Why Capitalism Fails

by Stephen Mihm - September 13th, 2009 - Boston Globe

Since the global financial system started unraveling in dramatic fashion two years ago, distinguished economists have suffered a crisis of their own. Ivy League professors who had trumpeted the dawn of a new era of stability have scrambled to explain how, exactly, the worst financial crisis since the Great Depression had ambushed their entire profession.

This is an intriguing article by a person who is clearly an enemy of capitalism and free enterprise. You can tell that by a single sentence from the article, "In his writings, Minsky looked to his intellectual hero, Keynes, arguably the greatest economist of the 20th century." Actually, Milton Friedman pretty much superseded the thinking of Keynes. Anyone who still thinks of Keynes as "the greatest economist of the 20th century" is not up to speed. You will note, the writer of this article never even mentions Friedman. This antipathy to Friedman is typical of anti-capitalists who favor the socialism of Keynes.

I have a lot of problems with much of economic theory. As people like Schumpeter has noted, it is a messy process. Never so messy as when it discards rational history for Utopian perfection. However when someone writes an article titled "Why capitalism fails", you have to expect a bias in their writing. Certainly the history of America is proof that capitalism, whatever its imperfections, is a better solution in the long haul than any other system that has been proposed. Europe is a pretty good example of socialism. The key complaint about capitalism is it cannot guarantee full employment. Yet the socialism of Europe consistently has unemployment twice as high as America.

What supporters of capitalism often ignore is that there is a role for government in capitalism. The reality of competition is that ultimately there will be a single winnereven when the players do not cheat. That is called a monopoly, and capitalism has self destructed. Unfortunately that is the primary role of Wall Street in our modern system. As noted in this article, Minsky is right. Capitalism has inherent in it the elimination of risk when it stops funding new companies and only funds mergers and acquisitions. That leads to asset bubbles that bring the system down when the bubble bursts.

However we have to acknowledge that issue mentioned above, cheating. Capitalism doesn't work for the people unless it is fair competition. This gives a second powerful reason that government must play a role in capitalism. However that role must not pick winners or allow for monopolies. However we have evolved into a system that is not effectively resisting cheating or fraud based bubbles.

We have observed this problem in the last 20 years with the Internet, Real Estate, Banks and Insurance. That does not mean we abandon capitalism. We simply need to stop bailing out the failures and provide some more orderly mechanism to deflate the bubbles. Unregulated laissez faire capitalism is not the answer.

Ronald Reagan unleashed small business and created 20 years of growth. Clinton and Bush tried to unleash big business and created a rapid series of bubbles and busts. There are some important lessons in that pattern.