Saving Capitalism from the Capitalists

Title: Saving Capitalism from the Capitalists – Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity

Author: Raghuram G. Rajan and Luigi Zingales

Publisher: Collins Business, 2014 (First published 2003)

ISBN: 9789351361756

Pages: 378

 

Capitalism and communism are the two extremities in between which national economies strive for progress. To argue that there is no ideal form of any one system is probably cliché. But that is a fact which keeps the financial systems securely on the middle ground with variations in the proximity to any of the two ends. Capitalism, or free market system, is the most cost-effective way to organize production and distribution that human beings have found till date. Healthy and competitive financial markets are essential or else economies would ossify and decline. When competition slackens occasionally, the incumbent market leaders prefer to stay in power and feel threatened by renewed competition from new entrants from either within the country or overseas. Even though democracy is, by definition rule by majority, that majority is often quite defused and unsure of what their interests are. This makes a well-heeled, focused body of opinion very powerful in engendering legislation that further stifle free competition in the market. In such instances, the society has to intervene in reining in the government from overstepping its mandate of providing a level playing field for all players and trying to erect hurdles against new rivals of the existing participants. This book seeks to create awareness in the society to monitor the descent to market oligarchy and intervene as part of well-informed public opinion to check the unbridled power of incumbents. In other words, this book points to a way through the society can save capitalism from the capitalists. Raghuram G. Rajan was the former Governor of the Reserve Bank of India and a former professor of finance at the University of Chicago’s Booth School of Business. Luigi Zingales teaches entrepreneurship and finance at the same institution. The book was first published in 2003.

 

Not all capitalist countries possess the same type and genre of capitalism. The level of freedom and competition in the financial markets also vary. History has a major role to play in the wide diversity we see at present. For free competitive markets to develop, first of all, the government has to respect and guarantee the property rights of even the weakest citizen. The authors then make a historical comparison of Britain and other countries to establish how this came about. The historical narrative is delightfully simplified, but at the same time, is too simplistic. Moreover, the preconditions for the way it progressed negate any chances of its duplication in any other country on account of their specificity to the situations prevailing in the original country. Finance in an undeveloped system tends to be chubby, uncompetitive and conservative.

 

On several occasions the authors make a clear elucidation of what they mean by markets. It does include the place of exchange for products and services which are also affected by increased competition by domestic and foreign participants. Rajan and Zingler however assert the primacy of financial or capital markets in determining growth. This particular market controls the flow of capital in a society and decides who gets what and how much. It is the just and proper allocation of resources that helps a financial system to flourish by maximizing employment and production of goods and services. It needs to be competitive as well as innovative to remain relevant under fast changing conditions. Exotic forms of economic activities are to be devised routinely. The book describes a peculiar innovation developed in the US to broaden access of the public to finance. Most terminally ill AIDS patients had valid life insurance policies, but that provided no succor to them while they were alive. When they died, their heirs pocketed the insured amount. Some companies devised a clever instrument called viatical for those patients whose chances of recovery were very slim. It linked the life insurance policy of the patient and paid him for basic comforts in the last days, but staked a claim with a profit margin on the amount payable when he actually died. The scheme looks macabre as the company stands to gain only if the client died. Naturally, the company looked for the most critically ill to have any chance of recouping its investment! Such are the ways in which financial enterprises innovate.

 

The authors then make an observation that the first enemies of free market competition are not any external agents but the incumbents themselves who had long become accustomed with the way things are ‘managed’ in business. At first, they group together to prevent the entry of fresh players. India’s much famed liberalisation drive in the 1990s is a case in point. Decades of protectionism, crony capitalism, and misdirected populism had sapped the vitality of the Indian economic system that its foreign reserves were almost totally wiped out and creditors were prepared to lend further only if the nation’s gold reserves were pledged as collateral and physically moved to the vaults of the Bank of England in London. There was near unanimous consensus that the nation urgently needed reforms and should open up its markets for free competition. Still, a group of industry majors formed an informal platform called the ‘Bombay Club’ to oppose the initiative. Prominent among them was Bajaj who was enjoying a very high market share for his products. Capitalism is to be saved from the clutches of this type of capitalists, because they very well know that foreign competitors would make common cause with domestic entrants in making life difficult for domestic incumbents.

 

The book’s claim that the financial markets were not fully free even in developed countries till the 1980s comes as a surprise to many. However, they carefully arrange all the pieces in the puzzle in order. This was because the markets that went down in the Great Depression of 1929 recovered completely only after half a century! The great crash of 1929 shook the Western Civilization to its core. Stock market crash, bank runs and huge surge in unemployment became common. At the same time, economy in communist Russia appeared to be making great strides. Or so the communist propaganda machine made it look like. Revulsion of financial markets welled up among the public and strict government oversight was ensured by legislation. Then came the next big shock in the form of the Second World War. In the first two decades after the war, the system of managed competition (relationship capitalism) worked well in guaranteeing phenomenal rates of growth in a politically stable environment. This was aided by the Bretton Woods Agreement which imposed curbs on the cross-border capital flows. However, the oil shock of 1973 and events that followed it helped bring about the smooth capital flow across nations. This created the political and economic conditions for the resurgence of capital markets.

 

Each chapter in the book begins with an introduction and ends with a summary of the major ideas discussed in the chapter. It also sports a conclusion and an afterword that attempts to focus on the 2008 crash, but this effort is half-hearted. Rajan is remembered for predicting the crash, so the logic of the effort is clear. The remaining text belongs to the year 2003. In a sense, the book thus looks somewhat outdated. A review of capitalism and what to expect from it in future is very interestingly given. Capitalism is not fundamentally flawed. Its biggest enemies are not the firebrand trade-unionists spewing vitriol against it, but the executives in pin-striped suits who extol the virtues of competition with every breath while attempting to stifle it with every action. To ensure a healthy financial market it is essential to keep borders open to the flow of goods and capital. The country’s capitalists will then feel the impact of bad government policies and they will become a force for good, market-liberating reform.

 

Every page of the book rings out loud with the clear logic of the scholarly authors, but one obviously shortsighted observation stands out like a sore thumb. The book notes that there is such overcapacity in telecom bandwidth that if all the six billion people in the world talked continuously for a year, their words could be transmitted in a few hours. No doubt, the authors claim, that we will find new kinds of information to send along these wires and eventually much of this investment will be utilized (p.105). This was written in the early 2000s when data transmission was in its infancy. The authors couldn’t foresee the explosion in data exchange that occurred within a few years. Anyhow, the remark on education reform is novel yet very prescient. They say that “a system of formal education that terminates when one is 25 probably leaves one with too much information relative to what one needs for the first few years of one’s career and too little knowledge for the half century that follows. Would it not make more sense to cut back a little early on and have more formal doses of reeducation later on so that individuals can cope with changes in environment and preferences?” (p.304)

 

The book is recommended.

Rating: 3 Star