Ruchir Sharma critiques the expanding role of government and central banks, arguing that excessive intervention has derailed capitalism from its core principles, leading to growing inequality

Ruchir Sharma’s remarkably researched and passionately argued book, What Went Wrong With Capitalism (Penguin Random House), begins with the creeping disenchantment of the young against the excesses and failings of modern capitalism, which US Senator Bernie Sanders once described as ‘Socialism for the very rich.’ In turn, they expect the government to be more interventionist, more socialist in nature.

The book — after railing against how the government, in tandem with the central bank of the developed countries and other players with vested interests, has ridden roughshod over the tenets of capitalism — ends on a wishfully sanguine note: “Capitalism is still Humanity’s best hope for economic and social progress, but only if it is free to work.” In between, it seeks to expose what went wrong with capitalism.

Change in the nature of State-capitalism relationship

The idea of capitalism was premised upon the ‘invisible hand’ of Adam Smith. While the invisible forces of demand and supply were at the core of capitalism and the market economy, the state was supposed to be mostly invisible, letting the market economy run its course. Joseph Schumpeter, Austrian political economist proposed the idea of ‘creative destruction’ as central to capitalism. Inefficient and unproductive enterprises would go bust, to be replaced by more efficient and productive ones, based upon efficient and market-driven allocation of resources.

Even J. M. Keynes — a proponent of the state intervention to cope with the recession — had argued that the government should borrow and spend to make up for weak demand in hard times, but it must build surplus to spend in the next crisis. Everyone remembered the first part and the second part was conveniently forgotten. Sharma rues that ‘none of us are Keynesians now’. The result has been the hollowing out of capitalism with the ever-expanding footprints of the state in the economy. This led to many distortions.

How capitalism went haywire

Sharma, the chairman of Rockefeller International and Founder and Chief Investment Officer of Breakout Capital, is a passionate votary of capitalism so he goes hammers and tongs — time and again through the book — to emphasize what went wrong. First, the state ventured upon a ‘hands-on’ approach from a ‘hands-off approach’, from laissez-faire to intervention.

Even when Francis Fukuyama was singing paeans to the ‘End Of History’ heralding the triumph of capitalism, the nation-state was not in retreat and was expanding its footprint in the economy. The state itself redefined welfare in absolute sense, rushing out to rescue everything regardless of its economic rationality and practical desirability. This was reflected in expensive state guarantees for everyone — bailouts for the rich, entitlements for the middle-class, welfare for the poor.

Along the way, the state stopped believing in the efficacy of ‘creative destruction,’ leading to directed (mis)allocation of resources. Further, the nation-state gave way to the national security state, accentuating its borrowings which further skewed the balance against the market and resulted in the aggrandisement of the state.

Sharma makes an extremely important point that even under Ronald Reagan, the state refused to retreat. He borrowed massively to fund the national security state, which would eventually hasten the collapse of the Communist block but which would also undermine capitalism. The state became regulation freak and the central bank, which could have acted upon as a check on the aggrandising whims of the state, chose to go along. The result: capitalism went haywire.

Regrettable consequences

Playing fast and loose with the basic tenets of capitalism has had regrettable consequences. First, the intrusive state willing to rescue anything and everything played havoc with the idea of creative destruction. The massive infusion of bailout money to rescue fragile business enterprises led to the misallocation of scarce resources. The deadwood continued to operate, albeit inefficiently and without contributing positively to the economy.

At the same time, they were competing for resources with the better-performing enterprises in the same sector, thereby sub-optimising their operational efficiency and increasing operational cost. Had the deadwood been allowed to go under, more robust enterprises could have replaced them, generating more employment and value in the economy.

Second, the prolonged regime of easy money — merely because inflation was under control — led not to increase in productivity and creation of employment opportunities but to dangerously speculative investment in financial assets of dubious kinds. This dubious investment in financial assets has been to such an extent that the capital market and the fundamentals of the economy are perniciously out of consonance.

Third, in the quest to enhance liquidity in the market, the Central Bank began buying bonds of all sorts — regardless of their actual worth. This led to further asset bubbles. Inevitably, these bubbles would come home to roost, causing distress in the economy. But something fundamental had got altered in the thinking of the government. The government would rush to rescue anything and everything upon the first sign of trouble. The idea of a safety net — originally meant for the desperately poor — was extended under the financial markets, where the big beneficiaries were far from hungry.

The changing nature of recession and capitalism

Frequent government rescues have had different impacts upon weak firms and big firms. While weak firms would survive the downturn, they would lose their resilience and vitality. They would continue to exist like Zombie companies, which do not earn enough profit to cover even the interest payments on their debt and stay alive only by taking out cheap new loans merely because money in the market was cheaply available. On the other hand, with the process of creative destruction turned on its head and competition stifled, the largest firms kept getting bigger. The number of billionaires would surge as never before.

Sharma reckons that the vicious cycle operates like this: big government — by gravely undermining competition — is slowing productivity growth, which is lowering economic growth in the long run, thus shrinking the pie and concentrating what is left in few hands, thereby fuelling inequality. He also underlines that both sides of the Atlantic are seeking to outdo each other when it comes to the growing footprints of the government in the economy.

And within America, it is difficult to tell the Republicans from the Democrats. He concludes that in the age of treasury and Fed expansion and free money for far too long, capitalism has lost its dynamism, suffering fewer recessions, each with less cleansing effect, thanks to bailouts, leaving behind more fragile companies, more bad monopolies, and more corporate deadwood. The results are low productivity, slump in overall growth, and a capitalist system with less and less potential to advance the greater good.

Light at the end of the tunnel

In Sharma’s estimation, everything's not lost, not yet at least. He cites three examples of Switzerland, Taiwan and Vietnam to exemplify how capitalism still works and could still work elsewhere. Switzerland has got the balance right between private enterprise and social welfare. Taiwan has been successful in creating a business environment that is conducive for start-ups as also for giants and where wealth is relatively well distributed. And Communist Vietnam — thanks to an optimal balance between building basic infrastructure and progressively improving welfare services — proves that even a communist country can give a good account of capitalism, so long as it eases state control.

In the final analysis, Sharma makes a passionate case for letting capitalism function in the conventional sense and wishes the state not to be too big and too intrusive. He also advocates a fine balance between market and welfare. But this is easier said than done. As Rumi points out, “Life is a balance of holding on and letting go.” But what and how to hold on and what and how to let go are never easy to achieve. China tried to strike a fine balance between Mao and Marx but this balance could not have lasted forever.

Further, capitalism — through its operational dynamics — generates tendencies and forces that throw what Max Weber calls ‘Spirit of Capitalism’ into tailspin. Sharma also points out the basic compatibility between democracy and capitalism but with democracy itself looking down the barrel in different parts of the world with democracy pitted against growing authoritarian populism, capitalism could not remain unaffected.

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