How to Save Capitalism

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Fabrice Coffrini / AFP / Getty Images

As the global economic crisis enters its fourth excruciating year, just about everybody who can be blamed for the downturn has been blamed. Irresponsible bankers. Greedy corporate executives. Incompetent regulators. Bickering politicians. Underpaid Chinese workers. Overpaid Greek workers. George W. Bush. Ben Bernanke. Angela Merkel. Credit-rating agencies. The euro. Spendthrift American consumers. After the worst financial disaster since the Great Depression of the 1930s, there has been no shortage of vilification to go around. With another grim year likely ahead and no ready solutions in sight, a new target has arisen in the public’s crosshairs: capitalism itself.

It’s easy to see why. As jobs remain scarce and the welfare of middle-class American and European families has come under strain, capitalism, as it functions today, seems to have failed to do what it is supposed to do: provide economic opportunity and a better future for all. We’re taught in school that capitalism is a meritocracy that rewards the hardworking and talented. In the wake of the 2008 financial crisis, however, capitalism often appears to benefit only the connected and privileged. To many, Wall Street financiers remain unreformed and unrepentant; they’re still getting rich off the same sort of risky shenanigans that caused the U.S. economy to tank in the first place. Bankers evict families from their homes only to tear those homes down. Greek, Spanish and Portuguese citizens suffer through budget cuts and tax hikes to appease impatient bondholders and bankers. CEOs pocket multimillion-dollar bonuses while laying off thousands.

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The roots of discontent with capitalism run much deeper than the current slump. Over the past three decades, as capitalism has become freer and more globalized, the rich have benefited enormously while the many have often been left with the crumbs. The gap between rich and poor has been widening just about everywhere. In a 2011 report, the Organisation for Economic Co-operation and Development figured that the level of income inequality in the 22 member nations it studied increased by 10% since the mid-1980s, with conditions deteriorating in 17 of them. Free-trade-led globalization has forged an international labor market that pits Indian and American college students against one another, pushing those who can’t compete to the sidelines. Factories are shuttered in the U.S. and Europe, only to reopen in China, costing the West millions of manufacturing jobs.

Those still on the payroll in the U.S. don’t gain as much from today’s capitalism as their bosses do. A recent report by the Institute for Policy Studies, a Washington-based think tank, found that CEOs at large U.S. firms earned, on average, $10.8 million in 2010, a 28% increase from the year before, while the average worker took home $33,121, a mere 3% more. At that level, CEOs’ paychecks are 325 times bigger than their employees’. In the 1970s, CEO pay rarely topped 30 times more. “A lot of people say capitalism doesn’t work,” says Kaylee Dedrick, an Occupy Wall Street protester. “We want to see capitalism used to create more, not consolidate power into one small subset, where the rest of America is saying, ‘Where’s our slice?’”

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Capitalism, of course, has confronted such criticism many times before. Karl Marx famously intoned that oppression is built into the very way capitalism operates. The Great Depression was pinned on capitalism as well. Immoral bankers ran amuck through unregulated financial markets and caused the disaster, the thinking went. Yet capitalism defeated its chief rival — communism — and has absorbed more and more of the globe into its dynamic orbit. That’s because no other economic system in human history has proved more adept at generating wealth and development.

Only since the first textile looms of the Industrial Revolution began to stir has humankind climbed out of the primordial sludge of peonage and destitution into a new world of opportunity, entrepreneurship and social mobility. According to the late statistical wizard Angus Maddison, global GDP increased by a factor of seven over the first 1,820 years of the common era; since then — during the two centuries dominated by modern capitalism — it surged by more than 70 times. Capitalism has eradicated poverty on a grand scale; propelled innovation in medicine, information and transportation; and stitched together a global community through trade and finance.

A Dynamic System

one reason capitalism has been able to deliver such success, however, is that it never stays static. It has survived and thrived because it has reformed, again and again, in response to the ills of the moment. The suffering brought on by the Great Depression sparked a movement to make capitalism equitable and stable, which led to greater government protection and regulation — the New Deal and the European welfare state. Then, to overcome the stagflation of the 1970s, capitalism had to be more productive and innovative. Ronald Reagan and Margaret Thatcher ushered in an era of deregulation, free trade and free flows of capital that spawned a global economic boom. Today, amid the protracted downturn, capitalism has reached another inflection point. The world’s financial sector remains so unsound, and the pain inflicted on the average family has been so great, that capitalism needs to morph yet again, to become more inclusive and balanced and less prone to recurrent meltdowns. The question is not whether capitalism must be reformed. It is how.

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On that, there is no agreement. The answer lies with the never-ending waltz of the state and market that has determined the many historical twists and turns of capitalism. Many today believe the financial crisis was caused, like the Great Depression, by capitalism gone wild, fueled by 30 years of willy-nilly deregulation. Left to their own devices, this thinking goes, bankers and executives can never be trusted to act responsibly. They’ll risk the well-being of the economy to ring up bigger profits or work people to death without paying a decent wage. The solution is a renewed government role to control the worst excesses of capitalism.

A priority, says Mark Bray, one of the organizers of the Occupy Wall Street movement, should be stiffer regulation of bankers. “There has been too much freedom in the financial sector,” Bray says. “If you give [bankers] an inch, they take a mile. The government hasn’t stepped up to that.” That’s not quite true; there are plenty of legislative efforts to rein in bankers, most notably the Dodd-Frank reform bill in the U.S. President Obama also recently appointed a head of the new U.S. Consumer Financial Protection Bureau. But for many, that’s just a start. Chuck Collins, a specialist on income inequality at the Institute for Policy Studies, advocates tax reform that would hike levies on the wealthiest and end the abuse of offshore havens; new corporate rules that would enhance labor and community influence over company management; and restrictions on the ability of Big Business to fund and lobby politicians. Inequality “is part of the natural dynamic of capitalism when there are no checks to counter-balance wealth and power,” Collins asserts.

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But governments may not have that much muscle left. With debt and deficits bulging, governments across the industrialized world have been forced to cut back on the social-welfare spending that protects the poor. The debt is also pressuring politicians to make capitalism even freer — breaking down barriers to entrepreneurship and loosening up protected labor markets — to enhance the competitiveness of their economies. Instead of riding to the rescue, governments across the West are sounding the retreat.

Moral Hazards

some argue that’s exactly what capitalism needs. The woes of the global economy, they contend, were caused not by a failure of capitalism but by a failure of government. “We have a lot of sympathy with the Occupy Wall Street guys,” says Jim Walker, founder of research firm Asianomics in Hong Kong. “But they should be occupying Pennsylvania Avenue and the Federal Reserve.” As Walker sees it, regulators permitted the banks to ignore risk, then bailed them out when their risky behavior became a threat to economic stability. Ever since, the Fed has helped Wall Street dodge reform by spoon-feeding it easy money, which allows bankers to turn profits at little cost. In doing so, government has thwarted the self-regulating nature of capitalism.

By rescuing big banks, governments overturned the verdict of the markets and rewarded bad practices. “If capitalism had been left to its own devices, none of these guys would still have a job,” Walker says. “The only way to make them responsible is to make them fail.” Capitalism hasn’t perpetrated injustice; faulty government policy has, Walker says. The way to fix that problem is more capitalism: only freer markets can ensure that wrongdoers lose and do-gooders win. “Capitalism hasn’t been given a chance,” he says.

Capitalism, though, hasn’t regulated itself all that well either. Government officials and central bankers aren’t the only ones who failed to prevent the financial crisis. The shareholders, board directors, accountants and other agents of capitalism tasked with monitoring risk and corporate behavior didn’t do their jobs. Mike Mayo, bank analyst at brokerage CLSA in New York City and author of the book Exile on Wall Street: One Analyst’s Fight to Save the Big Banks from Themselves, says capitalists have become their own worst enemies. “Big-bank CEOs are more of a threat to capitalism than those on the outside protesting,” he says. Mayo equates reform of capitalism with restoring the checks and balances that police a well-functioning free-market economy. Shareholders and directors are supposed to safeguard the health of corporations and link compensation to performance. Instead, managers of banks and companies have been incentivized to notch short-term profits over long-term gains, encouraging them to take dangerous risks and earning them tens of millions in undeserved payouts. Such behavior “defeats the moral justification for having a capitalist system—that it is more fair and based on merit,” Mayo says. His solution is to repair capitalism one boardroom at a time by strengthening corporate governance. “The problem with our economic system today is not a problem of capitalism,” Mayo says. “It is due to a lack of capitalism.”

However these debates play out, the capitalism that emerges from the Great Recession will be a different capitalism. The groundswell of public discontent that has exploded on the streets from Los Angeles to London to Athens simply cannot be ignored. Yet however loud the calls for change, capitalism is here to stay. While many in the West sour on the system that made them rich, China, India and much of the rest of the rapidly advancing emerging world are slowly, inexorably turning toward freer trade, deregulation and more-open capital flows in their drive for riches. The challenge facing the world’s politicians, economists, bankers and corporate leaders is to reform capitalism in ways that enhance its power to grow and uplift the downtrodden while mitigating the ill effects of globalization and greed. The outcome will shape the fortunes of capitalism — and the world economy — for the next generation.

— With ­reporting by Nate Rawlings / New York

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