Have we lost faith in the market economy? Much turns on the answer to this question. Relatively free, open and competitive markets have been the driving force behind technological advances and improved living standards, making the U.S. the most prosperous nation in the world. But the recent financial crisis, deep recession, excessive risk taking and bloated executive pay have caused some to reconsider their longstanding confidence in the market system (democratic capitalism).
While this loss of trust is understandable, it may be misdirected, or so thinks Luigi Zingales, writing in the new journal National Affairs. According to Zingales, we should support “pro-market” policies that improve the functioning and fairness of the market. At the same time, we should oppose “pro-business” policies that serve special interests, restrict competition and impose huge costs on taxpayers. Such polices are opposed to the common good and are rightly seen as unfair.
The distinction between pro-market and pro-business policies has a long and venerable history, reaching back to Adam Smith, the “father” of economics. Smith wanted to tear down the mercantilist system—a system of laws and regulations that were “pro-business,” but that benefited only a privileged few—and replace it with a system of free and open markets that would redound to the benefit of all. He favoured the elimination of pro-business policies, such as trade restrictions that limited the scope of the market and government grants of monopoly power to businesses, which insulated them from competition. A competitive marketplace, on the other hand, was essential for channeling the self-interested behavior of businessmen toward serving the public good. For Smith, self-interest was a fact to be recognized, though not something to be promoted. It was Smith’s belief in the primacy of self-interest as the primary economic motivator that led him to a general distrust of the leaders of big business.
Consider these words from Smith’s Wealth of Nations: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” The businessmen of his day, Smith thought, were constantly seeking to gain some advantage over consumers by manipulating the market. Such behavior could only be restrained in a system of free and open competition.
Smith argued that business leaders, especially big business leaders, are likely to promote public policies that serve their own interests, often at the expense of the common good. Their interests include breaking down barriers to expansion and growth and the adoption of business friendly regulations. Again quoting Smith: “The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.”
This is not to suggest that all policies endorsed by big business should be rejected outright, but should be treated with suspicion and subjected to close scrutiny. We would do well today to take Smith’s distrust of businessmen and their motives to heart. Unfortunately many of our government leaders seem to be moving us in the opposite direction, toward a broader and closer alliance between big business and big government.
Historically, the people of the United States have remained largely pro-market, even as certain business practices were sharply condemned. Even in the depths of the Great Depression there was no strong outpouring of support for socialism. Zingales argues that this is a direct result of the common perception that the market system is fair: it rewards hard work and innovation, not special deals with the government. This makes the U.S. a rare exception to the practice of “crony capitalism” or “corporatism” as practiced in much of Europe and the rest of the world.
Zingales believes that the public’s perception of fairness, and thus its support for the market system, may be waning. He points to the increasing number of executives from the world of big finance that are filling high-level government posts—including Secretary of the Treasury—in both Democratic and Republican administrations. This trend is reinforced by the massive bailouts of large financial firms and General Motors, all considered “too big to fail,” while smaller businesses are left to fend for themselves. Then there is the push for the federal government to “reform” (or, as some would say, “take over”) the health care system, which amounts to 17% of U.S. GDP, leading to a new alliance between big health care providers and the government.
Small wonder that more and more Americans have come to believe that their economic system is unfair. Hard work and playing by the rules are no longer seen as the surest path to economic success. Instead, success in the market economy is viewed increasingly as the product of who you know and what sort of special favours you might have obtained through government connections. Big businesses increasingly engage in what economists call “rent seeking behavior.” Instead of investing in the development of new technologies or products, businesses find it more profitable to invest in lobbying the government for special favours, or what is sometimes referred to as “corporate welfare.” This behavior further erodes public confidence in the economic system.
Zingales sees dire consequences in these trends: “When people are angry to the point of threatening the lives of bankers; when the majority of Americans are demanding government intervention not only to regulate the financial industry but to control the way companies are run; when voters lose confidence in the economic system because they perceive it as fundamentally corrupt—then the sanctity of private property becomes threatened as well. And when property rights are not protected, the survival of an effective financial sector, and with it a thriving economy, is in doubt.”
What is to be done? Restoring perceptions of fairness will require replacing pro-business policies with pro-market policies. This means doing away with the idea that some businesses are too big to fail. It also means regulating financial markets by introducing new consumer protection, curbing excessive risk taking and making complex financial transactions more transparent. Most importantly, the public should press elected officials to reject the pleadings of big business for special favours, even if it is not in their personal interest to do so. But, perhaps this is too much to ask.