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September 15, 2005

Saving Capitalism From Itself.

Owen Barder picks up on a Robert Reich meme that liberals have twice saved capitalism from itself and need to do so again.

The first time was in the early 1900s. By then, captains of American industry had monopolized the economy into giant trusts, American politics had sunk into a swamp of patronage and corruption, and many factory jobs were unsafe - entailing long hours of work at meager pay, often exploiting children.  In response, liberals championed anti-trust laws, civil service reforms, and labor protections.

The second save occurred in the 1930s, after the stock market collapsed and a large portion of the American workforce was unemployed. Then liberals regulated banks and insured deposits, cleaned up the stock market, and provided social insurance to the destitute.

Both times, liberal reformers were accused of interfering in the free market. But in both instances, liberal reformers prevailed.  They did so by appealing to public morality and common sense.

It is time, once again, for liberals to restore confidence in our system and save capitalism from itself.

Nice thought, you know, thanks for thinking of us, but entirely wrong. If you get your basic analysis wrong then anything you build upon it is going to be, umm, wrong.

The 1900s and trusts:

The businessmen of the latter half of the nineteenth     century, however, aggressively attempted to affect the conditions of their markets by     advertising, varying production rates, and bargaining on price with suppliers and     customers. Many observers assumed that these activities were incompatible with the     classical theory. They concluded that competition was no longer working effectively. In     the sense in which they understood competition, it had never worked or existed, except     possibly in some isolated agricultural markets. But in a meaningful sense of the word,     competition did, and does, exist-in the nineteenth century as well as today.


"Competition" is an active, not a passive, noun.     It applies to the entire sphere of economic activity, not merely to production, but also     to trade; it implies the necessity of taking action to affect the conditions of the market     in one's own favor. The error of the nineteenth-century observers was that they restricted     a wide abstraction -- competition -- to a narrow set of particulars, to the     "passive" competition projected by their own interpretation of classical     economics. As a result, they concluded that the alleged "failure" of this     fictitious "passive competition" negated the entire theoretical structure of     classical economics, including the demonstration of the fact that laissez-faire is the     most efficient and productive of all possible economic systems. They concluded that a free     market, by its nature, leads to its own destruction -- and they came to the grotesque     contradiction of attempting to preserve the freedom of the market by government controls,     i.e., to preserve the benefits of laissez-faire by abrogating it.


The crucial question which they failed to ask is whether     "active" competition does inevitably lead to the establishment of coercive     monopolies, as they supposed -- or whether a laissez-faire economy of "active"     competition has a built-in regulator that protects and preserves it. That is the question     which we must now examine.


A "coercive monopoly" is a business concern that     can set its prices and production policies independent of the market, with immunity from     competition, from the law of supply and demand. An economy dominated by such monopolies     would be rigid and stagnant. The necessary precondition of a coercive monopoly is closed     entry -- the barring of all competing producers from a given field. This can be     accomplished only by an act of government intervention, in the form of special     regulations, subsidies, or franchises. Without government assistance, it is impossible for     a would-be monopolist to set and maintain his prices and production policies independent     of the rest of the economy. For if he attempted to set his prices and production at a     level that would yield profits to new entrants significantly above those available in     other fields, competitors would be sure to invade his industry.

Just in case you think that’s some right wing nutjob actually, it’s Alan Greenspan. Yes, that one. It’s a long essay but worth reading.

1930s and the Great Depression?

Many free-market economists had attempted to answer the first question, including Benjamin M. Anderson and Murray N. Rothbard, but none had the impact equal to Milton Friedman's empirical studies on money in the early 1960s. His was the first effective effort to destroy the argument that the Great Depression was the handiwork of an inherently unstable capitalistic system. Friedman (and his co-author, Anna J. Schwartz) demonstrated forcefully that it was not free enterprise, but rather government - specifically the Federal Reserve System - that caused the Great Depression. In a single sentence underlined by all who read it, Friedman and Schwartz indicted the Fed: "From the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third."  

Friedman and Schwartz also proved that the gold standard did not cause the depression, as some Keynesian economists have alleged. During the early 1930s, the U.S. gold stock rose even as the Fed perversely raised the discount rate and allowed the money supply to shrink and banks to collapse.

Caused by Government, not by laissez faire capitalism nor any version of a free market. And yes, this is the sort of thing Uncle Milt got his Nobel for.

Just as a small further point, if social insurance helped to save people from the Depression why didn’t it do so in Germany after Bismark? In the UK after 1909?

So, a pity for Owen’s theory there. As capitalism (or as I prefer to call it, a free market, Liberal in the English sense, order) has not been saved by the interventions of liberals (in the US sense), rather, the two most damaging episodes were caused by said liberals and progressives wittering about their misconceptions of reality, how seriously should we take the idea that  we are due another instance of salvation? Ready for another Depression are we?

September 15, 2005 in Economics | Permalink


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Did the trusts bust themselves? Did competition bust them? Or did trust-busting laws break up the monopolies and cartels?

I am wary of disagreeing with Greenspan, and I haven't read the entire article to which you refer, but the following sentence that you quote (and on which your argument is based) is true only in special circumstances:

"Without government assistance, it is impossible for a would-be monopolist to set and maintain his prices and production policies independent of the rest of the economy"

There are many circumstances (eg when there are increasing returns to scale, as in the software industry) in which this is just plain false. (I suspect Greenspan had a qualification somewhere in his text; but, as I say, I haven't read the article.)


Posted by: Owen Barder | Sep 15, 2005 3:47:14 PM

Just in case you think that’s some right wing nutjob actually, it’s Alan Greenspan.

Oh Tim you kill me, you really do. From the link:

Published by Nathaniel Branden Institute, New York, 1962

Anyone care to guess which Russian lady novelist's philosophy the "Nathaniel Branden Institute" existed to promote? Starts with "A" and to be honest doesn't get much further. This is Greenspan from his youthful Randian period, a period during which the description "right wing nutjob" is very hard to argue with.

Tim adds: I’d be interested to see where he’s recanted the views in that essay.

Posted by: dsquared | Sep 15, 2005 5:52:25 PM

Is anything that Robert Reich writes anything other than nonsense!? The guy is responsible for many of the worst labour market myths and scareamongering shite.

Posted by: Dr. angry economist | Sep 16, 2005 9:30:06 AM