Field Experiments in Human History
For many people, the collapse of one socialist regime after another in the late 1980s firmly established market capitalism as the superior system. Nevertheless, anti-capitalist resentment – sometimes latent, sometimes expressed openly – not only still persists in some quarters but has gained a lot of ground in the wake of the 2008 financial crisis. Policy makers, media commentators and intellectuals almost unanimously interpret the crisis as a failure of the market, or of the capitalist system, that can only be resolved by more government intervention.
This book was written as a response to these views and was driven by the worry that we are about to disown the foundations on which our economic prosperity is based. For many people, ‘capitalism’ is a dirty word. Although these negative connotations frequently date back to well before the financial crisis, the proponents of a genuinely free market increasingly find themselves on the receiving end of accusations of ‘market radicalism’.
A modern economy can be organized according to one of two basic principles. In the first scenario, there is no private ownership of land or means of production. Instead, all of these assets are owned by the state. Government agencies in charge of economic planning decide what and how much is manufactured. In the second scenario, the right to private ownership is guaranteed and entrepreneurs operate within a legal framework to manufacture products they believe consumers will want. The prices they are able to charge for their products serve as a measure of the extent to which their assumptions were right – in other words, the extent to which their supply of products was aligned to the consumers’ demand for these products. The first definition describes a socialist system, the second a capitalist one. Throughout this book, the latter term will be used to designate a genuinely free-market economy rather than a watered-down version sometimes defined as a ‘social’ or ‘eco-social’ market economy.
In reality, neither of the two systems exists today, or has ever existed, in a pure form. Even in socialist countries such as the German Democratic Republic (GDR), or even North Korea, some individuals did or do own private property, while the overarching economic plan has never completely suppressed all elements of the free market. Without these elements, the economies of the countries in question would have been even more dysfunctional. While prices nominally exist in socialist economies, the function they perform is radically different from their function in capitalist economies. In fact, they more closely resemble taxes, as the economist Zhang Weiying has noted.
In capitalist economies, on the other hand, a degree of both public ownership and regulatory intervention exists, while taxes essentially represent a system of redistribution that takes from the rich and gives to the middle classes and the poor. Sweden in the 1970s is an extreme example of this kind of redistribution, while the UK during the same period makes a sobering case study that shows the negative economic outcomes of disproportionate government intervention and proves that limiting such intervention is crucial to increasing prosperity.
None of the countries presented in this book operate a ‘pure’ form of capi-talism. In each case, the important issue is the proportion or balance between regulatory intervention and entrepreneurial freedom. The central argument proposed in this book is that increasing the proportion of capitalist elements in a given economy generally leads to more growth, which increases the well-being of a majority of people living within that economy. China’s development over the past few decades is a case in point.
Plenty of books seek to marshal theory in order to prove that either of the two economic systems is superior to the other. This is not one of them. Rather than approaching its subject from a theoretical angle, this book takes economic history as its starting point. Unlike socialism, capitalism is not a system invented by intellectuals. Instead, it has evolved organically over centuries, much in the same way in which plants and animals have evolved in nature and continue to do without requiring any centralized planning or theorizing. Among the economist and philosopher Friedrich August von Hayek’s most important insights is the realization that the origin of well-functioning institutions is to be found “not in contrivance or design, but in the survival of the successful”, with the selection process operating “by imitation of successful institutions and habits”.
The biggest error that unites socialists of various stripes with the men and women running the central banks is the belief that a few designated master planners are better able to determine what the people need than the millions of entrepreneurs, investors and consumers whose individual decisions, when added together, are in fact far superior to those of any governmental planning agency, central bank or other organ of state control.
This is why ‘top-down’ attempts to impose a market-based economy remain largely unsuccessful – although politicians will always need to be involved to some extent. A closer look at China will show that its successful transition towards capitalism was substantially due to the ‘bottom-up’ growth and widespread adoption of capitalist economic practices – none of which would have been possible without the top-down tolerance of such practices by political leaders such as Deng Xiaoping. Deng and his fellow reformers were smart enough not to invent a new system based on ideals. Instead, they did two things: firstly, rather than attempting to ban or rein in spontaneous developments across that vast country, they allowed them to evolve organically. Secondly, they took a hard look at many other countries to see what was working and what wasn’t – and then implemented this knowledge at home.
In this book, I take a similar approach: looking at what has worked and what hasn’t. I compare countries that invite comparison because they have a lot of shared history and culture: North and South Korea, the GDR and the Federal Republic of Germany, Venezuela and Chile. The book also shows how the advance of capitalism and the retreat of socialism turned China from a dirt-poor country, where tens of millions of people starved to death less than 60 years ago, into the world’s largest export nation, where famine has been eradicated. While left-wing critics of capitalism and globalization blame capitalism for causing hunger and poverty in various parts of the world, the recent history of the African continent furnishes plenty of examples to prove that the opposite is true: capitalism is not the problem but the solution. Capitalism has proved more effective at fighting poverty than financial aid. Studies show that the more market-oriented developing countries have a poverty rate of only 2.7%, compared to 41.5% in developing countries without a free market.
In general, more state intervention means lower, in some cases even negative, growth rates, while the recent economic history of the US and the UK provides compelling evidence that more capitalism leads to a faster increase in prosperity for the majority of people. In the 1980s, Ronald Reagan and Margaret Thatcher – two political leaders who firmly believed in the benefits of the free market – introduced reforms that reduced the influence of the state on the economy and significantly improved economic prospects in both countries. As the example of Sweden – discussed in Chapter 7 – shows, welfare-state programmes can sometimes stifle economic growth and need to be curtailed.
Over the past 70 years, these real-world experiments have consistently produced similar outcomes – overwhelming evidence pointing to the conclusion that more capitalism means greater prosperity. Still, in many quarters a remarkable reluctance or inability to learn from these outcomes persists. In his Lectures on the Philosophy of History, the German philosopher Georg Wilhelm Friedrich Hegel said: “But what experience and history teach is this, – that peoples and governments never have learned anything from history, or acted on principles deduced from it.”
Even if his verdict may be too harsh, it does seem that a majority of people are unable to abstract and draw general conclusions from historical experience. Despite the numerous examples of more capitalist economic policies leading to greater prosperity (some of which are discussed in this book, while others, such as India, are not) and the failure of every single variant of socialism that has ever been tested under real-world conditions, many people still refuse to learn the obvious lesson.
Following the collapse of the majority of socialist systems in the early 1990s, attempts to implement socialist ideals are still happening in various parts of the world in the vain hope that ‘this time’ the outcome will be different – most recently in Venezuela. Just as they were captivated by similar earlier experiments, many intellectuals across the Western world were enthralled by Hugo Chávez’s attempt to take socialism into the 21st century. As with previous large-scale socialist experiments, the consequences were disastrous, as shown in Chapter 6. Even in the US today, many young people cling to the ‘socialist’ dream – although the system they have in mind is an idealized and misguided version of Scandinavian-style socialism rather than Soviet-era communism. However, this book demonstrates that this variant, too, has been thoroughly discredited by its comprehensive failure in the 1970s and 1980s (Chapter 7).
I am not too worried about large-scale nationalization of assets and enter- prises sweeping across industrialized Western nations any time soon. Rather, what concerns me is the far greater and more immediate danger of a gradual curtailment of capitalism concomitant with an increase in states’ powers of planning and redistribution. Central banks are already acting as if they were planning authorities. Originally set up to guarantee the stability of monetary value, they now see themselves as engaged in the task of neutralizing market forces. By de facto abolishing market interest rates, the European Central Bank partially deactivated the pricing mechanism that is an essential feature of any functioning market economy. Rather than containing excessive public debt, this has only exacerbated the issue.
“The policy of keeping interest rates low over an extended period of time will increasingly distort asset prices and exacerbate the danger of another economic collapse followed by a financial crisis as soon as this policy is jettisoned,” the economist Thomas Mayer warns. It does not take a crystal ball to predict that these crises will be blamed on ‘capitalism’, even though they are in fact the result of a violation of capitalist principles. A wrong diagnosis inevitably leads to the wrong treatment being prescribed – in this case, even more governmental intervention in an even more weakened market.
Once upon a time, socialists simply used to nationalize commercial enterprises. Today, elements of a planned economy are introduced in other ways – increasing governmental intervention in commercial decision-making processes and a range of fiscal and regulatory measures, subsidies and legal restrictions that curtail the freedom of entrepreneurs. In this way, the German energy market has gradually been transformed into a planned economy.
This is possible only because many people are simply unaware – or have forgotten – that the free market is the foundation on which our current level of prosperity is based. This is particularly true of the millennial generation, whose only experience of the socialist regimes in the Soviet Union and other Eastern Bloc countries comes through history books, if at all. ‘Capitalism’ and ‘free market’ have become dirty words.
In a GlobeScan poll published in April 2011, respondents in a number of different countries were asked to rate the extent to which they agreed with the following statement: “The free enterprise system and free market economy is the best system on which to base the future of the world.” In the UK, which a mere 30 years earlier had been transformed from a desperate economic situation to more growth and prosperity thanks to Margaret Thatcher’s uncompromising free-market reforms, only 19% of respondents agreed strongly. Across Europe, these figures were highest in Germany, with 30% of respondents agreeing strongly. In France, many of whose problems are directly related to the population’s low opinion of the free market, this number dropped to only 6%.
It is reassuring to note that these percentages significantly increase if we include respondents who agreed “somewhat” with the proposition quoted above: 68% in Germany, 55% in the UK and 52% in Spain. In France, on the other hand, a whopping 57% of respondents expressed disagreement. In the US, the survey showed a drop in approval of the free-market system from 80% in 2002 to only 59% in 2011. Among lower-income tiers of society, this dropped again to 45%. The economist Samuel Gregg quotes these statistics in Becoming Europe, a book that serves as a dire warning to Americans against following the model of the European welfare states.
Younger generations of Americans in particular express a strong affinity with anti-capitalist ideas. A 2016 YouGov poll showed that 45% of Americans between the ages of 16 and 20 would consider voting for a socialist, while 20% would even give their vote to a communist candidate. Only 42% of Americans in that age bracket were in favour of a capitalist economy (compared to 64% of Americans over 65). Even more worryingly, in the same poll a third of young Americans revealed the belief that more people had been killed under the George W. Bush administration than under Stalin.9 In another poll conducted by Gallup in April 2016, 52% of Americans agreed that “our government should redistribute wealth by heavy taxes on the rich”.
In an Infratest dimap poll conducted in Germany in 2014, 61% of respondents agreed with the view that “we don’t live in a real democracy because the power lies with business interests rather than voters”. Moreover, 33% of Germans (41% in the former GDR) agreed that capitalism “inevitably causes poverty and starvation”, while 42% (59% in the former GDR) agreed that “socialism/ communism is a good idea that has been badly executed in the past”.
As the collapse of the socialist systems gradually retreats from living memory, many people across the Western world appear to be at risk of losing their awareness of the superior benefits of the free market. This is particularly true of younger people, whose history lessons barely touched on the economic and political conditions in socialist countries.
This book focuses on a single question: Which economic system delivers the greatest quality of life for a majority of people? Quality of life is determined, especially though not exclusively, by the individuals’ level of economic wealth and also by their level of political freedom. While history provides many examples of democracy and capitalism going hand in hand, there are other cases of authoritarian regimes with a capitalist economy: South Korea had yet to become a democracy at the time it adopted capitalism, as did Chile. For all its economic success as a capitalist economy, China is still governed by an authoritarian regime. Any comparisons drawn between countries in this book are based only on the criteria of their respective economic systems and economic performance. This is not to say that political freedom is a less important aspect of quality of life – however, it is beyond the scope of this book and would merit a separate investigation.
Much as I disagree with the premises of, and the arguments developed in, Thomas Piketty’s Capital in the Twenty-First Century, in many respects I do share his criticism of much current research in economics, which demonstrates a “childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences”. Instead, Piketty argues for “a pragmatic approach” that uses “the methods of historians, sociologists, and political scientists as well as economists” and describes his book as “a work of history [as much] as of economics”. My own first degree is in history and political science and I went on to obtain two PhDs, respectively in history and sociology. Accordingly, my approach in this book is that of a historian.
Piketty’s main complaint is that economics and social sciences no longer focus on the “distributional question”: “It is long past the time when we should have put the question of inequality back at the center of economic analysis.” Other authors have published comprehensive critiques of Piketty’s dataset and methodological errors, forcing him to retract some core tenets of his book. My objective here is merely to point out that I am asking a completely different question – one that, in my view, for the majority of people holds far greater significance than Piketty’s concern with “inequalities of wealth”. Whether capitalism tends to raise or lower the overall standard of living strikes me as far more important than any putative increase in the inequality of wealth.
Piketty bemoans a widening of the gap between the poor and the rich in terms of income and wealth in the period from 1990 to 2010. However, the fact is that during the same period hundreds of millions of people – predominantly in China as well as in India and other parts of the world – escaped from abject poverty as a direct result of the expansion of capitalism.
What is more important to these hundreds of millions of people – that they are no longer starving or that the wealth of multi-millionaires and billionaires may have increased to an even greater degree than their own standard of living? As the first chapter of this book will demonstrate, the increase in the number of millionaires and billionaires in China over the past decades and the massive improvements in the standard of living of hundreds of millions of people are two faces of the same coin. Both can be directly traced back to the same process, i.e. the transition from socialism to capitalism, from a planned towards a free-market economy.
Beyond any doubt, capitalist globalization has reduced poverty worldwide. Whether the rise of prosperity in previously underdeveloped countries has led to losses in prosperity among lower-income strata in industrialized nations in the West, i.e. Europe and the US, is a more controversial issue. Let me point out two things in response. First of all: if this is the case because lower-income earners are now directly competing with workers in emerging countries, it follows that – contrary to their self-styled role as defenders of the rights of the poor in countries across Africa, Asia and Latin America – the anti-cap- italist, anti-globalization movement in the West is primarily upholding the privileged status quo of Europeans and Americans. Secondly, the hypothesis that globalization has impoverished swathes of the population in Europe and the US is itself controversial. A 2011 study by the Organisation for Economic Co-operation and Development (OECD) showed a decrease in real incomes among the poorest 10% of the population since the 1980s in only two member states – Japan and Israel.
In many cases, media reports on the alarming rise of poverty in developed Western nations are based on studies that define and measure poverty in relative terms. The official reports on poverty and prosperity published by the German government, for example, apply a definition of poverty that includes anybody who earns less than 60% of the median income. A simple mental experiment shows this definition to be dubious at best: let’s assume an across-the-board tenfold increase in income while the value of money remains stable. Those in the lower income bracket who previously made 1,000 euros a month are now getting 10,000 euros. All their money worries would be over. Life would be great for everyone. Nonetheless, the 60% formula would still apply, and the number of people living below the official poverty line would remain the same.
For critics of capitalism of Piketty’s ilk, the economy is a zero-sum game in which the rich win what the middle classes and the poor lose. This isn’t how the market works, though. Critics of capitalism are always looking at how the pie is split; in this book, I am looking at the conditions that make the pie grow or shrink in size.
Here’s yet another mental experiment – I’ll leave it up to you to decide which of the following outcomes you’d prefer. Let’s assume you live on an island where three rich people have a fortune of 5,000 dollars each, while 1,000 others only have 100 dollars each. The total wealth of the island’s residents is 115,000 dollars. Now you decide between two alternatives: due to economic growth, the total wealth of the island’s residents doubles to 230,000 dollars. The wealth of the three rich people triples to 15,000 dollars each; they now own 45,000 dollars between them. Meanwhile, the wealth of the island’s remaining 1,000 residents grows by 85% to 185 dollars per capita. The inequality gap between the richest and the poorest residents has widened considerably.
In the alternative scenario, let’s take the total wealth of 115,000 dollars and split it evenly between all 1,003 residents – 114.66 dollars per capita. As one of the poor with a baseline wealth of 100 dollars, which of the two societies would you prefer – economic growth or equal distribution? And what would happen if, as a consequence of economic reforms aimed at creating greater equality, the island’s total wealth were to shrink to a paltry 80,000 dollars, or less than 79.80 dollars per capita?
Of course, you may well object that the best outcome would be economic growth and a higher general standard of living in tandem with greater equality. And that’s exactly what capitalism achieved in the 20th century, as even Piketty admits. The above mental experiment is still useful as a way of demonstrating a fundamental difference between two competing value systems. Somebody who prioritizes fighting inequality over raising the standard of living for the majority will make a different choice from somebody who believes the opposite. If you are primarily interested in equality, this is the wrong book for you.
If you care about identifying the conditions under which a majority of people are better off – if you believe it does matter whether a society as a whole is rich or poor – please join me on my journey through time across five continents in search of answers. Karl Marx was right in his assertion that the means of production (technology, equipment, organization of the production process etc.) and the conditions of production (the economic system) are not just inextricably linked but mutually dependent on each other. However, contrary to Marx’s contention, the crucial point is not that the development of the means of production precedes changes in the conditions of production. Much more importantly, changes in the conditions of production can sometimes cause the means of production to develop.
Capitalism is the root cause of a global increase in living standards on a scale unprecedented in human history before the emergence of the market economy. It took humanity 99.4% of its 2.5-million-year history to achieve a per-capita GDP of 90 international dollars about 15,000 years ago (the international dollar is a unit of calculation based on buying-power levels in 1990). It took another 0.59% of human history to double the global GDP to 180 international dollars in 1750. Between 1750 and 2000 – in a period that represents less than 0.01% of the total span of human history – the global per-capita GDP grew 37-fold to 6,600 international dollars. To put it differently, 97% of the total wealth created throughout human history was produced within those 250 years.22 Global life expectancy almost tripled in the same short period of time (in 1820, it was only 26 years). None of this happened because of a sudden increase in human intelligence or industry – it happened because the new economic system that emerged in Western countries about 200 years ago proved superior to any other before or since: capitalism. It was this system based on private property, entrepreneurship, fair pricing and competition that made the unprecedented economic and technological advances of the past 250 years possible – a system that, for all its successes, is still young and vulnerable.
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