The world did not end. Despite all the forebodings of disaster in the 2007-09 financial crisis, the riots, soup kitchens, and bankruptcies did not materialise–and no one any longer expects the global capitalist system to “collapse”, whatever that emotive word may mean. Yet the capitalist system’s survival does not imply that the pre-crisis faith in the wisdom of financial markets and the efficiency of free enterprise will ever again be what it was before the bankruptcy of Lehman Brothers on 15 September 2008. What, then, will replace the global capitalism that crumbled in the autumn of 2008? The answer is–global capitalism, but of a new kind.
The traumatic events of 2007-09 have neither destroyed nor diminished the fundamental human urges that have always powered the capitalist system–ambition, initiative, individualism, the competitive spirit, etc. But these natural human qualities are already being redirected to create a new version of the capitalist that will ultimately be more successful and productive than the one that collapsed in 2008.
Rather than blaming greedy bankers, incompetent regulators or gullible homeowners, the meltdown in the global financial system needs to be put into historical and ideological perspective. Capitalism is an adaptive system that evolves in response to a changing environment. Once we recognise that capitalism is not a static set of institutions, but an evolutionary system that reinvents itself through crises, we can see the events of 2007-09 in a new light: as the fourth systemic transformation of capitalism, comparable to the transformations that followed the inflationary crisis of the 1970s, the Great Depression of the 1930s, and the Napoleonic Wars of 1803–15. The emerging politico-economic system can therefore be described as “Capitalism 4.0”.
Viewing the crisis in this historical perspective we can also see that the global boom was not just an episode of mass hysteria, but in part a logical response to four great politico-economic trends that began in the late 1980s: the breakdown of communism, the re-emergence of Asia, the revolution in electronic technology and the creation of a global financial system based on pure fiat money. These benign trends inspired speculation and produced a boom-bust cycle, in a pattern typical of previous periods of productivity-enhancing structural change. What turned a severe but manageable boom-bust cycle into an unprecedented financial disaster was the fundamentalist interpretation of the economic theory of efficient markets, first by Alan Greenspan and then by Henry Paulson, with even more disastrous results.
The clearest consequence of the crisis is therefore a transformed relationship between public policy and markets. Such shifts in the boundary between economics and politics have been the defining feature of each successive version of the capitalism system. In classical 19th century capitalism, politics and economics were completely distinct spheres, with interactions between government and private enterprise largely confined to the raising of military revenues and protection of powerful vested interests. The second version of capitalism, from the 1930s onwards, was characterised by a distrust of markets and a faith in benign, omniscient government. The third phase, defined by the Thatcher-Reagan revolution, exactly reversed these prejudices– governments were distrusted and markets were always right. In the fourth phase, the world is beginning to recognise that governments and markets can both be catastrophically wrong.
Recognising the fallibility of both markets and political institutions may seem paralysing, but is, in fact, empowering. Imperfect knowledge implies a balanced collaboration between politics and economics, rather than an adversarial relationship, and creates scope forleadership, creativity and experimentation in both government and business. If the world is too complex and unpredictable for either markets or governments to be perfect mechanisms for achieving social objectives, then systems of checks and balances reflecting both private incentives and public interests will have to be devised. Experimentation and pragmatism must therefore become the watchwords in public policy, economics and business strategy, even if this means a loss of consistency and coherence. The ability to operate by trial and error, to correct mistakes before they do too much social harm, is the greatest virtue of the market system. A similar pragmatism will have to be extended in the years ahead to political decisions and to the interaction of government with the economy.
Political and business leaders are acknowledging the shift from a world of rationalist predictability to one characterised by ambiguity, unpredictability and fuzzy logic, and economists will have to follow suit. Mainstream economic assumptions of rational expectations, neutrality of money and efficient markets left only one important role for macroeconomic policy, which is to keep inflation under control. But if financial cycles, banking crises and self-reinforcing economic slumps are recognised as natural features of the capitalist system–then governments and central banks must again accept the broad responsibilities they abandoned in the 1980s for managing growth and employment, as well as maintaining financial stability and keeping inflation under control.
These vast new responsibilities may suggest that government will grow ever larger, but the opposite is more likely. The size of government will have to shrink, even as its responsibilities expand, because deficits and tax burdens have reached the limits of public acceptance–and also because the complex demands of advanced societies, ranging from healthcare and higher education to energy independence and stable mortgage financing, can only be satisfied by profit enterprise acting through competitive capitalist markets. The expanding role of the government will not be in replacing markets, but in changing incentives, so that profit-seeking businesses pursue politically-desired objectives, whether in financial markets, healthcare, education or energy investment.
The opportunities created by technology, globalisation and social reform in the 21st century suggest that the world economy, instead of descending into a “new normal” of stagnant growth and high unemployment, should actually become more prosperous in the coming decades than it was in the 30 years of market fundamentalism before the crisis.
Politicians and central bankers have enormously powerful tools at their disposal to stimulate growth–zero interest rates, open-ended credit guarantees, fiscal stimulus and a limitless ability to print money. The economic doctrines of the pre-crisis period assumed that efforts to boost growth with monetary and fiscal policies were doomedto failure. But these market fundamentalist assumptions are being replaced by a more pragmatic understanding of macroeconomics. Policymakers are rediscovering the use of monetary policy to manage employment as well as inflation, of public spending to create jobs, of tax incentives to encourage investment and currencies to promote export growth.
Speaking at the World Economic Forum in Davos in January, the White House chief economist Larry Summers made the following prediction: “When historians look back on the economic figures for 2010-19, I will be very surprised if they are not much better than the figures for 2000-09. If we renew our failing systems, we can provide much better outcomes to the American people than we did in the last decade.”
No one at the time paid much attention, because a new normal of mass unemployment and stagnant living standards was generally believed to be inevitable after the financial disasters of 2007-09. But with every month that goes by, Summers’ optimism becomes more credible.
If America and Europe fail to show the ideological flexibility required to make the new model of capitalism more successful than the old one, the political economy of the coming decades will be shaped more by China’s state-led capitalism than Western democracy. If, however, the rising generation of American, European and Asian politicians and business leaders recognise that changes are inevitable in both market and state fundamentalist thinking, then a mutually beneficial balance should soon be re-established in the politico-economic dynamics of emerging economies and advanced capitalist nations.
Anatole Kaletsky is a columnist and principal economic commentator of The Times of London. He wrote this article for the OECD Observer. It is based on Mr Kaletsky’s new book, Capitalism 4.0, which will be published by Bloomsbury in the UK and by Public Affairs Books in the US in June 2010. It will be published by CITIC Publishing House in China.
©OECD Observer No 279 May 2010