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that Changed the World

Capitalism - Big Ideas

That Changed The World

Capitalism

Joseph Stiglitz

New York city is the epitome of capitalism, an idea that connects it to businesses and people across the globe and affects every waking minute of our lives.

Joseph Stiglitz, a Nobel Prize for Economics winner and top economic adviser to President Clinton, should be fully in favour of capitalism, but he isn't. While he recognises capitalism as the only practical way to run an economic society, he is worried about a particular brand of free-market capitalism that is being promoted around the world.

To understand the risks of global economies we need to trace the idea of capitalism itself, and where better to do this than in New York. From the very first settlers, who bartered and traded in Soho, to the high-finance trading on Wall Street, we see a history of huge growth and the creation of massive wealth. New York symbolises all that is great and all that is deplorable about capitalism.

The Greeks first cut metal into coins and invented money, and it is money that has remained at the heart of capitalism ever since.

So, what is capitalism? To understand this we have to understand the market. What is the first thing we see in the market? The prices! But who sets these prices? We all do, through the law of supply and demand and with competition.

Adam Smith

Ever since the Greeks, people have wondered what the motive, that drove this system, might be. Some businessmen like to claim that it was altruism that drove them to create wealth, some thought the system was so perfect that God must be behind it, but then a Scotsman came up with a much more sobering insight. Adam Smith was the first person to try and really understand how the capitalist system works. Smith's book "The Wealth of Nations", was first published in 1776, the same year as the American Declaration of Indepedence. Even as an American, it is not easy to say which is of greater historical importance. The declaration sounded a call for a new society dedicated to "Life, Liberty and the Pursuit of Happiness". Adam Smith explained how the economics of this society would actually work. For the first time in history industry, business and commerce were taking place on a massive scale.

Smith realised that certain things allowed this to happen. Things like the rule of law, the nation state and banks and institutions created the conditions for a thriving market. These factors gave people confidence to invest their money and to trade.

But, there was something even more mysterious, something Adam Smith called the invisible hand and explains this in his quote:

"While every individual was working for his own labour he intends only his own gain and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention, that is the well-being of society as a whole."

Adam Smith's work has been used to back unregulated markets ever since it was first published. But, in fact, it is full of warnings. "capitalism" he said "doesn't just generate wealth, it could create huge inequality, making some very rich and others very poor".

At the turn of the 19th century, one of the biggest and most important changes in human history began. The competition amongst young entrepreneurs fuelled innovation, this led to investment in new technology, enabling the modern industrial economy. As factories sprang up, labourers, in their millions, moved from farms to cities. Money was driving the most rapid social changes humans had ever seen, transforming landscapes and the way they lived. It was in the United States, with no aristocracy and no class system, that the entrepreneurial spirit would truly flourish.

The capital that built up in London made possible the growth of the British Empire. As the Empire grew, capitalism spread to all parts of the world. Britain protected it's own interests and forced trade on it's terms, and in doing so, imposed a trading system that was far from free. The legacy of these inequalities and hypocrisies remains with is today.

In an attempt to protect this trade and trade routes, economic competition grew into something worse. The 1st World War, while not caused by this colonial protectiveness, was certainly exacerbated by economic competitiveness.

On 23rd Oct 1929 everything seemed fine. In fact, one top American investor said "Now is the time to invest". How wrong could he have been. On Oct 24th 1929 a sudden loss of investor confidence sparked the famous Wall Street crash which brought about the great depression. The average share price had peaked at 386.1 on 3rd Sep 1929 and by 8th July 1932 it had collapsed to just 40.56. This brought on a loss of confidence in capitalism itself.

Industrial production in the United States almost halved in the three years following the crash. Adam Smith had said "people all working in their own self-interest would make the market efficient", but the situation at this time was far from efficient. Smith's model was clearly wrong.  For the first time it seemed that there was a flaw in the system of capitalism. The meltdown of the US economy was to be repeated throughout the world with every capitalist nation experiencing problems with recession, depression and unemployment. The forces that this unleashed would prove unpredictable, and in one country in particular it would lead to desperate measures and catastrophe. Adolf Hitler rose to power on the fallout of the depression and he ruthlessly exploited the disaffection  with capitalism. Poverty led, ultimately, to World War II.

Hitler would eventually be defeated and the future of capitalism was ensured, but communism, the opposite of capitalism, would oppose the west for the next 50 years.

Capitalism had to evolve and institutions like The World Bank, The International Monetary Fund and The World Trade Organisation were created in the 1940's to ensure the rational, smooth functioning of a complex, global capitalist system. Within western nations, economic policy changed radically, and welfare states were created to protect those people in society who would, otherwise, fall foul of the dynamic market.

In the quarter of a century since World War II, the economics of America and the west enjoyed remarkable growth, economic conditions were stable, unemployment fell and the standard of living rose immeasurably. This success, through the 50's and 60's, was an experiment in managed capitalism. For a time it seemed the experiment might be permanent, but, it wasn't to be. By the 1970's something was going wrong. A new combination of recession and inflation had appeared.

Economists differed on what the real cause of the problem was. Some argued that it was largely the result of quadrupling oil prices, others that the economic strains of the Vietnam War unbalanced the global economy, Certainly, the war in Vietnam highlighted how the capitalist system could be affected by political and social events.

In the UK this period, of recession and inflation, led to falling living standards which provoked unions into strikes which culminated in the so-called Winter of Discontent when the country ground to a stand-still. In the United States, inflation reached record highs, it appeared that a radical approach was needed, and it arrived in the shape of an iron lady and a Hollywood movie star.

 

The Rich versus The Poor

Margaret Thatcher and Ronald Reagan had a bold new plan for the world economy. They believed they could return the global economy to a form of free-market - unregulated capitalism. This, they said, would release the enterprise of individuals.

During the 80's people were encouraged to make as much money as they could for themselves. A type of free-market was revived by rolling back the state. Governments said they would not interfere with the running of the market. The power of the unions was drastically reduced and public service industries and services were returned to the market place through privatisation.

The natural markets were deregulated and for a while, as before, it seemed to work. The economies of the UK and the United States ame back stronger than ever. It seemed too good to be true, and it was.

The free-market approach created enormous wealth, just as that early pioneer of free-markets, Adam Smith, had said it would do. But what the proponents of free-markets conveniently forgot, were his warnings. He said that free-markets inevitably led to inequalities and that's exactly what happened. Most of the wealth created went to a small percentage of the population, it created an even greater divide between rich and poor. As markets were freed up they became more volatile. In the UK there was turbulence in the financial markets which culminated in the collapse of the pound on Black Wednesday in 1992. In America too, the late 80's and early 90's were marked by financial scandals which contributed to a full-scale recession. The free-market had run it's roller-coaster course. Thatcher and Reagan had failed to learn the lessons from the past.

And what of capitalism's historical rival? The fall of the Berlin wall indicated the end of the cold war. It soon became clear that the people of the former Soviet Bloc wanted the same opportunity to generate wealth and prosperity that we enjoy in the west. Communism, it would seem, could not stay the course either.

 

CREDITS: All of the above information was taken from the UK's Channel Five series "Big Ideas"