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Capitalist Cure

How to save the free market from big business and big government
Luigi Zingales

In 1934, University of Chicago economist Henry C. Simons published a seminal policy pamphlet titled A Positive Program for Laissez Faire. An early leader of the so-called Chicago School of economics, Simons laid out in this short but dense work a series of reforms aimed at rehabilitating a free-market liberal economic order in the United States.

Simons began by noting the grave threats to liberty and democracy posed by the challenges of the Great Depression and the political responses to it. Indeed, A Positive Program was the product of a classical-liberal mind petrified by what could happen in a world in which capitalism and freedom were under siege: “the future of our civilization hangs in balance,” Simons wrote.

He fleshed out his argument in two steps. First, he diagnosed the overarching problems afflicting America’s economic and political systems. Perhaps surprising for a Chicago economist who influenced Milton Friedman and George Stigler, Simons considered monopoly to be foremost among these afflictions: “the great enemy of democracy is monopoly, in all its forms,” he argued, while the “existence of competition … serves to protect the community as a whole and to give an essential flexibility to the economy.”

Simons also fingered government as a major part of the problem. He argued that the state failed to meet its responsibilities in the area of money, harmfully interfered with prices, and was ineffective in maintaining market competition. Most radically, Simons thought government was not doing enough to diminish inequality of power and income.

His second step was to offer a reform program with specific “drastic” policy proposals. He called for the “elimination of private monopoly in all its forms” and the preservation of a competitive order through a heavy dose of government power. This included strict limits on corporations and even “direct government ownership and operation of all industries where competition cannot be made to function effectively as an agency of control.” Less radically and more like the Chicago School economists who would follow him, Simons also called for banking and tariff reform, as well as rules limiting discretion over monetary policy. Finally, Simons—quite illiberally—advocated restrictions on advertising and the use of progressive taxation and redistribution to reduce inequality.

Fast forward to today, and we see another Chicago economist, Luigi Zingales, confronting another economic crisis and likewise trying to put capitalism back on the right path in his book, A Capitalism for the People. The similarities between Simons and Zingales do not stop there. In fact, Zingales’s philippic against the early 21st century’s economic and political trends—including growing income inequality—and in favor of competition over monopoly frequently calls to mind the older Chicago tradition that Simons represented in A Positive Program.

Unlike his predecessor’s, Zingales’s reform measures are far more consistent with the tenets of a free society. In recognizing the danger of bigness—especially big business tied to big government—while hoping to meet the threat with greater respect for markets and freedom, Zingales fuses many of the best parts of the “old” and “new” Chicago Schools.

He begins his positive program with a touching personal expression of what motivated him to join the effort to rescue capitalism and freedom. In short, Zingales did not want the United States to turn into his home country—Italy—with its disabling crony capitalism, something he saw taking root in American finance. So Zingales, a “strong believer in the free-market system, who loves America for what it has always stood for: freedom in the pursuit of happiness,” decided to enter the fray.

A Capitalism for the People is divided into two sections. The first identifies and discusses our ailments, especially the “cancer of crony capitalism” and growing inequality. The second part lays out remedies that can fight these problems before they metastasize.

Zingales starts by explaining that Americans have been and remain exceptionally positive towards capitalism—hence his lingering hope for turning things around. That pro-market attitude is partly due to our continuing belief that rewards and responsibilities should be assigned based on merit and that capitalism accomplishes this to a great extent, when functioning properly. However, for Zingales, “the benefits conferred by meritocratic capitalism are neither as great nor as widespread as they once were” and “this change weakens political support for the market system.” What is most destructive of pro-market sentiment, according to Zingales, is when people believe the system is “rigged.” Enter crony capitalism and the people who thrive off it.

Zingales proceeds to expose the extent to which the American system, especially its financial institutions, has become perverted by cronyism and is less and less cleansed by the forces of competition. He details how the financial system became more concentrated and more politically influential. As businesses in general have grown in power, the result has been a broken system in which corporations and politicians—assisted by well-connected lobbyists—collude to create a “bailout nation” addicted to rent-seeking and averse to real competition.

Of course, the increased size and scope of government spending and regulation only further incentivize businesses and other organized interests to “ask for favors.” Academics are not exempt from Zingales’s criticism, as he warns that they too can be influenced or pressured by business interests rather than serving as beacons of unbiased truths. These things undermine citizens’ trust in both the public and private sectors.

Is there a solution to this collectively suboptimal but often individually rational activity? Zingales thinks the problem can be solved—and without “massive government intervention, which would interfere with economic freedom and suppress growth.” His solution relies instead on a counterintuitive combination of populism (American-style, and thus pro-free-market) and the power of competition.

Zingales focuses on education as an antidote to the increasing inequality that accompanies globalization. Unfortunately, as he points out, “perhaps the most destructive cronyism that uses lobbying to extract money from the American people in exchange for a product that doesn’t meet their real needs is in the public school system.” Sounding a lot like his fellow Chicagoan, Zingales repeats Milton Friedman’s argument for publically funded school vouchers as a means to increase equality of opportunity. He adds the twist that there should be “higher-value vouchers for people who start from less privileged conditions” and “match-specific vouchers” to incentivize good schools to “rescue poorer-performing students at risk.” To allow individuals to take risks and invest in themselves “when the consequences of failure are very harsh,” Zingales also supports a safety net of forgiving bankruptcy laws, unemployment insurance, and job retraining.

Zingales wants to reinvent antitrust, with regulators focusing not just on the economic advantages of mergers but the political consequences that arise from large corporate combinations. Where the political results would likely be “welfare-reducing,” Zingales would have the government prevent such mergers or limit the lobbying those corporations can engage in. As he admits, “This would be a radical departure from the status quo”—indeed, one reminiscent of Simons’s anti-monopoly program. Further steps he recommends to revive a competitive market include better balancing our patent and copyright regime, empowering shareholders in corporate governance (even by quotas), and enacting progressive taxation on corporate lobbying.

He supports a number of other critical institutional reforms to the tax and finance system: simplifying corporate taxes, ending expiring tax provisions, applying legal rules to the government (which creates them in the first place), instituting a reward system for whistleblowers, and increasing data transparency through disclosure requirements. Financial regulation, he says, should be parceled out to three agencies, each responsible for meeting only one key goal: price stability, protection against fraud and abuse, and system stability. Zingales disapproves of using the tax system for “massive” redistribution of wealth and income. Instead, he favors Pigouvian taxes (which “correct distorted incentives”), such as levies on lobbying or on potentially destabilizing short-term debt.

With all of these reforms, Zingales desires simple rules rather than complex ones that invite chicanery—thus, despite the economic arguments against separation of commercial and investment banking, he favors such simple designs as Glass-Steagall.

Unlike many economists, Zingales looks beyond institutions: he also wants to use ethical and social norms to promote positive economic and political change—for example, to buttress the beneficial effects of a lobbying tax through the development of taboos against “unacceptable” lobbying. He advocates using the power of public shaming to promote self-regulation. In this way, “opportunistic actions that are detrimental to society at large” will be less incentive-compatible. He calls on business schools to teach and reward good behavior among their students and alumni. Where these efforts fail to contain voracious corporate lobbying efforts, he proposes using the proceeds from the lobbying tax to support, in effect, the lobbying activities of “diffused interests.”

A Capitalism for the People follows right in the footsteps of A Positive Program. Both highlight the danger bigness and monopoly pose to our political system, not just to economic efficiency. Simons declared early in his work that “political liberty can survive only within an effectively competitive system” since “If the organized economic groups were left to exercise their monopoly powers without political restraint, the result would be a usurpation of sovereignty by these groups—and, perhaps, a domination of the state by them.” Likewise, Zingales argues, “In a socialist economy, the political system controls business; in a crony capitalist system of this kind, business controls the political process. The difference is slim: either way, competition is absent and freedom shrinks.”

Both economists think intellectuals have a special role to play in preserving a liberal order. Simons notes that “The precious measure of political and economic freedom which has been won through centuries may soon be lost irreparably; and it falls properly to economists, as custodians of the great liberal tradition out of which their discipline arose, to point the escape from the chaos of political and economic thought which warns of what impends.” Similarly, Zingales holds that business schools should be “churches of the meritocratic creed” and “frown on behavior that we recognize as detrimental to the long-term survival of the free-market system.”

As for solutions, both favor government “establishing and maintaining effectively competitive conditions in all industries where competition can function as a regulative agency,” as Simons argued. And the two economists share a similar sensibility on anti-trust and monopoly.

Zingales tries to recapture the high ground for capitalism by highlighting competition as the best remedy for the problems identified by the Tea Party and Occupy movements. He argues that the market—assisted by government enforcement of simple rules—is the best means to deliver the public from the anti-competitive clutches of an alliance of big government, big business, big lobbyists. This argument is made more compelling by Zingales’s restatement of Simons’s fear of bigness in all realms and his similar concern for inequality. This will likely make his book better received in many quarters that are unhappy with the rise of crony capitalism and the continuing scourge of rent-seeking but that are usually less friendly to markets.

A key feature of the book is Zingales’s reminder that being pro-market is different from being pro-business. Unfortunately, too many Republicans and conservatives fail to appreciate this distinction, with the result that they unwittingly assist the erosion of public support for capitalism and pro-market politicians.

What’s more, Zingales nicely explains how some policies that are not efficient from a strict economic standpoint may nonetheless be good because of their political consequences. For example, measures reducing the power and concentration of large firms, especially in finance, may not make the most economic sense. Yet they may be optimal for non-economic reasons. It is refreshing to see an economist who appreciates that narrow economic efficiency should not be the only or most important criterion of public policy.

Lastly, Zingales hits a winning note by stressing the role of culture, norms, and ideas—rather than just institutional reform—in social and political change. Although his discussion of these factors reads a bit awkwardly and at times seems incomplete compared to his other proposals, Zingales should be praised for bringing these concepts on stage and encouraging us to think more about them. In fact, the book ends by stressing the importance of “a rediscovery and renewal of the moral foundation of capitalism.

Despite all of these commendable features, Zingales’s book is not without some blemishes. In particular, there are some rather strange policy proposals in the midst of so many well-constructed ones. For example, Zingales’s argument that there should be a progressive tax on corporate lobbying is fine and good. That the proceeds of this tax should be redistributed “to support the arguments of the more diffused interests” is, however, hard to imagine working in practice. Moreover, isn’t Zingales asking for the wolves to pass laws that benefit the sheep?

Zingales’s reform program would certainly make the U.S. a more just and prosperous society. Yet he does not convincingly demonstrate that his ideas will put a dramatic dent in inequality. A meritocratic, globalized, efficient economy is going to yield substantial returns to those with high human capital while leaving behind—justly or otherwise—those without the talents, education, or work ethic required to succeed in such an intensely competitive realm. If Zingales is correct that Americans will largely support a system that produces inequality as long as they perceive that the economic rewards are distributed according to merit, then his program might be enough to head off any social instability. But his program will do little to keep those who think that the only fair system is one that more vigorously distributes wealth from occupying Wall Street and trying to enforce such a system in the halls of power.

Those qualms aside, Zingales offers a refreshing and improved program for saving capitalism that harkens back to two older Chicago traditions. And hopefully it will stimulate as much discussion as they did.

William Ruger is the author of Milton Friedman.



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