Posted by: Dirk | July 28, 2011

(Book review) Capitalism 4.0

Anatole Kaletsky’s book from 2010 has been written just after the Great Recession was over – at least in terms of shrinking GDP. Therefore, reading and reviewing the book now may seem a little bit unfair, but frankly, it wasn’t top of my list back then. Kaletsky acquired his fame as a financial journalist at The Economist, the Financial Times and The Times. If the Wikipedia entry on him is to be believed, his predictions came out on the wrong side more than once. This is the fate of the financial journalist, who has to write about the future in his columns. He does not shy away from predicting long-term trends in his book neither.

Kaletsky argues – in chapter three – that capitalism is like an operating system for mankind that evolves as the society (tastes&technology, etc.) changes. Capitalism 1.0 was the start, beginning with Adam Smith and the Declaration of Independence. It underwent some minor changes (1.1-1.4) until Capitalism 2.0 took over during the Great Depression with the New Deal and the widespread abandonment of gold. 1979 till 2008 was the period of Capitalism 3.x, and now we are about to witness another transformation of capitalism. Part II of the book deals with this last part and explains the historical roots of our problems. Right at the start Kaletsky cites Raghuram Rajan of the IMF as “presenting probably the most optimistic World Economic Outlook in this august institution’s sixty year history”. Let’s take a look at the transcript published by the IMF:

Plentiful global liquidity, in part because of the commutative policy stance of important central banks, has prompted a global search for yield that has held down long rates and risk premia. With the change in Japanese monetary policy, the liquidity cycle is turning. In addition, with growth opportunities and pricing par improving, corporations are likely to invest more. The reduction in corporate excess savings will be another factor pushing real interest rates higher. High real rates will further slow the search for yield, and the extreme tolerance for risk that we have seen in financial markets is likely to dissipate.

All this should be seen as a normalization of financial conditions from the current extremely benign ones. Nevertheless, an environment of rising interest rates and risk spreads—however normal—should be of concern in markets where asset prices are inflated, such as housing in some countries.

I would argue that Mr Kaletsky is mistaken in what he writes. The WEO 2006 is not overly optimistic – it just acknowledges that the world economy “never had it so good” when it comes to growth rates. There are more smaller text passages like this where I would disagree with some minor facts, but in a book project like this these disagreements are nothing unusual. Most economists would roughly agree with the history as told in “Capitalism 4.0”, at least up to “The econonomic consequences of Mr Paulson”. Here, Mr Kaletsky attacks Hank Paulson for almost destroying the global financial system. He claims that by nationalizing Fannie Mae and Freddie Mac and letting private shareholders evaporate Paulson effectively made it impossible for investors to buy shares in financial institutions. The threat of being returned to zero in case of bankruptcy made financial institutions dependent on government finance, since private investors lost faith.

Speculators selling short financial firm stocks then took over and brought the system to the point where Lehman failed and a bank-run of institutional investors set in, demanding their money back from other financial intermediators. Since Paulson did not want to use government powers (money) to bail out these institutions, the credit markets froze. Kaletsky argues that free market fundamentalism almost brought down the global economy, and that only when the British showed to the US what must be done with the TARP money the US was able to return markets to more tranquil waters. While I agree with this description, I find the text a bit to imprecise. Mr Kaletsky always writes of a bank run going on, but never locates that bank run. While in the UK people cued at Northern Rock, there were no such bank runs in the US. The shadow banking system somehow has escaped the attention of the author.

There are other parts in the text which I don’t agree with, especially later on when Capitalism 4.0 and what it should look like are described. Here is one paragraph which I disagree with:

Third, for Europe, an intellectual convergence with America will require policymakers and electorates to acknowledge some of the dysfunctional features of the European socioeconomic system that have allowed special interests, such as agricultural lobbies and trade unions, to disguise what is essentially exploitative rent-seeking economic behaviour, as culturally unique characteristics of the European model.

Apart from the fact that the sentence seems German to me it is strange in other ways. First of all, the agricultural problem is one which is shared by all developed economies. Japan, the US, the EU, subsidies for agriculture are all around. People already have acknowledged that this is a problem, it is just that the problem is quite complex because of the distribution problem. Agriculture loses from free trade, if it were not subsidized, and thus it is part of the winners compensate losers form free trade group of policies. I doubt that this will become one of the most important issues in the 21st century in the EU.

Also, rent-seeking by powerful European unions? OK, let us destroy those German monster unions that were able to limit real wage increases to only a bit below productivity increases. What we need in Capitalism 4.0 is that very competitive nations increase their competitveness further, isn’t it? No, of course not, but from reading this bit you might have this idea.

In the end, I liked the book and would recommend to those interested in discussing Capitalism and macroeconomics which have not much background in economic theory. The main ideas on how history has been influenced by underlying trends are quite well elaborated upon, and their institutional consequences are neatly summed up. However, I would prefer some economic theory or at least balance sheet “thinking” in the background so that the issues could be understood in a proper framework. Perhaps the greatest advantage of a journalist is to write about everything he wants to, but the biggest drawback is that this style of prose does not mix well with explanations of how the system actually works. The part on Friedman’s monetarism seems to imply that many economists actually believed in monetarism. However, Volcker abandoned the experiment quite early and after that no academic was in praise of monetarism any more. There is a difference between what academics think about certain subjects and what the lay public thinks about it (or what a journalist thinks the academic and/or lay public think).


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