Since the fall of the Berlin Wall, much ink has been spilled on the virtues of capitalism. Last year, Andrew Bernstein of Pace University capitalized on this momentum by issuing a declaration “On the Principles and Possibilities of Capitalism.” Written to rebut the Marx-Engels Communist Manifesto, the Bernstein Declaration asserts, “Capitalism is the only social system in which individuals are free to pursue their rational self-interest, to own property and to profit from their actions.”
In the Bernstein construct, capitalism is synonymous with free markets where a large number of sellers and buyers interact, and none has any influence over the price at which goods and services are bought and sold. Such a situation constitutes the case of “perfect competition,” which is found in textbooks on economics, and nowhere else. In most modern economies, a few large firms dominate major industries. There is limited freedom of entry, and these large firms often have the power to set prices.
In his seminal work on Capitalism, Socialism and Democracy, the late economist Joseph Schumpeter wrote that capitalism couldn’t survive, because “its very success undermines the social institutions which protect it, and ‘inevitably’ creates conditions in which it will not be able to live.” A notable failing of capitalistic societies is that they promote an unequal distribution of income, in which the rich get richer and the poor get poorer.
The ideologues of capitalism only dwell on its virtues, and ignore its problems. Thus, they do not talk about the problems of “crony capitalism” that brought about the Asian financial crisis of 1997. Nor do they discuss Japan’s decade-long spell of economic stagnation. They look past the dot-com bubble that burst in the US in the spring of 2000 and the wave of corporate scandals that began with Enron and WorldCom and ultimately touched dozens of American companies. None of these events register with them.
When Fed Chairman Alan Greenspan raised interest rates a few years ago to restrain what he dubbed the “irrational exuberance” of investors, the defenders of capitalism accused him of destroying $400 billion of wealth. There was nothing wrong with the American economy, they asserted. Growth was strong, corporate earnings were up, inflation was down and job creation was robust.
The year 2000 was a banner year for capitalism. On January 14, the Dow Jones Industrials Index reached 11,728. On March 10, the Nasdaq hit 5,049, “knocking aside valuation, interest-rate and psychological barriers like tenpins.” Since many investors feared that the bubble would burst, Wall Street analysts put out rosy forecasts of economic growth, seeking to assuage investors that bull markets don’t falter in a sound economy.
The stock market has now declined three years in a row, something that last happened when the Axis powers were over-running the planet. It is worth noting that the S&P 500 Index dropped by 23 percent in 2002, exceeding the 13 percent drop in 2001 and the 10 percent drop in 2000. It is falling at an increasing rate. Over the past three years, the S&P Index has lost 40 percent of its value. The more narrowly focused Dow Jones Index has lost 28 percent of its value, while the high-tech Nasdaq has lost 67 percent. First to fall were the Internet stocks, then came the established companies. General Electric and Microsoft are down more than 50 percent off their highs, IBM is down 40 percent and Cisco is down more than 80 percent. Overall, investors are poorer by $6 trillion.
The stock market is at the heart of the capitalistic economy, and it is not possible to dismiss its travails as not being a predictor of the real economy. The market creates its own “economic weather” through the wealth effect. As stocks rise or fall, the 80 million Americans who own stocks feel richer or poorer. Ultimately, this affects their consumption decisions, particularly of big-ticket items such as appliances, furniture, cars and homes. Consumer spending accounts for two-thirds of the US GDP, and has a significant impact on it. Thus, it is not surprising that Wall Street’s decline in March 2000 foreshadowed the recession that came in the first quarter of 2001. In 1982, a powerful stock rally accurately foretold an economic recovery.
Consumer spending is stalling. Retail sales during the holiday season, typically accounting for 40 percent of annual sales, were down by 11 percent compared to last year. Consumer confidence fell in December, according to the widely used index of the University of Michigan. The number of people on welfare rose in three-quarters of the states last summer. This is in contrast to the striking decline that swept the US in the mid-late 1990s when the economy was booming. Unemployment forecasts for this year stand at 6 percent, with some economists predicting 6.5 percent by the spring.
Jeremy Siegel of the Wharton School says that the Fed, which has dropped short-term interest rates to 1.25 percent, should work with the Treasury to reduce long-term rates. However, he admits that it is “is possible that even lower long-term rates will not stimulate the economy. After all, Japanese long-term bonds are currently below 2 percent and Japan is still in an economic slump.”
The US current account deficit equals 5 percent of GDP, and has been sustained by the desire of non-Americans to invest in the US. However, the inflow of capital has slowed down, causing the trade-weighted dollar to go down some 9 percent since February.
Notwithstanding these sobering developments, the Wall Street Journal opines that 2003 will be a year of accelerating growth. It says that historians may find the last three years are merely a pause in the economic renaissance of the past 20 years, and has labeled the US as the “economy of the year.”
Capitalism is in crisis, not just in America. On a global basis, world trade fell by 1.5 percent in 2001, the first such decline since 1982. It grew by a slim 1 percent in 2002.
The problems of capitalism are structural in nature. CEOs remain focused on quarterly earnings reports and with pumping up share prices. Jeffrey Garten, dean of the Yale school of management, says, “it would be an important turn of events if the administration and business leaders took a longer and broader view of the policies that would stimulate economic growth and strengthen our free market system.” But Garten concedes this is unlikely to happen any time soon. Andrew Bernstein and the editors of the Wall Street Journal would do well to dust off their Schumpeter to find out why.