By Leszek Balcerowicz

Only the rulers of Cuba, Venezuela, Iran and some ideologues in the west condemn capitalism. Empirically minded people know that there is no good alternative. However, capitalism takes many forms and evolves over time. The questions to ask, then, are “What capitalism?” and “Does the present crisis shed new light on this issue?”

The popular condemnations of “greed” in response to the crisis seem to me superficial. Economists are expected to explain human behaviour in terms of situational factors and not to compete with preachers and politicians. Equally unconvincing is the speculation about what John Maynard Keynes would be saying were he alive.

As a preliminary step to a more productive analysis, let us recall that not long ago Japan Inc, the Rhineland model and other statist or corporatist varieties of capitalism were praised as a better alternative to the more market-oriented Anglo-Saxon variant of this system. Since then, based on solid empirical research, there has been a wave of deregulation of the product and labour markets, and the European Union has set itself the ambitious goals of the Lisbon Agenda.

Faced with high structural unemployment, fiscal pressures and ageing societies, many western economies have started to reform their over-extended welfare states. China and India have accelerated their growth thanks to a reduction in the political control of their economies. Central and eastern European countries show that the more market reforms you accumulate, the faster is your longer-term growth. These and other initiatives have reduced the crippling statist bias and extended the role of markets and civil society. The present crisis means we must take further measures to release entrepreneurial capitalism, offsetting declines in gross domestic product caused by the financial crisis and the legacy of attempts to manage it, especially the hugely increased public debt.

But is the financial sector an exception? Can the crisis be interpreted as a pure market failure, which requires more public intervention? It is easy to agree on the facts – increased leverage and asset bubbles in many economies, as well as serious errors made at the top of huge financial conglomerates. Symptoms, however, should not be confused with causes, and it is with respect to the causes that there is serious disagreement.

The argument that we have witnessed a pure market failure fails the most elementary tests. Financial institutions and markets operate within the macroeconomic, regulatory and political framework created and maintained by public bodies, and it is empirically not difficult to point to the serious deficiencies of this framework that contributed to the present crisis.

There is scope for further analysis of the relative contributions of the US Federal Reserve’s easy monetary policy in the early 2000s and the “savings glut” in some emerging economies. With a more restrictive Fed policy (and with more disciplined fiscal policy under George W. Bush, the former US president), there would have been initially slower growth but less increase in the savings glut later, a smaller build-up of financial imbalances and, as a result, less disruption to growth.

Excess liquidity encouraged the spread of powerful short-term incentives in the financial institutions. Fannie Mae and Freddie Mac were largely the tools of political intervention in the US housing market. Some financial regulations might have accelerated the spread of the originate-to-distribute model, which is blamed for amplifying leverage and obscured the allocation of risks. Those EU economies that developed the most extreme housing bubbles – Britain, Ireland, Spain – stimulated demand for housing with tax breaks.

Analytically based lessons from the present crisis should focus on revisions of the macroeconomic and regulatory frameworks for financial markets that would reduce the risks of dangerous booms and the resulting busts. Policies that contribute to the emergence and growth of huge financial conglomerates – which, once in crisis, endanger the financial stability of whole countries – should be identified and eliminated.

These proposals have nothing to do with grandiose schemes for reinventing market capitalism. However, every crisis produces a shock to mass beliefs and thus may have policy consequences. In a democracy, the impact of economic crises is mediated by competing interpretations provided by intellectuals and politicians, and conveyed by the media. There is a risk that empirically dubious but emotionally attractive interpretations, which condemn markets and call for more statism, could gain ground. This would damage longer-term growth in the affected countries and could have serious geopolitical consequences if major western economies, especially the US, already burdened by the legacy of the crisis, were to succumb while China continued its reforms.

Mises, Hayek, Schumpeter, Nozick and other thinkers have noted that under democratic capitalism there are always influential intellectuals who condemn capitalism and call for the state to restrain the markets. Such an activity bears no risk and may be very rewarding. (This contrasts strongly with the consequences of criticising socialism while living under socialism.)

Dynamic, entrepreneurial capitalism has nowadays no serious external enemies; it can only be weakened from within. This should be regarded as a call to action – for those who believe that individuals’ prosperity and dignity are best ensured under limited government.

The writer, a former Polish deputy prime minister and governor of the National Bank of Poland, is a professor at the Warsaw School of Economics.

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By Edmund Phelps

Ingram Pinn illustration









In countries operating a largely capitalist system, there does not appear to be a wide understanding among its actors and overseers of either its advantages or its hazards. Ignorance of what it can contribute has in the past led some countries to throw out the system or clip its wings. Ignor­ance of the hazards has made imprudence in markets and policy neglect all the more likely. Regaining a well-functioning capitalism will require re-education and deep reform.

Capitalism is not the “free market” or laisser faire– a system of zero government “plus the constable”. Capitalist systems function less well without state protection of investors, lenders and companies against monopoly, deception and fraud. These systems may lack the requisite political support and cause social stresses without subsidies to stimulate inclusion of the less advantaged in society’s formal business economy. Last, a huge social insurance system, with resulting high taxes, low take-home pay and low wealth, may not hurt capitalism.

In essence, capitalist systems are a mechanism by which economies may generate growth in knowledge – with much uncertainty in the process, owing to the incompleteness of knowledge. Growth in knowledge leads to income growth and job satisfaction; uncertainty makes the economy prone to sudden swings – all phenomena noted by Marx in 1848. Understanding was slow to come, though.

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By Sir Martin Sorrell









Every era of financial or irrational exuberance ends with the shutters coming down. Tulip mania, the South Sea bubble, the panic of 1825 and the first internet bust were all part of the same ebb and flow. We should not expect it to be different now, but that does not make it any easier to accept the cyclical nature of economies.

In good times, collective human psychology and self-reinforcing experience convince us that we are living in a new era, where the old oscillations of boom and bust have been banished. Then comes catastrophe and bankruptcy, and a fresh consensus emerges from the debris of the last great party. That new orthodoxy says that Anglo-Saxon liberal market economics is dead and globalisation discredited. Even capitalism itself, it seems, is on life support under the watchful eye of the prison hospital staff. The former giants of finance are pariahs. Right now it would probably be more acceptable to confess at a dinner party to having stolen Christmas presents, than admit you dabble in investment banking.

This too shall pass and things will change. There will be a recovery of sorts, not this year but perhaps next – just by dint of the scale of fiscal stimulus in the US, UK and elsewhere and even by the atmosphere surrounding Gordon Brown’s seemingly triumphant Group of 20 nations summit.

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By Mario Monti

If the world economy is in crisis, the market economy is even more in crisis. It is seen as unfair, having generated unacceptable inequalities; and inefficient, having attracted massive resources into financial activities whose contribution to the economy is questioned. Yet the world needs an integrated market economy, a necessary, though not sufficient, condition for growth and welfare.

The Group of 20 countries has focused on recovery plans and financial regulation. But this is only a first step towards restoring the credibility of the market economy and taming economic nationalism, the seed of disintegration.

The key test for market economies, perhaps even for democracies, will be whether they master the growing in­equalities, including within countries, caused by ungoverned globalisation and aggravated by the crisis. This requires two developments: getting the best out of competing economic models; and firming up market integration by moderating tax competition. While the former has started, the latter is not even on the agenda.

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By Alan Greenspan

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Global economic policymakers are currently confronted with their most daunting challenge since the 1930s. There is considerable fear in the marketplace that the unprecedented set of stimulus programmes and efforts to recapitalise banks with sovereign credits will fall short of success. It is thus useful to contemplate alternatives to that distressing outcome.

Over the past two centuries, global capitalism has experienced similar crises and, up until now, has always recovered and proceeded to achieve ever higher levels of material prosperity. What would today’s world look like if, instead of the vast government policy efforts to stem the onset of crisis, we had allowed market mechanisms and automatic stabilisers, currently built into most of our economies, to function without any additional assistance? Counterfactual scenarios are highly problematic to say the least. But there are intriguing possibilities that offer comfort that, if all else fails, the global economy is not on a track towards years of stagnation or worse.

In one credible scenario, behind the unprecedented loss of wealth during the last year and a half, lie the seeds of recovery. Stock markets across the globe have to be close to a turning point. Even if a stock market recovery is quite modest, as I suspect it will be, the turnround may well have large (and positive) economic consequences.

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By Alan Greenspan

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The extraordinary risk-management discipline that developed out of the writings of the University of Chicago’s Harry Markowitz in the 1950s produced insights that won several Nobel prizes in economics. It was widely embraced not only by academia but also by a large majority of financial professionals and global regulators.

But in August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively monitoring their firms’ capital and risk positions. For generations, that premise appeared incontestable but, in the summer of 2007, it failed. It is clear that the levels of complexity to which market practitioners, at the height of their euphoria, carried risk-management techniques and risk-product design were too much for even the most sophisticated market players to handle prudently.

Even with the breakdown of self-regulation, the financial system would have held together had the second bulwark against crisis – our regulatory system – functioned effectively. But, under crisis pressure, it too failed. Only a year earlier, the Federal Deposit Insurance Corporation had noted that “more than 99 per cent of all insured institutions met or exceeded the requirements of the highest regulatory capital standards”. US banks are extensively regulated and, even though our largest 10 to 15 banking institutions have had permanently assigned on-site examiners to oversee daily operations, many of these banks still took on toxic assets that brought them to their knees. The UK’s heavily praised Financial Services Authority was unable to anticipate and prevent the bank run that threatened Northern Rock. The Basel Committee, representing regulatory authorities from the world’s major financial systems, promulgated a set of capital rules that failed to foresee the need that arose in August 2007 for large capital buffers.

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By Karl-Theodor zu Guttenberg

T he current financial and econ­omic crisis is apparently sweeping aside many established ideas of how societies should run their economies. In Germany, the crisis has ballooned into the worst recession in postwar history. By way of diagnosis, some say we are observing the end of the financial world as we know it. Not so long ago some had heralded the era of Alan Greenspan, former US Federal Reserve chairman, as the realisation of a new economic paradigm. By way of therapy, some have called for the renaissance of state-monopoly capitalism, sometimes labelled “new capitalism”. The crisis should have a cathartic impact on the financial sector but there is a risk that responses to it will overshoot.

We already have the conceptual approach we need to set up intelligent rules to which all market actors have to adhere and that will foster transparency, credibility and trust. We know how to pursue stability-orientated monetary policies. We need to revive a culture of stability and responsibility in business. Individual incentives should reward long-term success, prevent short-termist excesses and punish inordinate risk-taking. We know that sticking to rules on competition, state aid and trade shelters the long-term gains from competition and trade from short-term protectionist and interventionist reflexes. Our social systems should shield market participants from the consequences of market upheaval – but not at the expense of market flexibility. These principles are the leitmotifs of the social market economy model on which Germany’s economic rise after the second world war was built.

For both short-term crisis management and long-term decisions, it is imperative that policymakers, bankers, investors and voters understand clearly what went wrong with the world economy. Some elements of the build-up of the housing and financial bubbles have been clearly identified: loose monetary policy; the wrong kind of incentive in the housing markets; a lack of regulation of financial institutions, which allowed the creation of a shadow banking system; inadequate incentive and risk-management systems within banks; and a failure of rating agencies and of financial market supervision.

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By Kemal Dervis

We are talking about the end of the economic crisis while it deepens. Economic projections have had to be continuously revised downward. Yet a relatively quick economic recovery is possible, provided four things happen.

First, public authorities must restructure and rewrite balance sheets in the financial sector, when necessary by taking over banks, instead of waiting any longer. Second, public expenditure must replace faltering private demand to reverse the downward spiral before it becomes a rout. Third, this must be done with international co-operation so that the global current account imbalances that contributed to the crisis will diminish rather than increase. Fourth, there must be aid to the most vulnerable so that they will not be pushed into destructive despair.

Will politics allow all this to be accomplished in time to avoid a catastrophe? If so, growth may resume some time in 2010. Even under this optimistic scenario, however, the world will have changed irreversibly.

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By Gary Becker and Kevin Murphy

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Capitalism has been wounded by the global recession, which unfortunately will get worse before it gets better. As governments continue to determine how many restrictions to place on markets, especially financial markets, the destruction of wealth from the recession should be placed in the context of the enormous creation of wealth and improved well-being during the past three decades. Financial and other reforms must not risk destroying the source of these gains in prosperity.

Consider the following extraordinary statistics about the performance of the world economy since 1980. World real gross domestic product grew by about 145 per cent from 1980 to 2007, or by an average of roughly 3.4 per cent a year. The so-called capitalist greed that motivated business people and ambitious workers helped hundreds of millions to climb out of grinding poverty. The role of capitalism in creating wealth is seen in the sharp rise in Chinese and Indian incomes after they introduced market-based reforms (China in the late 1970s and India in 1991). Global health, as measured by life expectancy at different ages, has also risen rapidly, especially in lower-income countries.

Of course, the performance of capitalism must include this recession and other recessions along with the glory decades. Even if the recession is entirely blamed on capitalism, and it deserves a good share of the blame, the recession-induced losses pale in comparison with the great accomplishments of prior decades. Suppose, for example, that the recession turns into a depression, where world GDP falls in 2008-10 by 10 per cent, a pessimistic assumption. Then the net growth in world GDP from 1980 to 2010 would amount to 120 per cent, or about 2.7 per cent a year over this 30-year period. This allowed real per capita incomes to rise by almost 40 per cent even though world population grew by roughly 1.6 per cent a year over the same period.

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By Kishore Mahbubani

Asian elites have always looked at the world differently from western elites. And after this crisis is over, the gap in perspectives will widen. Asians will naturally view with caution any western advice on economics, particularly because most Asians believe that the crisis has only vindicated the Asian approach to capitalism.

To be accurate, there is more than one Asian approach. China’s economy is managed differently from India’s. Yet neither China nor India has lost faith in capitalism, because both have elites who well remember living with the alternatives. The Chinese well remember the disasters that followed from the Maoist centrally planned economy. The Indians well remember the slow “Hindu rate of growth” under Nehruvian socialism.

The benefits of the free market to Asia have been enormous: increased labour productivity, efficient use and deployment of national resources, a tremendous increase in economic wealth and, most importantly, hundreds of millions have been lifted out of absolute poverty. Just look at Chinese history through Chinese eyes. From 1842 to 1979, the Chinese experienced foreign occupation, civil wars, a Japanese invasion, a cultural revolution. But after Deng Xiaoping gradually instituted free market reforms, the Chinese people experienced the fastest increase so far in their standard of living.

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