Why Liberal Capitalism Should Be Saved

Martin Wolf
The Wincott Memorial Lecture, 14th November 2019

"Why Liberal Capitalism Should Be Saved" - The Wincott Memorail Lecture

“The bourgeoisie has through its exploitation of the world market given a cosmopolitan character to production and consumption in every country. . . In place of the old local and national seclusion and self-sufficiency, we have intercourse in every direction, universal inter-dependence of nations. And as in material, so also in intellectual production. The intellectual creations of individual nations become common property.”

The authors of this passage were Marx and Engels. They understood what is striking about capitalism: it is global; and it is revolutionary. Over the past four decades we have re-lived this experience in one of the greatest transformations of world history: the triumphant expansion of the economies of developing Asia, home to over half of humanity, and of China, above all.

“Globalisation”, which is no more than a name for an emerging global market economy, has delivered a staggering reduction in global poverty. According to the World Bank, the share of the world’s population in “absolute poverty” (gross domestic product per head of a mere $1.90 a day, at 2011 purchasing power parity) fell from 42 per cent of the world’s population in 1981 to 10 per cent in 2015. Astoundlingly, since 1980, the purchasing power of Chinese GDP per head has risen from 3 per cent to 30 per cent of US levels. Nothing comparable has ever happened before, in scale or speed. India, too, enjoyed a noteworthy acceleration of development after its pro-market reforms of the early 1990s.
Make no mistake about it: private enterprise was the chief driver of this extraordinary progress. The decisive decision was that of Deng Xiaoping to take the Chinese government out of the way in vital sectors. The share of state-owned enterprises in industrial output collapsed, from 80 per cent in 1978 to 20 per cent in 2016. Return on assets of private industrial enterprises has also massively outstripped that of state-owned enterprises. *Private enterprise has also driven China’s “tech” revolution: Alibaba, Tencent, Baidu and so forth are private businesses. So, though its structure is unusual, is Huawei.

When we consider all the complaints about globalisation in the West, we need to understand one overriding fact: it is not that it failed, but that it succeeded. Nor was this a surprise. We have had something close to controlled experiments on the relative efficacy of private enterprise and socialism since World War II in South versus North Korea and West versus East Germany. North Korea is an impoverished prison state, while South Korea, once poorer than the North, is today a high-income country. East Germany collapsed when its people were given a chance to vote with their feet. That says it all.

As important, the market-oriented countries in these pairings were (or became) democracies. That was no accident. An entrenched market economy should protect democracy from irresponsible demagogy, just as a lively democracy should protect the market economy from predatory plutocracy. No fully socialised economy has been a democracy. How could it be? If an economy is socialised, the concentration of power is surely too great to remain peacefully contestable.

More granular aspects to the shift towards the market economy that began to take hold in the early 1980s also occurred, especially in the US, under Ronald Reagan, and the UK, under Margaret Thatcher. Important elements were privatisation and deregulation of labour markets.

History shows that the privatisation of those businesses that operate in competitive markets was a success: Few can now imagine that the state needs to run airlines, steel mills, coal mines, telecoms, or electricity generators? More controversial, inevitably and properly, are natural monopolies or quasi-monopolies: water; the electricity grid; the rail tracks. Experience has re-taught us that these are difficult industries, whether run as state-owned monopolies or regulated private monopolies. I prefer the relative clarity of the latter. But the risks of regulatory ineffectiveness or capture are both real and permanent.

Again, there are important arguments to be had on labour markets. But we can say with some confidence that the combination of substantial deregulation with a carefully implemented minimum wage (introduced under Labour) and tax credits for those in work was a success. Today, partly as a result, the UK enjoys the highest employment rate it has ever had.

If the era of global capitalism has worked well in crucial respects, why is it now condemned?

The answer is threefold: first, there has been a lengthy period of rising income and wealth inequality in some (but not all) high-income countries, most significantly the US; second, there has also been a long period of real income stagnation for large proportions of the workforce, again, especially in the US, but also elsewhere since the crisis, as well as a sharp slowdown in productivity growth, notably the UK since the crisis; finally, a huge credit boom ended with an enormous financial crisis, which inflicted a huge recession in the high-income economies and a brutal and brutally mishandled crisis in the eurozone.

How far is global capitalism to blame for these unhappy developments? The answer is: not as much as many suppose.

First, the globalisation of the real economy was not a dominant cause of the ills listed above. In the US, the sentiment is widespread that trade and migration inflicted large losses on what they call the “middle class”. Arguably, that is why Donald Trump is now president. But the evidence against this view is unambiguous. Rising imports have had an impact, especially in localities where a single plant or industry was a dominant employer. But it has not been a significant cause of rising inequality and stagnant real incomes in the US. The very fact that the US experience in both regards has been much worse than in many other high-income countries, all similarly buffeted by globalisation, demonstrates that trade cannot be the dominant cause of America’s ills (or, for that matter, those of the UK).

So what have been the true failures? There is increasing evidence, notably for the US, of a sharp increase in concentration and declining competition. As Thomas Philippon, of New York University, points out in a compelling recent book, The Great Reversal, margins have risen and investment has declined. The combination suggests a rise in both monopoly and monopsony. Behind this, in turn, lie over-generous protection of intellectual property, abandonment of restrictions on mergers and acquisitions, notably in the case of “big tech”, short-sighted and exploitative corporate governance, including via the “bonus culture”, as Andrew Smithers argues.

Behind the latter, in turn, is excessive “financialisation” of corporate governance. Contrary to impressions, “natural” monopoly in big tech may be more an excuse than a reality, except perhaps in the case of search (and so Google) and, to a lesser degree, social media (and so Facebook). But such powerful natural monopolies do need to be regulated.

The financial crisis of 2007-09 and the subsequent crisis of the eurozone was also partly the product of grossly irresponsible behaviour in a poorly regulated and undercapitalised financial system. We can argue that a good part of this failure was due not to capitalism per se, but to implicit and explicit guarantees, not offset by adequate oversight. To that extent, it was as much a failure of policy as of finance. Nevertheless, we have been powerfully reminded of the tendency of the capitalist economy towards instability. In the case of the eurozone, a huge policy error greatly exacerbated this instability: the decision to create a currency union without the necessary institutions of risk-sharing and adjustment needed if it was to work successfully. This was not a failure of capitalism, but of over-enthusiastic and irresponsible politics.

So where does this leave us today? Let me return to that quotation at the beginning of my speech from The Communist Manifesto. It called for the end of capitalism and its replacement by socialism. It did not happen. Where it was tried, socialism proved a disastrous failure. Instead, capitalism, politics and policy were all reformed, repeatedly, and so given a new lease of life.

We need such a reformation again: an active and dynamic anti-trust policy to overthrow monopoly; tighter control over finance; radical reforms of taxation, to reduce tax avoidance and evasion; more active attention to the roots of “secular stagnation”; and a greater commitment to the supply of essential public goods, including that most important of global public goods, the management of our shared environment; and a more active redistribution of income.

We will need to act both locally and globally. But we must never ignore the role that will have to be played by that dynamic engine of prosperity and freedom – a market economy that values, encourages and exploits the initiative of countless individuals. This has been the great engine of economic advance. That remains as true today as it has been in the past. Capitalism must not be allowed to operate outside politics or above it. That is the naïve ideology of libertarians. But the market economy has to be an essential part of any worthwhile political settlement, in our era, as it has been in our past.

* Nicholas Lardy, “Private sector Development”, in Ross Garnaut, Ligang Song, and Cai Fang, eds. China’s 40 Years of Reform and Development: 1978–2018. Acton ACT, Australia: ANU Press, 2018. http://www.jstor.org/stable/j.ctv5cgbnk.