Why Capitalism Must be Saved from the Capitalists Research by Raghuram Rajan and Luigi Zingales
Capitalism has always been seen as an instrument for the rich
to get richer. A new book turns this view upside down: Capitalism
is instead a system that fundamentally benefits everyone, especially
"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 new book,
Saving Capitalism from the Capitalists (Crown Business,
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
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
"Once you accept that some rules and regulations are needed
but not too much, the old mantras are useless," note the
authors. "One cannot adopt the posture of the traditional
right that any government suffocates markets. 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."
"It is because this middle ground is so narrow that capitalism
in its best form is very unstable," write Rajan and Zingales.
"It easily degenerates into a system of the incumbents,
for the incumbents, by the incumbents."
Who Makes the Rules?
Rajan and Zingales point out that 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 they cite is the recent case of President
Bush levying tariffs on imported steel. The alleged reason for
the tariff was to protect American jobs. However, there are
only 190,000 workers producing steel and 9 million workers in
steel-consuming jobs. While steel prices in the United States
have indeed gone up, steel prices in the rest of the world have
fallen as exporters redirect their steel away from the United
States. This hurts U.S. industries that rely on steel as an
input: 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 30,000 workers who
were bussed to Washington to press for tariff protection were
effectively used as human shields to protect dominant firms'
interests at the expense of the vitality of the free market
system. The reason they prevailed is that the concentrated lobbying
power of the powerful private interests often outweighs the
public interest in all countries, not just the United States.
It is because rules are made in the interest of business elites
that free market economists have traditionally opposed government
"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. But to liberate this powerful
force, we need to strengthen political support in favor of capitalism."
Tenets of an Ideal System
What ensures that political action is public spirited and that
rules and regulations are not made to protect the interest of
a few business elites? 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.
Studies also show that 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
also perform a useful role. Rajan and Zingales note that they
do not support the recent move to eliminate estate taxes.
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