Capitalism has always been seen as an instrument for the
rich to get richer. A recent book turns this view upside down:
Capitalism is instead a system that fundamentally benefits
everyone, especially the have-nots.
"The paradox we are suggesting is that true capitalism
is very much a threat for the rich," says Luigi Zingales.
"As a result, the rich are the greatest opponents of
competition, which is a key part of the capitalist system."
Zingales and Raghuram Rajan, both professors at the University
of Chicago Graduate School of Business, address misconceptions
about capitalism and the role of government in their recent
book, Saving Capitalism from the Capitalists (Crown
Business, 2003).
To illustrate their main argument, Rajan and Zingales use
the example of a poor Bangladeshi villager who needs 22 cents
to buy raw material for making stools. For lack of better
alternatives, she has to borrow the money from a middleman,
who forces her to sell the stools back to him as repayment
for the loan. He, of course, sets the price. As a result,
the stoolmaker receives only two cents for her day's labor.
This example points to one of the worst ills of capitalism:
exploitation of labor. This exploitation, however, is not
an inevitable consequence of the system. The true essence
of capitalism is embodied in equal access and competitive
markets. It is the lack of access to funds that keeps the
stoolmaker's labor captive.
The authors suggest that in many countries, true capitalist
markets and institutions do not emerge for the simple reason
that capitalists oppose them. The business elites (the middlemen
in the example) would risk losing their position if access
to finance became freer and they faced competition. In order
to protect their positions, the capitalists may turn against
free markets.
Free markets are the single most important tool to eliminate
poverty and spread opportunity. Breaking from the traditional
view that any government regulation hinders the development
of free markets, Rajan and Zingales suggest that competitive
markets are not well served by this laissez-faire approach.
The authors point to the airline industry as a key example
of the complicated balance between regulation and competition.
If there were no supervisory authority and no regulations
enforcing safety standards, people would be very reluctant
to fly fledgling airlines and would stick with established
airlines. Having no safety regulations in the airline industry
would favor established firms and make entry impossible, therefore
killing competition.
However, if regulation required every airline to have a proven
five-year track record of profitable flying before being allowed
to accept passengers, new entry still would be killed off.
How can new entrants have a proven record? The authors argue
that it is on this delicate middle ground that competition
flourishes-with enough rules so that people feel confident
in flying the new entrants, but not so many rules that the
new entrants can never compete.
"One cannot adopt the posture of the traditional right
that any government suffocates markets," Rajan and Zingales
write. "Neither should one adopt the posture of the traditional
left that markets are terrible and governments should replace
them. The right position is the Goldilocks position-neither
too little nor too much of the government is best for markets."
The authors argue that since this middle ground is narrow,
capitalism in its best form is very unstable. It easily degenerates
into a system of the incumbents, for the incumbents, by the
incumbents.
Who Makes the Rules?
Even in democracies where it is assumed that rules are made
by the people through their elected representatives for the
common good, governments tend to act in the interest of the
business elites.
One pertinent example the authors cite is the case of President
George W. Bush levying tariffs on imported steel to protect
American jobs. However, there are only 190,000 workers producing
steel and 9 million workers in steel-consuming jobs. Steel
prices in the United States have risen in relation to the
rest of the world as exporters redirect their steel away from
the United States. This hurts U.S. industries that rely on
steel as an input, because they can no longer compete with
foreign manufacturers who now enjoy cheaper steel inputs.
As a result, some U.S. manufacturers have threatened to move
their facilities abroad. Far more American jobs were put at
risk outside the steel industry by the tariffs than were saved.
The tariffs were a subsidy not so much to the steel workers,
but to the owners and top managers of the distressed steel
firms, who benefit handsomely from the tariff. The reason
the firms prevailed is that the concentrated lobbying power
of the powerful private interests often outweighs the public
interest in all countries.
It is because rules are made in the interest of business
elites that free market economists have traditionally opposed
government regulation.
"We need to find ways to ensure that rules are made
to enhance the access to free markets and encourage competition,"
says Zingales. "We do not want to tame the creative power
of markets, we want to liberate it. To do so, we need to strengthen
political support in favor of capitalism."
Tenets of an Ideal System
Rajan and Zingales propose four pillars to help promote the
public good, recognizing that politics and economics cannot
be kept separate in modern democracies.
First, they advocate a series of measures to promote the
transfer of ownership into efficient hands. Inefficient owners
tend to oppose rules that promote competition, seeing the
downside of free markets rather than the upside of opportunity
that those markets bring. Since taxes on income subsidize
inefficient owners (who do not produce much income), while
property taxes penalize them, one step in the right direction
would be to substitute some of the taxes on income with taxes
on property.
Firm owners who inherit their control tend to be particularly
inefficient. An inheritance tax levied on the transfer of
active control of corporate assets would also support efficient
ownership. In this respect, estate taxes may perform a useful
role.
Second, the authors advocate open borders. Borders open to
trade and capital flow force domestic firms to compete with
foreign firms, essentially creating competition between domestic
rule makers and foreign rule makers. Domestic incumbent interests
can no longer prevail since inefficient rules favoring certain
segments will jeopardize the entire economy.
Open borders provide a country's people with the best chance
that their country's policies will be made to enhance the
public interest. When regulation faces competition across
borders, the result is better regulation in every country.
"We can't let anti-globalization protestors on the street
determine the agenda, because they have the argument backwards,"
says Rajan. "There is a moral ground to oppose the protestors,
since open borders prevent us from being at the mercy of the
current political elite and large domestic firms."
A third component of their prescription is a safety net.
Competition creates winners and losers, which is one of the
biggest sources of tension between democracy and free markets.
People who don't fare as well in the economy still have their
political power. The problem, however, is that the have-nots
may use their political power to lobby for deep-rooted change
that would destroy the foundations of the capitalist system.
Worse, the incumbent powers may ride the coattails of the
anti-free market protest and pressure for protection as well.
Therefore, a safety net is needed to give the have-nots hope
so that they do not turn against markets and become easy political
prey for the incumbents. However, much of the safety net in
developed countries is focused on protecting firms not people,
while in developing countries there is too much reliance on
family as a safety net.
Rajan and Zingales caution that the safety net should not
come in the form of handouts. Crucial elements of the safety
net they propose include a good education system and sound
healthcare to enable the average citizen to take advantage
of opportunities. A well-developed financial system will give
people resources to create their own wealth. With these support
mechanisms, people will have the tools to reinvent themselves
for the job market. The capitalist system in turn is then
better able to survive crises such as economic downturns.
The fourth important pillar in their prescription is awareness.
Collective belief in the power of free markets and knowledge
of the implications of faulty government regulation will help
keep business leaders and politicians in check.
Keeping Capitalism Alive
Recent corporate scandals have added to the perception that
the capitalist system is unfair. Combined with the general
economic downturn, these perceptions can turn into anger against
the system. If unchecked and egged on by politicians, such
anger could result in a movement against free markets.
Instead of enhancing the power of large corporations and
domestic elites, free markets actually curb that power and
channel activities into more productive pursuits.
"People feel guilty about the capitalist system when
they see the poor," says Rajan. "There is no reason
to feel guilty, because capitalism offers the poor the best
access to opportunities. For those who care about the well-being
of others, the goal should be expanding access to everyone
and making it possible for even the have-nots to participate
in the capitalist system."
Raghuram Rajan is Joseph L. Gidwitz Professor of Finance at the University of Chicago Graduate School of Business. Luigi Zingales is Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago Graduate School of Business.
