Dec 4, 2008

World - Anarchic capitalism vs. sensible capitalism

Prabhudev Konana

Wall Street practised anarchic capitalism, not sensible capitalism. However, history suggests that American capitalism will survive, although with greater transparency and sanity checks.

The world is in an economic crisis. Free market capitalism is now synonymous with the free-falling stock market. Some on the Left trumpet that this is the end of American capitalism. They thrash free-market capitalism as a vulgar passion of the greedy rich that mercilessly tramples on the working poor. For them Karl Marx’s prognosis of capitalism creating increasingly severe periodic crisis has come true. Massive layoffs and economic despair-driven suicides provide f urther evidence. Extending this argument, some conclude that India’s liberalisation, privatisation, and free trade are draconian measures destined to fail one day.

The free-market capitalists on the Right blast the current mess as a result of anti-capitalistic governmental interventions like subsidised home ownership, government-backed enterprises, and bail-outs. They pound ‘let the market take its course’ with passion. There is some truth that excess capacity must go either through consolidation and/or bankruptcy, but they shamelessly ignore comical financial engineering — as a result of lobby-driven deregulations — that have fooled even the savviest investors around the world. Sadly these free market proponents blessed subsidised ethanol from corn as a fuel substitute and cheered speculators who drove commodity prices to the stratosphere.

Wall Street mortalled

President George W. Bush said that Wall Street was slightly drunk. In fact, Wall Street is mortalled — a state of extreme drunkenness — with exotic financial instruments, hedge funds, private equity, naked shorting, and endless acronyms like MBS, CDS, CDO, and LBO, which made understanding finance even more complex than understanding rocket science.

The torchbearers of capitalism on Wall Street utterly disregarded elementary risk management and accountability. Yet they were rewarded with mind-numbing bonuses. The top five investment banks (only two are left now) doled out $39 billion for 2007 as bonuses. The same folks who pounded free markets are now holding tin cups in suits (as one Senator said) while famously disembarking from their private jets.

Wall Street practised anarchic capitalism, not sensible capitalism. However, history suggests that American capitalism will survive, although with greater transparency and sanity checks. The innovations and entrepreneurship — the bedrock of American capitalism — are still strong. There may be hiccups but it is na├»ve to suggest the demise of sensible capitalism. The ‘American Dream’ is deep rooted in the American psyche. It is not about owning a three-car garage or gas-guzzling SUVs but it is about innovation and opportunities. U.S. universities are the best in the world for innovation and continue to attract worldwide talent. U.S. firms continue to invest enormous amounts of resources in R&D. All these form the foundation for capitalism to thrive and are not going to go away.

The capitalistic system has nurtured a risk-taking younger generation and an unmatched list of creative teenagers. The most famous ones are Bill Gates (Microsoft), Michael Dell (Dell Computers), and Steve Jobs (Apple, Inc). Aaron Swartz was 14 years old when he co-developed content distribution software RSS. Blake Ross was 17 when he helped create the Firefox web browser. Mark Zuckerberg was 19 years old when he founded Facebook. The list goes on and on with the founders of Napster, ColdFusion, and (the co-founder is one of my students). If we include those in their twenties — like the founders of Google and Yahoo! — the list grows even faster.

The capitalistic system in the U.S. brings out latent entrepreneurial spirits. If not, how do we explain that over 50 per cent of the new ventures in Silicon Valley are founded by immigrants? They include the famous ones like Andy Grove of Intel, Vinod Khosla of Sun Microsystem, and Sergey Brin of Google. There is something in the American spirit — inquisitiveness, individuality, education, risk-taking ability, entrepreneurship, and venture funds — to nurture ideas into great businesses.

Yes, the big three U.S. automakers are struggling and some or all of them may go belly up. The management is incompetent and the policies — driven by the industry lobby — favoured the status quo. But as brutal as it may sound, the capitalistic system is teaching them a lesson: if they do not innovate they will pay the ultimate price. Many pundits find fault with capitalism but fail to recognise that Hindustan Motors, a public sector enterprise, did not change its borrowed technology in Ambassador cars for five decades. The quality and mileage were abysmal. The venture was kept alive by government policies, subsidies, and monopoly. My previous employer, Hindustan Photo Films, was chugging along with imported technology of the 1940s only to shut down. The top two-wheeler manufacturer in India would be still selling polluting scooters of the 1950s without liberalisation and competition. Capitalism will punish bad quality and inefficiency. Of course, bailing out the auto industry stinks of free market hypocrisy, but it is a necessity to protect the large number of citizens under threat.

The other side

But there is another side to the U.S. auto industry debacle — the role of unions. During boom time in the 1950s and 1960s, when U.S. automakers had a better than 90 per cent market share, the unions demanded and received unprecedented benefits and wages. The average wage of autoworkers in GM, Ford, and Chrysler is over $73 per hour, which amounts to $150,000 a year. They have extensive pension and healthcare paid by these firms. In contrast, the non-unionised foreign companies in the U.S. give 40 per cent less in salary with greater security, quality, and benefits. Often the union prevented quick changes in firm strategy or failed to recognise the need for cooperation when needed. Rather than fight for job security only, the union could have played a key role in pressurising the management to build more fuel-efficient cars to compete in the marketplace. The perfect storm of incompetent management, dogmatic unions, and imprudent regulations on bio fuel and mileage standards has now resulted in an economic nightmare.

Still sensible free-market capitalism is the most desirable system for wealth and job creation. While many, including me, have criticised India’s growth in the last two decades as one-sided development, the fact remains that millions of new jobs — some of which are very high-paying jobs — were created. There is passion and excitement among the educated class. It is disingenuous to assume that liberalisation and free-market principles are bad. However, any criticism should be on the government’s heavy handedness in violating the private property rights of farmers, heavily subsidising industries, and excessive preference to some sectors while ignoring infrastructure and neglecting education and healthcare for the underprivileged sectors.

There is a role for the government to facilitate economic activities with sensible regulations. Regulations play two important roles within a capitalistic system. First, they protect investors and innocent bystanders. For instance, greater transparency in credit default swaps (CDS), the up-tick rule (that is, to allow shorting only when prices move up), elimination of naked shorting, and checks on excessive commodity speculators and predatory lending practices are regulations necessary for sensible capitalism. While short selling is shown to reduce market bubbles, it can severely disrupt markets when investors sell aggressively. Shorting refers to selling a security by an investor without actually owning it, but by borrowing from a broker. This is made in the expectation of a price decline and hoping to return (buy) that stock when prices fall. Naked shorting is even worse; an investor does not have to borrow stocks but can still sell anyway. There is nothing capitalistic about this.

The zeal for de-regulation and the ensuing lack of regulations and transparency simply made the stock market a giant gambling machine. Innocent investors paid the price. Likewise, regulations are needed that will let shareholders call back the bloated compensation of executives when past actions lead to future losses.

Secondly, sensible regulations induce innovations and new job creation. Some well-known regulations include environmental and consumer safety measures, and fuel-efficiency standards. The development of unleaded gasoline, gas turbines for electricity generation, and catalytic converters for cars to reduce hazardous emissions has roots in stricter regulations. While some strict regulations can have unintended consequences, sensible regulations can create new growth opportunities while preventing unwanted innovations like the financial engineering of the last decade.

The bottom line is that the American Dream is not dead. The economic ideologues at the extremes are harmful to any nation. India’s potential was trapped for decades by intense protectionism. Capitalism has unlocked that potential and is still the best path to prosperity. The only thing we need is some common sense regulations and policies for sensible capitalism to thrive.

(The author is the William H. Seay Centennial Professor and Distinguished Teaching Professor at the University of Texas at Austin and can be contacted at

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