Much has been written about the crisis in capitalism. For some critics on the Left this is the beginning of the end of the free market economy. Sadly for the critics, and happily for the rest of us, capitalism isn?t going to disappear. Flawed in parts though it may be?as has been exposed by this crisis?it has a unique ability to adapt to changing circumstances. It is this openness of the capitalist system, which has allowed it to survive many a crisis.
Socialism and communism on the other hand were closed systems, resistant to change, which ultimately collapsed and disappeared when they reached a brink. For those who don?t see the world in black and white, a cursory glance at successful economic systems around the world will reveal capitalism thriving in different forms. Anglo-Saxon capitalism is very different from continental European capitalism, which is very different from Chinese capitalism, which is different from Indian capitalism. Yet, all have delivered growth and increasing prosperity. Compare this to the stagnation of communist/socialist systems in North Korea, Cuba and earlier in the Soviet Union, Eastern Europe, and even China and India before reforms.
That said, a crisis is also a time to introspect on what went wrong. While much of the blame has been laid on Wall Street and the way they practiced high finance, less has been said or written about the intellectual framework in economics, and the public policy positions which supported Wall Street?s excesses. I would argue, that unlike the capitalist system which has a unique openness, the discipline of economics and the stance of mainstream public policy had become increasingly closed, orthodox and too sure of themselves in the run up to the crisis. Here?s how.
At the heart of the ivory tower of economics?and this is evident in mainstream economics departments in almost all western universities?is a strong desire and aspiration to be a natural science like physics rather than a social science which economics actually is and should be. The quest to shift economics into the category of physics involves two steps: at a methodological level, increasing the use of mathematical equations and models to the point of seeing them as an end in themselves; and at a second, prescriptive level, to use equations to predict outcomes with absolute certainty: as certain, if possible, as the law of gravity.
While this lends a certain neatness to the discipline and gives it a more scientific flavour, it tends to assume away many real world situations/occurrences which often leave the model hollow, particularly in times of a crisis. Think of the Nobel prize winning finance formula (Black-Scholes formula), which caused a major economic crisis in 1998 when Long Term Capital Management, a hedge fund founded using the Nobel winning principles went bust. The problem with that model, like many others, was that they worked well when the going was good. But nobody had bothered to test what the model?s strength might be in bad times.
The fundamental point is that economics, at least as it is taught in mainstream universities these days, leaves no room for the ?we don?t know for sure? position. Or even the classic ?on the one hand and on the other hand? sort of openness. This is dangerous because a whole generation of trained economists will find it difficult to grapple with a crisis that challenges the fundamentals of what they have learnt and practiced.
It is often difficult to label a politician as an intellectual. But they often buy the certainty that economists sell them and use it blindly in their policy stances. In this, at least those who operate in democratic systems are not entirely to blame. The economy still tends to be a major factor in people?s voting choices (ask poor John McCain) and if a particular policy stance promises sustained growth and no recession or crisis, a policymaker will lean towards it. This was as true of policy makers following Keynesian demand management as a rule in the ?Golden Age? in the 1950s and 1960s, until stagflation caught the Keynesian model short. It is true of the 1990s and 2000s when deregulation and accommodating monetary policies delivered good times, until they were caught out by ?subprime?. Gordon Brown famously, and in hindsight foolishly, claimed that he had eliminated the cycle of boom and bust in his ten years as chancellor. Clearly, he hadn?t understood the nature and history of capitalism.
In the ultimate analysis, it isn?t capitalism that has turned up short. Study the history of capitalism over the last two-three centuries and you will find a regular cycle of boom, bust and boom again?and the best long-run performance of any economic system. What have fallen short are the discipline of economics and the nature of public policy both of which haven?t quite understood or wanted to understand the true nature of capitalism. Beginners? classes are then in order. For economists, a class in classical political economy and economic history, including the work of Karl Marx who understood capitalism better than he did socialism. And for politicians, a harsh lesson on a simple fact of life: there won?t always be soft landings, so prepare well for the bad times?by building safety nets and systemic checks?rather than wishing them away.
dhiraj.nayyar@expressindia.com