A CREDO FOR A REVIVED CAPITALISM / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( RECOMMENDED READING )

A credo for a revived capitalism

By Samuel Brittan

Last updated: May 6 2010 20:25

At some stage it will be necessary to look beyond bail-outs and emergency packages and ask what kind of capitalism should emerge after the present crisis. More is at stake than the nitty-gritty of bank regulation.

To start with, “market fundamentalism”, which had no real existence outside North America, is now well and truly dead. Let us take two sayings that embody it.

First there is the rhetorical question: “What should you do if you found a $100 bill on the street?” The Chicago answer is supposed to be: “You wouldn’t. Somebody would have picked up the bill long ago.” The response presupposes a combination of extreme rationality and extreme selfishness, which does not always prevail.

The second is the slogan: “Government is not the answer. It is the problem.” Unless you are a sincere anarchist, you cannot really believe that; and I hope that I have never said it, even in my most anti-statist moments.

There is a third utterance to which I would plead guilty. This is to quote the great English 18th-century man of letters, Samuel Johnson: “There are few ways in which a man can be more innocently employed than in getting money.” That can scarcely stand up after the latest asset-price bubble and ensuing credit crunch.

Shorn of these extremist statements, the basic case for competitive markets is still Adam Smith’s invisible hand. A trader or a manufacturer will make most profit if he supplies what consumers most want at the lowest possible cost. There is the American saying that if you invent a better mouse trap, the world will come rushing to you. This core statement says nothing about capitalism. You could have state-owned enterprises or workers’ or consumers’ co-operatives competing for profit. It is just a fact that wholesale “market socialism” has never worked, even though there have been outstanding individual successes such as the John Lewis Partnership or Mondragon.

What, then, are the main exceptions to the doctrine of the invisible hand or, to put it more positively, the areas requiring state intervention. I leave aside the antitrust case against monopoly, which is relatively uncontroversial, except to note that many monopolies owe their strength to state barriers or subsidies, especially in foreign trade. The other main areas of “market failure” are:

1. Externalities. This is jargon for costs or benefits for which those responsible do not pay directly. The early example was of a smoking chimney or a well-tended front garden. Today, the whole argument about global warming concerns externalities. They can often be treated by market remedies without too much detailed government intrusion. Over-fishing could be reduced by extending property rights to the sea bed and urban pollution by saleable “pollution permits”.

2. Public goods. This does not refer to anything the public likes, but to products or services that cannot be charged to individual citizens according to taste, such as national defence, or which confer benefits to those who do not pay, such as the urban park that improves the outlook from neighbouring streets even for those who do not enter it.

3. Income and wealth distribution. Almost no one would claim that the pattern of rewards resulting from market transactions and inherited property rights is a just one. In any case, governments can go a long way, although not always as far as they would like, to correct matters through progressive taxation and social security benefits.

These categories were analysed nearly a century ago by a Cambridge economist, A.C. Pigou. They can only provide a framework, which has to be filled in by case-by-case examination and broad political judgment. We also need to remember a further consideration not discussed by the pioneering economists. This is “government failure”. It is a controversial category. But there are aspects that can be analysed, such as the incentive to undertake activities whose benefits are highly concentrated, perhaps in key constituencies, but whose costs are thinly spread. Support for the arms trade is an obvious example.

Despite the inevitable failure to implement the right kinds of intervention and the persistence of the wrong kind, there have been enormous benefits from economic liberalisation. As Jagdish Bhagwati points out in a contribution to The Future of Money (Virgin Books), such reforms have pulled nearly 500m people in China and India above the poverty line. The policy mistake, he argues, has been to “carry over the legitimate approbation of freer trade” and direct foreign investment “to the altogether more volatile financial sector, which represents the soft underbelly of capitalism”. He goes into detail about how this error was encouraged by the constant movement of senior figures between Wall Street and the US Treasury Department. I used to think that such statements by Prof Bhagwati represented mainly the natural frustrations of a highly regarded trade economist at all the attention being focused on financial issues. I think that no longer.

Copyright The Financial Times Limited 2010