Saving Capitalism from the Capitalists: How Open Financial Markets Challenge the Establishment and Spread Prosperity to Rich and Poor Alike [Hardcover]

This book, written by two heavyweight University of Chicago financial economists, was published during our last financial market "crisis" in 2003. This was the time of the post internet equity bear market, the time of the Enron, Worldcom and Global Crossing scandals. The thesis is that free markets, for all their benefits particularly to the poor and powerless, rest on precarious political grounds. The impulse of elites to curtail the functioning of markets is strong and always a threat, particularly in times of crisis when the public loses confidence in markets' fundamental fairness. . The authors fret about the dark clouds of 2003; the clouds are certainly darker today. Moreover, they show that the threat to markets often comes from the "capitalists" themselves, established incumbents who seek to use the power of government to curtail the free functioning of market to protect their entrenched position

Seems uncontroversial as a thesis. The "rent seeking" impulse in modern democracies has been elaborated before. Nevertheless, this book makes some new and worthwhile contributions. The authors are professors of finance and thus skew much of their discussion to the operation of financial markets. They show in accessible terms the benefits to society of smoothly functioning financial markets, and how in particular they benefit new entrants and indirectly enforce competitiveness in product markets. Oftentimes even reputable economists will rationalize nations' desire to protect domestic financial markets even while advocating openness in product markets. Rajan and Zingales show that this is typically the result of some politically powerful vested interest in the country protecting its own position. Indeed, open financial markets are arguably even more potent in bringing the benefits of capitalism to the masses. The authors explode the myth of the financier as economic parasite, and show how through the spreading of risk, required returns are reduced and productive investment increased.

They introduce an intriguing and, to me at least, novel theory that private property will be more robust as an institution in circumstances where property is held by those who are the most efficient users of it. The better part of an entire chapter is devoted to an explication of the emergence of the "Squirearchy" in Tudor England, and how it, through the increasing strength of Parliament, was able to suppress the power of the Monarchy and its arbitrary control over property rights. The argument is the that redistribution of land previously expropriated from the Church into the hands of efficient gentleman farmers not only helped create a free market in land, but buttressed the institution of private property because more efficient holders of land had both the economic power and the interest to defend their property rights. Although the argument feels slightly ad hoc at times, the question of why and how strong property rights emerged in some societies and not in others is an important one, and the authors' thesis is plausible and worthy of consideration.

Thus England emerged first among western European countries in establishing secure property rights and circumscribed government, and from there led in industrialization and the development of financial markets. The authors emphasize the importance of financial markets in nurturing industrialization and the importance of keeping governments and vested interests from rigging the financial markets for the benefit of a privileged few. Here however is where the essential argument becomes ambivalent. Developed countries have an advantage over the developing world in that their financial markets are well-established and tolerably transparent: they have established a functioning financial "infrastructure". For developing economies to emulate this, they need to establish similarly strong institutions to protect property rights, enforce contracts, prevent and punish fraud, etc. The implication for the authors seems to be that many of the trappings of modern Western finance are part and parcel of this minimum institutional framework for the stable operation of markets. Financial regulation via, e.g., the SEC, the FDIC, the Federal Reserve system, forms the essential infrastructure for efficient financial markets. But most of this regulatory framework is of reasonably recent origin (the Fed from just before World War I, the rest from the Depression era), and it is not at all clear why the authors assume that none of it is the result of regulatory capture by the incumbents they worry about elsewhere.

The book describes the precariousness of a regime of mostly free markets and documents "the great reversal" of the 1930's and beyond when hostility to capitalism and free markets led to a backtracking on the longer historical trend of increasing freedom and expansion of markets. They document how deeply the development of financial markets were set back, and for how long - by many measures in much of West they still had not reached their pre-WW I level by 1980! And they show how many of the measures instituted, in Italy, in Japan and in the U.S., were bald sops to the established interests of incumbents and not, as advertised, public-interested reforms to protect the majority of the populous.

The point is well-taken, but the authors don't take it far enough. At one point they write:

"It is worth dwelling on this last point, for it goes counter to the belief that the securities legislation in the early 1930s, with its emphasis on disclosure and transparency, was entirely focused on laying the foundations for a vibrant, competitive financial system. It may have broadly done that, but particular interest groups also shaped the legislation for their own benefit. The legislation on securities issuance offers an example of how seemingly innocuous changes in laws can limit competition severely" [Emphasis added.]

Isn't the securities legislation of the 1930s the very financial infrastructure the authors cite elsewhere as essential to well-functioning financial markets? They repeatedly make the point: "a little government good, too much government bad". But nowhere do they attempt to distinguish the good from the excessive regulation, the stuff of smooth modern markets as distinct from the detritus of rent-seeking incumbent opportunists.

Alas, in the end, the book does not live up to its subtitle, for nowhere will the reader find the answer to how we can "unleash the power of financial markets to spread opportunity" while keeping the incumbents and their government enablers at bay. The last chapter offers the authors' suggestions, but it feels little different in character from the typical policy recommendations of mainstream economists. Ensure economic power is not concentrated for that gives incumbents more latitude to tilt the field their way. Build a social safety net so the general public will not turn against free markets during downturns. Keep borders open to trade in goods and capital. Educate the public on sound economics. The authors seem to forget themselves; how in the real world of self-interested political dealing do they think these high-minded ideas will be put into force?

The worries that the authors express in this book are valid and important. The "capitalists" of the title are meant to represent the vested interests of the status quo and the real world evidence of the politically connected writing the rules of the game to their own advantage under cover of "public interest" is overwhelming. The arguments Rajan and Zingales marshal in favor of openness, in particular in financial markets, are convincing and more relevant today than ever. However, in these days of bailouts of elite Wall Street firms and special handouts to politically favored unions, one wishes they had some useful recommendations on how exactly to save capitalism from the capitalists.