Daily Archives: January 20, 2012

Coming from very different perspectives, the columns in the ‘Crisis in Capitalism’ series have each provided insights and identified steps that, in their opinion, could make things better. But, is there a way to reach a clear overall conclusion? I think the answer is yes, although the implications are disconcerting.

The majority of writers agree that the crisis in capitalism is caused by two distinct failures: the inability of the system to deliver sustained prosperity through economic growth and jobs; and the perception that it is grossly unfair and socially unjust.

To fail on one count is a problem. Yet many would have probably glossed over that, especially those who – erroneously in my view – believe that there are rigid trade-offs between efficiency and equity. However, to fail on both counts, and to do so in such a spectacular manner, is indeed a “crisis.” It raises legitimate questions about the model itself.

There are three main reasons for this.

Firstly, capitalism has always, and will always be, prone to traditional market failures. The answer is to accept this, and work harder at reducing the chances of a catastrophic failure reaching the few areas that amplify the good and bad aspects of the system.

Finance is clearly one of these. In the last decade, five countries in particular (Iceland, Ireland, Switzerland and most importantly given their systemic role, the UK and US) lost sight of the fact that finance is not a standalone industry but, instead, depends on its ability to serve the real economy. This failure was compounded by the view held by some that finance could even constitute the next phase in the natural evolution of capitalism (from agriculture to industry, services and, ultimately finance).

These illusions were aided and abetted by patchy prudential regulation, bad incentives and horrid compensation practices. They coincided with the revolution in structured finance, an innovation that suddenly and dramatically opened up new global credit windows.

Society as a whole produced and consumed too much finance, especially through a disruptive technology that was insufficiently understood and tested. The result was the mother of all capitalistic overdoses, the implications of which are enormous and will be felt for years to come.

Secondly, during the past decade, in another part of the world, a set of countries embarked on their own capitalist economic revolution. This enabled them to pull millions of their citizens out of poverty. In the process, they added considerable productive capacity to a global economy, which only partially understood the consequences.

Countries such as China used the mix of technology catch-up, low wages, and quality improvements with great success. But imbalances inevitably reached unsustainable levels.

Lastly, too many of the institutions that are critical for the smooth functioning of capitalism utterly failed to deliver when they were needed most. They were hindered by poor governance, uneven global representation and partial information. This is true for both the private and public sectors.

Each of these areas can be corrected. Theoretically at least, what has occurred is less a calamity of the system as a whole, and more an issue of how it was run. Yet, four years into the crisis, little has been done to repair the damage coherently and comprehensively and to safeguard the real victims, let alone counter the risk of further costly dislocations. Until this is done, it will be difficult to convince the world that capitalism itself is not the problem.

The writer is the chief executive and co-chief investment officer of Pimco 

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