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FUTURECASTS JOURNAL

Capitalism:
Its Origins and Evolution as a System of Governance
by
Bruce R. Scott

Page Contents

Market disciplinary mechanisms and administered alternatives

Financial oligarchs

Constitutional constraints

Tilting the markets

Stakeholder capitalism

Industrial policy

Abuse of the commons

Government enterprises

Political market competition

February, 2013
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Part II: Financial Oligarchs, Stakeholders, and Other Issues of Political Economy.

Issues of political economy:

 

 

 

&

  Besides the primary problems of political economy, such as economic development, economic growth and decline, and the business cycle, Bruce R. Scott, in "Capitalism: Its Origins and Evolution as a System of Governance," addresses a variety of other important issues of political economy that cannot be adequately addressed within the narrow focus of modern economics. These other issues are covered in this Part II, "Financial Oligarchs, Stakeholders, and Other Issues of Political Economy."
 &

Sometimes there is agreement and sometimes there is disagreement, as might be expected, but FUTURECASTS joins Scott in emphasizing that such issues and capitalism itself can only be analyzed and understood within the broader focus of political economy.

  The future of the U.S. capitalist system will be shaped by a host of contentious issues. Scott and FUTURECASTS herein provide some discussion of market disciplinary mechanisms and administered alternatives, financial oligarchs, Constitutional constraints, stakeholder capitalism, the strategic objectives of economic policy,  industrial policy, abuse of the commons, government enterprises, and economic policy competition in political markets. Sometimes there is agreement and sometimes there is disagreement, as might be expected, but FUTURECASTS joins Scott in emphasizing that such issues and capitalism itself can only be analyzed and understood within the broader focus of political economy. See, Scott, "Capitalism, Its Origins and Evolution as a System of Governance," Part I, "The Concept of Capitalism."

  Thus, Scott's "Capitalism: Its Origins and Evolution as a System of Governance," is clearly the most important modern book FUTURECASTS has reviewed in its dozen year history. It is scholarship at its rigorous best. With impeccable logic, Scott demonstrates the inherent ineptness of narrowly focused modern economics and its mathematical versions with respect to a wide variety of interdisciplinary political economy issues.

  FUTURECASTS readers are encouraged to add their input on the issues covered in these articles. E-mail comments to blat1@futurecasts.com.

 E-MAIL

Market disciplinary mechanisms and administered alternatives:

 

&

  At bottom, the view about economic freedoms of Bruce R. Scott, set forth in this book, is that they are bestowed by government.

  "Capitalism at the most general level is a generic system of governance for economic relationships wherein governments create institutions that shape economic markets and the rules of acceptable behavior for the actors, all within the boundaries of a political entity."

  The view of the U.S. Constitution, however, is that government has only the powers granted by the people. Those powers are designed primarily to safeguard the people and their freedoms. Scott acknowledges that, at the federal level at least, government authority to shape those freedoms was intended to be limited. While capitalist markets cannot exist without the laws, regulations, and the institutions that shape them, that does not answer the question of where in the Constitutional scheme those powers and responsibilities reside, their extent, and how they should be exercised.
 &
  There are many variances to the capitalist model, the author points out. Governments at all levels tilt the markets to achieve various objectives. This is especially true of the factor markets - for land, natural resources, labor, and finance. Capitalism can be "oligarchic" or social democratic, favor producers or consumers, and have an infinite variety of regulatory regimes. Political governance need not be democratic.
 &
  Markets have clearly failed to discipline participants
during the last 20 years. Scott emphasizes that it will take political action primarily at the federal level to provide the necessary disciplines.
 &

Scott is talking about regulations that are administered alternatives to market mechanisms.

 

The costs and constraints of Dodd-Frank regulations threaten to overwhelm smaller banks, force even more consolidation and reduce small business access to credit.

 

Markets will be reduced to a price-finding mechanism sensitive to a wide variety of government policy influences, closer to the European social democratic model. Incentives will diminish for economic enterprise but will increase for political enterprise, including the influencing of government policy.

  Scott favors a "formal system of regulation" that will not only impose regulatory disciplines but that can be adjusted to achieve policy outcomes. He has no faith in market disciplinary mechanisms and indicates no concern for their absence. He is thus not talking about regulations that are designed to facilitate market mechanisms, like securities law disclosure regulations and real estate title recording regulations. He is talking about regulations that are administered alternatives to market mechanisms.

  Of course, it was political action, influenced by powerful political, financial and business interests, that neutered market disciplinary mechanisms prior to the Credit Crunch recession. These mechanisms didn't fail, they were disabled by government policies during the last three decades - with disastrous results. Today, except for some restoration of lending standards, there is still no sign of any intention to restore the market's disabled disciplinary mechanisms. Instead, the effort is to establish administered regulatory alternatives of immense complexity, expense, and ultimate futility, and there remains pressure to bend lending standards to fulfill political objectives.
 &
  The new financial regulations, for instance, have not even been fully promulgated as yet and are already inadequate. Action is picking up in the "shadow banking system," including repurchase and repo markets and money market funds, now in excess of $10 trillion, with some entities reaching sizes that render them "too big to fail." With Bernanke artificially low interest rates extending into many years, there is not even the restraint of market interest rates to inhibit the instances of excess that will be revealed when interest rates again rise towards market levels, as eventually they must.
 &
  More to the point of this article, the costs and constraints of Dodd-Frank regulations threaten to overwhelm smaller banks, force even more consolidation and reduce small business access to credit.

  In presenting an outline of his views, the author provides an indication - just an indication - of the vast complexity of administered regulatory alternatives adequate to take the place of proven if admittedly imperfect market disciplinary mechanisms. Markets will be reduced to a price-finding mechanism sensitive to a wide variety of government policy influences, closer to the European social democratic model. Incentives will diminish for economic enterprise but will increase for political enterprise, including the influencing of government policy.
 &

Competition is to be limited sufficiently so market participants can generate rents that can be distributed among stakeholder interests.

 

Scott properly emphasizes that firms, markets, regulations, institutions, laws, and the pertinent people are inherently imperfect and always playing catch-up with changing conditions.

 

Analysis and policy limited to economic factors is inherently incompetent. Mathematical models can make the figures line up in perfect order, but such models are of Never-Never land economies. They have never existed and never will.

  "Chaos" is the only alternative to an administered regulatory framework, the author asserts. He ignores the alternative of restoration of market disciplinary mechanisms. He wants competition to be limited sufficiently so market participants can generate rents that can be distributed among stakeholder interests.

  Politicized economic decision making will increase the incentives for influencing - and corrupting - political actors. Inevitably, many of these efforts will succeed.
 &
  Restoration of the most prominent of the disabled market disciplinary mechanisms requires:

  1.  The reinvigoration of the credit market vigilantes by the elimination of moral hazard credit guarantees except for relatively small savings deposits.
  2. the restoration of market interest rates so businesses and creditors can ascertain the time cost of money and the prudent limits of the use of leverage;
  3. The restoration of prudent lending standards.
  4. the elimination of government tax, credit and fiscal subsidies for housing and other favored industries to restore the pricing functions of the markets and eliminate the elevated rates of asset or cost price inflation in the subsidized markets; and, 
  5. the elimination of government sponsored entities like Fannie Mae and Freddie Mac to restore market competition, avoid capture by the politically influential, and remove the temptation for abuse in the interests of political incumbents..

  The restoration of market disciplinary mechanisms would be far less expensive and infinitely less complex, and clearly more effective, than any administered alternatives. Of course, market mechanisms cannot be of direct use as a mechanism for achieving an ideological agenda, but the resulting economic expansion can provide the resources for government programs.

  1. Too-big-to-fail credit market subsidies remove the fear of default and transform credit market vigilantes into credit market enablers.
  2. Health care, college and university education as well as housing are examples of how subsidized markets become chronically dysfunctional and suffer high rates of asset or cost price inflation, depending on whether it is production or consumption that is being subsidized. These subsidies increase dependency on government and require increasingly complex regulatory interventions. They ultimately become "bubbles" ready to pop whenever government resources prove insufficient to sustain them.
  3. Artificial interest rates make it impossible for entities and creditors to evaluate the extent of leverage that can prudently be employed.
  4. The reduction of lending standards on the basis of inherently invalid and often biased mathematical analysis just asks for trouble.
  5. Fannie Mae and Freddie Mac will always be easy targets for abuse for political and/or private gain.

  Scott does not offer any simplistic recipe for reform. He properly emphasizes that firms, markets, regulations, institutions, laws, and the pertinent people are inherently imperfect and always playing catch-up with changing conditions. He concludes:

  "This brief look at the role of the firm in a capitalist society suggests that achieving accountability for firms is a vital aspect of a successful, decentralizing system of decision-making. At the same time, it suggests that achieving such accountability on a continuing basis as conditions change is anything but a simple task. As a result, market frameworks can be expected to be continually contested between the firms, the regulators, and other societal interests that are affected. We should expect that some measure of distortion is the rule rather than the exception. Maintaining and modernizing market frameworks in developing countries is, if anything, an even more difficult and contentious task."

  Analysis of the system and making the system work for the national interest involves the broad factors of political economy. Analysis and policy limited to economic factors is inherently incompetent. Mathematical models can make the figures line up in perfect order, but such models are of Never-Never land economies. They have never existed and never will.

  Regulation that is an alternative to market mechanisms is never the answer to any economic problem. It is always at best just an approach for handling otherwise intractable problems. Such economic regulation is always operating behind the power curve of changes in market conditions and the market adjustments made in response to the regulations themselves. Regulatory "visible hands" are forever active, and unfortunately tend towards increased regulatory elaboration and complexity that may materially reduce regulatory benefits over time. Whole volumes can be written about such difficulties.

Financial oligarchs:

  Wealth and power in the financial sector have increased beyond any economic reason, Scott points out. This is far beyond the growth of wealth and power in the productive and distributive sectors.
 &

Mathematical modeling simply can't deal with these markets and their human participants where events are humanly determined rather than randomly or physically determined, the author accurately points out. There is no substitute for human relationships and trust in a complex financial and commercial system. These relationships cannot be replaced by market mechanisms because they are perhaps the most essential mechanisms that determine market effectiveness and efficiency.

  The fragmentation of political power hinders any appropriate response. 

  "[Even] 2 years after it first emerged, there has been no serious inquiry into why [the Credit Crunch] occurred. Any such inquiry was bound to be embarrassing for U.S. leaders in business, government, and academia, and especially for those who had sponsored the notion of self-regulating markets while in position of regulatory responsibility, thus providing a rationale for their own passivity in high office in time of crisis."

  Responses to the crisis have been more than just problematic. The Federal Reserve has extended its lawful and implied powers far beyond tested practices - now including the extension of credit to non-banking institutions, the acceptance of subprime assets as collateral - and the extension of an implied moral hazard credit market subsidy broadly to major economic and financial institutions. The author reviews the now familiar excesses in the housing and mortgage and other related securities markets. The financial system was stripped of regulatory safeguards. The "insurance mechanism" of default swaps was totally unregulated and without reserve requirements.
 &
  Mathematical modeling simply can't deal with these markets and their human participants where events are humanly determined rather than randomly or physically determined, the author accurately points out. There is no substitute for human relationships and trust in a complex financial and commercial system. These relationships cannot be replaced by market mechanisms because they are perhaps the most essential mechanisms that determine market effectiveness and efficiency.
 &

Compensation systems based on short term results provided incentives to risk the whole firm for short term gains. With too-big-to-fail credit subsidies, major financial institutions were privatizing gains and socializing losses on a grand scale.

  Scott wisely leans on Paul Volcker for analysis of the Credit Crunch recession. Volcker explained the gross weaknesses of the pertinent policies.

  "Clever equations and mathematical models spread risk among borrowers and lenders who did not know each other, did not check up on their credit histories; the lenders simply focused on making transactions in order to collect the transaction fees prior to selling off the paper to third party. Even the investors buying up the borrowers' paper relied on numbers, in the form of third-party ratings from allegedly expert and neutral sources, to determine the quality of the paper. They all trusted the numbers, and had no reason therefore to have to trust the people behind them."

  Compensation systems based on short term results provided incentives to risk the whole corporation for short term gains. With too-big-to-fail credit subsidies, major financial corporations were privatizing gains and socializing losses on a grand scale.

  The financial system is a vital element of the nation's monetary system. A fiat monetary system does not regulate itself. Even a fractional reserve gold standard monetary system requires intense central bank and Treasury management to function properly. See, Eichengreen, "Golden Fetters," at section on "The Gold Standard." Financial regulation must be considered a necessary role of government, no matter how poorly it may occasionally fulfill that role.

An increasingly powerful financial sector created a financial "oligarchy" with influence powerful enough to subvert the regulatory apparatus.

 

Scott finds no evidence that the United States or its economy has realized any benefit from this transfer of wealth from the business and industrial sectors to finance. By the last decade, finance absorbed 41% of the nation's taxable "earnings," up from about 16% in the 1970s.

  Primary villains in the Credit Crunch crisis were Congress and the Federal Reserve which dismantled regulatory safeguards, refused to regulate as the bubble grew, and supported the implicit too-big-to-fail credit subsidy. Reliance on debt after 1980 more than doubled - especially to finance homes and other consumption items rather than for government and business. This leverage increased the earnings and influence of the financial sector. An increasingly powerful financial sector created a financial "oligarchy" with influence powerful enough to subvert the regulatory apparatus. 

  Top management of Fannie Mae and Freddie Mac - privately owned government sponsored financial firms with a public purpose - were among the most active and influential financial leaders in dismantling market and regulatory safeguards. See, Morgenson & Rosner, "Reckless Endangerment," analyzing the responsibility of the top management of Fannie Mae and Freddie Mac and their Congressional allies for the boom and bust of the housing and mortgage markets. See, Johnson & Kwak, "13 Bankers: The Wall Street Takeover and the Next Financial Meltdown," analyzing the responsibility of the mega banks. See, also, Understanding the Credit Crunch and Moral Hazard & Conflicts of Interest in Credit Crunch.

  Scott finds no evidence that the United States or its economy has realized any benefit from this transfer of wealth from the business and industrial sectors to finance. By the last decade, finance absorbed 41% of the nation's taxable "earnings," up from about 16% in the 1970s.

  "Was the financial sector creating value added for the U.S. economy, or was it mostly transferring income form Main Street to Wall Street while creating huge risks for society as a whole? Was this an important enough question to study, or was this the kind of question that must not be studied to avoid potentially contentious issues?"

  Can an economy that is highly reliant on debt capital, especially an economy managed along Keynesian lines, avoid massive growth of the financial sector with corresponding growth of financial power and political and economic influence? Doesn't the tax code and chronic price inflation dictate vast expansion of debt and the financial sector?

The power of the financial oligarchs must be broken - by the federal government - like that of the robber barons of a century ago - to permit the appropriate reorientation of the system and limitation of the power of the financial sector.

  The financial oligarchy today obstructs development and implementation of needed regulatory reforms, the author points out. Their power must be broken - by the federal government - like that of the robber barons of a century ago - to permit the appropriate reorientation of the system and limitation of the power of the financial sector.

  Scott is clearly correct. Moral hazard too-big-to-fail credit subsidies undermine the market system. Given the rapidity of change and the rigidity of regulatory responses, there can be no adequate regulation of the financial system as long as its major firms remain "too-big-to-fail." As pointed out in "Market disciplinary mechanisms and administered alternatives," above, the "shadow banking system" has already grown to massive proportions sufficient to generate serious risks for the financial system and a new cast of financial entities achieving too-big-to-fail status. Moreover, the costs and constraints of Dodd-Frank regulations threaten to overwhelm smaller banks, force even more consolidation and reduce small business access to credit.
 &
  For those FUTURECASTS readers who haven't as yet guessed, FUTURECASTS is inherently skeptical of regulatory schemes intended as administered alternatives to market mechanisms. However, as FUTURECASTS has repeatedly pointed out, the right to fail is absolutely as important for a properly functioning capitalist market as the right to succeed. There is, of course, real need for the risk management services of investment bankers. However, any institution that is deemed too-big-to-fail must be either broken up or regulated heavily in the nature of a public utility. They must have considerably higher capital requirements than smaller financial entities, and must be forbidden high risk business plans. It would even be wise to impose higher fees on these entities to cover the extensive costs of the regulatory apparatus they require.
 &
  Such costs would easily be covered by the massive benefits of the too-big-to-fail credit subsidies. If management nevertheless finds this regulation too expensive and confining, maybe that will be incentive for voluntary downsizing so their firms are no longer too-big-to-fail. Personnel who want to pursue the rewards possible for success in such high risk activities should create or move to smaller financial entities that are not too-big-to-fail, or should once again conduct such activities as partnerships with all their personal wealth at risk.

Constitutional constraints:

 

 

 

 

 

&

  Legal Realists believe that federal economic powers are unduly constrained by legal standards judicially established by reference to the common law and Constitutional principles. Legal Realists argue that rapid economic and societal change requires a more responsive judicial approach. They recognize that any judicial philosophy has major economic and societal impacts that cannot in any manner be considered neutral. They believe that desired changes in the economic system should come through legislation essentially unhindered by Constitutional constraints, and by court decisions if the changes cannot be achieved through legislation.
 &

Legal Realism has facilitated the establishment of welfare state programs and an economic system closer to the European model.

  Since 1937, federal powers to regulate interstate commerce have been radically expanded by "Realist" Supreme Court decisions. Liberals believe these decisions sufficient to free federal economic regulatory powers from Constitutional constraint. Federal government oversight is permitted not just to facilitate market mechanisms but to "protect the national common from a corporate free-for-all." Legal Realism has facilitated the establishment of welfare state programs and an economic system closer to the European model. 

  At present, the outcome of this transformation does not look propitious. Politicians as expected vie for public favor by promising ever greater benefits from an insolvent public treasury - a situation currently also plaguing many European nations.

  These disputes concern the fundamental nature of the legal system. They are all the stuff of political economy, and they must be analyzed as such. "For want of a clear recognition of capitalism as a system of economic governance, public discourse was impoverished and a distorted ideological view of capitalism as natural law came to prevail." Legal philosophy itself should be evaluated and suitably revised.

  Of course, by recognizing the judiciary as an active political decision-making arm of government, Judicial Realism has also inevitably politicized judicial appointments and elections - much to the chagrin of those who favor Legal Realism. The constraints of a rule of law system have been reduced to mere "politics by other means." By accepting a considerably broadened economic role for the federal government, it has also loosed the inherent ineptness of government economic administration not just in individual states, but from sea to shining sea.
 &
  Legal Realism offers no "limiting principle" for federal economic power and thus changes without the bother of formal amendment the intent of the Constitution to limit federal economic powers. The Supreme Court has just recently shrunk from accepting this view - also much to the chagrin of the Legal Realism advocates. However, it would take just one additional liberal appointment on the Supreme Court for Legal Realism to triumph even on this point.
 &
  Governments and courts in the U.S. had in fact had remarkable success in facilitating market mechanisms prior to the New Deal. Unless Congress passed specific regulations favoring administered alternatives to market mechanisms, the courts would not do that for them. To a substantial extent, the Court affirmed this approach and continued to approach issues of economic regulation in this manner even after the New Deal. The "Realist" Court accepted explicit regulatory initiatives, but with respect to antitrust and commercial law, interpreted the authorizing statutes as predominantly designed to facilitate market disciplinary mechanisms.
 &
  The most effective political interventions continue to be those that facilitate market mechanisms and strengthen market disciplines. There were several of these during the New Deal period. The least effective have been those that substituted administered alternatives for market mechanisms or disabled market disciplinary mechanisms for favored interests. As set forth in "Market disciplinary mechanisms and administered alternatives," above, a host of political interventions that disabled vital market mechanisms lay at the heart of the housing and mortgage securities boom and bust of the recent Credit Crunch recession  - but the politically neutered markets still took most of the blame.
 &
  The apparent "primacy" of the judicial branch in shaping the laws is discussed by the author. This primacy is supported by the widespread confidence that judicial interpretation will indeed comport with legislative and Constitutional intent and can more precisely shape laws to meet particular circumstances by dealing with those circumstances as they arise. Except for Constitutional rulings, legislatures are always free to alter judicial results, and have in fact acted to alter them in numerous instances.
 &
  In recognition of the special character of Constitutional rulings, the Court frequently refused to get to Constitutional questions unless they were essential to resolve a case. Liberal courts discarded this prudent practice with results that as a practical matter removed some highly contentious issues - like abortion - from political resolution. In the process, they have created sometimes outraged disenfranchised segments of the electorate.
 &
  The politicization of the courts also brings into question the rule of law itself, as new judicial appointments inevitably shift rulings back and forth with shifting political winds. The law becomes ephemeral - something built on shifting sands - like much of the "criminal law revolution" of the Warren Court. Fortunately, such turmoil has not spread beyond a few ideologically fraught issues.

Stakeholder capitalism:

 

 

&

  Scott's personal view is that "stakeholder" capitalism should displace the narrow focus on "shareholder" capitalism in the broader interests of society. He provides a compelling critique of the massive weaknesses of the corporate model. These weaknesses extend far beyond the conflict of agent and owner interests discussed by Smith and epitomized by the widespread aligning of options compensation with management interests rather than shareholder interests or the broader interests of the firm.
 &

A market system neutered by government policies favoring powerful financial interests can hardly be expected to balance optimism with pessimism, ambition with caution, greed with fear, to generate prudent management.

 

The excesses and failings of stock options compensation based on short term results are thoroughly explained by Scott. "It was a 'one way only' upside system to favor a privileged few."

  The excesses and foibles of corporate management since the age of the robber barons are covered at length by the author. He correctly points out that powerful economic actors continue to exercise inordinate and sometimes destructive influence over government economic policy.
 &
  The disabling of market disciplinary mechanisms and regulatory disclosure requirements at the behest of corporate interests fatally undermined market regulatory structures leading to the recent housing and related mortgage securities boom and bust. A market system neutered by government policies favoring powerful financial interests can hardly be expected to balance optimism with pessimism, ambition with caution, greed with fear, to generate prudent entrepreneurial management. As the author points out, it was a prescription for financial instability and chaos. (See, "Financial oligarchs," above.)
 &
  The excesses and failings of stock options compensation based on short term results are thoroughly explained by Scott. "It was a 'one way only' upside system to favor a privileged few." He recognizes that the nation's dysfunctional tax system provided powerful incentives in favor of stock option compensation. The practical effect was to greatly increase the attractiveness of the highly risky business models that could achieve elevated short term gains. He deplores the ominous growth of economic leverage. (He does not mention in this case that increased leverage is an inevitable result of the Federal Reserve's monetary policies and the tax advantages bestowed on debt financing.)
 &

As in the 19th century, the private sector has overcome government to gain the right to profit without being held accountable for the results of its behavior."

 

The view of this book is that economic governance should be "a balancing of the empowerment of firms to earn a decent return and the regulation of their behavior in the interests of other societal stakeholders."

  The extension of taxpayer credit guarantees to major "too big to fail" business entities is "a silent U.S. repudiation of private-sector responsibility for results as the quid-pro-quo for the right to earn and keep the profits in a capitalist system, and notably in the financial sector. As in the 19th century, the private sector has overcome government to gain the right to profit without being held accountable for the results of its behavior."
 &
  Thus, the view of this book is that economic governance should be "a balancing of the empowerment of firms to earn a decent return and the regulation of their behavior in the interests of other societal stakeholders."
 &
  That "reform" often involves major noxious unintended consequences is acknowledged by the author. He deplores the unintended consequences of the "well intentioned but na´ve" liberal political and educational reforms of the 1960s and 1970s. (See, "Industrial policy," below.) He candidly recognizes the costs, including slower economic growth and some loss of economic efficiency. However, he does not go into the likely unintended consequences of stakeholder capitalism, the entitlement welfare state and the economic regulatory state that he favors.

  A nation with a massive chronic balance of payments deficit cannot adopt an economic strategy that intentionally reduces economic efficiency and competitiveness.

  When corporations become agencies for achieving political and social objectives, they will logically expect protection from the rigors of competition - as occurred in regulated industries like airlines, trucking and telecommunications prior to their deregulation. Indeed, Scott favors the economic policies of the 1960s and 1970s prior to deregulation.

  The author totally ignores the dysfunctional state of the 1970s economy that was the natural result of those policies. The liberal criticism of the deregulatory policies of the 1980s based on the lack of growth of median incomes between 1980 and 2010 is unfortunately accepted uncritically by Scott. Aside from ignoring the dubious starting and ending dates of this argument, it ignores the substantial increases in purchasing power of median incomes due to the increase in economic productivity and the rapid technological advance of a healthy economy. Did the median income family of 1980 enjoy as many computers, i-phones, i-pads, i-pods as that of 2010? Were their household implements as varied and as good? Was the Chevrolet car of 1980 as good as that of 2010? On average, did the incomes of those who entered the middle class in 1980 rise often substantially within the middle class by 2010? Scott accepts a similar misuse of income statistics for average worker incomes in the 1920s.

The regulatory framework will have to reduce competition enough to give firms sufficient pricing power to generate "rents" that can be divided up amongst the various "stakeholder" interests. Since markets without competition lack all disciplinary function, administered alternatives of great sophistication will be required.

  Scott thus deplores the rigors imposed by competitive markets that have often forced downsizing, divesting, outsourcing and similar decisions harmful to established "stakeholders." He labels deregulation, shareholder capitalism and stock option compensation as "the toxic trio," without distinguishing between regulations designed to facilitate market mechanisms and those designed to impose administered alternatives. He complains that the disconnect between the "stakeholder" capitalism of much of the rest of the world and the "shareholder" capitalism of the U.S. "is not taken as evidence that the United States is out of step with the world but, rather, that the world is out of step with the United States."
 &
  Stakeholder capitalism will necessarily involve a regulatory effort of impressive complexity, the author bluntly acknowledges. The regulatory framework will have to reduce competition enough to give firms sufficient pricing power to generate "rents" that can be divided up amongst the various "stakeholder" interests. Since markets without competition lack all disciplinary function, administered alternatives of great sophistication will be required.
 &

"The principals who authorize charters are the governments and ultimately legislators who act on behalf of society, and the behavior of firms should be expected to recognize that broader mandate."

  Liberal reform of the combined political and economic system will require extraordinary legal and regulatory changes, the author candidly recognizes. Desired changes include Constitutional amendments - like that for direct election of Senators almost a century ago. Amendments are needed to establish desired campaign finance reforms to establish that only natural persons can make political contributions and to introduce mandatory voting requirements as an obligation of citizenship. As with so many societal reformers, he targets the next generation. School curricula should focus on the obligations of citizenship that should accompany and support these stakeholder rights. 

  Children must learn to accept a high tax, slow growth economy whose major industries perform like the current health care industry and that make the middle class increasingly dependent on government subsidies and their attendant regulations. An education system so hamstrung by teachers unions and ideological policies that it cannot even adequately teach literacy and numeracy and ordinary civics is to be harnessed to instruct students to appreciate a vast, politicized economic system.

  Scott sums up his recommendation for reform of corporate governance.

  "U.S. capitalism needs to be modified to recognize that the power of a corporation comes from society and not from the shareholders. Corporations must acknowledge these responsibilities explicitly. To do so would imply that it most certainly is not the mandate of the firm, nor of its senior managers, to use the powers conferred upon the firm to enrich a tiny few on the pretext that such behavior is in the interests of the shareholders, alleged to be the 'principals.' The principals who authorize charters are the governments and ultimately legislators who act on behalf of society, and the behavior of firms should be expected to recognize that broader mandate."

  Moreover, as Scott candidly concedes, this is just the beginning of the social, political, institutional and economic reforms required to create the system of capitalist governance that he advocates. "How these policy goals can be achieved without dulling the incentive structure of society is a much more subtle question, and one beyond the scope of this book." (Indeed!)

  The introduction of a substantial increase in political economic influence and nebulous stakeholder rights heightens litigation risks, complexity and rigidity during an age of accelerating change when only flexibility can prosper. Ultimately, Scott wants federal power to extend so that the entire corporate business community can be enlisted in the effort to achieve various aspects of the liberal agenda.
 &
  Whatever the limits of competition as a guiding and disciplinary market mechanism, no administered alternative has ever come close to matching it in flexibility, efficiency, and productive focus - and in enhancing the broader interests of society - as proven by the deregulation of industries like the airlines, trucking and telecommunications.  As always, administered alternatives will prove inflexible, grossly inefficient, inadequate, and themselves not free from private and political influence and corruption. Firms that are "too big to fail" will be joined by those deemed "too important to fail," with the same noxious results. Indeed, there is no end to the regulatory responses required once administered alternatives to market mechanisms are introduced.
 &
  Fannie Mae and Freddie Mac, after all, were privately owned government sponsored corporations with public stakeholder purposes. They are precisely the kinds of corporations favored by advocates of stakeholder capitalism. Yet their politically connected management, too, was not free from the natural conflicts of interest between agents and their many public "stakeholders." Political actors, too, can abuse the system. There is not a single American financial oligarch who caused as much economic and financial damage and more thoroughly corrupted Congress and the federal and many state governments during the 1990s as the top management of Fannie Mae. See, Morgenson & Rosner, "Reckless Endangerment." Yet, more than four years since their collapse, there is still no political interest in examining the role of these noxious government sponsored enterprises in the Credit Crunch collapse or in winding them up .
 &
  The Federal Reserve, too, was created as a private financial firm with a public purpose, somewhat like the Bank of England. It has repeatedly pursued the electoral interests of political incumbents at great cost to public and national interests. Even Paul Volcker, as Scott acknowledges, felt impelled to interrupt his essential monetary austerity efforts during the 1980 election period. In its century of existence and responsibility for the nation's monetary system, the Fed has presided over a dollar devaluation of approximately 95% and the nation has experienced extraordinary economic and financial turmoil.
 &
  The railroads declined precipitously during the first half of the 20th century under the burdens of their stakeholder obligations and regulatory requirements. The maritime industry was literally driven offshore by its stakeholder obligations and regulatory requirements. Today, the post office staggers under its stakeholder obligations and the rigidity of its Congressional oversight.
 &
    It is this contest between the advocates of the entitlement welfare state with stakeholder corporate management and those supporting market disciplines, shareholder oriented corporate management and maintenance of the Constitutional limits on the economic role of the federal government that will determine the nature of capitalism in the U.S. during these next decades. Scott's emphasis on the broader factors of political economy is thus absolutely essential for any valid understanding of the modern capitalist market economic system and its prospects. Any analysis limited to economic factors or mathematical analysis is inherently incompetent.

Tilting the markets:

  Factors that tilt the playing fields in the political and economic markets are of especial concern to Scott. He goes at length into several of these factors - some emanating from the economic sector and some from the political sector.
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The breadth of civil society and the extent of its legal, political and economic empowerment must be included in any analysis of economic development and market functions. How effective are the mechanisms by which the public can hold government to account? How should government mobilize economic resources to achieve public purposes?

 

Japan, Korea, Singapore and Taiwan are used by Scott as examples of successful neo-mercantilist export forcing strategy for initial economic development.

  It is through the "visible hand" of government that nations seek to address some of the problems of the tilted political and economic playing fields. Evaluating the quality of governance - public, private and societal - is an essential element in economic analysis, and Scott dedicates hundreds of pages to the topic. The breadth of civil society and the extent of its legal, political and economic empowerment must be included in any analysis of economic development and market functions. How effective are the mechanisms by which the public can hold government to account? How should government mobilize economic resources to achieve public purposes?
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  The legal system has tilted U.S. markets in various directions during different phases of economic development. During the 19th century, the legal system favored producer interests over labor or consumer interests, among others. During the first half of the 20th century, legislation shifted the legal system in favor of labor. The last half of the 20th century saw a major tilt in favor of consumer interests (as well as environmental and labor health and safety interests). These were clearly "visible hand" choices imposed on the markets. They are the stuff of political economy.
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  Scott views "Washington Consensus" and "neo-mercantilist" policies as examples of modern economic strategies that currently tilt market economies in different countries. He discusses the possibility of raising employee interests in relation to shareholder interests as a way to combat increasing inequality. (A playing field tilted in favor of labor turned out to be a matter of life and death for several heavily unionized industries, most recently including the auto industry.)
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  Japan, Korea, Singapore and Taiwan are used by Scott as examples of successful neo-mercantilist export forcing strategy for initial economic development. On the other hand, for neo-mercantilist import substitution strategies and the economic strategies associated with a "resource bonanza" such as oil or gold, or some individual product like wool, coffee, rubber or palm oil, there are many pitfalls. 
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The 20th century examples involved a social bargain sufficient to gain support for wage restraint. Typically, taxpayer credit subsidies were used to enhance growth prospects for favored industries. Labor and consumer interests are initially sacrificed to accelerate economic growth with the understanding that this will ultimately enhance labor and consumer interests. Scott provides considerable detail. 

  A successful economic development strategy that the author terms "enhanced mobilization" is used as an example. He recognizes that there are "necessary preconditions" for success. These conditions include the standard fare of "good governance" such as capitalist markets, property rights, at least some trade liberalization, infrastructure, rule of law, responsible fiscal and monetary policies. However, Scott adds to this list an extensive program of government industrial and financial policy designed to achieve government and societal goals.
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  He traces the origins of enhanced mobilization strategies
back to the economic strategies of Venice, the Netherlands of the 16th and 17th centuries, Great Britain by the end of the 17th century, Alexander Hamilton during the first years of the United States, and U.S. state strategies that favored producer interests. Examples during the 20th century come from Sweden from 1905, Germany after WW-II and again after reunification, the Netherlands and Australia since 1980, Ireland since 1990.
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  In all these 20th century instances, strategies designed for the national interest instead of just the interests of elites were adopted in response to national emergencies. The 20th century examples involved a social bargain sufficient to gain support for wage restraint. Typically, credit subsidies were used to enhance growth prospects for favored industries. Labor and consumer interests were initially sacrificed to accelerate economic growth with the understanding that this will ultimately enhance labor and consumer interests. Scott provides considerable detail.
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  The strategy involved a daunting degree of financial and industrial policy engineering that not every government is likely to get technically right or successfully shelter from corrupt practices, but Scott offers many examples of success. The Asian Tigers - Japan, Korea, Taiwan and Singapore - and more recently, China and Malaysia, adopted similar strategies.
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Some of the favored industries are subject to the harsh disciplines of competitive export markets, but others fatten in uncompetitive domestic markets.

 

"Solidaristic" wage policies and agreements bring industrial peace, enhanced profitability and economic growth without international payments problems. They promote "medium-term performance through coordinated action," but are not "necessarily right for the long term."

  Inevitably, influential elites are primary beneficiaries, but the trickle down of wider benefits grow to a considerable extent. Some of the favored industries are subject to the harsh disciplines of competitive export markets, but others fatten in uncompetitive domestic markets. Generally, the strategy has been justified by some sense of national crisis often involving market failure or outside threat sufficient to gain broad public support.
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  Repeatedly, it has taken the harsh realities of market failure to convince labor organizations of the necessity of labor market flexibility and the moderation of wage and benefit demands. (A similar process was recently at work in the General Motors and Chrysler bailout arrangements.) "Solidaristic" wage policies and agreements bring industrial peace, enhanced profitability and economic growth without international payments problems. They promote "medium-term performance through coordinated action," but are not "necessarily right for the long term."

  "[In] each case, these agreements tilted the market frameworks for policy-based reasons to favor capital relative to labor, not to level an imaginary playing field. In each case we looked at, this meant lower wage growth -- or outright wage reductions -- in order to improve the profit share in national income. Other employer friendly changes, such as more flexible employment contracts -- in the Netherlands -- and greater management autonomy -- in Sweden  -- were also featured. By enhancing the returns to capital, negotiated wage restraint sought to establish a 'high investment, high productivity,' virtuous circle."

  Enhanced mobilization is a form of the much maligned "trickle down" economic approach, and provides substantial proof that it can indeed work. The change in terminology may be essential to satisfy the dictates of political correctness. Efforts along these lines are now being initiated in the insolvent European PIGS nations.

  Most of the Tiger and other East Asian growth economies achieved similar wage restraint results by repressing unions and by initially taking advantage of the flow of labor out of the agricultural sector. Again, benefits could be described as eventually "trickling down." As full employment was achieved, wages rose, and improved education permitted an economic "virtuous circle" movement to higher value-added activities.

  After first massively favoring its elites, China is now in the wage growth phase of its trickle down policies.

  The political context of development in these instances was single party and authoritarian, the social context initially egalitarian. The financial context included extensive controls and government credit subsidies to direct flows to favored industries at below-market interest rates. "As the invested capital per worker in the developing country begins to approach the levels existing in developed countries, it becomes a natural time to phase out such a strategy."
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There is always considerable risk of politicization, waste and corruption of the strategy.

  These national strategies generate problems over time due to the rigidity of government decision making and the inability to properly respond to changing political, technological and economic conditions. Scott explains the trouble that eventually overtook Sweden. (Problems related to the Credit Crunch in Ireland came after the period covered by this book.) He provides considerable detail about the various versions of "enhanced mobilization" strategy. There is always considerable risk of politicization, waste and corruption of the strategy. Scott points out that the development of canals and railroads in 19th century U.S. also involved considerable politicization, waste and corruption, but at least in the U.S. the infrastructure was still enormously beneficial to the entire economy.
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Financial manipulation has resulted in many instances of substantial financial and economic distortions including the spectacular busting of the financial bubble in Japan in 1990 and in the U.S. in 2000 (and again in 2008 involving much of Europe as well).

 

Import substitution strategies perform well only so long as creditors or foreign aid finances deficits. Demagoguery, corruption and patron-client systems typically afflict them.

  In its financial form, as enhanced financial mobilization, there have been repeated failures to adjust adequately to the rapidly changing circumstances of financial markets. Financial manipulation has resulted in many instances of substantial financial and economic distortions including the spectacular busting of the financial bubble in Japan in 1990 and in the U.S. in 2000 (and again in 2008 involving much of Europe as well). In Japan and Korea, economic contraction resulted in a piling up of bad loans, politicization of lending and business decisions, and maintenance of "zombie" corporations. Well over a trillion dollars worth of loans have had to be written off in Japan since 1990, and the entire economy stagnated for over a decade.
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  Despite such instances of mismanagement, politicization, corruption and abandonment of the strategy, the author asserts that, overall, "most of the sustained high-growth strategies of the post-World War II era have been of the Enhanced Mobilization sort, and a source of remarkable success for decades at a time." However, after successful development, failure to shift to a more market-directed system can create pervasive economic distortions and dangerous financial bubbles.
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  For governments with import substitution strategies,
there is a tar-baby effect where each effort to fix problems inevitably creates more problems in a spiral of unmanageable complexity. These strategies perform well only so long as creditors or foreign aid finances deficits. Demagoguery, corruption and patron-client systems typically afflict them. Export forcing strategies have done considerably better because many of the favored industries remain subject to the disciplinary forces of harshly competitive international markets.

  "All in all, one of the great weaknesses of the import substitution strategy is that it seems to be easy, almost painless. Strategies that are seemingly easy to implement are not very demanding upon government to implement, and, unless conditions are demanding, governments are not likely to rise to the occasion." (This description could apply just as easily to Keynesian economic policies.)

Success with Washington Consensus development strategy has been limited to countries that were already "close to the technological and organizational frontiers."

 

Neoclassical economics "is simply a very incomplete model of an economy, and especially of one that has the imperfect institutions so characteristic of developing countries."

  Washington Consensus development strategy also has major problems. In essence, Scott points out, it was originally limited to economic factors - an inherently incompetent approach. It has not been "a well-trodden route to wealth." Success has been limited to countries that were already "close to the technological and organizational frontiers."
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  Originally it was an easily administered strategy and "a great improvement" over the failed mercantilist and Keynesian strategies that it displaced. It was later revised to include a host of political economy factors but remained a "one-size-fits-all" permanent strategy. It still ignored social, political and administrative obstacles existing in many developing countries. 

  "The Washington Consensus implicitly assumed that the countries in trouble had sound institutional foundations, such as sophisticated legal systems and competent bureaucracies. The program also underestimated the ability of elite, entrenched interests to stymie the reform process. When these omissions became apparent, the Washington Consensus was 'augmented' to an almost unending list of policy prescriptions, including legal/political reforms, regulatory reforms, reduction of corruption, labor market flexibility, financial codes and standards, 'prudent' capital account opening, and social safety nets. At the same time, it had little to say on the adequacy of public goods and services provided by the state, such as education, sanitation, highways, and law enforcement, all of which required both competency and financial capacities for government. And, instead of having a single goal of growth, the consensus grew to encompass goals such as sustainable development, egalitarian development -- and poverty reduction --, and democratic development. In essence, the augmented list recommended that developing countries try to mimic the institutions and policies of the developed countries, but without much provision for finding the managerial capabilities to do so or the financing to make them affordable."

  The Washington Consensus has yet to take into account "the inevitable antagonistic side of the relationship between capitalism and democracy." Impoverished electorates will not accept the sacrifices needed to implement economic reforms, especially if their privileged elites find shelter from those sacrifices. Neoclassical economics "is simply a very incomplete model of an economy, and especially of one that has the imperfect institutions so characteristic of developing countries."
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The problem of "systemic distortions due to oligarchy seems to be completely missing" from standard economic theory.

  The existence of powerful privileged elites is a primary problem of political economy. Such elites block needed political and administrative reforms that might disadvantage them. "Indeed, they are often prepared to corrupt the system if necessary to stymie such reforms, as they did in the U.S. South prior to the 1960s and continue to do so in the Mezzogiorno."
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  The problem of "systemic distortions due to oligarchy seems to be completely missing" from standard economic theory. It is not just a simplistic problem of income inequality, however. It involves analysis of the robustness or fragility of political and social institutions and their susceptibility to dominance or corruption by powerful elites.
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  Capitalism naturally tends to create unequal outcomes, some of which result in great differences in wealth and economic power. Great wealth can also provide inordinate political influence. The lobbying efforts of industrial and financial giants can provide them with major competitive advantages.
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  On the other side, political power can be used to force businesses to provide political support. Patrons can gain support by the grant or withholding of benefits. The power of incumbency dwarfs all other influences that tilt political markets and can be used to greatly influence economic markets. The "natural resource curse" has become notorious for its pernicious impacts in both domains.
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  Evaluation of the legitimacy of the income inequality of the superrich involves the difficult task of distinguishing between those who have earned their status and those who have obtained it by corruption or abuse of position. Should extraordinary income levels "be prima facie grounds for suspicion?"

  Scott is obviously correct, here. In the real world, there are no such things as level playing fields in either the political or economic markets. The analysis of capitalism or democracy in isolation as ideal or perfect processes is highly unrealistic and will always lead to highly unrealistic results. Any analysis of not just economic development but of also capitalist economic performance and the business cycle must take such interrelationships into account. It must extend broadly across the many factors of political economy, especially including the impacts of government economic policies and political and private regulatory frameworks.

Industrial policy:

 

&

  The fear of centralized power that shaped the Constitution and federal economic policy for the first 140 years of the nation's history is epitomized by the demise of the Second National Bank when Pres. Andrew Jackson blocked renewal of its charter.
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  Scott speculates that a central bank acting as lender of last resort and an instrument of national economic influence might have prevented the economic contractions that afflicted the nation in the 1840s, 1870s and 1907. Private competition led to periods of over-expansion of the railroads and other new industrial giants. This was followed inevitably by periods of economic contraction and enhanced creative destruction.
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  The author indicates that much of this could have been avoided by government planning. He views favorably the consolidation of the steel industry under the influence of J. P. Morgan. He assumes that government influenced development would have had fewer mishaps and more egalitarian results.

  The deregulation of monopoly and oligopoly communications and transportation services in the 1970s and 1980s proved that "ruinous competition" provides vastly superior and more efficient services despite the wastage during major bankruptcies.
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  The execution of government industrial policy initiatives always appears easier in the contemplation of na´ve academics than it turns out to be in practice. There are precious few administrations in the century after the demise of the Second Bank that could have been confidently entrusted with the "guidance" of the nation's economic development, and NONE that would have performed competently.
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  The New Deal made the effort and had several notable successes with sometimes elegant regulatory responses to governance problems, most of which like the disclosure approach to securities regulation were designed to facilitate market disciplinary mechanisms. One administered alternative, bank deposit insurance, was hailed as a great success by Milton Friedman, but the weaknesses of such moral hazard credit guarantees became increasingly evident as Congress and the Fed typically simply couldn't restrain their tendencies to extend taxpayer credit subsidies far beyond the original narrow limits. The policy simply could not be successfully scaled up.
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  Most New Deal industrial and monetary policies were immediate unmitigated disasters that materially worsened and lengthened the Great Depression. See, Blatt, "Understanding the Great Depression and the Modern Business Cycle," at Ch. IX, "The Heedless Young Giant," Table of Contents and Introduction, and Meltzer, "The History of Federal Reserve," Vol. I (1913-1951), Part III: The Engine of Inflation (1933-1951)"  Government sponsored economic entities generally depend on monopoly status or other types of protection from market competition and/or extensive public subsidies to survive. They are always easy targets for capture for political purposes and abuse for private profit. Only in the realm of natural resource development - such as hydroelectric power - did the New Deal achieve any arguable success.
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  Government regulations that are administered alternatives to market mechanisms frequently inhibit competition and inevitably favor the oligopolies that are big enough to deal with - and influence - government regulation.  The postal service is a modern example of a heavily regulated economic entity with a public purpose too rigid to adequately respond to changing conditions.
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  Keynesian interventions gave us the Keynesian inflationary morass of the 1970s. Now the Keynesians are back for another effort to destroy the American economy.
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  "Waste, fraud and abuse" has been increasingly notorious during the half century of increasing government dominance of health care. Government housing policy with its manipulation of regulatory requirements and weakening of lending standards played a major role in the wasteful and corrupt housing bubble of the recent Credit Crunch recession. Scott's "Enhanced Mobilization" examples of guided economic development (see, "Tilting the markets," above) certainly didn't include egalitarian objectives.
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  The Federal Reserve System has been a lender of last resort and an increasingly politicized central bank for a century. It played a role in the onset of the Great Depression, is always the agency primarily responsible for periods of chronic price inflation such as during the 1970s, and played a prominent role in generating the financial bubbles of the Credit Crunch recession. Booms and busts in new technologies continue with not the slightest indication of government ability to evaluate appropriate scope and speed of development.
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  Lender of last resort and financial regulatory roles are certainly needed, however poorly a central bank may occasionally exercise those basic roles, but as an instrument of "state-led industrial development" picking winners and losers and determining scope of economic activities, such central banks become precisely what the founding fathers and ratifying citizens intended that the Constitution should prevent.

The hazard of unintended consequences is geographically limited for state policy initiatives. However, at the federal level, the hazard applies from sea to shining sea.

  Unintended consequences are an inherent hazard of government policy initiatives. The hazard is geographically limited for state policy initiatives. However, at the federal level, the hazard applies from sea to shining sea. Scott discusses at some length examples from changes in the social and political "markets" in the last half century that are somewhat related to the economic market changes. Indeed, he emphasizes several of the destructive unintended consequences.
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  Government policy interventions in nondiscrimination law and education during the 1960s and 1970s had noxious impacts on educational standards and resulted in the concentration of the black underclass in urban ghettos, the author ruefully points out. The Congressional reforms of the 1970s that were designed to open up and democratize the legislative process instead transferred power away from legislative leaders. The chief beneficiaries were the lobbyists and the powerful special and ideological interests instead of the people.

  Politics have thus become increasingly frozen in partisan conflict about the basic nature of the federal government. As the federal government has undertaken more societal and welfare tasks, its public approval rating has (unsurprisingly) plummeted along with voter participation.
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  The typically "one-size-fits-all" character of federal government interventions cannot help but produce ludicrous results and noxious unintended consequences. The inherent ineptness of government managerial capabilities becomes painfully evident. The vast sums involved inevitably attract the ethically challenged, which the bureaucracy has little capacity to constrain. See, Government Futurecast, at Part II, "Government Management."

Abuse of the commons:

  Mitigating "the tragedy of the commons" is a vital political and institutional role emphasized by the author.
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Prevention of the degradation of commons assets can only be done through government.

 

"Abuse of the common is an ever-present temptation that comes with economic freedom. Effective use of a commercial common, as well as its effective protection from abuse, depends upon the maintenance of an effective system of economic governance, and, for all practical purposes, today that means governance through a capitalist system headed by a legitimate political authority."

  He uses the term "commons" broadly to encompass not just tangible assets but intangible assets as well, like defense, law, and the institutions of capitalism and democracy themselves. Prevention of the degradation of such assets can only be done through government.

  "Simply put, a legitimate political authority employing coercive force indirectly through politico-economic institutions ensures that such abuse is limited or perhaps non-existent."

  Currently, the degradation of fisheries provides a classic example of the tragedy of the commons in a still largely informal economic market of the type Milton Friedman described. Atmospheric pollution provides another example.

  However, a large part of the environmental abuse of the 19th and early 20th centuries was due to political and judicial decisions to limit riparian rights and nuisance laws. The political market almost invariably has to wrestle with unintended consequences and, as Scott notes, is subject to influence by elites and is hardly infallible.

  Market frameworks themselves are an intangible "common" that can be - and have been - and even today are being - subject to abuse. The framework for goods and services markets grew naturally from common practices in addition to the laws, infrastructure and physical security that facilitate the markets. However, factor markets, involving land, labor, technologies and capital, required far more political and institutional input. Serfs and slaves had to be freed from feudal obligations, corporate entities had to be accorded legal status. These developments occurred much earlier in some nations than in others, and sometimes required violent change. In some nations, even today, these changes remain partial at best.

  "While excessive regulation has stifled many economies for long periods, inadequate regulation is also a threat to effective decentralized decision-making throughout the global common. Abuse of the common is an ever-present temptation that comes with economic freedom. Effective use of a commercial common, as well as its effective protection from abuse, depends upon the maintenance of an effective system of economic governance, and, for all practical purposes, today that means governance through a capitalist system headed by a legitimate political authority."

  Abuse of the commons, in all its manifestations, remains a vexing problem that can only be addressed in the realm of political economy.

Government enterprises:

 Government ownership of economic entities and government sponsorship or control of the policies of privately owned enterprises create conflicts of interest that as a practical matter become irresistible. 
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"The government may indirectly contribute to others' abuse by allowing those economic actors with greater economic or political power to influence its own agents and thereby shape the institutions and markets of capitalism to their private advantage."

  The regulatory and tax framework will always be biased in favor of the government entities.

  Fannie Mae and Freddy Mac are the most recent and dramatic examples of this bias - and of the budget costs that these non-budget activities can accrue. The same thing will most assuredly occur with respect to any "public health insurance option." Private "competition" is routinely destroyed by taxpayer benefits and regulatory advantages for government owned or sponsored entities. Such "competition" becomes a joke as the government entity uses its taxpayer benefits to take over or dominate the entire market. Already, Congress is aggressively loading up private health insurers with  mandates, regulations and tax burdens that will doom them in favor of a public "option."

  Scott thus advises caution in establishing government economic entities or in government takeover of private entities. Exceptions for public utilities and during periods of national emergency are recognized.

  "If direct interventions are widespread and/or last indefinitely, they invite corruption and the distortion of market frameworks for the benefit of the few at the expense of society as a whole. In a second, more passive form of abuse, the government may indirectly contribute to others' abuse by allowing those economic actors with greater economic or political power to influence its own agents and thereby shape the institutions and markets of capitalism to their private advantage." (Indeed!)

  This in fact occurred with Fannie Mae and Freddie Mac as they used their implied credit subsidies to dominate their markets. They became cash cows funneling millions into the campaign funds of incumbent politicians. Party favorites were routinely given the highest management positions and munificent pay packets. These abuses were notorious and were the frequent subject of articles in the financial press, but the politicians did nothing to disturb their cash cows. Now the taxpayer is on the hook for hundreds of billions of dollars, and the politicians pretend innocence and shocked amazement as to what has occurred. See, Morgenson & Rosner, "Reckless Endangerment."

Competition in the political market:

  Government actions inevitably "tilt" the markets towards politically influential groups. The tilt may be explicit and/or implicit. Indeed, there will always be a combination of impacts, and they will not always be consistent.
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Governments thus shape capitalist systems, fulfilling their political "entrepreneurial" role to - at best - achieve societal goals or - at worst - favor the politically influential. There is frequently a mix of both in market reform efforts.

  Among the broad categories of people vying for political favor are capital and labor, investors and creditors, producers and consumers. Promotion of growth and development may vie with protection of the status quo. Different levels of risk may be accepted or rejected. Responsibilities are allocated. Government decisions inevitably favor certain interests over others.
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  The author explains that government "strategies" may be implicit or explicit, broadly or narrowly focused. They typically are developed and applied over time and are the work of numerous people and groups, acting usually in a haphazard sequence of action rather than according to some grand plan. Government strategy can be influenced by outside groups through campaign funding and lobbying.

  Business groups, for example, routinely engage in "managed" litigation. They settle unattractive cases while waiting for attractive cases to take to appellate levels to establish favorable legal rules.

  The market for land is a primary example. This market is shaped by zoning laws and laws governing property rights. Both zoning laws and property rights can be changed by pertinent officials as societal priorities change.
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  Different strategies lead to different outcomes.
The author contrasts the different strategies in the EU and the U.S. concerning gasoline and pharmaceuticals.
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  Higher taxes in the EU make its gasoline considerably more expensive. Although both the EU and the U.S. favor increased fuel efficiency, Europe's market oriented tax policy has been far more effective than the administered U.S. alternative of imposed regulatory requirements. The U.S. permits patent monopoly pricing for patent drugs while almost all other nations enforce price controls at lower price levels. Thus, the U.S. market subsidizes drug research for the whole world. The world is free-riding on the U.S. market. Since much of this extra cost is borne by employers, U.S. producers are at a competitive disadvantage.
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  The quintessential capitalist example is the way governments distribute risks and rewards amongst creditors and investors, corporations and individuals. Corporations, with their rights and risks, are creatures of the law. Foreclosure rights and creditors rights are also creatures of the law.
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  Governments thus shape capitalist systems, fulfilling their political "entrepreneurial" role to - at best - achieve societal goals or - at worst - favor the politically influential. There is frequentlly a mix of both in market reform efforts.

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