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Free Market Newspeak as opium for regulators

“Capitalism After the Crisis” and “Free Markets” Newspeak

Reader Don B pointed out a generally top notch piece by Luigi Zingales at a new publication, National Affairs, on how the financial crisis may change attitudes towards what he calls “democratic capitalism”. Even though the article is thoughtful and well written, it does fall prey to a major bit of intellectual sloppiness that is common and I believe played a role in getting us into this mess.

First, some key elements of Zingales’ argument:

The nature of the crisis, and of the government’s response, now threaten to undermine the public’s sense of the fairness, justice, and legitimacy of democratic capitalism. By allowing the conditions that made the crisis possible (particularly the concentration of power in a few large institutions), and by responding to the crisis as we have (especially with massive government bailouts of banks and large corporations), the United States today risks moving in the direction of European corporatism and the crony capitalism of more statist regimes. This, in turn, endangers America’s unique brand of capitalism, which has thus far avoided becoming associated in the public mind with entrenched corruption, and has therefore kept this country relatively free of populist anti-capitalist sentiment.

In fact, corruption and concentration of power are all relative; America has had a proud tradition of robber barons of various sorts. But Zingales stresses that the US has avoided, at least so far, having an entrenched upper class:

In a recent study, Rafael Di Tella and Robert MacCulloch showed that public support for capitalism in any given country is positively associated with the perception that hard work, not luck, determines success, and is negatively correlated with the perception of corruption. These correlations go a long way toward explaining public support for ​ America’s capitalist system. According to one recent study, only 40% of Americans think that luck rather than hard work plays a major role in income differences. Compare that with the 75% of Brazilians who think that income disparities are mostly a matter of luck, or the 66% of Danes and 54% of Germans who do, and you begin to get a sense of why American attitudes toward the free-market system stand out.

Some scholars argue that this perception of capitalism’s legitimacy is merely the result of a successful propaganda campaign for the American Dream — a myth embedded in American culture, but not necessarily tied to reality. And it is true that the data yield scant evidence that social mobility is higher across the board in the United States than in other developed countries. But while this difference does not show up in the aggregate statistics, it is powerfully present at the top of the distribution — which often gets the most attention, and most shapes people’s attitudes. Even before the internet boom created many young billionaires, in 1996, one in four billionaires in the United States could be described as “self-made” — compared to just one out of ten in Germany. And the wealthiest self-made American billionaires — from Bill Gates and Michael Dell to Warren Buffett and Mark Zuckerberg — have made their fortunes in competitive businesses, with little or no government interference or help.

Notice how the piece is already getting a bit slippery. The polarity is between “freedom” and “government interference or help.” JP Morgan, the Rothschilds, the Japanese zaibatsu (save latecomer Mitsubishi) built long lived enterprises without government support; indeed, the Rothschilds could make or break governments. Even the Krupps, which later became inextricably associated with German rearmament before and during World War II, was an innovative steel-maker and was in the mid 1800s a supplier to multiple national armies, rather than dependent on German patronage. The idea that concentrations of power can arise due solely to competitive dynamics such as economies of scale, network effects is absent, and there is curiously no mention of the role of once more punitive estate taxes (readers are welcome to correct me, but I believe as recently as the 1970s, the top rate was 70%) in limiting intergenerational transfers of wealth in the US.

But the article had started getting on thin ice a bit earlier:

Capitalism has long enjoyed exceptionally strong public support in the United States because America’s form of capitalism has long been distinct from those found elsewhere in the world — particularly because of its uniquely open and free market system. Capitalism calls not only for freedom of enterprise, but for rules and policies that allow for freedom of entry, that facilitate access to financial resources for newcomers, and that maintain a level playing field among competitors. The United States has generally come closest to this ideal combination — which is no small feat, since economic pressures and incentives do not naturally point to such a balance of policies. While everyone benefits from a free and competitive market, no one in particular makes huge profits from keeping the system competitive and the playing field level. True capitalism lacks a strong lobby.

That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one, though American capitalism has always managed this tension far better than most.

This section illustrates the sort of muddy headed thinking about “free markets” that is not simply annoying, but I believe played a much greater role in creating the conditions that led to the crisis than most realize. First, the sort of rules that Zingales argues are necessary for a “free and competitive” market, as in limiting power concentrations, are in fact directly contradict the sort of “free market” idea espoused by libertarians and staunch follower of Milton Friedman, which views government action of any sort save the bare minimum (defense and a court system) as “interference”. That vision is in fact close to anarchy. So you have people using the same term to mean quite different things, but the zealotry of the “free market” fundamentalists means that people who use the same phrase to use something more moderate wind up seeming to endorse the more extreme version.

Second, Zingales’ “pro market” versus “pro business” lobbying construct has broken down since the 1970s. Big businesses started an organized campaign in the Carter adminsitration, arguing that regulation were interfering with their ability to innovate. The claim was utter rubbish. There was no evidence of a slow-down in innovation or invention. Moreover, a robust body of research showed that the the big businesses that were calling for fewer rules were not innovators. Small and mid-sized enterprises are the locus on new ideas and procedures (indeed, there was a whole industry of books and consulting practices in the 1980s trying to help big companies figure out how to be innovative).

“Free markets” is an amazing bit of Newspeak. Unlike “free enterprise” which clearly implies that business in the beneficiary of more liberalized rules, “free markets” creates the illusion that everyone automagically benefits. Zingales unwittingly endorses that idea by offering a false dichotomy between “pro market” and “pro business” when business has taken up the “free markets” branding to promote deregulation, particularly in financial services, that led to the concentration of power than Zingales decries.

With that huge caveat, the article is still worth reading, and you will find it here.