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Capitalism 4.

0: The Birth of a New Economy

Capitalism is not a static set of perfect institutions in a permanent equilibrium: it evolves by natural selection when prompted by crisis. As the global economy and financial system recovers from the recent Financial Crisis, a new model of capitalism will again emerge, involving new relationships between governments and markets.

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1. The world economy has recovered strongly. Global capitalism did not collapse (as many in the early stages of the Crisis warned it would). 2. Banks survived and repaid their governments. 3. Europe is harder hit by the Crisis then the US. The survival of the Euro is under threat the single currency, far from insulating Europe from trouble, has increased its financial risk. 4. Economic policies have been permanently transformed by the Crisis. Previously denounced by market fundamentalists, the massive fiscal and monetary stimuli during 2009 are widely acknowledged to have worked. 5. Economic theories are being reconsidered. 6. Governments are simultaneously expanding and contracting. Even as they are being forced to reduce spending, they are expanding their responsibilities in creating jobs, regulating financial institutions, and so on. 7. A new model of capitalism has begun to evolve. A more constructive relationship is being developed between the public and private sectors.


Capitalism reinvents itself through natural selection when prompted by crises The 2008/2009 Crisis marks for a fourth time a systematic transformation of the capitalist system, comparable to the three previous transformations: the Inflationary Crisis 40 years ago (1970s), the Great Depression 40 years before that (1930s), the period of geopolitical and economic turmoil 100 years earlier. Capitalism is still in no danger of collapse

These historical economic crises have not destroyed or diminished the fundamental human instincts that drive the capitalist system: ambition, initiative, individualism and a competitive spirit. However, humanity's naturally competitive and inquisitive nature can and will be channelled differently as a result of the most recent crisis. The new version of capitalism that will emerge may eventually prove to be even more successful and productive than the one that collapsed in 2008.

There is a fresh appreciation for the role of governments in market economies The dominant economic theories of the 1980s assumed that efficient markets moved automatically towards equilibrium with full employment. Based on this assumption, the government's sole important goal was to control inflation. 2008/2009 showed that banking crises are natural features of the financial system. Market economies cannot function properly without competent and active regulation. Governments and central banks are again beginning to accept the broad responsibilities they mostly abandoned in the 1980s managing growth, employment and financial stability, as well as keeping inflation under control. Governments will be more active but could become smaller, not bigger Despite the government's expanding involvement in economic management and financial regulation, the public sector is likely to shrink rather than grow ever larger. This is because: Governments have run out of money: Given the loss of tax revenue resulting from the Crisis, the health and pensions promises made by successive governments in Europe and America are obviously unsustainable. Governments cannot satisfy advanced economies' complex demands for healthcare, education and personalised retirement planning.


Finance and government are interdependent The banking system is the heart of any market economy, pumping the lifeblood of capitalism: money, credit and investment. These cannot be allowed to stop flowing, particularly in a crisis. Rather than introduce everincreasing new regulations, Capitalism 4.0 must accept the need for openended government guarantees in extreme conditions. There is the need for prefunded insurance mechanisms and much simpler capital structures that make clear ex ante which bank liabilities will be guaranteed by governments and which will not.

Financial regulation will require mutual checks and balances While the financial system is vulnerable to market failure, governments are also prone to error, political bias and corruption. The new system therefore needs checks and balances that involve regulators and financial markets correcting or at least limiting each other's capacity to make mistakes. There may be "crisis" periods where banks will need government support, potentially unlimited government support.

Tremendous global transformations preceded the Crisis The 30 years before the Financial Crisis was characterised by several megatrends: the end of communism; the technology revolution; the arrival of three billion new consumers and producers into the world economy; the ability of the world to live with paper money, not backed by gold. The world economy will continue to grow rapidly With increasing globalisation, technology and social reform in the 21st century, the world economy is likely to become even more prosperous in the coming decades. Advanced economies must evolve to keep up Advanced economies must now come up with the ideological flexibility that is needed to create a new model of capitalism Capitalism 4.0 to build this optimistic future.