Capitalism in crisis

Financial Times Series

January-February 2012

1 Contents:

John Plender!!!!!!3 David Rubenstein - Adam Smith!!7 Gideon Rachman!!!!!9 Samuel Brittan!!!!!!11 Edward Luce!!!!!!13 John Kay!!!!!!!18 Philip Stephens!!!!!!19 Ed Miliband!!!!!!!24 Jeffrey Sachs!!!!!!!26 Otmar Issing!!!!!!28 Andrew Hill!!!!!!!30 Martin Wolf!!!!!!!35 Alan Greenspan!!!!!!40 Occupy London!!!!!!42 George Osborne!!!!!!44 Hernando de Soto!!!!!46 Kenneth Rogoff!!!!!!48

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FT January 8, 2012 Capitalism in crisis: The code that forms a bar to harmony By John Plender

The enrichment of bankers, corporate chiefs, flash traders and their cronies is testing tolerance of inequality, argues John Plender in the first part of an FT series Greedy bankers, overpaid executives, anaemic growth, stubbornly high unemployment – these are just a few of the things that have lately driven protesters on to the streets and caused the wider public in the developed world to become disgruntled about capitalism. The system, in all its different varieties, is widely perceived to be failing to deliver. Business in the leading English-speaking countries attracts misgivings. Fewer than half of the American and British people sampled in the 2011 Edelman Trust Barometer have faith in business to do what is right. The survey rates the US and the UK only marginally ahead of Russia on this score. So there is talk of a crisis of legitimacy and an erosion of business’s “licence to operate”. This article, the first in a series on rethinking capitalism after the financial crisis that began in 2007, argues that popular acceptance – which is a basic condition for business success – has waned in the Anglosphere for good reason. At the heart of the problem is widening inequality. In a recent study, the Paris-based Organisation for Economic Co- operation and Development, the club of developed nations, declared that the wealthiest Americans “have collected the bulk of the past three decades’ income gains”. Much the same is true of the UK. In both cases, most of the spoils have gone to finance professionals and top executives. As Stewart Lansley, author of a recent book on inequality*, puts it, the modern economy appears to consist of two tracks: a fast one for the super-rich and a stalled one for everyone else. Those in the slow lane enjoyed rising living standards before 2007, despite stagnant real incomes, thanks to increased borrowing on the security of their homes. Since the crisis, however, American and British homeowners have faced a long and deep squeeze on real living standards, while struggling to service an unprecedented level of indebtedness. At the same time, says Mr Lansley, finance has come to play a new role as “a cash cow for a global super-rich elite”. ------CEO pay as a ratio of average worker pay Source: Economic Policy Institute Year 1965!24! 3 Year 1975!35! Year 1990!70! Year 2000!299! Year 2010!325! ------In continental Europe, the increase in inequality is less pronounced and the legitimacy problem has more to do with the way imbalances in the eurozone are being addressed. Northern Europeans resent a monetary union that has permitted southern Europe to engage in what they see as fiscally profligate behaviour, while southern Europeans and the Irish are required to submit to extreme austerity programmes that exacerbate their sovereign debt problems. As the German-led policy elite inches towards “more Europe” as a solution to the fissures in the eurozone, it is far from clear that more Europe is what the citizens of Europe want. Democratic legitimacy has been largely lacking from the outset of this gigantic monetary experiment. On both sides of the Atlantic there is now a risk that reasonable aspirations to equality of opportunity are being undermined, accompanied by a growing threat of political instability. Support for open trade and free markets is also being adversely affected.

Misery and money motive The problem of consent in relation to capitalism is nothing new. In fact, it returns with nagging frequency. In the early years of the industrial revolution, average per capita incomes were slow to rise and the contrast between the plight of the working population and the lifestyle of rich manufacturers prompted savage diatribes such as that of Charles Dickens in Hard Times. Even when living standards did rise, David Ricardo and Karl Marx worried whether the free markets trumpeted by Adam Smith could produce an income distribution that was politically tolerable. By the late 19th century the debate turned more heavily on the moral question posed by the unedifying behaviour of the American robber barons at a time of spectacular economic growth. The centrality of the money motive in wealth creation appeared to detract from capitalism’s legitimacy unless there was an implicit social contract between the rich and the rest of society, whereby the wealthy tempered ostentation and engaged in philanthropy. Then, in the unstable 1920s and the Depression of the 1930s, the efficacy as well as the moral basis of capitalism was once again called into question. While F. Scott Fitzgerald chronicled the moral vacuity of jazz age capitalism in The Great Gatsby, John Maynard Keynes, who provided a theoretical basis for the mixed economy and a more humane form of capitalism, was notably acerbic on what he called “individualist capitalism” and the money motive. Such questioning was sharpened by the existence for the first time of a seemingly

4 successful alternative to capitalism in the Soviet Union; also of competing models, such as the corporatist approaches developed in Germany and Italy. What, then, is different about today’s outbreak of disaffection? Perhaps the most important difference is that it is not the product of despair. The people in Manhattan’s Zuccotti Park and on the steps of St Paul’s Cathedral in London had no need of soup kitchens and took to their tents out of choice, unlike many in the 1930s US who slept in cardboard box colonies – Hoovervilles – out of necessity. If there is no proliferation of soup queues, it is because in all the economies of the developed world capitalism has been humanised to a greater or lesser degree by forms of social democracy and by bank bail-outs. Unemployment in the US has gone nowhere near the 25 per cent rate that prevailed in 1933. While there are exceptionally high rates of youth unemployment, especially in southern Europe, there is more of a safety net for the victims than in the Depression. And if today’s protesters articulate no coherent programme, it seems clear that underlying frustrations are to do with perceptions of unfairness, not immiseration. Much of that frustration relates to the banks. In contrast to the 1930s, when banking was about deposit-taking and lending, modern bankers engage in complex trading that they themselves do not always understand and whose social utility is not apparent to ordinary mortals – or even to the likes of Lord Turner, head of the UK Financial Services Authority, who famously declared that many parts of the banking business had “grown beyond a socially reasonable size”. Many have shown a disregard for their customers, while fiduciary obligation has become a casualty of deregulation and the shareholder value revolution. There is a widespread conviction that these bankers constitute a protected class who enjoy bonuses regardless of performance, while relying on the taxpayer to socialise their losses when they have taken excessive risks. At the same time, the public is aware that top executive rewards more generally are poorly related to performance and tend to go up even when profits fall.

Human capital or ‘hand’ Such resentment is not completely new. It bears some resemblance to the hostility towards profiteers after the first world war, which prompted Keynes to remark: “To convert the business man into the profiteer is to strike a blow at capitalism, because it destroys the psychological equilibrium which permits the perpetuance of unequal rewards. The businessman is only tolerable so long as his gains can be held to bear some relation to what, roughly and in some sense, his activities have contributed to society.”** On that basis, no one can be surprised that the legitimacy of capitalism is currently in question. And it would be wrong to call it a “winner takes all” form of capitalism, because privileged losers appear to be making off with the prizes too.

5 What is unquestionably novel is the ferocity with which US business sheds labour now that executive pay and incentive schemes are more closely linked to short-term performance targets. In effect, the American worker has gone from being regarded as human capital to a mere cost, or what was known in the 19th century as a “hand”. Yet this pursuit of a narrowly financial conception of shareholder value may destroy value for the ultimate pension beneficiaries – because of the disruption that slashing and burning causes, and the cost and time involved in hiring and retraining when conditions improve. That underlines the “agency problem” at the heart of the banking and boardroom pay sagas. The accountability of management – the agent acting on behalf of the highly dispersed beneficiaries of equity ownership – is fundamentally flawed. While the public may not be aware of the details of the weak chain of accountability, or the growing number of investors such as high-frequency traders or hedge funds that have no interest in playing a stewardship role, it sees the outcome, which contributes to the wider inequality story. So what to do? It is not as if there are attractive alternative models. While the west is chastened by the rise of Asia, few would wish to adopt the communist Chinese mixture of state ownership, red-in-tooth-and-claw private markets, wholesale corruption and even greater inequality than the US. As for the cleaner authoritarian approach of Singapore, despite delivering high economic growth, it has started to lose its appeal with the island’s electorate. Nor would many in the west find free-market Hong Kong a comfortable environment. The real question, as Keynes argued in the 1930s, is therefore how to improve the existing model of capitalism. The snag is that there is minimal flexibility in macro policy after the crisis, especially in the US where broadly centrist politics have been replaced by a polarised, stalemated debate. And in both the US and UK there is a greater mistrust of big government, according to the Edelman Trust Barometer, than of business. Efforts to re-regulate the banking system, meantime, have failed to convince many experts that an even larger financial crisis can be avoided.

From distribution to decline If Hyman Minsky, the expert on financial market fragility, provided the best route map for understanding events before the crisis, and Keynes offered the best guide to crisis management, Mancur Olson, a theorist on institutional economics, could now be a posthumous beacon on how to manage the aftermath. Olson argued that nations decline because of the lobbying power of distributional coalitions, or special-interest groups, whose growing influence fosters economic inefficiency and inequality.*** When he was writing, the main interest groups were trade unions and business cartels. Today, the pre-eminent interest group consists of finance professionals on Wall Street and in

6 London. Through campaign finance and political donations, they have bought themselves protection from proper societal accountability. And they pose a continuing obstacle to the de- risking of banking of the kind recommended by the Vickers commission in the UK. Tackling such interest groups both in the US and Europe is one of the biggest post-crisis tasks for policymakers and a key to addressing concerns about systemic legitimacy. The inchoate nature of the public’s complaints is another. Not the least of the difficulties, to reformulate Winston Churchill’s famous remark on democracy, is that capitalism is the worst form of economic management except for all those other forms that have been tried from time to time. The public relations problem implicit in that pale endorsement is an underlying reason why legitimacy crises recur. * The Cost of Inequality, Gibson Square, 2011 ** Quoted in Keynes and Capitalism, Roger E. Backhouse and Bradley W. Bateman, History of Political Economy, 2009 *** The Rise and Decline of Nations, Yale University Press, 1982 ------www.ft.com/intl/cms/s/0/a3e50fa6-3ab7-11e1-a756-00144feabdc0.html#axzz1kw6ib8Wx

FT January 9, 2012 7:03 pm A letter to capitalists from Adam Smith By David Rubenstein To: Capitalists of the World!!!!!From: Adam Smith

What has become of my beloved capitalism? Countries teeter, protests rage, unemployed multiply, deficits abound the virtues of capitalism are questioned. Based on a few hundred years of observation, I have some fresh thoughts on how to sustain this system for a few hundred years more, or at least do better in 2012 than it did in 2011. I am pleased to see that capitalism has triumphed over communism and socialism in virtually every part of the world – and many of the most skilled capitalists are, ironically, in the countries where communism and socialism once prevailed (now endearingly called emerging markets). This triumph has occurred because capitalism’s greatest strength – productive economic activity – has succeeded in creating more opportunities for more people than anyone – including me – ever imagined. And with more wealth, billions of people now in the middle class can secure education for their progeny, purchase necessities and luxuries at once- unimagined levels, pursue leisure activities for a greater part of their lives and retire with higher levels of economic security. All that is satisfying. 7 What is not satisfying is the view that capitalism has to work perfectly to justify its presence. I never said it would. I just said it was better than the alternatives, as Winston Churchill famously said about democracy. I always felt there were two principal flaws – and we saw them come to a head over the past few years. The first is that unfettered exuberance about wealth creation will produce unsustainable booms and inevitable crashes. The great recession, fuelled by cheap credit, is a textbook example of this flaw. The second is the inequality that results when the charge towards wealth creation leaves behind those less able (in most cases through no fault of their own) to adapt or to compete with the hard-chargers. The income disparity in many wealthy countries is now at its greatest level since I left the scene – and it was not so wonderful then either. While there is no simple cure to capitalism’s two big flaws, here is what I would do in 2012 to get the system back on its feet and to modulate income disparities. 1. Save the euro and the European Union. A functioning and vibrant EU – the world’s largest economic unit – is essential to global prosperity. The largest countries using the euro – and also those outside the eurozone or those dependent on a thriving EU – must dig deeply into their pockets now to save the euro. If they do not, the pain and cost will be greater in the future. And those of more modest means will suffer the most if the euro is abandoned. 2. Fix the US debt and deficit. To my amazement, when the super committee failed to reach an agreement the markets yawned, undaunted by a $1.4tn deficit and accumulated debt in excess of $16tn. Beware, though. At some point during 2012 the markets will wake up and say: “No! We cannot wait until after the presidential election to fix this problem.” The Obama administration and Congress must quickly cobble a credible debt-reducing package. Otherwise, as in Europe, the markets’ harsh solutions will be borne disproportionately by the low income and disadvantaged. This is not acceptable, nor is it good for capitalism. 3. Integrate the emerged markets. The world needs to acknowledge that the centre of capitalism is shifting to the emerging markets – where most of the growth will occur in 2012. But having emerged, China, India and Brazil, among others, need to be fully integrated into the global economic decision-making process. If they are not, the capital needed to solve many of the developed markets’ current problems, especially residual issues of the great recession, will not be available on tolerable terms. Again, this will hurt the poor more than the wealthy. 4. Educate. Educate. Educate. Perhaps the greatest cause of income inequality is the dismal state of primary and secondary education. The mismatch between job openings and qualified candidates is growing, which leads to reduced economic activity, a greater sense of disparity between the haves and the have-nots, and social unrest. To address these issues, governments need to embrace reform, ensure effective funding and allocate resources more

8 efficiently. By educating all their children, reducing soaring high-school dropout rates, and re-educating and retraining adults, nations can more effectively prepare workers to embrace new technological realities. Though much time has passed since I last put pen to paper, my faith in capitalism is steadfast. The problems you face – saving the EU, fixing the US budget, welcoming emerged nations as full partners and making education a real priority – are huge challenges that must be addressed now. It is the only way to continue creating wealth for all nations and people, while giving capitalism the legitimacy it needs to thrive. ------www.ft.com/intl/cms/s/0/95d3d2c6-3ab7-11e1-a756-00144feabdc0.html#axzz1oAzUJ3aV

FT January 9, 2012 7:21 pm Why I’m feeling strangely Austrian By Gideon Rachman

The old is dying and the new cannot be born: in the interregnum a great variety of morbid symptoms will appear.” That statement from the Prison Notebooks of the Italian communist Antonio Gramsci was a favourite of student Marxists when I was at university in the 1980s. Back then it struck me as portentous nonsense. But Gramsci’s observation does resonate now – in an age of ideological confusion. Old certainties about the onward march of the markets are collapsing. But no new theory has established ideological “hegemony”, to use the concept that Gramsci made famous. Some ideas are, however, gathering new strength. The four strongest emerging trends that I can spot are, in very broad terms: rightwing populist, social democratic-Keynesian, libertarian- Hayekian and anti-capitalist/socialist. Each of these new trends is a reaction against the dominant ideas of 1978-2008. Back then, for all the nominal differences between communists in China, capitalists in New York and the soft left in Europe, their agreements were more striking than their arguments. Political leaders from all over the world talked the same language about encouraging free trade and globalisation. Increasing inequality was embraced as a price worth paying for faster growth. Deng Xiaoping set the tone when he declared: “To get rich is glorious.” Ronald Reagan or Margaret Thatcher could not have put it better. In post-crisis Europe, however, rightwing populism is on the rise – from the Freedom party in the Netherlands to the National Front in France and the Northern League in Italy. The populists are anti-globalisation, anti-EU and anti-immigration – the common thread

9 being that all these forces are felt to be hostile to the interests of the nation. Hostility to Islam links Europe’s populist right to parts of the Tea Party movement in the US. There is some overlap between the populists and the libertarian Hayekians – but the two movements have different obsessions. In the US, Ron Paul, the maverick Republican, carries the banner for libertarianism. He fondly recalls dining with Friedrich Hayek himself and watching an inspiring denunciation of socialism by Ludwig von Mises, another economist of the Austrian school. That explains Mr Paul’s otherwise baffling remark, after last week’s Iowa caucus, in which he said: “I’m waiting for the day when we can say we’re all Austrians now.” The libertarians are unusual because they argue that the current crisis is caused not by an excess of capitalism, but by too much state intervention. As far as the Austrian school is concerned, the Keynesian “cure” for the crisis of capitalism is worse than the disease. Mr Paul is the purest advocate of a powerful conviction on the American right that the US is afflicted by an over-mighty state. The urge to slash the government back into the 18th century is not a common one in Europe. But Paulite suspicion of central banks that threaten to debase the currency is powerfully echoed in Germany – where the Hayekian right is horrified by the operations of the European Central Bank, and by bail-outs for bankrupt nations. This ideological trend is not confined to the west. In a recent article, Simon Cox of The Economist argued that policy debates in China about the state’s role in reflating the economy also pit Hayekians against Keynesians. In the west, the fiercest opponents of the Hayekians are the Keynesian-social democrats. Their belief in deficit spending as the key to stimulating the economy often goes hand in hand with a call for a more active and expansive state. In Europe, where there is little scope for more state spending, the social democrats are arguing for much tougher regulation of high finance, a revival of industrial policy – and a renewed stress on tackling inequality. While efforts to label Barack Obama a “socialist” are silly, it is fair to label him a social democrat. The US president does not reject capitalism, but he does seek to soften its edges through a more active state that promises universal healthcare and redistributive taxation. The fact that inequality has become a global concern from China to Chile, and from India to Egypt, suggests that this is another trend that has gone global. The failure of the hard left to capitalise on the economic crisis testifies to how profoundly communism was discredited by the collapse of the Soviet system. But mass unemployment in Europe might yet produce the conditions for the revival of an anti-capitalist movement. Greece’s two far-left parties are currently at about 18 per cent in the polls. The diverse groups that campaign under the banner of Occupy Wall Street contain some genuine socialists. And China has a powerful “new left” movement that pays lip-service to Maoism. Events will determine which of these ideological trends sets the tone for the new age. Most people will be buffeted by personal circumstances, and by the news.

10 Under normal conditions I would probably sign up with the social democratic tendency. The Tea Party is not my cup of tea. But I spent the weekend reading newspaper accounts of the ever more incredible figures that may have to be poured into the bail-outs for banks and countries in Europe. Then I turned the page to read of demands for more protectionism and regulation in the EU. For light relief, I then went to see The Iron Lady – the new film about Margaret Thatcher. The whole experience has left me feeling strangely Austrian. ------www.ft.com/intl/cms/s/0/768aabbc-3c86-11e1-9bcc-00144feabdc0.html#axzz1oAzUJ3aV

FT January 12, 2012 6:46 pm The market still has no rivals By Samuel Brittan

Longer ago than I like to think back I wrote a book, Capitalism and the Permissive Society, the title of which puzzled some people, as I was in favour of both. Like most books on political economy it was highly imperfect. But its faults were those of omission rather than commission; and, looking back on it, nearly two and a half decades later there is almost nothing I wish to withdraw. There is no need to pretend that market rewards reflect personal merit. As Lord Melbourne said in another context: “There is no damn’d merit about it.” Redistribution is best carried out by a (preferably unified) tax and social security system, and not by interfering with prices and wages. Successful capitalism is also compatible with – and in my view requires – the use of monetary and fiscal policy to moderate fluctuations in economic activity, and to prevent long periods of demand deficiency causing needless unemployment as well, of course, as to prevent runaway inflation. My central case for competitive capitalism is that it promotes personal and political freedom. A businessman outside the financial sector will prosper by providing what adults wish to have – even if that is pop records, candyfloss or nude shows rather than what their supposed elders and betters think is good for them. Above all, the individual is free to use his abilities in line with his own choices. He or she can concentrate on personal pleasure, social service at home, the relief of poverty abroad or any combination of these and other activities. Early in the 20th century Ludwig von Mises, an Austrian economist, challenged socialists to say how to determine what should be produced and by what methods in the absence of capitalist markets. The most interesting response came from “market socialists”, who asserted that state-owned enterprises could mimic capitalist ones in using market prices to guide their activities. Indeed they could with a known set of products, a known technology 11 and known and static public tastes. The matter is wholly different when it comes to inventing new products or discovering low-cost methods. And who should be the managers and who the managed and how is a limited amount of investment funds to be allocated to everyone with a bright idea? Above all there is the political consideration enunciated by John Stuart Mill: “If the roads, the railways, the banks, the insurance offices, the great joint stock companies were all of them branches of government ... If the employees of all these enterprises ... looked to the government for every rise in life, not all the freedom of the press and popular constitution of the legislature would make this or any other country free otherwise than in name.” The importance of private capital for freedom of expression was demonstrated by its role in the launch of the critical and satirical periodical Private Eye, or by the way in which supposedly subversive US writers in the 1950s found refuge from McCarthy-inspired persecution by taking jobs in the private sector. There are some attractions in worker-owned enterprises (to which Mill was sympathetic) and there have been some successes here – for instance, the Mondragon group in Spain; and I write as a satisfied customer of the John Lewis Partnership. But there is simply not enough evidence or analysis to support a politically ordained wholesale transfer of enterprises to such entities. Jesse Norman, the Conservative MP, has listed some of the numerous ways in which capitalism can be corrupted by cronyism. These include old-fashioned monopoly; Russian- type capitalism symbolised by oligarchs who have gained control over natural resources; khaki capitalism in states dominated by the military and narco-capitalism based on dealings in illicit drugs. The last is aggravated by over-intrusive western legislation akin to US prohibition in the 1920s. There is, however, no need to say that these are not “real capitalism” or to claim a Conservative patent on the genuine variety. The real shortcoming of my book was that, like many others, I did not discuss the financial sector and how its activities could undermine the capitalist order even if there were no overt inflation or deflation of consumer prices. Any working market order requires there to be some way of marrying savings with the desire to borrow; a market for investible funds and some way of insuring against the vicissitudes of life as well, of course, as a better way of keeping ready cash than storing it under the mattress. But none of this justifies the threat posed by masses of invented money to institution after institution and country after country. Capitalism is a means to freedom and prosperity, not an end in itself. Improvement here may justify not merely international regulation but the retention for quite a long time in public ownership of banks and other institutions that have had to be rescued by government. ------

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FT January 13, 2012 7:25 pm Caught between apathy and anger By Edward Luce

As Americans steadily lose trust in their system, demographics are likely to play a bigger political role than class If the campaign rhetoric is any guide, the US is in the throes of a Marxist change in consciousness. In spite of belonging to a party that draws much of its cash from Wall Street, rival Republican contenders for the presidential nomination have ripped into Mitt Romney’s past as a private equity executive. Without any help from the left, the former chief executive of Bain Capital stands accused of being “a vulture”, “looting”, “greed” and “profiting from other people’s misery”. If it carries on like this, the Democrats will have nothing left to say when it comes to the general election. Is the US seeing a backlash against capitalism? A visit to any of the country’s now 50,000 or so storage houses – places where people rent space to keep their surplus belongings – gives an eerie sense of a country in a continual flux of insecurity. These centres, which according to industry data have grown roughly tenfold since the 1980s, hold frequent auctions of the belongings of those who have failed to pay the rent. In recent years, such auctions have exploded. “We call it the five Ds – Debt, Divorce, Displacement, Death and Disinterest [uninterest],” says the branch manager at ezStorage, one of the chain groups, in Glen Burnie, near Baltimore. “If we’re auctioning your unit, then you’re going to be one of those Ds.” There is nothing, however, in the atomised discomfort of middle-class America that would suggest a revolution in the making. People do talk about a new age of populism. Perhaps “age of transition” would be more accurate – although to what is not yet clear. Earlier periods of economic turmoil, most notably during the robber baron decades of the late-19th and early-20th century, did turn populist. Then, like now, both parties tended to go to the same sources for money. In Mark Twain’s novel The Gilded Age, the deepest well of election finance was the railroad capitalists. Today it is Wall Street. Then, as today, was a period of electoral volatility – the last time Congress changed party control as often as it has in the past six years was in the last two decades of the 19th century. Both eras were also driven by disruptive technologies that upended settled patterns of work and pushed the winners into stratospheric new levels of wealth: what the internet and financial globalisation has done for the net worth of America’s superclass since the 1990s finds its closest parallel in the income effects the railway, electricity and the internal 13 combustion engine had 100 years ago. The vast concentrations of wealth in the economy in turn produced growing inequalities of influence in the political arena. Mark Hanna, the late-19th century electoral manager, famously said: “The three most important things in American politics are money, money and I forget what the other one is.” Rahm Emanuel, the mayor of Chicago and former White House chief of staff, said much the same thing in 2006 when he helped engineer the Democratic party’s handsomely bankrolled midterm congressional victory. So much for the parallels. The differences between now and then are also instructive. Unlike the “progressive era”, today’s America is shaped as much by apathy as it is by anger. The early 1900s were characterised by the “prairie populism” of the small farmer and the rise of an organised working class. They tended to meet around the small town “cracker barrel” and in the industrial workplace. Today’s squeezed middle classes share no obvious gathering place. They are economically diffuse and geographically scattered. “The largest squeezed group today are people with high-school diplomas working in the service sector,” says Michael Lind, author of a forthcoming economic history of America. “Most of them are living in the suburbs and watching TV.” When the politicians appear, they tend to switch channel. The two exceptions are the Tea Party and Occupy Wall Street. Taken at face value, the Tea Party represents a rebellion against the nexus between bankers and Washington. It first began to stir during the $700bn Wall Street bail-out in October 2008 – a package Congress enacted only on its second vote. On closer inspection, however, the Tea Party is driven as much by demography as ideology. Surveys of Tea Party supporters show an overwhelmingly white and middle-aged or elderly support base. Their biggest flare-up came during the angry town hall protests against President Barack Obama’s healthcare reform in August 2009. Instead of opposing government in general, the protesters claimed Mr Obama’s reform would rob from Medicare to fund healthcare reform – transferring federal dollars from retired people to working-age Americans. “Keep government hands off my Medicare!” was the totemic – if oxymoronic – slogan of the moment. A recent survey of Tea Party supporters showed that more than three quarters wanted to leave untouched Medicare and Social Security, the public pension system – the largest items in the federal budget. When Paul Ryan, the House budget chairman, unveiled a fiscal road map last year that would have rapidly slashed Medicare’s largesse, fellow Republicans rapidly distanced themselves from his plan. Newt Gingrich, the Republican former speaker of the House of Representatives and now improbable anticapitalist rival to Mr Romney, attacked the Ryan plan as “rightwing social engineering”. Polls explain the direction of Mr Gingrich’s apparent tangent. “If you study public opinion, Americans are deeply ambivalent,” says Lawrence Jacobs, author of Class War? What

14 Americans Really Think About Economic Inequality. “They hate government in the abstract. But they love government programmes that benefit them in particular.” The Tea Party’s demography also helps to explain why the only cut the Republican- controlled Congress has so far pushed through is a freeze on the so-called “domestic non- defence discretionary budget”. This excludes the far costlier Medicare and Social Security programmes but targets education, infrastructure, research and development, and other items that matter to the younger generations.

Income inequality frames the terms of debate At one of the Republican debates last month, Mitt Romney extended his hand to Rick Perry and offered a large bet on an arcane subject of dispute. “Rick, I’ll tell you what, $10,000,” Mr Romney said to the Texas governor. Dumbfounded, Mr Perry said he was not in the “betting business”. Mr Romney, whose personal wealth is estimated at $250m, may be headed for the Republican nomination as presidential candidate. But Democratic operatives believe he has already given them a trove of material they can use to reinforce the impression that he is out of touch with ordinary Americans. The rhetorical dress rehearsals suggest a November election that will revolve around questions of privilege and opportunity – with Barack Obama calling for fairness and railing against inequality, while Mr Romney attacks the president’s support for a European-style “entitlement society”. In any event, the two candidates will square off against the backdrop of the most acute income inequality in almost a century. Over the past 30 years, the top 1 per cent of Americans have seen their incomes grow by almost 300 per cent in real terms – and the top 0.1 per cent by an even greater proportion. Median household income has, meanwhile, risen by a more modest 40 per cent, according to the Bureau of Labor Statistics – and much of that is inflated by many households having turned dual-income with the entry of women into the workforce. Male real median earnings have stayed flat. Polls show a large majority of Americans believe their country is “going in the wrong direction” and resentment is evident against the titans of finance. Yet the widening disparity has not translated into a backlash against capitalism. There is little sign of a revolt against wealth itself if it is seen to have been earned fairly. The prosperity of Lloyd Blankfein, the Goldman Sachs chief executive, attracts disapproval. But the late Steve Jobs, who worked his magic on Apple, is something of a folk hero.

15 Bracketing Mr Romney’s personal fortune with that of people such as Mr Blankfein will thus be one of the Obama campaign’s main objectives. . . . Eschewing an ideological lens, Ronald Brownstein, editor of the National Journal, a Washington weekly, says we have entered a new political age of “grey versus brown” – an increasingly elderly “Anglo” Republican party is squaring off against a youthful rainbow coalition of other races supporting the Democrats. The era of grey-haired Smith against twenty-something Sanchez perfectly mapped Mr Obama’s 2008 strategy, where he exploited America’s changing make-up to win the traditionally Republican states of Virginia and North Carolina. Mr Obama is supported by large majorities of America’s black people, Hispanics and Asians. Fewer than 40 per cent of blue-collar whites now approve of him. That divide has grown stronger since 2008, even while voter “intensity”, or depth of support, has shifted back to working-class white people. This year, Mr Obama will hold his nominating convention in Charlotte, North Carolina, and home of a young and educated multi-ethnic population. The Republicans, meanwhile, have settled on the white retirement zone of Tampa, Florida. If there is a political war brewing, it will be between generations and ethnic groups rather than between classes. According to the latest US Census, in 2010, white people will become a minority by 2040. The decennial survey also revealed that 46.5 per cent of Americans under the age of 18 were non-white – up from 39 per cent in 2000. Between those years, the number of white children shrank by 4m while the number of American children in total grew by 6m. This was almost all because of the growth in the Hispanic population. As the age of fiscal austerity begins to bite, the grey-brown divide is likely to become more political. “At some stage we are all going to realise that we only have about 80 per cent of the wealth we thought we had before 2008,” says Mr Lind. “When that happens, politics will get uglier as each group fights to defend its piece of the federal pie.” In spite of last year’s battle over the debt ceiling, that moment of fiscal reckoning is yet to hit Washington. Mr Obama is doing his best to rekindle the enthusiasm that swept him to office in 2008, however. Some of the president’s rhetoric has been supplied by the Occupy protesters, who have helped to rebrand American politics as a fight between the richest 1 per cent and the rest. However, unlike the Tea Party movement, the Occupy movement has no institutional apparatus. The former is Republican and rooted in towns. The latter is drawn more from the fringe of left activists, students and anarchists. They seem to be as unenthusiastic about Mr Obama as most Tea Partyers are about Mr Romney. “It is a strange thing that at this moment we are likely to get two presidential candidates who completely lack any populist touch,”

16 says Jacob Hacker, a political scientist at Yale University. “Yet both feel obliged to adopt the rhetoric of populism, however unnatural it might sound in their mouths.” Early in his candidacy, Mr Romney launched an advertisement depicting the “invisible” middle class of Mr Obama’s America. In turn, allies of the president – and now Mr Romney’s Republican rivals – depict the former Massachusetts governor as a greedy plutocrat who speaks only for the elite. Both candidates’ super-political action committees, which can take unlimited donations but are not allowed to co-ordinate with the campaigns, are funded by wealthy donors, many of them from Wall Street. Both super-Pacs – the pro-Romney Restore Our Future and pro-Obama Priorities USA – are headed by former senior aides. The contrast between the populism of their messages and the source of their money is hidden in plain view. . . . Facing a disillusioned electorate, Mr Obama is spending a lot of time trying to enthuse his original support base. Among other “outreach” efforts, he is already meeting more Hispanic groups and talking about immigration reform (having largely avoided the subject in his first two years in office). Meanwhile, Mr Romney will surely try his best to make America’s older voters forget that he embraced Mr Ryan’s fiscal road map last year. And he is proposing far deeper domestic spending cuts than the president. “Candidates often say that 2012 will be the most important election of our lifetimes,” says Mr Jacobs, the author. “But an Obama-Romney election could easily drain the passion from national politics – it is more likely to turn activists away.” Whatever transpires in 2012 is unlikely to be populist – although it will often be packaged to sound as though it is. Some observers speculate about the disruptive possibility of a third- party candidacy. The likeliest would come from the gold-obsessed “Austrian” candidacy of Republican Ron Paul, who provides the closest echo to the rhetoric of Williams Jennings Bryan, the late-19th century populist. Others foresee a dirty general election campaign – a “war of the super-Pacs” – followed by a low turnout in November. Yet America’s mood remains far too mercurial for clear-cut predictions. When an electorate conveys this degree of disaffection, it is prone to unexpected swings. “We seem to be living in an age of disenchantment with democracy,” says Mr Jacobs. “Trust in the system has almost entirely vanished.” ------

17 www.ft.com/cms/s/0/01f74164-40fc-11e1-b521-00144feab49a.html#axzz1oAzUJ3aV

FT January 17, 2012 7:25 pm A real market economy ensures that greed is good By John Kay

Sixty years of division of the Korean peninsula has created two states with very different standards of living in one country. The Korean example is pathological. The division of Germany resulted in two states, both functional in economic terms, but one far richer. The less noticed comparison between the modern economic histories of Finland and Estonia had the same outcome. There are few controlled experiments in economics, but these are as close as we get, and the results were clear. They were also unexpected. Hard though it is to believe today, in the 1960s many serious commentators on left and right believed that Russian economic progress threatened western hegemony. Those on the left were naively credulous and those on the right victims of paranoid fantasies. A perhaps apocryphal story tells of a Russian visitor, impressed by the laden shelves in US supermarkets. He asked: “So who is in charge of the supply of bread to New York?” The market economy’s answer – that not only is no one in charge, but it is a criminal offence for anyone to seek that position – is surprising. In the words of the economists Kenneth Arrow and Frank Hahn, “the immediate common sense answer to the question ‘what will an economy motivated by individual greed and controlled by a very large number of different agents look like?’ is probably ‘there will be chaos’.” Our intuition is that a centrally planned allocation of resources will be more efficient than an uncoordinated one. In a market economy, that error constantly leads us to overestimate the economic advantages, and longevity, of large companies. Our intuitions about the merits of scale and centralisation are generally wrong, partly because a price system can co-ordinate the decentralised decisions of many small companies and households well. Adam Smith’s insight about the invisible hand is often interpreted in this way and modern mathematical economists have established that proposition more precisely. But if co-ordination were the only strength of the market economy, a computer could do that job equally well. Computers are very good at processing information. But the prices and entrepreneurs of the market economy are much better at eliciting the information, on preferences and products, needed to make the calculations. Prices, and entrepreneurs, manage the market’s process of discovery. A functioning market economy allows endless small-scale experimentation. When such experiments succeed, they are quickly imitated: when they fail, as experiments usually do, they are abandoned. Centralised 18 economies, lacking this disciplined pluralism, experimented too rarely: when they did, they typically implemented on too large a scale. They often lacked honest feedback on performance. Subordinates had good reason to tell the great leader what he wanted to hear. We see the same mechanisms at work in our large corporations. But what of profit? North Korea is hardly free of the profit motive. The Kim dynasty and the cliques around it may profess disdain for capitalism, but they understand the goal of personal enrichment as well as any Wall Street Master of the Universe. The difference between North Korea and the US is not that one society offers more scope for greed than the other. In both countries, as in many others, there are greedy people and many who are not, and those who are greedy are disproportionately represented in the controlling elite. The difference lies in the channels of greed – the degree to which the quest for profit is directed towards the creation of new wealth rather than the appropriation of wealth already created by other people. A successful market economy emphasises the former and restricts the latter through rules and institutions, in a structure that has evolved slowly and requires constant defence against those who would use economic and political power to subvert it. Success or failure in that endeavour is the central explanation for why some societies are rich and others poor. Crony capitalism is very different from the market economy. ------www.ft.com/intl/cms/s/0/36297676-413f-11e1-8c33-00144feab49a.html#axzz1oAzUJ3aV

FT January 18, 2012 7:05 pm Leaders who generate diminishing returns By Philip Stephens

The financial system is still sickly. So now is politics For a fleeting moment after the collapse of Lehman Brothers it seemed the politicians were masters again. Leaders of rich and rising nations sidestepped their differences to avert a global economic slump. The Group of 20 issued ringing declarations promising a new political architecture for the international financial system. Wall Street and the City of London were unceremoniously toppled from their gilded pedestals. Three years on, the markets call the shots. Rating agencies humiliate the mighty US government and also strip France of its cherished triple A credit status. The implosion of financial capitalism has become a crisis of political authority in the west. Behind this lies an unequal contest between a globalised economy and politicians struggling to answer the demands of national electorates. “It is not the ratings agencies that dictate the policies of

19 France,” François Baroin, that country’s finance minister, declared after the Standard & Poor’s downgrade. To some it seemed a statement of hope as much as fact. The financial system is still sickly. So now is politics. Economic stagnation has bred popular disaffection, stirring protests from right and left. The politics of inequality, banished during the boom years, have returned to view. In Britain, the gap between those at the top and bottom of the income scale is as wide as it has been in living memory. The “middle” is feeling badly squeezed. Easy credit masked this unequal share-out. Now, in a time of austerity, the gulf between the 1 per cent and the 99 per cent puts a question mark over the legitimacy of the market system. Confidence in capitalism has fallen. A recent opinion poll conducted by GlobeScan indicated that support for the free enterprise system had fallen to about 60 per cent in the US. Ten years ago it was at 80 per cent. Mitt Romney, frontrunner for the Republican nomination in this year’s presidential contest, once boasted of his success in building Bain Capital, the private equity business. Now, a career at the sharp end of capitalism’s creative destruction may prove a political liability. Ironically, the poll found that faith in the market was significantly stronger in China. There were higher scores, too, in Brazil and Germany. Capitalism, leaders of most political colours seem to agree, is still the only show in town – but must it be unfettered? In Europe, the debts of the banks have been piled on to the deficits of governments, turning a financial crisis into one centring on sovereign debt. The storms engulfing the euro threaten the continent’s most ambitious project. Angela Merkel, German chancellor, warns with only slight hyperbole that the euro’s failure would imperil decades of European integration. On the other side of the Atlantic, an initial fragile consensus in Washington on rescuing Wall Street has given way to political gridlock. Barack Obama faces a constant struggle with Republicans in Congress to secure enough money to keep the federal government running. All the while, the Tea Party, the Occupy movement and, in parts of Europe, rightwing populists shout from the sidelines. Greece and Italy have lost elected politicians to technocrats. Elsewhere, presidents and prime ministers more closely resemble victims than masters. In 2009, things looked as if they would be otherwise. Surveying the nationalisation of a slew of US financial institutions and Washington’s takeover of the automotive industry, a senior Chinese official remarked laconically that he detected “socialism with American characteristics”. In Britain, the crash obliged the government to take controlling stakes in two of the biggest banks and to prop up several smaller ones. What had seemed be a life- threatening event has become a chronic illness – not so much a crisis of capitalism but of the capacity of politicians to manage it.

20 The banks’ losses have been nationalised. Billions of dollars of toxic assets that once sat on the books of financial institutions have piled further pressure on public deficits already swollen by recession. Governments badly need growth. The US economy shows signs of life, but its recovery has been anaemic. Mr Obama’s hopes of a second presidential term rest critically on a sustained fall in unemployment. In Europe, growth has all but disappeared. The eurozone’s peripheral economies – Greece, Spain, Portugal and Ireland – are on life support and the continent’s banking groups are kept afloat on a sea of liquidity provided by the European Central Bank. The pervasive sense of political powerlessness is a western rather than a global phenomenon. China, India, Brazil and the rising rest are not immune from the troubles of the rich nations but their economies have continued to grow. For most Asians, today still feels better than yesterday and tomorrow looks better still. American and European politicians have discovered that capitalism no longer belongs to the west. Instead, the troubles faced by the advanced economies have crystallised the wrenching shift in the balance of global economic power. The Chinese, Indians, Turks and Brazilians now have a say in setting the terms of exchange. . . . Politicians of the left and centre-left saw opportunity in the crash. The Washington consensus, the organising idea behind the global advance of laisser-faire financial capitalism, had been discredited. The demise of market liberalism, the socialists and social democrats assumed, would rehabilitate the role of government as the pivotal actor in economic management. Popular fury with the bankers would translate into renewed faith in the efficacy of the state. As things have turned out, the centre-right has all but swept the electoral board. Policy Network, the progressive think-tank, has an explanation. The mistake of the centre-left was to misread the anger at the excesses of the market as a return of public confidence in the state. The organisation’s opinion surveys show that the crisis has come to be seen in the minds of voters as one of public borrowing and debt as well as of bankers’ greed. Voters do not think the answer to spiralling deficits is more government borrowing. “It is the question of the state – its size, its role, its efficiency – that has become the central issue, not the inherent instability and free-market ideology,” Policy Network observes. Put another way, if capitalism needs fixing, Europeans have decided to leave the task to the politicians who best understand the marketplace. The Occupy movement that has sprung up across American and European cities has drawn sympathy from beyond the protesters’ natural constituency. But its many threads – some anti-capitalist, some anti-globalisation and many social democratic – have fallen short

21 of a coherent prospectus. On the populist right the themes are sometimes complementary, as in opposition to immigration, but as often as not contradictory. The Tea Party has harnessed Americans’ scepticism about the role and motives of the federal government: Washington is the big danger. In France, the Netherlands, Finland, Hungary and beyond, parties of the far right have targeted global capitalism as the enemy – with the International Monetary Fund and the European Union at times thrown in as co-conspirators. Waning public confidence is in part simply a reflection of the brutal economic facts. The financial crash inflicted huge losses on the innocent. Unemployment has risen sharply and living standards have stagnated or fallen. Yet even as they have been swept along in treacherous currents, politicians have not helped themselves. The west is not blessed by decisive leadership. Mr Obama lacks the temperament of a Franklin Roosevelt. Ms Merkel’s almost pathological caution has significantly raised the cost of rescuing the euro – if such a rescue remains possible. Nicolas Sarkozy, the French president, has energy and rhetorical ambition but lacks clarity and concentration. Missing, too, has been a convincing prospectus. The regulation of financial institutions has been tightened. The US has its Dodd-Frank Act and Volcker rule; Britain has its Vickers commission on banking. Germany and France are plotting a financial services tax. Mr Obama promises less Wall Street and more Main Street, Britain’s David Cameron less financial engineering and more of the real sort. The talk of “responsible” capitalism, of rebalancing economies and constraining the rewards of the super-rich, falls short of anything resembling a grand plan. The ambition is to make do and mend. . . . Behind all this, however, lies the structural problem – the mismatch between global economics and local politics. States have been shedding power to globalisation. The big lesson has been about the extent to which globalised capitalism has outstripped the capacity of national governments to manage it. Governments have ceded power to mobile capital, to cross-border supply chains, to instant global communications and to rapid shifts in comparative advantage. Citizens expect their politicians to protect them against the insecurities of the age – whether economic or physical. Yet governments no longer have the tools to provide such a shield. “Inequality is being driven by globalisation,” one senior minister in Mr Cameron’s government says of the wage stagnation faced by the middle classes. “And there is not a lot we can do about it.” The same might be said of the rise in structural unemployment in most rich economies as comparative advantage has moved rapidly eastwards. It is this gap between the supply and demand for governance that fuels popular discontent, and gives impetus to the temptation for states to look in on themselves. It explains the rise both of rightwing populism and the anti-capitalist movements of the left,

22 and risks fuelling a dangerous revival of the politics of identity on both sides of the Atlantic. The response of many governments has been to turn inwards and seek to defy the realities of interdependence by elevating narrow definitions of national interest. Old concepts of mutual interest and solidarity have cracked even in the eurozone, the most closely integrated group of rich nations. Ms Merkel says German voters cannot be held responsible for the feckless behaviour of their spendthrift European cousins. Politicians on the continent’s troubled periphery rail against German selfishness. The effect has been to recast the euro crisis as a zero-sum game. What Greece, Portugal, Spain and Italy stand to gain, creditor nations such as Germany, the Netherlands and Finland must lose. The signal this sends to rising states is equally counterproductive. The sense of collective interest visible at the post-crash meetings of the G20 has dissipated. If states so politically integrated as those in the eurozone are so reluctant to act in concert, why should China, India or Brazil invest their faith in co-operative global governance? It is a question to which western leaders have yet to find an answer. Charles Kupchan, a professor of international relations at Georgetown University, says the political breakdown – political stasis in the US, a fracturing of solidarity in Europe and a merry-go-round of prime ministers in Japan – adds up to a crisis of governability. The diffusion of power in the international economic system has diluted the efficacy of traditional policy tools. There are answers to the malaise, he says, including more government activism in the provision of infrastructure and training, and drives to improve competitiveness and weaken the special-interest groups that have captured some of capitalism’s commanding heights. These, though, are not quick fixes. The danger is that what started out as a crisis of financial capitalism will give way to a new age of nationalisms – a backlash against globalisation and a return to zero-sum politics. The better route would be an effort to extend and refurbish the multilateral order to match economic integration with great global governance. But, for the moment, we are as far from that as from a serious attempt to remake the rules of capitalism...... How a vicious credit cycle has left states saddled with debt Debt crises rarely occur in isolation – which is why many investors and academics looking at the sovereign debt inferno raging in the eurozone prefer to cast it as the latest in a series of rolling crises stretching back at least a decade, writes Richard Milne. Today it is government debt that is under the microscope. The net debt of advanced economies has risen from 45 per cent of gross domestic product in 2007 to an expected 73 per

23 cent this year – and will rise to 78 per cent by 2016, according to forecasts from the International Monetary Fund. However, the debt cycle began with companies at the start of the century, as businesses launched expansion programmes funded by cheap credit, which were followed by a wave of bankruptcies. By 2007-08, consumers and banks caught up in the escalating global financial turmoil were facing their own debt crises. This forced states to intervene, both to save lenders and to try to keep their economies growing, leading to a rise in public debt. Taking the UK as an example, a new report from the McKinsey Global Institute on debt and deleveraging shows government debt was reasonably stable between 1987 and 2008 at 40-50 per cent of GDP. But between the end of 2008 and the end of 2011, it shot up from 53 to 81 per cent of GDP. The ballooning in household and financial institutions’ borrowing came earlier. Both experienced big rises from 2000 to 2008. Household debt jumped from 69 to 103 per cent of GDP, while financial institutions’ debt nearly doubled from 122 to 209 per cent of GDP. The McKinsey report looks to the experiences of Sweden and Finland in the 1990s for an idea of how deleveraging will play out in the west. The authors find that the US has followed the Nordic path most successfully, with aggressive debt reduction by consumers, companies and financial institutions. Household borrowing could be cut to sustainable levels in just two years, whereas in the UK it could take as long as a decade. The question of how developed countries can reduce their debt piles is knottier. Many investors and academics have turned to the work of Carmen Reinhart, a US academic who has shown how states have opted for “financial repression”. A combination of caps on interest rates – such as the quantitative easing policies used by the US and UK central banks – and captive domestic investors helps to keep state borrowing costs low. It is a phrase likely to be heard more and more. ------www.ft.com/intl/cms/s/0/c599d23c-41fe-11e1-9506-00144feab49a.html#axzz1oAzUJ3aV

FT January 18, 2012 7:44 pm Our toxic blend of capitalism and short-termism By Ed Miliband, The writer is leader of the Labour party

What is surprising about the current debate on the future of capitalism is not that it is taking place but that it has taken fully three years since the global financial crisis for this to reach a pitch. Even three months ago, when I challenged some of the assumptions that have underpinned our economy for a generation, my speech to Labour’s annual conference was not – I think it is fair to say – universally well-received. 24 Since then, politicians from different parties have begun discussing how we can build a better, more responsible and productive form of capitalism. And business leaders have shown this is their agenda, too. The debate now needs to move on from recognising the issue to offering some solutions. Some have you believe this is “a branding problem” for capitalism. I think they seriously underestimate the scale of the change we need if we are to pay our way in the world and tackle the growing inequality that scars our society. The world economy is struggling to recover from a crisis caused by inadequately regulated financial activity. Governments are struggling to deal with deficits that are too high and growth that is too low. And, long before the credit crunch, people in the middle were struggling with squeezed living standards. These are not isolated phenomena but caused by rules that encourage wealth creation focused on short-term returns, fail to reward productive behaviour and skew distribution towards the top. When centre-left politicians talk about rules, our opponents routinely warn about the danger of stifling enterprise with red tape. But markets always operate in a context set by government. It is not a question of having more or fewer rules, it is about the right rules. Let me give you one such example: I will be speaking on Thursday to the consumer organisation Which? about tackling the surcharge culture that strains the budgets of so many families in Britain. Banks and credit card companies, low-cost airlines, energy suppliers, train operators and pension firms make billions through hidden charges and overly complex pricing policies. No government should tolerate, let alone encourage, predatory practices such as these. If markets are to operate properly and competition is to flourish, consumers need to understand – at the point of purchase – how much they will eventually have to pay. There are practical steps on this which can make Britain fairer but do not involve spending more money. One is to give the new Financial Conduct Authority real teeth so that it can tackle excessive, unfair or opaque charges levied by banks and credit card companies. It is not enough to fiddle at the margins. That is what the government does when confronted by the rigged market of the energy suppliers or the surcharge culture. But nor must reform be based merely on a moral case: there is also a hard-headed argument for change. There is no starker example of the short-termism that blights British enterprise than in some of the hostile takeovers of recent years. Some might have been crucial to turning a failing company around. But in 2010, we saw the unedifying spectacle of Cadbury being purchased by Kraft as investors gambled that the bid would succeed.

25 Some argue that government should just stay out of the way. But the rules that govern the system shape outcomes and it is no accident that too many takeovers are decided on the basis of short-term decision-making by people who never had any interest in the long-term success of the company concerned. The rules need to change to help companies take decisions that drive long-term value creation. We are looking at a proposal to require a threshold of two-thirds rather than a simple majority of shareholders before a takeover can succeed. Another option under consideration is to limit voting rights to those holding shares before the offer period opens. Although much of the investment in British companies comes from the public through our pensions, the decisions taken on our behalf by fund managers chasing the fast buck are often contrary to the long-term interests of both those saving for their retirement and business. Short-termism seems hard wired in to our economy, with small companies unable to access the capital they need. We are looking at significant reform of our pension industry and proposals for a National Investment Bank for small business. I have heard it argued that in tough times such as these, the only politicians who can meet the challenges ahead are found on the right. I disagree. Centre-left parties are better- placed – provided we do two things: first, face up to the new fiscal reality where there is substantially less money around. Second, engage in fresh thinking about the role of government in shaping the rules of the market, taking on predatory practices and vested interests that hold our economy back, and working with the private sector to create a fairer, more responsible capitalism. ------blogs.ft.com/the-a-list/2012/01/18/self-interest-without-morals-leads-to-capitalisms-self- destruction/#axzz1oBGGMwKx

FT 18 Jan 2012 Jeffrey Sachs The writer is director of The Earth Institute at Columbia University and author of ‘The Price of Civilization’

Self-interest, without morals, leads to capitalism’s self-destruction Capitalism earns its keep through Adam Smith’s famous paradox of the invisible hand: self-interest, operating through markets, leads to the common good. Yet the paradox of self- interest breaks down when stretched too far. This is our global predicament today. Self-interest promotes competition, the division of labor, and innovation, but fails to support the common good in four ways. 26 First, it fails when market competition breaks down, whether because of natural monopolies (in infrastructure), externalities (often related to the environment), public goods (such as basic scientific knowledge), or asymmetric information (in financial fraud, for example). Second, it can easily turn into unacceptable inequality. The reasons are legion: luck; aptitude; inheritance; winner-takes-all-markets; fraud; and perhaps most insidiously, the conversion of wealth into power, in order to gain even greater wealth. Third, self-interest leaves future generations at the mercy of today’s generation. Environmental unsustainability is a gross inequality of wellbeing across generations rather than across social classes. Fourth, self-interest leaves our fragile mental apparatus, evolved for the African savannah, at the mercy of Madison Avenue. To put it more bluntly, our sense of self-interest, unless part of a large value system, is easily transmuted into a hopelessly addictive form of consumerism. For these reasons, successful capitalism has never rested on a moral base of self-interest, but rather on the practice of self-interest embedded in a larger set of values. Max Weber explained that Europe’s original modern capitalists, the Calvinists, pursued profits in the search for proof of salvation. They saved ascetically to accumulate wealth to prove God’s grace, not to sate their consumer appetites. Keynes noted the same regarding the mechanisms underpinning Pax Britannica at the end of the 19th Century. As he put it, the economic machine held together because those who ostensibly owned the cake only pretended to consume it. American capitalism, more secular and less patriotic, created its own vintage of social restraint. The greatest capitalist of the second half of the 19th century, Andrew Carnegie developed his Gospel of Wealth, according to which the great wealth of the entrepreneur was not personal property but a trust for society. Our 21st century predicament is that these moral strictures have mostly vanished. On the one hand, the power of self-interest is alive and well and is delivering much that is good, indeed utterly remarkable, at a global scale. Former colonies and laggard regions are bounding forward as technologies diffuse and incomes surge through global trade and investment. Yet global capitalism has mostly shed its moral constraints. Self-interest is no longer embedded in higher values. Consumerism is the world’s secular religion, more than science, humanism, or any other -ism. “Greed is good” is not only the mantra of a 1980s Hollywood moral fable: it is the operating principle of the top tiers of world society. Capitalism is at risk of failing today not because we are running out of innovations, or because markets are failing to inspire private actions, but because we’ve lost sight of the operational failings of unfettered gluttony. We are neglecting a torrent of market failures in

27 infrastructure, finance, and the environment. We are turning our backs on a grotesque worsening of income inequality and willfully continuing to slash social benefits. We are destroying the Earth as if we are indeed the last generation. We are poisoning our own appetites through addictions to luxury goods, cosmetic surgery, fats and sugar, TV watching, and other self-medications of choice or persuasion. And our politics are increasingly pernicious, as we turn political decisions over to the highest-bidding lobby, and allow big money to bypass regulatory controls. Unless we regain our moral bearings our scope for collective action will be lost. The day may soon arrive when money fully owns our politics, markets have utterly devastated the environment, and gluttony relentlessly commands our personal choices. Then we will have arrived at the ultimate paradox: the self-destruction of prosperity at the very moment when technological knowhow enables sustainable prosperity for all. ------www.ft.com/intl/cms/s/0/f673c85a-42b1-11e1-93ea-00144feab49a.html#axzz1oAzUJ3aV

FT January 19, 2012 7:28 pm Too Big to Fail undermines the free market faith By Otmar Issing, The writer is president of the Center for Financial Studies and a former member of the European Central Bank’s executive board

Isn’t it strange? When the Berlin Wall fell and the Iron Curtain was raised, a historic competition appeared to have come to an end. Observers saw capitalism triumphing over communism, free markets over central planning, democracy over dictatorship, Hayek over Marx. Francis Fukuyama even proclaimed the end of history – mankind had supposedly reached an optimum state, with no feasible alternative. From the outset, this was a false doctrine. Whereas “real socialism” ended in disaster wherever it was tried, history teaches that the idea of a socialist society promising equality will never fade, whatever empirical evidence shows. Moreover, there was hardly a country in the world where capitalism had become established in a way that was satisfying in every respect. Historical determinism was the most absurd aspect of Fukuyama’s notion. No liberal philosopher would have embraced the idea of history being predetermined. Competition between different ways of organising societies has continued since the end of the cold war. Socialism still suffers from the fatal blow dealt by its past collapse. As a consequence it is seen mainly in grassroots protests such as the Occupy movement. How this might be achieved remains totally unclear – the movement encompasses a variety of issues with one dominant element: an attack on the finance industry.

28 Looking at the evolution of the financial market crisis, the only surprise is that it took so long before a serious movement materialised. The crisis has provided strong arguments for opponents of the financial system. Interventions to avoid its collapse have severely undermined not only confidence in financial markets but also in the market economy as a whole. Once a financial institution has become so big or interconnected that its insolvency threatens the stability of the system, politicians must intervene. The problem of “too big to fail” has made society – more precisely, the taxpayer – hostage to the survival of individual financial institutions. As a result, the basis of free markets has been shaken. A market economy rests on the principle that individuals are free to act within boundaries set by a legal system. Individuals are invited to exploit opportunities and to assess risk. No other system can release the same amount of potential locked inside individuals. As Hayek explained, the market is the best discovery process. The rules of the game should be clear. Those who succeed are free to take the profits (after taxation); those who make losses have to bear the consequences, with bankruptcy the ultimate sanction. Thus, “too big to fail” not only undermines a fundamental principle of market economies but also a principle of societies in which individuals are responsible for their actions. The taxpayers’ billions committed to rescue supposedly systemic institutions have dealt a big blow to confidence in the free market system – and has in turn become a threat to free societies. The threat has been aggravated by people expecting more from governments than politicians can actually deliver – while at the same time trust in politicians, it seems, has fallen almost everywhere to its lowest ever levels. Meanwhile, the financial industry still fails to give a convincing answer to fundamental questions: to what extent do its activities contribute to the welfare of society and are they indispensable for a dynamic economy? It would probably be too much to expect the financial sector to respond by saying that, in fact, some parts of its businesses are superfluous or even dangerous. So, governments are confronted with the challenge of creating a convincing system of regulation and supervision that enables the financial industry to deliver services considered indispensable but, as far as possible, prevents it pursuing activities deemed detrimental to society. Notwithstanding a number of encouraging improvements, such as higher capital requirements and greater transparency, this task is anything but completed. The challenge of strengthening the fundamentals of market economies and free societies continues. History never ends – except in the minds of those who believe in the inevitability of the Mayan calendar, which predicts the end of the world in December 2012. ------

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FT January 20, 2012 7:28 pm A rather civil partnership By Andrew Hill

Can store provide macroeconomic model? For nearly 150 years, John Lewis has had a shop on London’s Oxford Street. Customer “footfall” is steady. The department store group’s carefully nurtured and increasingly well- marketed reputation for dependable quality and value for money, from picnicware in the basement up to personalised stationery on the fifth floor, remains intact even as other UK retailers are failing. But while the group’s commercial success and enduring hold on middle-class Middle Britain are clear, the retailer also has a growing – and somewhat unlikely – role as a political talisman. Like unhappy couples seeking to make the home they cannot afford to leave more liveable, UK politicians are drawn to the John Lewis Partnership – owned by its staff and managed on democratic principles – as a model for economic and organisational reform. From the US, where California has just enshrined in law new forms of socially aware “flexible purpose” and “benefit” corporations, to Spain, where the UN year of the co- operative has refocused attention on the Mondragon network of worker-led businesses, the leaders of crisis-hit economies are on a global shopping expedition. They are hunting for successful businesses run outside listed-company lines to help reinvent, rebalance and revive capitalism. Nowhere does this urge to refurbish the economy seem more urgent than in the UK, where the influence of the shareholder-owned joint stock company is stronger and the dominance of financial capitalism greater than almost anywhere else. Speaking this week, Nick Clegg, deputy prime minister, told an audience at the Mansion House, in the heart of the City of London: “We don’t believe our problem is too much capitalism. We think it’s that too few people have capital. We need more individuals to have a real stake in their firms. More of a John Lewis economy, if you like.” The location was telling. The ornate banqueting hall of the Lord Mayor’s official home was where in 2007, on the eve of the crisis, Gordon Brown – then chancellor of the exchequer, later Labour prime minister – laid out a quite different economic vision. He told a gathering of bankers and financiers that: “Britain needs more of the vigour, ingenuity and aspiration. ... that is the hallmark of your success.” From local council services to the Royal Mail, UK politicians have settled on John Lewis as the model for reorganisation. It seems an odd choice of political touchstone and an 30 idiosyncratic model for modern management. In retailing terms, the shops fall somewhere between Bloomingdale’s and Macy’s in the US, and have parallels with Spain’s El Corte Inglés or La Rinascente in Italy. But the partnership operates barely three-dozen department stores, in the UK only, as well as Waitrose, a high-end supermarket chain, and a successful online arm. In other respects, however, John Lewis represents a Utopia encapsulating the ambitions of the main political parties. It is a haven for middle-class inhabitants of Britain’s heartland. Its sugary commercials have captured the public imagination better than most election advertising campaigns. But does it make sense for Britain to fetch a new economic model off the shelf, in the same way a consumer would drop into a department store to replace a faulty coffee-maker, a threadbare rug or a worn-out jacket? Even if it does, is John Lewis the right choice? There is a strong tradition of lofty idealism in the retailing sector. In 1900, Bradford Peck, owner of a successful department store in the US state of Maine, even published a novel – The World a Department Store: A Story of Life Under a Co-operative System – to promote the wider application of the co-operative model. In his novel, Au Bonheur des Dames, Emile Zola also used the glittering microcosm of a Parisian grand magasin to chart the 19th-century transformation of commerce from family business to dog-eat-dog capitalism – and to suggest how the new system could be tempered with humanity. However, John Spedan Lewis, son of the retailer’s original founder, put his idealism into lasting action, pioneering a model of co-ownership that was, and remains, radical. In two chunks, in 1929 and 1950, he transferred his shares in the business to a trust. The company has an executive chairman and is governed under a set of principles and a constitution, with policy influenced by an elected council that represents the staff or “partners”. Spedan Lewis ensured that all staff would benefit from an annual share of profits, and that pay would be regulated according to a ratio. The highest paid staff member cannot earn more than 75 times the average wage of the shop-floor salesperson. Staff are encouraged to air their concerns in the weekly Gazette, and senior managers are expected to respond. Generous pensions and holiday amenities are available for partners. “Spedan’s ‘big idea’ was a simple one – employees work better if they feel they have a stake in their company,” says Peter Cox, who wrote a history of the group after retiring from Waitrose in 2003. “In the John Lewis case, they know that no nameless shareholders are taking a cut before they get their bonus. Unless a business distributes its profits to its employees, that subliminal motivational benefit is not replicable. But the knowledge that they can appoint their own representatives, that they can complain and be listened to, is still a major advantage.”

31 It helps, of course, that John Lewis and Waitrose continue to demonstrate commercial success. This month the group reported an “outstanding” Christmas. Its total sales increased 9.3 per cent in the five weeks to New Year’s eve compared with the same period of 2010. Waitrose pushed up its December sales by 9.5 per cent. Meanwhile, the UK’s biggest retailer, Tesco – whose relentless expansion, like that of Walmart in the US, has attracted fierce criticism – registered a rise in total UK sales, excluding petrol, of only 1.7 per cent in the six weeks to January 7 and issued a profits warning.

Cinematic celebration for the founding fathers of a billion-strong movement After The Iron Lady, another film about British economic revolutionaries is about to hit the big screen: The Rochdale Pioneers, writes Andrew Bounds There is no Oscar-winning leading lady, such as Meryl Streep playing Margaret Thatcher, but that suits the tale of how 28 cloth weavers, shoemakers and joiners created what is hailed as the world’s first successful retail co-operative. The men who founded the Rochdale Pioneers Society in 1844 had a vision of self-help to free their communities from the rent-seeking merchants who adulterated flour with chalk and tilted scales in their favour. Profits were shared among members as dividends. The film includes a famous incident where they pushed wheelbarrows from Rochdale, a town in the Pennine foothills of north-west England, to Manchester 14km away to buy wholesale goods that the local grocers refused to sell them. Much action takes place on cobbled streets among the red brick mill chimneys that still dominate Rochdale’s skyline – these days without their accompanying plumes of smoke. In the 1840s the town was expanding fast as labourers poured in from the countryside to work in the steam-powered cotton mills. But this workforce was reliant on overpriced foodstuffs: while US cotton was freely imported for spinning, aristocratic farming interests kept out American corn. Manchester itself was seized by “Manchester liberalism”, which pushed for the deregulation of markets and succeeded in abolishing the corn laws and their import quotas in 1846. That doctrine of free trade, as embraced by the Iron Lady herself 130 years or so later, may have been more influential but the co-operative movement has 12m members in the UK. Manchester remains home to the Co-operative Group, a business with £13bn ($20bn) in annual revenues spanning supermarkets, banking, insurance and farming, which grew out of the Pioneers Society and has made the film to mark the UN’s International Year of Co- operatives. The Rochdale Pioneers will premiere in Manchester in October and is to be shown in cinemas worldwide. The first retail store, at 31 Toad Lane, is now a museum but it became a

32 tourist attraction as early as the 1860s, with people from across Europe signing a visitors’ book. Northern England, long subject to the boom and decline of great industries such as textiles, steel and shipbuilding, has been a rich source of films featuring working-class characters fighting adversity through family ties, trust and friendship forged at the coalface, and, above all, with humour. The Full Monty, the 1997 story of unemployed steelworkers from Sheffield who turned to striptease, is one of most successful ever British films. Brassed Off in 1996 depicted a colliery band playing on while they lost their livelihoods during the 1984-85 miners’ strike. Billy Elliot, made in 2000 and now a musical, focused more on loner than community: a boy growing up in a dying mining village who escapes through his love of ballet. So The Rochdale Pioneers has a lot to live up to. But the potential audience is large. The legacy of the 28 is more than 1bn co-operative members around the world today. . . . But even advocates of the John Lewis model point out that the form is no guarantee of success. A periodic accusation is that the management system tends towards bureaucracy, while employee-ownership impedes expansion and hinders productivity improvements. Charlie Mayfield, a suave former McKinsey consultant who is the group’s executive chairman, says managers have to demonstrate their accountability to staff – the council can dismiss him if he fails in his duties – because the trust structure means employees cannot sell their shares. Low staff turnover improves the return on investment in training and encourages better service. But it takes work: “It doesn’t just happen. You don’t have to go back that many years to find a time when this ownership model wasn’t performing as well as it is now.” Failed experiments in employee control – notably the bankruptcy of America’s United Airlines nine years ago – continue to colour discussion of the model. But Professor Jonathan Michie of Oxford university, an expert in employee motivation, says: “The insights and model [of Spedan Lewis] could indeed be applied more widely, with more expectation of success given the track record today than could reasonably have been held at the time.” This is far more easily said than done – and not just because few companies have a visionary such as Spedan Lewis at the helm. One reason is that the elements of the formula – participative management style, employee ownership and profit-sharing – work best when applied together. David Erdal, author of Beyond the Corporation: Humanity Working, about employee-owned companies, says productivity can be increased by applying any of those approaches, but “if you do all three, you have a knockout”. Mr Mayfield, too, says John Lewis principles cannot be cherry-picked. The constitution states that the purpose of the group is to ensure “the happiness of all its members, through

33 their worthwhile and satisfying employment in a successful business”. But he sometimes has to explain that this does not mean managers should avoid action – such as job reductions – that upset members but help sustain commercial success. Mr Cox, the company historian, adds that the ownership structure is nothing without consistent application of Spedan Lewis’s trading principles – value, assortment, service and honesty – that keep customers coming back, as embodied in the enduring slogan he devised: Never knowingly undersold. . . . Politicians’ good intentions could still founder on the reefs of tax codes and the UK’s engrained corporate culture. A change in the tax code to make it easier for entrepreneurs to transfer shares to staff would run up against the Treasury, traditionally a staunch backer of the shareholder-owned publicly listed company model, according to critics of the existing system. As one politician puts it: “The Treasury’s full of very clever, neoclassical economists who think the PLC was divinely created and handed down on tablets of stone to Moses.” The fact that the financial sector is geared towards serving the stock markets and listed companies is a further obstacle to change, Prof Michie says. “If you want to sell your family firm, and go to your bank or financial adviser for advice, they will tell you that you can sell it in a trade sale, or float it on a stock market. End of story,” he says. “They won’t tell you that you can sell it to an employee trust. If you ask whether you can sell it to an employee trust, they will probably say ‘no’.” What is clear is that politicians’ idealistic rhetoric about alternative models will not on its own dismantle barriers to wider employee ownership. But for those who believe capitalism should foster a more diverse range of ownership models, this has been a good week, with David Cameron, UK prime minister, weighing in three days after Mr Clegg with a proposal to make it simpler to establish worker co-operatives. “I do think a more plural approach would be a good thing for the economy,” says Mr Mayfield, who – unlike many fans of co-op or employee-owned businesses – even has a good word for private equity, which he says can, in some cases, be a useful form of ownership. Nobody is counting out shareholder-owned companies, which, despite the blow to their reputation inflicted during the crisis, have proved their adaptability over time. But Tomorrow’s Company, a London-based think-tank, points out that equity market capitalisation as a proportion of gross domestic product has fluctuated in developed countries in the past century. In other words, even the listed company model goes in and out of economic fashion. As political leaders survey the racks of options for capitalism’s next season, it is hardly surprising that the electable virtues of John Lewis – popular, durable, reliable and middle-of- the-road – should catch their eye. ------

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FT January 22, 2012 6:39 pm Seven ways to fix the system’s flaws By Martin Wolf, The writer is the FT’s chief economics commentator

The shocks inflicted on the world by the upheavals of the past few years make a thoroughgoing overhaul urgent Three years ago, when the worst financial and economic crisis since the 1930s gripped the global economy, the Financial Times published a series on “the future of capitalism”. Now, after a feeble recovery in the high-income countries, it has run a series on “capitalism in crisis”. Things seem to be worse. How is this to be explained? In 2009, the world was in a state of shock. Now, despite successful efforts at stabilising economies, people are closer to despair. Something seems to be wrong with the system. But what, and what needs to be done? Capitalism has always changed. That is its genius. Today’s shocks make the case for reform urgent. Let us consider seven challenges. Some relate to capitalism itself, others to the context in which it operates.

Managing macro instability One of the biggest debates in economics is whether a modern capitalist economy is inherently stable. Before the crisis, the orthodox view was that it would be if one had a competitive economy and a central bank that anchored inflation expectations. Events have disproved this view. The late Hyman Minsky, in his masterpiece, Stabilizing an Unstable Economy, provided incomparably the best account of why this theory is wrong. Periods of stability and prosperity sow the seeds of their downfall. The leveraging of returns, principally by borrowing, is then viewed as a certain route to wealth. Those engaged in the financial system create – and profit greatly from – such leverage. When people underestimate perils, as they do in good times, leverage explodes. Finance then progresses from what Minsky called “hedge”, in which interest and principal is repaid out of expected cash flow, to “speculative”, in which interest is paid out of cash flow but debt needs to be rolled over, and finally to “Ponzi”, in which both interest and principal is to be paid out of capital gains. Does this sound familiar? It certainly should. What is the answer? We can see three elements if one puts to one side the notion that we should return to the 19th-century gold standard or eliminate banking.

35 The first is to recognise that, as critics have long noted, crises are inherent in free-market capitalism. This is partly because of the way capitalism itself behaves. It is also because all participants, including regulators and even economists, act and think pro-cyclically. Second, so-called “macroprudential” policy – oversight over the financial system as a whole – matters. Regulators need to watch the build-up of leverage. They also need to ensure adequate levels of loss-absorbing capital in financial institutions and among the ultimate borrowers. Finally, the government and its agencies, including the central bank, have a big role. They acted as stabilising forces during the crisis. But they also acted as destabilising forces before the crisis: central banks responded too aggressively to incipient recessions in previous decades and governments were too willing to encourage excessive leverage in the household sector. These serious mistakes must not be repeated.

Fixing finance The financial system is an essential part of any market economy. But it is based on a complex and fragile network of trust. The lesson of the crisis is that such networks are prone to abuse and then to collapse. Again, what is the answer? It is to protect finance from the economy and the economy from finance. This requires bigger shock absorbers. If that change is made, the normal disciplines of the market can operate, as they should: no more “too big and connected to fail”. Yet mistakes will still be made. People are always influenced by the fads and fashions of the moment. But if the financial system is more robust, it will be in a better position to survive such errors. What are the elements of the shock absorbers? The most important is far more capital. The core financial institutions should not in the long run have leverage of more than 10 to one. An additional requirement is a resolution regime that lets the authorities act promptly once institutions are on the brink of losing funding. Moreover, as the UK’s Independent Commission on Banking (of which the writer was a member) has also recommended, managing the payments system and providing credit to households and small and medium- sized businesses should be separated from investment banking, to strip away implicit subsidies. Finally, too often, consumers cannot understand what they are buying. The principle of “caveat emptor” – let the buyer beware – does not work. People need protection from the predatory practices seen so egregiously in US subprime lending before 2008.

Change born of experience and a revolution in economic thinking

36 Capitalism has an extraordinary survival instinct. This is partly because crises trigger reforms that make it more robust, effective and politically legitimate. The bigger the crisis, the bigger the reforms. Since the Great Depression of the 1930s was the biggest economic crisis in history, it delivered commensurately hefty reforms. The second world war assisted this effort, by underlining the dire consequences of crises, by bringing the allies together and by making society more cohesive. The resulting reforms were born of the experience itself and the revolution in economic thinking – Keynesianism – it triggered. Many governments, including that of the US, enacted the objective of full employment and accepted the primary role of fiscal policy. The goal of full (or “maximum”) employment is still, along with price stability, one of the twin mandates of the Federal Reserve. Keynesian economics also shaped the thinking about the new global monetary regime, enshrined in the International Monetary Fund. The objective of currency convertibility was as a result limited to current account transactions, since free capital flows were seen as destabilising.

The experience of the 1930s brought forth three further reforms. The first was financial regulation and controls on capital flows. In the US, the Glass- Steagall act split investment from commercial banking. Tight controls on finance were introduced everywhere. The second area of reform was the birth or at least rapid development of the welfare state in many countries. In the US, this was the product of Franklin Delano Roosevelt’s New Deal. In the UK, the Beveridge report paved the way for today’s welfare state. Similar ideas about state provision of a safety net spread across the west. Finally, after the second world war, a carefully managed reversal of the protectionism of the 1930s began. This was enshrined in the General Agreement on Tariffs and Trade and, ultimately, the World Trade Organisation; and also in the forerunners of the OECD and the European Union. Today’s crisis is smaller than that of the 1930s – so far. Yet it is a big event, particularly in conjunction with a shift in economic power to the east. Whether this brings forth big reforms remains unclear. But it is possible.

Addressing inequality and jobs As the Organisation for Economic Co-operation and Development, the Paris-based think- tank, showed in a recent report, high-income countries have seen large rises in inequality over the past three decades. This is captured in the slogan of the Occupy Wall Street protest movement: “We are the 99 per cent”. The rise in inequality is the result of complex forces:

37 globalisation, technological change, “winner-take-all” markets, the birth of new and dynamic industries, changes in social norms over pay, the rise of finance, and shifts in taxation. Many of these changes were irresistible and are irreversible. But the level and increase in inequality does vary across countries, which suggests that economic structure and policies do alter outcomes. The US and UK, for example, have seen far faster rises in the real incomes of the top decile than of the bottom decile of household income distribution since the 1980s. In France, this went the opposite way. Many would argue that inequality is unimportant. To this, there are two powerful responses. The first is that it is important if it is politically salient. It is. The second is that inequality of outcome has a strong bearing on equality of opportunity, about which many more do care. It is harder for children who grow up in deprivation to obtain a decent start in life than those brought up in happier conditions. The effort becomes harder still if parents cannot find remunerative jobs and young people cannot hope to do so when entering the job market. What are the answers? Among them must be explicit fiscal redistribution from the winners to the losers and particularly to the children of the losers; subsidisation or direct provision of jobs; big efforts to improve the quality of education and childcare for all, including public financing of access to higher education; and a determination to sustain demand more effectively in severe downturns.

Changing corporate governance The core institution of contemporary capitalism is the limited liability corporation. It is a brilliant social invention. But it has inherent failings, the most important of which are that companies are not effectively owned. That makes them vulnerable to looting. Incentives allegedly provided to align the interests of top employees with those of shareholders, such as share options, create incentives to manipulate corporate earnings, at the expense of the long- term health of the company. Shareholder control is too often an illusion and shareholder value maximisation a snare, or worse. What is the answer? Unfortunately, no simple remedy exists. The corporation is the best institution we know of for running large, complex and dynamic businesses. It is surely important to ensure that taxation and regulation do not obstruct other forms of ownership, including partnerships and mutuals. It is vital to encourage the creation of genuinely independent, diverse and well-informed boards. It is sensible to ensure that pay packages are transparent and any incentives for destructive forms of remuneration are removed. But except in banks, where the public interest demands intervention in the incentives of management, governments should not intervene directly.

38 Tinkering with taxation The general thrust of political discussion, outstandingly so in the US, is against any and all taxation. Yet taxes play a decisive role in determining how the market economy operates, for good and ill. They determine the resources available for the supply of essential public goods and services. Finally, they can make a big difference to the outcome on inequality. What are the answers? Among the most important tasks is to remove the incentives for leverage embedded in personal and corporate taxation. On the latter, treating equity and debt equally might significantly reduce fragility. Another sensible idea is to shift the tax burden from incomes on to consumption and wealth. Yet another objective is to ensure richer people pay tax. At present a host of loopholes protect them, including the ability to turn income into capital gains. Some of this demands global co-operation, which is horribly difficult to obtain.

Curbs to purchasing politics Among the biggest concerns must be the relationship between wealth and democratic politics. Politics and markets each have their proper spheres. The market is based on the roles of people as producers and consumers. Politics is based on their roles as citizens. In the absence of protection for politics, the outcome is plutocracy. Plutocrats like closed political and economic systems. But if they succeed, they undermine the open access on which democratic politics and a competitive market economy depend. Protecting democratic politics from plutocracy is among the biggest challenge to the health of democracies. What is to be done? The protection of politics from the market comes by regulating the use of money in elections and by the supply of public resources to those engaged in them. At least partial public financing of parties and elections is inescapable.

Globalising public goods Last but not least, today’s capitalism is global. This creates a host of both challenges and constraints. One issue is how to regulate businesses that operate on a vast global scale. This has turned out to be particularly difficult in finance. There is a choice: align support in times of trouble with regulation at the national level and so break up the integrated global financial system, or align support with regulation at higher levels and move towards a more integrated European or global politics. More broadly, the disjunction between the level at which politics operates and the levels at which business and the economy function is a concern. Among the issues it raises is how to provide a host of global public goods by agreement among a range of very different states. Those include open markets, monetary and financial stability, security and, above all, protection of the environment.

39 What are the answers? The long-term one is likely to be more global governance. Will that be feasible? Not in the near future, in many areas. . . . A crisis, it has been said, “is a terrible thing to waste”. Capitalism has always changed. It needs to change right now if it is to survive and thrive. We need to find specific practical reforms within capitalism and to review the framework within which it operates. But capitalism must still be capitalism. It is highly imperfect. Yet so are we. It is still a uniquely flexible, responsive and innovative economic system. It may be “in crisis” right now. But it is still among humanity’s most brilliant inventions. It is the basis for the prosperity that so many now enjoy and far more aspire to. It is transforming the lives of billions of people. Let us strive to make it better. ------www.ft.com/intl/cms/s/0/1c76d726-4687-11e1-89a8-00144feabdc0.html#axzz1oAzUJ3aV

FT January 25, 2012 7:47 pm Meddle with the market at your peril By Alan Greenspan, The writer is former chairman of the US Federal Reserve

Controlled experiments are not feasible in economics. But we came close in the competition between East and West Germany after the second world war. Both countries started with the same culture, the same language, the same history and the same value systems. Then for 40 years they competed on opposite sides of a line. The only major difference was their political and economic systems: central planning vs market capitalism. The experiment came to an abrupt close in 1989 with the fall of the Berlin Wall, exposing the economic ruin of decades of Soviet-bloc economics. Centrally planned East Germany had exhibited productivity levels little better than one-third those of market-oriented West Germany. Much of the then third world, absorbing the tutorial, converted quietly to market capitalism. China, especially, replicated the successful export-orientated economic model of the so- called Asian tigers: fairly well-educated, low-cost workforces, joined with developed-world technology. Functioning in newly opened competitive markets, China and much of the developing world unleashed explosive economic growth. Between 2000 and 2007 the growth rate of real gross domestic product in the developing world was almost double that of the developed world. The International Monetary Fund estimated that in 2005 more than 800m members of the world’s labour force were engaged in export-orientated and therefore competitive markets, an increase of 500m since the fall of the Wall. Additional millions became subject to domestic competitive forces, especially in the former Soviet Union. 40 Capitalism, since it was spawned in the Enlightenment, has achieved one success after another. Standards and quality of living, following millennia of near stagnation, have risen at an unprecedented rate over large parts of the globe. Poverty has been dramatically reduced and life expectancy has more than doubled. The rise in material well-being – a tenfold increase in global real per capita income over two centuries – has enabled the earth to support a sixfold increase in population. While central planning may no longer be a credible form of economic organisation, the intellectual battle for its rival – free-market capitalism – is far from won. At issue, the dynamic that defines capitalism, that of unforgiving market competition, clashes with the inbred human desire for stability and, for some, civility. A prominent European politician several years ago best expressed the widely held anti-capitalist ethos when he asked: “What is the market? It is the law of the jungle, the law of nature. And what is civilisation? It is the struggle against nature.” While acknowledging the ability of competition to promote growth, many such observers nonetheless remain concerned that economic actors, to achieve that growth, are required to behave in a manner governed by the law of the jungle. These observers accordingly choose lesser growth for more civility. But is there a simple trade-off between civil conduct, as defined by those who find raw competitive behaviour deplorable, and the material life most people nonetheless seek? From a longer-term perspective, does such a trade-off exist? During the past century, for example, competitive-market-driven economic growth created resources far in excess of those required to maintain subsistence. That surplus, even in the most aggressively competitive economies such as America’s, has been mainly employed to improve the quality of life: advances in health, greater longevity and pension systems that go with it, a universal system of education and vastly improved conditions of work. We have used much of the substantial increases in wealth generated by our market-driven economies to purchase what most would view as greater civility. Anti-capitalist virulence appears strongest from those who confuse “crony capitalism” with free markets. Crony capitalism abounds when government leaders, usually in exchange for political support, routinely bestow favours on private-sector individuals or businesses. That is not capitalism. It is called corruption. The often-assailed greed and avarice associated with capitalism are in fact characteristics of human nature, not of market capitalism, and affect all economic regimes. The legitimate concern of increasing inequality of incomes reflects globalisation and innovation, not capitalism. But an additional contributor to inequality in America is our immigration law, which “protects” many high earners from skilled migrant competitors. The American H1B programme is in effect a subsidy for the wealthy, a policy that is anathema to the supporters of capitalism.

41 Whatever the imperfections of free-market capitalism, no regime that has been tried as a replacement, from Fabian socialism to Soviet-style communism, has succeeded in meeting the needs of its people. Capitalist practice needs adjustment. I was particularly distressed by the extent to which bankers, previously pillars of capitalist prudence, had allowed their equity buffers to dwindle dangerously as the financial crisis approached. Regulatory capital needs to be increased. Yet I fear that, in response to the crisis, innumerable “improvements” to the capitalist model will be enacted. I am very doubtful those “improvements”, in retrospect, will appear to have been wise. ------/www.ft.com/intl/cms/s/0/89d242b0-4687-11e1-89a8-00144feabdc0.html#axzz1oAzUJ3aV

Ft January 25, 2012 7:47 pm How Hayek helped us to find capitalism’s flaws By Occupy London, The writers, David Dewhurst, Peter Dombi and Naomi Colvin, are members of the economics working group at Occupy London

Fans of Friedrich von Hayek may be surprised to learn that the Austrian economist is the talk of Occupy London. Hayek’s observation that distributed intelligence in a voluntary co- operative is a hallmark of real economy rings true beneath the bells of St Paul’s. Occupy is often criticised for not having a single message but that misses the point: we are committed to incorporating different preferences before coming up with policies. In this sense, it could be said we work more like a market than the corporate boardroom or lobbyist-loaded politics – our ideas are radical but also just and democratically decided. Occupy London is now over three months old. Our encampments have lasted much longer than those at Zuccotti Park in New York, but there is a clear continuity of thought between us and Occupy Wall Street, as there is with Spanish indignados and the other grassroots movements that spread throughout 2011. The world faces an economic crisis and problems in our political system have prevented it from being tackled in ways that protect the interests of the majority of its population. Across the developed world, higher levels of inequality are associated with social ills such as crime and mental illness. Ultimately, we believe that all of us fare better when wealth and income are more equal. We reject austerity as a route to economic recovery and call for genuinely transparent and effective regulation of the banking system so that its structural problems can be tackled once and for all. This month we’ve had figures from across the political spectrum attest to the positive contribution Occupy London is making to the national discussion. Yet still we are accused of 42 lacking substance. In fact, we can point to specific breaches of the social contract and how to fix them. Here are three examples. First, tax avoidance is endemic in the UK. Companies use complicated structures to hide their earnings from HM Revenue & Customs. Individuals stash money abroad while enjoying all the benefits of living in this country. Tax havens are used by 98 of the FTSE 100 companies, according to Action Aid. Sir Philip Green was reported to have avoided about £285m in tax and still he became a government adviser. In calling for Jersey, Guernsey and the Isle of Man to disclose those with financial affairs on the islands, Ed Miliband, the Labour party leader, is moving towards our position. Adopting a system of “formulary apportionment” could stop corporations avoiding tax. It would create a tax base for UK companies aligned with a level of activity that actually occurs in this country rather than relative tax advantages. If applied alongside a system of unitary taxation, whereby all a company’s subsidiaries are added together to produce a single whole, we could prevent companies shifting profits between different countries. Second, housing is increasingly unaffordable and the social costs of homelessness are enormous. The Bank of England should use quantitative easing, not to buy gilts in the forlorn hope it will stimulate the economy but to fund housebuilding. This could serve the triple purpose of easing the housing problem, boosting construction and raising confidence in the economy. Third, income inequality in the UK is growing faster than in any other rich country, according to the Organisation for Economic Co-operation and Development. Unfairness at the top was highlighted this week by the business secretary Vince Cable’s proposals on executive pay. While we welcome the government’s focus on this issue, these proposals will not work. The metrics by which bonuses are calculated must be changed, not just in banking but across the corporate sector. As Andrew Haldane of the Bank of England has pointed out, if bankers’ pay were linked to return on assets it would be much closer to median household incomes than if based on return on equity. We are also looking at the feasibility of directly linking executive pay with average or minimum wages in the company, or even in the country as a whole. A substantial critique of government policy will become an ever more important task for Occupy London as the political debate moves in our direction. Our movement started in a group of tents in St Paul’s churchyard, but it will not end there – the issues that brought us together are still far from resolved. This year we will show that we cannot only pose questions but also have them answered. ------

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FT January 27, 2012 7:34 pm It’s a crisis of confidence, not of capitalism By George Osborne The writer is UK chancellor of the exchequer

There have been many parallels drawn recently between the current economic situation and the 1930s. It is easy to see how the collapse of over-leveraged financial markets and the painful recovery from a balance-sheet recession lends itself to comparisons. But are we witnessing a crisis of capitalism or a crisis of confidence in the ability of western democracies to offer decisive leadership and rising living standards to their populations? I think it is the latter. In a much more extreme form, of course, this contributed to the most dangerous development of the 1930s. In the west we have to confront this self- doubt before it takes root. Travel east and no one is talking of “capitalism in crisis”. The spread of free enterprise in Asia over the past 30 years has lifted hundreds of millions of people out of grinding poverty. The challenge for these countries is not stagnant incomes, but meeting the growing political aspirations that prosperity brings. In the west there is no shortage of political expression. Indeed, when the Occupy movement starts penning articles in the Financial Times quoting Hayek, you could say that political expression has reached surreal new levels. The problem facing western democracies is doubt about the ability of government to deliver rising living standards: the promise that our children’s world will be better than our own. My argument is that the way to address this doubt is not to run away from capitalism but to run towards it. Let us look at how this crisis of confidence manifests itself. First, there is the widely felt anger at the rising incomes of a wealthy few when the incomes of the majority have fallen. This is potent when rewards accrue to those participating in the very industry, financial services, that contributed to the crisis. I always thought it was incredibly short-sighted, even stupid, of banks to pay bonuses in 2009 when taxpayers had only months earlier spent vast sums bailing them out and propping up the whole system. It was reward for failure, which undermined a central premise of free markets. What we need now is a greater application of free-market principles, not cosy protection for vested interests. Britain’s reforms to ringfence retail banks are designed so banks that fail go bust, without holding the taxpayer to ransom. Second, people are starting to doubt the ability of western democracies to secure for the majority of their populations the rewards of globalisation. The answer from governments has been to construct ever larger welfare systems to redistribute income. Few deny some 44 redistribution is desirable. But surely we know by now that it will not address the long-term decline in the relative living standards of the majority. Unreformed welfare systems have not only become unaffordable in an age of large deficits but they have become increasingly difficult to defend when they have trapped millions in dependency and joblessness. Some on the left, forced to give up on tax and spend, now want to legislate and regulate for outcomes that markets are not delivering. This may seem like a free lunch but we know from painful experience that trying to control prices and wages in a market economy is a recipe for unemployment and economic decline. Instead of trying to compensate people for lack of opportunity, we should devote our precious resources to increasing those opportunities and giving people a stake in the global economy. Our populations will be the losers from globalisation if they lack the human capital, good schools, world-class universities and investment in research and development that would enable them to charge more for their labour. Finally, we must confront the fears that western political systems are not able to take decisive steps to deal with problems and think long-term. Paralysis in the US Congress and slow progress in the eurozone have not helped. We in the UK have our own problems but we have not fought shy of taking bold decisions, and I believe these decisions have inspired confidence in our ability to act. We need further bold decisions in the UK on controversial issues such as airport capacity, regulation and nuclear energy if we are to stay competitive. And the west as a whole needs to take bold steps to support enterprise if we are to bring greater prosperity. A global free-trade deal is an economic no-brainer but everyone says the politics are too difficult. However, the politics of declining incomes are even worse, so in Europe let’s have the courage to deepen our single market and strike trade agreements with the likes of India, Japan and Singapore. Let’s have the confidence to open up our infrastructure to investment from sovereign wealth funds and not use national security as an excuse for protectionism. Let’s have the self-belief to open our economies to competition, not hide behind the crypto- protectionist language of reciprocity. Let’s work to strengthen institutions such as the World Trade Organisation and the IMF, to show global markets are governed by global rules. What we are witnessing in the west is a crisis of confidence, not a crisis of capitalism. The open society has always had enemies. The fortunes of our populations will be favoured if we confront them. ------

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FT January 29, 2012 7:50 pm Knowledge lies at the heart of western capitalism By Hernando de Soto The writer is author of ‘The Mystery of Capital’ and ‘The Other Path’

The world economy is made up of many tiny parts that are useful only when we combine them into more complex wholes. The higher the value of these aggregations, the more economic growth. Humanity’s achievements – from the 120 ingredients of my clock to the countless financial deals and developments that produced the internet and flight navigation systems – all result from joining people and things to each other. That’s why western capitalism has triumphed for the past 150 years: it gave us the best knowledge to explore economic combinations. Capitalism does not need to be re-thought or re-invented; it simply has to be re-discovered. The reason credit and capital have contracted for the past five years in the US and Europe is that the knowledge required to identify and join parts profitably has been unwittingly destroyed. The connections between mortgage loans and liquid securities, between non- performing financial derivatives and the organisations that hold them; the non-standardised, scattered records that obscure who holds risks; and the off-balance-sheet accounting that obscures many companies’ health: these all make it harder to trust and hence combine. Until this knowledge system is repaired, neither US nor European capitalism will recover. Reformers and policymakers must recognise that they are not dealing with a financial crisis but with a knowledge crisis. Capitalism lives in two worlds: there is a visible one of palm trees and Panamanian ships, but it is the other – made up of the property information cocooned in laws and records – that allows us to organise and understand fragments of reality and join them creatively. The world of organised knowledge and joining began in earnest in the mid-19th century, when reformers in Europe and the US concluded that the segmented, undirected knowledge left by the old regimes could not cure the recessions that beset early capitalism. They faced what was known as “the knowledge problem”, the inability to select and store dispersed information about economic things. Those reformers created “property memory systems” to map – in rule-bound, certified and publicly accessible registries, titles and accounts – all the relevant knowledge available on assets, whether intangible (stocks, patents, promissory notes) or tangible (land, buildings, machines). Knowing who owned – and owed – what and where, and fixing that information in public records, made it possible for investors to locate suppliers, infer value, take risks and 46 combine such simple things – to borrow a famous example – as graphite from Sri Lanka and wood from Oregon into pencils. Reformers also helped to solve “the binding problem,” finding the information needed for parts to fit together. This metaphysical concern affected all disciplines: physiologists discovered that what binds cells to form an organ performing specific, sophisticated functions is a nucleic acid now called DNA. The logic behind the property documentation is the DNA of capitalism. Modern recording systems evolved from data warehouses certifying isolated assets, into factories of facts for facilitating the knowledge entrepreneurs need to combine assets, skills, technologies and finance into more complex and valuable products. Thus, real estate documentation no longer just says that Smith owns the house on the hill but also describes that house as the address at which mortgages can be foreclosed; debts, rates and taxes collected; deliveries made; and from which utilities services can be controlled and bills collected. This knowledge allowed western economies to grow more since the second world war than in the previous 2,000 years without big credit contractions. Until 2008, when we began to learn that memory systems had stopped telling the truth – through off-balance-sheet accounting; debts buried in footnotes or the ledgers of “special purpose entities”; financing raised by “bundling” mortgages into securities not recorded in traditional public registries; and nations masking debt as income by swapping it from one currency to another. No wonder institutions and investors have lost confidence in the system. The brilliance of western capitalism lies not in providing a formula for wealth creation but in its property memory systems, which are the result of examining, selecting and validating information about who owns land, labour, credit, capital and technology, how they are connected and how they can be profitably recombined. For the past 15 years, the records of western capitalism have been debased, leaving governments without the facts to spot what needs to be fixed and for businesses to know where their risks are. To regain its vitality, western capitalism must bring under the rule of law and public memory hundreds of trillions of dollars now swirling mindlessly out of control in the obscure world of financial innovation. That task requires major political leadership. ------

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FT February 1, 2012 7:36 pm Our ignorance will yield more crises in capitalism By Kenneth Rogoff

Over the past three weeks, contributors to these pages have engaged in a vigorous debate on the merits of contemporary capitalism. Entrepreneurs who have earned billions, world leaders who have spent trillions, journalists, academics, and even “Occupiers” have all weighed in. A few clear themes have emerged, highlighting points of agreement and controversy. Virtually everyone defends the market system, albeit some with more unvarnished enthusiasm than others. Failures in financial regulation, environmental and consumer protection, and particularly in regulating income distribution, are all emphasised. Bill Clinton, former US President rightly argues that markets can be made to work better for charity as well as production. Economist Jeffrey Sachs points to addictive consumer behaviour as a central flaw in today’s growth dynamic, a point with which I strongly agree. Occupy London argues that regardless of overall income level, higher levels of inequality breed social ills, a very plausible conjecture. But no one is seriously arguing against markets; only for regulating them more effectively and more fairly. The general enthusiasm for economic markets does not extend to political markets. It is striking that both George Osborne, UK chancellor, and Ed Miliband, leader of the Labour party, highlight short-termism in politics as a key flaw. Although the two politicians highlight problems in financial policies, their arguments could well be extended to a host of other areas, ranging from global warming to world food production. The purchase of influence is hardly unique to the financial industry. Nor is the problem of excessive political influence by business unique to developed countries. Perhaps China’s greatest challenge in the decades ahead will be to shift away from an investment and export-driven development model to a world in which domestic consumers adjudicate the competition between China’s producers. As China grows it must shift to a domestic-demand driven model where it will be much harder to resist internal political pressures to interfere with competition. The idea that Chinese capitalism, which is evolving and transitional, provides a blueprint for the rest of the world, is an absurd exaggeration. Creating impressive infrastructure eventually runs into diminishing returns, as evidenced by the history of Japan and the Soviet Union. As Martin Wolf points out, contemporary capitalism, which does such an extraordinary job of generating a cornucopia of private goods, is far less effective at generating public 48 goods, whether it be education, infrastructure, environment or financial stability. Improving political markets – and as a corollary, regulation – is a central challenge facing all countries in the world, not just those in the west. Europe, along with countries such as Canada, has arguably done a better job balancing public and private goods than either the US or China. Governments at least pay some attention to pollution. For the moment, Europe still has a reasonably strong social safety net. Mass transit systems work, at least when the employees are not on strike. Indeed, many countries around the world look to the Nordic model, which at least according to a variety of surveys produces some of the highest happiness levels in the world. In Europe, of course, the big challenge is dealing with overly generous pension schemes and insufficiently flexible labour markets in the face of the rapid changes emanating from globalisation. How to strike a balance? One absolutely essential prerequisite is emphasised in Adam Smith’s letter to the Financial Times (as imagined by David Rubenstein): educate, educate, educate. It is really hard to see another way out of the growing sustainability problems that capitalism has given us. Mr Rubenstein focuses on the inadequacies of primary and secondary education, as well as the need to re-educate and retrain adults. I would take the point much further: Societies need to find ways to make adult education, including economic and financial literacy, far more available and far more compelling. If voters are uninformed and easily swayed towards demagogues peddling short-term ill- considered policies, there is little hope for righting the course of capitalist economies. The idea that the masses are indifferent to education, and that any broader notion of literacy beyond the three R’s (reading, writing and arithmetic) is a hopeless cause, is nonsense. As someone who has spoken to all kinds of people in the wake of the financial crisis, my sense is that most citizens are starved of information, and would consume it hungrily if offered in a palatable form. One must admit that followers of the recent political debate in the United States might feel justified in being supremely cynical. But perhaps today’s errant political dialogue is only a symptom of a profound deeper failure of modern societies to pay attention to ongoing adult education and literacy. Without major changes, including attractive web learning platforms, expanded public radio and television, and greater educational choice for children, it is hard to see a long-term cure for contemporary capitalism’s many political problems. Improved education alone will not resolve the flaws inherent in today’s capitalism, but it is an essential first step down any path to a solution. ------

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