The Third Pillar: How Markets and the State are Leaving Communities Behind. Raghuram Rajan

and creative destruction of the free market. What the cartels called waste was in fact the constant experimentation fostered by the market, energized by competition. In a sense, the magnates of the late-nineteenth-century Gilded Age in the United States wanted to restore the aristocracy, where they decided what was best for the public, but without the explicit responsibilities of the feudal manor.

      In many ways, Rockefeller’s personal life was exemplary. He lived in the Gilded Age but was not of it. In the latter part of his life, he did take public responsibility seriously, figuring out how to spend his enormous fortune on the well-being of society. Among the extraordinarily successful institutions he founded are the University of Chicago, where I teach. His dismal view of competition had less resonance with Adam Smith, though, than with another insightful economist, Karl Marx.

      THE MARXIST RESPONSE

      The Industrial Revolution that started in Britain in the late eighteenth century created tremendous new possibilities as well as widespread despair. I have already referred to workers displaced by new machines like the power loom. In addition, though, the promise of new technologies, as well as new lands, especially in the Americas, made accessible by railways and the steamship, prompted waves of euphoria fuelled by finance. The business cycle, with its production booms and busts, emerged in many industrialising countries, as did the financial cycle, with sustained booms in lending and euphoric rises in land and stock prices, followed by crashes. In the United States, there were serious financial panics about once every twenty years between 1819 and the start of the Great Depression in 1929. Among these were the Long Depression, a series of global downturns between 1873 and 1896, bookended by financial crises. The seventy years or so of relative financial calm between the bank failures of the Great Depression and the Global Financial Crisis in 2007–2008 were an aberration, not the norm.

      Barring a few at the top of the societal pyramid, people in preindustrial times had experienced collective poverty. While industrialisation, transmitted through the competitive market, lifted average living standards steadily over generations, what was also new was great dispersion in incomes across society at any particular point in time, and great volatility over time. The market offered bountiful rewards and merciless punishment, which was both its greatest economic strength and its greatest political weakness. Economic security, not physical security, was now the primary public concern in industrialising countries.

      Karl Marx was wrong in some ways, especially in his economic theories, but he was one of the greatest social thinkers of modern times. He recognised that society adapts to, and is therefore shaped, by the underlying production technologies of the time. ‘The hand mill gives you society with the feudal lord; the steam mill society with the industrial capitalist,’ he wrote.17 Subsistence agriculture bred feudal arrangements, while industrialisation and machines facilitated capitalistic corporations run by the emerging bourgeoisie. The technology of production did not fully determine the nature of society, of course, but Marx was right in that it was influential.

      Unlike Rockefeller, who wanted capital to be left alone to create its mon-opolies, or utopian socialists like Robert Owen who, touched by the plight of the worker, called for a responsible, sharing, capitalism, Marx and his long time coauthor, Frederick Engels, were convinced that capitalism itself was fundamentally flawed and would collapse because of its own contradictions. Moreover, instead of appealing to the social conscience of the elite, Marx wanted to eliminate them. He believed that it was both morally right and economically beneficial for property to be commonly owned. Marxists did not look for crumbs off the capitalist’s table, they wanted the whole table itself to belong to those they thought were its rightful owners, the community of workers.

      In their view, the industrialist exploited the worker through his ownership of the fixed plant and equipment of the factory, its capital, which was also why capitalism contained the seeds of its eventual downfall. Marx believed labour was the source of all value, and the only reason the industrialist made a profit was because the industrialist’s ownership of the means of production gave him bargaining power over workers. Any worker could go off on her own and become self-employed, but without the machines she would be unproductive. The industrialist would pay her a better wage than the self-employment alternative, but less than the value she produced for him. The difference between the value she produced working for the industrialist and her wage was the surplus value accruing to the industrialist, the source of his profits.

      The more unemployed workers there were – the so-called reserve army, set adrift as enclosures rendered agricultural labour redundant and better machines rendered industrial workers redundant – the lower would be the employed worker’s alternative options, her bargaining power, and hence her wage. The industrialist’s profits would rise. By emphasising labour as the only source of value, Marx was wrong, but not out of line with economic thinkers of his time. This theorising also meant that all profits ought morally to belong to labour, and the profits accruing to the industrialist were mere exploitation, made possible by his property rights over capital.

      But Marx went further to say that the capitalist structure of ownership was economically unsound, and the world should change for this reason only, even if it was not convinced by the moral argument. Essentially, competition would force the profit accumulated by the industrialist to be reinvested in yet more productive machines, forcing more workers out of the labour force, pushing wages further down. Crises, where product prices collapsed and industrial losses exploded, could arise for a variety of reasons. Along the lines of Rockefeller’s thinking, it could stem from the myopic greed or irrational exuberance of industrialists, pushing to get a greater share of the market, and ending up overinvesting and overproducing. It could arise when overindebted industrialists, pressed by bankers to repay, dumped their excess inventory and machines on the market. Most important, it could arise because the true source of industrial profits was appropriating the surplus value of labour. As the quantity of labour fell relative to accumulated capital machinery, Marx believed it was inevitable that the rate of profit would also fall, and hence the susceptibility of the system to accidents and crises would rise. A more modern version would be that as labour’s wages were squeezed, the ability of workers as consumers to buy what was produced would fall, leading to overproduction and crises.18

      When crisis hit, the Rockefellers of the industrial world would buy up failing competitors, close them down and fire their workers, and eventually restore equilibrium between supply and demand, but with much distress for all. The collapse of capitalism was not inevitable – it might be stuck in perpetual torment. As the Russian revolutionary Leon Trotsky wrote, ‘capitalism does live by crises and booms, just as a human being lives by inhaling and exhaling. First there is a boom in industry, then a stoppage, next a crisis, followed by a stoppage in the crisis, then an improvement, another boom, another stoppage, and so on…. The fact that capitalism continues to oscillate cyclically … merely signifies that capitalism is not yet dead, that we are not dealing with a corpse. So long as capitalism is not overthrown by proletarian revolution, it will continue to live in cycles, swinging up and down. Crises and booms were inherent in capitalism at its very birth; they will accompany it to its grave.’19

      The Marxist solution to the problem – ending competition – resembled Rockefeller’s, except Marxists wanted to replace the monopolist capitalist with the dictatorship of the proletariat. Since they argued capital was essentially accumulated profit extracted by squeezing labour (or amassed from other dishonorable activities buried in a typical family enterprise’s past like smuggling, bootlegging, usury, war profiteering and outright theft), the capitalist should be expropriated. All property would be held by the state in the name of the working proletariat, and a centralised bureaucracy would make production decisions. As Frederick Engels wrote, ‘If the producers as such knew how much the consumers required, if they were to organise production, if they were to share it out amongst themselves, then the fluctuations of competition and its tendency to crisis would be impossible.’20

      Therefore, instead of the benevolent Rockefeller directing production and prices, it would be the benevolent revolutionary turned bureaucrat. Once again, what would prevent the benevolent from becoming self-interested?