Hasn’t the last year and a half been a horrible nightmare? Aren’t you sick and tired of our fallacious infatuation with the “free market”? Maybe we should bring back Glass-Steagall, reinforce Sarbanes-Oxley, create an uber-regulator for the financial services industry. Aren’t we all well and thoroughly sick of deregulation and privatization? Most of all, hasn’t capitalism shown us to a fare-thee-well that, left uncontrolled, it can all too easily run off the rails? What have we been thinking for the past couple of decades?
I mark this time because it was just over 30 years ago–May 4, 1979–that Margaret Thacher become Prime Minister of the UK, to be followed shortly thereafter as President of the US by Ronald Reagan, seen rightly in retrospect as cross-Atlantic twins as far as promoting the virtues of the free market and dragging down the curtain on the sad, sclerotic decade of the 1970’s (stagflation, depressing cardigan sweaters, and “malaise,” anyone?)
I’m reminded of this anniversary by Martin Wolf, writing in the Financial Times, who sums up what she did:
Mrs (now Lady) Thatcher entered office determined to reverse a national decline marked by high inflation, slow growth and trade union militancy. Her government emphasised monetary control, deregulation, particularly of the financial sector, flexible labour markets, and privatisation. The post-1997 Labour government did not overthrow these policies but built upon them. Labour increased public spending but not hugely: in 2007-08, expenditure was below where it had been under Mrs Thatcher until 1988-89. Labour also abandoned active fiscal policy, adopted inflation targeting, introduced central bank independence and welcomed the vigour of the financial sector.
Note the emphasis on “revers[ing] a national decline, … monetary control, deregulation particularly of the financial sector, … and privatisation.”
We also can choose to celebrate the anniversary of another systemic earthquake, the 20th Anniversary (last month) of the fall of the Berlin Wall.
Why are you reading about these momentous–but exhaustively analyzed–events on Adam Smith, Esq.?
Simply this: To provide a moment’s worth of perspective.
Since it has been 20 years since the Fall of the Wall, memory has clouded over what it represented: Very simply, the end of a 40-year experiment in which Germany, a First World Country by any measure, was divided in two economically, one region a market economy and the other centrally planned. Once the gap in living standards became so egregious, the experiment self-destructed.
John Kay, writing in the FT, reminds us of this, and reminds us, more importantly, of exactly in what the genius of the market economy consists. He cites three primary components, to which I would add a fourth:
- Prices act as signals for resource allocation.
- Markets promote innovation by adapting to change “through a chaotic process of experimention.” And
- Markets diffuse political and economic power. “This is the most effective way to protect society from rent-seeking – a culture in which the principal route to wealth is not creating wealth, but attaching oneself to wealth created by others.”
And the fourth, mine:
- Markets permit, enable, encourage, and all but insist upon individuals finding their own highest uses in society (the real meaning of the Invisible Hand, as I construe it). Few things contribute more highly to human happiness.
Scarred as we all are by the events of last September (2008, that is), we may be tempted to retreat to the faux security of command and control by the best and brightest. Don’t go there; don’t even be tempted to go there.
The market excels not just at creating and spreading new ideas, but at getting rid of failed ones. As John Kay puts it:
Disruptive innovations most often come to market through new entrants [and] from unpredicted sources. If you had been planning the future of the computer industry in the 1970s, would you have asked Bill Gates and Paul Allen? If you had been planning the future of retailing in the 1990s would you have asked Jeff Bezos? Of course not: members of the politburo, cabinet or large company board would have consulted grey men in suits like themselves.
Markets are not a well-oiled machine: they are a constantly changing, adaptive biological system. Pluralism is their motive force, their essence chaotic, their development inherently uncertain. If we could predict the evolution of markets, we would not need markets in the first place.
To tie this to reality, this week the always-worthwhile Economic Principals, concidentally, has a tour de force recap of the nascent venture capital industry, starting in Boston immediately after World War II, which begins:
“It is hard to describe how quickly attitudes changed in Great Britain in the wake of the Thacher Revolution. It was as if a oppressive shroud had been removed.”
After noting that Deng Xiaoping did more or less the same for China, only perhaps on a greater scale, he hits his stride:
Of course New England businessmen were scrambling up “the value chain” for three centuries before the term would be invented. None knew where it led. But from cod to candy, from slaves and opium to ice and stone, from railroads and telephones to electricity and radio, merchant traders and manufacturers in Boston understood that the essence of competitive advantage was that it didn’t last.
Now we’re getting to the heart of how markets work.
Out of the shockingly tiny world of Boston-centric venture capitalists came, in the space of a short career:
- American Research and Development Corp., which merely sired Digital Equipment Corp.;
- Greylock Partners;
- TA Associates;
- Arthur Rock (West Coast, but who went to school on the Boston gang, with Fairchild Semiconductor and Intel to his credit);
- And just a few other Boston-funded startups including FedEx, Cablevision, Wang, and Biogen.
What about Silicon Valley?
Following is more commentary from the same Economic Principals piece upon the recently published A Vision for Venture Capital: Realizing the Promise of Global Venture Capital and Private Equity, by Peter Brooke:
But Brooke’s book is equally interesting, about, for instance, about the difference between Boston and California. East Coast lenders didn’t know much about technology, at least in the early days; they were generalists, not technologists. They took a portfolio approach, emphasizing diversification and limited appetite for risk, preferred companies that had a revenue base and were moving towards profitability.
The West Coast guys were not averse to supplying seed capital and early stage financing, all part of the pioneer spirit. “They were good at what they did, and gained an edge that they have never relinquished.” That said, Brooke continues, technological savvy will take an investor only so far. It’s still essential to know how to identify market opportunities, size up entrepreneurs and develop relationships “in which information and ideas flow freely.”
These skills are not easy to acquire, he says, but those who possess them can add substantial value, “even without knowing everything there is to know about a particular product or technology.” Harvard and MIT: it was ever thus.
The whole second part of Brooke’s book is an extended meditation on changing styles of venture finance, meaning mostly startups, usually high tech firms, and private equity, meaning restructuring large public companies through buyouts. The same skills are required at either end of the spectrum, he says, but emphases differ.
On the manner in which today’s financiers have insulated themselves from risk at the expense of their investors, he quotes [Tony] Perkins [co-founder of the legendary Kleiner Perkins] approvingly: “Today I stand in awe of the way the managing partners of some of the huge buyout funds reward themselves; fees for raising the fund, fees for managing the fund, fees for doing the deals within the fund, and profit participation for individual investment, whether or not the overall profits are achieved.”
Why do I focus on what may now seem like old news? I mean, Fairchild Semiconductor and Wang, for heaven’s sake?
Again, perspective: These firms were enormous drivers of economic growth in their day, and even though both ultimately failed (news flash–most firms do), the way we work today and our overall economy would be fundamentally poorer without them and their kind.
What, then, has this to do with Thacher and Reagan and the free market?
Simply this: Let us not lose faith.
All things considered, I believe that free market capitalism has done more to promote the quality of life of more human beings than any non-theological belief system in the history of mankind.
And even after all the Sturm und Drang we’ve been through since September, 2008, here’s a telling graph comparing the growth, from the start of 1991 through the third quarter of 2009, of the US and other major world economies:
So if you think the Thacher/Reagan era of deregulation and its aftermath was a misguided detour, think again. To recap:
- US up 63%
- Canada 60%
- UK 48%
- France 35%
- Germany 22%
- Italy 19%
- Japan 16%
Finally, if you think the Asian tigers are overtaking the US, here, courtesy of David Brooks in today’s NYT, is an incontrovertible rebuttal: In 1975, US GDP amounted to 26.3% of world G.D.P. The US share today? 26.7%.
The genius of the free market, present and potent since before (yes, even before) Adam Smith, is not to be gainsaid.
