Capitalism’s Crisis Within, and How Larry Summers Still Doesn’t Get It

It’s strange to think that, while attend­ing a recent con­fer­ence of some of the most illus­tri­ous names in eco­nom­ics and finance, the talk of the 2008 mar­ket implo­sion actu­ally trans­ported me back to east­ern Europe in the years before and soon after com­mu­nism fell.

When lis­ten­ing to the many ways that eco­nomic dogma has diverged from eco­nomic real­ity, it began to seem as if cap­i­tal­ism, like com­mu­nism, was a sys­tem that had rot­ted from within. The con­fer­ence, held in the iconic set­ting of Bret­ton Woods, New Hamp­shire, was orga­nized by the Insti­tute for New Eco­nomic Think­ing. INET is backed by bil­lion­aire financier and phil­an­thropist George Soros, some­one with inti­mate knowl­edge of com­mu­nism and its many cor­rup­tions. The mes­sage from some at INET seemed to be, if cap­i­tal­ism is to thrive, it needs to be saved from itself and its most ideologically-hardened practitioners.

Among those prac­ti­tion­ers are the free mar­ket econ­o­mists at pres­ti­gious uni­ver­si­ties and insti­tu­tions whose pre­dic­tions have been so wildly off the mark, and the finan­cial wiz­ards who espouse the ideals of cap­i­tal­ism but have actu­ally twisted and com­pro­mised those ideals at trad­ing desks and board­rooms across the world. As they sold the con­ven­tional wis­dom that a ris­ing tide lifts all boats, the real­ity is that most of us have been pushed under water by a wave of surg­ing income and wealth inequality.

Prince­ton eco­nomic his­to­rian Harold James believes that trust in eco­nomic pre­dic­tions has been bro­ken, and it’s not hard to see why. In the free mar­ket utopia, mar­kets are sup­posed to allo­cate effi­ciently, self-correct, and bring ever greater pros­per­ity to all, if only reg­u­la­tors would get out of the way of ratio­nal finan­cial actors. But just as in that other, now-discredited utopian sys­tem (com­mu­nism), the ide­ol­ogy and the real­ity had lit­tle con­nec­tion to each other. What we have seen in the dis­as­ter of the past few years is that get­ting out of the way allowed a small frac­tion of the elite to get very rich by mak­ing extremely risky bets. In my view, they used what I call shadow, or unreg­is­tered, lob­by­ists to shape and keep gov­ern­ment poli­cies to their lik­ing. And when their luck turned, these “free mar­ke­teers” sought and got gov­ern­ment help. So much for “get­ting out of the way.” And wel­come to the era of moral haz­ard, a threat which, Soros said, now “looms larger than ever before.”

Where exactly have econ­o­mists gone wrong? A screen that served as a back­drop for one INET ses­sion put it well: chalk it up to “arro­gance and its igno­rance.” First there’s a faith in the inher­ent sta­bil­ity and resilience of finan­cial mar­kets, which, of course, is amply dis­cred­ited by recent history.

Then there’s the tyranny of the math­e­mat­i­cal mod­els favored by so-called “mar­ket fun­da­men­tal­ists.” As James points out “.…cal­cu­la­tions about likely risks.… are ter­ri­bly.… mis­lead­ing. If we think there’s one-in-a-1000-year chance of some­thing hap­pen­ing, we’re inclined to ignore it. But then we find sud­denly that these one-in-a-1000-year chances.…seem to be hap­pen­ing every 10 minutes.…”

Eco­nomic mod­els also can’t truly account for, as Soros pointed out, the uncer­tain­ties that, by def­i­n­i­tion, can­not be quan­ti­fied. Nor can they model irra­tional­ity. Polit­i­cal eco­nom­ics (a field often derided by main­stream eco­nom­ics) got some of its due at the meet­ing among those who hope to cap­ture the real­ity of how mar­ket sys­tems actu­ally work. That would mean at least try­ing to account for the unruly human fac­tors that com­pli­cate any pre­dic­tions and/or pol­icy prescriptions.

There’s the igno­rance of econ­o­mists who mis­take con­cepts for real­ity, accord­ing to Berke­ley econ­o­mist and Nobel Lau­re­ate George Akerlof. He says the mis­take is in treat­ing con­cepts like the pro­duc­tion func­tion or util­ity func­tion as a thing that is sta­ble with­out con­sid­er­ing the con­text in which it is applied.

And finally there is the zeal­ous devo­tion to the idea of broad eco­nomic growth cre­at­ing pros­per­ity for all. This mar­ket dogma has dri­ven eco­nomic (often dereg­u­la­tory) pol­icy for decades under both Democ­rats and Repub­li­cans. You could say that it has a sort of par­al­lel in the cor­po­rate world where CEO’s say that their pri­mary goal is to max­i­mize share­holder value. These ideals might be worth­while if they actu­ally deliv­ered, but they haven’t. As INET speaker Uni­ver­sity of Massachusetts-Lowell Pro­fes­sor William Lazon­ick pointed out, CEO’s have used stock option manip­u­la­tions to keep deliv­er­ing rewards to exec­u­tives under the guise of “max­i­miz­ing share­holder value.” Aver­age stock­hold­ers mean­while are still reel­ing from the losses of 2008. This recalls the asset-stripping in Rus­sia that occurred after com­mu­nism fell, with U.S.-sponsored eco­nomic “reforms” often pro­vid­ing incen­tives to those doing the strip­ping. A cru­cial patron of those “reforms” was then-Treasury offi­cial Larry Sum­mers, who gave a keynote at the conference.

And in terms of the broader econ­omy, the focus on growth has been a boon for power bro­kers and the already-wealthy, and a bust for nearly every­one else. Uni­ver­sity of Massachusetts-Boston polit­i­cal sci­en­tist Tom Fer­gu­son laid a lot of the blame for income inequal­ity on the fact that reg­u­la­tors can now rou­tinely walk out the door and make some­times mil­lions as one of the reg­u­lated: “in effect it turns gov­ern­ment agen­cies into recruit­ing agen­cies for the regulated.…there’s a point beyond which sheer inequal­ity destroys a [demo­c­ra­tic] polit­i­cal sys­tem.…” U.K. finan­cial reg­u­la­tor Adair Lord Turner also attacked the inequal­ity issue, sug­gest­ing the time has come to ques­tion whether a sin­gle­minded focus on over­all growth should shift to goals of sta­bil­ity and cri­sis prevention.

While Turner struck a reflec­tive tone, one of the most impor­tant eco­nomic pol­icy play­ers shap­ing the envi­ron­ment lead­ing up to the finan­cial crash did not. For­mer Trea­sury Sec­re­tary and avid dereg­u­la­tor Larry Sum­mers said he wasn’t con­vinced finan­cial “inno­va­tion” caused the cri­sis, a con­ve­nient nar­ra­tive for some­one who allowed exotic deriv­a­tives to grow unchecked under his watch. (And a bit hard to square with what he said last year on PBS when asked if he had any respon­si­bil­ity for the crash. He said that credit default swaps were “the cen­ter of the issue now,” and this finan­cial inno­va­tion “barely existed [dur­ing his tenure at Treasury.]”)

He also warned against the demo­niza­tion of main­stream eco­nom­ics by peo­ple who “don’t do math,” and flagged the dan­gers of over­reg­u­lat­ing in the wake of a cri­sis. Sum­mers sug­gested that a cri­sis men­tal­ity is what led Com­mu­nists to cre­ate a planned econ­omy, which even­tu­ally col­lapsed. To my ear, Sum­mers him­self sounded not unlike com­mu­nist author­i­ties who deflected blame by sim­ply deny­ing hav­ing agency or author­ity, and strik­ing a dis­in­ter­ested, dis­tanc­ing voice. By the way, in that PBS inter­view, he said the word “mis­takes”, “error” or “fail­ure” five times, with his fin­ger pointed not at him­self but squarely at Wall Street and cor­po­rate Amer­ica. Arro­gance and igno­rance, meet eva­sion and avoidance.

By Janine Wedel. Linda Keenan edited this column.

Pub­lished in The Huff­in­g­ton Post, April 21, 2011.

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