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Thursday, March 11, 2010

Unfettered markets were rare because they were inimical to elites

The American Interest  From the September - October 2009 issue: The Real New Deal Politics, Truth and Trust in the 1930s John V. C. Nye

The system of orderly, global trade developed in the 19th century under the financial and political leadership of the United Kingdom, and backed by the gold standard, produced growth and prosperity. But it also produced plenty of social disruption and downward as well as upward mobility. It certainly never inspired the kind of devotion that nationalist and communal ideology more readily induce, as suggested by the rise of fascism during the interwar period. The world’s experience with democracy and market capitalism was limited. The more common experience by far consisted of political systems that allowed limited access to property rights and trade, reserving the most exalted benefits for elites who treated control of the political economy as their reward for preserving peace.
This older, more organic order, which even today represents the default for most nations, has the advantage of being both stable and intuitively natural. So thoroughly has the West taken for granted the triumph of the more abstract liberal nation-state that its denizens must remind themselves how fragile its origins were and how little emotional loyalty it has commanded. Indeed, the evidence suggests that few people trust large-scale systems of commerce. It is much easier to focus on political economy as a system of extended associations in which successes or failures can be attributed to individuals or groups for whom we feel either loyalty or loathing. Despite the prevalence of market behavior throughout history, it has rarely trumped communal corporate identity, especially in hard or frightening times. Abstractions do not generally prevail over concrete social relations because personal trust is more readily attained and maintained than impersonal trust.
Even in America, where visceral support for individualism and self-reliance remains strong, this has always been so. In good times, economic systems are supported by inertia and utilitarian compromise that appeal to the broad center. In hard times abstract convictions tend to melt away. The American preference for the free market is neither as common nor as “American” as many suppose. There are always strong minorities in favor of a more communal, even socialistic approach to the economy, especially among elites, who complement populist pressures in segments of the public at large. It is easy to find those who see markets and the process of commercial integration we now refer to as globalization as fundamentally immoral. And it was easy to find them during and in the immediate wake of the Depression as well.

A classic case in point is Karl Polanyi’s famous work, The Great Transformation. Polanyi, a Hungarian-born intellectual who once taught at Columbia University, noted that the “market economy if left to evolve according to its own laws would create great and permanent evils.” Writing in 1944, Polanyi was keen to attack the rise of the modern market economy and to welcome interventions that crippled it. Although economic historians place little stock in his claims that, until just a few centuries ago, markets and market forces played a scant role in most economies, he was correct to observe that states everywhere had tried to control markets, and that the 19th century thus represented a startling shift in the extent to which formal institutions were permitted to abet and encourage market competition.
Polanyi has much to teach us. He claimed that reasonably unfettered markets were rare because they were inimical to elites. Their very openness and the instabilities they caused led ruling classes to constrain commerce and markets to ensure order and their own social control. The predictability and stability of slow economic growth more than compensated for the widespread poverty and stagnation it abetted. The 19th century showed that freer markets brought both prosperity and an end to older political systems, but the early 20th demonstrated that the newer system could not guarantee stability despite the confidence governments had in new techniques of administration and organization. Polanyi saw that the inability of government to regulate the market would evoke more calls for regulation and control, and that these new regulations would often be tangential to the specific problems of macroeconomic stability and financial safety. They would be counsels of political fear masquerading as counsels of economic policy.
Seen as a reversion to older habits, the odd mix of regulation, make-work, intervention, protectionism, nationalism and (as in Germany and elsewhere) anti-Semitism that characterized the Western policy response to the Depression suddenly seems less like an incoherent flaying in all directions and more like elements of a uniform retrenchment in social relations. What all these habits had in common, in all the countries in which they loomed large, was their role in spurning the system of abstract, anonymous and international exchange for more parochial, inward-looking responses to danger. So afraid of the new were they that some national elites followed this path of retrenchment to the point of utter self-destruction. Indeed, the severity with which people rose to tear up or overturn that still new system, despite the unprecedented prosperity it had wrought, seems indisputable testimony to how paper thin support for liberal trading regimes truly was.
The Politics of Trust
Is it still paper thin? It seems odd that humans in their day-to-day interactions think of buying or selling as the most natural of activities, recreating markets unprompted in the most dismal of circumstances. Yet there is something about the ideology of a market system, or of any generally decentralized order, that seems inconceivable to most people. Support for any existing abstract economic order seems predicated on generally favorable circumstances, and even in good times markets find themselves subjected to acute scrutiny for the disorder and creative destruction they invariably unleash. In bad times, support for the system shifts into a rush to assign blame and to personalize or politicize failure.
In a sense, Western markets are like Western medicine: Just as an outbreak of incurable plague would lead to both a renewed search for sound cures and an atavistic appeal to folk remedies, so the Depression stimulated both productive thinking about the sources of business instability as well as destructive appeals to extreme nationalism, protectionism and military aggression.
Economists have a hard time dealing with nationalism. The essence of Adam Smith’s insight is that voluntary trade is mutually beneficial; hence specialization leads to to riches. Indeed, the Ricardean corollary of comparative advantage is that trade between people or nations with different preferences and capacities is especially beneficial. In difference is wealth. But difference evokes a rejoinder from Smith’s historical predecessor and intellectual counterpoint, Thomas Hobbes. For Hobbes, the problem of political economy is the maintenance of public order, which in his view is essentially an uphill battle against the human tendency to engage in conflict. Hence, to the extent people prefer those who are most like them, usually meaning those of similar ethnicity, religion, culture or nationality, then difference can undermine order as easily as it can promote prosperity.
The contradiction between the economically integrative and the politically divisive dimensions of difference is activated in a crisis. In a crisis, people want action, and they tend to ignore boundaries between economic policy and politics more broadly construed. A severe economic crisis implicates the entire system of political economy, regardless of how narrow the source of that crisis may be. Thus those with long-simmering fears and resentments—as well as those with more venal or ideological motives—see crisis as an opportunity to strike out at the system.
The Depression empowered both the venal and the ideological, but especially the latter. The managerial interventions of the Roosevelt era, and the even more dramatic centralization of the economy in Germany and other parts of Europe, were different in degree but not in kind from earlier interventions in the late 19th century. There had already been attempts to re-impose protectionism and reassert national control in Europe, and to extend the regulatory powers of the Federal government in the United States. Anti-market movements, whether pushed by Populists or Progressives in the United States or the various forms of socialism in Europe, took for granted that vigorous political action was the only way to impose order and bring social harmony to an unfettered market economy. But the specific remedies and the zeal with which reformers sought to repudiate the past belie ideological origins more than technocratic ones. Indeed, although Hoover’s fumbling mix of interventionist and managerial solutions was in many ways similar to Roosevelt’s, FDR’s fumbles were greeted both during and after the Depression with greater forbearance largely because he seemed to have a coherent social vision that rejected the past and sought a new system. He had mastered the politics of trust.
Roosevelt was careful, therefore, to avoid any suggestion that he wanted to overturn the entire American economic structure. Nor did he or his advisers think they were promoting anything as radical as socialism or fascism. Nonetheless, members of FDR’s famed Brain Trust were associated with a rejection of market competition and went out of their way to signal that the interventions were part of a new paradigm. The most prominent of these “critics” was Professor Rexford Tugwell of Columbia, whose writings stressed the failure of laissez faire and market competition, which he saw as outmoded (rather than as too novel, as did Polanyi). Tugwell argued for increased concentration and regulation of business. He especially favored the expansion of business size, arguing that in expansion lay both greater efficiencies and a greater ease of government regulation. Tugwell backed Roosevelt’s desire to exploit public regulation and control as a check on monopoly, but he also saw regulation as a superior alternative to private enterprise. However different the National Industrial Recovery Act (NIRA) or the Agricultural Adjustment Act (AAA) were from the more radical state expansions throughout Europe, the new thinkers on both sides of the Atlantic shared the view that planning was inevitable, modern and good.
Roosevelt deserves credit for largely resisting these ideological enthusiasms. On balance, he dealt with the crisis pragmatically and forthrightly. He realized that everyday citizens and experts alike understood only poorly what was happening in the world, that reliable data was hard to find, and that no one could really know how new measures, beyond the experience of the economics profession and the government, would work out. But his pragmatism was tied to a rhetorical spin, concocted by the President himself, that rendered his policies more odious to some and more praiseworthy to others than the policies themselves deserved.
This raises an interesting question: If FDR had left out the high-flying rhetoric and only pursued an attenuated New Deal—namely the financial policies that economists now agree truly helped us out of the Depression—would he be as celebrated a figure as he is today? Not likely. He might have had even more, and more venomous, critics then and today. But we can’t know for sure, of course, because Roosevelt’s place in the pantheon of American leaders cannot be separated from the fact that he was a successful wartime President; he has not been judged by posterity on the years 1933–39 alone.
The end of World War II furnishes still more evidence that political images leave a wider trace in historical memory than actual policies. Harry Truman left office in 1953 a very unpopular man. Almost no one at the time gave him credit for overseeing a period of rapid recovery that was much broader and more impressive than anything that happened under Roosevelt’s tenure—and this at a time when most economists predicted a deep postwar recession. He did this while shrinking the government and dismantling wartime regulations at a rate Ronald Reagan could only have dreamed of. He smoothly pulled us back from a regime of wage and price controls that could have easily been allowed to linger (indeed, it would have if those sharing Rexford Tugwell’s views had gotten their way). Thanks to Truman we were once again moving in the direction of a competitive, open-access market economy. Had there been a lingering recession and a continuation of older, harmful regulations into the 1946–48 period, Truman, not his predecessor, would have been blamed. Yet Truman’s stellar reputation today owes nothing to his economic achievements, which most of those who today praise his foreign policy acumen know nothing about.

The main lesson that comes out of all this for us is that we should be focused on whatever it is that restores impersonal trust. But of what does it consist? How much of it is skillful leadership? How important was it that, mixed policy success aside, Roosevelt could inspire confidence while Hoover could not? Or that Roosevelt could speak as though he had a master plan while acting all the while as a pragmatist, often against the advice of his own advisers? (President Obama, take note). How much of it has to do with substantive rules and regulations that prevent good times from suddenly lunging into bad ones? After all, as the heterodox economist Hyman Minsky argued long ago, capitalist financial systems are prone to booms and busts, so that regulation to tame the casino-like tendencies of financial markets has to be different from, and stronger than, that pertaining to other market sectors.1
Still, it is no easy matter for regulators to know what will work in different circumstances. The Federal Reserve of 1929, given the constraints of the gold standard, may have known what to do but been unable to do it. On the other hand, Roosevelt’s fortuitous decision to abandon the gold standard might have been an arbitrary judgment made largely for the wrong reasons. The right solution at any one time can morph into a new problem in due course. Perhaps the strong role assigned to the postwar Federal Reserve to assume the dual task of stabilizing price levels and keeping watch on output and employment contributed to the present crises.
In any event, we would do well to bear in mind how important, yet also how unnatural, the modern system of impersonal finance and trade really is. If we would preserve that system as a basis for our prosperity, we must recognize that many of the regulatory solutions we apply to our current crisis may themselves induce responses that can generate new crises. History suggests, too, that fears of the market and the political pressures it generates will wax and wane as crises deepen or ease. Patience and prudence are, therefore, the best watchwords for government amid the many trials and errors we will surely endure in the months, and perhaps years, ahead.

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