From free enterprise to Bailout Nation via bigger government and Robert Rubin
A Capitalism for the People:
Recapturing the Lost Genius of American Prosperity
By Luigi Zingales
Basic Books, New York
By Nick Schulz
August 27, 2012
via American Enterprise Institute, Washington, D.C.
"I believe in American exceptionalism, just as I suspect that the Brits believe in British exceptionalism and the Greeks believe in Greek exceptionalism."
When President Obama spoke these words, on April 4, 2009, he waded into a long-raging debate on American exceptionalism. And he set off a torrent of speculation about whether he believed the United States, thanks to its history, institutions, and character, stood apart from (and above) other nations, or whether he was really saying that, since all nations are in some sense unique, no nation is truly unique, including America.
Luigi Zingales certainly thinks America is exceptional, or at least that it used to be; and in his new book, he argues that we must recapture some elements of what made America exceptional if we want the nation's future to be as prosperous as its past.
Zingales is an economist at the University of Chicago's Booth School of Business and writes frequently for popular business and political publications such as City Journal. In 2003, he co-authored (with Raghuram Rajan) an important, if underappreciated, book called "Saving Capitalism from the Capitalists."
He immigrated to the United States from Italy, and this experience has shaped his views about capitalism profoundly, helping him appreciate the exceptional nature of his adopted country. "Capitalism in the United States is distinct from its counterparts in Europe and Asia," he writes, "for reasons that reach deep into history, geography, culture, and the institution of federalism."
He contends that this distinctive form of capitalism is an essential component of American exceptionalism. He notes, for example, that America's free-enterprise system developed when the federal government was relatively small. "At the beginning of the 20th century," he says, "when modern American capitalism was taking shape, U.S. government spending was only 3 percent of gross domestic product." When a similar system of market economics took hold in Western Europe after World War II, in contrast, government's share of the economy in those countries was over 30 percent.
Why does this matter? "When government is small and relatively weak," Zingales says, "the most effective way to make money is to start a successful private-sector business. But the larger the size and scope of government spending, the easier it is to make money by diverting public resources. ... Thus in nations with large and powerful governments, the state usually finds itself at the heart of the economic system, even if the system is relatively capitalist."
While Zingales does not mention it, there is a large body of economic literature demonstrating that the size of the state at the time an economy modernizes is correlated with how well the economy performs. The fact that the U.S. government was so small when it began to modernize helps explain America's extraordinary economic performance and its dynamism.
Thanks to this auspicious beginning, the American economy was much more hospitable to entrepreneurship than other countries were. America's system of free enterprise was noteworthy for its relative lack of crony capitalism and rent seeking, and its embrace of vigorous market competition unencumbered by government interference.
Other factors have contributed to making America's economic system exceptional. It emerged without heavy influence from foreign powers or the direct and sustained influence of Marxism. The New World's colonial developments were driven not so much by the quest for gold as by the quest for freedom. The openness of America's frontier and its sparse population made mobility easy and undermined centralization of government power.
Zingales also stresses the populist roots of American culture and the federalist system enshrined in the Constitution. "For all of these reasons," he concludes, "the United States constructed a system of capitalism that comes closer than any other to embodying the free-market ideal of economic liberty and open competition."
That system has served the American people -- and the millions of immigrants who have come to these shores -- extraordinarily well. Not just because it helped make America the wealthiest large nation in history, but also because it was the fairest economic system ever contrived, especially when compared with Europe. Zingales writes:
"I came here in 1988 from Italy because I was trying to escape a system that was fundamentally unfair. Italy invented the term nepotism and perfected the concept of cronyism, and it still lives by both. You are promoted based on whom you know, not what you know. ... I emigrated to the United States because I realized that it offered me an inestimably brighter future than my native country. And when I got to America in 1988, I wasn't disappointed. I experienced for the first time the inebriating feeling that any goal was within my reach. I had finally arrived in a country where the limits to my dreams were set only by my abilities, not by the people I knew."
Zingales arrived here at the end of the Reagan presidency, when American capitalism was reinvigorated after the malaise of the 1970s. So it's easy to see how he could be enamored of the country's economy. But his personal story didn't end there; if it had, this book would have been just another lovely account of an immigrant successfully seeking good fortune in the land of the free.
Instead, Zingales documents how the United States has changed since then, how much it has betrayed its exceptional character, and how much this matters for the future. "It wasn't long after arriving in the United States that I began to notice things that felt more like home," he says, "as if I were watching a movie I'd seen before." In this movie, the government intervenes to pick winners and losers in the economy; to blunt the necessarily rough edges of competition; to rescue failing but politically well-connected firms; to bail out the undeserving and reckless.
The first scene of this movie is the rescue of the hedge fund Long Term Capital Management in 1998. Warren Buffett offered to rescue the firm after it made a series of bad arbitrage wagers. Given the firm's weak financial position, Buffett's terms would understandably have been extremely costly to the original investors. But the Federal Reserve stepped in and "coordinated a rescue effort that proved more generous to LTCM's investors and managers -- a group that happened to include David Mullins, former vice chairman of the Fed."
Another scene is the successful effort by Citigroup in the late 1990s to overhaul the Glass-Steagall Act:
"At that time, the head of the Treasury was Robert Rubin, who worked very hard to convince his fellow Democrats to change the law. Rubin left the Treasury in July 1999, the day after the House passed its version of the bill by a bipartisan vote of 343 to 86. Three months later, on October 18, 1999, Rubin was hired by Citigroup at a salary of $15 million a year, without any operating responsibility. It is hard not to see a connection between these two events."
It's not just Rubin's swift turn through Washington's revolving door that troubles Zingales: More important, he indicts Rubin for being, in his role as economic adviser to Bill Clinton and later Clinton's secretary of the Treasury, "the person who may have done the most to make bailouts the prevailing doctrine in the United States." In the mid- and late 1990s, a series of economic crises threatened developing countries in Latin America and Asia. Following the "Rubin doctrine," Mexico was bailed out in 1994. This was followed by South Korea, Thailand, and Indonesia in 1997. Brazil received a bailout in 1998. These bailouts helped the receiving nations, of course, but helped the banks that lent money to them even more.
The examples Zingales cites of crony capitalism and bailouts in the 1990s were followed by still others in the next decade. These include the imposition of steel tariffs by President Bush in 2002 to protect sensitive constituencies, and the Bush administration's offer to corporations of "special rates to repatriate their profits." Zingales does not mention it, but he could have included the unfunded prescription-drug mandate, a giveaway that was pushed by health-care interests.
It wasn't just Bush 43-era Republicans. "At the time," he notes, "Democrats were becoming cozier with big-business interests, launching 'public-private partnerships,' a way to suck money from the government while pretending to do good."
The most egregious examples of crony capitalism and bailouts occurred, of course, with the 2008 financial panic, the subsequent recession, and the federal government's ham-handed response: the interventions to address problems at Bear Stearns, AIG, General Motors, Chrysler, Rubin's Citigroup, and more.
Zingales is not ideologically opposed to government interventions to stem a panic. His critique is different, and it has two parts: First, he'd like to see greater recognition on the part of policymakers that it was earlier government meddling that paved the way for excessive risk-taking in the financial system. Second, he'd like to see recognition that there is a right way and a wrong way for governments to respond to panics.
"I am not opposed to the idea of a government intervention in such extreme circumstances, but I do object to the way it was done," he writes. "When a drug addict is undergoing a withdrawal crisis, one certainly should not stand by and do nothing -- but one also should not give the addict a full year's supply of drugs, which is roughly equivalent to what the U.S. government opted for with TARP. The program was a pillage of defenseless taxpayers that benefited powerful lobbies: not just the triumph of Wall Street over Main Street, but the triumph of K Street over the rest of America."
Zingales is rightly outraged by the behavior of his adopted country's political and financial elites over the last two decades. Their actions have eroded the exceptional character of the nation's free-enterprise system and put the nation on a path toward the crony capitalism and corruption he fled when he left Europe.
Fifty years ago, the great Italian liberal thinker Bruno Leoni remarked that "it seems to be the destiny of individual freedom at the present time to be defended mainly by economists." Half a century later, we are fortunate to have an Italian-born economist so powerfully and persuasively defending America's once-exceptional free-enterprise system.
Mr. Schulz is the DeWitt Wallace Fellow at the American Enterprise Institute and the editor of American.com.
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