failed repeatedly? We shouldn't. end the mindless wars. The remedies to the US deficit follow immediately from this diagnosis: put America back to work by stimulating the economy. There is an alternative: an economic-growth strategy supported by the European Union and the International Monetary Fund. so that it can return to its previous. But austerity undermines growth.

in particular. in their heyday. with its emphasis on private entrepreneurship and free markets. . Mercantilist theorists such as Thomas Mun were in fact strong proponents of capitalism. but in its lands. after the country had become the world's dominant industrial power. 2013 CAMBRIDGE . mercantilists certainly did defend some very odd notions. offers a corporatist vision in which the state and private business are allies and cooperate in pursuit of common objectives. the model's "government-business collaboration" or "pro-business state" quickly garners heavy praise. not in its gold and silver only. houses.and frequent success . So it advocates a strict separation between the state and private business.of mercantilist practices. But when it works." But it is more accurate to think of mercantilism as a different way to organize the relationship between the state and the economy . In fact. is today's dominant doctrine. "liberalism" and "mercantilism. Lagging economies have not failed to notice that mercantilism can be their friend. by contrast. mercantilism remains alive and well. The mercantilist model can be derided as state capitalism or cronyism. Even in Britain. "the wealth of a country consists. and consumable goods of all different kinds. classical liberalism arrived only in the mid-nineteenth century . But its intellectual victory has blinded us to the great appeal . Adam Smith's 1776 treatise The Wealth of Nations masterfully demolished many of these ideas. as it has so often in Asia.gold and silver. they just propounded a different model than liberalism.that is. that money should not be confused for wealth." Economic liberalism. and its continuing conflict with liberalism is likely to be a major force shaping the future of the global economy. mercantilism is typically dismissed as an archaic and blatantly erroneous set of ideas about economic policy. As he put it.a vision that holds no less relevance today than it did in the eighteenth century. Today. And. Mercantilism.The history of economics is largely a struggle between two opposing schools of thought. Smith showed. chief among which was the view that national policy ought to be guided by the accumulation of precious metals .The New Mercantilist Challenge By Dani Rodrik January 9. The liberal model views the state as necessarily predatory and the private sector as inherently rentseeking. such as domestic economic growth or national power.

appropriated "intellectual property. Indeed. And consumption needs to be underpinned by high employment at adequate wages. . resulting in a sizable trade surplus (which has come down recently. Mercantilists. and prefer to spur exports rather than imports. the better. Today's China is the leading bearer of the mercantilist torch. From the liberal perspective. Governments in rich countries for the most part looked the other way while Japan. For liberals. even if the result is a trade deficit. mercantilism's support system remains largely in place.too much opprobrium still attaches to the term. Although China phased out many of its explicit export subsidies as a condition of membership in the World Trade Organization (which it joined in 200 1). From the mercantilist perspective. South Korea. For them. however. the government has managed the exchange rate to maintain manufacturers' profitability.A second difference between the two models lies in whether consumer or producer interests are privileged. stimulated. and gains to the rest of the world at around 1% of global income. a sound economy requires a sound production structure. by contrast. however. but largely as a result of an economic slowdown). The logic of the liberal approach is that the economic benefits of trade arise from imports: the cheaper the imports. and managed their currencies. and China protected their home markets. These different models have predictable implications for international economic policies. the two models can co-exist happily in the world economy.both domestic and foreign. Much of China's economic miracle is the product of an activist government that has supported. consumers are king. is the story of the last six decades: a succession of Asian countries managed to grow by leaps and bounds by applying different variants of mercantilism. these export subsidies impoverish Chinese consumers while benefiting consumers in the rest of the world. in a nutshell. In particular. export-oriented firms continue to benefit from a range of tax incentives. emphasize the productive side of the economy." subsidized their producers. Taiwan. As the example of export subsidies shows. that. A recent study by the economists Fabrice Defever and Alejandro Riaflo of the University of Nottingham puts the "losses" to China at around 3% of Chinese income. The ultimate objective of economic policy is to increase households' consumption potential. these are simply the costs of building a modern economy and setting the stage for long-term prosperity. Moreover. though Chinese leaders would never admit it. Liberals should be happy to have their consumption subsidized by mercantilists. view trade as a means of supporting domestic production and employment. which requires giving them unhindered access to the cheapestpossible goods and services. and openly subsidized industrial producers . Mercantilists.

We have now reached the end of this happy coexistence. So mercantilist pressures will likely intensify in the advanced countries. . Medium-term growth prospects for the American and European economies range from moderate to bleak. Professor of International Political Economy at Harvard University. together with the financial crisis that deregulation spawned. It may also reignite long-dormant debates about the type of capitalism that produces the greatest prosperity. Unemployment will remain a major headache and preoccupation for policymakers. Dani Rodrik. is the author ofThe Globalization Paradox: Democracy and the Future of theW orld Economy. the new economic environment will produce more tension than accommodation between countries pursuing liberal and mercantilist paths. owing to the rise in inequality and the plight of the middle class in the West. The liberal model has become severely tarnished. As a result.

Stiglitz August 5. The European Central Bank's vehement opposition to what is essential to all capitalist economies . if that is a real fear for the ECB . the euro's very survival was in growing jeopardy. A busted bubble led to a massive Keynesian stimulus that averted a much deeper recession. The discussions before the crisis illustrated how little had been done to repair economic fundamentals. possibly for years.massive spending cuts . that have become mired in slow growth and high unemployment. one positive . the ECB should have barred banks from the risky CDS market.The Great Recession of 2008 has morphed into the North Atlantic Recession: it is mainly Europe and the United States. for fear that any private-sector involvement (PSI) would trigger a "credit event." Indeed. and that growth could not be achieved without assistance. But. The European Union has finally committed itself to helping its financially distressed members. The ECB argued that taxpayers should pick up the entire tab for Greece's bad sovereign debt. undermining the proclaimed goal of fiscal consolidation. and thus that of its most distressed economies: after all. It had no choice: with financial turmoil threatening to spread from small countries like Greece and Ireland to large ones like Italy and Spain. nothing would help Greece more than robust growth in its trading partners. to the denouement of a grand debacle. And it is Europe and America that are marching.surely it should have demanded that the banks have more capital. not the major emerging markets. The resulting austerity will hinder Europe's growth. Likewise.A Contagion of Bad Ideas By Joseph E. Europe's leaders recognized that distressed countries' debts would become unmanageable unless their economies could grow. they doubled down on the belief that non-crisis countries must cut spending. 2011 NEW YORK. The response .is evidence of the continuing fragility of the Western banking system." which would force large payouts on credit-default swaps (CDSs).ensures that unacceptably high levels of unemployment (a vast waste of resources and an oversupply of suffering) will continue. possibly fueling further financial turmoil. where they are held hostage to ratings agencies' decisions about what constitutes a "credit event.if it is not merely acting on behalf of private lenders .the restructuring of failed or insolvent entities' debt . alone and together. even as Europe's leaders promised that help was on the way. But. but that also fueled substantial budget deficits. And low growth will hurt tax revenues.

is needed . As a result. . And. President Barack Obama acquiesced in an unbalanced debt-reduction strategy. There. with a political agenda. which undermine economic efficiency and contribute to environmental degradation. and financial turmoil in Europe would not be good for the US . GDP growth faltering.for the sake of balancing the budget as well.roughly $25 billion in expenditure cuts in the coming year.especially given the fragility of the US banking system and the continuing role it plays in non-transparent CDSs. with no tax increases -not even for the millionaires who have done so well during the past two decades. And matters are little better on the other side of the Atlantic. Optimists argue that the short run macroeconomic impact of the deal to raise America's debt ceiling and prevent sovereign default will be limited . with housing prices continuing to fall. Indeed. the single best remedy would be to put America back to work. The end of the stimulus itself is contractionary. the former prevail. and unemployment remaining stubbornly high (one of six Americans who would like a full-time job still cannot get one). This episode serves as a reminder that central banks are political institutions. and thus equally acceptable. But the payroll-tax cut (which put more than $100 billion into the pockets of ordinary Americans) was not renewed. and surely business. The whole point of restructuring was to discharge debt and make the remainder more manageable. The single most important driver of deficit growth is weak tax revenues. the most curious aspect of the ECB's position was its threat not to accept restructured government bonds as collateral if the ratings agencies decided that the restructuring should be classified as a credit event. and not even by eliminating tax giveaways to oil companies. If the bonds were acceptable as collateral before the restructuring. the extreme right threatened to shut down the US government. confirming what game theory suggests: when those who are irrationally committed to destruction if they don't get their way confront rational individuals. anticipating the contractionary effects down the line. The recent debt deal is a move in the wrong direction. surely they were safer after the restructuring. After all. and that independent central banks tend to be captured (at least "cognitively") by the banks that they are supposed to regulate.achievement by European leaders at the recent Brussels summit was to begin the process of reining in both the ECB and the power of the American ratings agencies. owing to poor economic performance. America's financial mismanagement played an important role in triggering Europe's problems. more stimulus. There has been much concern about financial contagion between Europe and America. not austerity. will be even more reluctant to lend.

a Nobel laureate in economics.But the real problem stems from another form of contagion: bad ideas move easily across borders. Joseph E. Stiglitz is University Professor at Columbia University. and the author ofFreefall: Free Markets and the Sinking of the Global Economy. and misguided economic notions on both sides of the Atlantic have been reinforcing each other. . The same will be true of the stagnation that those policies bring.

But the facts on the ground tell a more ambiguous story. and other societies organized along Anglo-American lines . . Rigid rules and distant policymakers merely suffocate the animal spirits of the business class. This view reflects a venerable tradition that goes back to Adam Smith and continues a proud existence in today's economics textbooks.to promote exports. not producers. This idea survives today in the practices of Asian export superpowers (most notably China). the objective of government policy should be to make producers happy.even though actual practice often deviates from idealized principles. It is also the dominant perspective of governance in the United States. Britain. Because investment and job creation ensure economic prosperity. and. Adam Smith and his followers decisively won the intellectual battle between these two models of capitalism. and other discretionary benefits. It is consumers. In their view. who are king. 2009 CAMBRIDGE. the government's role is to establish clear rules and regulations and then let businesses sink or swim on their own. on the principle that government should not be handing out favors to business? This question constitutes a Rorschach test for policymakers and economists. On the other side are what we may call corporatists or neo-mercantilists.A businessman walks into a government minister's office and says he needs help.Mercantilism Reconsidered By Dani Rodrik July 10. who view an alliance between government and business as critical to good economic performance and social harmony. This view reflects an even older tradition that goes back to the mercantilist practices of the seventeenth century. greases the wheels of commerce by providing incentives. who believe in a stark separation between state and business. What should the minister do? Invite him in for a cup of coffee and ask how the government can be of help? Or throw him out. and establish trade monopolies that would enrich business and the crown alike. the economy needs a state that eagerly lends an ear to business. subsidies. Public officials should hold private interests at arm's length and never cozy up to them. On one side are freemarket enthusiasts and neo-classical economists. In this model. when necessary. discourage finished imports. Mercantilists believed in an active economic role for the state .

Moreover.have all had activist governments collaborating closely with large business. Governments can too easily end up in the pockets of business.Japan in the 1950's and 1960's. whose harmful effects are easy to see. Nonetheless. Just look at how the search for the causes of the financial crisis has played out in the US. the problem is that it didn't listen enough to Main Street. and China since the early 1980's . such as monopoly charters. unilateral mercantilism is no guarantee of success. the mercantilist mindset provides policymakers with some important advantages: better feedback about the constraints and opportunities that private economic activity faces. government intervention in favor of business can outlive its usefulness and become ossified.The growth champions of the past few decades.but in hindsight it is clear that it merely led to a blowup. including governments. enabling financial interests to gain hegemony. For textbook liberals. resulting in cronyism and rent-seeking instead of economic growth. As many economic historians argue. China will have to make important changes to its economic strategy. Indeed. where the real producers and innovators were. the inability to see the advantages of close state-business relations is the blind spot of modern economic liberalism. It is doubtful that the great expansion of intercontinental trade in the sixteenth and seventeenth centuries would have been possible without the incentives that states provided. None of this is to idealize mercantilist practices. the trade networks and profits that mercantilism provided for Britain may have been critical in launching the country's industrial revolution around the middle of the eighteenth century. large-tradesurplus economy in recent years embodies mercantilist teachings. The Chinese-US trade relationship may have seemed like a marriage made in heaven -between practitioners of the mercantilist and liberal models. a necessity for which it has yet to prepare itself. Even when initially successful. respectively. The pursuit of trade surpluses inevitably triggers conflicts with trade partners. As a result. Current conventional wisdom places the blame squarely on the close ties that developed between policymakers and the financial industry in recent decades. . There is much that liberals can learn from it. and the effectiveness of mercantilist policies depends in part on the absence of similar policies elsewhere. rather. Early mercantilism deserves a rethink too. while leaving everyone else. China's pursuit of a high-saving. All aggressively promoted investment and exports while discouraging (or remaining agnostic about) imports. the state should have kept its distance. But the problem is not that government listened too much to Wall Street. That is how untested economic theories about efficient markets and self-regulation could substitute for common sense. acting purely as Platonic guardians of consumer sovereignty. South Korea from the 1960's to the 1980's. to pick up the pieces. and the ability to create a sense of national purpose around economic goals.

and Economic Growth. Institutions. Kennedy School of Government. Hirschman Prize. is the first recipient of the Social Science Research Council's Albert 0. . Professor of Political Economy at Harvard University's John F. His latest book is One Economics.Dani Rodrik. Many Recipes: Globalization.

On the other side stand Helmut Reisen and his colleagues at the OECD's Development Centre. concern about the health of the US recovery continues to mount. Their reasoning is that currency appreciation would almost certainly slow China's growth.China's trade balance is on course for another bumper surplus this year. even in multilateral fora. On one side stands Arvind Subramanian. and their economies would become better positioned to reap the benefits of globalization. retarded their industrialization. With a less competitive currency. Subramanian argues. and especially the poorest among them. many analysts hope. poor countries must make common cause with the US and other advanced economies in pressuring China to alter its currency policies. poor countries' exports would become more competitive. however. who conclude that developing countries. and set back their growth. Yet a noticeable rise in the renminbi's value may have significant implications for developing countries. Discussion of China's currency focuses around the need to shrink the country's trade surplus and correct global macroeconomic imbalances.Is Chinese Mercantilism Good or Bad for Poor Countries? By Dani Rodrik September 9. 2010 CAMBRIDGE . is hotly contested. He argues that developing countries have suffered greatly from China's policy of undervaluing its currency. Both developments suggest that China will be under renewed pressure to nudge its currency sharply upward. Meanwhile. . China will export less and import more. would be hurt if the renminbi were to rise sharply. Hence. Whether they stand to gain or lose from a renminbi revaluation. and that anything does that must be bad news for other poor countries as well. which has made it more difficult for them to compete with Chinese goods in world markets. from the Peterson Institute and the Center for Global Development. If the renminbi were to gain in value. where many voices will urge the Obama administration to threaten punitive measures if China does not act. The conflict with the US may well come to a head during Congressional hearings on the renminbi to be held in September. making a positive contribution to the recovery of the US and other economies. In all this discussion. the renminbi is viewed largely as a US-China issue. and the interests of poor countries get scarcely a hearing.

First. Strip away the technicalities. When developing nations are forced into overvalued currencies. temporary growth of the wrong kind. The rapid growth that many developing countries experienced prior to the crisis was largely the result of the same model. True. But this model suffers from two fatal weaknesses. China's currency policies not only undercut the competitiveness of African and other poor regions' industries. were propelled forward by the growing demand for their natural resources from other countries .3 percentage points . as it determines the competitiveness and profitability of modern tradable activities. The real exchange rate is of paramount importance here. developing countries find themselves with collapsing export prices. They need to restructure away from traditional primary products to higher-productivity activities. They estimate that a slowdown of one percentage point in China's annual growth rate would reduce lowincome countries growth rates by 0. mainly manufactures and modern services. in particular.almost a third as much. Lest we blame China too much. The problem for poor countries is that they are not producing the right kinds of goods. they also undermine those regions' fundamental growth engines. a protracted domestic crisis. They.China chief among them. When such demand falters. and the debate boils down to one fundamental question: what is the best. though. we should remember that there is little that prevents developing countries from replicating the essentials of the Chinese model. To make sense of these two contrasting perspectives. too. at best. it depends heavily on rapid growth in foreign demand. could have used their exchange rates more actively in order to stimulate industrialization and growth. we need to step back and consider the fundamental drivers of growth. From this perspective. Second. poor regions of the world have often relied on what is called a "vent-for-surplus" model. and how oil states have become wealthy during the last 40 years. too often. entrepreneurship and investment in those activities are depressed. What poor nations get out of Chinese mercantilism is. the central challenge of economic development is not foreign demand. all . most sustainable growth model for low-income countries? Historically.They buttress their argument with empirical work that suggests that growth in developing countries has become progressively more dependent on China's economic performance. it does not stimulate economic diversification. Economies hooked on this model find themselves excessively specialized in primary products that promise little productivity growth. Countries in Sub-Saharan Africa. and. This is how Argentina grew rich in the nineteenth century. but domestic structural change. Indeed. This model entails exporting to other parts of the world primary products and natural resources such as agricultural produce or minerals.

Dani Rodrik is Professor of Political Economy at Harvard University's John F. perhaps we should not hold China responsible for taking care of its own economic interests. and Economic Growth. Given this. relying on booming commodity demand or financial inflows.countries in the world cannot simultaneously undervalue their currencies. even if it has aggravated in the process the costs of other countries' misguided currency policies. where. . too many developing countries have allowed their currencies to become overvalued. And they have made little systematic use of explicit industrial policies that could act as a substitute for undervaluation. Institutions. Many Recipes: Globalization. Kennedy School of Government and the author of One Economics. it ought to be placed. But poor nations could have shifted the "burden" onto rich countries. Instead. economic logic suggests.

In the age-old contest of economic-growth models. state capitalism has been independently invented many times in world history. and recorded it all using knotted strings called quipus. It monopolized trade. Robinson December 31. It supplied food and inputs to weavers and then took their output. Consider the Greek Bronze Age. South Korea. and. in the absence of money. not economic. during which many powerful states. like farming or democracy. moved all of the goods around by fiat. it seems that. or Pylos. In essence.000 kilometers) of roads. had no money (or writing). and now China all ended up with state capitalism? . Any realworld economy is riddled with market failures. built roughly 25.Is State Capitalism Winning? By Daron Acemoglu and James A. These states had no money and essentially no markets. So. but ancient civilizations. but have also weathered recent economic storms with surprising grace. so a benevolent and omnipotent government could sensibly intervene quite often.000 miles (40. but the state conducted decennial censuses. it is useful to recall some early examples . They. So did the Incas as they built their huge Andean empire in the century before the Spanish arrived. But who has ever met a benevolent or omnipotent government? To understand the logic of state capitalism. Soviet Russia. The problems with state capitalism are primarily political.not the socialist command economies or modern societies seeking to combat market failures. economics does not say that unfettered markets are better than state intervention or even state capitalism. organized around a city housing the political elite. state capitalism has seemed to be gaining the upper hand in recent years. Indeed. Avatars of liberal capitalism like the United States and the United Kingdom continued to perform anemically in 2012. the Greek Bronze Age societies had something that looked remarkably like state capitalism. the Inca Empire. formed throughout the Mediterranean basin. All of this was part of their control of land and labor. relying on various versions of dirigisme. operated a system of runners to send messages and collect information. The state taxed agricultural output and controlled nearly all goods production. How is it that societies as disparate as the Greek Bronze Age cities of Knossos. most of which cannot be read today. based on centrally planned allocation of resources and coercion. have not only grown rapidly and steadily over the last several decades. Mycenae. too. while many Asian countries. is it time to update the economics textbooks? In fact. 2012 CAMBRIDGE.

Yes. and rightly so.The answer lies in recognizing that state capitalism is not about efficient allocation of economic resources.not the other way around. rents. What it did was help to consolidate political power. state ownership tends naturally to remove one of the key pillars of an inclusive society. But political control of the economy generally becomes problematic. State capitalism will persist so long as existing elites are able to maintain it and benefit from it even if economic growth ultimately stalls. If state managers can grab all productive resources and control access to them. and China is doing likewise today. Extractive institutions in .even if it sacrifices economic efficiency. But the success of such a project crucially depends on society having control over the state . and narrowly concentrated benefits for those with political power and connections.and the creative destruction and instability that it wreaks . this maximizes control . not that it alone could have provided price incentives to farmers and then managed liberalization of urban markets. often creates deep inequalities and tilted playing fields. nor did it necessarily create a more efficient economy. To be sure. The state capitalism of the Greek Bronze Age or the Inca Empire was not motivated by economic inefficiency. But herein lies the problem for state capitalism: inclusive institutions require a private sector powerful enough to counterbalance and check the state. Sustained economic growth presupposes inclusive institutions. but about maximizing political control over society and the economy. The modern regulatory and redistributive state can. At a deeper level. South Korea grew rapidly under state capitalism. the real dichotomy is not between state capitalism and unfettered markets. The genius of China's state capitalism is that it ensured the continued dominance of Communist Party elites while improving the allocation of resources. because those running the state do not have social welfare or optimal resource allocation in mind. Inclusive institutions create a level playing field and give incentives and opportunities to the great mass of people. state capitalism has helped to consolidate states and centralize authority . This is not an endorsement of unfettered markets. help to redress these problems.preconditions for the development of modern societies and economies. because innovation . Thus. in many parts of the world. it is between extractive and inclusive economic institutions. endangering those institutions' very survival.depends on them. Modern economic growth. but because it enabled growth without destabilizing the existing power structure. The state plays a central role in modern society. even under inclusive institutions. Extractive institutions create a non-level playing field. It should be no surprise that state capitalism is almost always associated with authoritarian regimes and extractive political institutions. within certain bounds. And there is a good reason why it eventually will. But state capitalism emerged not because there was no other way to ensure economic growth in these countries. To argue that state capitalism's success proves its superiority is to put the cart before the horse.

before starting to transform its society and economy more radically. and social control in the service of the elites who control the state. Daron Acemoglu. are co-authors ofWhy Nations Fail: The Origins of Power. can support economic growth for a while. a professor of government at Harvard University. Prosperity. Robinson. and instability that only inclusive institutions can underpin and continued economic. but only the sort of catch-up growth that South Korea experienced from the 1960's to the 1980's. China. political. too. and Poverty. As the low hanging fruit from catch-up growth is consumed. a professor of economics at MIT. .general. will be forced to choose between the economic and social freedom. and state capitalism in particular. innovation. and James A.

and its gap with the rest has been widening. But. and increasing poverty at the bottom. But most Americans today are worse . what really matters are the statistics: to what extent do an individual's life chances depend on the income and education of his or her parents? Nowadays. to the brink of ruin. This is one of the reasons that America has the highest level of inequality of any of the advanced countries. in any advanced industrial country for which there are data.like wealth. and still others have used political connections to benefit from government munificenceeither excessively high prices for what the government buys (drugs).America likes to think of itself as a land of opportunity. but the Great Recession showed otherwise: even bankers who had led the global economy. A closer look at those at the top reveals a disproportionate role for rent-seeking: some have obtained their wealth by exercising monopoly power.are as bad or even worse. while we can all think of examples of Americans who rose to the top on their own. It might not be so bad if there were even a grain of truth to trickle-down economics . It would be one thing if the high incomes of those at the top were the result of greater contributions to society. Other inequality indicators . Those at the top. The clear trend is one of concentration of income and wealth at the top. the top 1% of US income earners captured 93% of the income growth. these numbers show that the American dream is a myth. received outsize bonuses. as well as their own firms. 2012 NEW YORK. indeed. There is less equality of opportunity in the United States today than there is in Europe . others are CEOs who have taken advantage of deficiencies in corporate governance to extract for themselves an excessive share of corporate earnings. health. part of the wealth of those in finance comes from exploiting the poor. and others view it in much the same light. In the "recovery" of 2009-2010.The Price of Inequality By Joseph E. Likewise. in such cases.or. and life expectancy . or excessively low prices for what the government sells (mineral rights). through predatory lending and abusive credit-card practices. the hollowing out of the middle.the quaint notion that everyone benefits from enriching those at the top. are enriched at the direct expense of those at the bottom. Stiglitz June 5.

than they were in 1997. Rent-seeking distorts the economy. Defenders of America's inequality argue that the poor and those in the middle shouldn't complain. or even in the middle. thanks to the contributions of the rich and superrich. and. Some are even reducing inequalities. and the International Monetary Fund have both warned that inequality leads to economic instability. flatly contradicts this. such legislation has become predictably frequent. America has become a country not "with justice for all. and technology." but rather with favoritism for the rich and justice for those who can afford it - . In a country where money trumps democracy. play a role. the United Nations Commission of Experts on Reforms of the International Monetary and Financial System. With inequality reaching such extremes. impeding the engines of growth. For example. While they may be getting a smaller share of the pie than they did in the past. when it began growing apart. Market forces. The evidence. no matter how inadequate the education provided.with lower real (inflation-adjusted) incomes. All of the benefits of growth have gone to the top. Many at the bottom.its people . America is paying a high price for continuing in the opposite direction. when it was growing together. it is not surprising that its effects are manifest in every public decision. But. from the conduct of monetary policy to budgetary allocations. both in terms of both GDP growth and rising living standards for most citizens. This shouldn't come as a surprise. the pie is growing so much. This leads to underinvestment in infrastructure. politics is shaped by money. too. Lack of opportunity means that its most valuable asset . once one understands the sources of inequality. most importantly. because the rich. a decade and a half ago. There are market economies that are doing better. that the size of their slice is actually larger. a bankruptcy law that privileges derivatives over all else. Moreover. The Great Recession has exacerbated inequality. use their political influence to cut taxes and curtail government spending. investigating the causes of the Great Recession. in America. America grew far faster in the decades after World War II. than it has since 1980. are not living up to their potential. education. again. but markets are shaped by politics. enriches bankers and impoverishes many at the bottom. Indeed. but does not allow the discharge of student debt.is not being fully used. of course. with its quasi-corrupt system of campaign finance and its revolving doors between government and industry. with cutbacks in basic social expenditures and with high unemployment putting downward pressure on wages. America's inequality is undermining its values and identity. Inequality leads to lower growth and less efficiency. But growing inequality is not inevitable. needing few public services and worried that a strong government might redistribute income.off.

. Joseph E. is Professor of Economics at Columbia University. His latest book is The Price of Inequality: How Today's Divided Society Endangers our Future. a Nobel/aureate in Economics.so evident in the foreclosure crisis. in which the big banks believed that they were too big not only to fail. America can no longer regard itself as the land of opportunity that it once was. but also to be held accountable. But it does not have to be this way: it is not too late for the American dream to be restored. Stiglitz.

but rather about the different ways in which capitalism is understood in different countries. What we are witnessing today is a reversal of the debates of the 1980's.as some perceive or even desire. and pounds on stabilizing financial markets and the economy in general. yen.The financial and economic crisis that erupted in 2008 will. In fact. one that no doubt contributed significantly to the crisis. These questions are not so much about the end of capitalism. which is assumed to be more controllable. faith in the market has been dented. This shift will not only impede future growth.not least financial innovation in exchange for a slower pace of change. Deficits will improve somewhat as economies recover and support measures are withdrawn. the state is now widely seen as a beneficial force that should play an active role in the economy. Most governments have used their stimulus packages to serve vested interests as well. This is happening despite the lack of a clear indication of the superiority of the state. euros. 2010 BERLIN. After decades of consensus that the state should set the rules and otherwise leave the private sector alone. But not all of the measures are temporary or economically reasonable. while trust in government and regulation is increasing. On the contrary. those words seem far less terrifying. Back then. The accumulated debt will constitute a lasting burden on public finances. but could bring other dangers as well. the US government's heavy intervention in the American housing market is probably the most pertinent example of the state's shortcomings. in retrospect.20 economies will deteriorate dramatically as a result of the crisis. . The fiscal balances of the G. I sense a growing willingness to forego the benefits of innovation . because it raised fundamental questions about the future shape of our economic systems. Ronald Reagan used to joke: "The nine most terrifying words in the English language are: I'm from the government and I'm here to help!" Now that governments have spent trillions of dollars. The first dangeris that the state overextends itself.Balancing the State and the Market By Josef Ackermann April 30. be regarded as a transformative moment.

It is understandable that governments seek solace in the presumed safety of national markets. depriving us of the opportunities offered by the crisis to build more competitive and dynamic industries .Moreover.and will continue to grow when interest rates start to rise again. Structural change may be delayed. We can see this in the financial industry. paving the way for various forms of national protectionism. And in times of globalization. Indeed. aid must be limited. In order to preserve the state's ability to act while avoiding competitive distortions between and within industries.and accelerating the relative global decline of mature economies. either deliberately or as an unintended side effect. Moreover. But the shelter that national markets provide is illusory: the only way to increase the resilience of financial markets and to ensure that recurrence of this kind of crisis becomes less likely is to build a regulatory framework that is commensurate with integrated markets. The instinct of governments. the third dangeris that greater state intervention in the economy entails a shift away from globalization. for example. lead to re-nationalization of markets. we should establish criteria to guide future decisions in this area. A line must be drawn between a time of crisis. there is a risk that new regulation may. where increased state ownership has led to a distinct danger of re-nationalization and re-fragmentation of financial markets. there is a distinct risk that at some point sovereign yields will rise markedly . Interest payments account for an ever-larger share of budgets . Many financial institutions that received government funds have concentrated on their respective home markets and scaled back their activities abroad. and normal circumstances. may be to revert to the idea of protecting national champions or reasserting national sovereignty in some sectors. companies that were in trouble prior to a severe economic crisis should not be eligible for state assistance of the type that the world recently witnessed.with negative implications for the economy and politics. In Germany. As a matter of principle. however. lest firms become addicted to it. in which the full force of market mechanisms applies. In the absence of strong political commitment and credible plans for gradual fiscal consolidation. when emergency measures are needed to avert economic collapse. distinguishing between "national" and "foreign" is neither appropriate nor feasible. We need global (or at least . But instinct is not necessarily a sound basis for decision-making. Similarly. overall debt jumps from the current 65% of GDP to 250% when pension liabilities are included. we must remember that budgets were already strained before the crisis. and that governments' balances do not reflect all aspects of reality. The second dangeris that governments will continue to see it as their duty to decide which firms to save and which to let fail. Governments should also be aware of the long-term costs: large-scale state interference in market processes will produce its own set of corporate winners and losers.

and we need strong institutional structures to enforce these rules. 11-12 December 2009. would lose out if we moved in that direction. We must resist the temptation to believe that a meddling. .European) rules. Josef Ackermann is Chairman of the Management Board and Group Executive Committee of Deutsche Bank and Chairman of the Board of Directors of the Institute for International Finance (IIF). paternalistic state is the way of the future. Columbia University. Or. but also society as a whole. Not only business.a requirement that is not necessarily limited to the financial markets." This text is an abridgment of a keynote address given at a Berlin conference on post-crisis economic policies. hosted by the Center on Capitalism and Society. as has been said by many: "A government big enough to give you everything you want is strong enough to take everything you have.

" All that governments needed to do to ensure the division of labor was to enforce property rights. self-sustaining. The real question is not whether capitalism can survive . Capitalism has no equal when it comes to unleashing the collective economic energies of human societies. 2009 CAMBRIDGE . Those who predict capitalism's demise have to contend with one important historical fact: capitalism has an almost unlimited capacity to reinvent itself. The history of capitalism has been a process of learning and re-learning these lessons. and collect a few taxes to pay for a limited range of public goods.it can . Indeed. A combination of deep recession.Capitalism is in the throes of its most severe crisis in many decades. Through the early part of the twentieth century. So property rights rely on courts and legal enforcement. keep the peace. Where the new balance will be struck is anybody's guess. As the current crisis has demonstrated yet again. They require other social institutions to support them. its malleability is the reason it has overcome periodic crises over the centuries and outlived critics from Karl Marx on. self-regulating. Adam Smith's idealized market society required little more than a "night-watchman state. At the political level. and effective nationalization of large swathes of the financial sector in the world's advanced economies has deeply unsettled the balance between markets and states. In practice. the state's reach often went beyond this . The catch is that neither property rights nor markets can function on their own. global economic dislocations. capitalism needs stabilizing arrangements such as a lender of last resort and counter-cyclical fiscal policy.Coming Soon: Capitalism 3. capitalism was governed by a narrow vision of the public institutions needed to uphold it. and markets depend on regulators to rein in abuse and fix market failures.but whether world leaders will demonstrate the leadership needed to take it to its next phase as we emerge from our current predicament.0 By Dani Rodrik February 11. or selfstabilizing. That is why all prosperous societies are capitalistic in the broad sense of the term: they are organized around private property and allow markets to play a large role in allocating resources and determining economic rewards. In other words. capitalism requires compensation and transfer mechanisms to render its outcomes acceptable. capitalism is not self-creating.

which Keynes and his contemporaries had viewed as crucial for domestic economic management. When Chinese-style capitalism met American-style capitalism. in combination with US regulatory failings. with few safety valves in place. from below 10% on average at the end of the nineteenth century to more than 20% just before World War II. But governments continued to see their economic roles in restricted terms. Countries were required to undertake only limited trade liberalization. This "mixed-economy'' model was the crowning achievement of the twentieth century. It is that we need to reinvent it for a new century in which the forces of economic globalization are much more powerful than before. it gave rise to an explosive mix. The usefulness of activist monetary and fiscal policies became widely accepted in the aftermath of the Great Depression. The share of public spending in national income rose rapidly in today's industrialized countries. in particular. Financial globalization. The new balance that it established between state and market set the stage for an unprecedented period of social cohesion. This means imagining a better balance between markets and their supporting institutions at the global level. Sometimes. and required keeping the international economy at bay. The reason can be expressed in one word: globalization. from producing a spectacular housing boom and crash. and prosperity in the advanced economies that lasted until the mid-1970's. The current crisis shows how far we have come from that model. And. with plenty of exceptions for socially sensitive sectors (agriculture. The Bretton W oods-GA TT regime entailed a "shallow" form of international economic integration that implied controls on international capital flows.conception (as. stability. and then. and now appears to have broken down. played havoc with the old rules. The lesson is not that capitalism is dead. This model became frayed from the 1980's on. There were no protective mechanisms to prevent a global liquidity glut from developing. in the case of Bismarck's introduction of old-age pensions in Germany in 1889). it will mean preventing markets from expanding . Anti-trust policies were spearheaded in the Unites States. At other times. as long as they obeyed a few simple international rules. we need to contemplate a transition from the national version of the mixed economy to its global counterpart. textiles. Just as Smith's minimal capitalism was transformed into Keynes' mixed economy. This began to change as societies became more democratic and labor unions and other groups mobilized against capitalism's perceived abuses. in the wake ofWWII. This left them free to build their own versions of national capitalism. most countries erected elaborate social-welfare states in which the public sector expanded to more than 40% of national income on average. say. The postwar mixed economy was built for and operated at the level of nation-states. services). Nor were there any international roadblocks to prevent the crisis from spreading from its epicenter. this will require extending institutions outward from nation states and strengthening global governance.

is the first recipient of the Social Science Research Council's Albert 0.beyond the reach of institutions that must remain national. Professor of Political Economy at Harvard University's John F. and Economic Growth. His latest book is One Economics. Institutions. Kennedy School of Government. . Many Recipes: Globalization. But we do have history on our side: capitalism's saving grace is that it is almost infinitely malleable. Designing the next capitalism will not be easy. The right approach will differ across country groupings and among issue areas. Dani Rodrik. Hirschman Prize.

economic development. Corporations could exist only as long as free individuals willingly purchased their goods . The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. Capitalism became a world-beater in the 1800's. Today. a dearth of engaging work. and greater opportunity and inclusiveness." The costs of corporatism are visible all around us: dysfunctional corporations that survive despite their gross inability to serve their customers. and well-connected firms at the expense of dynamic newcomers and outsiders. corporatism chokes off the dynamism that makes for engaging work. will it transform itself or will government take the lead? The term "capitalism" used to mean an economic system in which capital was privately owned and traded. and favors declared goals such as industrialization. unproductive. failure meant losses. In various ways. and much more has at some point been deemed too important to weather the free market on its own. Will it survive the ongoing crisis in its current form? If not.The future of capitalism is again a question. and could draw on the foresight and creative ideas of entrepreneurs and innovative thinkers. Now the capitalist system has been corrupted. wasteful. when it developed capabilities for endemic innovation. obtained productivity growth that was the marvel of the world and ended mass privation.and would go out of business quickly otherwise. media. governments bankrupted by their efforts . 2012 NEW YORK . hedge funds. auto manufacturers. scant opportunities for young people. is not capitalism. receiving a helping hand from government in the name of the "public good. however. airlines. and national greatness over individuals' economic freedom and responsibility. This system of individual freedom and individual responsibility gave little scope for government to influence economic decision-making: success meant profits.Blaming Capitalism for Corporatism By Saifedean Ammous and Edmund Phelps January 31. sclerotic economies with slow output growth. agricultural companies. but rather an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism. investment banks. enjoyed widespread job satisfaction. This system. It maintains lethargic. owners of capital got to judge how best to use it. Societies that adopted the capitalist system gained unrivaled prosperity. faster economic growth.

Edmund Phelps. and a capitalist system could re-emerge from the discredited corporatist rubble. has not been kind to corporatism. There was no need for government regulation to bring about this transition. depending on how well they serve their customers. It seems unlikely that so disastrous a system is sustainable." but it is not likely to be seen trending on Twitter. People who grew up with its decentralization and free competition of ideas must find alien the idea of state support for large firms and industries. the 2006 Nobel laureate in economics. Sites such as Friendster and MySpace sought extra profit by compromising the privacy of their users. Many in the traditional media repeat the old line "What's good for Firm X is good for America. had modern corporatist states attempted to do so. rather than the one attributed to it by corporatists seeking to hide behind it and socialists wanting to vilify it. If politicians cannot repeal corporatism. for example. as a largely free marketplace for ideas. and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal. . rise and fall almost instantaneously.to palliate these problems. Yet this system's apologists and beneficiaries have the temerity to blame all these failures on "reckless capitalism" and "lack of regulation. The Internet. Then "capitalism" would again carry its true meaning. Saifedean Ammous is a professor of economics at the Lebanese American University and Foreign Member of Columbia University's Center for Capitalism and Society. The corporatist model makes no sense to younger generations who grew up using the Internet. in fact. and were instantly punished as users deserted them to relatively safer competitors like Facebook and Twitter. The legitimacy of corporatism is eroding along with the fiscal health of governments that have relied on it. which in reality means more corporatism and state favoritism. is Director of the Center. The success and failure of firms on the Internet is the best advertisement for the free market: social networking Web sites. the world's freest market for goods and ideas. today they would be propping up MySpace with taxpayer dollars and campaigning on a promise to "reform" its privacy features. This shift of power from owners and innovators to state officials is the antithesis of capitalism. it will bury itself in debt and default." which they argue necessitates more oversight and regulation.

It rests on a bedrock of good governance and the rule of law. fostering a fierce suspicion. the erosion of the middle class in the West. 2012 MADRID . However. Leading economists have long argued that the West's greater reliance on markets resulted in faster and more robust economic growth. while the Soviet bloc viewed the slightest notion of individual freedom and responsibility as a stalking horse for capitalist counter-revolution. The standard bearers of the Cold War were not just the United States and the Soviet Union. But viewing the state and the market in terms of their inherent conflict no longer reflects reality (if it ever did). of rival principles. Indeed. history's interpreters shifted their focus to the economy: not everybody would be free and elect their government. the economic tumult shaking Europe. which is facing certain economic losses as anxious investors have second thoughts about the country in the aftermath of the government's nationalization of . but capitalist prosperity would hold sway worldwide. in ideological terms. following China's intellectual pirouette to maintain one-party rule while embracing the capitalist credo. The West overlooked the fundamental importance of this while it was fighting communism. and the growing social inequalities worldwide are undermining capitalism's claim to universal triumph. Now. Consider recent events in Argentina. however.The triumph of democracy and market-based economics -the "End of History. When competing in newly independent or developing countries. but. if not outright rejection. it is increasingly obvious that the threat to capitalism today emanates not from the state's presence." as the American political philosopher Francis Fukuyama famously called it. this ideological opposition became Manichean. soon proved to be little more than a mirage. Hard questions are being asked: Is capitalism as we know it doomed? Is the market no longer able to generate prosperity? Is China's brand of state capitalism an alternative and potentially victorious paradigm? The pervasive soul-searching prompted by such questions has nurtured a growing recognition that capitalism's success depends not only on macroeconomic policy or economic indicators.Giving the Well-Performing State Its Due By Ana Palacio May9.which was proclaimed to be inevitable with the fall of the Berlin Wall. a well-performing state. As a result. the individual and the collectivity.in other words. strengthening state institutions was too often seen in the West as communist subterfuge. but rather from its absence or inadequate performance.

Meanwhile. That response is only logical. Venezuelan President Hugo Chavez's undermining of his country's institutions. the show trial and imprisonment of former Ukrainian Prime Minister Yulia Tymoshenko is jeopardizing her country's international economic standing. it still confronts feckless democracies. Indeed. it is time to say loud and clear that the future of capitalism is linked to effective governance and the rule of law. Latin America and Africa are not the only examples that prove the point. prodding it onto a narco-state trajectory. Ana Palacio is a former Spanish foreign minister and former Senior Vice President and General Counsel of the World Bank. At the opposite extreme." Adam Smith. An efficient judiciary and effective policing are necessary for capitalism to thrive. Mexico provides further proof that the market alone is not enough. and. President Viktor Yanukovich's contempt for the rule of law has put Ukraine's relations with the European Union in cold storage. as investors seek the security of a well-functioning legal system to protect them from capricious political decisions. like Brazil's. and its ongoing sovereign-debt crisis. In particular. with a comprehensive free-trade and association agreement on hold pending the release of Tymoshenko and other political prisoners. officials are acknowledging the importance of good governance. it is going hand in hand with improved governance. and thus to the consolidation of well-functioning states. that icon of market theory. places Venezuela alongside Haiti as an exception to Latin America's recent economic success. little more than an intellectual remnant of the Cold War. With its remarkable ability to adapt. In the process. More generally. Approaching them as alternatives is. much like the concept of "state capitalism" itself. to address the lawlessness of the overcrowded favelas that ring the country's large cities. in fact. as demonstrated by recent efforts to justify the purge and investigation of Bo Xilai as an example of the Communist Party "safeguarding the rule of law. on Europe's doorstep. argued that wealth is created when public institutions enable the "invisible hand" of the market to align interests. In Asia. The European Union's internal problems. . political trials in Egypt are attracting international attention and deterring foreign investment. backed by legal frameworks that guarantee the rule of law. In a world free of that era's ideological constraints. China is making strides to accommodate the rising power of its markets and people.energy giant YPF. In Brazil. the government is daring. China is exposing the fallacy of looking at state capitalism as a competing alternative to liberal capitalism. Or consider Ghana's prosperity and how. for the first time. The Cold War distorted that wisdom. are clearly linked to the weakness of its institutions. on Europe's periphery. the world's thriving countries are those with strong and effective institutions.

particularly in the US. in close partnership with the private sector and civil society. In the US.What Role for the State? By Kemal Dervis July 20. the new center-left government faces the challenge of delivering on its promise of strengthening social solidarity while substantially reducing the budget deficit. In the United States. believe that the only solution is to bring a larger share of governance and policy initiation to the state and municipal level. link the euro crisis to the outsize role of government there.is appropriate. where too much fiscal decentralization to regional governments contributed significantly to weakening otherwise strong public finances. though the Scandinavian countries are doing well. A crucial problem for this global debate is that. Questions concerning the state's size and the sustainable role of government are central to the debate over the eurozone's fate as well. DC . Consider Spain. too. For starters. such as my colleague Bruce Katz at the Brookings Institution. it is a key theme in the upcoming presidential election. Many there. Many critics of Europe. 2012 WASHINGTON. might have a downside." Brazil's development policies have also accorded a strong role to the state. despite high public spending. and it is shaping politics in Europe and emerging markets as well. China's impressive growth performance over the last three decades has given the world an economically successful example of what many call "state capitalism. and new parties and movements. it is still conducted largely as if governance and public policy were .and what kind.The financial crisis of 2008 has spurred a global debate on how much government regulation of markets. Alongside the mostly economic arguments about the role of government. such as the Pirate Party in Germany and the Five Star Movement in Italy. participation rates in national elections are falling. But that approach. reflect strong discontent with existing governance. despite the realities of twenty-first-century technology and globalization. In many countries. In France. many countries are experiencing widespread disillusionment with politics and a growing distance between citizens and government (particularly national government). the approval rating of Congress is at a record-low of 14%.

regional or continental. free-trade areas. The levels often will overlap (infrastructure and clean energy issues. counterterrorism.including support for local infrastructure. which is most advanced in the European Union (and is being tested in Latin America. The US system is manageable. climate change. First. Moreover. but democracy could be greatly strengthened if the issues were linked to the levels at which decisions can best be taken. The eurozone has finally recognized this. defense and foreign policy will continue to be conducted primarily at the second levelthe nation-state. the size and functions of government. as they must be in a monetary union. Customs unions.almost exclusively the domain of the nation-state. and the legitimacy of public decision-making should be conducted with the four levels of governance much more clearly in focus. banking regulation and deposit insurance are centralized in the US. facilitation of industrial production and training. In today's interdependent world. level of governance. and Asia) and can be very useful. The key problem in Europe today is whether eurozone members will advance towards something resembling a federal nation-state. which can lead to benefits from economies of scale that remaining trade impediments at the global level do not permit. Of course. and must therefore pursue fiscal and economic policies that support a monetary union. or a single market. there is the global level. and cyber security are just some of the issues that require broad international cooperation and global governance. Africa. nuclear non-proliferation. There is also a third. Most nation-states maintain national currencies. . land zoning. There are also aspects of infrastructure that can best be addressed at the continental level. Finally. for example). the debate about the role of public policy. To adapt the debate to the real challenges that we face. we should focus on four levels of governance and identify the most appropriate allocation of public-policy functions to them. The spread of infectious disease. as in Europe. So. governance at the nation-state level remains hugely important and is intimately linked to monetary sovereignty. it is difficult to see how the common currency can survive. Unless they do. while the federal government accounts for most fiscal policy. lest it threaten the common currency's survival. many policies . decentralization cannot extend too far into the budgetary sphere. Europe's borderless Schengen Area is another example of regional supra-national governance. traffic ordinances. allow greater mobility of goods and services. and environmental regulations -can largely be determined at the local or metropolitan level and reflect the wishes of a local electorate. global trade and finance. As the eurozone crisis has starkly reminded us. because the American states are largely constrained to running balanced budgets.

but. democracy and globalization will be difficult to reconcile. has said.As Pascal Lamy. the director of the World Trade Organization. is currently Vice President and Director of the Global Economy and Development Program at the Brookings Institution. national. if it is not met. Kemal Dervis. it is not only the "local" that has to be brought to the "global". How to conduct democratic debate with reference to these local. continental. a former minister of economics in Turkey. the inherently "local" political sphere has to internalize the global or regional context. and to structure a political space that better reflects economic and social space. That is a huge challenge for political leadership and communication. . and global levels. will be the great challenge of the decades ahead. administrator of the United Nations Development Program (UNDP). and vice president of the World Bank.

rising unemployment. owing to over-specialization and fragmentation of knowledge. and ecologists gathering to rethink economic and political theory for the challenges and uncertainty posed by growing inequality. systems analysts. we can infer the principles. the rise of emerging markets has challenged traditional Western deductive and inductive logic. if we know the cause and effects. which began in 2007 as a crisis of US subprime lending and has broadened into a European sovereign-debt (and banking) crisis. which I was there to attend. By inductive reasoning. Abductive inference is pragmatic. guessing at the rule. overarching theory to explain complex economic. Almost everyone agreed that the old paradigm of neoclassical economics was broken. Eastern thinking. moving from pragmatism to guessing the next steps. has been abductive. technological. and identifying the cause. Berlin today is vibrant and rejuvenated. political scientists. Deductive inference enables us to predict effects if we know the principles (the rule) and the cause. In particular. Nobel laureate Amartya Sen attributed the European crisis to four failures ." with more than 300 economists. European continental thinking. And yet there is no denying that the world has become too intricate for any simple. rebuilt by the German peoples' hard work and sacrifice to unify the country. by contrast. who migrated and colonized territories.A Berlin Consensus? By Andrew Sheng April 29. economic. and environmental shifts. has raised questions that we cannot answer. and intellectual. 2012 HONG KONG. when I was a poor student who marveled at the Wall that would divide and devastate an entire society for another two decades. looking only at outcomes. social. and an apt setting for the conference of the Institute for New Economic Thinking (INET). Like history. responding to urbanization and the need for social order. global financial disarray.A recent trip to Berlin brought back memories of an earlier visit in the summer of 1967. demographic. and climate change. allowing fortunate individuals to assume that there were no limits to consumption. emphasized institutional analysis of political economy. The global financial crisis.political. . but there was no agreement on what can replace it. Free-market thinking evolved from Anglo-Saxon theorists (many from Scotland). The conference's theme was "Paradigm Lost. social-scientific theory is written by the victors and shaped by the context and challenges of its time.

on the contrary. and knowledge gaps between countries) and local divergence (widening income. the historian Ray Huang explained it for China: "As the world enters the modern era. and knowledge gaps within countries). Comprehensive destruction is often the order. moving from qualitative analysis to quantifying human behavior by assuming rational behavior and excluding uncertainty.. Economists like Hyman Minsky. and globalization brought dramatic new challenges that the neoclassical approach could not foresee. most countries under internal and external pressure need to reconstruct themselves by substituting the mode of governance rooted in agrarian experience with a new set of rules based on commerce . we can see Japanese deflation." Using this macro-historical framework. Even as the world's advanced countries over-consumed through leveraging from derivative finance. Adaptive systems struggle with order and creativity as they evolve. A change of mindset is needed not just in the West. multipolar global system. and inevitably it is necessary to recondition the institutional links between them. four billion of the world's seven billion people began moving to middle-income status. In 1987. but also in the East. which must extend to the creation of a world government if it is to be effective.." thereby becoming blind to financial markets' destabilizing effects. New thinking is required to manage these massive and systemic changes.reflected in the view that markets always self-correct . This is easier said than done. By the 1970's.Thus." . European debt. We are witnessing simultaneous global convergence (the narrowing of income. Progress. who tried to correct this. The renewal process could affect the top and bottom layers.led to policy paralysis until the Great Depression. But then technology. This "predetermined equilibrium" thinking . requires the utmost scope for personal initiative that is compatible with social order.. wealth. As the philosopher Bertrand Russell presciently put it: "Security and justice require centralized governmental control. as well as the integration of giants like China and India into the modern world. the emergence of neoclassical economics in the nineteenth century was very much influenced by Newtonian and Cartesian physics. and even the Arab Spring as phases of systemic changes within complex structures that are interacting with one another in a new. the neoclassical general-equilibrium school captured Keynesian economics through real-sector models that assumed that "finance is a veil. wealth. were largely ignored as Milton Friedman and others led the profession's push for free markets and minimal government intervention. when John Maynard Keynes's argument for government intervention to address unemployment and output gaps gained traction. and it may take decades to bring the work to completion. making huge demands on global resources and raising the issue of ecological sustainability. demographics.

We cannot postpone the pain of adjustment forever by printing money. Sustainability can be achieved only when the haves become willing to sacrifice for the have-nots. Europe could use it. sound governance. existing political systems promise good jobs. credit to business and households is shrinking. Andrew Sheng is President of Fung Global Institute. TheW ashington Consensus of free-market reforms for developing countries ended more than two decades ago. of unprecedented prosperity amid growing inequality. and social harmony without sacrifice . Meanwhile. and of technological advancement and resource depletion. We live in an age of simultaneous fear of inflation and deflation. . The INET conference in Berlin showed the need for a new one .a paradise of self-interested free riders that can be sustained only by sacrificing the natural environment and the welfare of future generations.a consensus that supports sacrifice in the interest of unity.A new wave of what the economist Joseph Schumpeter famously called "creative destruction" is under way: even as central banks struggle to maintain stability by flooding markets with liquidity. a sustainable environment.

seemed to be that there would be nothing in the next 20 years as transformative as Alfred Marshall's synthesis of the 1890's or the revolution initiated by John Maynard Keynes in the 1930's. The consensus. this would allow economists-in-training to take the evolution of economic institutions more seriously. but there is a widespread sense that much of their research turned out to be irrelevant. in which human foibles are brought to bear to explain the failure of the socalled efficient markets hypothesis. participants argued. argued that future textbooks would embed analysis of recent experience in the longerterm historical record. Applied econometricians pointed to the growing importance of "big data" and to the likelihood that large data sets will have significantly enhanced our understanding of economic decision-making by 2033. in other words. fully integrating contributions that today constitute the frontiers of economic research. and that should receive more attention two decades from now. 2013 TOKYO . argued that much more attention would be paid to randomized trials and field experiments. much of the advice proffered by economists was of little use to policymakers seeking to limit the economic and financial fallout. however. A textbook two decades from now might be more sophisticated than this year's edition. economics today is a . Economic historians.Our Children's Economics By Barry Eichengreen February 11. for example.The economics profession has not had a good crisis. Will future generations do better? One of the more interesting exercises in which I engaged at the recent World Economic Forum in Davos was a collective effort to imagine the contents of a Principles of Economics textbook in 2033. In contrast to the economics of those years. Worse still. for their part. argued that behavioral finance. would be given more prominence. There was no dearth of ideas and topics. Development economists. that existing textbooks neglected. Overall. Queen Elizabeth II may have expected too much when she famously asked why economists had failed to foresee the disaster. Economists working on the border of economics and psychology. But it would not differ fundamentally in structure or approach from today's economics. meanwhile. Among other things. the picture was one in which the economics of 2033 differed only marginally from the economics of today.

the result is likely to be slower productivity growth and a "Great Stagnation. News.mature. We can't say what the next radical innovation will be. insofar as the increments are small. Knowledge. All of this suggests that the economics textbook of 2033 will look very different from the economics textbook of today. it advances incrementally rather than in revolutionary steps. Indeed. News is now assembled and disseminated via Web sites. with faculty adopters and students modifying text and contributing content. as encapsulated in the textbook and interpreted by the professor. but centuries of human experience suggest that there will be (at least) one. and the newspaper that they produced was then delivered to the subscriber's doorstep. there will be textbooks as we know them. we can't say what the next revolution in economic analysis will be. There still may be a role for the author as gatekeeper. like any mature discipline. As this view is sometimes put." In fact. where everyone has an opinion and first-hand experience with the subject. is increasingly delivered from the bottom up. This presumption is almost certainly mistaken. of course. Technological progress will be incremental rather than revolutionary. but the textbook will know longer be the font of wisdom. But the economics profession will also become more diverse and dynamic. This. everyone is becoming their own news curator. and its writer will no longer control the table of contents. is delivered from above. Editors and publishers assembled and collated stories. wikis. We just can't say how. Rather than relying on editors. two decades from now. is also how newspapers traditionally delivered the news. Something similar is likely to happen to textbooks. It reflects the same error made by scholars of technology who argue that all of the radical breakthroughs have already been made. The outcome will be messy. Textbooks will be like wikis. his) students. . but more than a century of modern economic thinking suggests that there will be one. well-established discipline. Today. and the comment sections ofblogs. one might question the very premise that. Indeed. the next 20 years will see no breakthrough as revolutionary as the steam engine or the transistor. introductory economics is taught using a textbook in which an eminent professor authoritatively bestows the conventional wisdom on his or her (typically. especially in economics.and our children's economics will be healthier as a result. in other words. Similarly. the history of technology has repeatedly refuted this pessimistic view. But the last decade has seen a veritable revolution in the news business. And.

Barry Eichengreen is Professor of Economics and Political Science at the University of California. . Berkeley.

These models. has been pessimistic enough.9% in 2011 and will flat-line in 2012.1% in 2012.Models Behaving Badly By Robert Skidelsky December 18. It is among these assumptions that the source of the errors must lie.that is. Two key mistakes stand out. printing money. even over quite short periods of time.6% growth in 2011 and 2.could counterbalance fiscal tightening. rely on a built-in theory of the economy. but no one. The OECD's latest forecast for eurozone GDP in 2012 is 2.8% growth in 2012. it looks certain to shrink this year by 0. Until recently. it seems. the IMF now predicts that the European economy will be 7. the systematic overestimate of the economic recovery in Europe is quite another. In the United Kingdom. In its 2011 forecast. the OBR. in fact. the 2010 forecast of the Office for Budget Responsibility (OBR) projected 2. So judgment calls and best guesses are an inevitable part of"scientific" economic forecasts. the UK economy grew by 0. But imprecision is one thing. the repeated failure of economic forecasters to predict the depth and duration of the slump would have elicited a similar question from the queen: Why the overestimate of recovery? Consider the facts.3% lower than its projection in 2010."Why did no one see the crisis coming?" Queen Elizabeth II asked economists during a visit to the London School of Economics at the end of 2008. Likewise. casting strong doubt on the validity of the economic models being used. Four years later. 2012 LONDON .2%. and the institutions using them. they overestimated the extent to which quantitative easing (QE) by the monetary authorities. Economic forecasting is necessarily imprecise: too many things happen for forecasters to be able to foresee all of them. Some forecasters are more pessimistic than others (the OBR has a particularly sunny disposition). the International Monetary Fund predicted that the European economy would grow by 2. In fact.8% smaller in 2015 than it thought just two years ago. The models used by all of the forecasting organizations dramatically underestimated the fiscal multiplier: the impact of changes in government spending on output. broadly in line with the IMF. the figures have been repeatedly revised. the economy would shrink by only 60 cents. assumed a fiscal multiplier of 0. Indeed. This assumes .6: for every dollar cut from government spending. which enables them to "assume" certain relationships. Second.

This implies that the problem has mainly been a lack of demand for credit. But when there is spare capacity in the economy. but it matters a great deal for the welfare of populations.3 . All of these models assume outcomes on the basis of existing policies. Forecasting organizations are finally admitting that they underestimated the fiscal multiplier. if fiscal austerity relieves households of the burden of future tax increases. and the positive impact of quantitative easing is weaker. . and enables governments to claim that their remedies are "working. This is a cruel deception. then the policy mix favored by practically all European governments has been hugely wrong." The IMF has conceded that "multipliers have actually been in the 0. they will increase their spending. The Bank of England hoped that by printing £375 billion of new money." when they clearly are not. Before they can do any good. These two mistakes compounded each other: If the negative impact of austerity on economic growth is greater than was originally assumed. and never reached the real economy. the resources "freed up" by public-sector retrenchment may simply be wasted.more than double our estimate . and ask themselves whether the theories of the economy underpinning their models are the right ones.to fully explain the weak level of GDP in 2011-12. the forecasters must go back to the drawing board. The OBR. On this view. the extra money was largely retained within the banking system. Their consistent over-optimism about these policies' impact on economic growth validates pursuing them. If households and firms anticipate a tax increase in the future as a result of government borrowing today. This may be true when the economy is operating at full employment when state and market are in competition for every last resource. accepted that "the average [fiscal] multiplier over the two years would have needed to be 1." The effect of underestimating the fiscal multiplier has been systematic misjudgment of the damage that "fiscal consolidation" does to the economy. they will reduce their consumption and investment accordingly. reviewing its recent mistakes. There is much greater scope for fiscal stimulus to boost growth. or 3% of GDP."Ricardian equivalence": debt-financed public spending at least partly crowds out private spending through its impact on expectations and confidence.7 range since the Great Recession. This leads us to the second mistake. This is all quite technical. Forecasters assumed that monetary expansion would provide an effective antidote to fiscal contraction.9 and 1. and much smaller scope for monetary stimulus. it would stimulate total spending to the tune of £50 billion. But the evidence emerging from successive rounds of QE in the UK and the US suggests that while it did lower bond yields.reluctance on the part of businesses and households to borrow on almost any terms in a flat market. ($600 billion).

is Professor Emeritus of Political Economy at Warwick University.Robert Skidelsky. . a member of the British House of Lords.

as . Finally. Perhaps the reason was ideology: we were too wedded to the idea that markets are efficient. But some of this criticism of"market fundamentalism" reflects a misunderstanding. in great detail. we had studied all this too. The dominant "efficient markets theory" says only that markets reflect what is publicly known. Yet. But hindsight distorts analysis. market participants are rational. We cannot point to a lonely Cassandra like Robert Shiller of Yale University.Why Did Economists Not Foresee the Crisis? By Raghuram Rajan February 7. Economists even analyzed the political economy of regulation and deregulation. The theory does not say that markets cannot plummet if the news is bad. It is not true that we academics did not have useful models to explain what happened. and that the market (and economists) ignored it. and high prices are justified by economic fundamentals. so we could have understood why some US politicians pushed the private sector into financing affordable housing. and that it is hard to make money off markets consistently. we did not bring all this understanding to bear and collectively shout our warnings. 2011 CHICAGO . If you believe that the crisis was caused by a shortage of liquidity. lulled by the promise of a government bailout. we had plenty of models analyzing liquidity shortages and their effects on financial institutions. the truth lies elsewhere. somehow. who regularly argued that house prices were unsustainable. In my view.At the height of the financial crisis. while others deregulated private finance. but one for which there is no easy answer: Why did academic economists fail to foresee the crisis? Several responses to that query exist.something verified by the hit that most investor portfolios took in the crisis. or with a market driven crazy by irrational exuberance. or if investors become risk-averse. an answer that is gaining ground is that the system bribed economists to stay silent. If you believe that the blame lies with greedy bankers and unthinking investors. the Queen of England asked my friends at the London School of Economics a simple question. One is that economists lacked models that could account for the behavior that led to the crisis. Critics argue that the fundamentals were deteriorating in plain sight. Another is that economists were blinkered by an ideology according to which a free and unfettered market could do no wrong.

are turning points . nor progressive economists.for economists to declare a monetary interest in a particular analysis and. Of course. There are always naysayers. I would argue that three factors largely explain our collective failure: specialization. The bias could be implicit: our worldview is shaped by what our friends in industry believe.macroeconomists typically do not pay attention to what financial economists or real-estate economists study. few economists try to span sub-fields. give speeches to investor conferences. and vice versa. Or it may be an explicit bias: an economist might write a report that is influenced by what a sponsor wants to hear.just as it takes a good general practitioner to recognize an exotic disease. well-supported. What is hardest to forecast. . for example. As a group. While there may be some factors that signal turning points. but necessarily narrow analysis.they are not infallible predictors of trouble to come. and they are often wrong. more generally. predicted the crisis. One way to restore trust may be disclosure . There are enough instances of possible bias that the issue cannot be ignored. The main advantage that academic economists have over professional forecasters may be their greater awareness of established relationships between factors. One remedy would be to ban all interaction between economists and the corporate world. who distrust free markets. But if economists were confined to the ivory tower. were unlikely to fall across the board. But I believe that corruption is not the main reason that the profession missed the crisis. but we would also be ignorant of practicalities and thus even less capable of predicting problems. Most economists have very little interaction with the corporate world. and these "unbiased" economists were no better at forecasting the crisis. the difficulty of forecasting. and the disengagement of much of the profession from the real world. Yet. neither behavioral economists. serve as expert witnesses. economics has become highly compartmentalized . often presages a bust .when the old relationships break down.a runup in short-term leverage and asset prices.proof that the truth was ignored. But there is a better reason to be skeptical of explanations relying on ideology. Even if they did. and carry out sponsored research. they would shy away from forecasting. though high. these expectations could have been distorted by ideology. we might be unbiased. though. Because the profession rewards only careful. to explain who pays us.it is hard to get into the past minds of economists. who think that market efficiency is a joke. Could it be corruption? Some academic economists consult for banks or rating agencies. or give testimony that is purely mercenary. A number of universities are moving in this direction. It would be natural to suspect us of bias. to see the crisis coming would have required someone who knew about each of these areas . There were many more economists who believed that house prices. Like medicine.

The meager professional rewards for breadth, coupled with the inaccuracy and reputational risk associated with forecasting, leads to disengagement for most academics. And it may well be that academic economists have little to say about short-term economic movements, so that forecasting, with all its errors, is best left to professional forecasters. The danger is that disengagement from short-term developments leads academic economists to ignore medium-term trends that they can address. If so, the true reason why academics missed the crisis could be far more mundane than inadequate models, ideological blindness, or corruption, and thus far more worrisome; many simply were not paying attention!

Raghuram Rajan is Professor of Finance at the Booth School of Business, University of Chicago, and author ofFault Lines: How Hidden Fractures Still Threaten the World Economy.

Economics in Denial
By Howard Davies

August 22, 2012
PARIS - In an exasperated outburst, just before he left the presidency of the European Central Bank, Jean-Claude Trichet complained that, "as a policymaker during the crisis, I found the available [economic and financial] models oflimited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools." Trichet went on to appeal for inspiration from other disciplines- physics, engineering, psychology, and biology- to help explain the phenomena he had experienced. It was a remarkable cry for help, and a serious indictment of the economics profession, not to mention all those extravagantly rewarded finance professors in business schools from Harvard to Hyderabad. So far, relatively little help has been forthcoming from the engineers and physicists in whom Trichet placed his faith, though there has been some response. Robert May, an eminent climate change expert, has argued that techniques from his discipline may help explain financial-market developments. Epidemiologists have suggested that the study of how infectious diseases are propagated may illuminate the unusual patterns of financial contagion that we have seen in the last five years. These are fertile fields for future study, but what of the core disciplines of economics and finance themselves? Can nothing be done to make them more useful in explaining the world as it is, rather than as it is assumed to be in their stylized models? George Soros has put generous funding behind the Institute for New Economic Thinking (INET). The Bank of England has also tried to stimulate fresh ideas. The proceedings of a conference that it organized earlier this year have now been edited under the provocative title What 's the Use of

Economics?
Some of the recommendations that emerged from that conference are straightforward and concrete. For example, there should be more teaching of economic history. We all have good reason to be grateful that US Federal Reserve Chairman Ben Bernanke is an expert on the Great Depression and the authorities' flawed policy responses then, rather than in the finer points of dynamic stochastic general equilibrium theory. As a result, he was ready to adopt unconventional measures when the crisis erupted, and was persuasive in influencing his colleagues.

Many conference participants agreed that the study of economics should be set in a broader political context, with greater emphasis on the role of institutions. Students should also be taught some humility. The models to which they are still exposed have some explanatory value, but within constrained parameters. And painful experience tells us that economic agents may not behave as the models suppose they will. But it is not clear that a majority of the profession yet accepts even these modest proposals. The socalled "Chicago School" has mounted a robust defense of its rational expectations-based approach, rejecting the notion that a rethink is required. The Nobel laureate economist Robert Lucas has argued that the crisis was not predicted because economic theory predicts that such events cannot be predicted. So all is well. And there is disturbing evidence that news of the crisis has not yet reached some economics departments. Stephen King, Group Chief Economist of HSBC, notes that when he asks recent university graduates (and HSBC recruits a large number of them) how much time they spent in lectures and seminars on the financial crisis, "most admitted that the subject had not even been raised." Indeed, according to King, "Young economists arrive in the financial world with little or no knowledge of how the financial system operates." I am sure they learn fast at HSBC. (In the future, one assumes, they will learn quickly about money laundering regulations as well.) But it is depressing to hear that many university departments are still in denial. That is not because students lack interest: I teach a course at Sciences Po in Paris on the consequences of the crisis for financial markets, and the demand is overwhelming. We should not focus attention exclusively on economists, however. Arguably the elements of the conventional intellectual toolkit found most wanting are the capital asset pricing model and its close cousin, the efficient-market hypothesis. Yet their protagonists see no problems to address. On the contrary, the University of Chicago's Eugene Fama has described the notion that finance theory was at fault as "a fantasy," and argues that "financial markets and financial institutions were casualties rather than causes of the recession." And the efficient-market hypothesis that he championed cannot be blamed, because "most investing is done by active managers who don't believe that markets are efficient." This amounts to what we might call an "irrelevance" defense: Finance theorists cannot be held responsible, since no one in the real world pays attention to them! Fortunately, others in the profession do aspire to relevance, and they have been chastened by the events of the last five years, when price movements that the models predicted should occur once in a million years were observed several times a week. They are working hard to understand why, and to develop new approaches to measuring and monitoring risk, which is the main current concern of many banks.

These assumptions took a hard hit in the crisis. causing an abrupt shift to far more intrusive regulation. and that financial institutions and their boards were best placed to control risk and defend their firms. and Director of the London School of Economics. Finding a new and stable relationship between the financial authorities and private firms will depend crucially on a reworking of our intellectual models. Howard Davies.These efforts are arguably as important as the specific and detailed regulatory changes about which we hear much more. . So the Bank of England is right to issue a call to arms. Deputy Governor of the Bank of England. is a professor at Sciences Po in Paris. Economists would be right to heed it. Our approach to regulation in the past was based on the assumption that financial markets could to a large extent be left to themselves. former Chairman of Britain's Financial Services Authority.

fingers were pointed at the United States as an example of how badly things could go wrong. and then the European version. . lay in over-reliance on highly complex financial instruments. attacking "clueless" American monetary policy. Steinbriick's successor. Critics now had a new focus. The other G-7 financial ministers in continental Europe share this opinion. but also to other countries . Now it looks as if the Asian approach may take some knocks. Coming after the failure of state socialism. with its addiction to a costly and inefficient welfare state. too. does this mean that there is no correct way of organizing an economy? In the aftermath of the subprime crisis and the collapse of Lehman Brothers.Schadenfreude Capitalism By Harold James January 4. Naturally. propagated by globalized American institutions: "The financial crisis is above all an American problem. with its roots in lax government finance in some (mostly southern European) countries. and then by the financial crisis. Immediately after Lehman Brothers' collapse. 2012 PRINCETON . Steinbriick argued. The American model had supposedly failed. But such criticism ignores the problems faced by banks that did not use or deal in complex financial products. many conservative Americans were delighted by the imminent failure of what they saw as Europe's tax-and-spend model.that had "Americanized" their financial system. German Finance Minister Peer Steinbriick put this diagnosis as a challenge not only to the US. Bank regulators had long insisted that the safest possible financial instrument was a bond issued by a rich industrial country. which was supposedly designed only to feed the American financial monster." Criticism of America did not stop there. which he called "a worn-out welfare society" with "outdated" welfare laws that induce dependence and sloth. commented skeptically on a proposed Chinese bailout of Europe. Wolfgang Schauble. The problem. Then came the eurozone's sovereign-debt crisis. persisted in the same tone. The chairman of China Investment Corporation.The protracted financial and economic crisis discredited first the American model of capitalism. Jin Liquin. Anyone who dreamed of the American way of life now looked stupid.notably the United Kingdom . its reputation weakened first by the Iraq invasion. They were not the only critics.

In a market economy. And Spain and Ireland before the crisis did not have a fiscal problem. But soon they encounter their own banana peel. new airport buildings. But haven't similar capital investments and soaring property prices also been an increasingly important part of China's transformation since the 1990's? Chinese citizens are now not only frustrated with the high-speed trains' increasingly obvious imperfections and inadequacies. the world's major economies share many more vulnerabilities than is commonly supposed. today's global economy is a riot of slipping economic models. and railroads were not." Underpinning comparisons of different models is the wish to find an absolutely secure way of generating wealth and prosperity.some other society.tripped on an enormous political banana peel. Asian critics looking at America and Europe could easily convince themselves that the Western model of democratic capitalism was collapsing. and high profits associated with an original innovation turn out to be transitory. And tomorrow the cacophony will be even louder. steel. From a longer-term perspective. as people often like to think how lucky they are to have escaped a mess that originated elsewhere. best translated as "schadenfreude": somebody else. Greek. then the answer is "no. say. And restrictive labor laws have indeed discouraged many firms from hiring new workers. high-speed train links. competition rapidly leads to emulation. One of the most widely used Chinese terms of recent years is???? (xing z?i le huo}. the pioneers and innovators in textiles. So. During the Industrial Revolution in Western Europe in the late eighteenth and early nineteenth centuries. but are also wondering whether their government has set the right priorities.Criticism of large European transfer payments may have some justification. and Italian civil servants could indeed retire young. there are only temporary surges of relative wealth. just as there are only temporary surges of apparent success in a particular way of doing business. A response to global challenges based simply on schadenfreude may promote a short-term sense of well-being. But such criticism captures only one small part of Europe's difficulties. is there any absolutely sure way of organizing economic life? If the quest is for a way of securing perpetual security or dominance. Both now face major problems with disillusioned populations. Russia's Prime Minister Vladimir Putin and Argentina's President Christina Kirchner liked to think that their versions of a controlled economy and society built in the aftermath of default on foreign debt offered a more viable alternative to cosmopolitan international capitalism. however. insofar as French. indeed. In short. on the whole. The fiscal problems of Greece and Spain were also the result of spending a great deal on hightechnology and high-prestige projects: facilities for the Olympic Games. . owing to the rapid economic growth produced by a real-estate boom that seemed to promise a new era of economic miracles. Schadenfreude comes in several flavors.

rewarded with immense riches: their profits were competed away. Florence. because public policies and resources could be used to protect accumulated wealth from the otherwise inevitable erosion stemming from competitive pressure. Behind the idea of a particular model of growth was the belief that a sensibly ordered state could somehow capture and eternalize the fruits of economic success. Like it or not. He is the author ofThe Creation and Destruction of Value: The Globalization Cycle. . The late nineteenth and the twentieth century produced a different sort of growth. Harold James is Professor of History and International Affairs at Princeton University and Professor of History at the European University Institute. states cannot organize themselves in that way any more than individuals can.

so they are the ones most likely to get the distribution of possible futures right. or that supporting the economy would produce inflation (or high short-term interest rates). for once. 2012 BERKELEY . however. rather than to structural changes. So the big lesson is simple: trust those who work in the tradition of Walter Bagehot. And we understood that we faced the threat of a jobless recovery. Not just a little wrong. break their way. coupled with the extension of leverage. Carmen Reinhart. we understood that the rapid run-up of house prices. or that recovery would be rapid. Completely wrong. we understood that monetarist cures were likely to prove insufficient. and that preventing a deep depression required active official intervention as a lender oflast resort.and thus be counterproductive in the long-run. Of course. their reputations under water. surprised at how few of them have marked their beliefs to market in any sense. Larry Summers. Gary Gorton. Olivier Blanchard. On the contrary. we historically-minded economists are not surprised that they were wrong. many of them.and aware of the history of economic thought concerning financial crises and their effects . Raghuram Rajan. Ken Rogoff. Those who said that there would be no downturn. We recognized that large bubble-driven losses in assets held by leveraged financial institutions would cause a panicked flight to safety. Bradford DeLong June 27. posed macroeconomic dangers. historically-minded economists were right. or that the economy's real problems were structural. We understood where we were heading. That means trusting economists like Paul Krugman. Just as they got the recent past right. or that immediate fiscal austerity would be expansionary were wrong. and Charles Kindleberger. Indeed. Barry Eichengreen.have reason to be proud of our analyses over the past five years. . Hyman Minsky. On all of these issues.We economists who are steeped in economic and financial history . owing to cyclical factors. and that withdrawing support too soon implied enormous dangers. Paul Romer. In particular.The Perils of Prophecy By J. because we knew where we had been. and that people might thus be induced to forget their abysmal forecasting track record. We knew that premature attempts to achieve long-term fiscal balance would worsen the short-term crisis . apparently in the hope that events will. and their peers. have doubled down on those beliefs. We are. that sovereigns need to guarantee each others' solvency.

and it was below 1. The first is the failure of central banks to adopt a rule like nominal GDP targeting or its equivalent.have gotten significant components of the last four years wrong.But we . even if not to.toward. even the expectation of five years of deep depression and near-zero short-term interest rates should not push the 10-Year Treasury rate below 3%. even with one-third of the US labor force changing jobs every year. the yield curve did not steepen sharply for the United States: federal funds rates at zero I expected. Since the ten-year US Treasury bond rate tends to be one percentage point above the average of expected future shortterm interest rates over the next decade. One possibility is that those investing in financial markets expect economic policy to be so dysfunctional that the global economy will remain more or less in its current depressed state for perhaps a decade. may be the most interesting. more than three years after the US financial crisis erupted. As for wages. leaving them incapable of doing their job: bearing and managing risk in order to channel savings to entrepreneurial ventures. or more. Neither alternative is something that I would have predicted . sociological factors and human-network ties appear to exercise an even stronger influence on the level and rate of change. zero. the Nobel laureate Robert Lucas confidently predicted that the US economy would be back to normal within three years. a former deputy assistant secretary of the US Treasury.at the expense of balancing supply and demand . The normal rules of thumb would say that the market is now expecting 8.than I would have expected. The only other explanation is that even now. is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research. financial markets' ability to price relative risks and returns sensibly has been broken at a deep level. J.or even imagined. . the Treasury rate mostly fluctuated between 3% and 3. A normal US economy has a short-term nominal interest rate of 4%. Bradford DeLong. I expected wage inflation in the North Atlantic to fall even farther than it has. The failure of central banks to target nominal GDP growth remains incomprehensible to me. in July 2011. but 30-Year US Treasury bonds at a nominal rate of 2.75 years of near-zero short-term interest rates before the economy returns to normal. and I will not write about it until I think that I have understood the reasons. And similar calculations for the 30-year Treasury bond show even longer and more anomalous expectations of continued depression. The possible conclusions are stark.5% at the start of June. Finally. however. the ten-year US Treasury bond rate crashed to 2%. Second.7% I did not.or at least I .5% from late 2008 through mid-2011. Back in March 2009. Three things surprised me (and still do). But. Indeed. The third surprise.

when we already have all the wealth we need." I mean better ethically. saddled with a system of incentives that are essential for accumulating wealth.In 1995. and is. stretches a vista o£ . I wonder whether there will be a world after capitalism. a superb system for overcoming scarcity. It was. capitalism. . And.. and directing it to the pursuit of welfare rather than power. it comes from the feeling that Western civilization is increasingly unsatisfying. thrills. By organising production efficiently. Today. Capitalism has always had crises. not materially. Now. By "better. Public production is inferior to private production for any number of reasons. though evidence shows that they no longer make people happier. My discontent is with the quality of a civilization in which the production and consumption of unnecessary goods has become most people's main occupation.Life after Capitalism By Robert Skidelsky January 20. not least because it destroys choice and variety. Yet what happens to such a system when scarcity has been turned to plenty? Does it just go on producing more of the same. it has lifted a large part of the world out of poverty. and excitements? How much longer can this continue? Do we spend the next century wallowing in triviality? For most of the last century. failed . it seems. 2011 LONDON. Capitalism may be close to exhausting its potential to create a better life. which could be put to one side because capitalism was so successful at generating wealth. since the collapse of communism. Rather. stimulating jaded appetites with new gadgets. I published a book called The World After Communism. the alternative to capitalism was socialism. but that undermine our capacity to enjoy it. there has been no coherent alternative to capitalism. and will go on having them. Material gains may continue. That question is not prompted by the worst economic slump since the 1930's.at least in the world's rich countries. we are right to wonder whether the costs of capitalism are worth incurring. in its classical form. But socialism.as it had to. Beyond capitalism. This is not to denigrate capitalism. There have always been huge moral questions about capitalism.

they must continue to suffer its costs. And increasing numbers do. The end of capitalism means simply the end of the urge to listen to it. It was now considered healthily Promethean to turn wealth into money and put it to work to make more money. means the freedom to vote capitalism out of office. yet we should believe that unrestricted advertising of consumer goods affects only the distribution of demand. This inspired the American way of life. but claim that re-training programs will fit workers into new. This made him a fervent free trader. because the rich would not always want to become richer. believing that they affect people negatively. People do not form their preferences in isolation. Defenders of the current system reply: we leave such choices to individuals to make for themselves. because by doing this one was benefiting humanity. too. Today's apostles of free trade argue the case in much the same way as Adam Smith.worth paying. People would start to enjoy what they have. Greed. "drop out. and envy were among the deadly sins. They typically admit that free trade costs jobs. This answer is powerful but naive. Before then. Yet he thought that this was a price." Democracy. This amounts to saying that even though rich countries (or regions) no longer need the benefits of free trade. they are free to do so. Usury (making money from money) was an offense against God. in fact. avarice. where money always talks. markets for buying and selling were hedged with legal and moral restrictions. Indeed. It has always been the function of culture (including religion) to encourage some and limit the expression of others.Adam Smith. It was only in the eighteenth century that greed became morally respectable. recognized that the division of labor would make people dumber by robbing them of non-specialized skills. whose main objective is to lead good lives. Is it really supposed that constant pressure to consume has no effect on preferences? We ban pornography and restrict violence on TV. the "spirit of capitalism" entered human affairs rather late in history. since the widening of the market increased the growth of wealth. If people want to step off the conveyor belt. As more and more people find themselves with enough. But human nature is a bundle of conflicting passions and possibilities. One can imagine a society of private wealth holders. but not the total? Capitalism's defenders sometimes argue that the spirit of acquisitiveness is so deeply ingrained in human nature that nothing can dislodge it. ignoring the fact that wealth has expanded enormously since Smith's day. "higher value" jobs.possibly compensated by education . not to turn their wealth into "capital. Their choices are framed by their societies' dominant culture. one might expect the spirit of gain to lose its social . for example." Financial services would shrink. instead of always wanting more. A person who devoted his life to making money was not regarded as a good role model.

Perhaps socialism was not an alternative to capitalism. And even there.the need to stimulate people to be more productive. and a board member of the Moscow School of Political Studies. is Professor Emeritus of Political Economy at Warwick University.collapses when growth ceases to be so important. but its heir. author of a prize-winning biography of the economist John Maynard Keynes. It will inherit the earth not by dispossessing the rich of their property. Capitalism would have done its work. Robert Skidelsky.approbation. but by providing motives and incentives for behavior that are unconnected with the further accumulation of wealth. The dishonoring of greed is likely only in those countries whose citizens already have more than they need. many people still have less than they need. . The evidence suggests that economies would be more stable and citizens happier if wealth and income were more evenly distributed. and the profit motive would resume its place in the rogues' gallery. a member of the British House of Lords. The economic justification for large income inequalities .

The second task remains open.When the heads of state of the world's 20 largest economies come together on short notice. More importantly. need to be supported. they committed themselves to launching a lasting process to reform the world's financial system. and productive work. Some merely face a . But. The essential problem in addressing the third task is to find out precisely what is going on in the real economy. it is clear how serious the current global crisis is. The recent G-20 summit occurred with virtually no real preliminary work. if the economy is to grow again. but the recession has led entrepreneurs to cut their investments. those who dreamed of a Bretton Woods II were disappointed. although the United States and some European countries have gone a long way toward restoring the lending capacity of banks. The first task is already being tackled. reform the capitalist system to make it be less dependent on finance. Three tasks must now be addressed. the world has experienced a huge financial crisis every five years.Redesigning Capitalism By Michel Rocard November 27. Disagreements about how to re-regulate the financial markets are deep. new regulations are needed once the system revives. and. not short-term profits. above all. Some states (Iceland and Hungary) are clearly bankrupt. But the original Bretton Woods framework was not built in a day. After all. end the recession. that may not be enough. a floor must be put under the international financial system in order to stop its collapse. Long-term investments. owing to countless taboos and the huge interests at stake. the 1944 conference was preceded by two and a half years of preparatory negotiations. D. They did not decide much. indeed.. because if it remains the same way.C. it will only produce new crises. Moreover. Second. For 25 years. as they just did in Washington. rather than paper gains. except to call for improved monitoring and regulation of financial flows. banks need borrowers. 2008 PARIS . Finding the right mix will not be easy. there can be no comprehensive agreement that does not take into account the relationship between finance and the real economy. each seemingly with its own cause. First. which is probably the minimum needed to decide such weighty issues. The third task is to focus on real economic activity. Of course. sustain growth.

and large financial crises were absent. During the 27 years that it lasted.weakened. shareholders became well organized and seized power in developed countries' firms. but with a slow. more and more processes were "outsourced.hazardous financial situation (Denmark. the average real wage has been stagnant for 25 years in the US). Today's crisis marks the end of economic growth fueled only by credit. Since then. Everywhere. supported by non-volatile pricing. and arbitrage (or hedge) funds. It is now increasingly evident that today's crisis has its roots in February 1971. Prices were (mostly) stabilized. But untying the knot that an overweening financial sector has drawn around the economy will take time. if continuous. the international financial system has been highly volatile. Through pension funds. Under such circumstances. wages no longer rose (indeed. Under their pressure.smooth and successful between 1945-1975 (sustained high growth. and others). During this time. there is still no consensus that this needs to be done. These innovations were considered technical successes. and unemployment stopped declining. Indeed. and a growing share of manpower (currently around 15%) was without steady employment. Until that point. investment funds. selling and buying on credit. Yet the G-20 has opened the way to discussion of these fundamental issues. the share of wages and incomes began to fall as a proportion ofGDP. and led to the under-regulated financial system's seizure of power over the entire economy. huge growth in international trade. . This promoted inequality. Their financial crisis is the main reason for their weakness. when US President Richard Nixon decided to break the link between the dollar and gold. rising trend. which provided a strong incentive for market participants to play with them more and more. The era of floating exchange rates that followed the end of the gold standard required the development of products that could protect international trade from price volatility. which was the heart of the Bretton Woods framework. As a result. consumption weakened. but it will compel everybody to consider its root causes. America's pledge to maintain the gold standard was the basis for the global fixed-exchange-rate system. Today's recession will be a long one. and no financial crises) . destabilizing the real economy by fatally weakening its capacity to react to external shocks." In real terms. was the norm. Spain. and derivatives of all kinds. the upper middle classes in developed countries increasingly came to look for capital gains instead of improving their living standards through productive work. This opened the way to options. unsteady employment grew. low unemployment. All of these problems are so difficult to resolve because they have been festering for so long. The market for these financial products grew over 30 years to the point that they delivered huge opportunities for immediate gain. capitalism .

Michel Rocard former Prime Minister of France and leader of the Socialist Party, is a member of the European Parliament.

How Capitalist is America?
By Mark J. Roe

June20, 2011
CAMBRIDGE- If capitalism's border is with socialism, we know why the world properly sees the United States as strongly capitalist. State ownership is low, and is viewed as aberrational when it occurs (such as the government takeovers of General Motors and Chrysler in recent years, from which officials are rushing to exit). The government intervenes in the economy less than in most advanced nations, and major social programs like universal health care are not as deeply embedded in the US as elsewhere. But these are not the only dimensions to consider in judging how capitalist the US really is. Consider the extent to which capital -that is, shareholders - rules in large businesses: if a conflict arises between capital's goals and those of managers, who wins? Looked at in this way, America's capitalism becomes more ambiguous. American law gives more authority to managers and corporate directors than to shareholders. If shareholders want to tell directors what to do -say, borrow more money and expand the business, or close off the moneylosing factory- well, they just can't. The law is clear: the corporation's board of directors, not its shareholders, runs the business. Someone naive in the ways of US corporations might say that these rules are paper-thin, because shareholders can just elect new directors if the incumbents are recalcitrant. As long as they can elect the directors, one might think, shareholders rule the firm. That would be plausible if American corporate ownership were concentrated and powerful, with major shareholders owning, say, 25% of a company's stock - a structure common in most other advanced countries, where families, foundations, or financial institutions more often have that kind of authority inside large firms. But that is neither how US firms are owned, nor how US corporate elections work. Ownership in large American firms is diffuse, with block-holding shareholders scarce, even today. Hedge funds with big blocks of stock are news, not the norm. Corporate elections for the directors who run American firms are expensive. Incumbent directors typically nominate themselves, and the company pays their election expenses (for soliciting votes from distant and dispersed shareholders, producing voting materials, submitting legal filings, and, when an election is contested, paying for high-priced US litigation). If a shareholder dislikes, say, how GM's directors are running the company (and, in the 1980's and 1990's, they were running it

into the ground), she is free to nominate new directors, but she must pay their hefty elections costs, and should expect that no one, particularly not GM, will ever reimburse her. If she owns 100 shares, or 1,000, or even 100,000, challenging the incumbents is just not worthwhile. Hence, contested elections are few, incumbents win the few that occur, and they remain in control. Firms and their managers are subject to competitive markets and other constraints, but not to shareholder authority. In lieu of an election that could remove recalcitrant directors, an outside company might try to buy the firm and all of its stock. But the rules of the US corporate game -heavily influenced by directors and their lobbying organizations- usually allow directors to spurn outside offers, and even to block shareholders from selling to the outsider. Directors lacked that power in the early 1980's, when a wave of such hostile takeovers took place; but by the end of the decade, directors had the rules changed in their favor, to allow them to reject offers for nearly any reason. It is now enough to reject the outsider's price offer (even if no one else would pay more). American corporate-law reformers have long had their eyes on corporate elections. About a decade ago, after the Enron and WorldCom scandals, America's stock-market regulator, the Securities and Exchange Commission (SEC), considered requiring that companies allow qualified shareholders to put their director nominees on the company-paid election ballot. The actual proposal was anodyne, as it would allow only a few directors- not enough to change a board's majority- to be nominated, and voted on, at the company's expense. Nevertheless, the directors' lobbying organizations - such as the Business Roundtable and the Chamber of Commerce (and their lawyers) -attacked the SEC's initiative. Lobbying was fierce, and is said to have reached into the White House. Business interests sought to replace SEC commissioners who wanted the rule, and their lawyers threatened to sue the SEC if it moved forward. It worked: America's corporate insiders repeatedly pushed the proposal off of the SEC agenda in the ensuing decade. Then, in the summer of 2010, after a relevant election and a financial crisis that weakened incumbents' credibility, the SEC promulgated election rules that would give qualified shareholders free access to company-paid election ballots. As soon as it did, the US managerial establishment sued the SEC, and government officials felt compelled to suspend the new rules before they ever took effect. The litigation is now in America's courts. The lesson is that the US is less capitalist than it is "managerialist." Managers, not owners, get the final say in corporate decisions. Perhaps this is good. Even some capital-oriented thinking says that shareholders are better off if managers make all major decisions. And often the interests of shareholders and managers are aligned.

we know which side the US is on. . and too often fail to act aggressively enough to enter new but risky markets. But when it's managers vs.But there is considerable evidence that when managers are at odds with shareholders. the US is managerialist. When it comes to capitalism vs. capital-owners. socialism. not capitalist. Mark Roe is a Professor ofJaw at Harvard Law School. managerial discretion in American firms is excessive and weakens companies. pay themselves too much relative to their and the company's performance. Managers of established firms continue money-losing ventures for too long.

and neglect of the "world-trade multiplier" (the tendency for countries to drag each other down as their economies contract). when the global economy was beginning to recover from the shock of the 2008-2009 financial crisis.where household deleveraging continues to constrain economic growth . Moreover. the fiscal multiplier was seriously underestimated. underestimation of the "fiscal multipliers" (the size of output loss owing to fiscal austerity). In fact.Missing Growth Multipliers By Ashoka Mody November 14. GDP is likely to contract this year and increase by roughly 1% next year. the severity and implications of the financial crisis were judged well.6% in 2013.as the WEO has now recognized. the International Monetary Fund's World Economic Outlook predicted that global GDP growth would exceed 4% in 2010. The April 2010 report forecast a US growth rate of roughly 2. Lessons from the October 2008 WEO.have fallen short only modestly. and by 3. global growth has decelerated. predictions for the United States . The April 2010 WEO forecast a UK annual growth rate of nearly 3% in 2012-2013. . For the most part. In its most recent WEO. As a result. The forecast errors have three potential sources: failure to recognize the time needed for economic recovery after a financial crisis. were incorporated into subsequent forecasts. But the forecast proved to be far too optimistic. current projections put the rate a little higher than 2%. which analyzed recoveries after systemic financial stress. forecasts for the United Kingdom. the IMF forecasts global GDP to grow by only 3. the downgrading of growth prospects is remarkably widespread. instead. Much of this costly divergence from the earlier projections can be attributed to the benign view of fiscal consolidation that UK authorities and the IMF shared.In April 2010. Consequently. 2012 PRINCETON. By contrast.where financial-sector stresses largely resembled those in the US.3% in 2012.have been significantly less accurate. with a steady annual growth rate of 4.5% annually in 2012-2013.5% maintained through 2015.

owing partly to decreased exports to Europe. The projected increase in global growth next year will likely not happen. But.the German GDP forecast has been halved. To escape the crisis. in turn undermining global growth. while less ominous and dramatic than financial contagion. Failure to recognize their impact implies that export . in fact. Since eurozone countries trade extensively with each other and the rest of the world. which was not burdened with excessive household or corporate debt. Global trade has steadily weakened. in times of crisis.and. growth in their imports from the rest of the world has lost momentum.and could even be contracting. too. As the global economy has become increasingly interconnected. it was forecast at roughly 2% in 2012-2013. Germany's economy has now plateaued . East Asian economies' growth is down sharply from last year and the 2010 forecast. When a country's economic growth slows. trade spillovers profoundly influence global growth prospects. though less widely recognized. helps to explain why the growth deceleration has been so widespread and persistent. On the contrary. and Spain) have performed considerably worse than projected. Indeed.Likewise. the trade spillovers have the opposite effect. The impact of slowing global trade is most apparent for Germany. given that this year's growth has largely already occurred. the eurozone's heavily indebted economies (Greece. in turn.and. rather than fiscal consolidation. Portugal. In particular. falling import demand from trade partners has caused economic woes to spread and deepen. with almost no increase in the last six months. Ireland. it imports less from other countries. Italy. to reduce imports. The world-trade multiplier. And. policy errors and delays in individual countries will seriously damage economies worldwide. predictably. thereby reducing those countries' growth rates. as European imports from East Asia have fallen.especially to meet voracious Chinese demand. built into growth forecasts. is belied by the UK. Germany used rapid export growth . Although growth was expected to slow subsequently.projections will continue to miss the mark. That notion has now been turned on its head: as economic growth has stalled. growth . their slowdowns have contributed significantly to a decrease in global trade. The European Commission's claim that this slowdown reflects high sovereigndefault risk. the trade generated by a country's growth bolsters global growth. it will contract by a stunning 3%. owing to significant spending cuts and tax hikes. But. The oncepopular notion. The eurozone has been at the epicenter of this contractionary force on global growth. and enjoyed a favorable fiscal position. as Chinese growth has decelerated. For example. these trade multipliers have increased. . Portugal's GDP was expected to grow by 1% this year. where the sovereign risk is deemed by markets to be virtually nonexistent. In good times. and causing them. that exports would provide an escape route from the crisis was never credible.

Princeton University. .Ashoka Mody is a visiting professor ofInternational Economic Policy at the Woodrow Wilson School ofPublic and International Affairs.

. and associated views of the world. liquidity/financial risk. epidemics of new narratives. and how reliably such shocks can be predicted. uncertainty. we are left to wonder what caused large shocks to "uncertainty" and to "liquidity/financial risk" in recent years. which are difficult to quantify." But.Recent indications of a weakening global economy have led many people to wonder how pervasive poor economic performance will be in the coming years.the language of uncertainty itself." about which George Akerlof and I have written. they claimed that the recent slowdown in the United States is basically no different from other recent slowdowns. the OECD issued an interim assessment on the near-term global outlook. If the current slowdown is typical of other slowdowns in recent decades. productivity. written by Pier Carlo Padoan. on September 6. For example. that blandly reports "significant risks" on the horizon . Their model reduces the sources of all recessions to just six shocks . James Stock of Harvard University and Mark Watson of Princeton University unveiled a new "dynamic factor model." estimated using data from 1959 to 2011. 2012 NEW HAVEN . and fiscal policy" ."oil. even if we accept that conclusion. most professional economists do not seem overly glum about the global economy's prospects. DC. monetary policy. then we can predict the same kind of recovery. so economists naturally like to describe the situation as normal. in a paper presented last spring at the Brookings Institution in Washington.and explains most of the post-2007 downturn in terms of just two of these factors: "uncertainty" and "liquidity/financial risk. Having thus excluded the Great Depression. and relate to fluctuating confidence and changing "animal spirits.The Narrative Structure of Global Weakening By Robert J. For example. except larger. We argue that such shifts reflect changing stories. Shiller September 20. or possibly even a depression? A fundamental problem in forecasting nowadays is that the ultimate causes of the slowdown are really psychological and sociological. Are we facing a long global slump. In fact. The problem is that the statistical models that comprise economists' toolkit are best applied in normal times.

But connections between countries do not occur solely through the direct impact of market prices. is the rise of global trade and financial markets. even though the increase was modest (for example. This augmented news reports about Greek profligacy. But opinion leaders.and very far from the kind of statistical analysis exemplified by Stock and Watson. Popular stories tend to take on moral dimensions. with Greeks taking to the streets in protest. when the market for Greek debt started to become increasingly unsettled. of course. and thus closed a negative feedback loop by attracting intensifying public interest. The European crisis began with a Greek meltdown story.When one considers the evidence about external economic shocks over the past year or two. One might object that most people outside of Europe surely were not following the European crisis closely. if at all). what emerges are stories whose precise significance is unknowable. But the economic importance of stories bears no close relation to their monetary value (which can be measured only after the fact. This brings us to the importance of stories . and it appears that the entire global economy is threatened by events in a country of only 11 million people. up from SO). Reports began to appear in global news media portraying an excessive sense of entitlement.and are motivated by. The OECD's interim assessment called it "the most important risk for the global economy. instead. It depends. the Greek story went viral. Interacting public psychology is likely to play a role as well. were following it. These asset bubbles were inflated by . which eventually fueled crises in other European countries. The Greek crisis story began in 2008 with reports of widespread protests and strikes when the government proposed raising the retirement age to address a pension funding shortfall. which is talked about everywhere around the globe. Psychologists have stressed that there is a narrative basis to human thinking: people remember . and the least informed have not even heard of it. and their influence can create an atmosphere that makes everyone less willing to spend.stories. leading people to imagine that bad outcomes reflect some kind of loss of moral resolve." That may seem unlikely: Why should the European crisis be so important elsewhere? Part of the reason. That story might have invited some gossip outside of Greece. but it gained little purchase on international attention until the end of 2009. Foremost among those stories is the European financial crisis. with rising interest rates causing further problems for the government. on their story value. The Greek story seems connected in many people's minds with the stories of the real-estate and stock-market bubbles that preceded the current crisis in 2007. We only know that most of us have heard them many times. women with children or in hazardous jobs would be able to retire with full benefits at just 55. particularly human-interest stories about real people. and friends and relatives of the least informed in each country. Like a YouTube video.

even if the euro crisis appears to be resolved satisfactorily. people saw the Greek crisis not just as a metaphor. is co-author. all over the world. The natural consequence was to support government austerity programs. The European story is with us now. so vivid that. Then as now. of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism. Professor of Economics at Yale University.lax lending standards and an excessive willingness to borrow. which seemed similar to the Greek government's willingness to take on debt to pay lavish pensions. but also as a morality tale. we will not be able to understand the world economic outlook fully without considering the story on people's minds. it will not be forgotten until some new story diverts public attention. Thus. Robert Shiller. which can only make the situation worse. . with George Akerlof.

And. . in truth.a dialogue that has never been more important. I recently participated in a panel discussion of this phenomenon at the American Economic Association annual meeting in Denver. as a collaborator. and when a crisis occurs.D. Until recently. they can go spectacularly wrong. the public is right: while there is a somewhat scientific basis for these models. they would argue.A People's Economics By Robert J. Shiller January 20. blogs. the biggest since the Great Depression. Since it does not include equations or statistical tables. of course. means that economists must be willing to include new and original theories that are not yet received doctrine among professional specialists. most economists did not see this crisis coming in part because they had removed themselves from what real-world people were doing and thinking. An apparent paradox emerged from the discussion: the boom in popular economics comes at a time when the general public seems to have lost faith in professional economists. The panelists all said. That. Sometimes we need to turn off autopilot and think for ourselves. public lectures. would need a Ph. that popular economics facilitates an exchange between specialized economists and the broader public . many professional economists would be reluctant to write a popular book. or even warn of. Successful popular economics involves the reader or listener. because it no longer seems to be a finished and closed discipline. why is the public buying more books by professional economists? The most interesting explanation I heard was that economics has become more interesting. to understand. After all. in one way or another. in some sense.We are in the midst of a boom in popular economics: books. It is no fun to read a book or article that says that economic forecasting is best left to computer models that you. all followed closely by the general public. the general reader. 2011 NEW HAVEN. Certainly. So. articles. the current economic crisis. use our best human intellect. it is not serious work that is worthy of scholarly attention. it would not be viewed favorably in considering a candidate for tenure or a promotion. because almost all of us failed to predict.

as the economist Edwin R. Their models. or even to be harmful. These were judgments made by economists who were familiar with our business leadership . after careful study. encouraged by research trends. and impressions that complacency had set in. The financial crisis delivered a fatal blow to that overconfidence in scientific economics. at least until recently. There is no established scientific procedure that could prove their validity. and the stability of confidence." The competitive forces that underlie stock exchanges were seen to force all securities prices to their true fundamental values. and rationalizations. Seligman put it in 1889. The relatively few professional economists who warned of the current crisis were people. after 1960. Their views could never be submitted to a scholarly journal and evaluated the way a new medical procedure is. not to work. it seems. sometimes suggested that a crisis of this magnitude couldn't happen. Medical professionals know how often seemingly promising new therapies turn out. associated with professional journals that uphold high research standards. For example. when the University of Chicago started creating a Univac computer tape that contained systematic information about millions of stock prices. and the work of our scholars and their computer models really does matter. who not only read the scholarly economics literature. a great deal of scientific research on the properties of stock prices was taken as confirming the "efficient markets hypothesis. "Economics is . All trading schemes not based on this hypothesis were labeled as either misguided or outright frauds. There is a rigorous process of scholarly review of proposed new therapies. economists gradually came to view themselves and their profession in the same way. Of course. subterfuges. But.their inspirations. but also brought into play more personal judgment: intuitive comparisons with past historical episodes. A.Worse than that. One way to interpret this is that the economics profession was not fully accounting for the economy's human element. evaluations of the moral purposes of economic actors. Imagine how the medical profession would view one of its members who recommended to the general public some therapy that had not yet passed scrutiny from the appropriate authorities. lulling watchdogs to sleep. beliefs. taken literally.or so it seemed. It is not just that the profession didn't forecast the crisis. Science had triumphed over stock-market punditry. economics is in many ways a science. conclusions about speculative trading. Circumventing that process and promoting new. In the decades prior to the current financial crisis. price bubbles. untested ideas to the general public is unprofessional. an element that can't be reduced to mathematical analysis. a committee evaluating an economist would likely think that writing a popular economics book that does not repeat the received wisdom of the discipline might even be professionally unethical.

learning from them." To me. i. is co-author.. and no doubt to the other panelists. . .It is not a natural science. and then searching one's soul to decide whether one's favored theory is really close to the truth. Robert Shiller. part of the process of pursuing the inexact aspects of economics is speaking honestly to the broader public.e. of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism. it is an ethical and therefore an historical science. reading the emails they send.a social science. with George Akerlof. and therefore not an exact or purely abstract science. Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC. looking them in the eye...

a substantial and growing minority have had unwanted leisure thrust upon them in the form of unemployment. "technological unemployment" has been on the rise. and forced withdrawal from the labor market. working hours have not fallen since the early 1980's. it might benefit us to take a look at a visionary essay that John Maynard Keynes wrote in 1930. was a cause for hope. as we recover from the current recession. he thought.the problem of scarcity that kept mankind tethered to a burdensome life of toil. however. Keynes thought that by about now (the early twenty-first century) most people would have to work only 15 hours a week to produce all that they needed for subsistence and comfort. Machines were rapidly replacing human labor. the prophecy of vastly increased leisure for all has not been fulfilled." Keynes reckoned that we would hear much more about this kind of unemployment in the future. Interest. called "Economic Possibilities for our Grandchildren." Keynes's General Theory of Employment. published in 1936. In fact. and work has become less physically demanding. But its emergence. "unemployment due to the discovery of means of economizing the use oflabor outrunning the pace at which we can find new uses for labor. For it showed that the developed world. Developed countries are now about as rich as Keynes thought they would be.that is. In fact. at least. Automation has been proceeding apace. was on track to solving the "economic problem". in broad terms. we have never regained the full employment levels of the 1950's and 1960's. . equipped governments with the intellectual tools to counter the unemployment caused by slumps. so we also live longer.Labor's Paradise Lost By Robert Skidelsky June 21. Since the 1980's. though we do take longer holidays. Keynes distinguished between unemployment caused by temporary economic breakdowns and what he called "technological unemployment". but most of us who work still put in an average of 40 hours a week. 2012 LONDON .As people in the developed world wonder how their countries will return to full employment after the Great Recession. holding out the prospect of vastly increased production at a fraction of the existing human effort. If most people still work a 40hour week. At the same time. But. In this earlier essay. rather than despair. and Money. most experts expect this group to grow even larger. but most of us work much longer than 15 hours a week. And. under-employment.

Advertisers proclaim a single message: your soul is to be discovered in your shopping. Without such efforts of social imagination. Apart from its moral implications. And. leisure. Obviously. That road leads to a division of society into a minority of producers. this is unsustainable. The rich and very rich have gotten very much richer. leading to today's massive debt overhangs in advanced economies. Satisfying it has become the great palliative of modern society. recovery from the current crisis will simply be a prelude to more shattering calamities in the future. the answer has been to borrow. This is not just or mainly because we will soon enough run up against the natural limits to growth. It is not surprising that they are working longer than Keynes thought they would. It is because we cannot go on for much longer economizing on labor faster than we can find new uses for it. in fact.What this means is that we have largely failed to convert growing technological unemployment into increased voluntary leisure. our counterfeit reward for working irrational hours. is How Much is Enough? . The civilization of "always more" would have struck him as moral and political madness. and thus is no answer at all. while everyone else's incomes have stagnated. we have witnessed a return to the capitalism "red in tooth and claw" depicted by Karl Marx. such a society would face a classic dilemma: how to reconcile the relentless pressure to consume with stagnant earnings. and financial speculators on one side. four or five times better off than they were in 19 30. for it implies periodic collapse of the wealth-producing machine. Aristotle knew of insatiability only as a personal vice. So far. professionals. politically orchestrated insatiability that we call economic growth. The truth is that we cannot go on successfully automating our production without rethinking our attitudes toward consumption. supervisors. Modern capitalism inflames through every sense and pore the hunger for consumption. Robert Skidelsky's new book. beyond a certain point. co-authored with Edward Skidelsky. work. and the distribution of income. The main reason for this is that the lion's share of the productivity gains achieved over the last 30 years has been seized by the well-off. Particularly in the United States and Britain since the 1980's. and a majority of drones and unemployables on the other. he had no inkling of the collective. But there is something else. So most people are not. it is also economic madness.

is the crucial economic driver. leaving a trail of zombie banks (whose liabilities far exceeded their assets) and ruined borrowers. much favored by followers of Friedrich von Hayek and the Austrian School of economics. For example. Commercial banks. advanced credit for many unsound investment projects. Impaired banks that do not want to lend must somehow be "made whole. As a result. house prices collapsed. arguing that. while seemingly plausible." This analysis.Inequality is Killing Capitalism By Robert Skidelsky November 21. particularly the United States Federal Reserve. After all.) At the same time. it cannot be overcome with more. banks lent more money to borrowers than savers would have been prepared to lend otherwise. (The Fed raised its benchmark federal funds rate from 1% in 2004 to 5.25% in 2006 and held it there until August 2007). with the explosion of financial innovation (particularly of derivative instruments) fueling the lending frenzy. thanks to excessively cheap money provided by central banks. which is that demand for credit. goes like this: In the run up to the crisis. But one can take another view. in the run-up to the . banks are bound to lend on adequate collateral.It is generally agreed that the crisis of 2008-2009 was caused by excessive bank lending. 2012 LONDON. depends on the belief that it is the supply of credit that is essential to economic health: too much money ruins it. This inverted pyramid of debt collapsed when the Fed finally put a halt to the spending spree by hiking up interest rates." by which central banks print money and pump it into the banking system through a variety of unorthodox channels. rather than supply." This has been the purpose of the vast bank bailouts in the US and Europe. The problem now appears to be one of re-starting bank lending. (Hayekians object to this. because the crisis was caused by excessive credit. while too little destroys it. in addition to its price-stability mandate. owing to their "broken" balance sheets. followed by several rounds of "quantitative easing. and. the Bank of England has been given the new task of maintaining "the stability of the financial system. and that the failure to recover adequately from it stems from banks' refusal to lend. flush with central banks' money. A typical story. regulatory regimes have been toughened everywhere to prevent banks from jeopardizing the financial system again.

they should borrow from their central banks and spend the extra money themselves on public works and infrastructure projects. It was not so much predatory lenders as it was imprudent. believe that they cannot borrow any more from the public. In an earlier era. now they are indebted to banks or credit-card companies. with their already-high level of indebtedness. Just as lenders did not force money on the public before the crisis. but the income distribution within countries was becoming steadily more unequal. even as per capita GDP has grown. recovery cannot be left to the Fed. or deluded. This means that the rich have been creaming off a giant share of productivity growth. Our current situation requires not a lender oflast resort. and that they always want more than they can afford. If governments. for all the moneypumping by central banks. but a spender oflast resort. the European Central Bank. commercial banks have not started lending again. And. did this "greed" manifest itself so manically? To answer that. In short. they became indebted to the pawnbroker. who bear the blame. and the economic recovery has petered out. in other words. this view of things explains much better than the orthodox account why. Of course. The world was getting steadily richer. In one of his last articles. or the Bank of England. and that can only be governments. or businesses to seek loans to expand production when markets are flat or shrinking. . then. Why. some worried about the collapse of the household savings rate. so now they cannot force heavily indebted households to borrow. This puts the question of the origins of the crisis in a somewhat different light. Median incomes have been stagnant or even falling for the last 30 years. This is the only way to get the big economies of the West moving again. Milton Friedman wrote that savings nowadays took the form of houses. borrowers. but few were overly concerned. resulted from the demand for credit. we must look at what was happening to the distribution of income. creditors were happy to let them sink deeper and deeper into debt. To me.crisis. because their poverty was only relative and house prices were racing ahead. rising house prices provided it. The supply of credit. And what did the relatively poor do to "keep up with the Joneses" in this world of rising standards? They did what the poor have always done: got into debt. It requires the active involvement of fiscal policymakers. So the question arises: Why did people want to borrow so much? Why did the ratio of household debt to income soar to unprecedented heights in the pre-recession days? Let us agree that people are greedy.

beyond this. is Professor Emeritus of Political Economy at Warwick University. Concerted redistribution of wealth and income has frequently been essential to the long-term survival of capitalism. we cannot carry on with a system that allows so much of the national income and wealth to pile up in so few hands.But. . Robert Skidelsky. We are about to learn that lesson again. a member of the British House of Lords.

The Mirage of Youth Unemployment By Steven Hill August 15.a serious problem. together with GDP indicators. Unemployment estimates also are surprisingly misleading . to 40%. the same number of unemployed individuals is divided by a much smaller number. including an $8 trillion real-estate bubble in the United States. and more than 20% in the eurozone as a whole. investors. because they are neither working nor looking for a job. But these numbers result from flawed methodology.Economists worldwide need better ways to measure economic activity. making the situation appear far worse than it is. Even the eurozone's macroeconomic imbalances largely went unnoticed. Only SO individuals remain in the labor force. to reflect the smaller labor force. In the example above.supposedly near SO% in Spain and Greece. So the perverse result of this way of counting the unemployed is that the more young people who pursue additional education or training. the unemployment rate quadruples. But the millions of young people who attend university or vocational training programs are not considered part of the labor force. So if the labor force comprises 200 workers. and 20 are unemployed. therefore. While standard measures exaggerate youth unemployment. because those who have given up their job search are not counted among the . they likely understate adult unemployment. almost all of them missed the warning signs of the 2008 financial crisis. Although the number of unemployed people remains at 20. financial institutions. The problem stems from how unemployment is measured: The adult unemployment rate is calculated by dividing the number of unemployed individuals by all individuals in the labor force. In calculating youth unemployment.makes headlines daily. as well as property bubbles in Spain. the unemployment rate is 10%. economists were swept up in the financial euphoria that led to excessive risk-taking and severe over-leveraging of banks and households. considering that. Relying on GDP growth rates to assess economic health. let us say that 1SO of the 200 workers become full-time university students. and the United Kingdom. 2012 PARIS . the higher the youth unemployment rate rises. Together with households. Outrageously high youth unemployment. and governments. which makes the unemployment rate look a lot higher. unemployment drives so much economic-policy debate. Ireland.

8% far exceeds the 8. while some young people use higher education to escape a rocky job market. To be sure. Failing to account for the millions of young people either attending university or in vocational training programs undermines the unemployment rate's credibility. Thus. while the eurozone's youth unemployment rate has increased since 2009. its ratio has remained the same (though both significantly exceed pre-2008 levels). their choice to build new skills should not negatively impact perceptions of their country's economic health. respectively. During the 2006 French student protests. the US. Likewise. need to address the problem of youth unemployment. As the Great Recession drives up the number of such "discouraged workers. Spain's 48. . As any pilot knows. four years after the crisis erupted. and Germany. France simply had a higher percentage of young people who were full-time students.even for respected economists like the Nobel laureate Paul Krugman. calculates youth unemployment using both methodologies. Fortunately. the European Union's statistical agency. And the eurozone-wide rate of20. Eurostat. of course.7% ratio. methods for measuring and assessing economic health remain alarmingly inadequate.unemployed. France's 22% youth unemployment rate appeared to compare unfavorably to rates of 11%. And.about the same ratio as in the other three countries. Greece's rate is 49.is a far more meaningful indicator than the youth unemployment rate. Steven Hill is the author of Europe's Promise: Why the European Way is the Best Hope in an Insecure Age and 10 Steps to Repair American Democracy.8% of French under-25's were unemployed . For example. But. but its ratio is only 13%.presenting a distorted picture of reality. But the Financial Times showed that only 7. but only the flawed indicator is widely reported. and 13% in the United Kingdom. these distorted results have become conventional wisdom. Policymakers do.3%.the number of unemployed youth relative to the total population aged 16-24. Unfortunately. flying without radar or accurate weather forecasts is likely to end in a crash. 12%. a youth unemployment ratio of 13% or 19% is not grounds for complacency. who recently invoked the flawed "50% youth unemployment" figure. but they must also acknowledge that the problem is not as serious as the headlines indicate.9% youth unemployment rate implies significantly worse conditions for young people than its 19% youth unemployment ratio. despite major discrepancies." adult unemployment rates appear to fall . there is a better methodology: The youth unemployment ratio .

Although some countries have resisted the trend. Getting rich was what the "new economy" was all about. Top pay rates are simply fixed by comparing them to other top pay rates in similar jobs. people are said to be paid what they are worth: so top CEOs add 263 times more value to the American economy than the workers they employ.The Bad Society By Robert Skidelsky July 19. today it is 263 times higher. The growth of inequality leaves ideological defenders of capitalism unfazed. In 1970. Inequality within countries has increased. Since the late 1970s. and inequality between countries increased sharply after 1980. as taxes were slashed to encourage them to get still richer. the basic pay (without bonuses) of a top CEO was 47 times the average worker's in 1970. After all. alternatively. 2012 LONDON. the proportion of the population living on half or less of the average income in the US and Britain has been growing. In a competitive market system. inequality has been increasing over the last 30-40 years in the world as a whole. The only secure way to get "trickle-down" wealth to trickle faster is by cutting marginal tax rates still further. especially in the United States and Britain. and efforts to divide up the pie more fairly were abandoned. there is no way whatsoever to calculate the marginal products of different individuals in cooperative productive activities. Even more important has been the growing gap between average (mean) and median income: that is. In Britain. or. are still better off than they would have been had the gap been artificially narrowed by trade unions or governments. The results were predictable. it was 81 times more. by improving the "human capital" of the poor. before leveling off in the late 1990's and finally falling back after 2000. New Labour's Peter Mandelson voiced the spirit of the past 30 years when he remarked that he felt intensely "relaxed" about people getting "filthy" rich. And the newly rich kept an increasing part of what they got. a great deal of it. so that they become worth more to their employers.How much inequality is acceptable? Judging by pre-recession standards. it is claimed. the post-tax income of the richest fifth has increased five times as fast as the poorest fifth in the US. in 2010. as catch-up growth in developing countries accelerated. the pre-tax pay of a top American CEO was about 30 times higher than that of the average worker. This is a method of economic reasoning that is calculated to appeal to those at the top of the income pyramid. But the poor. and four times as fast in the UK. .

The greater the knowledge. and responsibility attached to a job. the higher the acceptable and accepted reward for doing it.that has led to today's spurious methods of calculating pay. a member of the British House of Lords.ultimately rests. . 1%. in developed countries. There is a strange. In poor countries. This must be wrong for moral and even practical reasons. is Professor Emeritus of Political Economy at Warwick University. say. very rich. Top business salaries were rarely more than 20 or 30 times higher than average wages. it puts the prospect of the good life perpetually beyond reach for most people. consequence of the failure to distinguish value from price: the only way offered to most people to boost their incomes is through economic growth. common -sense ways of valuing human activities -framing them in larger social contexts. And. But all of this occurred within bounds that maintained some connection between the top and the bottom. In moral terms. family conditions. with the rich. Nor is it by any means certain that the human capital of the majority can be increased faster than that of the minority. 3% to raise the earnings of the majority by.In the past. there is not enough wealth to spread round. skill. contented society . But. because it means that an economy must grow by. not ten times or more. any type of peaceful. it is bound to destroy the social cohesion on which democracy. which is itself a guarantee of economic stability. the income of doctors and lawyers used to be about five times higher than that of manual workers. and connections. in practical terms. Redistribution in these circumstances is a more secure way to achieve a broad base of consumption. indeed. concentration on economic growth is an extraordinarily inefficient way to increase general prosperity. Robert Skidelsky. say. pay differentials were settled by reference to what seemed fair and reasonable. who capture all of the educational advantages flowing from superior wealth. though little-noticed. and for most people differentials were far less.or. It is the breakdown of non -economistic. as they are today. Thus. The attitude of indifference to income distribution is in fact a recipe for economic growth without end. and super-rich drawing ever further ahead of the rest. this is reasonable.

the strategic government intervention needed to ensure macroeconomic stability was not only straightforward. But. but that now seem to be pretty clearly false. In the United States. it turned out that what they really meant was the second: whenever private-market instability threatened to cause a depression. it turned out. the Friedmans made three powerful factual claims about how the world works. rather. Federal Reserve Chairman Ben Bernanke has executed the Friedmanite playbook flawlessly in the current downturn. Considering them together. not by the unstable private market. Their case for small-government libertarianism rested largely on those claims. In other words. Real libertarians never bought the Friedmans' claim that they were as advocating a free-market. my overwhelming thought is that the Friedmans would find their task of justifying and advocating small-government libertarianism much harder today than they did in 1979. The first claim was that macroeconomic distress is caused by the government. Bradford DeLong April 30. 2012 BERKELEY . that the form of macroeconomic regulation required to produce economic stability is straightforward and easily achieved. the belief that macroeconomic stability requires only minimal government intervention is simply wrong.On my desk right now are reporter Timothy Noah's new book The Great Divergence: America's Growing Inequality Crisis and What We Can Do about It and Milton and Rose Director Friedman's classic Free to Choose: A Personal Statement. . was entirely unwarranted. and has now largely crumbled. The aggressive and comprehensive intervention that Keynesians claimed was needed to manage aggregate demand. Back then.Re-Capturing the Friedmans By J. or. whatever its packaging. "neutral" monetary regime: Ludwig von Mises famously called Milton Friedman and his monetarist followers a bunch of socialists. The Friedmans almost always made the claim in its first form: they said that the government had "caused" the Great Depression. disagreed with them about how it works. but also minimal: the authorities need only manage a steady rate of money-supply growth. because the world. the government could avert it or produce a rapid recovery simply by purchasing enough bonds for cash to flood the economy with liquidity. and that Minskyites claimed was needed to manage financial risk.claims that seemed true or maybe true or at least arguably true at the time. and it has not been enough to preserve or rapidly restore full employment. But when you dug into their argument.

would lead to the most equitable outcomes possible. And it did not happen because the world described by the Friedmans is not the world in which we live. the South's segregationist Jim Crow laws). and most important. in the absence of government-mandated discrimination (for example.The second claim was that externalities were relatively small. In the US. J. courts. the Friedmans' hopes have been disappointed. The end of American preeminence in education. . it had appeared to do so . is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research. The third. too. the market economy would produce a sufficiently egalitarian distribution of income.at least for those who did not suffer from legal discrimination or its legacies . this is most apparent in changing attitudes toward medical-malpractice lawsuits. the emergence of a winner-take-all informationage economy. reality does not seem to have endorsed Free to Choose. After all. Alas. claim is the subject of Noah's The Great Divergence. with libertarians no longer viewing the court system as the preferred arena to deal with medical risk and error. Profit-seeking employers. a former assistant secretary of the US Treasury. In 1979. and the return of Gilded Age-style high finance have produced an extraordinarily unequal pre-tax distribution of income. too. the Friedmans could confidently claim that. Bradford DeLong. the collapse of private-sector unions. which will burden the next generation and make a mockery of equality of opportunity. that did not happen. would bring us as close to a free society of associated producers as is attainable in this fallen sublunary sphere.for the entire post-WWII era. Here. or at least that they were better dealt with via contract and tort law than through government regulation. using and promoting human talents. because the disadvantages of government regulation outweighed the harm done by those externalities that the legal system could not properly address. It would have been nice if a relatively equal and prosperous society with full employment and equal opportunity had followed from a government that stood back from the economy and provided nothing but a minimal safety net. So the Friedmans argued that a minimal safety net for those whom bad luck or a lack of prudence had rendered destitute. and a constantly growing money supply. Here. and elimination of all legal barriers to equality of opportunity. It would have been nice if the political program laid out a generation ago in Free to Choose had lived up to the Friedmans' billing.

there was no economic malfunction that the two words "vested interests" could not account for. the less room was left for improving matters. Why do governments erect barriers to international trade? Because the beneficiaries of trade protection are concentrated and politically influential. citizens became rent-seeking lobbies and special interests.There was a time when we economists steered clear of politics. Indeed. when they fail. The apparent payoff was that we could now explain why politicians did so many things that violated economic rationality. But there was a deep paradox in all of this. equity versus efficiency). Why are so many industries closed off to real competition? Because politicians are in the pockets of the incumbents who reap the rents. Why are there financial crises? Because banks capture the policymaking process so that they can take excessive risks at the expense of the general public. and to bureaucrats to implement it. We viewed our job as describing how market economies work. In order to change the world. The more we claimed to be explaining. we need to understand it. and how well-designed policies can enhance efficiency. Then some of us became more ambitious. We began to examine political behavior using the same conceptual framework that we use for consumer and producer decisions in a market economy. and prescribed policies to meet desired economic outcomes. If politicians' behavior is determined by the vested interests to . 2013 CAMBRIDGE . Politicians became income-maximizing suppliers of policy favors. Why do political elites block reforms that would spur economic growth and development? Because growth and development would undermine their hold on political power. including redistribution. And this mode of analysis seemed to transport us to a higher level of understanding of economic and political outcomes. and political systems became marketplaces in which votes and political influence are traded for economic benefits. We analyzed trade-offs between competing objectives (say. It was up to politicians to take our advice (or not). and a style of theorizing that many political scientists readily emulated. Thus was born the field of rational-choice political economy. while consumers are diffuse and disorganized. we turned our analytical toolkit on the behavior of politicians and bureaucrats themselves.The Tyranny of Political Economy By Dani Rodrik February 8. Frustrated by the reality that much of our advice went unheeded (so many free-market solutions still waiting to be taken up!).

There are three ways in which ideas shape interests. Revenue hungry governments will impose a lower tax when they think that it can be evaded than when they think that it cannot. engineers can build better bridges and buildings. political economy disempowers policy analysts. Improvements in natural science enhance. the biggest winners were "vested interests" (Korea's business establishment and the Chinese Communist Party). but the emergence of new strategies. political leadership. but also determined which bridges and buildings engineers would build.money. For example. First. you are on to something. and the decisive role of vested interests evaporates. longevity in power. By endogenizing politicians' behavior. ideas determine how political elites define themselves and the objectives they pursue . Policy design. Make those assumptions explicit. respectively). If it seems to you that something is wrong with this. It is as if physicists came up with theories that explained not only natural phenomena. ideas determine the strategies that political actors believe they can pursue. our ability to shape our physical environment. Second. Indeed. Most important from the perspective of policy analysis. one way for elites to remain in power is to suppress all economic activity. In both cases. These questions of identity are central to how they choose to act. and you radically change behavior and outcomes. economists' advocacy of policy reforms is bound to fall on deaf ears.which they are beholden. honor. Powerful business interests will lobby for different policies when they believe that fiscal stimulus yields only inflation than when they believe that it generates higher aggregate demand. The relationship between political economy and policy analysis is not at all like this. this is what explains some of the most astounding turnarounds in economic performance in recent decades. What enabled reform was not a reconfiguration of political power. the more irrelevant our policy analysis. or pursuing a variety of other strategies limited only by the elites' imagination. fostering state-directed industrialization. Economic change often happens not when vested interests are defeated. . This is where the analogy between human sciences and natural sciences breaks down. The more complete our social science. Expand the range of feasible strategies (which is what good policy design and leadership do). Consider the relationship between science and engineering. or simply a place in history. There would then scarcely be any need for engineering schools. rather than impede. such as South Korea's and China's breakout growth (in the 1960's and the late 1970's. But another is to encourage economic development while diversifying their own economic base. our contemporary frameworks for political economy are replete with unstated assumptions about the system of ideas underlying the operation of political systems. establishing coalitions. status. As scientists' understanding of the physical laws of nature grows more sophisticated. but when different strategies are used to pursue those interests. In reality. ideas determine political actors' views about how the world works. and human agency come back to life.

Professor of International Political Economy at Harvard University.Political economy undoubtedly remains important. Without a clear understanding of who gains and who loses from the status quo. . But an excessive focus on vested interests can easily divert us from the critical contribution that policy analysis and political entrepreneurship can make. it is difficult to make sense of our existing policies. Dani Rodrik. is the author ofThe Globalization Paradox: Democracy and the Future of theW orld Economy. but also by the poverty of our ideas. The possibilities of economic change are limited not just by the realities of political power.

even if the economic pie grew as a result. 2012 CAMBRIDGE . But the Harvard students' response was not entirely surprising. which entails a similar. that almost all of them had instinctively favored free trade. Clearly the students were uncomfortable about condoning a significant redistribution of income. saved and invested more.not just Harvard students. he had asked the students how many of them preferred free trade to import restrictions. And this was before the students had been instructed in the wonders of comparative advantage! We know that when the same question is asked in real surveys with representative samples . I asked.the outcome is quite different. I picked two volunteers." one of them warned me beforehand. Or maybe they did not understand how trade really works. "I have to tell you. I said next. most likely greater. and told them that I was capable of making $200 disappear from Nicholas's bank account. Highly skilled and better-educated respondents tend to be considerably more pro-free trade than blue-collar workers are. that Nicholas and John own two small firms that compete with each other. the response was more than 90%.in fact. emphasizing the likely distributional effects of trade. Let's assume. "this is a pretty pro-globalization crowd.Free-Trade Blinders By Dani Rodrik March 9. Suppose that John got richer by $300 because he worked harder. In the United States. Nicholas and John.redistribution from losers to winners? They appeared taken aback. This time. Many were uncertain. I posed the same question in a different guise. Perhaps the Harvard students were simply voting with their own (future) wallets in mind. the free-trade consensus evaporated. This feat of social engineering would leave the class as a whole better off by $100. How is it possible. when I met with them. respondents favor trade restrictions by a two-to-one margin.even more rapidly than I had anticipated. Would they allow me to carry out this magic trick? Those who voted affirmatively were only a tiny minority. I began the class by asking students whether they would approve of my carrying out a particular magic experiment. After all.poof! -while adding $300 to John's. Even more opposed the change. and .I was recently invited by two Harvard colleagues to make a guest appearance in their course on globalization." In the very first meeting.

in fact. Suppose John had driven Nicholas out of business by importing higher-quality inputs from Germany? By outsourcing to China. They were against certain kinds of redistribution. ravaging the environment. By ignoring the fact that international trade sometimes . Here. We would think differently if Gates and Buffett had enriched themselves not through perspiration and inspiration. but by cheating. they fail to engage the public debate properly. the forces of trade repeatedly hit the same people . even if some of their rivals have suffered along the way. like trade. despite its short-run destructive effects on some. So the students were not necessarily against redistribution. or taking advantage of government subsidies abroad. few students would condone blocking technological progress. why should we accept it just because it involves transactions across political borders? Similarly. When. even when there are genuine ethical issues at stake. If we do not condone redistribution that violates widely shared moral codes at home. That is a key reason why we believe that technological progress should run its course. They are prone to attribute concerns about globalization to crass protectionist motives or ignorance. now directly related to international trade. when we expect redistributive effects to even out in the long run. blue-collar workers .we may feel less sanguine about globalization. everyone except Nicholas approved! I posed other hypotheticals. We do not begrudge Bill Gates or Warren Buffett their billions. we are more likely to overlook reshufflings of income. where labor rights are not well protected? By hiring child workers in Indonesia? Support for the proposed change dropped with each one of these alternatives. They also miss the opportunity to mount a more robust defense of trade when ethical concerns are less warranted. Too many economists are tone-deaf to such distinctions.less educated. Banning the light bulb because candle makers would lose their jobs strikes almost everyone as a silly idea. we need to know about the circumstances that cause them. breaking labor laws.created better products. we should not respond automatically by restricting trade. presumably because they and their competitors operate according to the same ground rules and face pretty much the same opportunities and obstacles. While globalization occasionally raises difficult questions about the legitimacy of its redistributive effects. There are many difficult trade-offs .certainly not always involves redistributive outcomes that we would consider problematic at home. driving Nicholas out of business and causing him a loss of$200. Like most of us. To pass judgment on redistributive outcomes. so that everyone eventually comes out ahead. on the other hand. they care about procedural fairness. often leaves some people worse off. which. How many of the students now approved of the change? This time a vast majority did . But what about technological innovation.

is the author ofThe Globalization Paradox: Democracy and the Future of theW orld Economy.to consider. so that they make such choices consciously and deliberately. . including the consequences for others around the world who may be made significantly poorer than those hurt at home. Professor of International Political Economy at Harvard University. Dani Rodrik. But democracies owe themselves a proper debate. Fetishizing globalization simply because it expands the economic pie is the surest way to delegitimize it in the long run.

.Occupy the Classroom? By Dani Rodrik December 12. taught by my colleague Greg Mankiw. economists get stuck with the charge of being narrowly ideological. he retorted. of course. The students were part of a growing chorus of protest against modern economics as it is taught in the world's leading academic institutions. And non -economic motives and socially cooperative behavior are increasingly part of what economists study. Nevertheless. and disregard for social concerns. Quoting John Maynard Keynes. coursework in a typical economics doctoral program produces a bewildering variety of policy prescriptions depending on the specific context. Indeed..Early last month. much economic research is devoted to understanding how government intervention can improve economic performance. 2011 CAMBRIDGE . by choosing his assumptions . with no foreordained policy conclusions. while others don't. In fact. because they are their own worst enemy when it comes to applying their theories to the real world. seeming to validate longstanding charges against the profession's unrealistic assumptions. Economics has always had its critics. Some of the frameworks economists use to analyze the world favor free markets. Their complaint: the course propagates conservative ideology in the guise of economic science and helps perpetuate social inequality. As the late great international economist Carlos Diaz-Alejandro once put it. "by now any bright graduate student. but the financial crisis and its aftermath have given them fresh ammunition. Instead of ." And that was in the 1970's! An apprentice economist no longer needs to be particularly bright to produce unorthodox policy conclusions.. Mankiw. Economics 10. can produce a consistent model yielding just about any policy recommendation he favored at the start. a group of students staged a walkout in Harvard's popular introductory economics course. found the protesting students "poorly informed. though you may be excused for skepticism if you have not immersed yourself in years of advanced study in economics." Economics does not have an ideology. reification of markets. he pointed out that economics is a method that helps people to think straight and reach the correct answers. for his part. carefully.

Consider the global financial crisis. like the vast majority of the profession. the professor might add that the effect of free trade on an economy's growth rate is not clear. It is an economics that recognizes its limitations and knows that the right message depends on the context. and depends on an altogether different set of requirements. But. "What do you mean by 'good?"' he will ask. Applied appropriately and with a healthy dose of common sense. Let him pose the same question: Is free trade good? I doubt that the answer will come as quickly and be as succinct this time around. in the years leading up to the crisis. because everything becomes so much simpler that way. In fact. "And good for whom?" The professor would then launch into a long and tortured exegesis that will ultimately culminate in a heavily hedged statement: "So if the long list of conditions I have just described are satisfied. Macroeconomics and finance did not lack the tools needed to understand how the crisis arose and unfolded. the invisible hand. Now let the reporter go undercover as a student in the professor's advanced graduate seminar on international trade theory.we skip over the real-world complications and nuances. in policy terms. Oddly. self-fulfilling crises. will be enthusiastic in his support of free trade." If he were in an expansive mood. comparative advantage. unqualified assertion about the benefits of free trade has now been transformed into a statement adorned by all kinds of ifs and buts.often those that best accord with their own personal ideologies. A direct. and assuming we can tax the beneficiaries to compensate the losers.communicating the full panoply of perspectives that their discipline offers. We can be fairly certain that the economist. economics would have prepared us for the financial crisis and pointed us in the right direction to fix what caused it. Indeed. In my book The Globalization Paradox. I contemplate the following thought experiment. which. But the economics we need is of the "seminar room" variety. many economists downplayed these models' lessons in favor of models of efficient and self-correcting markets. Let a journalist call an economics professor for his view on whether free trade with country X or Y is a good idea. the knowledge that the professor willingly imparts with great pride to his advanced students is deemed to be inappropriate (or dangerous) for the general public. the professor is likely to be stymied by the question. and systemic risk. either. asymmetric information. not the "rule-of-thumb" kind. resulted in inadequate governmental oversight over financial markets. In our zeal to display the profession's crown jewels in untarnished form -market efficiency. the academic literature was chock-full of models of financial bubbles. freer trade has the potential to increase everyone's well-being. they display excessive confidence in particular remedies . incentive distortions. . Economics instruction at the undergraduate level suffers from the same problem. It is as if introductory physics courses assumed a world without gravity. well recognized as they are in the discipline.

Nor does it make them more popular. is the author ofThe Globalization Paradox: Democracy and the Future of theW orld Economy.Downplaying the diversity of intellectual frameworks within their own discipline does not make economists better analysts of the real world. . Dani Rodrik. Professor of International Political Economy at Harvard University.

While China's ability to maintain high growth through the "Lehman Shock" was a remarkable feat of economic management.7%. three important changes in China hold geo-political implications for the region and the world. is needed to fight inflation. capital. The question is how rapidly will China's authorities allow the renminbi to appreciate. .In today's Asia. the renminbi appreciated by 20%. Japan and China. like South Korea and Singapore. owing not only to pressure over China's huge trade surplus. is spreading rapidly across Asia and the rest of the world. which so far has been achieved mostly by rapidly increasing factor inputs -labor. however. Sometime this year. about one-third of growth in China now comes from technological progress. China's growth rate last year was 8. and more than 10% in the past two quarters.a level that could be re-attained relatively soon. Given rapid economic growth and continuous renminbi appreciation. also are recording very high rates of growth. In 1989.Asia's Dueling Duopoly By Heizo Takenaka July 1. 2010 TOKYO. According to recent research. but also to the Chinese government's understanding that a stronger renminbi. Between 2003 and 2005. the renminbi is expected to appreciate substantially in the coming years. Chinese GDP could exceed that of the US as soon as 20 15. China's growth pattern is coming to resemble that of industrialized economies. before the Tiananmen Square incident. or an increase in total factor productivity. China's economic footprint. where a lack of political leadership and a limited knowledge of basic economics among government ministers undermines mid-term growth prospects. In other words. Second. there are two economic powers of global standing. and fast. moreover. China's GDP will exceed that of Japan (if it has not already done so). the renminbi's exchange rate was 45% higher than it is now . Most Asian countries are recovering strongly from the global recession that set in following the collapse of Lehman Brothers in 2008. But the balance of economic power between the two is changing. The first change concerns China's pattern of economic growth. Neighboring countries. despite its negative impact on exporters. and energy. The only exception is Japan.

China will face a third dramatic change .a demographic shift reflecting the effects of its long-standing one-child policy. including huge new grants to households and farmers. In other words.such as income inequality . government debt will no longer be backed up by taxpayers' assets. implying that the working-age population will begin to decline by the mid-2010's. At that point. This situation. however. And. despite the seriousness of the budget situation. compared to 120% in Greece.But around 2015. Instead. Indeed.will worsen.political leadership that it is unlikely to find. as pension and health-care costs rise. the government's negative saving is being financed by the private and household sectors' positive saving. the volume of JGBs has soared relative to Japanese household assets. On the contrary. Japan's demographic trends will boost demand for fiscal expenditure. as the DPJ had promised its voters. a tax hike alone cannot solve Japan's problems. Without comprehensive reform under strong political leadership. At the same time.5. Japan is still struggling. Because JGBs are purchased mainly by domestic organizations and households. Japan's GDP share is about one-third of Asia and 8% of the world. reflecting the aging of Japanese society. So. but will continue to hold his post on the all-important Central Military Commission until a complete succession is completed. Hatoyama's cabinet. sooner or later. China's total fertility rate is estimated at around 1. there is little risk of capital flight. making it difficult for the private sector to finance annual budget deficits. all things considered. Greece's GDP share in the European Union is about 3%. And the impact on Asia and the global economy of a fiscal crisis in Japan would make Greece's troubles look like a walk in the park. is changing. As a result. the share of tax revenue in total spending is less than SO% for the first time in Japan's post-war history. the recent resignation from the premiership of Yukio Hatoyama created more uncertainty than his own government did. economic growth will slow. led by his Democratic Party of Japan (DPJ). As a result. and China's domestic problems . the role of political leadership will become much more important. even as political institutions that can channel popular grievances remain underdeveloped. First. ignored macroeconomic management after taking office in September 2009. also around 2015. the country desperately requires strong political leadership to prevent a Greek scenario . While China's economy is growing very rapidly. the market for Japanese Government Bonds (JGBs) has so far remained stable. the government focused on increasing spending. a tax hike will be necessary. So. President HuJintao will step down in 2013. . Under such circumstances. an amount that will be exceeded in about 3-5 years by the value of JGBs. China's looming leadership transition is shaping up to be a very challenging period for China and the world. the household savings rate itself will decline dramatically. And the government debt-to-GDP ratio is around 190%. Japanese households hold about ¥1.100 trillion in net monetary assets. Nevertheless.

and governments should be careful to avoid measures that distort resource allocation. Tokyo. In order to compete with China's export-boosting public-private schemes.and whose mercantilism is prevailing in the region.So the future in Asia now appears to belong to China. This matters for every country. because Asia is now an important center of global economic growth. and Minister of Internal Affairs and Communications under Prime Minister Junichiro Koizumi. In some cases. this will harm free trade.and thus the need for it.are growing by the day. . Heizo Takenaka was Minister of Economics. Minister of Financial Reform. whose economic growth supports that of neighboring countries . The world's expectations for responsible economic management by the governments of both China and Japan. he is currently Director of the Global Security Research Institute at Keio University. other Asian countries are now pursuing similar policies.

and workers' unions. Today. Keynesian fiscal and monetary policy to soften the impact of the business cycle.The reality of market exchange . Thanks to democracy. failed. In this novel social relationship. It was a form of slavery. After the war.direct transactions between merchants and customers appeared gradually 3.000 or 4. Indeed. who became capitalists. the customer was free to buy whatever he wanted.Good and Bad Capitalism By Michel Rocard July 31. Eventually. together with the political efforts of social democracy. the system is unstable. it is 150 times higher. It remains dominant today. Because of these features. traders. a step taken as early as 1946 by social democrats around the world. . and corporations could attract a large number of small savers. Capitalism when it arose three centuries ago was simply the same activity on a larger scale. For several thousand years. By the time of the French Revolution. the standard of living had hardly doubled since the Roman Empire. and. 2009 PARIS . a policy of high salaries and reduction of economic inequality in order to boost household consumption. This system is fantastic. Because of steam engines and electricity. Nevertheless. The twentieth century's worst crisis. the free market was comprised of individuals: craftsmen. At its inception. whenever and from whomever he chose. social struggle. the United States. the free market is part of a basic freedom that is rooted in everyday life. a more balanced system emerged. as all efforts to establish an alternative. between 1929 and 1932. It brought Adolf Hitler to power. the inhumanity of the system was partly softened. the belief that the system needed to be stabilized became widespread. But capitalism is also cruel. even totalitarianism. left to itself.000 years ago. and Germany to lose their jobs (with no unemployment benefits) in less than six months. and consumers. often bargaining with the seller about the price. it has been 20 years since the former communist countries of Eastern Europe rejoined the world of market exchange. leading to a war that left SO million dead. caused 70 million workers in Great Britain. a large number of people were enabled to work together. people were compelled to work 17 hours a day without a day off or retirement. It undergoes a crisis about once a decade. based on three main institutions: health insurance. of utmost importance.

has erupted every four or five years. the banking sector is trying to take advantage of publicly financed rescue packages to protect its privileges. and journalists herald the end of the crisis just because large banks are no longer failing every week. with another 5-10% of unemployed workers and 5-10% dropping out of the labor market altogether. Standards of living rose nearly ten-fold during this period. punctuated by periodic financial crises. In developed nations. . is a member of the European Parliament. In these circumstances. Shareholders organized themselves into pension funds. economic activity is painfully stabilizing at 5% to 10% below 2007 levels. We are now in a strange period in which governments. Capitalism's three stabilizing devices lost their efficacy. and unemployment continues to rise. Because of their pressure. and the hemorrhaging of banks was stanched. former Prime Minister of France and leader of the Socialist Party. Annual growth fell below 3% on average. the number of the working poor reached 10-1 5% of the workforce. reducing the share of wages in total national income by 10% over the past 30 years. we can expect a long period of stagnation. investment funds.regional or global. bankers. that they favor the right and its tendency to support the fortune seekers. which triggered a deep recession and with it a brutal rise in unemployment.The achievement was stunning: 30 years of consistent and rapid economic growth. full and permanent employment in all developed nations. But if we are to have a system where nearly everybody can become better off. Michel Rocard. and no financial or economic crisis. A bleak future awaits us. employment fell. came at the very moment when the system was starting to deteriorate. Today's crisis was triggered by widespread concealment of bad loans within pools of securities sold all over the world. and the collapse of speculative bubbles created by the wealthy classes' greed for more. Capitalism's political success. including immorally huge bonuses and extravagant freedoms to create speculative financial assets with no links to the real economy. The people of Eastern Europe were eager to embrace this kind of capitalism. a severe financial crisis. Even worse. this has not been enough to boost growth. High salaries drove growth but reduced earnings. the wealthy cannot become ever wealthier at the same time. But nothing has been solved. Indeed. The spread of bankruptcies triggered a severe credit crunch. a majority of European voters have recently shown. Prosperity became the main weapon that ensured the West's victory over Soviet communism. however. While rich countries reacted more quickly and more wisely in stimulating their economies than in 1929. once again. Moreover. the so-called end of the crisis looks more like a reconstruction of the mechanisms that caused it. Otherwise. and hedge funds. The root of the crisis remains the fall in purchasing power on the part of the middle and lower classes. over the past 25 years. Everywhere.

a valuable and effective tool .The Moral Limits of Markets By Michael J. Is there anything wrong with buying and selling these things? Some would say no. and claim a front-row seat in the hearing room. Almost without realizing it. 2012 TOKYO. the paying customer can take his or her line-stander's place in the queue. Others believe that there are some things that money should not be able to buy. but don't want to wait for hours in line. health and education. If you want to help to prevent the tragic fact that. as markets and market-oriented thinking have reached into spheres oflife previously governed by non-market values: family life and personal relations. environmental protection and criminal justice. we have drifted from having market economies to becoming market societies. by contrast.for organizing productive activity.Today. The company hires homeless people and others in need of work to wait in line. The last three decades have witnessed a quiet revolution. Just before the hearing begins. A market society. if you want to attend a US Congressional hearing. But why? What exactly is wrong with selling prison-cell upgrades to those who can afford them. there are very few things that money can't buy. and don't like the standard accommodations. If you are sentenced to a jail term in Santa Barbara. we need to pose a bigger question: What role should money and markets play in a good society? Asking this question. Sandel December 31. or hiring linestanders? To answer questions such as these. is more important than ever. people should be free to spend their money to buy whatever someone else is willing to sell. or offering cash for sterilization. thousands of babies are born to drugaddicted mothers. The difference is this: A market economy is a tool . California. is a place where almost everything is . Or. each year.overnight if necessary. and debating it politically. you can buy a prison-cell upgrade for about $90 per night. national security and civic life. you can enlist the services of a line-standing company. you can contribute to a charity that uses a market mechanism to ameliorate the problem: a $300 cash grant to any drug-addicted woman willing to be sterilized.

" in the economist's sense of the term." To decide whether prostitution is degrading. and we often try to avoid addressing them in public discourse. But. These are controversial questions. But that is a mistake.matters more. as money looms larger in our societies. even though such a market would arguably be "efficient. for whom the choice to sell their bodies may not be truly voluntary. The idea that market relations can corrupt higher goods is not restricted to matters of sex and the body. We should be worried about this trend for two reasons. and safe neighborhoods. It is a way of life in which market values seep into social relations and govern every domain. what about systems of campaign finance (including the one currently in place in the United States) that give wealthy donors a disproportionate voice in elections? The reason to reject a market in votes . health care. But others object on the grounds that reducing sex to a commodity is inherently degrading and objectifying. To decide whether we should allow the buying and selling of human organs for transplantation.and its absence. and where do they not belong? . Some object to it on the grounds that it typically exploits the poor. or hire mercenaries to fight our wars. It also applies to civic goods and practices. we have to think through hard questions about human dignity and civic responsibility. affluence. To treat a vote as an instrument of profit would be to degrade it. we have to decide how human sexuality is properly valued. to corrupt its meaning as an expression of civic duty. if a market in votes is objectionable because it corrupts democracy. Consider voting. First. To decide whether selling prison-cell upgrades corrupts the meaning of criminal justice.may be a reason to limit financial contributions to political candidates as well. rather. The best argument against a market in votes is that the vote is not a piece of private property. Our reluctance to engage morally contested questions in politics has left us illequipped to deliberate about one of the most important issues of our time: Where do markets serve the public good. Of course. we have to decide what purpose criminal punishment should serve.up for sale. inequality would matter less than it does today.preserving the integrity of democracy . as money comes to govern access to education. life becomes harder for those of modest means. A second reason to resist putting a price tag on all human activities is that doing so can be corrupting. it is a public responsibility. Many people don't use their votes. We don't allow a free market in votes. political influence. But. we often disagree about what counts as "corrupting" or "degrading. so why let them go to waste? Why not let those who don't much care about an election's outcome sell their vote to someone who does? Both parties to the transaction would be better off. The marketization of everything sharpens the sting of inequality. Prostitution is a classic example. If the main advantages of affluence were the ability to afford yachts and fancy vacations.

Sandel teaches political philosophy at Harvard University. ofWhat Money Can't Buy: The Moral Limits of Markets.Michael J. on which this commentary is based. most recently. . He is the author.

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