Economics Books » Financial Crisis

The best books on A New Capitalism

recommended by Anatole Kaletsky

Capitalism 4.0 by Anatole Kaletsky

Capitalism 4.0
by Anatole Kaletsky


We need to build an entirely new market system, not just patch up the old one, says economics commentator Anatole Kaletsky. He picks the best books to help us think about what form a new capitalism might take.

Capitalism 4.0 by Anatole Kaletsky

Capitalism 4.0
by Anatole Kaletsky

Buy all books

Let’s take a step back from the latest stage of the financial crisis which is playing out in the eurozone, and take a longer view of what has happened over the last five years. How will economic historians write about the financial crisis in 50 years’ time?

This crisis is going to be viewed as the fourth historic transition that capitalism has gone through since the modern market economy was created in the late 18th century. The argument that I make in my book on the crisis – perhaps one of the few predictions in it that has been fully realised – is that this was not just another financial boom and bust, nor a crisis in one particular country or one part of economy. This was, and still is, a crisis of the entire global economy of a kind that has only happened three times before.

I compare this crisis with the great inflation of the late 1960s and 1970s, which created a completely new form of capitalism – Thatcherism and Reaganomics were totally different from the Keynesian social democracy they replaced. The previous systemic transformation started with the Russian Revolution and culminated with the Great Depression. This also created a new form of capitalism, almost unrecognisable from the classical capitalism of the 19th century. And the systemic crisis before that was the one that created liberal capitalism in the first place – the American and French revolutions that broke down agrarian aristocratic economies and established the market-oriented capitalist globalisation that Marx so vividly described.

So in my view this is the fourth systemic crisis of capitalism, and it’s going to give rise to a new kind of capitalist system. One still based on private property, competition and profits, but fundamentally distinct from the classic capitalism of the 19th century – from the government-led Keynesian economics of the postwar period, and from the Reagan and Thatcher market fundamentalism of the last 30 years.

Is it a natural and unavoidable characteristic of capitalism to have gone through such crises? And what is the new capitalism that you believe will emerge from this financial crisis going to look like?

Any market economy is intrinsically prone to financial crisis. But the humdrum, routine financial crises that happen every five or 10 years are not ones that transform the system as a whole. Only rarely – maybe once every generation or two – do these financial bubbles mutate into systemic crises that transform the entire political economy. That is how 2007 and 2008 turned out. This was not inevitable, or completely evident at the time. The US housing and financial bubble was actually quite modest by historic standards, and Lehman was only a medium-sized bank that would not qualify on any reasonable definition of “too big to fail”. But with every month that passes, it is becoming clearer that the global political economy has been permanently changed and the pre-Lehman structures – not only in finance but also in politics, and even in economic theory – can never be the same.

“This was not just another financial boom and bust. This was, and still is, a crisis of the entire global economy of a kind that has only happened three times before.”

What will this new political economy be? Well, I can tell you what forces and ideas will shape it, but not exactly how it will turn out. Each of the previous transformations of capitalism have been about the relationship between politics and economics, between governments and markets – between decision-making on the basis of one-man-one-vote and one-dollar-one-vote. In the classical capitalism of the 19th century, politics and economics were essentially separate spheres. After the Russian Revolution and Great Depression, the markets were perceived to have failed and huge power was transferred to the political sphere. In the 1970s, the world came to the opposite conclusion: Government was the problem and the market was always right. In the last decade this was taken to its logical conclusion and beyond, which is what made this crisis much worse than previous bubbles. The checks and balances on market forces had been dismantled, and there were no safety nets when the global banking system went over a cliff. A safety net was patched together after Lehman, but by that time it was too late.

The next phase of capitalism will involve a new balance between government and markets – something different both from the market fundamentalism that failed in 2008 and from the overweening government that failed in the 1970s. To put it another way, in the 1930s the world discovered that markets made disastrous mistakes. Forty years later, we learned that governments made disastrous mistakes. Now, after another 40 years, we have learned that markets and governments can both make disastrous mistakes. This sounds terribly depressing and paralysing, but actually it can be empowering, because whatever makes mistakes can be improved, and now we can demand improvements and reform in both politics and previously unquestionable markets.

How exactly these reforms will work, one can only speculate – as I do in the second half of my book, for about 200 pages. But I am no prophet, and predictions of this kind rarely work. Even the greatest books on political economy and history, all the way back to Marx or even Plato, analyse brilliantly what is going on but generally fail to predict what comes next. They see the forces shaping the future, but not the way it will turn out.

Despite the devastating impact of the financial crisis for many, there doesn’t seem to be huge popular support either in Europe or the US for greater government intervention in the economy.

That’s right. What my book got most wrong was the idea that after the crisis, societies would quickly recognise the need for truly fundamental reform. Instead, the first reaction has been to try to rebuild the old system and implement the rules that have already failed, with some superficial changes such as financial regulation. That’s not going to work, and over the next decade we are going to see much deeper changes. But looking back at the previous systemic crises, this process takes much longer than I suggested. It took 15 years from the Russian Revolution to the New Deal. In the inflation crisis, it took 12 years from 1968 until the elections of Thatcher and Reagan. So I was overoptimistic in suggesting that the pre-crisis market fundamentalist system would be quickly abandoned, and a new system would rise phoenix-like from its ashes. But that is where we’re heading.

You’re right that there is no groundswell of popular demand today for a new relationship between government and markets, except in specific areas like financial regulation, which I regard as almost irrelevant. But there is a tremendous disillusionment with politics as it stands. In my view, the main reason for this disillusionment is that political leaders in America and Europe are not presenting the public with a vision for a new kind of capitalism. They are talking about simply patching up and fixing the old system that failed. If you try to build a new and better world, you can create political support. But if you say “let’s patch up the old world so that it doesn’t fail quite so catastrophically,” that is a less inspiring vision – and one for which people will not make efforts or sacrifice.

Let’s get stuck into your books. First up we have John Kay’s The Truth About Markets, published in 2004. So, does it tell the truth about markets?

Yes. I think it’s a very profound book of permanent truths about markets. It’s not just about the dotcom bubble in 2000, which prompted Kay to write it. Reading it 10 years later, it seems incredibly prescient about the bursting of the Lehman bubble, which of course hadn’t even formed when Kay wrote this.

The book shows why markets inevitably cause repeated financial crises, and why a pure market system can never avoid disruptive booms and busts. But more profoundly, it’s about whether a market system can become an all-embracing mechanism for all social interactions, largely replacing politics and government, or whether markets can only operate when they are embedded into very specific political structures, which require quite powerful governments.

The example that he gives – which is the clincher for the whole book – is that the purest profit-oriented market systems that exist anywhere are in countries like Haiti or Somalia after a complete breakdown of government. Such failed states are pure market systems, in the sense that decisions are driven solely by the economic motivation to acquire wealth. Kay shows, with a brilliant command both of theory and of historical examples, that without a political structure around them, market systems have not just been unsuccessful but catastrophic.

It’s a very readable book. He goes off to interesting places around the world and looks at how different markets work.

Kay is very good on a broad, philosophical level, and even better at illustrating these abstractions with very concrete – and often amusing – examples. For instance, he compares two farm workers, in Switzerland and in India. They both work just as hard, they both have the same access to knowledge through the Internet, and they even use much the same tools. Yet one farmer’s productivity is about 100 times greater than the other. That’s because of the different social structures – politics, education, environment, transport and so on – in which they operate.

John Kay has written a review of UK equity markets for the government. In both this and his more recent book Obliquity, he examines the obsession company executives have with share price and shareholder returns, and argues that in the cases of Enron and ICI [Imperial Chemical Industries] this had very negative – or catastrophic – implications. Do you agree?

One of his strongest arguments is that desirable objectives are often achieved not by aiming for them directly but through indirect means. He quotes the ultimate utilitarian, John Stuart Mill, who concluded at the end of his life that the way for humans to achieve happiness is not simply to aim to maximise happiness – as that is hedonism and is not going to make you happy – but by trying to live a more socially useful life. Kay relates this to the shareholder capitalist system, saying that companies which focus on solely maximising profits or earnings per share rarely actually achieve it. The purpose of the market system, he points out, is not to maximise profits but to produce goods and services that satisfy human needs and wants. Profits are a tool for achieving those objectives, a by-product of fulfilling human needs. If you view profits as the main objective, you will ultimately fail to create products and services that satisfy people, and so, because of the very logic of the market system, you will eventually lose your profits.

Kay explains particularly clearly two crucial areas where simplistic faith in markets tends to produce perverse results. One is financial markets – they trade predictions about the future but the future is intrinsically uncertain. It is impossible, even in theory, to rely on supposedly “rational” financial trading to produce socially desirable results, because there is no reliable knowledge about the future for market traders to be rational about. The other area of unavoidable market failure, which also relates to the future, is in very long-term investment. Markets on their own are unlikely to make appropriate decisions on very long-term investments, for instance in energy infrastructure or drug development, because the pay-off for these investments is so long term and uncertain that no rational investor managing a portfolio for a pension fund could legitimately allocate vast amounts to bets on possible outcomes that are 40 or 50 years into the future.

This is one of the key reasons why markets alone can never be the sole decision-making mechanism in a society that wants to achieve technological progress. Even though most of the economic decisions in a successful capitalist society should be made by markets, there will always be crucial exceptions, often involving uncertainty about the future.

The economist Paul Seabright is fascinated by human cooperation and its evolution. Please tell us more about this book.

This book probes a layer deeper into the mystery John Kay describes – that successful markets and economic structures, driven by rivalry and competition, can only exist in basically cooperative societies. Competition only produces economic success when it’s conducted within clearly defined bounds, and in creating those bounds, cooperation dominates over competition. The question that Seabright raises is how the strong biological drive to compete – in many cases violently and ruthlessly – can coexist with the cooperation that makes competitive societies successful.

He gives the amusing example of taking a taxi in a strange city. Why do you believe the driver will take you to your destination instead of following the instinct bred into him through millions of years of evolution to steal your food and possessions? And when he does bring you to your destination, why do you hand over your fare instead of simply getting out of the taxi and running away? This is not just about fear of law enforcement – you could claim to the police that you had already paid the taxi driver and he was trying to rob you – and if necessary you could bribe the policeman with half the fare you would otherwise have paid. So what is it about human biology that has made us trusting and cooperative, as well as competitive?

Seabright engages in some fascinating speculations on anthropology and biology. He posits a form of “group selection” – natural selection operating within entire societies rather than individuals, a concept very controversial among biologists and anthropologists. Without our delving deeply into the issues, his economic arguments illuminate some of the fundamental paradoxes and mysteries of why the market system works.

I believe a new edition of his book has been published to include a chapter on the financial crisis. What does he tell us about it?

He concludes that the crisis marks a serious challenge to the way societies were organised before the crisis. His conclusion – which is quite pessimistic – is that over millions of years humans have evolved to operate quite successfully in limited and well-defined groups. But we’re now moving into a world where the social group that is relevant to the future success, maybe even survival, of humanity is no longer a tribe, a city or a nation. It is the world as a whole.

Once humanity is operating on a global level, people have to cooperate on a far broader scale, and the mechanisms for cooperation which have evolved over thousands of years may break down. He gives the financial crisis and the inability of nation states to control it as one example of this breakdown. Others are climate change, nuclear proliferation, energy depletion and environmental destruction. These are all global challenges for which cooperative social mechanisms have not had time to evolve.

Let’s turn to your next choice, which studies the moral limits of the markets – although it does strike me as rather naïve to expect morality to play any role in Wall Street and the City of London. Do tell us more.

I actually brought this book into the discussion as an example of exactly what you just said – so much of the debate on the aftermath of the crisis has been extremely naïve. I think this is quite a superficial book, which purports to deal with some of the profound paradoxes of markets that we have just talked about, but doesn’t do it all. Yet of all the books on my list, this one has attracted by far the largest attention. This illustrates what we discussed at the beginning – that despite the magnitude of the crisis that started in 2007, our societies and intellectual leaders have not been ready to seriously confront the flaws in the market system.

This book gives a laundry list of examples where markets overreached and led to clearly unacceptable moral outcomes – for example, selling babies or human organs. But these are just superficial pimples on the deep structure of the market economy, a structure which Sandel doesn’t really penetrate. Although he talks about the way that markets have eliminated morality and social awareness from public life, or fragmented and atomised society, he doesn’t even refer to the really serious work on these issues that started more than 150 years ago with Karl Marx.

Sandel and his many enthusiastic reviewers seem only just to have discovered that market forces tend to dissolve social bonds and ethical values. But this is exactly what Marx wrote, with infinitely more power and prescience, in the famous passage in the Communist Manifesto about the “uninterrupted disturbance of all social conditions” by what he called the “fetishism of commodities” operating at a global level: “All fixed relations are swept away, all that is solid melts into air, all that is holy is profaned.”

Why did you choose Larry Siedentop’s Democracy in Europe, written in 2000?

On the one hand it’s very relevant to what is going on in Europe right now, and on the other it illustrates the need to create new systems, rather than trying to rebuild the political and economic structures that have obviously failed.

Everybody now recognises that the euro can only survive as part of a political project to create a new federal Europe. This was the point that many of us who were Eurosceptics were making in the early 1990s. It was also the point made by true europhiles back then too. [The former president of the European Commission] Jacques Delors, the most prominent among them, always described the euro, when he invented it, as the most decisive step towards political union. But for the next 20 years, the connection between currency union and political union was disregarded as an issue for the long-distant future. Well, we’ve now reached the historical crossroads where Europe must decide: Does it become a political federation and keep the euro? Or does it remain a community of independent sovereign states, in which case the euro has to be abandoned?

Get the weekly Five Books newsletter

Larry Siedentop, who wrote this book 10 years ago, gives a clear account of what the necessary conditions for creating a successful European federation would be, but he also argues that the political hurdles are too high for a successful federation in the foreseeable future. He points out that the most important condition for a successful nation state is a sense of demos – a sense of community among the people who are going to be jointly ruled. His view, at least back in 2000, was that Europe was decades away from creating the sense of community and mutual solidarity that nationhood required. Unfortunately for Europe, the moment for decision has arrived much faster, partly as a result of the financial crisis. If it hadn’t been for [the collapse of] Lehman Brothers in 2008, Europe could probably have muddled on with this incomplete euro project for another 10 or 15 years. But that is no longer an option, and Europe has to decide.

Siedentop’s book identifies the two essential issues. First, the sense of mutual solidarity which is so obviously absent in the present arguments over whether German taxpayers should support Greece or Spain. And the second issue is that even if a sense of solidarity exists, there must also be a philosophy of government. The problem Siedentop identifies very clearly is that the two crucial European nations – France and Germany – have philosophies of government that are almost diametrically opposed. So even if there were a sense of common demos in Europe – and I personally think Europe could create this in response to the euro crisis – creating a United States of Europe would face another huge obstacle: Would the new federation be run along French or German lines?

Your final pick challenges the assumption that markets act mechanically and economic change is fully predictable. Please tell us more.

This book has had a very big impact on the economics profession since it was published 18 months ago, and justifiably so. It takes apart in a detailed and academic way – without being too technical – the economic assumptions which are at the root of all the issues discussed by all the other authors I have picked.

Take Europe, which we have just been discussing. The biggest mistake Germany is now making is trying to build the future of Europe on an outdated economic theory. Namely, the doctrine that monetary management must be – and can be – completely separated from politics. This is expressed by Merkel’s quasi-religious obsession with “protecting the political independence” of the European Central Bank. This doctrine is founded on an intellectual revolution that occurred in academic economics in the 1970s – to put it in tabloid terms, the victory of monetarism over Keynesian economics. This was a revolution based on two key phrases: “Efficient markets” and “rational expectations”.

The idea was that if you had markets that were efficient and competitive – if there was no cheating or insider trading, and if all traders behaved rationally in their own self-interest – not only would this system create profitable businesses, but it would also create a national or global economy that was automatically self-stabilising. In contrast to the Keynesian view, a fully deregulated and competitive economy would need no government intervention to moderate business cycles and ensure full employment. The only role for the central banks would be to focus on inflation and keep prices stable – the market would take care of everything else.

This “neo-classical” monetarist economic theory, which claimed to refute the conclusions of Keynesian economics, was absolutely fundamental to the political transformation that occurred from 1979 onwards with Thatcherism and Reaganomics. All the slogans – “You can’t buck the market”, “The market is always right”, “Government shouldn’t pick winners” – ultimately came back to the theories of efficient markets and rational expectations. Frydman and Goldberg demolish that theory in a more fundamental way than anybody has done since Keynes.

The main new element they bring to the demolition of neo-classical theory is uncertainty, and the impossibility of perfect knowledge. If you go back to the roots of the monetarist revolution in the 1970s, you find that all its conclusions depend on the assumption that profit-motivated individuals operating in free and competitive markets will make the best possible decisions about the allocation of resources. Frydman and Goldberg explain that this claim of optimal decisions by the markets is simply untrue, unless we also assume that perfect knowledge of reality is possible, at least in theory – and not just about the present, but about the forces shaping the future. If such perfect knowledge does not exist, even in theory, then the claims about self-stabilising markets at root of most economic policy since the early 1980s are false. And if perfect knowledge did exist, then ironically Communist central planning would work as well as a market system. All you would need is a computer large enough to take into account all this knowledge, and it would be able to plan the economy.

The reason you need markets is precisely because it’s impossible to know what the future will hold. Therefore, markets are a system of experimentation – and they will only work properly if non-market decisions, made by regulators and ultimately by politicians, set some bounds within which market prices can be allowed to freely fluctuate. This is a very important and profound insight which will ultimately undermine not just the structure of academic economics, but also the way in which people think about the relationship between markets and government.

So if we have imperfect knowledge the markets will sometimes behave incorrectly, and the role of government is to curb their excesses?

That’s right. What this analysis emphasises is that the very idea of perfect, efficient markets is logically incoherent. The problem lies not in any particular imperfection – like insider trading, or lack of competition – but in the fact that markets process information that is too complex to be judged as right or wrong, and must make predictions about the future which can never be objectively predicted, even in terms of probabilities. This means that booms and busts that appear irrational with hindsight are usually quite rational at the time – a point I also make in my book. Moreover, there is nothing irrational or undesirable about financial speculation. Speculation is a necessary part of competitive markets. If you eliminate speculation completely, you get the dead world of Soviet central planning.

Price volatility and financial speculation are necessary features of the market system. But politics needs to step in, to prevent this volatility and speculation from getting too far out of hand. It was not greed and irrationality that turned the routine financial bubble of the last decade into a global disaster. It was the quasi-religious belief among politicians that “the market is always right”. This market fundamentalist doctrine rested on academic theories that took economics by storm in the 1980s. Frydman and Goldberg show that these theories were not just empirically false and dangerous in political practice – they were logically incoherent too.

December 24, 2009

Five Books aims to keep its book recommendations and interviews up to date. If you are the interviewee and would like to update your choice of books (or even just what you say about them) please email us at [email protected]

Support Five Books

Five Books interviews are expensive to produce. If you've enjoyed this interview, please support us by .

Anatole Kaletsky

Anatole Kaletsky

Anatole Kaletsky is one of the UK's leading commentators on economics. Until March 2012 he was Editor at Large at The Times, where he has written a weekly column on economics and government since joining as economics editor in 1990. In June 2012 he joins Reuters as a columnist. Kaletsky is also a co-founder of economic consulting firm GaveKal. His book Capitalism 4.0 was published in 2010

Anatole Kaletsky

Anatole Kaletsky

Anatole Kaletsky is one of the UK's leading commentators on economics. Until March 2012 he was Editor at Large at The Times, where he has written a weekly column on economics and government since joining as economics editor in 1990. In June 2012 he joins Reuters as a columnist. Kaletsky is also a co-founder of economic consulting firm GaveKal. His book Capitalism 4.0 was published in 2010