Capitalism-and-Its-Critics-A-History-From-the

In this environment, Friedman’s policy prescriptions attracted increasing support, particularly from business interests. Some of his followers claimed that bringing down inflation by restricting the growth of the money supply would be relatively painless. Once workers and firms realized that the central bank was determined to hold the line, their expectations of future inflation would diminish, and this would translate into smaller wage claims and price increases. Under the guise of the theory of “rational expectations,” which swept through American economics departments like a virus during the mid-1970s, some conservative economists (but not Friedman) took this argument to its logical extreme and claimed that, if commitment to eliminating inflation was credible enough, inflation would fall sharply pretty much immediately. Once the central bank announced that it was restricting the growth of the money supply to, say, 3 percent, wage negotiators would adopt that figure as their estimate of expected inflation and adjust their wage claims accordingly. Inflation would drop with no increase in unemployment.

Many policymakers were skeptical of the theory of rational expectations, but the idea that a credible central bank could bring down inflation relatively easily appealed to elected politicians who didn’t like being held responsible for the rising cost of living. In 1977, the US Congress, with support from both parties, directed the Federal Reserve to set targets for the growth rate of the money supply and report back to it on whether they were being met. Monetarist dogma also provided a convenient cover for old-school inflation hawks who were determined to break the wage-price spiral whatever the cost. The key figure in this camp was Paul Volcker, a six-foot-seven New Jerseyite whom Carter appointed as chairman of the Federal Reserve in 1979. In September 1979, Volcker formally committed the Fed to monetarism, although many observers, Friedman included, believed this was just a feint to distract from the central bank’s determination to push up interest rates. Between September 1979 and March 1980, the Fed raised its discount rate from 10.7 percent to 13 percent.38 At the start of 1980, a recession began.39

Friedman’s hostility toward organized labor and government regulation also appealed to many politicians and business groups. Since the original publication of Capitalism and Freedom, the Republican Nixon administration had created two large new regulatory agencies, the Environmental Protection Agency (EPA) and the Occupational Safety and Health Administration (OSHA), which were given extensive powers to enforce new and preexisting regulations. In response to these developments, American corporations and wealthy interests looked for ways to bolster their political influence. In 1972, a number of CEOs from major corporations established the Business Roundtable as a lobbying group. The United States Chamber of Commerce and the National Association of Manufacturers, which already existed, increased their political budgets and expanded their presence in Washington, DC. So did individual corporations. Under the Federal Election Campaign Act of 1971, corporations and labor unions were allowed to set up and fund political action committees (PACs) that could support political candidates. By 1976, there were more than one hundred corporate PACs in existence.40 Simultaneously, a number of very rich right-wing individuals provided funding for new conservative publications and think tanks. In 1973, the conservative Colorado beer magnate Joseph Coors helped to finance the establishment of the Heritage Foundation, which quickly started churning out articles critical of regulation, welfare, and Keynesianism.

The embrace of deregulation wasn’t confined to the Republican Party. In 1974, Senator Ted Kennedy, the “liberal lion” of Massachusetts, became chairman of a new Senate subcommittee on “administrative practice and procedure,” which organized public hearings on the airline industry, where the Civil Aeronautics Board (CAB) had long controlled prices and allocated routes between airlines. As chief counsel of the subcommittee, Kennedy hired Stephen Breyer, a Harvard law professor whom Bill Clinton would eventually nominate to the Supreme Court. Like Kennedy, Breyer was a Democrat, but he believed, with some justification, that airline regulation operated against the interest of consumers, who were paying high fares on planes flown by a cozy cartel of major carriers. “The CAB was supposed to be protecting the public, but regulation was leading to higher prices,” he would later recall. “It spent 95 percent of its time keeping prices from being too low instead of pushing to get them lowered.”41

In 1977, Carter appointed another Democratic critic of regulation, the Cornell University economist Alfred Kahn, to run the CAB. Kahn was an independent-minded academic who had no time for special pleading from the big carriers. In 1978, he helped shepherd through Congress the Airline Deregulation Act, which eliminated the federal government’s authority to set fares and made it easier for new entrants to fly routes dominated by the big carriers. These reforms revolutionized the airline industry, opening the way to an era of cheaper fares, discount airlines, crowded planes, and wage cuts for workers at legacy carriers. The philosophy behind airline deregulation was encapsulated in a remark of Breyer’s: “Why regulate something if it can be done better by the market?”42 After this marketfriendly philosophy was applied to the airline industry, administrations of both parties would gradually extend it to many other industries, including telecommunications, power generation, and finance—all of which had been heavily regulated during the postwar decades. The era of deregulation had begun.

★ ★ ★

In 1980, Friedman and his wife, Rose, created a ten-part PBS television series, Free to Choose, that, according to the journalist Thomas Edsall, was partly funded by a \$650,000 grant from the Scaife Foundation.43 A book that Friedman and Rose wrote to accompany the television series sold four hundred thousand copies in hardcover and was translated into seventeen languages. In it, the Friedmans expounded many of Milton’s old themes, including the claim that government regulation was almost always harmful and unnecessary. Among the federal agencies they criticized were the EPA, the Consumer Product Safety Commission, the Securities and Exchange Commission, and the Food and Drug Administration, which they claimed had “done more harm by retarding progress in the production and distribution of valuable drugs than it has done good by preventing the distribution of harmful or ineffective drugs.”44 The Friedmans cleverly presented their radical free market agenda as an effort to restore traditional American values. “We have been forgetting the basic truth that the greatest threat to human freedom is the concentration of power, whether in the hands of government or anyone else,” they wrote. “Fortunately, we are waking up.”45

It was this sort of language that had drawn Ronald Reagan to Friedman. Their relationship was a long-standing one. Friedman first met the former screen actor when he was serving as governor of California from 1967 to 1975. He met with Reagan during his failed 1976 presidential campaign and advised him in his successful 1980 bid. After Reagan entered the White House, he appointed Friedman to a panel of outside economic advisers who met with him occasionally. Friedman wasn’t involved with day-to-day policymaking, but he didn’t need to be physically present to exert his influence. The administration’s policy platform was the same as his: cut taxes, deregulate, weaken labor laws, and wherever possible, downsize the federal government. (The Pentagon budget was a glaring exception, of course.) In short, undo the postwar political settlement and promote free market capitalism. And Reagan retained warm feelings toward Friedman. His domestic policy adviser Martin Anderson later recalled: “He could just not resist Friedman’s infectious enthusiasm and Reagan’s eyes sparkled with delight every time he engaged in a dialogue with him.”46

★ ★ ★

As conservative economics and the deregulation movement were sweeping through the American political arena, a number of more skeptical economists were registering serious concerns. One of them was Hyman Minsky, of Washington University in St. Louis, who was an expert on money and banking. As a left-liberal whose immigrant parents were active in the labor union movement, Minsky disliked Friedman’s conservative policy recommendations for political reasons, but he also believed they were grounded in outdated economics. He was particularly critical of Friedman’s assumption that a capitalist economy, if left to its own devices, will gravitate toward a position of balance, or “equilibrium.”

Minsky believed that in a modern financialized economy such as that of the United States, businesses and financial institutions were incentivized to take on too much risk and too much debt, and this made the financial system very fragile. If it was given too much leeway—and the proponents of deregulation wanted to give it as much as possible—it was apt to blow up and plunge the economy into a deep recession, or even a depression. “This implies that policies to control and guide the evolution of finance are necessary,” Minsky wrote in a 1978 paper.47 His language was understated, but the argument was potentially devastating to the policy of deregulating the financial system, which had begun even before Reagan came to power, with the passage of the 1980 Depository Institutions Deregulation and Monetary Control Act. (The legislation removed long-standing caps on the interest rates that banks could pay on their customer accounts.)

Minsky, who died in 1996, sometimes described himself as a “financial Keynesian.” It would be equally accurate to call him an institutional economist, because he believed that economic theory was useful only if it could be applied to the actual institutions of a capitalist economy rather than the textbook versions. Rare among academics, he had firsthand experience of the banking system. After doing his undergraduate degree at the University of Chicago and completing his doctorate in 1954 at Harvard, where his first supervisor was Joseph Schumpeter, he taught at Brown and Berkeley. In 1965 he moved to St. Louis, where, in addition to teaching at Washington University, he began a long-standing association with the local Mark Twain Bank, eventually serving as a director. Throughout the 1970s, Minsky published various versions of his theory, which he termed “the Financial Instability Hypothesis,” before summarizing and restating it in his 1978 paper, which described it as “an alternative to the neo-classical synthesis, i.e., to today’s standard economic theory. It is designed to explain instability as a result of the normal functioning of a capitalist economy.”48

Minsky said his theory was in the spirit of Keynes, who also had firsthand knowledge of the financial industry. In a modern economy, he emphasized, there were two parallel structures: the business sector, which invested in buildings and capital equipment to produce things, and the banking sector, which lends money to business based on their expected cash flows. Standard economics textbooks concentrated on the production side of the economy. Minsky emphasized the availability of credit and how it changes over time. In the early stages of a business cycle, he pointed out, financial institutions tend to lend only to business projects whose cash flows are expected to comfortably exceed their financial commitments, including interest costs. Minsky referred to this safety-first setup as “hedge finance.” Unfortunately, it doesn’t last.

As the cycle proceeds and the prices of assets, such as stocks and real estate, rise sharply, Minsky explained, banks and other lenders lower their credit standards and start lending to ventures that generate enough cash to meet their interest payments but not their other financial commitments. These types of businesses need to roll over their debts on a regular basis to keep operating, Minsky pointed out. He called this type of arrangement “speculative finance.” It is obviously riskier than hedge finance, but it isn’t the final word in financial recklessness. Minsky said that variant arrives, typically late in the cycle, in the form of “Ponzi finance.”

At this stage, lending standards have deteriorated so much that banks extend credit to ventures that don’t generate enough cash even to pay their interest bills. This is lending on the basis of a wish and a prayer. As the ratio of speculative and Ponzi finance to hedge finance increases, the fragility of the financial system becomes increasingly evident, Minsky noted. If for any reason the supply of new credit dries up, perhaps because of a rise in interest rates or a fall in profits, the Ponzi businesses are forced to sell assets to raise cash, “only to discover that their assets cannot be sold at a price that comes even close to covering debts.”49 Selling begets more selling, asset prices collapse, and borrowers face even greater difficulties servicing their debts. “What has been sketched out is the route to a financial crisis,” Minsky noted dryly.50

When he wrote these words, he wasn’t well-known, and they didn’t have much impact. Unlike Friedman, Minsky wasn’t invited to the White House or featured in a PBS television series. But as the great experiment in deregulation unfolded and the financial sector was unleashed, his instability hypothesis would eventually be rediscovered.

“Any use of the natural resources for the satisfaction of non-vital needs means a smaller quantity of life in the future”

Nicholas Georgescu-Roegen and the Limits to Growth

During the postwar decades, all the major economic systems—Western capitalism, Soviet and Chinese Communism, and the hybrid model of stateled industrialization that many former colonies pursued—prioritized a high rate of economic growth and judged themselves by how effectively they achieved it. Any signs of faltering GDP growth were regarded as cause for alarm. “We have not in recent years maintained the 4 to 4½ percent growth rate which characterized the early postwar period,” the White House Council of Economic Advisers lamented in the aforementioned 1962 Economic Report of the President. “We should not settle for less than the achievement of a long-term growth rate matching the early postwar record.”1

The economists who wrote these words were Keynesians of the Harvard/MIT school, but the goal of maximizing GDP growth was shared by socialist planners, nationalist postcolonialists, and free market conservatives. The economic advisers at the Kremlin and the Lok Kalyan Marg in New Delhi believed just as fervently in eternal economic expansion as the Keynesians in the White House; so did the members of the University of Chicago’s economics department. “Economic growth is the grand objective,” the English economist Roy Harrod wrote in 1965. “It is the aim of economic policy as a whole.”2 Economists from many different schools shared a belief that the easiest and most effective way to increase human welfare and raise the poor out of poverty was to grow the economic pie. Socialists and liberals believed in sharing it out more equally; conservatives and supporters of the free market tended to be less concerned about distributive shares. Few economic policymakers anywhere queried the need to expand the size of the pie.

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In this ecumenical church of growth, the faithful viewed the GDP hockey stick as a settled feature of the modern world. The big debate among them was how to make it rise more steeply. It was generally agreed that poorer countries, if they mobilized unused labor and imported technology, could grow even faster than advanced countries for a time—a phenomenon known as the “catch-up” effect. The rate of expansion in rich countries was believed to be largely determined by the pace of technological progress. When economists looked at the seemingly endless stream of innovations that scientists had developed since World War II— space rockets, mainframe computers, fertilizers, miracle drugs and vaccines, to name but a few—most of them assumed that growth could continue indefinitely, especially if policies were put in place that encouraged scientific research and innovation.

Environmental concerns weren’t entirely absent from this consensus. There was a growing recognition that unrestricted economic development could have harmful side effects, such as ground and air pollution. In 1948 the US Congress had passed the Federal Water Pollution Control Act, and in 1955 it had enacted the Air Pollution Control Act. In 1963 the state of California had introduced its first emissions standards for automobiles. Thanks to the efforts of some pioneering writers, public opinion was shifting. In 1962 Rachel Carson published Silent Spring, which documented the harmful effects of toxic pesticides, such as DDT, that the chemical industry had claimed were safe. A year later Stewart Udall, the secretary of the interior in the Kennedy administration, published The Quiet Crisis, in which he declared: “America today stands poised on a pinnacle of wealth and power, yet we live in a land of vanishing beauty, of increasing ugliness, of shrinking open space, and of an overall environment that is diminished daily by pollution and noise and blight.”3

In issuing these warnings, Carson and Udall could draw on a long tradition of American naturism and civic activism. A young Benjamin Franklin had campaigned for the removal of tanneries from Philadelphia because of the toxic wastes that seeped into local streams and rivers. In 1864, George Perkins Marsh, a diplomat and philologist, published Man and Nature, a landmark work in which he cataloged how human activity had transformed parts of the natural environment, often with disastrous results. “Man has too long forgotten that the earth was given to him for usufruct alone, not for consumption, still less for profligate waste,” Marsh wrote.4 Among other things, he claimed that forest clearing and soil degradation had contributed to the decline of ancient Mediterranean civilizations. His widely read book helped create the modern conservation movement, which by the end of the nineteenth century had scored some significant victories, including the creation of Adirondack Park in upstate New York and the establishment of other national forest reserves in many parts of the country.

In Britain, too, going back to the nineteenth-century writers William Morris and John Ruskin, critics had pointed out the harmful side effects of capitalist development. Even inside the field of economics, some of these evils had long been acknowledged. In his 1848 textbook Principles of Political Economy, John Stuart Mill, a keen botanist, had referred to virgin land as “the original inheritance of the whole species” and lamented the prospect of it being appropriated as private property and filled with human development.5 In the 1920s Arthur Cecil Pigou, Alfred Marshall’s successor at Cambridge, had developed Marshall’s concept of externalities, or negative spillovers, to describe how some economic activities, such as smoke pollution, had harmful effects that weren’t fully accounted for in the price system. Pigou’s solution to this problem, which economists now refer to as “market failures,” was to tax polluters and disincentivize their harmful behavior. Other economists favored direct regulation.

During the postwar period, economists developed some new tools to deal with complex environment issues, such as cost-benefit analysis, which they used to evaluate the economic gains and losses, including the environmental impact, attached to any given development project, such as a new airport. Where economists and policymakers had come up short, or so their critics claimed, was in integrating these microeonomic techniques with their macroeconomic analysis, which largely proceeded as if environmental concerns didn’t matter, or, at least, as if they could be dealt with adequately through taxes and regulation. In the sixth edition of Paul Samuelson’s textbook on economics, which was published in 1964, the terms environment and pollution didn’t appear in the index.6 Neglect of environmental issues wasn’t restricted to the capitalist world. The Soviet Union was a major polluter. Per unit of GDP, according to a 1994 study, it generated 1.5 times as much pollution as the United States did.7 Russia’s post-Communist government acknowledged that roughly 40 percent of the country was under moderately high or high ecological stress.8

★ ★ ★

While East and West pursued the grail of growth, it was largely left to noneconomists to query its physical and theoretical underpinnings. One of the few heretics inside the economics profession was Nicholas Georgescu-Roegen, a strong-minded Romanian who had done his graduate work at Harvard under Joseph Schumpeter in the 1930s and subsequently taught at Vanderbilt University. In 1971, Georgescu-Roegen published The Entropy Law and the Economic Process, a sprawling tome that identified the rapid depletion of the earth’s stock of natural resources as a limiting factor in growth. It said: “The almost fabulous comfort … attained by many past and present societies had caused us to forget, however, the most elementary fact of economic life, namely, that of all the necessaries for life, only the purely biological ones are absolutely indispensable for our survival.”9 Although The Entropy Law and the Economic Process didn’t have much immediate impact on policy debates, it is now widely recognized as a founding text of ecological economics.

Georgescu-Roegen had a hardscrabble upbringing. He was born in 1906 in Constanța, an ancient town located on the Black Sea, about 140 miles east of Bucharest. “It was then an ethnic mosaic of Romanians, Greeks  … Germans, Jews, Armenians, Turks, Tartars, and a few Bulgarians,” he recalled in his old age. “Because the environment of my childhood was truly cosmopolitan, my ethos has remained so ever since.”10 Romania was an underdeveloped country full of impoverished peasants. Georgescu-Roegen’s family was a bit further up the social ladder: his father was a retired army captain; his mother taught needlework. Georgescu-Roegen obtained a scholarship to a military high school, where he rose to the top of his class and won a succession of national student prizes in mathematics. He went on to study mathematics at Bucharest University, where he again excelled. After graduating in 1926, he was awarded a graduate scholarship to the Sorbonne, in Paris.