In 1979, Margaret Thatcher became British prime minister and a year later Ronald Reagan was elected US president. With these changes of government came a reversal of the trend to greater government economic intervention and higher state spending which had been characteristic of most of the 20th century and had continued uninterrupted since the second world war. This change of direction was reinforced by the fall of the Berlin wall and the disintegration of the Soviet Union. One of the most extraordinary episodes in the economic history of the world followed.
It was an American decade. The triumphalism expressed in Francis Fukuyama's careful prose was overtaken by more assertive accounts from business people and popular commentators. Walter Wriston, former chief executive of Citicorp, wrote "The Twilight of Sovereignty". For Reagan and Thatcher, reducing the economic role of the state involved a deliberate political choice. In the world Wriston described a decade later, there was no longer any choice. International trade and capital flows made the decline of national government inescapable. Through the 1990s, the term "globalisation" took over from "privatisation" as the label for market-oriented reforms.
Wriston provided an articulate account of one traditional view of how market economies work. Self-regarding materialism is the main determinant of economic behaviour. Financial markets are the main regulator of economic activity. The economic role of the state should be confined to the protection of property rights. I shall call this the American Business Model or ABM. (The model is, of course, a simplification even in its own terms?consider the highly regulated nature of many American markets.)
The greatest admiration for the ABM has been found, unsurprisingly, in the American business class. Arbitrariness and disparities in the distribution of income are morally justified simply because they are market outcomes. What could be more congenial to business leaders? As the 1990s rolled on, an increasing proportion of the profits of US corporations was diverted into the pockets of its senior managers.
Yet the US economy performed well in the 1990s. "Business Week" proclaimed the "new economy"?technology had raised American's long-term growth potential. This strong economic performance was translated into an extraordinary stock market boom. In 1996, the Chairman of the Federal Reserve Board, Alan Greenspan, warned of "irrational exuberance." As he spoke, the valuation of stocks was at the highest level ever recorded in US history?surpassing even 1929. But far more was to come. Belief in the magical commercial properties of the internet provided the pretext for the greatest speculative bubble in economic history. The Nasdaq index of technology stocks doubled in value, and then doubled again.
Europeans always displayed some scepticism about the universality of the ABM. The G7/G8 group of the world's rich nations met in Denver in 1997 and was subjected to a diet of what the "Financial Times" called "effusive self-praise" from Clinton. The paper quoted one European as saying "they keep telling us how successful their system is. Then they remind us not to stray too far from our hotel at night."
But the inexorable rise of the ABM provoked a loss of European self-confidence. In Britain and in Germany, speculation in technology stocks paralleled the bubble on Wall Street. At Lisbon in March 2000, European leaders signed up to a "new economy" agenda?the market liberalisation supposedly required by globalisation and new technology.
This was, however, the end of the affair. When the WTO met in Seattle in November 1999, rioters filled the streets and the conference ended in disarray. Just four months later, in March 2000, the stock market bubble burst. Three years later, world stock markets had, on average, halved and the iconic Nasdaq index had lost three quarters of its value. Enron and WorldCom, widely admired creations of the 1990s boom, collapsed amidst allegations of fraud and false accounting. The exposure of rampant greed on the part of Enron's senior executives was followed by the disintegration of Andersen, its auditors. Investment banks were forced to admit that they had known all along that many of the shares they had promoted so vigorously were worthless.
There was less outright fraud in Europe. And although executive remuneration grew, especially in Britain, it did not, as in the US, reach levels at which senior executives appropriated a significant share of the earnings of the businesses which employed them. But Britain's two largest industrial companies at the collapse of the Berlin wall?ICI and GEC?became mere shadows of their former selves, following some ill conceived restructuring and the assumption of debt to finance overpriced acquisitions. Jean-Marie Messier used his position at French water company Vivendi to reinvent himself as a media mogul, complete with glitzy Manhattan apartment.
At the height of the bubble in early 2000, the British government raised ?22.5 billion from the sale of licences to operate third generation mobile telephone services, and the German government raised even more. These licences were probably worth nothing at all: one of the "successful" German bidders has already handed its licence back. Established fixed-link operators in Britain, France and Germany were brought close to ruin by their spending on licences, overpriced acquisitions and the installation of unnecessary capacity.
Despite these setbacks, the ABM, somewhat bruised and battered, continues to play the role in political economy that socialism enjoyed for so long. All political positions, even hostile ones, are defined by their relationship to it. Globalisation and privatisation have displaced capital and class as the terms of discourse. Through the 20th century, the vocabulary of politics was determined by the left but, by its end, the right had defined the language of political debate.
The philosophy of the ABM, as articulated by Milton Friedman, is of government as referee: "It is important to distinguish the day-to-day activities of people from the general customary and legal framework within which these take place. The day-to-day activities are like the actions of the participants in a game... the framework, like the rules of the game they play... The role of government in a free society is to provide a means whereby we can modify the rules, to mediate differences among us on the meaning of the rules, and to enforce compliance on the part of those who would not play the game."
The claims of the ABM are of four kinds.
Self-interest rules?self-regarding materialism governs our economic lives.
Market fundamentalism?markets should operate freely, and attempts to regulate them by social or political action are almost always undesirable.
The minimal state?the economic role of government should not extend much beyond the enforcement of contracts and private property rights. Government should not itself provide goods and services.
Low taxation?while taxation is necessary to finance these basic functions of the minimal state, tax rates should be as low as possible and the tax system should not seek to redistribute income.
Both supporters and opponents of the model review moral and economic issues together. Many friends of the ABM see state action in economic matters as an attack on liberty, an improper use of the coercive power of the state. Freedom of contract requires a minimal state; market fundamentalism and low taxation are immediate corollaries.
Some right-wing radicals go further. It is a mistake to regard selfishness as a vice. Greed is good: nice guys finish last. The rambling but strident philosophy of Ayn Rand, Alan Greenspan's former mentor, proclaims the virtues of selfishness under the title of "objectivism." Concern for others is an emotion which can properly be called on only to the extent that we feel it spontaneously. Private charity is thus the only proper mechanism of redistribution.
More moderate friends of the ABM, for whom self-interested rationality is a harsh fact of life rather than a moral imperative, acknowledge that this thesis has a public relations problem. Stalin, Hitler and Bin Laden recruited followers by demonising other people. The ABM demonises itself. We dislike the ABM most of all for its unattractive account of our behaviour. It requires us to applaud the very characteristics of human behaviour we are brought up to despise.
Sympathetic but concerned admirers of the market struggle with this issue. Advocates of "corporate social responsibility" and well-meaning business people claim that if only self interest were to be interpreted sufficiently widely, there would be no conflict between self interest and the public good.
A more plausible argument is that there is simply a dichotomy between economic life and public morality. The values appropriate to business are simply different from those appropriate to our private lives. As Goethe observed at the start of the industrial revolution, "everything which is properly business we must keep carefully separate from life." Goethe's position mirrors that of Milton Friedman: "the social responsibility of business is to maximise its profits." This position has appeal for both left and right.
The dichotomy between economic values and ordinary values is acceptable to many business people because it puts few restrictions on their behaviour. The corollary is a general contempt amongst intellectuals and opinion formers towards business and those who engage in it.
But the primary objection to the description of human behaviour in the ABM is not that its values are immoral, but that they are not, in fact, the prevalent values of economic life. Greed is not, for most people, a dominant characteristic.
Real businesses designed on purely instrumental lines have proved, in the end, unsuccessful in the market economy's own terms. The piece-rate systems of car factories were abandoned because they destroyed social relationships in the workplace, provoked endless negotiation and confrontation, and established a working environment in which no one cared about the quality of the product. We learn to distinguish the synthetic "have a nice day" from genuine commitment to customer service.
And this is as true of bosses as of workers. Bill Gates may be the world's richest man but, if you read his books, and I cannot recommend you do, you can be in no doubt that his ruling passion is information technology, not money. That is why he is still in an office at Redmond rather than on the beach. Building businesses demands talent and hard work, and is not attractive to the truly greedy, even in the financial services sector. Donald Trump begins his autobiography by asserting, "I don't do it for the money. I've got enough, much more money than I'll ever need. I do it to do it. Deals are my art form." For legendary investor, Warren Buffet, "It's not that I want money. It's the fun of making money and watching it grow."
Some people are obsessed by money. And the idea that greed was an admirable value in business attracted them to financial services and to senior positions in corporations. In every era of excess, greedy financiers have preyed on the na?ve. What was new in the 1990s was the opportunity for salaried managers to divert a substantial proportion of corporate earnings to their own account.
Concern for status?always a strong motivation?was translated into concern for money, because, as never before, money was the measure of status. The overriding aspiration of the unattractive characters at Salomon Bros described in Michael Lewis's book "Liar's Poker" was to be regarded by their peers as a Big Swinging Dick. "What really stung the traders... was not their absolute level of pay but their pay in relation to the other bond traders."
The adulation of greed attracted the greedy: and so the denouement of the American 1990s was an extraordinary speculative bubble and an outburst of corporate fraud. The crude view of motivation in the ABM undermined not only the political acceptability of the real market economy, but its effectiveness too.
This is not to deny that self-interested materialism is an important feature of economic life. Economies based on appeals to work for the common good will fail. But self-interest is necessarily hedged by the complex institutions of modern economic, social and political life?formal regulation and implicit rules, mechanisms of reputation and co-ordination, instincts and structures of co-operation, feelings of solidarity.
Economic motivations are complex, multi-faceted, and not necessarily consistent. The study of human behaviour should be an empirical subject. It cannot rely solely on introspection and a priori assumption. The best starting point is to anticipate that people will behave in the way they are expected to in the circumstances in which they find themselves. This expectation will sometimes be false?which is itself an essential dynamic of a market economy.
Concern about the moral values at the heart of the ABM is closely associated with doubt about the legitimacy of the distribution of income and wealth that results from it. But if differences in income and wealth result from differences in talent, effort and productivity, then interference with that distribution may imply a high price in economic inefficiency. This leads directly to the fourth pillar of the ABM: redistribution of income and wealth should not extend beyond the provision of a modest safety net.
Yet differences in income and wealth in the world economy are not mainly explained by differences in effort, talent and skills. There are many talented, hard-working people in poor countries whose circumstances are the result not of their own deficiencies, but of the deficiencies of the institutional structures within which they work. Differentials in talent and effort explain only a small part of the distribution of income within rich states. Are the effort, talent and skills of Gates so exceptional? Do they justify an income many thousands times greater than that of, say, Alan Turing who invented the modern computer and never received more than an academic salary?
And what of those Big Swinging Dicks? They are valuable to their firms, which is why they receive multi-million dollar bonuses. But the social value of their activities is small, if positive at all. And corporate executives are paid a lot not because of their productivity?which cannot be measured?but because of their bargaining power. They take a slice of the economic rents which pass through their hands.
The complexity of the way in which market rewards are determined makes it impossible to argue that such rewards are necessarily just or efficient. Thoughtful conservatives do not make that claim: they assert instead that interference with the process that gives rise to them would be unjust, because it would involve illegitimate state coercion.
Some people might agree with this argument. But many would not. And that disagreement is itself a problem. If the distribution of income and wealth in the market economy does not secure general acceptance, that distribution will be expensively disputed. The costs of litigation and crime may be a serious burden on the economy. Worse still, in many Latin American countries and modern Russia, basic questions about the origin and legitimacy of property rights are associated with corrupt and confrontational structures of politics which have blocked effective economic development.
The ABM emphasises the central importance of property as an institution, so central that its defence is the principal function of the state. This assumes that the nature of property rights is obvious. But it is not. Property rights are socially constructed: they can be defined in many ways, allocated amongst individuals, households and firms in many ways, and the definition and allocation are the product of social and political mechanisms.
Friedman understands this better than some of his followers: "What constitutes property and what rights the ownership of property confers are complex social creations not self-evident propositions." But, he goes on, "in many cases, the existence of a well specified and generally accepted definition of property is far more important than just what the definition is."
But Friedman produces no evidence for this conjecture, and experience of economic history and geography demonstrates the opposite. The invention of agriculture and of limited liability companies?key developments in the creation of the modern economy?represented an evolution from one form of property rights to another. The very different economic histories of Argentina and Australia reflect the different ways land rights were determined in countries of settlement. We continue to argue over the scope of intellectual property and media ownership in pluralist societies. It is not easy to see how the evolution of technology and institutions in the internet and genome will play itself out. But no one thinks that the outcome of these debates doesn't matter.
"They are stealing absolutely everything and it is impossible to stop them. But let them steal... They will then become owners and decent administrators of this property," said Anatoly Chubais, a leading Russian reformer in the early 1990s, mirroring Friedman. But post-communist Russia's economic failure is an enduring reproach to those who say that the only requirement of a market economy is a system of property rights. The key difference between rich and poor states is the quality of their economic institutions?but there is much more to this difference than the protection given to property rights.
The ABM supposes that the market economy is defined and described by the activities of greedy people endowed with vigorously defended property rights, but otherwise free of regulation. The problem is not simply that this account is not true, it is that the attempt to make the world conform to the model has been deeply damaging, both to the functioning of the market economy and to its political legitimacy.
Yet an obvious question remains. If the ABM is not a plausible description of how market economies function, why is the US economy so successful? The answer, as de Tocqueville understood over 150 years ago, is association?the creation of social and economic institutions to mediate between the individual and the community, which was a distinguishing feature of US society from its start. The most important of these institutions today is the corporation. Corporate man, the epitome of the American submergence of the individual in the company, was once the butt of jokes. But it is corporate men and women who make the US economy work.
The real failure of the ABM is that it does not recognise the fundamental complexity of the social institutions of the market economy, and the degree to which these economic organisations are necessarily embedded in the society, politics and culture of productive economies. The "embedded market" extends to all aspects of economic life.
Information in complex modern economies is necessarily incomplete and imperfect. Competitive markets fail when there are major differences of information between buyers and sellers. Transactions usually take place within a social context. We prefer to deal with people we know. Or we rely on trusted suppliers, or trusted brands. This social context develops to deal with these differences of information.
It is social institutions, too, which handle most of the important economic risks we face?households, communities, and government. Markets for risk work poorly, despite the overblown financial services industries of all advanced economies. Securities markets are better described as arenas for professional gambling than institutions which minimise the costs of risk bearing and allocate capital efficiently.
Most economic activity cannot be organised by negotiations between large numbers of potential buyers and potential sellers in im-personal markets?the perfectly competitive markets of economic theory. We need to work in organisations and teams, to co-operate in small groups. Self-interested individuals often fail to co-operate with each other, even when it is in their best interests to do so. Corporate cultures, ethical values, and the blending of working and social lives are mechanisms which make co-operative productive activities possible.
Knowledge and information are key requirements of complex modern economies. These commodities are often hard to protect and should therefore, according to the standard ABM model, be under-produced. But they are not under-produced. Non-materialist motivations?the thrill of discovery and the satisfactions of philanthropy?have been more important stimuli to innovation than profit seeking.
Economists frequently describe the issues raised by asymmetric and imperfect information, co-ordination problems and the inadequacies of risk markets as examples of "market failure." But this phrase misses the point. They are failures of a model of the market economy, not failures of the market economy itself. Much of the strength of modern economic institutions comes from the social mechanisms which have evolved to handle these issues: market economies function only because they are embedded in a social context. The paradox of the last two decades is that the legitimacy and efficiency of modern capitalism has been undermined by an account of how it works that is at once repulsive and false.
