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Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity Hardcover – February 18, 2003
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From Publishers Weekly
Rajan and Zingales take the Chicago school of economic theory in a new direction with an erudite, comprehensive defense of the free market system, steering a course between conservative isolationists and liberal antiglobalizationists. Only unfettered markets, rather than protectionism, they argue, can provide an environment supporting competition, innovation and economic growth. When businesses suffer losses or fail completely, it means competition is successfully weeding out the incapable-and the authors have nothing but harsh words for governmental attempts to prop up sagging industries through subsidies or tariffs on foreign competitors. They're honest in acknowledging that their "tough break" approach to failure offers little consolation to downsized laborers, but gamely suggest the economically "distressed" should recognize their options and look beyond obfuscating corporate rhetoric about "saving jobs." The book draws strong historical parallels between the half-century market clampdown following the Great Depression, when the public recoiled at the consequences of unmanaged economic risk, and the pessimism fostered by recent high-profile failures and corporate excesses. Because the authors view political support for the free market system as always tenuous, they offer suggestions on how to combat antimarket sentiments by promoting a stronger international market, which would reduce the ability of economic "incumbents" to persuade governments to suppress competition while offering workers some protection against the risks of failure. They argue their case well (though general readers may find some of the more academic passages tough going) and provide a clear new definition for the terms of the free market debate.
Copyright 2003 Reed Business Information, Inc.
The authors, both professors of finance at the University of Chicago's graduate school of business, take an in-depth look at the advantages and shortcomings of free financial systems in a historical context. They argue that although free markets are often reviled, especially during economic downturns, the inherent risks involved and the propensity for some individuals and corporations to corrupt the system can be overcome somewhat. When markets are suppressed, as happened after the Great Depression, competition is stifled, and trade tariffs that are intended to benefit individual nations ultimately harm worldwide economic health. What role, then, should governments play in overseeing financial markets? Historically, so the authors show, respect for individual property rights is the essential first step, and when property is available to the widest classes of people who can actively manage it, the groundwork for free financial trading is laid. For advanced financial systems such as that found in the U.S., the authors propose a balanced approach of government participation, including both measures to provide incentives for free markets and insurance for safety during times of crisis. David Siegfried
Copyright © American Library Association. All rights reserved
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The authors are accused by many reviewers of begin laissez-faire right-wing ideologues, but it is the reviewers who cannot get beyond left versus right. I recommend this book highly.
The book goes to great lenghts to demonstrate the truth in this thesis, drawing examples from different countries and showing what rational behavior by capitalists leads to such a negative situation. The thesis is well defended and makes a reader -- especially an economist as myself -- question the very foundations of economics.
However, the authors also expose the reasons why capitalism has survived, especially in the West, despite such threats. It leads to the conclusion that one must fight for freedom in a wide sense, including economic freedom, meaning well oiled financial markets, open trade barriers, and low regulation to increase competition in as many markets as possible. Competition, whatever the source -- for capital, for labor, for markets, for foreign exchange --, is the heart of capitalism and should be defended by all.
The historical and well-founded account of the constitution and consequences of the financial system helps the reader better understand the healthy limits for the capitalist to live more responsibly with capitalism.
I have a few disagreements with the authors - they do not sufficiently address whether the existence of state central banks and fiat money may cause credit bubbles and crashes, for example. But generally speaking, this is a fine defence of the free market and an expose of the special pleading that often lies behind demands for greater state regulation. At a time when such demands are getting very noisy, this book pays a lot of study.
Seems uncontroversial as a thesis. The "rent seeking" impulse in modern democracies has been elaborated before. Nevertheless, this book makes some new and worthwhile contributions. The authors are professors of finance and thus skew much of their discussion to the operation of financial markets. They show in accessible terms the benefits to society of smoothly functioning financial markets, and how in particular they benefit new entrants and indirectly enforce competitiveness in product markets. Oftentimes even reputable economists will rationalize nations' desire to protect domestic financial markets even while advocating openness in product markets. Rajan and Zingales show that this is typically the result of some politically powerful vested interest in the country protecting its own position. Indeed, open financial markets are arguably even more potent in bringing the benefits of capitalism to the masses. The authors explode the myth of the financier as economic parasite, and show how through the spreading of risk, required returns are reduced and productive investment increased.
They introduce an intriguing and, to me at least, novel theory that private property will be more robust as an institution in circumstances where property is held by those who are the most efficient users of it. The better part of an entire chapter is devoted to an explication of the emergence of the "Squirearchy" in Tudor England, and how it, through the increasing strength of Parliament, was able to suppress the power of the Monarchy and its arbitrary control over property rights. The argument is the that redistribution of land previously expropriated from the Church into the hands of efficient gentleman farmers not only helped create a free market in land, but buttressed the institution of private property because more efficient holders of land had both the economic power and the interest to defend their property rights. Although the argument feels slightly ad hoc at times, the question of why and how strong property rights emerged in some societies and not in others is an important one, and the authors' thesis is plausible and worthy of consideration.
Thus England emerged first among western European countries in establishing secure property rights and circumscribed government, and from there led in industrialization and the development of financial markets. The authors emphasize the importance of financial markets in nurturing industrialization and the importance of keeping governments and vested interests from rigging the financial markets for the benefit of a privileged few. Here however is where the essential argument becomes ambivalent. Developed countries have an advantage over the developing world in that their financial markets are well-established and tolerably transparent: they have established a functioning financial "infrastructure". For developing economies to emulate this, they need to establish similarly strong institutions to protect property rights, enforce contracts, prevent and punish fraud, etc. The implication for the authors seems to be that many of the trappings of modern Western finance are part and parcel of this minimum institutional framework for the stable operation of markets. Financial regulation via, e.g., the SEC, the FDIC, the Federal Reserve system, forms the essential infrastructure for efficient financial markets. But most of this regulatory framework is of reasonably recent origin (the Fed from just before World War I, the rest from the Depression era), and it is not at all clear why the authors assume that none of it is the result of regulatory capture by the incumbents they worry about elsewhere.
The book describes the precariousness of a regime of mostly free markets and documents "the great reversal" of the 1930's and beyond when hostility to capitalism and free markets led to a backtracking on the longer historical trend of increasing freedom and expansion of markets. They document how deeply the development of financial markets were set back, and for how long - by many measures in much of West they still had not reached their pre-WW I level by 1980! And they show how many of the measures instituted, in Italy, in Japan and in the U.S., were bald sops to the established interests of incumbents and not, as advertised, public-interested reforms to protect the majority of the populous.
The point is well-taken, but the authors don't take it far enough. At one point they write:
"It is worth dwelling on this last point, for it goes counter to the belief that the securities legislation in the early 1930s, with its emphasis on disclosure and transparency, was entirely focused on laying the foundations for a vibrant, competitive financial system. **It may have broadly done that**, but particular interest groups also shaped the legislation for their own benefit. The legislation on securities issuance offers an example of how seemingly innocuous changes in laws can limit competition severely" [Emphasis added.]
Isn't the securities legislation of the 1930s the very financial infrastructure the authors cite elsewhere as essential to well-functioning financial markets? They repeatedly make the point: "a little government good, too much government bad". But nowhere do they attempt to distinguish the good from the excessive regulation, the stuff of smooth modern markets as distinct from the detritus of rent-seeking incumbent opportunists.
Alas, in the end, the book does not live up to its subtitle, for nowhere will the reader find the answer to how we can "unleash the power of financial markets to spread opportunity" while keeping the incumbents and their government enablers at bay. The last chapter offers the authors' suggestions, but it feels little different in character from the typical policy recommendations of mainstream economists. Ensure economic power is not concentrated for that gives incumbents more latitude to tilt the field their way. Build a social safety net so the general public will not turn against free markets during downturns. Keep borders open to trade in goods and capital. Educate the public on sound economics. The authors seem to forget themselves; how in the real world of self-interested political dealing do they think these high-minded ideas will be put into force?
The worries that the authors express in this book are valid and important. The "capitalists" of the title are meant to represent the vested interests of the status quo and the real world evidence of the politically connected writing the rules of the game to their own advantage under cover of "public interest" is overwhelming. The arguments Rajan and Zingales marshal in favor of openness, in particular in financial markets, are convincing and more relevant today than ever. However, in these days of bailouts of elite Wall Street firms and special handouts to politically favored unions, one wishes they had some useful recommendations on how exactly to save capitalism from the capitalists.
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