Don't Let U.S. Capitalism Go the Italian Route
Blunt-spoken, deeply informed, and relentless, Luigi Zingales has been one of the great public-intellectual heroes of the financial crisis. (See this September WSJ op-ed with John Cochrane for a sample of his work.) In this meaty and readable essay for National Affairs, he spells out just how much is at stake in the response to the crisis. Here are just a few small samples from a nuanced and long (by the standards of the Twitter age) essay:
In countries with prominent and influential Marxist parties, pro-market and pro-business forces were compelled to merge to fight the common enemy. If one faces the prospect of nationalization (i.e., the control of resources by a small political elite), even relationship capitalism (which involves control of those resources by a small business elite) becomes an appealing alternative.
As a result, many of these countries could not develop a more competitive and open form of capitalism because they could not afford to divide the opposition to Marxism. Worse, the free-market banner was completely appropriated by the pro-business forces, which were better equipped and better fed. Paradoxically, as the appeal of Marxist ideas faded, this problem in many of these countries became worse, not better. After decades of contiguity and capture, the pro-market forces could not separate themselves from the pro-business camp. Having lost the ideological opposition of Marxism and lacking any opposition from pro-market ideology, pro-business forces ruled unchecked. In no coun- try is this more evident than in Italy, where the pro-market movement today is almost literally owned by a businessman, Prime Minister Silvio Berlusconi, who often seems to run the country in the interest of his media empire.
The problem is that people who have spent their entire lives in finance have an understandable tendency to think that the interests of their industry and the interests of the country always coincide. When Treasury Secretary Henry Paulson went to Congress last fall arguing that the world as we knew it would end if Congress did not approve the $700 billion bailout, he was serious and speaking in good faith. And to an extent he was right: His world — the world he lived and worked in — would have ended had there not been a bailout. Goldman Sachs would have gone bankrupt, and the repercussions for everyone he knew would have been enormous. But Henry Paulson's world is not the world most Americans live in — or even the world in which our economy as a whole exists. Whether that world would have ended without Congress's bailout was a far more debatable proposition; unfortunately, that debate never took place.
Compounding the problem is the fact that people in government tend to rely on their networks of trusted friends to gather information "from the outside." If everyone in those networks is drawn from the same milieu, the information and ideas that flow to policymakers will be severely limited. A revealing anecdote comes from a Bush Treasury official, who noted that in the heat of the financial crisis, every time there was a phone call from Manhattan's 212 area code, the message was the same: "Buy the toxic assets." Such uniformity of advice makes it difficult for even the most intelligent or well-meaning policymakers to arrive at the right decisions.
If the free-market system is politically fragile, its most fragile component is precisely the financial industry. It is so fragile because it relies entirely on the sanctity of contracts and the rule of law, and that sanctity cannot be preserved without broad popular support. When people are angry to the point of threatening the lives of bankers; when the majority of Americans are demanding government intervention not only to regulate the financial industry but to control the way companies are run; when voters lose confidence in the economic system because they perceive it as fundamentally corrupt — then the sanctity of private property becomes threatened as well. And when property rights are not protected, the survival of an effective financial sector, and with it a thriving economy, is in doubt.
The government's involvement in the financial sector in the wake of the crisis — and particularly the bailouts of large banks and other insti- tutions — has exacerbated this problem. Public mistrust of government has combined with mistrust of bankers, and concerns about the waste of taxpayer dollars have been joined to worries about rewarding those who caused the mess on Wall Street. In response, politicians have tried to save themselves by turning against the finance sector with a vengeance. That the House of Representatives approved a proposal to retroactively tax 90% of all bonuses paid by financial institutions receiving TARP money shows how dangerous this combination of backlash and demagoguery can be.
We thus stand at a crossroads for American capitalism. One path would channel popular rage into political support for some genuinely pro- market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can intro- duce limits to the power of the financial industry — or any business, for that matter — and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.
The alternative path is to soothe the popular rage with measures like limits on executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism in the long run. They also reinforce the very practices that caused the crisis. This is the path to big-business capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism. Unfortunately, it looks for now like the Obama administration has chosen this latter path.