Why this book?
Global imbalances, traditional ideologues and increasing distressed groups constantly threaten the pillars of the free market system. A highly criticized and least understood model (i.e. Capitalism) requires proper assessment by understanding its fundamentals in the context of historical examples thereby enabling constructive realignment.
Approach & section-wise themes
The book is broadly divided into four sections – The first section explains the benefits of free financial markets. The second section delves into how financial markets emerge. The third section explains the causes for market reversals (1930 – 1980) and finally it touches upon how free markets can position themselves as a politically viable model without compromising on economical sanctity. Here is a synthesized version of the arguments presented by Rajan and Zingales in Sections 1 to 3.
Section 1: Underdeveloped financial infrastructure benefits only the rich -> leads to untapped resources -> wealthy and well connected are not the only skill based resources. Expand financial access -> Spread risks widely -> increase disclosures/transparency. Developed financial sector -> Promote competition -> Foster innovation -> Increase growth.
Section 2: Impediment to free markets -> Rapacity of governments -> Relationship-based-lending. Emergence of a new class between owners and labor -> Competition from outside -> New Technologies -> Skill based lending -> Creative destruction -> Public interest prevails.
Section 3: Influence of neighbors on borders -> Bretton Woods agreement -> Exchange rate stability -> Selective passage of cross border flows -> Relationship Finance -> Muted growth.
The authors derive strength to support the above arguments by analyzing the economic models of many countries (France, India, Japan, United Kingdom & United States to name a few) across the globe spanning the pre-world war and post-world war periods.
Demystifying economic phenomenon
The book is not an easy read and I mean this as a compliment. Rajan and Zingales provide sufficient metaphors/stories to make us understand some of the complex economic phenomenon. They point to factors (however debatable some data points could be) that derive economic outcomes. It goes beyond the common narrative of eulogizing leaders (Reagan, Thatcher) and attempts to seek economic underpinnings that shaped decision making. In the process, it does not discredit them but provides context surrounding the decisions made. As an observer, it educates you to look at the principles behind the personalities and consequently apply those principles to other leaders.
Breaking the finance-politics nexus
With capital being tied so much to politics, is there a way out? The last couple of chapters provide a few ideas ranging from corporate governance and provision of incentives to establishing an inheritance tax and designing novel insurance methods. Capitalism engenders creative destruction and when that coincides with bust cycles, there is huge uproar. Failure is often attributed to malfeasance rather than bad luck or incompetence. Murphy’s law prevails and the benefits of capitalism achieved during the glorious years seldom get noticed. A momentary pause could be taken to look around the infrastructure built in the past 40-50 years. It may be prudent to apply a customized version of Hanlon’s razor here. Never attribute anything to malice that which can be explained by incompetence.
This does not mean to rest on past laurels and the distressed should be ignored. The book argues that safety mechanisms should be put in place not after the fact but before. Rhetoric and groupthink could mean that benefits reach the politically charged; not necessarily the most needed. Relief provided ex-post is not insurance but pure redistribution. Discerning readers can relate to several events that happened/continue to happen across the globe.
A political version of anti-trust law is also mentioned briefly. This is to prevent a firm from growing big enough to have domestic clouts that could eventually tame market forces. With the exorbitant rise in market valuation of certain technology companies today, this point can be further explored.
Ideas & Economic policy making
Prescriptions from pure market oriented forces and centrally controlled anti-market forces seldom do achieve the planned economic results across the society. A thoughtful combination of the intent behind Marx, Smith and Keynes is required. The law of unintended consequences does play out in skewing the benefits towards a certain section of the society. Ideas have driven the human race and this book plays an important role in collating, digesting, analyzing and advancing them.
Economic policy making is extremely complex with many variables that continuously change. Long term decisions need to be implemented with levers that can revise short term plans. It is like laying the strong foundation for a fully planned house with enough leeway to change wall and roof designs. The principles required to build such a sturdy yet flexible model are particularly challenging. It requires a thorough review of historical examples, detailed examination of existing academic literature and careful prognosis. On the first two aspects, the book makes great strides. Regarding the third, it looked like quickly put together. However, this concern could be possible since the preceding chapters were presented with painstaking detail providing great insights.
Relevance today
I wish I had read this book (originally published in 2003) earlier. However, the challenges posed are still relevant today and even more greatly so in some ways. Some of the authors’ fears regarding free markets being in danger which could have been viewed as absurd then have started taking shape in some (if not significant) form now. It is also a grim reminder that capitalism’s political enemies stem from within when the model becomes of the incumbents, by the incumbents and for the incumbents.
Their view on portability of skills across borders in many disciplines has greatly propelled this year when digitization witnessed maximum boost. Technology is increasingly enabling remote collaboration between many labor groups. The 5 day online Singapore (organizing authority, does location matter?) fin tech festival with participation from exhibitors and experts across the world is a case in point. Rajan and Zingales argue that developing and developed countries should perceive each other’s comparative advantage to collaboratively work together.
They state that bubbles are easy to recognize with the benefit of hindsight. However, murkier to identify in the midst of it. Its relevance to the current environment can be left to the reader.
Does it make the cut?
Towards the end of the book, they state that the book’s objective would be fulfilled if the public can be partly convinced of the issues that drive growth/progress (Emphasis included by me). In my opinion, it has considerably met that standard. It also lays down in theory certain suggestions to save capitalism from the incumbent capitalists and drive towards a more ‘financially-inclusive’ model. Although the term benevolent capitalism and compassionate capitalism can be used (and rightly so), I think it makes more sense to use the term financially inclusive as that is more in line with the ‘heart’ of capitalism.
Personal note
In some ways, a truly good book is one that disturbs you. This is definitely one of them. It is often mentioned that capitalism results in the most efficient allocations of resources. I am convinced with a caveat that the rewards side of the equation can be improved. Sitting on the bedrock of capitalism, Rajan and Zingales have dispassionately dissected it. A model of competition across borders without cronies and cartels that result in co-operation is the need of the hour. It may be too much to wish for but Rajan and Zingales provide……hope.
ISBN-13: 978-0691121284
ISBN-10: 0691121281
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