In 1989, the repressive East German regime collapsed and the citizens of both East and West Germany tore down the Berlin Wall. Two years later, the Soviet Union disintegrated. The United States had won the cold war, as Kay states, “without firing a shot.” During the decade that followed, the market triumphed as countries around the globe embraced capitalism and governments sold off companies that they had previously nationalized. Information technology, which boosted the U.S. economy’s performance and resulted in an exceptional stock market boom, seemed to make conventional thinking about economics obsolete.
Capitalism under attack
But the decade, says Kay, “ended in a frenzy of speculation, followed by recrimination and self-doubt.” Corporations that had never earned a cent of profit, and never would, were sold to investors for billions of dollars. Corporate executives filled their pockets and invented revenues and profits. As a result, many “Americans lost faith in corporations as their savings were eroded.” Starting with the 1999 Seattle meeting of the World Trade Organization that broke up in chaos, “every subsequent international economic meeting would be besieged by demonstrators.” Puzzled observers saw a seemingly triumphant capitalism come under renewed attack.
Revisiting the American business model
Despite the market economy’s “public relations problem,” business leaders and politicians continue to espouse, what Kay calls the “American business model,” which may be summarized in four propositions:
greed is the dominant motivation in economic matters;
restrictions on the operation of free markets are costly and ought to be minimized;
the economic role of the state should not extend much beyond protection of private property rights and the enforcement of contracts; and
taxation should be limited to what is essential to perform these functions and to support a modest welfare safety net.
Kay challenges these propositions, arguing that “they bear little relation to a true account of how markets work,” and that “attempts to redesign market economies in line with such principles have done at least as much harm as good to the effective operation of a market economy.”
Role of self-interest
Economic behavior is not governed solely by narrow economic self-interest, Kay argues. The most successful entrepreneurs appear not to have cared much about making money for themselves. For Bill Gates—the richest man in the world—for example, information technology, not money, has been the consuming passion. For Warren Buffet, it’s been the fun of investing and doing it successfully. Looking back over time, Kay also cited Andrew Carnegie, “one of the greatest robber barons,” who said that “the man who dies rich, dies disgraced.” And John D. Rockefeller believed that his ability to make money was a God-given gift and that his duty to God was to exercise that talent.
Markets must be embedded
Successful market economies operate within a complex social, political, and cultural context. In the absence of this context—in countries like Nigeria and Haiti, “whose economies do not work”—it is impossible to achieve the cooperative working relationships, the information sharing, the coordination of economic activity, and the development of trust between individuals and businesses—all elements that a complex modern economy depends on. Furthermore, Kay explains, if the characteristics of successful economic institutions could be divorced from their context, there would be far fewer poor countries in the world. It is because markets must be “embedded” that attempts to transplant the economic institutions of a market economy—most recently and most strikingly in Russia—have in many respects failed.
Many market economies
In Kay’s view, a market economy in a free society is demonstrably the most effective form of economic organization. But there are many successful variations on this theme, as the diversity of the world’s 20 or so most economically productive economies indicates. Each of these countries—located in North America, Western Europe, Asia, and Australia—is the distinctive product of a process of coevolution of economic institutions and political culture, rather than representative of the American business model. Many are not characterized by unrestrained greed, market fundamentalism, or a minimal state. Regulatory structures, for example, are pervasive in Denmark, Norway, and Switzerland. Norway and Denmark also have some of the highest tax rates found anywhere. And the United States—the world’s largest economy—certainly does not have a minimal state.
What explains the range of development experiences around the world? The successes and failures are strongly correlated with the degree of institutional development, which gives reason for pessimism about development prospects in those parts of the world that are at an early stage of institutional coevolution. Asia, says Kay, has the most impressive examples of development outside the Western world. Given the coevolution of institutions in Asia, the biggest puzzle of economic history is why, two or three centuries ago, economic growth took off in Western Europe and not in southeast China.
Truth about markets
“If the strengths of the market economy were encapsulated in a single phrase, it would be disciplined pluralism—the process of perpetual experiment in market economies, in which most experiments fail and are terminated, but the few that succeed are quickly initiated.” The genius of markets, Kay observes, “is that they are not dependent on the genius of any individual.” In central planning, by contrast, or in autocratically managed corporations, a single voice articulates the right answer, and hierarchical authority is deployed to extract information and execute decisions. That, he concludes, is why less authoritarian countries and corporations tend to do better, at least over the long run.
The Truth About Markets was published in the United Kingdom in 2003 by Allen Lane/Penguin Press. It is published in the United States by HarperCollins under a new title, Culture and Prosperity: The Truth About Markets—why some nations are rich but most remain poor.
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