Books and Arts; Book Review;Rehabilitating capitalism

The financial crisis has led some people to question the viability of America’s economic system. Socialism’s appeal has faded in Russia and China, and to a degree in other countries that once were its champions, such as India and Cuba. But American-style capitalism has not had an easy time of it either. Crashing financial markets, bank bail-outs and high unemployment have all added to a growing sense of unease about a system that is based on private ownership of resources.

“Why Capitalism?” by Allan Meltzer, a professor of economics at Carnegie Mellon University in Pittsburgh, is an extended response to some of the calls he has received in recent years. The most thought-provoking came from a woman in Germany who, after reading the New York Times, wondered if, only two decades after the fall of the Berlin Wall, she was actually witnessing the implosion of the system that brought it down.

Capitalism’s core defence, Mr Meltzer argues, is that it is the only system that leads to freedom and economic growth. It is less good at ensuring virtue or stability; failure is an inherent part. Indeed the author’s observation that “capitalism without failure is like religion without sin. It doesn’t work well,” has already been widely circulated. However, the sins attributed to capitalism—corruption, fraud and greed, to name but three—are not only pervasive in systems where the state controls production, but far more damaging and far less likely to be rectified.

The main problem, he argues, is that even nominally capitalist systems have, for better and worse, elements of state control. These often begin with defence and the police, and go on to national transport systems, which leads, in America’s case, to an ever-expanding network of bureaus and agencies. Much of bureaucracy is adopted under the rationale of enhancing “fairness”. But, as Mr Meltzer notes, fairness often means providing present benefits using debt that must be repaid by taxpayers in the future (which is hardly fair) or through regulations and subsidies created by people in government who then go on to exploit them in private-sector jobs (which is also unfair).

It is this last issue that forms the heart of “A Capitalism for the People” by Luigi Zingales, a professor at the University of Chicago’s Booth School of Business. Mr Zingales has written an elegy to the America he found when he moved there 24 years ago from an Italy that was rife with nepotism. Italian businesses preferred to stay small and discreet. Growing bigger made them vulnerable to scrutiny and would require them to hire people on the basis of talent rather than loyalty; and loyalty was important because it, once again, helped protect the firm from scrutiny.

Arriving in America, Mr Zingales found an enthusiasm for capitalism. Americans believed that it was possible to become rich and that increasing wealth benefited the poor as well as the not so poor. They regarded their capitalist system as fair—or at least fair enough. All of those sentiments, says Mr Zingales, have been eroded.

Much of the change is a direct result of the vast expansion of the state through complex subsidies and anti-competitive regulations that invite the sort of cronyism that Mr Meltzer cites as well. When government favours the private sector, Mr Zingales argues, it is all too often by being “pro-business” rather than “pro-market”, meaning that favourable conditions are provided to particular institutions rather than to institutions broadly. This distorts the system, resulting in precisely the problem of select companies making profits while imposing costs on society that Mr Meltzer argues is at the core of what regulation should be designed to prevent.

Mr Zingales makes three proposals. Protected sectors, notably education and health care, should be opened up to competition. Tax policy should be changed in two ways. First, it should be used to make subsidies and their costs more transparent. The deduction on mortgages, for example, should be termed a tax on renting; the lavish benefits provided for ethanol production should be regarded as a tax on petrol. Secondly it should be used as a substitute for complicated regulation and applied against areas that cost society, such as pollution and (because it creates instability) the use of short-term debt by banks.

More broadly, Mr Zingales wants a closer, explicit, tie between capitalism and morality. He wants to extend the public shaming of corporate crooks to people who take actions that are legal, but damaging to society, such as borrowers who walk away from mortgages merely because their value exceeds the value of the underlying property. Business schools, Mr Zingales says, are ideally positioned to point out when an action that provides a benefit for an individual comes at a cost to society, but in reality they rarely bother. This, he believes, is part of the same malaise that has befallen the political debate on capitalism, which has been taken over by special interests and people who have no faith in a real market-based system. For all America’s success, he warns, Washington is on a trajectory that leads to Rome.